##### Table of Contents









UNITED STATES SECURITIES AND EXCHANGE COMMISSION


Washington, D.C. 20549


FORM 10-Q


|                                             |  |                                                                                             
|-------------------------------------------- |  | --------------------------------------------------------------------------------------------
|þ                                            |  | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
    SECURITIES EXCHANGE ACT OF 1934 
|                                            
|For the Quarterly Period Ended June 30, 2006
|                                            
|OR                                          
|                                            
|o                                            |  | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
    SECURITIES EXCHANGE ACT OF 1934

For the Transition Period From

to


Commission file number: 000-30758


Nortel Networks Limited


(Exact name of registrant as specified in its charter)


|                                                                    |  |                                         
|------------------------------------------------------------------- |  | ----------------------------------------
|Canada                                                              |  | 62-12-62580                             
|(State or Other Jurisdiction of
     Incorporation or Organization) |  | (I.R.S. Employer
    Identification No.)

|                                                                  |  |           
|----------------------------------------------------------------- |  | ----------
|8200 Dixie Road, Suite 100                                        |  | L6T 5P6   
|Brampton, Ontario, Canada(Address of Principal Executive Offices) |  | (Zip Code)

Registrants Telephone Number Including Area Code
(905) 863-0000




þ o


12b-2


þ o o


12b-2


o þ




1,460,978,638 shares of common stock without nominal or
par value










---



##### 










TABLE OF CONTENTS


|                                 |  |                                                                                           |    |      |    | 
|-------------------------------- |  | ----------------------------------------------------------------------------------------- | -- | ---- | -- | 
|                                 |  |                                                                                           |    | Page |   
|                                 |  |                                                                                           |    |      |   
|PART I
    FINANCIAL INFORMATION
|                                
|ITEM 1.                          |  | Condensed Consolidated Financial
    Statements (unaudited)                               |    |      | 1  | 
|ITEM 2.                          |  | Managements Discussion and
    Analysis of Financial Condition and Results of Operations |    |      | 46 | 
|ITEM 3.                          |  | Quantitative and Qualitative
    Disclosures About Market Risk                            |    |      | 83 | 
|ITEM 4.                          |  | Controls and Procedures                                                                   |    |      | 84 | 
|                                
|PART II
     OTHER INFORMATION  
|ITEM 1.                          |  | Legal Proceedings                                                                         |    |      | 87 | 
|ITEM 1A.                         |  | Risk Factors                                                                              |    |      | 87 | 
|ITEM 6.                          |  | Exhibits                                                                                  |    |      | 91 | 
|SIGNATURES                       |  |                                                                                           | 93 |     
|EX-10.1                         
|EX-10.2                         
|EX-10.3                         
|EX-10.4                         
|EX-10.5                         
|EX-10.6                         
|EX-10.10                        
|EX-10.11                        
|EX-10.12                        
|EX-10.13                        
|EX-10.14                        
|EX-10.15                        
|EX-10.16                        
|EX-10.17                        
|EX-31.1                         
|EX-31.2                         
|EX-32                           



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














i



---



##### Table of Contents






PART I


FINANCIAL INFORMATION





ITEM 1.     CONDENSED
CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)


NORTEL NETWORKS LIMITED


Condensed Consolidated Statements of Operations
(unaudited)


|                                                                                                                                                     |                |                            |       |              |                  |   |       |      |              |   |       |     |   |   |       |     |  
|---------------------------------------------------------------------------------------------------------------------------------------------------- | -------------- | -------------------------- | ----- | ------------ | ---------------- | - | ----- | ---- | ------------ | - | ----- | --- | - | - | ----- | --- | -
|                                                                                                                                                     |                | Three months ended         |       |              | Six months ended |  
|                                                                                                                                                     |                | June 30,                   |       |              | June 30,         |  
|                                                                                                                                                     |                |                            |       |              |                  |  
|                                                                                                                                                     |                | 2006                       |       |              | 2005             |   |       | 2006 |              |   | 2005  |    
|                                                                                                                                                     |                |                            |       |              |                  |   |       |      |              |   |       |    
|                                                                                                                                                     |                |                            |       | As restated* |                  |   |       |      | As restated* |  
|                                                                                                                                                     |                | (Millions of U.S. dollars) |      
|Revenues                                                                                                                                             |                | $                          | 2,744 |              |                  | $ | 2,619 |      |              | $ | 5,126 |     |   | $ | 5,008 |    
|Cost of revenues                                                                                                                                     |                |                            | 1,678 |              |                  |   | 1,515 |      |              |   | 3,151 |     |   |   | 2,890 |    
|                                                                                                                                                     |                |                            |       |              |                  |   |       |      |              |   |       |    
|Gross profit                                                                                                                                         |                |                            | 1,066 |              |                  |   | 1,104 |      |              |   | 1,975 |     |   |   | 2,118 |    
|Selling, general and administrative expense                                                                                                          |                |                            | 594   |              |                  |   | 585   |      |              |   | 1,188 |     |   |   | 1,159 |    
|Research and development expense                                                                                                                     |                |                            | 484   |              |                  |   | 483   |      |              |   | 958   |     |   |   | 954   |    
|Amortization of intangibles                                                                                                                          |                |                            | 6     |              |                  |   | 2     |      |              |   | 11    |     |   |   | 4     |    
|In-process research and development expense                                                                                                          |                |                            | 16    |              |                  |   |      |      |              |   | 16    |     |   |   |      |    
|Special charges                                                                                                                                      |                |                            | 45    |              |                  |   | 92    |      |              |   | 50    |     |   |   | 106   |    
|(Gain) loss on sale of businesses and assets                                                                                                         |                |                            | 16    |              |                  |   | 11    |      |              |   | (26   | )   |   |   | 33    |    
|                                                                                                                                                     |                |                            |       |              |                  |   |       |      |              |   |       |    
|Operating earnings (loss)                                                                                                                            |                |                            | (95   | )            |                  |   | (69   | )    |              |   | (222  | )   |   |   | (138  | )  
|Other income  net                                                                                                                                   |                |                            | 53    |              |                  |   | 77    |      |              |   | 123   |     |   |   | 132   |    
|Interest expense                                                                                                                                     |                |                            |       |              |                  |   |       |      |              |   |       |     |   |   |       |    
|                                                                                                                                                     | Long-term debt |                            |       | (38          | )                |   |       | (30  | )            |   |       | (63 | ) |   |       | (59 | )
|                                                                                                                                                     | Other          |                            |       |             |                  |   |       |     |              |   |       | (23 | ) |   |       | (2  | )
|                                                                                                                                                     |                |                            |       |              |                  |   |       |      |              |   |       |    
|Earnings (loss) from continuing operations before income taxes,
    minority interests and equity in net earnings (loss) of
    associated companies |                |                            | (80   | )            |                  |   | (22   | )    |              |   | (185  | )   |   |   | (67   | )  
|Income tax benefit (expense)                                                                                                                         |                |                            | (27   | )            |                  |   | 9     |      |              |   | (50   | )   |   |   | (6    | )  
|                                                                                                                                                     |                |                            |       |              |                  |   |       |      |              |   |       |    
|                                                                                                                                                     |                |                            | (107  | )            |                  |   | (13   | )    |              |   | (235  | )   |   |   | (73   | )  
|Minority interests  net of tax                                                                                                                      |                |                            | 14    |              |                  |   | (8    | )    |              |   | 35    |     |   |   | (13   | )  
|Equity in net earnings (loss) of associated
    companies  net of tax                                                                               |                |                            | (2    | )            |                  |   | 1     |      |              |   | (4    | )   |   |   | 2     |    
|                                                                                                                                                     |                |                            |       |              |                  |   |       |      |              |   |       |    
|Net earnings (loss) from continuing operations                                                                                                       |                |                            | (95   | )            |                  |   | (20   | )    |              |   | (204  | )   |   |   | (84   | )  
|Net earnings (loss) from discontinued operations  net
    of tax                                                                                    |                |                            |      |              |                  |   | (1    | )    |              |   |      |     |   |   | 1     |    
|                                                                                                                                                     |                |                            |       |              |                  |   |       |      |              |   |       |    
|Net earnings (loss) before cumulative effect of accounting change                                                                                    |                |                            | (95   | )            |                  |   | (21   | )    |              |   | (204  | )   |   |   | (83   | )  
|Cumulative effect of accounting change  net of tax
    (note 2)                                                                                     |                |                            |      |              |                  |   |      |      |              |   | 9     |     |   |   |      |    
|                                                                                                                                                     |                |                            |       |              |                  |   |       |      |              |   |       |    
|Net earnings (loss)                                                                                                                                  |                |                            | (95   | )            |                  |   | (21   | )    |              |   | (195  | )   |   |   | (83   | )  
|Dividends on preferred shares                                                                                                                        |                |                            | 13    |              |                  |   | 10    |      |              |   | 25    |     |   |   | 19    |    
|                                                                                                                                                     |                |                            |       |              |                  |   |       |      |              |   |       |    
|Net earnings (loss) applicable to common shares                                                                                                      |                | $                          | (108  | )            |                  | $ | (31   | )    |              | $ | (220  | )   |   | $ | (102  | )  
|                                                                                                                                                     |                |                            |       |              |                  |   |       |      |              |   |       |    






|  |           
|- | ----------
|* | See note 3

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


1



---



##### Table of Contents



NORTEL NETWORKS LIMITED


Condensed Consolidated Balance Sheets (unaudited)


|                                                                        |                                                                                                                |                            |         |       |              |   |         |       | 
|----------------------------------------------------------------------- | -------------------------------------------------------------------------------------------------------------- | -------------------------- | ------- | ----- | ------------ | - | ------- | ----- | 
|                                                                        |                                                                                                                | June 30,                   |         |       | December 31, |  
|                                                                        |                                                                                                                | 2006                       |         |       | 2005         |  
|                                                                        |                                                                                                                |                            |         |       |              |  
|                                                                        |                                                                                                                | (Millions of U.S. dollars, |        
|                                                                        |                                                                                                                | except for share amounts)  |        
|ASSETS                                                                 
|Current assets                                                          |                                                                                                                |                            |         |       |              |   |         |      
|                                                                        | Cash and cash equivalents                                                                                      |                            | $       | 1,898 |              |   | $       | 2,876 | 
|                                                                        | Restricted cash and cash equivalents                                                                           |                            |         | 64    |              |   |         | 77    | 
|                                                                        | Accounts receivable  net                                                                                      |                            |         | 3,654 |              |   |         | 3,166 | 
|                                                                        | Inventories  net                                                                                              |                            |         | 2,035 |              |   |         | 1,804 | 
|                                                                        | Deferred income taxes  net                                                                                    |                            |         | 348   |              |   |         | 377   | 
|                                                                        | Other current assets                                                                                           |                            |         | 603   |              |   |         | 567   | 
|                                                                        |                                                                                                                |                            |         |       |              |  
|Total current assets                                                    |                                                                                                                |                            | 8,602   |       |              |   | 8,867   |      
|Investments                                                             |                                                                                                                |                            | 208     |       |              |   | 244     |      
|Plant and equipment  net                                               |                                                                                                                |                            | 1,570   |       |              |   | 1,559   |      
|Goodwill                                                                |                                                                                                                |                            | 2,410   |       |              |   | 2,412   |      
|Intangible assets  net                                                 |                                                                                                                |                            | 205     |       |              |   | 172     |      
|Deferred income taxes  net                                             |                                                                                                                |                            | 3,728   |       |              |   | 3,629   |      
|Other assets                                                            |                                                                                                                |                            | 959     |       |              |   | 1,026   |      
|                                                                        |                                                                                                                |                            |         |       |              |  
|Total assets                                                            |                                                                                                                | $                          | 17,682  |       |              | $ | 17,909  |      
|                                                                        |                                                                                                                |                            |         |       |              |  
|                                                                       
|LIABILITIES AND SHAREHOLDERS EQUITY                                   
|Current liabilities                                                     |                                                                                                                |                            |         |       |              |   |         |      
|                                                                        | Trade and other accounts payable                                                                               |                            | $       | 1,060 |              |   | $       | 1,178 | 
|                                                                        | Payroll and benefit-related liabilities                                                                        |                            |         | 859   |              |   |         | 799   | 
|                                                                        | Contractual liabilities                                                                                        |                            |         | 258   |              |   |         | 346   | 
|                                                                        | Restructuring liabilities                                                                                      |                            |         | 111   |              |   |         | 95    | 
|                                                                        | Other accrued liabilities                                                                                      |                            |         | 3,674 |              |   |         | 3,365 | 
|                                                                        | Long-term debt due within one year                                                                             |                            |         | 18    |              |   |         | 1,446 | 
|                                                                        |                                                                                                                |                            |         |       |              |  
|Total current liabilities                                               |                                                                                                                |                            | 5,980   |       |              |   | 7,229   |      
|Long-term debt                                                          |                                                                                                                |                            | 1,952   |       |              |   | 639     |      
|Deferred income taxes  net                                             |                                                                                                                |                            | 107     |       |              |   | 104     |      
|Other liabilities                                                       |                                                                                                                |                            | 3,830   |       |              |   | 4,037   |      
|                                                                        |                                                                                                                |                            |         |       |              |  
|Total liabilities                                                       |                                                                                                                |                            | 11,869  |       |              |   | 12,009  |      
|                                                                        |                                                                                                                |                            |         |       |              |  
|Minority interests in subsidiary companies                              |                                                                                                                |                            | 202     |       |              |   | 244     |      
|Guarantees, commitments and contingencies (notes 11, 12
    and 17)     |                                                                                                                |                            |         |       |              |   |         |      
|                                                                       
|SHAREHOLDERS EQUITY                                                   
|Preferred shares, without par value  Authorized
    shares: unlimited; |                                                                                                                |                            |         |       |              |   |         |      
|                                                                        | Issued and outstanding shares: 30,000,000 as of June 30,
    2006 and 30,000,000 as of December 31, 2005       |                            |         | 536   |              |   |         | 536   | 
|Common shares, without par value  Authorized shares:
    unlimited;    |                                                                                                                |                            |         |       |              |   |         |      
|                                                                        | Issued and outstanding shares: 1,460,978,638 as of June 30,
    2006 and 1,460,978,638 as of December 31, 2005 |                            |         | 1,211 |              |   |         | 1,211 | 
|Additional paid-in capital                                              |                                                                                                                |                            | 22,239  |       |              |   | 22,193  |      
|Accumulated deficit                                                     |                                                                                                                |                            | (17,617 | )     |              |   | (17,397 | )    
|Accumulated other comprehensive loss                                    |                                                                                                                |                            | (758    | )     |              |   | (887    | )    
|                                                                        |                                                                                                                |                            |         |       |              |  
|Total shareholders equity                                              |                                                                                                                |                            | 5,611   |       |              |   | 5,656   |      
|                                                                        |                                                                                                                |                            |         |       |              |  
|Total liabilities and shareholders equity                              |                                                                                                                | $                          | 17,682  |       |              | $ | 17,909  |      
|                                                                        |                                                                                                                |                            |         |       |              |  

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


2



---



##### Table of Contents



NORTEL NETWORKS LIMITED


Condensed Consolidated Statements of Cash Flows
(unaudited)


|                                                                            |                                                                                                                                                                                                   |                                                                             |       |              |        |   |       |      |      |  
|--------------------------------------------------------------------------- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | --------------------------------------------------------------------------- | ----- | ------------ | ------ | - | ----- | ---- | ---- | -
|                                                                            |                                                                                                                                                                                                   | Six months ended                                                            |      
|                                                                            |                                                                                                                                                                                                   | June 30,                                                                    |      
|                                                                            |                                                                                                                                                                                                   |                                                                             |      
|                                                                            |                                                                                                                                                                                                   | 2006                                                                        |       |              | 2005   |  
|                                                                            |                                                                                                                                                                                                   |                                                                             |       |              |        |  
|                                                                            |                                                                                                                                                                                                   |                                                                             |       | As restated* |       
|                                                                            |                                                                                                                                                                                                   | (Millions of U.S. dollars)                                                  |      
|Cash flows from (used in) operating activities                              |                                                                                                                                                                                                   |                                                                             |       |              |        |   |       |     
|                                                                            | Net earnings (loss)                                                                                                                                                                               |                                                                             | $     | (195         | )      |   | $     | (83  | )   
|                                                                            | Adjustments to reconcile net earnings (loss) to net cash from
    (used in) operating activities from continuing operations, net
    of effects from acquisitions and divestitures of businesses: |                                                                             |       |              |        |   |       |      |     
|                                                                            |                                                                                                                                                                                                   | Amortization and depreciation                                               |       |              | 136    |   |       |      | 160  |  
|                                                                            |                                                                                                                                                                                                   | Non-cash portion of special charges and related asset write downs           |       |              |       |   |       |      | 2    |  
|                                                                            |                                                                                                                                                                                                   | Non-cash portion of In-process research and development expense             |       |              | 16     |   |       |      |     |  
|                                                                            |                                                                                                                                                                                                   | Equity in net (earnings) loss of associated companies                       |       |              | 4      |   |       |      | (2   | )
|                                                                            |                                                                                                                                                                                                   | Stock option compensation                                                   |       |              | 53     |   |       |      | 37   |  
|                                                                            |                                                                                                                                                                                                   | Deferred income taxes                                                       |       |              | 54     |   |       |      | 12   |  
|                                                                            |                                                                                                                                                                                                   | Cumulative effect of accounting change                                      |       |              | (9     | ) |       |      |     |  
|                                                                            |                                                                                                                                                                                                   | Net (earnings) from discontinued operations                                 |       |              |       |   |       |      | (1   | )
|                                                                            |                                                                                                                                                                                                   | Other liabilities                                                           |       |              | 159    |   |       |      | 181  |  
|                                                                            |                                                                                                                                                                                                   | (Gain) loss on sale or write down of investments, businesses and
    assets |       |              | (27    | ) |       |      | 17   |  
|                                                                            |                                                                                                                                                                                                   | Other  net                                                                 |       |              | 254    |   |       |      | (103 | )
|                                                                            |                                                                                                                                                                                                   | Change in operating assets and liabilities                                  |       |              | (1,237 | ) |       |      | (374 | )
|                                                                            |                                                                                                                                                                                                   |                                                                             |       |              |        |  
|                                                                            | Net cash from (used in) operating activities of continuing
    operations                                                                                                                         |                                                                             |       | (792         | )      |   |       | (154 | )   
|                                                                            |                                                                                                                                                                                                   |                                                                             |       |              |        |  
|Cash flows from (used in) investing activities                              |                                                                                                                                                                                                   |                                                                             |       |              |        |   |       |     
|                                                                            | Expenditures for plant and equipment                                                                                                                                                              |                                                                             |       | (177         | )      |   |       | (124 | )   
|                                                                            | Proceeds on disposals of plant and equipment                                                                                                                                                      |                                                                             |       | 89           |        |   |       | 10   |     
|                                                                            | Restricted cash and cash equivalents                                                                                                                                                              |                                                                             |       | 16           |        |   |       | 9    |     
|                                                                            | Acquisitions of investments and businesses  net of
    cash acquired                                                                                                                             |                                                                             |       | (125         | )      |   |       | (448 | )   
|                                                                            | Proceeds on sale of investments and businesses                                                                                                                                                    |                                                                             |       | 108          |        |   |       | 167  |     
|                                                                            |                                                                                                                                                                                                   |                                                                             |       |              |        |  
|                                                                            | Net cash from (used in) investing activities of continuing
    operations                                                                                                                         |                                                                             |       | (89          | )      |   |       | (386 | )   
|                                                                            |                                                                                                                                                                                                   |                                                                             |       |              |        |  
|Cash flows from (used in) financing activities                              |                                                                                                                                                                                                   |                                                                             |       |              |        |   |       |     
|                                                                            | Dividends paid                                                                                                                                                                                    |                                                                             |       | (31          | )      |   |       | (24  | )   
|                                                                            | Increase in notes payable                                                                                                                                                                         |                                                                             |       | 27           |        |   |       | 38   |     
|                                                                            | Decrease in notes payable                                                                                                                                                                         |                                                                             |       | (12          | )      |   |       | (46  | )   
|                                                                            | Borrowings in loan payable                                                                                                                                                                        |                                                                             |       | 1,300        |        |   |       |     |     
|                                                                            | Repayment of long-term debt                                                                                                                                                                       |                                                                             |       | (1,425       | )      |   |       |     |     
|                                                                            | Decrease in capital leases payable                                                                                                                                                                |                                                                             |       | (9           | )      |   |       | (4   | )   
|                                                                            |                                                                                                                                                                                                   |                                                                             |       |              |        |  
|                                                                            | Net cash from (used in) financing activities of continuing
    operations                                                                                                                         |                                                                             |       | (150         | )      |   |       | (36  | )   
|                                                                            |                                                                                                                                                                                                   |                                                                             |       |              |        |  
|Effect of foreign exchange rate changes on cash and cash
    equivalents    |                                                                                                                                                                                                   |                                                                             | 53    |              |        |   | (85   | )   
|                                                                            |                                                                                                                                                                                                   |                                                                             |       |              |        |  
|Net cash from (used in) continuing operations                               |                                                                                                                                                                                                   |                                                                             | (978  | )            |        |   | (661  | )   
|Net cash from (used in) operating activities of discontinued
    operations |                                                                                                                                                                                                   |                                                                             |      |              |        |   | 34    |     
|                                                                            |                                                                                                                                                                                                   |                                                                             |       |              |        |  
|Net increase (decrease) in cash and cash equivalents                        |                                                                                                                                                                                                   |                                                                             | (978  | )            |        |   | (627  | )   
|Cash and cash equivalents at beginning of period                            |                                                                                                                                                                                                   |                                                                             | 2,876 |              |        |   | 3,606 |     
|                                                                            |                                                                                                                                                                                                   |                                                                             |       |              |        |  
|Cash and cash equivalents at end of period                                  |                                                                                                                                                                                                   | $                                                                           | 1,898 |              |        | $ | 2,979 |     
|                                                                            |                                                                                                                                                                                                   |                                                                             |       |              |        |  






|  |           
|- | ----------
|* | See note 3

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


3



---



##### Table of Contents



NORTEL NETWORKS LIMITED


Notes to Condensed Consolidated Financial Statements
(unaudited)


(millions of U.S. dollars, unless otherwise stated)




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



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





10-K 8-K




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





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



|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(a) | In February 2006, the United States Financial Accounting
    Standards Board (FASB) issued Statement of Financial
    Accounting Standard (SFAS) No. 155,
    Accounting for Certain Hybrid Financial
    Instruments  an amendment to FASB Statements
    No. 133 and 140 (SFAS 155).
    SFAS 155 simplifies the accounting for certain hybrid
    financial instruments containing embedded derivatives.
    SFAS 155 allows fair value measurement for any hybrid
    financial instrument that contains an embedded derivative that
    otherwise would require bifurcation under
    SFAS No. 133, Accounting for Derivative
    Instruments and Hedging Activities
    (SFAS 133). In addition, it amends
    SFAS No. 140, Accounting for Transfers and
    Servicing of Financial Assets and Extinguishments of
    Liabilities (SFAS 140), to eliminate the
    prohibition on a qualifying special-purpose entity from holding
    a derivative financial instrument that pertains to a beneficial
    interest other than another derivative financial instrument.
    SFAS 155 is effective for all financial instruments
    acquired, issued or subject to a re-measurement event occurring
    after the beginning of an entitys first fiscal year that
    begins after September 15, 2006. Nortel will adopt the
    provisions of SFAS 155 on January 1, 2007. The
    implementation of SFAS 155 is not expected to have a
    material impact on Nortels results of operations and
    financial condition.



|    |                                                                                                                                                                                                                                                                                                                                                               
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(b) | In March 2006, the FASB issued SFAS No. 156,
    Accounting for Servicing of Financial Assets 
    an amendment of FASB Statement No. 140
    (SFAS 156). SFAS 156 simplifies the
    accounting for assets and liabilities arising from loan
    servicing contracts. SFAS 156 requires that servicing
    rights be valued initially at fair value, and

4



---



##### Table of Contents



NORTEL NETWORKS LIMITED


Notes to Condensed Consolidated Financial Statements
(unaudited)  (Continued)




| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | subsequently either (i) accounted for at fair value or
    (ii) amortized over the period of estimated net servicing
    income/loss, with an assessment for impairment or increased
    obligation each reporting period. SFAS 156 is effective for
    fiscal years beginning after September 15, 2006. Nortel
    will adopt the provisions of SFAS 156 on January 1,
    2007. The implementation of SFAS 156 is not expected to
    have a material impact on Nortels results of operations
    and financial condition.



|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(c) | In April 2006, the FASB issued FASB Staff Position
    (FSP), FASB Interpretation No. (FIN)
    46(R)-6, Determining the Variability to be Considered in
    Applying FASB Interpretation No. 46(R) (FSP
    FIN 46(R)-6). FSP FIN 46(R)-6 provides
    accounting guidance on how to distinguish between arrangements
    that create variability (i.e., the risks and rewards) within an
    entity and arrangements that are subject to that variability
    (i.e., variable interests). FSP FIN 46(R)-6 is responding
    to a need for accounting guidance on arrangements that can be
    either assets or liabilities (e.g., derivative financial
    instruments). FSP FIN 46(R)-6 is effective for the first
    fiscal period that begins after June 15, 2006. Nortel will
    adopt the provisions of FSP FIN 46(R)-6 effective
    July 1, 2006. Nortel is currently in the process of
    assessing the impact of FSP FIN 46(R)-6 on its results of
    operations and financial condition.



|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(d) | In June 2006, the FASB issued FIN No. 48,
    Accounting for Uncertainty in Income Taxes, an
    interpretation of FASB Statement No. 109
    (FIN 48). FIN 48 clarifies the accounting
    for uncertainty in income taxes recognized in an
    enterprises financial statements in accordance with FASB
    Statement No. 109, Accounting for Income Taxes
    (SFAS 109). The interpretation prescribes a
    recognition threshold and measurement attribute for the
    financial statement recognition and measurement of a tax
    position taken or expected to be taken in a tax return.
    FIN 48 also provides accounting guidance on derecognition,
    classification, interest and penalties, accounting in interim
    periods, disclosure and transition. FIN 48 is effective for
    fiscal years beginning after December 15, 2006. Nortel will
    adopt the provisions of FIN 48 on January 1, 2007.
    Nortel is currently in the process of assessing the impact of
    FIN 48 on its results of operations and financial condition.



|   |                   
|-- | ------------------
|2. | Accounting changes



| |                                                                                                  
| | -------------------------------------------------------------------------------------------------
| | (a) The Meaning of Other-than-Temporary Impairment
    and its Application to Certain Investments

03-1, 03-1),




| |                    
| | -------------------
| | (b) Inventory Costs





| |                        
| | -----------------------
| | (c) Share-Based Payment



5



---



##### Table of Contents



NORTEL NETWORKS LIMITED


Notes to Condensed Consolidated Financial Statements
(unaudited)  (Continued)






| |                                             
| | --------------------------------------------
| | (d) Accounting Changes and Error Corrections





| |                                                                                   
| | ----------------------------------------------------------------------------------
| | (e) Accounting for Purchases and Sales of Inventory
    with the same Counterparty

04-13). 04-13




|   |                                                      
|-- | -----------------------------------------------------
|3. | Restatement of previously issued financial statements



10-K


97-2),


percentage-of


6



---



##### Table of Contents



NORTEL NETWORKS LIMITED


Notes to Condensed Consolidated Financial Statements
(unaudited)  (Continued)






| |   |                                                                                                                                                                                                                                                                                                                                                                                      
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Certain complex arrangements with multiple deliverables were
    previously fully accounted for under the percentage of
    completion method of SOP 81-1, but elements outside of the
    scope of SOP 81-1 should have been examined for separation
    under the guidance in EITF Issue
    No. 00-21
    Revenue Arrangements with Multiple Deliverables
    (EITF 00-21);and
| |  | Certain complex arrangements accounted for under the
    percentage-of-completion
    method did not meet the criteria for this treatment in
    SOP 81-1 and should instead have been accounted for using
    completed contract accounting under SOP 81-1.                                                                                                                         





Condensed Consolidated Statement of Operations
(unaudited) for the three months ended June 30,
2005


|                                                                                                                                                     |                |            |       |     |             |   |      |             |  |   |       |     |  
|---------------------------------------------------------------------------------------------------------------------------------------------------- | -------------- | ---------- | ----- | --- | ----------- | - | ---- | ----------- |  | - | ----- | --- | -
|                                                                                                                                                     |                | As         |       |     |             |   |     
|                                                                                                                                                     |                | previously |       |     |             |   |     
|                                                                                                                                                     |                | reported   |       |     | Adjustments |   |      | As restated | 
|                                                                                                                                                     |                |            |       |     |             |   |      |             | 
|Revenues                                                                                                                                             |                | $          | 2,855 |     |             | $ | (236 | )           |  | $ | 2,619 |    
|Cost of revenues                                                                                                                                     |                |            | 1,650 |     |             |   | (135 | )           |  |   | 1,515 |    
|                                                                                                                                                     |                |            |       |     |             |   |      |             | 
|Gross profit                                                                                                                                         |                |            | 1,205 |     |             |   | (101 | )           |  |   | 1,104 |    
|Selling, general and administrative expense                                                                                                          |                |            | 576   |     |             |   | 9    |             |  |   | 585   |    
|Research and development expense                                                                                                                     |                |            | 474   |     |             |   | 9    |             |  |   | 483   |    
|Amortization of intangibles                                                                                                                          |                |            | 2     |     |             |   |     |             |  |   | 2     |    
|Special charges                                                                                                                                      |                |            | 90    |     |             |   | 2    |             |  |   | 92    |    
|(Gain) loss on sale of businesses and assets                                                                                                         |                |            | 36    |     |             |   | (25  | )           |  |   | 11    |    
|                                                                                                                                                     |                |            |       |     |             |   |      |             | 
|Operating earnings (loss)                                                                                                                            |                |            | 27    |     |             |   | (96  | )           |  |   | (69   | )  
|Other income  net                                                                                                                                   |                |            | 61    |     |             |   | 16   |             |  |   | 77    |    
|Interest expense                                                                                                                                     |                |            |       |     |             |   |      |             |  |   |       |    
|                                                                                                                                                     | Long-term debt |            |       | (30 | )           |   |      |            |  |   |       | (30 | )
|                                                                                                                                                     | Other          |            |       |    |             |   |      |            |  |   |       |    |  
|                                                                                                                                                     |                |            |       |     |             |   |      |             | 
|Earnings (loss) from continuing operations before income taxes,
    minority interests and equity in net earnings (loss) of
    associated companies |                |            | 58    |     |             |   | (80  | )           |  |   | (22   | )  
|Income tax benefit (expense)                                                                                                                         |                |            | 7     |     |             |   | 2    |             |  |   | 9     |    
|                                                                                                                                                     |                |            |       |     |             |   |      |             | 
|                                                                                                                                                     |                |            | 65    |     |             |   | (78  | )           |  |   | (13   | )  
|Minority interests  net of tax                                                                                                                      |                |            | (8    | )   |             |   |     |             |  |   | (8    | )  
|Equity in net earnings (loss) of associated
    companies  net of tax                                                                               |                |            | 1     |     |             |   |     |             |  |   | 1     |    
|                                                                                                                                                     |                |            |       |     |             |   |      |             | 
|Net earnings (loss) from continuing operations                                                                                                       |                |            | 58    |     |             |   | (78  | )           |  |   | (20   | )  
|Net loss from discontinued operations  net of tax                                                                                                   |                |            | (1    | )   |             |   |     |             |  |   | (1    | )  
|                                                                                                                                                     |                |            |       |     |             |   |      |             | 
|Net earnings (loss)                                                                                                                                  |                |            | 57    |     |             |   | (78  | )           |  |   | (21   | )  
|Dividends on preferred shares                                                                                                                        |                |            | 10    |     |             |   |     |             |  |   | 10    |    
|                                                                                                                                                     |                |            |       |     |             |   |      |             | 
|Net earnings (loss) applicable to common shares                                                                                                      |                | $          | 47    |     |             | $ | (78  | )           |  | $ | (31   | )  
|                                                                                                                                                     |                |            |       |     |             |   |      |             | 

7



---



##### Table of Contents



NORTEL NETWORKS LIMITED


Notes to Condensed Consolidated Financial Statements
(unaudited)  (Continued)


Condensed Consolidated Statement of Operations
(unaudited) for the six months ended June 30, 2005


|                                                                                                                                                     |                |            |       |     |             |   |      |             |  |   |       |     |  
|---------------------------------------------------------------------------------------------------------------------------------------------------- | -------------- | ---------- | ----- | --- | ----------- | - | ---- | ----------- |  | - | ----- | --- | -
|                                                                                                                                                     |                | As         |       |     |             |   |     
|                                                                                                                                                     |                | previously |       |     |             |   |     
|                                                                                                                                                     |                | reported   |       |     | Adjustments |   |      | As restated | 
|                                                                                                                                                     |                |            |       |     |             |   |      |             | 
|Revenues                                                                                                                                             |                | $          | 5,391 |     |             | $ | (383 | )           |  | $ | 5,008 |    
|Cost of revenues                                                                                                                                     |                |            | 3,127 |     |             |   | (237 | )           |  |   | 2,890 |    
|                                                                                                                                                     |                |            |       |     |             |   |      |             | 
|Gross profit                                                                                                                                         |                |            | 2,264 |     |             |   | (146 | )           |  |   | 2,118 |    
|Selling, general and administrative expense                                                                                                          |                |            | 1,146 |     |             |   | 13   |             |  |   | 1,159 |    
|Research and development expense                                                                                                                     |                |            | 945   |     |             |   | 9    |             |  |   | 954   |    
|Amortization of intangibles                                                                                                                          |                |            | 4     |     |             |   |     |             |  |   | 4     |    
|Special charges                                                                                                                                      |                |            | 111   |     |             |   | (5   | )           |  |   | 106   |    
|(Gain) loss on sale of businesses and assets                                                                                                         |                |            | 37    |     |             |   | (4   | )           |  |   | 33    |    
|                                                                                                                                                     |                |            |       |     |             |   |      |             | 
|Operating earnings (loss)                                                                                                                            |                |            | 21    |     |             |   | (159 | )           |  |   | (138  | )  
|Other income  net                                                                                                                                   |                |            | 108   |     |             |   | 24   |             |  |   | 132   |    
|Interest expense                                                                                                                                     |                |            |       |     |             |   |      |             |  |   |       |    
|                                                                                                                                                     | Long-term debt |            |       | (59 | )           |   |      |            |  |   |       | (59 | )
|                                                                                                                                                     | Other          |            |       | (2  | )           |   |      |            |  |   |       | (2  | )
|                                                                                                                                                     |                |            |       |     |             |   |      |             | 
|Earnings (loss) from continuing operations before income taxes,
    minority interests and equity in net earnings (loss) of
    associated companies |                |            | 68    |     |             |   | (135 | )           |  |   | (67   | )  
|Income tax benefit (expense)                                                                                                                         |                |            | (8    | )   |             |   | 2    |             |  |   | (6    | )  
|                                                                                                                                                     |                |            |       |     |             |   |      |             | 
|                                                                                                                                                     |                |            | 60    |     |             |   | (133 | )           |  |   | (73   | )  
|Minority interests  net of tax                                                                                                                      |                |            | (13   | )   |             |   |     |             |  |   | (13   | )  
|Equity in net earnings (loss) of associated
    companies  net of tax                                                                               |                |            | 2     |     |             |   |     |             |  |   | 2     |    
|                                                                                                                                                     |                |            |       |     |             |   |      |             | 
|Net earnings (loss) from continuing operations                                                                                                       |                |            | 49    |     |             |   | (133 | )           |  |   | (84   | )  
|Net earnings from discontinued operations  net of tax                                                                                               |                |            | 1     |     |             |   |     |             |  |   | 1     |    
|                                                                                                                                                     |                |            |       |     |             |   |      |             | 
|Net earnings (loss)                                                                                                                                  |                |            | 50    |     |             |   | (133 | )           |  |   | (83   | )  
|Dividends on preferred shares                                                                                                                        |                |            | 19    |     |             |   |     |             |  |   | 19    |    
|                                                                                                                                                     |                |            |       |     |             |   |      |             | 
|Net earnings (loss) applicable to common shares                                                                                                      |                | $          | 31    |     |             | $ | (133 | )           |  | $ | (102  | )  
|                                                                                                                                                     |                |            |       |     |             |   |      |             | 

8



---



##### Table of Contents



NORTEL NETWORKS LIMITED


Notes to Condensed Consolidated Financial Statements
(unaudited)  (Continued)


Adjustments




|                                                                          |  |                    |       |   |                  |   |       |  
|------------------------------------------------------------------------- |  | ------------------ | ----- | - | ---------------- | - | ----- | -
|                                                                          |  | Three months ended |       |   | Six months ended |  
|                                                                          |  | June 30,           |       |   | June 30,         |  
|                                                                          |  | 2005               |       |   | 2005             |  
|                                                                          |  |                    |       |   |                  |  
|Revenues  as previously reported                                         |  | $                  | 2,855 |   |                  | $ | 5,391 |  
|Adjustments:                                                              |  |                    |       |   |                  |   |       |  
|Application of SOP 81-1                                                   |  |                    | (23   | ) |                  |   | 59    |  
|Interaction between multiple revenue recognition accounting
    standards |  |                    | (155  | ) |                  |   | (338  | )
|Application of SAB 104 and SOP 97-2                                       |  |                    | (45   | ) |                  |   | (98   | )
|Other revenue recognition adjustments                                     |  |                    | (13   | ) |                  |   | (6    | )
|                                                                          |  |                    |       |   |                  |  
|Revenues  as restated                                                    |  | $                  | 2,619 |   |                  | $ | 5,008 |  
|                                                                          |  |                    |       |   |                  |  
|Net earnings (loss)  as previously reported                              |  | $                  | 57    |   |                  | $ | 50    |  
|Adjustments:                                                              |  |                    |       |   |                  |   |       |  
|Application of SOP 81-1                                                   |  |                    | (12   | ) |                  |   | (3    | )
|Interaction between multiple revenue recognition accounting
    standards |  |                    | (12   | ) |                  |   | (38   | )
|Application of SAB 104 and SOP 97-2                                       |  |                    | (25   | ) |                  |   | (51   | )
|Other revenue recognition adjustments                                     |  |                    | (50   | ) |                  |   | (53   | )
|(Gain) loss on sale of businesses                                         |  |                    | 25    |   |                  |   | 4     |  
|Foreign
    exchange(i)                                                   |  |                    | 11    |   |                  |   | 13    |  
|Other                                                                     |  |                    | (15   | ) |                  |   | (5    | )
|                                                                          |  |                    |       |   |                  |  
|Net earnings (loss)  as restated                                         |  | $                  | (21   | ) |                  | $ | (83   | )
|                                                                          |  |                    |       |   |                  |  






|    |                                                                                                                                                                
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------
|(i) | Includes the foreign exchange gains and losses resulting from
    the Third Restatement adjustments, and the correction of certain
    foreign exchange errors.

Revenue Recognition Adjustments:




| |                        
| | -----------------------
| | Application of SOP 81-1

percentage-of percentage-of


percentage-of percentage-of percentage-of


9



---



##### Table of Contents



NORTEL NETWORKS LIMITED


Notes to Condensed Consolidated Financial Statements
(unaudited)  (Continued)




| |                                                                          
| | -------------------------------------------------------------------------
| | Interaction between multiple revenue recognition
    accounting standards

97-2 00-21.


percentage-of 97-2.


00-21 97-2 00-21 97-2 97-2 97-2


percentage-of 97-2




| |                                        
| | ---------------------------------------
| | Application of SAB 104 and
    SOP 97-2

97-2


97-2,




10



---



##### Table of Contents



NORTEL NETWORKS LIMITED


Notes to Condensed Consolidated Financial Statements
(unaudited)  (Continued)






| |                                      
| | -------------------------------------
| | Other revenue recognition adjustments





| |                  
| | -----------------
| | Other adjustments











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





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



| |                    
| | -------------------
| | Other income  net:

|                                                 |  |              |    |  |            |   |    |      |  |   |      |  |  |   |     | 
|------------------------------------------------ |  | ------------ | -- |  | ---------- | - | -- | ---- |  | - | ---- |  |  | - | --- | 
|                                                 |  | Three months |    |  | Six months |  
|                                                 |  | ended        |    |  | ended      |  
|                                                 |  | June 30,     |    |  | June 30,   |  
|                                                 |  |              |    |  |            |  
|                                                 |  | 2006         |    |  | 2005       |   |    | 2006 |  |   | 2005 | 
|                                                 |  |              |    |  |            |   |    |      |  |   |      | 
|Interest income                                  |  | $            | 16 |  |            | $ | 14 |      |  | $ | 31   |  |  | $ | 28  | 
|Gain (loss) on sale or write down of investments |  |              | 2  |  |            |   | 21 |      |  |   | 1    |  |  |   | 16  | 
|Currency exchange gains (losses)                 |  |              | 14 |  |            |   | 20 |      |  |   | 23   |  |  |   | 49  | 
|Other  net                                      |  |              | 21 |  |            |   | 22 |      |  |   | 68   |  |  |   | 39  | 
|                                                 |  |              |    |  |            |   |    |      |  |   |      | 
|Other income  net                               |  | $            | 53 |  |            | $ | 77 |      |  | $ | 123  |  |  | $ | 132 | 
|                                                 |  |              |    |  |            |   |    |      |  |   |      | 

11



---



##### Table of Contents



NORTEL NETWORKS LIMITED


Notes to Condensed Consolidated Financial Statements
(unaudited)  (Continued)






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



| |                           
| | --------------------------
| | Accounts receivable  net:

|                                      |  |          |       |   |              |   |       |  
|------------------------------------- |  | -------- | ----- | - | ------------ | - | ----- | -
|                                      |  | June 30, |       |   | December 31, |  
|                                      |  | 2006     |       |   | 2005         |  
|                                      |  |          |       |   |              |  
|Trade receivables                     |  | $        | 2,076 |   |              | $ | 2,570 |  
|Notes receivable                      |  |          | 1,077 |   |              |   | 122   |  
|Contracts in process                  |  |          | 602   |   |              |   | 611   |  
|                                      |  |          |       |   |              |  
|                                      |  |          | 3,755 |   |              |   | 3,303 |  
|Less: provision for doubtful accounts |  |          | (101  | ) |              |   | (137  | )
|                                      |  |          |       |   |              |  
|Accounts receivable  net             |  | $        | 3,654 |   |              | $ | 3,166 |  
|                                      |  |          |       |   |              |  



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

|                                      |  |          |        |   |              |   |        |  
|------------------------------------- |  | -------- | ------ | - | ------------ | - | ------ | -
|                                      |  | June 30, |        |   | December 31, |  
|                                      |  | 2006     |        |   | 2005         |  
|                                      |  |          |        |   |              |  
|Raw materials                         |  | $        | 744    |   |              | $ | 777    |  
|Work in process                       |  |          | 44     |   |              |   | 50     |  
|Finished goods                        |  |          | 894    |   |              |   | 819    |  
|Deferred costs                        |  |          | 2,153  |   |              |   | 2,014  |  
|                                      |  |          |        |   |              |  
|                                      |  |          | 3,835  |   |              |   | 3,660  |  
|Less: provision for inventory         |  |          | (1,070 | ) |              |   | (1,039 | )
|                                      |  |          |        |   |              |  
|Inventories  net                     |  |          | 2,765  |   |              |   | 2,621  |  
|Less: long-term deferred
    costs(a) |  |          | (730   | ) |              |   | (817   | )
|                                      |  |          |        |   |              |  
|Current inventories  net             |  | $        | 2,035  |   |              | $ | 1,804  |  
|                                      |  |          |        |   |              |  






|    |                                                                 
|--- | ----------------------------------------------------------------
|(a) | Long-term portion of deferred costs is included in other assets.



| |                      
| | ---------------------
| | Other current assets:

|                         |  |          |     |  |              |   |     | 
|------------------------ |  | -------- | --- |  | ------------ | - | --- | 
|                         |  | June 30, |     |  | December 31, |  
|                         |  | 2006     |     |  | 2005         |  
|                         |  |          |     |  |              |  
|Prepaid expenses         |  | $        | 234 |  |              | $ | 198 | 
|Income taxes recoverable |  |          | 81  |  |              |   | 68  | 
|Other                    |  |          | 288 |  |              |   | 301 | 
|                         |  |          |     |  |              |  
|Other current assets     |  | $        | 603 |  |              | $ | 567 | 
|                         |  |          |     |  |              |  

12



---



##### Table of Contents



NORTEL NETWORKS LIMITED


Notes to Condensed Consolidated Financial Statements
(unaudited)  (Continued)




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

|                                 |                         |          |        |        |              |   |        |        |  
|-------------------------------- | ----------------------- | -------- | ------ | ------ | ------------ | - | ------ | ------ | -
|                                 |                         | June 30, |        |        | December 31, |  
|                                 |                         | 2006     |        |        | 2005         |  
|                                 |                         |          |        |        |              |  
|Cost:                            |                         |          |        |        |              |   |        |       
|                                 | Land                    |          | $      | 39     |              |   | $      | 45     |  
|                                 | Buildings               |          |        | 1,213  |              |   |        | 1,265  |  
|                                 | Machinery and equipment |          |        | 2,311  |              |   |        | 2,180  |  
|                                 | Capital lease assets    |          |        | 213    |              |   |        | 213    |  
|                                 | Sale lease-back assets  |          |        | 95     |              |   |        | 80     |  
|                                 |                         |          |        |        |              |  
|                                 |                         |          | 3,871  |        |              |   | 3,783  |       
|                                 |                         |          |        |        |              |  
|Less accumulated depreciation:   |                         |          |        |        |              |   |        |       
|                                 | Buildings               |          |        | (451   | )            |   |        | (455   | )
|                                 | Machinery and equipment |          |        | (1,745 | )            |   |        | (1,674 | )
|                                 | Capital lease assets    |          |        | (86    | )            |   |        | (78    | )
|                                 | Sale lease-back assets  |          |        | (19    | )            |   |        | (17    | )
|                                 |                         |          |        |        |              |  
|                                 |                         |          | (2,301 | )      |              |   | (2,224 | )     
|                                 |                         |          |        |        |              |  
|Plant and equipment 
    net(a) |                         | $        | 1,570  |        |              | $ | 1,559  |       
|                                 |                         |          |        |        |              |  






|    |                                                                                                                                                                                                                                                                                                                                                                                                                                              
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(a) | Included assets held for sale with a carrying value of $77 and
    $136 as of June 30, 2006 and December 31, 2005,
    respectively, related to owned facilities that were being
    actively marketed. These assets were written down in previous
    periods to their estimated fair values less costs to sell. The
    write downs were included in special charges. Nortel expects to
    dispose of all of these facilities during 2006.



| |          
| | ---------
| | Goodwill:



|                                  |                  |            |       |     |           |   |    |       |   |   |       |    |       |   |       |     |  
|--------------------------------- | ---------------- | ---------- | ----- | --- | --------- | - | -- | ----- | - | - | ----- | -- | ----- | - | ----- | --- | -
|                                  |                  | Enterprise |       |     | Mobility  |   |    |       |   |  
|                                  |                  | Solutions  |       |     | and       |   |    |       |   |  
|                                  |                  | and        |       |     | Converged |   |    |       |   |  
|                                  |                  | Packet     |       |     | Core      |   |    |       |   |  
|                                  |                  | Networks   |       |     | Networks  |   |    | Other |   |   | Total |   
|                                  |                  |            |       |     |           |   |    |       |   |   |       |   
|Balance  as of December 31, 2005 |                  | $          | 2,048 |     |           | $ | 86 |       |   | $ | 278   |    |       | $ | 2,412 |    
|Change:                           |                  |            |       |     |           |   |    |       |   |   |       |    |       |   |       |    
|                                  | Additions(a)     |            |       | 43  |           |   |    |      |   |   |       |   |       |   |       | 43  |  
|                                  | Disposal(c)      |            |       | (42 | )         |   |    | (4    | ) |   |       |   |       |   |       | (46 | )
|                                  | Foreign exchange |            |       | 7   |           |   |    | 4     |   |   |       |   |       |   |       | 11  |  
|                                  | Other            |            |       | (2  | )         |   |    | (2    | ) |   |       | (6 | ) (b) |   |       | (10 | )
|                                  |                  |            |       |     |           |   |    |       |   |   |       |   
|Balance  as of June 30, 2006     |                  | $          | 2,054 |     |           | $ | 84 |       |   | $ | 272   |    |       | $ | 2,410 |    
|                                  |                  |            |       |     |           |   |    |       |   |   |       |   






|    |                                                                                                                                                                                                               
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(a) | The additions of $43 relate to the goodwill acquired as a result
    of the Tasman Networks, Inc. (Tasman Networks)
    acquisition in the first quarter of 2006. See note 9 for
    additional information.
|   
|(b) | Relates to a $6 reduction of goodwill recorded as part of the
    acquisition of Nortel Government Solutions Incorporated
    (formerly PEC Solutions Inc.) (NGS), as a result of
    a tax adjustment.     
|   
|(c) | Includes a disposal of $42 related to the transfer of
    Nortels Calgary manufacturing plant assets to Flextronics
    in the second quarter of 2006. See note 9 for additional
    information.            



13



---



##### Table of Contents



NORTEL NETWORKS LIMITED


Notes to Condensed Consolidated Financial Statements
(unaudited)  (Continued)




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

|                               |  |          |     |  |              |   |     | 
|------------------------------ |  | -------- | --- |  | ------------ | - | --- | 
|                               |  | June 30, |     |  | December 31, |  
|                               |  | 2006     |     |  | 2005         |  
|                               |  |          |     |  |              |  
|Other intangible
    assets(a) |  | $        | 166 |  |              | $ | 135 | 
|Pension intangible assets      |  |          | 39  |  |              |   | 37  | 
|                               |  |          |     |  |              |  
|Intangible assets  net        |  | $        | 205 |  |              | $ | 172 | 
|                               |  |          |     |  |              |  






|    |                                                                                                                                                                                                                                                                                                                                                                                        
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(a) | Other intangible assets are being amortized over a weighted
    average period of approximately nine years ending in 2014, based
    on their expected pattern of benefit to future periods using
    estimates of undiscounted cash flows. The amortization expense
    is partially denominated in a foreign currency and may fluctuate
    due to changes in foreign exchange rates.



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

|                                                                              |  |          |       |  |              |   |       | 
|----------------------------------------------------------------------------- |  | -------- | ----- |  | ------------ | - | ----- | 
|                                                                              |  | June 30, |       |  | December 31, |  
|                                                                              |  | 2006     |       |  | 2005         |  
|                                                                              |  |          |       |  |              |  
|Outsourcing and selling, general and administrative related
    provisions    |  | $        | 265   |  |              | $ | 255   | 
|Customer deposits                                                             |  |          | 77    |  |              |   | 38    | 
|Product related provisions                                                    |  |          | 56    |  |              |   | 42    | 
|Warranty provisions (note 11)                                                 |  |          | 209   |  |              |   | 206   | 
|Deferred revenue                                                              |  |          | 1,723 |  |              |   | 1,289 | 
|Miscellaneous taxes                                                           |  |          | 58    |  |              |   | 65    | 
|Income taxes payable                                                          |  |          | 51    |  |              |   | 81    | 
|Interest payable                                                              |  |          | 14    |  |              |   | 40    | 
|Advance billings in excess of revenues recognized to date on
    contracts(a) |  |          | 1,012 |  |              |   | 1,194 | 
|Other                                                                         |  |          | 209   |  |              |   | 155   | 
|                                                                              |  |          |       |  |              |  
|Other accrued liabilities                                                     |  | $        | 3,674 |  |              | $ | 3,365 | 
|                                                                              |  |          |       |  |              |  






|    |                                                                                                        
|--- | -------------------------------------------------------------------------------------------------------
|(a) | Includes amounts which will be recognized beyond one year due to
    the duration of certain contracts.



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

|                                                                 |  |          |       |  |              |   |       | 
|---------------------------------------------------------------- |  | -------- | ----- |  | ------------ | - | ----- | 
|                                                                 |  | June 30, |       |  | December 31, |  
|                                                                 |  | 2006     |       |  | 2005         |  
|                                                                 |  |          |       |  |              |  
|Pension, post-employment and post-retirement benefit liabilities |  | $        | 2,465 |  |              | $ | 2,459 | 
|Restructuring liabilities (note 6)                               |  |          | 178   |  |              |   | 203   | 
|Deferred revenue                                                 |  |          | 948   |  |              |   | 1,073 | 
|Other long-term provisions                                       |  |          | 239   |  |              |   | 302   | 
|                                                                 |  |          |       |  |              |  
|Other liabilities                                                |  | $        | 3,830 |  |              | $ | 4,037 | 
|                                                                 |  |          |       |  |              |  

14



---



##### Table of Contents



NORTEL NETWORKS LIMITED


Notes to Condensed Consolidated Financial Statements
(unaudited)  (Continued)




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



| |                                            
| | -------------------------------------------
| | Change in operating assets and liabilities:

|                                                      |  |                |        |   |      |   |      |  
|----------------------------------------------------- |  | -------------- | ------ | - | ---- | - | ---- | -
|                                                      |  | Six months     |       
|                                                      |  | ended June 30, |       
|                                                      |  |                |       
|                                                      |  | 2006           |        |   | 2005 |  
|                                                      |  |                |        |   |      |  
|Accounts receivable  net                             |  | $              | (327   | ) |      | $ | (30  | )
|Inventories  net                                     |  |                | (286   | ) |      |   | (162 | )
|Income taxes                                          |  |                | (52    | ) |      |   | (33  | )
|Restructuring liabilities                             |  |                | (9     | ) |      |   | (95  | )
|Accounts payable, payroll and contractual liabilities |  |                | (331   | ) |      |   | (184 | )
|Other operating assets and liabilities                |  |                | (232   | ) |      |   | 130  |  
|                                                      |  |                |        |   |      |  
|Change in operating assets and liabilities            |  | $              | (1,237 | ) |      | $ | (374 | )
|                                                      |  |                |        |   |      |  



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

|                                  |  |                |     |  |      |   |    | 
|--------------------------------- |  | -------------- | --- |  | ---- | - | -- | 
|                                  |  | Six months     |    
|                                  |  | ended June 30, |    
|                                  |  |                |    
|                                  |  | 2006           |     |  | 2005 |  
|                                  |  |                |     |  |      |  
|Cash interest paid                |  | $              | 114 |  |      | $ | 58 | 
|Cash taxes paid (recovered)  net |  | $              | 52  |  |      | $ | 29 | 



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



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







| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Mobility and Converged Core Networks provides mobility
    networking solutions using (i) CDMA solutions and GSM and
    UMTS solutions and (ii) carrier circuit and packet voice
    solutions. 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. In addition,
    Nortels carrier circuit and packet voice solutions provide
    a complete range of voice solutions to its service provider
    customers, including local, toll, long-distance and
    international gateway capabilities using either circuit or
    packet-based switching technologies. These service provider
    customers include local and long distance telephone companies,
    wireless service providers, cable operators and other
    communication service providers.

15



---



##### Table of Contents



NORTEL NETWORKS LIMITED


Notes to Condensed Consolidated Financial Statements
(unaudited)  (Continued)




| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Enterprise Solutions and Packet Networks provides
    (i) enterprise circuit and packet voice solutions,
    (ii) data networking and security solutions and
    (iii) optical networking solutions. Nortels solutions
    for enterprises are used to build new networks and transform
    their existing communications network into a more cost
    effective, packet-based network supporting data, voice and
    multimedia communications. Nortels optical networking and
    carrier data networking and security solutions provide voice,
    data and multimedia communication solutions to its service
    provider customers that operate wireline networks.







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



|                                               |  |                |       |   |                |   |       |      |  |   |       |   |  |   |       |  
|---------------------------------------------- |  | -------------- | ----- | - | -------------- | - | ----- | ---- |  | - | ----- | - |  | - | ----- | -
|                                               |  | Three months   |       |   | Six months     |  
|                                               |  | ended June 30, |       |   | ended June 30, |  
|                                               |  |                |       |   |                |  
|                                               |  | 2006           |       |   | 2005           |   |       | 2006 |  |   | 2005  |  
|                                               |  |                |       |   |                |   |       |      |  |   |       |  
|Revenues                                       |  |                |       |   |                |   |       |      |  |   |       |   |  |   |       |  
|Mobility and Converged Core Networks           |  | $              | 1,591 |   |                | $ | 1,484 |      |  | $ | 3,017 |   |  | $ | 2,970 |  
|Enterprise Solutions and Packet Networks       |  |                | 1,068 |   |                |   | 1,074 |      |  |   | 1,939 |   |  |   | 1,952 |  
|                                               |  |                |       |   |                |   |       |      |  |   |       |  
|Total reportable segments                      |  |                | 2,659 |   |                |   | 2,558 |      |  |   | 4,956 |   |  |   | 4,922 |  
|Other                                          |  |                | 85    |   |                |   | 61    |      |  |   | 170   |   |  |   | 86    |  
|                                               |  |                |       |   |                |   |       |      |  |   |       |  
|Total revenues                                 |  | $              | 2,744 |   |                | $ | 2,619 |      |  | $ | 5,126 |   |  | $ | 5,008 |  
|                                               |  |                |       |   |                |   |       |      |  |   |       |  
|Management EBT                                 |  |                |       |   |                |   |       |      |  |   |       |   |  |   |       |  
|Mobility and Converged Core Networks           |  | $              | 168   |   |                | $ | 170   |      |  | $ | 286   |   |  | $ | 360   |  
|Enterprise Solutions and Packet Networks       |  |                | 19    |   |                |   | 75    |      |  |   | (24   | ) |  |   | 51    |  
|                                               |  |                |       |   |                |   |       |      |  |   |       |  
|Total reportable segments                      |  |                | 187   |   |                |   | 245   |      |  |   | 262   |   |  |   | 411   |  
|Other                                          |  |                | (172  | ) |                |   | (169  | )    |  |   | (365  | ) |  |   | (346  | )
|                                               |  |                |       |   |                |   |       |      |  |   |       |  
|Total Management EBT                           |  |                | 15    |   |                |   | 76    |      |  |   | (103  | ) |  |   | 65    |  
|                                               |  |                |       |   |                |   |       |      |  |   |       |  
|In-process research and development expense    |  |                | (16   | ) |                |   |      |      |  |   | (16   | ) |  |   |      |  
|Amortization of intangibles                    |  |                | (6    | ) |                |   | (2    | )    |  |   | (11   | ) |  |   | (4    | )
|Special charges                                |  |                | (45   | ) |                |   | (92   | )    |  |   | (50   | ) |  |   | (106  | )
|Gain (loss) on sale of businesses and assets   |  |                | (16   | ) |                |   | (11   | )    |  |   | 26    |   |  |   | (33   | )
|Income tax benefit (expense)                   |  |                | (27   | ) |                |   | 9     |      |  |   | (50   | ) |  |   | (6    | )
|                                               |  |                |       |   |                |   |       |      |  |   |       |  
|Net earnings (loss) from continuing operations |  | $              | (95   | ) |                | $ | (20   | )    |  | $ | (204  | ) |  | $ | (84   | )
|                                               |  |                |       |   |                |   |       |      |  |   |       |  

16



---



##### Table of Contents



NORTEL NETWORKS LIMITED


Notes to Condensed Consolidated Financial Statements
(unaudited)  (Continued)






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









17



---



##### Table of Contents



NORTEL NETWORKS LIMITED


Notes to Condensed Consolidated Financial Statements
(unaudited)  (Continued)




|                                                    |                                        |           |    |            |           |   |           |             |   |                 |              |                |      |            |                |      |   |   |    |    |  |   |    |    | 
|--------------------------------------------------- | -------------------------------------- | --------- | -- | ---------- | --------- | - | --------- | ----------- | - | --------------- | ------------ | -------------- | ---- | ---------- | -------------- | ---- | - | - | -- | -- |  | - | -- | -- | 
|                                                    |                                        |           |    |            |           |   |           |             |   | Special Charges |             
|                                                    |                                        |           |    | Contract   |           |   |           |             |   |                 |              |               
|                                                    |                                        |           |    | settlement |           |   | Plant and |             |   |                 | Three months |                |      | Six months |               
|                                                    |                                        | Workforce |    |            | and lease |   |           | equipment   |   |                 |              | ended June 30, |      |            | ended June 30, |     
|                                                    |                                        | reduction |    |            | costs     |   |           | write downs |   | Total           |              |                | 2006 |            |                | 2006 |  
|                                                    |                                        |           |    |            |           |   |           |             |   |                 |              |                |      |            |                |      |  
|2006 Restructuring Plan                             |                                        |           |    |            |           |   |           |             |   |                 |              |                |      |            |                |      |   |   |    |    |  |   |    |   
|Provision balance as of December 31,
    2005(a)    |                                        | $         |   |            |           | $ |          |             |   | $               |             |                |      | $          |               |      |   |   |    |    |  |   |    |   
|                                                    | Other special charges                  |           |    | 43         |           |   |           |            |   |                 |              |               |      |            |                | 43   |   |   | $  | 43 |  |   | $  | 43 | 
|                                                    | Revisions to prior accruals            |           |    |           |           |   |           |            |   |                 |              |               |      |            |                |     |   |   |    |    |  |   |    |    | 
|                                                    | Cash drawdowns                         |           |    | (3         | )         |   |           |            |   |                 |              |               |      |            |                | (3   | ) |   |    |    |  |   |    |    | 
|                                                    | Non-cash drawdowns                     |           |    |           |           |   |           |            |   |                 |              |               |      |            |                |     |   |   |    |    |  |   |    |    | 
|                                                    | Foreign exchange and other adjustments |           |    |           |           |   |           |            |   |                 |              |               |      |            |                |     |   |   |    |    |  |   |    |    | 
|                                                    |                                        |           |    |            |           |   |           |             |   |                 |              |                |      |            |                |      |   |  
|Provision balance as of June 30, 2006               |                                        | $         | 40 |            |           | $ |          |             |   | $               |             |                |      | $          | 40             |      |   |   |    |    |  |   |    |   
|                                                    |                                        |           |    |            |           |   |           |             |   |                 |              |                |      |            |                |      |   |  
|2004 Restructuring Plan                             |                                        |           |    |            |           |   |           |             |   |                 |              |                |      |            |                |      |   |   |    |    |  |   |    |   
|Provision balance as of December 31,
    2005(a)    |                                        | $         | 21 |            |           | $ | 61        |             |   | $               |             |                |      | $          | 82             |      |   |   |    |    |  |   |    |   
|                                                    | Other special charges                  |           |    |           |           |   |           |            |   |                 |              |               |      |            |                |     |   |   |    |    |  |   |    |    | 
|                                                    | Revisions to prior accruals            |           |    | 3          |           |   |           | 4           |   |                 |              |               |      |            |                | 7    |   |   |    | 1  |  |   |    | 7  | 
|                                                    | Cash drawdowns                         |           |    | (17        | )         |   |           | (11         | ) |                 |              |               |      |            |                | (28  | ) |   |    |    |  |   |    |    | 
|                                                    | Non-cash drawdowns                     |           |    |           |           |   |           |            |   |                 |              |               |      |            |                |     |   |   |    |    |  |   |    |    | 
|                                                    | Foreign exchange and other adjustments |           |    |           |           |   |           | 2           |   |                 |              |               |      |            |                | 2    |   |   |    |    |  |   |    |    | 
|                                                    |                                        |           |    |            |           |   |           |             |   |                 |              |                |      |            |                |      |   |  
|Provision balance as of June 30, 2006               |                                        | $         | 7  |            |           | $ | 56        |             |   | $               |             |                |      | $          | 63             |      |   |   |    |    |  |   |    |   
|                                                    |                                        |           |    |            |           |   |           |             |   |                 |              |                |      |            |                |      |   |  
|2001 Restructuring Plan                             |                                        |           |    |            |           |   |           |             |   |                 |              |                |      |            |                |      |   |   |    |    |  |   |    |   
|Provision balance as of December 31,
    2005(a)    |                                        | $         | 3  |            |           | $ | 213       |             |   | $               |             |                |      | $          | 216            |      |   |   |    |    |  |   |    |   
|                                                    | Other special charges                  |           |    |           |           |   |           |            |   |                 |              |               |      |            |                |     |   |   |    |    |  |   |    |    | 
|                                                    | Revisions to prior accruals            |           |    | 1          |           |   |           | (1          | ) |                 |              |               |      |            |                |     |   |   |    | 1  |  |   |    |   | 
|                                                    | Cash drawdowns                         |           |    | (1         | )         |   |           | (32         | ) |                 |              |               |      |            |                | (33  | ) |   |    |    |  |   |    |    | 
|                                                    | Non-cash drawdowns                     |           |    |           |           |   |           |            |   |                 |              |               |      |            |                |     |   |   |    |    |  |   |    |    | 
|                                                    | Foreign exchange and other adjustments |           |    | (1         | )         |   |           | 4           |   |                 |              |               |      |            |                | 3    |   |   |    |    |  |   |    |    | 
|                                                    |                                        |           |    |            |           |   |           |             |   |                 |              |                |      |            |                |      |   |  
|Provision balance as of June 30, 2006               |                                        | $         | 2  |            |           | $ | 184       |             |   | $               |             |                |      | $          | 186            |      |   |   |    |    |  |   |    |   
|                                                    |                                        |           |    |            |           |   |           |             |   |                 |              |                |      |            |                |      |   |  
|Total provision balance as of June 30, 2006
    (a) |                                        | $         | 49 |            |           | $ | 240       |             |   | $               |             |                |      | $          | 289            |      |   |   |    |    |  |   |    |   
|                                                    |                                        |           |    |            |           |   |           |             |   |                 |              |                |      |            |                |      |   |  
|Total special charges                               |                                        |           |    |            |           |   |           |             |   |                 |              |                |      |            |                |      |   | $ | 45 |    |  | $ | 50 |   
|                                                    |                                        |           |    |            |           |   |           |             |   |                 |              |                |      |            |                |      |   |  






|    |  |                                                                                                                                                                                         
|--- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(a) |  | As of June 30, 2006 and December 31, 2005, the
    short-term provision balance was $111 and $95, respectively, and
    the long-term provision balance was $178 and $203, respectively.



18



---



##### Table of Contents



NORTEL NETWORKS LIMITED


Notes to Condensed Consolidated Financial Statements
(unaudited)  (Continued)




| |                        
| | -----------------------
| | 2006 Restructuring Plan



| |                                         
| | ----------------------------------------
| | Three and six months ended June 30, 2006







| |                                     
| | ------------------------------------
| | 2006 Restructuring Plan  by Segment



|                                                             |                                          |           |    |    |       |   |    |    | 
|------------------------------------------------------------ | ---------------------------------------- | --------- | -- | -- | ----- | - | -- | -- | 
|                                                             |                                          | Workforce |    |    |      
|                                                             |                                          | reduction |    |    | Total |  
|                                                             |                                          |           |    |    |       |  
|Mobility and Converged Core Networks                         |                                          |           |    |    |       |   |    |   
|                                                             | For the three months ended June 30, 2006 |           | $  | 27 |       |   | $  | 27 | 
|Enterprise Solutions and Packet Networks                     |                                          |           |    |    |       |   |    |   
|                                                             | For the three months ended June 30, 2006 |           |    | 16 |       |   |    | 16 | 
|Other                                                        |                                          |           |   |    |       |   |   |   
|                                                             |                                          |           |    |    |       |  
|Total special charges for the six months ended June 30, 2006 |                                          | $         | 43 |    |       | $ | 43 |   
|                                                             |                                          |           |    |    |       |  



| |                        
| | -----------------------
| | 2004 Restructuring Plan



| |                                         
| | ----------------------------------------
| | Three and six months ended June 30, 2006









| |                                         
| | ----------------------------------------
| | Three and six months ended June 30, 2005





19



---



##### Table of Contents



NORTEL NETWORKS LIMITED


Notes to Condensed Consolidated Financial Statements
(unaudited)  (Continued)






| |                                     
| | ------------------------------------
| | 2004 Restructuring Plan  by Segment



|                                                             |                                          |                                           |    |            |           |   |           |             |    |   |       |   |   |   |     |   |    | 
|------------------------------------------------------------ | ---------------------------------------- | ----------------------------------------- | -- | ---------- | --------- | - | --------- | ----------- | -- | - | ----- | - | - | - | --- | - | -- | 
|                                                             |                                          |                                           |    | Contract   |           |   |           |             |   
|                                                             |                                          |                                           |    | settlement |           |   | Plant and |             |    |  
|                                                             |                                          | Workforce                                 |    |            | and lease |   |           | equipment   |    |   |      
|                                                             |                                          | reduction                                 |    |            | costs     |   |           | write downs |    |   | Total |  
|                                                             |                                          |                                           |    |            |           |   |           |             |    |   |       |  
|                                                             | Mobility and Converged Core Networks     |                                           |    |            |           |   |           |             |    |   |       |   |   |   |     |   |   
|                                                             |                                          | For the three months ended March 31, 2006 |    | $          | 1         |   |           | $           | 2  |   |       | $ |  |   |     | $ | 3  | 
|                                                             |                                          | For the three months ended June 30, 2006  |    |            | 1         |   |           |             |   |   |       |   |  |   |     |   | 1  | 
|                                                             | Enterprise Solutions and Packet Networks |                                           |    |            |           |   |           |             |    |   |       |   |   |   |     |   |   
|                                                             |                                          | For the three months ended March 31, 2006 |    |            | 1         |   |           |             | 2  |   |       |   |  |   |     |   | 3  | 
|                                                             |                                          | For the three months ended June 30, 2006  |    |            |          |   |           |             |   |   |       |   |  |   |     |   |   | 
|                                                             | Other                                    |                                           |    |           |           |   |           |            |    |   |       |  |   |   |     |  |   
|                                                             |                                          |                                           |    |            |           |   |           |             |    |   |       |  
|Total special charges for the six months ended June 30, 2006 |                                          | $                                         | 3  |            |           | $ | 4         |             |    | $ |      |   |   | $ | 7   |  
|                                                             |                                          |                                           |    |            |           |   |           |             |    |   |       |  
|                                                             | Mobility and Converged Core Networks     |                                           |    |            |           |   |           |             |    |   |       |   |   |   |     |   |   
|                                                             |                                          | For the three months ended March 31, 2005 |    | $          | 11        |   |           | $           | 1  |   |       | $ | 1 |   |     | $ | 13 | 
|                                                             |                                          | For the three months ended June 30, 2005  |    |            | 26        |   |           |             | 30 |   |       |   | 4 |   |     |   | 60 | 
|                                                             | Enterprise Solutions and Packet Networks |                                           |    |            |           |   |           |             |    |   |       |   |   |   |     |   |   
|                                                             |                                          | For the three months ended March 31, 2005 |    |            | 5         |   |           |             | 7  |   |       |   |  |   |     |   | 12 | 
|                                                             |                                          | For the three months ended June 30, 2005  |    |            | 12        |   |           |             | 16 |   |       |   | 1 |   |     |   | 29 | 
|                                                             | Other                                    |                                           |    |           |           |   |           |            |    |   |       |  |   |   |     |  |   
|                                                             |                                          |                                           |    |            |           |   |           |             |    |   |       |  
|Total special charges for the six months ended June 30, 2005 |                                          | $                                         | 54 |            |           | $ | 54        |             |    | $ | 6     |   |   | $ | 114 |  
|                                                             |                                          |                                           |    |            |           |   |           |             |    |   |       |  



| |                        
| | -----------------------
| | 2001 Restructuring Plan



| |                                         
| | ----------------------------------------
| | Three and six months ended June 30, 2006









| |                                         
| | ----------------------------------------
| | Three and six months ended June 30, 2005



20



---



##### Table of Contents



NORTEL NETWORKS LIMITED


Notes to Condensed Consolidated Financial Statements
(unaudited)  (Continued)








|                   |  |               |    |  |                  |   |                 |  |  |                    |     |   |             |   |   |  |  |   |    | 
|------------------ |  | ------------- | -- |  | ---------------- | - | --------------- |  |  | ------------------ | --- | - | ----------- | - | - |  |  | - | -- | 
|                   |  | Accrued       |    |  | Costs during the |   | Payments during |  |  | Adjustments during |     |   | Accrued     |  
|                   |  | balance as of |    |  | six months       |   | the six months  |  |  | the six months     |     |   | balance as  |  
|                   |  | December 31,  |    |  | ended June 30,   |   | ended June 30,  |  |  | ended June 30,     |     |   | of June 30, |  
|                   |  | 2005          |    |  | 2006             |   | 2006            |  |  | 2006               |     |   | 2006        |  
|                   |  |               |    |  |                  |   |                 |  |  |                    |     |   |             |  
|Lease
    costs(a) |  | $             | 25 |  |                  | $ |                |  |  | $                  | (10 | ) |             | $ | 4 |  |  | $ | 19 | 
|                   |  |               |    |  |                  |   |                 |  |  |                    |     |   |             |   |  






|    |  |                                                                                                                                                                                                                          
|--- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(a) |  | Total estimated costs, net of estimated sublease income,
    associated with these accruals are $69, of which $25 was drawn
    down by cash payments of $22 and non-cash adjustments of $3
    prior to January 1, 2006.



| |                                     
| | ------------------------------------
| | 2001 Restructuring Plan  by Segment



|                                                             |                                          |                                           |    |            |           |   |           |             |    |   |       |   |    |   |    |   |     |  
|------------------------------------------------------------ | ---------------------------------------- | ----------------------------------------- | -- | ---------- | --------- | - | --------- | ----------- | -- | - | ----- | - | -- | - | -- | - | --- | -
|                                                             |                                          |                                           |    | Contract   |           |   |           |             |   
|                                                             |                                          |                                           |    | settlement |           |   | Plant and |             |    |  
|                                                             |                                          | Workforce                                 |    |            | and lease |   |           | equipment   |    |   |      
|                                                             |                                          | reduction                                 |    |            | costs     |   |           | write downs |    |   | Total |  
|                                                             |                                          |                                           |    |            |           |   |           |             |    |   |       |  
|                                                             | Mobility and Converged Core Networks     |                                           |    |            |           |   |           |             |    |   |       |   |    |   |    |   |    
|                                                             |                                          | For the three months ended March 31, 2006 |    | $          | 1         |   |           | $           | (1 | ) |       | $ |   |   |    | $ |    |  
|                                                             |                                          | For the three months ended June 30, 2006  |    |            |          |   |           |             |   |   |       |   |   |   |    |   |    |  
|                                                             | Enterprise Solutions and Packet Networks |                                           |    |            |           |   |           |             |    |   |       |   |    |   |    |   |    
|                                                             |                                          | For the three months ended March 31, 2006 |    |            |          |   |           |             | (1 | ) |       |   |   |   |    |   | (1  | )
|                                                             |                                          | For the three months ended June 30, 2006  |    |            |          |   |           |             | 1  |   |       |   |   |   |    |   | 1   |  
|                                                             | Other                                    |                                           |    |           |           |   |           |            |    |   |       |  |    |   |    |  |    
|                                                             |                                          |                                           |    |            |           |   |           |             |    |   |       |  
|Total special charges for the six months ended June 30, 2006 |                                          | $                                         | 1  |            |           | $ | (1        | )           |    | $ |      |   |    | $ |   |  
|                                                             |                                          |                                           |    |            |           |   |           |             |    |   |       |  
|                                                             | Mobility and Converged Core Networks     |                                           |    |            |           |   |           |             |    |   |       |   |    |   |    |   |    
|                                                             |                                          | For the three months ended March 31, 2005 |    | $          | (1        | ) |           | $           |   |   |       | $ |   |   |    | $ | (1  | )
|                                                             |                                          | For the three months ended June 30, 2005  |    |            | (1        | ) |           |             | 1  |   |       |   | 3  |   |    |   | 3   |  
|                                                             | Enterprise Solutions and Packet Networks |                                           |    |            |           |   |           |             |    |   |       |   |    |   |    |   |    
|                                                             |                                          | For the three months ended March 31, 2005 |    |            | (2        | ) |           |             |   |   |       |   | (8 | ) |    |   | (10 | )
|                                                             |                                          | For the three months ended June 30, 2005  |    |            | (1        | ) |           |             |   |   |       |   | 1  |   |    |   |    |  
|                                                             | Other                                    |                                           |    |           |           |   |           |            |    |   |       |  |    |   |    |  |    
|                                                             |                                          |                                           |    |            |           |   |           |             |    |   |       |  
|Total special charges for the six months ended June 30, 2005 |                                          | $                                         | (5 | )          |           | $ | 1         |             |    | $ | (4    | ) |    | $ | (8 | )
|                                                             |                                          |                                           |    |            |           |   |           |             |    |   |       |  



21



---



##### Table of Contents



NORTEL NETWORKS LIMITED


Notes to Condensed Consolidated Financial Statements
(unaudited)  (Continued)




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





















|   |                       
|-- | ----------------------
|8. | Employee benefit plans





22



---



##### Table of Contents



NORTEL NETWORKS LIMITED


Notes to Condensed Consolidated Financial Statements
(unaudited)  (Continued)










|                    |                                                                 |                |    |      |                |   |    |      |   |   |      |      |   |   |     |      |  
|------------------- | --------------------------------------------------------------- | -------------- | -- | ---- | -------------- | - | -- | ---- | - | - | ---- | ---- | - | - | --- | ---- | -
|                    |                                                                 | Three months   |    |      | Six months     |  
|                    |                                                                 | ended June 30, |    |      | ended June 30, |  
|                    |                                                                 |                |    |      |                |  
|                    |                                                                 | 2006           |    |      | 2005           |   |    | 2006 |   |   | 2005 |     
|                    |                                                                 |                |    |      |                |   |    |      |   |   |      |     
|Pension expense:    |                                                                 |                |    |      |                |   |    |      |   |   |      |      |   |   |     |     
|                    | Service cost                                                    |                | $  | 36   |                |   | $  | 30   |   |   | $    | 71   |   |   | $   | 65   |  
|                    | Interest cost                                                   |                |    | 116  |                |   |    | 114  |   |   |      | 229  |   |   |     | 230  |  
|                    | Expected return on plan assets                                  |                |    | (115 | )              |   |    | (107 | ) |   |      | (228 | ) |   |     | (216 | )
|                    | Amortization of prior service cost                              |                |    | 1    |                |   |    | 1    |   |   |      | 2    |   |   |     | 2    |  
|                    | Amortization of net losses (gains)                              |                |    | 32   |                |   |    | 25   |   |   |      | 63   |   |   |     | 48   |  
|                    | Curtailment, contractual and special termination losses (gains) |                |    | 8    |                |   |    | 13   |   |   |      | 9    |   |   |     | 25   |  
|                    |                                                                 |                |    |      |                |   |    |      |   |   |      |     
|Net pension expense |                                                                 | $              | 78 |      |                | $ | 76 |      |   | $ | 146  |      |   | $ | 154 |     
|                    |                                                                 |                |    |      |                |   |    |      |   |   |      |     



|                                 |                                    |                |    |    |                |   |    |      |   |   |      |    |   |   |    |    |  
|-------------------------------- | ---------------------------------- | -------------- | -- | -- | -------------- | - | -- | ---- | - | - | ---- | -- | - | - | -- | -- | -
|                                 |                                    | Three months   |    |    | Six months     |  
|                                 |                                    | ended June 30, |    |    | ended June 30, |  
|                                 |                                    |                |    |    |                |  
|                                 |                                    | 2006           |    |    | 2005           |   |    | 2006 |   |   | 2005 |   
|                                 |                                    |                |    |    |                |   |    |      |   |   |      |   
|Post-retirement benefit cost:    |                                    |                |    |    |                |   |    |      |   |   |      |    |   |   |    |   
|                                 | Service cost                       |                | $  | 3  |                |   | $  | 2    |   |   | $    | 5  |   |   | $  | 4  |  
|                                 | Interest cost                      |                |    | 10 |                |   |    | 11   |   |   |      | 21 |   |   |    | 21 |  
|                                 | Amortization of prior service cost |                |    | (1 | )              |   |    | (1   | ) |   |      | (2 | ) |   |    | (2 | )
|                                 |                                    |                |    |    |                |   |    |      |   |   |      |   
|Net post-retirement benefit cost |                                    | $              | 12 |    |                | $ | 12 |      |   | $ | 24   |    |   | $ | 23 |   
|                                 |                                    |                |    |    |                |   |    |      |   |   |      |   



23



---



##### Table of Contents



NORTEL NETWORKS LIMITED


Notes to Condensed Consolidated Financial Statements
(unaudited)  (Continued)




|   |                                        
|-- | ---------------------------------------
|9. | Acquisitions, divestitures and closures



| |             
| | ------------
| | Acquisitions



| |                     
| | --------------------
| | Tasman Networks Inc.







|                                  |  |   |     | 
|--------------------------------- |  | - | --- | 
|Purchase price                    |  | $ | 99  | 
|                                  |  |   |    
|Assets acquired:                  |  |   |     | 
|Cash and cash equivalents         |  | $ | 1   | 
|Accounts receivable  net         |  |   | 2   | 
|Inventories  net                 |  |   | 1   | 
|Other current assets              |  |   | 1   | 
|Plant and equipment  net         |  |   | 1   | 
|Intangible assets  net           |  |   | 58  | 
|Goodwill                          |  |   | 43  | 
|                                  |  |   |    
|                                  |  |   | 107 | 
|                                  |  |   |    
|Less liabilities assumed:         |  |   |     | 
|Trade and other accounts payable  |  |   | 3   | 
|Other accrued liabilities         |  |   | 5   | 
|                                  |  |   |    
|                                  |  |   | 8   | 
|                                  |  |   |    
|Fair value of net assets acquired |  | $ | 99  | 
|                                  |  |   |    



|                                       |  |            |    |              |                |  |    | 
|-------------------------------------- |  | ---------- | -- | ------------ | -------------- |  | -- | 
|                                       |  |            |    | Amortization |               
|                                       |  | Fair Value |    |              | Period (years) | 
|                                       |  |            |    |              |                | 
|Existing router technology             |  | $          | 19 |              |                |  | 10 | 
|Access router technology               |  |            | 16 |              |                |  | 7  | 
|In-process research and development    |  |            | 16 | (a)          |                |  |   | 
|Non-contractual customer relationships |  |            | 7  |              |                |  | 8  | 
|                                       |  |            |    |              |                | 
|Total intangible assets                |  | $          | 58 |              |                |  |    | 
|                                       |  |            |    |              |                | 






|    |  |                                                                                               
|--- |  | ----------------------------------------------------------------------------------------------
|(a) |  | Nortel expensed $16 for in-process research and development in
    the second quarter of 2006.



24



---



##### Table of Contents



NORTEL NETWORKS LIMITED


Notes to Condensed Consolidated Financial Statements
(unaudited)  (Continued)




| |                                 
| | --------------------------------
| | LG-Nortel Co. Ltd. Joint Venture





| |             
| | ------------
| | Divestitures



| |                         
| | ------------------------
| | Manufacturing operations









|    |                                              
|--- | ---------------------------------------------
|10. | Long-term debt, credit and support facilities

10-Q




| |                
| | ---------------
| | Credit facility



25



---



##### Table of Contents



NORTEL NETWORKS LIMITED


Notes to Condensed Consolidated Financial Statements
(unaudited)  (Continued)












| |                 
| | ----------------
| | Support facility





26



---



##### Table of Contents



NORTEL NETWORKS LIMITED


Notes to Condensed Consolidated Financial Statements
(unaudited)  (Continued)












|    |           
|--- | ----------
|11. | Guarantees





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









27



---



##### Table of Contents



NORTEL NETWORKS LIMITED


Notes to Condensed Consolidated Financial Statements
(unaudited)  (Continued)






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







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







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







|    |                                                                                           
|--- | ------------------------------------------------------------------------------------------
|(e) | Indemnification of lenders and agents under credit
    facilities and EDC Support Facility



28



---



##### Table of Contents



NORTEL NETWORKS LIMITED


Notes to Condensed Consolidated Financial Statements
(unaudited)  (Continued)














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









29



---



##### Table of Contents



NORTEL NETWORKS LIMITED


Notes to Condensed Consolidated Financial Statements
(unaudited)  (Continued)




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



|                                |  |   |      |  
|------------------------------- |  | - | ---- | -
|Balance as of December 31, 2005 |  | $ | 206  |  
|Payments                        |  |   | (140 | )
|Warranties issued               |  |   | 138  |  
|Revisions                       |  |   | 5    |  
|                                |  |   |     
|Balance as of June 30, 2006     |  | $ | 209  |  
|                                |  |   |     



|    |            
|--- | -----------
|12. | Commitments





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





|                                               |  |          |     |  |              |   |     | 
|---------------------------------------------- |  | -------- | --- |  | ------------ | - | --- | 
|                                               |  | June 30, |     |  | December 31, |  
|                                               |  | 2006     |     |  | 2005         |  
|                                               |  |          |     |  |              |  
|Bid and performance related
    bonds(a)       |  | $        | 242 |  |              | $ | 222 | 
|Other
    bonds(b)                             |  |          | 40  |  |              |   | 44  | 
|                                               |  |          |     |  |              |  
|Total bid, performance related and other bonds |  | $        | 282 |  |              | $ | 266 | 
|                                               |  |          |     |  |              |  






|    |                                                                                                                                   
|--- | ----------------------------------------------------------------------------------------------------------------------------------
|(a) | Net of restricted cash and cash equivalent amounts of $25 and
    $36 as of June 30, 2006 and December 31, 2005,
    respectively.
|   
|(b) | Net of restricted cash and cash equivalent amounts of $31 and
    $31 as of June 30, 2006 and December 31, 2005,
    respectively.



| |                          
| | -------------------------
| | Venture capital financing

start-ups




|    |                                                      
|--- | -----------------------------------------------------
|13. | Financing arrangements and variable interest entities



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



30



---



##### Table of Contents



NORTEL NETWORKS LIMITED


Notes to Condensed Consolidated Financial Statements
(unaudited)  (Continued)




|                                   |  |          |     |   |              |   |     |  
|---------------------------------- |  | -------- | --- | - | ------------ | - | --- | -
|                                   |  | June 30, |     |   | December 31, |  
|                                   |  | 2006     |     |   | 2005         |  
|                                   |  |          |     |   |              |  
|Drawn and outstanding  gross      |  | $        | 46  |   |              | $ | 51  |  
|Provisions for doubtful accounts   |  |          | (37 | ) |              |   | (35 | )
|                                   |  |          |     |   |              |  
|Drawn and outstanding 
    net(a) |  |          | 9   |   |              |   | 16  |  
|Undrawn commitments                |  |          | 51  |   |              |   | 50  |  
|                                   |  |          |     |   |              |  
|Total customer financing           |  | $        | 60  |   |              | $ | 66  |  
|                                   |  |          |     |   |              |  






|    |                                                                                                                                                                                                       
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(a) | Included short-term and long-term amounts. Short-term and
    long-term amounts were included in accounts
    receivable  net and other assets, respectively, in
    the consolidated balance sheets.







| |                                            
| | -------------------------------------------
| | Consolidation of variable interest entities











31



---



##### Table of Contents



NORTEL NETWORKS LIMITED


Notes to Condensed Consolidated Financial Statements
(unaudited)  (Continued)




|    |                            
|--- | ---------------------------
|14. | Comprehensive income (loss)



|                                               |                                                                        |              |     |     |            |   |      |      |   |   |      |     |   |   |      |      |  
|---------------------------------------------- | ---------------------------------------------------------------------- | ------------ | --- | --- | ---------- | - | ---- | ---- | - | - | ---- | --- | - | - | ---- | ---- | -
|                                               |                                                                        | Three months |     |     | Six months |  
|                                               |                                                                        | ended        |     |     | ended      |  
|                                               |                                                                        | June 30,     |     |     | June 30,   |  
|                                               |                                                                        |              |     |     |            |  
|                                               |                                                                        | 2006         |     |     | 2005       |   |      | 2006 |   |   | 2005 |    
|                                               |                                                                        |              |     |     |            |   |      |      |   |   |      |    
|Net earnings (loss)                            |                                                                        | $            | (95 | )   |            | $ | (21  | )    |   | $ | (195 | )   |   | $ | (83  | )   
|Other comprehensive income (loss) adjustments: |                                                                        |              |     |     |            |   |      |      |   |   |      |     |   |   |      |     
|                                               | Change in foreign currency translation adjustment                      |              |     | 117 |            |   |      | (94  | ) |   |      | 143 |   |   |      | (162 | )
|                                               | Unrealized gain (loss) on investments 
    net(a)                     |              |     | (34 | )          |   |      | (16  | ) |   |      | (16 | ) |   |      | (23  | )
|                                               | Minimum pension liability adjustment  net                             |              |     |    |            |   |      |     |   |   |      | (1  | ) |   |      | 2    |  
|                                               | Unrealized derivative gain (loss) on cash flow
    hedges 
    net(b) |              |     | 9   |            |   |      | (11  | ) |   |      | 3   |   |   |      | (19  | )
|                                               |                                                                        |              |     |     |            |   |      |      |   |   |      |    
|Comprehensive income (loss)                    |                                                                        | $            | (3  | )   |            | $ | (142 | )    |   | $ | (66  | )   |   | $ | (285 | )   
|                                               |                                                                        |              |     |     |            |   |      |      |   |   |      |    






|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(a) | Certain securities deemed available-for-sale by Nortel were
    measured at fair value. Unrealized holding gains (losses)
    related to these securities were excluded from net earnings
    (loss) and were included in accumulated other comprehensive
    income (loss) until realized. Unrealized gain (loss) on
    investments was net of tax of nil and nil for the three and six
    months ended June 30, 2006 and 2005, respectively.                                                                                              
|   
|(b) | During the three and six months ended June 30, 2006, $5 and
    $9, respectively, of net derivative gains (losses) were
    reclassified to other income  net. During the three
    and six months ended June 30, 2005, $5 and $13,
    respectively, of net derivative gains (losses) were reclassified
    to other income  net. Nortel estimates that $10 of
    net derivative gains (losses) included in accumulated other
    comprehensive income (loss) will be reclassified into net
    earnings (loss) within the next 12 months.



|    |                               
|--- | ------------------------------
|15. | Stock-based compensation plans



| |              
| | -------------
| | Stock options

1 3




32



---



##### Table of Contents



NORTEL NETWORKS LIMITED


Notes to Condensed Consolidated Financial Statements
(unaudited)  (Continued)












| |                                                   
| | --------------------------------------------------
| | Restricted stock units and Performance stock units







33



---



##### Table of Contents



NORTEL NETWORKS LIMITED


Notes to Condensed Consolidated Financial Statements
(unaudited)  (Continued)




|                             |  |             |        |   |               |          |            |             |  |  |     | 
|---------------------------- |  | ----------- | ------ | - | ------------- | -------- | ---------- | ----------- |  |  | --- | 
|                             |  |             |        |   |               | Weighted |           
|                             |  | Outstanding |        |   | Weighted-     |          |            | average     | 
|                             |  | RSU         |        |   | average       |          |            | remaining   | 
|                             |  | awards      |        |   | grant date    |          |            | contractual | 
|                             |  | granted     |        |   | fair value(a) |          |            | life        | 
|                             |  |             |        |   |               |          |            |             | 
|                             |  | (thousands) |        |   |               |          | (in years) |            
|Balance at December 31, 2005 |  |             | 6,897  |   |               | $        | 3.15       |             |  |  | 9.7 | 
|Granted RSU awards           |  |             | 7,310  |   |               | $        | 2.11       |             |  |  |     | 
|Awards exercised             |  |             |       |   |               | $        |           |             |  |  |     | 
|Awards forfeited             |  |             | (100   | ) |               | $        | 2.92       |             |  |  |     | 
|Awards expired               |  |             |       |   |               | $        |           |             |  |  |     | 
|                             |  |             |        |   |               |          |            |             | 
|Balance at June 30, 2006     |  |             | 14,107 |   |               | $        | 2.63       |             |  |  | 9.6 | 
|                             |  |             |        |   |               |          |            |             | 






|    |                                                                                                                                                                                                                 
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(a) | RSU awards do not have an exercise price therefore grant date
    weighted average fair value has been calculated. The grant date
    fair value for the RSU awards is the stock price on the date of
    grant.





|                             |  |             |       |  |               |          |            |             |  |  |      | 
|---------------------------- |  | ----------- | ----- |  | ------------- | -------- | ---------- | ----------- |  |  | ---- | 
|                             |  |             |       |  |               | Weighted |           
|                             |  | Outstanding |       |  | Weighted-     |          |            | average     | 
|                             |  | PSU         |       |  | average       |          |            | remaining   | 
|                             |  | awards      |       |  | grant date    |          |            | contractual | 
|                             |  | granted     |       |  | fair value(a) |          |            | life        | 
|                             |  |             |       |  |               |          |            |             | 
|                             |  | (thousands) |       |  |               |          | (in years) |            
|Balance at December 31, 2005 |  |             |      |  |               | $        |           |             |  |  |      | 
|Granted PSU awards           |  |             | 4,310 |  |               | $        | 2.26       |             |  |  |      | 
|Awards exercised             |  |             |      |  |               | $        |           |             |  |  |      | 
|Awards forfeited             |  |             |      |  |               | $        |           |             |  |  |      | 
|Awards expired               |  |             |      |  |               | $        |           |             |  |  |      | 
|                             |  |             |       |  |               |          |            |             | 
|Balance at June 30, 2006     |  |             | 4,310 |  |               | $        | 2.27       |             |  |  | 10.0 | 
|                             |  |             |       |  |               |          |            |             | 






|    |                                                                                                                                                                                                                             
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(a) | PSU awards do not have an exercise price therefore grant date
    weighted average fair value has been calculated. The grant date
    fair value for the PSU awards was determined using a Monte Carlo
    simulation model.





| |                         
| | ------------------------
| | Stock-based compensation



34



---



##### Table of Contents



NORTEL NETWORKS LIMITED


Notes to Condensed Consolidated Financial Statements
(unaudited)  (Continued)










| |                     
| | --------------------
| | Pro forma disclosure



|                                                                |                                             |          |     |     |          |   |      |     |  
|--------------------------------------------------------------- | ------------------------------------------- | -------- | --- | --- | -------- | - | ---- | --- | -
|                                                                |                                             | Three    |     |     | Six      |  
|                                                                |                                             | months   |     |     | months   |  
|                                                                |                                             | ended    |     |     | ended    |  
|                                                                |                                             | June 30, |     |     | June 30, |  
|                                                                |                                             | 2005     |     |     | 2005     |  
|                                                                |                                             |          |     |     |          |  
|Net earnings (loss) applicable to common shares 
    reported  |                                             | $        | (31 | )   |          | $ | (102 | )  
|                                                                | Stock-based compensation  reported         |          |     | 18  |          |   |      | 36  |  
|                                                                | Stock-based compensation  pro
    forma(a) |          |     | (18 | )        |   |      | (43 | )
|                                                                |                                             |          |     |     |          |  
|Net earnings (loss) applicable to common shares  pro
    forma |                                             | $        | (31 | )   |          | $ | (109 | )  
|                                                                |                                             |          |     |     |          |  






|    |                                                                        
|--- | -----------------------------------------------------------------------
|(a) | Stock-based compensation  pro forma expense was net
    of tax of nil.



35



---



##### Table of Contents



NORTEL NETWORKS LIMITED


Notes to Condensed Consolidated Financial Statements
(unaudited)  (Continued)




|                                                     |                      |              |    |    |            |   |    |      |  |   |      |    |     |   |    |    |  
|---------------------------------------------------- | -------------------- | ------------ | -- | -- | ---------- | - | -- | ---- |  | - | ---- | -- | --- | - | -- | -- | -
|                                                     |                      | Three months |    |    | Six months |  
|                                                     |                      | ended        |    |    | ended      |  
|                                                     |                      | June 30,     |    |    | June 30,   |  
|                                                     |                      |              |    |    |            |  
|                                                     |                      | 2006         |    |    | 2005       |   |    | 2006 |  |   | 2005 |   
|                                                     |                      |              |    |    |            |   |    |      |  |   |      |   
|Stock-based compensation:                            |                      |              |    |    |            |   |    |      |  |   |      |    |     |   |    |   
|                                                     | Stock option expense |              | $  | 27 |            |   | $  | 18   |  |   | $    | 41 | (b) |   | $  | 37 |  
|                                                     | RSU
    expense(a)   |              |    | 1  |            |   |    |     |  |   |      | 3  |     |   |    |   |  
|                                                     | PSU expense          |              |    |   |            |   |    |     |  |   |      |   |     |   |    |   |  
|                                                     | DSU
    expense(a)   |              |    |   |            |   |    |     |  |   |      |   |     |   |    | (1 | )
|                                                     |                      |              |    |    |            |   |    |      |  |   |      |   
|Total stock-based compensation reported  net of tax |                      | $            | 28 |    |            | $ | 18 |      |  | $ | 44   |    |     | $ | 36 |   
|                                                     |                      |              |    |    |            |   |    |      |  |   |      |   






|    |                                                                                                                                                                                                                     
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(a) | Compensation related to employer portion of RSUs and Director
    Stock Units (DSUs) was net of tax of nil in each
    period.                                                                                    
|   
|(b) | Includes a reduction of stock option expense of approximately
    $9, recognized during the first quarter of 2006, to align
    Nortels recognition of stock option forfeitures with the
    adoption of SFAS 123R.



|                                                                |                                      |              |      |       |            |   |      |       |  
|--------------------------------------------------------------- | ------------------------------------ | ------------ | ---- | ----- | ---------- | - | ---- | ----- | -
|                                                                |                                      | Three months |      |       | Six months |  
|                                                                |                                      | ended        |      |       | ended      |  
|                                                                |                                      | June 30,     |      |       | June 30,   |  
|                                                                |                                      |              |      |       |            |  
|                                                                |                                      | 2006         |      |       | 2006       |  
|                                                                |                                      |              |      |       |            |  
|Black-Scholes weighted-average assumptions                      |                                      |              |      |       |            |   |      |      
|                                                                | Expected dividend yield              |              |      | 0.00  | %          |   |      | 0.00  | %
|                                                                | Expected
    volatility(b)           |              |      | 73.99 | %          |   |      | 73.99 | %
|                                                                | Risk-free interest
    rate(c)       |              |      | 5.01  | %          |   |      | 5.01  | %
|                                                                | Expected option life in
    years(a) |              |      | 4     |            |   |      | 4     |  
|Weighted-average stock option fair value per option
    granted |                                      | $            | 1.23 |       |            | $ | 1.23 |      






|    |                                                                                                                                                 
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------
|(a) | The expected term of the options is estimated based on
    historical grants with similar vesting periods.                                      
|   
|(b) | The expected volatility of Nortels stock is estimated
    using the daily historical stock prices over a period equal to
    the expected term.
|   
|(c) | The risk free rate used was the five year government treasury
    bill rate.                                                                    



|                        |                                |              |  |      |            |  |  |      |  
|----------------------- | ------------------------------ | ------------ |  | ---- | ---------- |  |  | ---- | -
|                        |                                | Three Months |  |      | Six Months | 
|                        |                                | ended        |  |      | ended      | 
|                        |                                | June 30,     |  |      | June 30,   | 
|                        |                                |              |  |      |            | 
|                        |                                | 2006         |  |      | 2006       | 
|                        |                                |              |  |      |            | 
|Monte Carlo assumptions |                                |              |  |      |            |  |  |     
|                        | Beta                           |              |  | 2.1  |            |  |  | 2.1  |  
|                        | Risk-free interest
    rate(a) |              |  | 5.13 | %          |  |  | 5.13 | %
|                        | Equity risk premium            |              |  | 5.00 | %          |  |  | 5.00 | %






|    |                                                                              
|--- | -----------------------------------------------------------------------------
|(a) | The risk free rate used was the three year government treasury
    bill rate.





36



---



##### Table of Contents



NORTEL NETWORKS LIMITED


Notes to Condensed Consolidated Financial Statements
(unaudited)  (Continued)












| |                                                    
| | ---------------------------------------------------
| | Suspension of Nortel Stock based compensation plans





|    |                           
|--- | --------------------------
|16. | Related party transactions





|           |                                              |              |    |    |                |   |   |      |  |   |      |     |  |   |   |   | 
|---------- | -------------------------------------------- | ------------ | -- | -- | -------------- | - | - | ---- |  | - | ---- | --- |  | - | - | - | 
|           |                                              | Three months |    |    |               
|           |                                              | ended        |    |    | Six months     |  
|           |                                              | June 30,     |    |    | ended June 30, |  
|           |                                              |              |    |    |                |  
|           |                                              | 2006         |    |    | 2005           |   |   | 2006 |  |   | 2005 |    
|           |                                              |              |    |    |                |   |   |      |  |   |      |    
|Revenues   |                                              | $            | 3  |    |                | $ |  |      |  | $ | 5    |     |  | $ |  |  
|           |                                              |              |    |    |                |   |   |      |  |   |      |    
|Purchases: |                                              |              |    |    |                |   |   |      |  |   |      |     |  |   |   |  
|           | Bookham                                      |              | $  | 9  |                |   | $ | 2    |  |   | $    | 12  |  |   | $ | 6 | 
|           | LG Electronics
    Inc.(a)                   |              |    | 58 |                |   |   |     |  |   |      | 111 |  |   |   |  | 
|           | Sasken Communications Technology
    Ltd.(b) |              |    | 9  |                |   |   | 2    |  |   |      | 17  |  |   |   | 2 | 
|           | Other                                        |              |    | 12 |                |   |   |     |  |   |      | 21  |  |   |   |  | 
|           |                                              |              |    |    |                |   |   |      |  |   |      |    
|Total      |                                              | $            | 88 |    |                | $ | 4 |      |  | $ | 161  |     |  | $ | 8 |  
|           |                                              |              |    |    |                |   |   |      |  |   |      |    






|    |                                                                                                                                                                                                                                                                                                                                  
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(a) | LG holds a minority interest in LG-Nortel. Nortels
    purchases relate primarily to certain inventory related items.
    As of June 30, 2006, accounts payable to LG were $50,
    compared to $18 as at December 31, 2005.                                                                                                    
|   
|(b) | Nortel currently owns a minority interest in Sasken
    Communications Technology Ltd. (Sasken).
    Nortels purchases from Sasken relate primarily to software
    and other software development related purchases. As of
    June 30, 2006, accounts payable to Sasken were $2, compared
    to $2 as at December 31, 2005.

37



---



##### Table of Contents



NORTEL NETWORKS LIMITED


Notes to Condensed Consolidated Financial Statements
(unaudited)  (Continued)




|                            |  |          |     |   |              |   |     |  
|--------------------------- |  | -------- | --- | - | ------------ | - | --- | -
|                            |  | June 30, |     |   | December 31, |  
|                            |  | 2006     |     |   | 2005         |  
|                            |  |          |     |   |              |  
|Consolidated balance sheets |  |          |     |   |              |   |     |  
|Owing from NNC              |  | $        | 755 |   |              | $ | 206 |  
|Owing from NNC subsidiaries |  |          | 115 |   |              |   | 98  |  
|Other related parties       |  |          | (47 | ) |              |   | (18 | )
|                            |  |          |     |   |              |  
|Related party receivables   |  | $        | 823 |   |              | $ | 286 |  
|                            |  |          |     |   |              |  









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



38



---



##### Table of Contents



NORTEL NETWORKS LIMITED


Notes to Condensed Consolidated Financial Statements
(unaudited)  (Continued)
















39



---



##### Table of Contents



NORTEL NETWORKS LIMITED


Notes to Condensed Consolidated Financial Statements
(unaudited)  (Continued)








mark-to




40



---



##### Table of Contents



NORTEL NETWORKS LIMITED


Notes to Condensed Consolidated Financial Statements
(unaudited)  (Continued)












41



---



##### Table of Contents



NORTEL NETWORKS LIMITED


Notes to Condensed Consolidated Financial Statements
(unaudited)  (Continued)










42



---



##### Table of Contents



NORTEL NETWORKS LIMITED


Notes to Condensed Consolidated Financial Statements
(unaudited)  (Continued)








| |                      
| | ---------------------
| | Environmental matters









de minimis de minimis de
minimis




43



---



##### Table of Contents



NORTEL NETWORKS LIMITED


Notes to Condensed Consolidated Financial Statements
(unaudited)  (Continued)






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



| |                      
| | ---------------------
| | Senior notes offering













44



---



##### Table of Contents



NORTEL NETWORKS LIMITED


Notes to Condensed Consolidated Financial Statements
(unaudited)  (Continued)








45



---



##### Table of Contents








|        |                                                                                                                  
|------- | -----------------------------------------------------------------------------------------------------------------
|ITEM 2. | MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL
    CONDITION AND RESULTS OF OPERATIONS  TABLE OF
    CONTENTS

|                                                   |                                                                                      |                                                        |    |    |    | 
|-------------------------------------------------- | ------------------------------------------------------------------------------------ | ------------------------------------------------------ | -- | -- | -- | 
|Business Overview                                  |                                                                                      |                                                        | 48 |   
|                                                   | Our Business                                                                         |                                                        |    | 48 |   
|                                                   | Our Segments                                                                         |                                                        |    | 48 |   
|                                                   | How We Measure Performance                                                           |                                                        |    | 49 |   
|                                                   | Our Strategy                                                                         |                                                        |    | 49 |   
|Developments in 2006                               |                                                                                      |                                                        | 50 |   
|                                                   | Consolidated Results Summary                                                         |                                                        |    | 50 |   
|                                                   | Significant Business Developments                                                    |                                                        |    | 51 |   
|                                                   |                                                                                      | Credit Facility and Senior Notes                       |    |    | 51 | 
|                                                   |                                                                                      | 2006 Restructuring and Pension Plan Changes            |    |    | 52 | 
|                                                   |                                                                                      | Global Class Action Settlement                         |    |    | 52 | 
|                                                   |                                                                                      | Acquisitions                                           |    |    | 52 | 
|                                                   |                                                                                      | Evolution of Our Supply Chain Strategy                 |    |    | 52 | 
|                                                   |                                                                                      | Microsoft Alliance                                     |    |    | 53 | 
|Restatements; Material Weaknesses; Related Matters |                                                                                      |                                                        | 53 |   
|                                                   | First and Second Restatements, Independent Review and Revenue
    Independent Review |                                                        |    | 53 |   
|                                                   | Material Weaknesses in Internal Control over Financial Reporting                     |                                                        |    | 53 |   
|                                                   | Third Restatement                                                                    |                                                        |    | 54 |   
|                                                   | Third Restatement Impacts                                                            |                                                        |    | 55 |   
|                                                   | Regulatory Actions                                                                   |                                                        |    | 55 |   
|Results of Operations  Continuing Operations      |                                                                                      |                                                        | 56 |   
|                                                   | Consolidated Information                                                             |                                                        |    | 56 |   
|                                                   |                                                                                      | Revenues                                               |    |    | 56 | 
|                                                   |                                                                                      | Geographic Revenues                                    |    |    | 58 | 
|                                                   | Gross Profit and Gross Margin                                                        |                                                        |    | 59 |   
|                                                   | Operating Expenses                                                                   |                                                        |    | 59 |   
|                                                   |                                                                                      | Selling, General and Administrative Expense            |    |    | 59 | 
|                                                   |                                                                                      | Research and Development Expense                       |    |    | 59 | 
|                                                   |                                                                                      | Special Charges                                        |    |    | 60 | 
|                                                   | (Gain) Loss on Sale of Businesses and Assets                                         |                                                        |    | 62 |   
|                                                   | Other Income  Net                                                                   |                                                        |    | 62 |   
|                                                   | Interest Expense                                                                     |                                                        |    | 63 |   
|                                                   | Income Tax Benefit (Expense)                                                         |                                                        |    | 63 |   
|                                                   | Segment Information                                                                  |                                                        |    | 64 |   
|                                                   |                                                                                      | Mobility and Converged Core Networks                   |    |    | 65 | 
|                                                   |                                                                                      | Enterprise Solutions and Packet Networks               |    |    | 66 | 
|                                                   |                                                                                      | Other                                                  |    |    | 67 | 
|Liquidity and Capital Resources                    |                                                                                      |                                                        | 68 |   
|                                                   | Cash Flow                                                                            |                                                        |    | 68 |   
|                                                   |                                                                                      | Operating activities                                   |    |    | 68 | 
|                                                   |                                                                                      | Investing activities                                   |    |    | 70 | 
|                                                   |                                                                                      | Financing activities                                   |    |    | 70 | 
|                                                   |                                                                                      | Credit Facility and Senior Notes                       |    |    | 70 | 
|                                                   | Future Uses and Sources of Liquidity                                                 |                                                        |    | 71 |   
|                                                   | Future Uses of Liquidity                                                             |                                                        |    | 71 |   
|                                                   |                                                                                      | Contractual cash obligations                           |    |    | 72 | 
|                                                   |                                                                                      | Customer financing                                     |    |    | 72 | 
|                                                   | Future Sources of Liquidity                                                          |                                                        |    | 72 |   
|                                                   |                                                                                      | Available support facility                             |    |    | 73 | 
|                                                   |                                                                                      | Shelf registration statement and base shelf prospectus |    |    | 73 | 
|                                                   | Credit Ratings                                                                       |                                                        |    | 74 |   
|Off-Balance Sheet Arrangements                     |                                                                                      |                                                        | 74 |   
|                                                   | Bid, Performance Related and Other Bonds                                             |                                                        |    | 74 |   
|                                                   | Receivables Securitization and Certain Variable Interest
    Transactions            |                                                        |    | 75 |   

46



---



##### Table of Contents



|                                                          |                                   |  |    |    | 
|--------------------------------------------------------- | --------------------------------- |  | -- | -- | 
|Application of Critical Accounting Policies and Estimates |                                   |  | 75 |   
|                                                          | Provisions for Doubtful Accounts  |  |    | 76 | 
|                                                          | Provisions for Inventory          |  |    | 76 | 
|                                                          | Provisions for Product Warranties |  |    | 77 | 
|                                                          | Tax Asset Valuation               |  |    | 77 | 
|                                                          | Goodwill Valuation                |  |    | 78 | 
|                                                          | Special Charges                   |  |    | 78 | 
|Accounting Changes and Recent Accounting Pronouncements   |                                   |  | 79 |   
|                                                          | Accounting Changes                |  |    | 79 | 
|                                                          | Recent Accounting Pronouncements  |  |    | 80 | 
|Outstanding Share Data                                    |                                   |  | 80 |   
|Market Risk                                               |                                   |  | 80 |   
|Equity Price Risk                                         |                                   |  | 81 |   
|Environmental Matters                                     |                                   |  | 81 |   
|Legal Proceedings                                         |                                   |  | 81 |   
|Cautionary Notice Regarding Forward Looking Information   |                                   |  | 81 |   

47



---



##### Table of Contents



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 Operations, or
MD&A, in combination with the accompanying unaudited
condensed consolidated financial statements, or unaudited
financial statements, prepared in accordance with accounting
principles generally accepted in the United States, or
U.S. GAAP.


Certain statements in this MD&A contain words such as
could, expects, may,
anticipates, believes,
intends, estimates, plans,
envisions, seeks and other similar
language and are considered forward-looking statements or
information under applicable securities laws. These statements
are based on our current expectations, estimates, forecasts and
projections about the operating environment, economies and
markets in which we operate. These statements are subject to
important assumptions, risks and uncertainties, which are
difficult to predict and the actual outcome may be materially
different. Although we believe expectations reflected in such
forward-looking statements are reasonable based upon the
assumptions in this MD&A, they may prove to be inaccurate
and consequently our actual results could differ materially from
our expectations set out in this MD&A. In particular, the
risk factors described in the Risk Factors section
of this report, and in our Annual Report on
Form 10-K for the
year ended December 31, 2005, or
2005 10-K, and our
current report on
Form 8-K dated
June 16, 2006, or 2006
Form 8-K, or 2006
Form 8-K and
2005 10-K together
the 2005 Annual Report, and our Quarterly Report on
Form 10-Q for the
quarter ended March 31, 2006, or the 2006 First Quarter
Report, could cause actual results or events to differ
materially from those contemplated in forward-looking
statements. Reference is also made to the Cautionary
Notice Regarding Forward Looking Information below. Unless
required by applicable securities laws, we disclaim any
intention or obligation to publicly update or revise any
forward-looking statements, whether as a result of new
information, future events or otherwise.


Where we say we, us, our,
NNL, 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. All dollar amounts in this
MD&A are in millions of United States, or U.S., dollars
unless otherwise stated. Certain 2005 amounts are presented on a
restated basis as described under Restatements; Material
Weaknesses; Related Matters  Third Restatement,
and reclassified to conform to our new segments unless otherwise
stated. Restated amounts presented herein are consistent with
those disclosed in our 2005 Annual Report.


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.


Business Overview


Our Business




Our Segments




48



---



##### Table of Contents









| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | MCCN provides mobility networking solutions using CDMA
    solutions, GSM and UMTS solutions and carrier circuit and packet
    voice solutions. 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. In addition, our
    carrier circuit and packet voice solutions provide a broad range
    of voice solutions to our service provider customers in this
    segment, including local, toll, long-distance and international
    gateway capabilities using either circuit or packet-based
    switching technologies. Our service provider customers include
    local and long distance telephone companies, wireless service
    providers, cable operators and other communication service
    providers.
| |  | ESPN provides enterprise circuit and packet voice solutions,
    data networking and security solutions and optical networking
    solutions. Our solutions for enterprises are used to build new
    networks by customers who want to transform their existing
    communications networks into more cost effective, packet-based
    networks supporting data, voice and multimedia communications.
    Our optical and data networking solutions efficiently transform
    our enterprise and carrier customers networks to be more
    scaleable and reliable for the high speed delivery of diverse
    multi-media communications services.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                

How We Measure Performance




Our Strategy










49



---



##### Table of Contents







end-to




Developments in 2006


Consolidated Results Summary




|                                               |                                             |                            |       |     |                          |  |      |          |  |   |          |     |  |          |      |      |          |   |       |          |  |  |          |      |  |   |       |       |  |  |      |      | 
|---------------------------------------------- | ------------------------------------------- | -------------------------- | ----- | --- | ------------------------ |  | ---- | -------- |  | - | -------- | --- |  | -------- | ---- | ---- | -------- | - | ----- | -------- |  |  | -------- | ---- |  | - | ----- | ----- |  |  | ---- | ---- | 
|                                               |                                             | For the Three Months Ended |       |     | For the Six Months Ended | 
|                                               |                                             |                            |       |     |                          | 
|                                               |                                             | June 30,                   |       |     | % of                     |  |      | June 30, |  |   | % of     |     |  | June 30, |      |      | % of     |   |       | June 30, |  |  | % of     |     
|                                               |                                             | 2006                       |       |     | Revenues                 |  |      | 2005     |  |   | Revenues |     |  | 2006     |      |      | Revenues |   |       | 2005     |  |  | Revenues |     
|                                               |                                             |                            |       |     |                          |  |      |          |  |   |          |     |  |          |      |      |          |   |       |          |  |  |          |     
|Revenues                                       |                                             | $                          | 2,744 |     |                          |  |      |          |  | $ | 2,619    |     |  |          |      |      |          | $ | 5,126 |          |  |  |          |      |  | $ | 5,008 |       |  |  |      |     
|Gross profit                                   |                                             |                            | 1,066 |     |                          |  | 38.8 |          |  |   | 1,104    |     |  |          | 42.2 |      |          |   | 1,975 |          |  |  | 38.5     |      |  |   | 2,118 |       |  |  | 42.3 |     
|Operating expenses                             |                                             |                            |       |     |                          |  |      |          |  |   |          |     |  |          |      |      |          |   |       |          |  |  |          |      |  |   |       |       |  |  |      |     
|                                               | Selling, general and administrative expense |                            |       | 594 |                          |  |      | 21.6     |  |   |          | 585 |  |          |      | 22.3 |          |   |       | 1,188    |  |  |          | 23.2 |  |   |       | 1,159 |  |  |      | 23.1 | 
|                                               | Research and development expense            |                            |       | 484 |                          |  |      | 17.6     |  |   |          | 483 |  |          |      | 18.4 |          |   |       | 958      |  |  |          | 18.7 |  |   |       | 954   |  |  |      | 19.0 | 
|                                               | Special charges                             |                            |       | 45  |                          |  |      | 1.6      |  |   |          | 92  |  |          |      | 3.5  |          |   |       | 50       |  |  |          | 1.0  |  |   |       | 106   |  |  |      | 2.1  | 
|Gain (loss) on sale of businesses and assets   |                                             |                            | (16   | )   |                          |  | (0.6 | )        |  |   | (11      | )   |  |          | (0.4 | )    |          |   | 26    |          |  |  | 0.5      |      |  |   | (33   | )     |  |  | (0.7 | )   
|Operating earnings (loss)                      |                                             |                            | (95   | )   |                          |  | (3.5 | )        |  |   | (69      | )   |  |          | (2.6 | )    |          |   | (222  | )        |  |  | (4.3     | )    |  |   | (138  | )     |  |  | (2.8 | )   
|Other income  net                             |                                             |                            | 53    |     |                          |  | 1.9  |          |  |   | 77       |     |  |          | 2.9  |      |          |   | 123   |          |  |  | 2.4      |      |  |   | 132   |       |  |  | 2.6  |     
|Interest expense                               |                                             |                            | 38    |     |                          |  | 1.4  |          |  |   | 30       |     |  |          | 1.1  |      |          |   | 86    |          |  |  | 1.7      |      |  |   | 61    |       |  |  | 1.2  |     
|Income tax benefit (expense)                   |                                             |                            | (27   | )   |                          |  | (1.0 | )        |  |   | 9        |     |  |          | 0.3  |      |          |   | (50   | )        |  |  | (1.0     | )    |  |   | (6    | )     |  |  | (0.1 | )   
|Net earnings (loss) from continuing operations |                                             |                            | (95   | )   |                          |  | (3.5 | )        |  |   | (20      | )   |  |          | (0.8 | )    |          |   | (204  | )        |  |  | (4.0     | )    |  |   | (84   | )     |  |  | (1.7 | )   
|Net earnings (loss)                            |                                             | $                          | (95   | )   |                          |  | (3.5 | )        |  | $ | (21      | )   |  |          | (0.8 | )    |          | $ | (195  | )        |  |  | (3.8     | )    |  | $ | (83   | )     |  |  | (1.7 | )   
|                                               |                                             |                            |       |     |                          |  |      |          |  |   |          |     |  |          |      |      |          |   |       |          |  |  |          |     





50



---



##### Table of Contents













Significant Business Developments




| |                                 
| | --------------------------------
| | Credit Facility and Senior Notes









51



---



##### Table of Contents





| |                                            
| | -------------------------------------------
| | 2006 Restructuring and Pension Plan Changes





| |                               
| | ------------------------------
| | Global Class Action Settlement











| |             
| | ------------
| | Acquisitions





| |                                       
| | --------------------------------------
| | Evolution of Our Supply Chain Strategy



52



---



##### Table of Contents









| |                   
| | ------------------
| | Microsoft Alliance

go-to


Restatements; Material Weaknesses; Related Matters


First and Second Restatements, Independent Review and Revenue
Independent Review


10-K


10-K.


Material Weaknesses in Internal Control over Financial
Reporting






| |   |                                                                                                                                                                                                                                                                                                                                                                                                                           
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | 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 Statement of Financial
    Accounting Standards, or 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;                                                                                                                                                       

53



---



##### Table of Contents



| |   |                                                                                                                                                                                                                                                                                 
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | 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; and
| |  | lack of sufficient awareness of, and timely and appropriate
    remediation of, internal control issues by Nortel personnel.                                                                                                                                                    



Third Restatement




percentage-of




| |   |                                                                                                                                                                                                                                                                                                                                                                                                         
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Certain complex arrangements with multiple deliverables were
    previously fully accounted for under the percentage of
    completion method of SOP 81-1, but elements outside of the
    scope of SOP 81-1 should have been examined for separation
    under the guidance in Emerging Issues Task Force, or EITF, Issue
    No. 00-21,
    Revenue Arrangements with Multiple
    Deliverables; and
| |  | Certain complex arrangements accounted for under the
    percentage-of-completion
    method did not meet the criteria for this treatment in
    SOP 81-1 and should instead have been accounted for using
    completed contract accounting under SOP 81-1.                                                                                                                                            

10-K/A


54



---



##### Table of Contents





|                                                                          |  |                    |       |   |                  |   |       |  
|------------------------------------------------------------------------- |  | ------------------ | ----- | - | ---------------- | - | ----- | -
|                                                                          |  | Three months ended |       |   | Six months ended |  
|                                                                          |  | June 30, 2005      |       |   | June 30, 2005    |  
|                                                                          |  |                    |       |   |                  |  
|Revenues  as previously reported                                         |  | $                  | 2,855 |   |                  | $ | 5,391 |  
|Adjustments:                                                              |  |                    |       |   |                  |   |       |  
|Application of SOP 81-1                                                   |  |                    | (23   | ) |                  |   | 59    |  
|Interaction between multiple revenue recognition accounting
    standards |  |                    | (155  | ) |                  |   | (338  | )
|Application of SAB 104 and SOP 97-2                                       |  |                    | (45   | ) |                  |   | (98   | )
|Other revenue recognition adjustments                                     |  |                    | (13   | ) |                  |   | (6    | )
|                                                                          |  |                    |       |   |                  |  
|Revenues  as restated                                                    |  | $                  | 2,619 |   |                  | $ | 5,008 |  
|                                                                          |  |                    |       |   |                  |  
|Net earnings (loss)  as previously reported                              |  | $                  | 57    |   |                  | $ | 50    |  
|Adjustments:                                                              |  |                    |       |   |                  |   |       |  
|Application of SOP 81-1                                                   |  |                    | (12   | ) |                  |   | (3    | )
|Interaction between multiple revenue recognition accounting
    standards |  |                    | (12   | ) |                  |   | (38   | )
|Application of SAB 104 and SOP 97-2                                       |  |                    | (25   | ) |                  |   | (51   | )
|Other revenue recognition adjustments                                     |  |                    | (50   | ) |                  |   | (53   | )
|(Gain) loss on sale of businesses                                         |  |                    | 25    |   |                  |   | 4     |  
|Foreign
    exchange(a)                                                   |  |                    | 11    |   |                  |   | 13    |  
|Other                                                                     |  |                    | (15   | ) |                  |   | (5    | )
|                                                                          |  |                    |       |   |                  |  
|Net earnings (loss)  as restated                                         |  | $                  | (21   | ) |                  | $ | (83   | )
|                                                                          |  |                    |       |   |                  |  






|    |                                                                                                                                                                
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------
|(a) | Includes the foreign exchange gains and losses resulting from
    the Third Restatement adjustments, and the correction of certain
    foreign exchange errors.





| |                          
| | -------------------------
| | Third Restatement Impacts

10-K/A




| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | we were in breach of the continued listing requirements of the
    NYSE and TSX and were not in compliance with our obligations to
    deliver our respective SEC filings to the trustees under our
    public debt indentures. With the filing of the 2006 First
    Quarter Reports with the SEC and the delivery of the 2006 First
    Quarter Reports to the trustees under our and NNCs public
    debt indentures, we and NNC became compliant with these delivery
    obligations;
| |  | we entered into an amendment and waiver with the lenders under
    the 2006 Credit Facility and with Export Development Canada, or
    EDC, under our $750 support facility, or the EDC Support
    Facility, which, among other things, waived the events of
    default that had occurred under the facilities;                                                                                                                                                                         
| |  | as of March 10, 2006, we suspended the grant of any new
    equity and exercise or settlement of previously outstanding
    awards under certain equity and stock option compensation plans.
    Upon our becoming current with U.S. and Canadian regulatory
    securities filing requirements upon the filing of the 2006 First
    Quarter Reports we lifted those suspensions;                                                                                                        
| |  | our Annual Shareholders Meeting was postponed to
    June 29, 2006; and                                                                                                                                                                                                                                                                                                                                                                                                                  
| |  | the Ontario Securities Commission, or OSC, issued a final order
    on April 10, 2006 prohibiting all trading by our directors,
    officers and certain current and former employees in our and
    NNCs securities which was revoked upon us and NNC becoming
    current with our financial reporting obligations for the first
    quarter of 2006 under Ontario securities laws.                                                                                                    

Regulatory Actions




55



---



##### Table of Contents







Results of Operations  Continuing Operations


Consolidated Information




| |         
| | --------
| | Revenues



| |                                        
| | ---------------------------------------
| | Demand Trends for Our Network Solutions



|                                         |          |                                               |       |    |      |   |       |        |                |   |        |    |     |      |    |    |      |   |       |        |       |   |        |    |       |   |     |    |     |   |    |    |     |  
|---------------------------------------- | -------- | --------------------------------------------- | ----- | -- | ---- | - | ----- | ------ | -------------- | - | ------ | -- | --- | ---- | -- | -- | ---- | - | ----- | ------ | ----- | - | ------ | -- | ----- | - | --- | -- | --- | - | -- | -- | --- | -
|                                         |          | For the                                       |       |    |      |   |       |        | For the        |   |        |    |     |     
|                                         |          | Three Months                                  |       |    |      |   |       |        | Six Months     |   |        |    |     |     
|                                         |          | Ended June 30,                                |       |    |      |   |       |        | Ended June 30, |   |        |    |     |     
|                                         |          |                                               |       |    | $    |   |       | %      |                |   |        |    |     | $    |    |    | %    |  
|                                         |          | 2006                                          |       |    | 2005 |   |       | Change |                |   | Change |    |     | 2006 |    |    | 2005 |   |       | Change |       |   | Change |   
|                                         |          |                                               |       |    |      |   |       |        |                |   |        |    |     |      |    |    |      |   |       |        |       |   |        |   
|Mobility and Converged Core Networks     |          |                                               |       |    |      |   |       |        |                |   |        |    |     |      |    |    |      |   |       |        |       |   |        |    |       |   |     |    |     |   |    |   
|                                         |          | CDMA solutions                                |       | $  | 588  |   |       | $      | 620            |   |        | $  | (32 | )    |    |    | (5   | ) |       | $      | 1,102 |   |        | $  | 1,154 |   |     | $  | (52 | ) |    |    | (5  | )
|                                         |          | GSM and UMTS solutions                        |       |    | 723  |   |       |        | 565            |   |        |    | 158 |      |    |    | 28   |   |       |        | 1,356 |   |        |    | 1,278 |   |     |    | 78  |   |    |    | 6   |  
|                                         |          | Circuit and packet voice solutions            |       |    | 280  |   |       |        | 299            |   |        |    | (19 | )    |    |    | (6   | ) |       |        | 559   |   |        |    | 538   |   |     |    | 21  |   |    |    | 4   |  
|                                         |          |                                               |       |    |      |   |       |        |                |   |        |    |     |      |    |    |      |   |       |        |       |   |        |   
|                                         |          |                                               | 1,591 |    |      |   | 1,484 |        |                |   | 107    |    |     |      | 7  |    |      |   | 3,017 |        |       |   | 2,970  |    |       |   | 47  |    |     |   | 2  |   
|Enterprise Solutions and Packet Networks |          |                                               |       |    |      |   |       |        |                |   |        |    |     |      |    |    |      |   |       |        |       |   |        |    |       |   |     |    |     |   |    |   
|                                         |          | Circuit and packet voice solutions            |       |    | 361  |   |       |        | 459            |   |        |    | (98 | )    |    |    | (21  | ) |       |        | 700   |   |        |    | 781   |   |     |    | (81 | ) |    |    | (10 | )
|                                         |          | Optical networking solutions                  |       |    | 326  |   |       |        | 304            |   |        |    | 22  |      |    |    | 7    |   |       |        | 576   |   |        |    | 541   |   |     |    | 35  |   |    |    | 6   |  
|                                         |          | Data networking and security
    solutions(a) |       |    | 381  |   |       |        | 311            |   |        |    | 70  |      |    |    | 23   |   |       |        | 663   |   |        |    | 630   |   |     |    | 33  |   |    |    | 5   |  
|                                         |          |                                               |       |    |      |   |       |        |                |   |        |    |     |      |    |    |      |   |       |        |       |   |        |   
|                                         |          |                                               | 1,068 |    |      |   | 1,074 |        |                |   | (6     | )  |     |      | (1 | )  |      |   | 1,939 |        |       |   | 1,952  |    |       |   | (13 | )  |     |   | (1 | ) 
|                                         | Other(b) |                                               |       | 85 |      |   |       | 61     |                |   |        | 24 |     |      |    | 39 |      |   |       | 170    |       |   |        | 86 |       |   |     | 84 |     |   |    | 98 |    
|                                         |          |                                               |       |    |      |   |       |        |                |   |        |    |     |      |    |    |      |   |       |        |       |   |        |   
|Total                                    |          | $                                             | 2,744 |    |      | $ | 2,619 |        |                | $ | 125    |    |     |      | 5  |    |      | $ | 5,126 |        |       | $ | 5,008  |    |       | $ | 118 |    |     |   | 2  |   
|                                         |          |                                               |       |    |      |   |       |        |                |   |        |    |     |      |    |    |      |   |       |        |       |   |        |   






|    |                                                                                                                                                                                                                             
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(a) | Includes revenue from our enterprise customers of $186 and $194
    for the three months ended June 30, 2006 and 2005,
    respectively, and $357 and $395 of revenue for the first half of
    2006 and 2005, respectively.
|   
|(b) | Other includes our revenues from NGS, which we acquired in June
    2005, and various other network solutions and miscellaneous
    business activities and corporate functions.                                            





| |                                     
| | ------------------------------------
| | Mobility and Converged Core Networks



| |               
| | --------------
| | CDMA Solutions



56



---



##### Table of Contents





| |                       
| | ----------------------
| | GSM and UMTS Solutions







| |                                   
| | ----------------------------------
| | Circuit and Packet Voice Solutions







| |                                         
| | ----------------------------------------
| | Enterprise Solutions and Packet Networks



| |                                   
| | ----------------------------------
| | Circuit and Packet Voice Solutions





| |                             
| | ----------------------------
| | Optical Networking Solutions





| |                                       
| | --------------------------------------
| | Data Networking and Security Solutions



57



---



##### Table of Contents





| |                    
| | -------------------
| | Geographic Revenues



|              |  |                |       |  |      |   |       |          |                |   |          |   |  |      |     |   |      |   |       |          |  |   |          |  |  |   |      |   |  |  |     |  
|------------- |  | -------------- | ----- |  | ---- | - | ----- | -------- | -------------- | - | -------- | - |  | ---- | --- | - | ---- | - | ----- | -------- |  | - | -------- |  |  | - | ---- | - |  |  | --- | -
|              |  | For the        |       |  |      |   |       |          | For the        |   |          |   |  |     
|              |  | Three Months   |       |  |      |   |       |          | Six Months     |   |          |   |  |     
|              |  | Ended June 30, |       |  |      |   |       |          | Ended June 30, |   |          |   |  |     
|              |  |                |       |  |      |   |       |          |                |   |          |   |  |     
|              |  | 2006           |       |  | 2005 |   |       | $ Change |                |   | % Change |   |  | 2006 |     |   | 2005 |   |       | $ Change |  |   | % Change | 
|              |  |                |       |  |      |   |       |          |                |   |          |   |  |      |     |   |      |   |       |          |  |   |          | 
|United States |  | $              | 1,114 |  |      | $ | 1,371 |          |                | $ | (257     | ) |  |      | (19 | ) |      | $ | 2,246 |          |  | $ | 2,590    |  |  | $ | (344 | ) |  |  | (13 | )
|EMEA          |  |                | 894   |  |      |   | 666   |          |                |   | 228      |   |  |      | 34  |   |      |   | 1,525 |          |  |   | 1,339    |  |  |   | 186  |   |  |  | 14  |  
|Canada        |  |                | 139   |  |      |   | 168   |          |                |   | (29      | ) |  |      | (17 | ) |      |   | 298   |          |  |   | 280      |  |  |   | 18   |   |  |  | 6   |  
|Asia          |  |                | 449   |  |      |   | 284   |          |                |   | 165      |   |  |      | 58  |   |      |   | 750   |          |  |   | 548      |  |  |   | 202  |   |  |  | 37  |  
|CALA(a)       |  |                | 148   |  |      |   | 130   |          |                |   | 18       |   |  |      | 14  |   |      |   | 307   |          |  |   | 251      |  |  |   | 56   |   |  |  | 22  |  
|              |  |                |       |  |      |   |       |          |                |   |          |   |  |      |     |   |      |   |       |          |  |   |          | 
|Consolidated  |  | $              | 2,744 |  |      | $ | 2,619 |          |                | $ | 125      |   |  |      | 5   |   |      | $ | 5,126 |          |  | $ | 5,008    |  |  | $ | 118  |   |  |  | 2   |  
|              |  |                |       |  |      |   |       |          |                |   |          |   |  |      |     |   |      |   |       |          |  |   |          | 






|    |                                              
|--- | ---------------------------------------------
|(a) | Caribbean and Latin America, or CALA, region.







| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                            
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | 19% decrease in revenues in the U.S. primarily due to
    significant declines in CDMA solutions, and substantial declines
    in enterprise circuit and packet voice solutions and GSM and
    UMTS solutions. These declines were partially offset by revenues
    related to our acquisition of NGS.                                                                                                                                                    
| |  | 34% increase in revenues in EMEA primarily due to a substantial
    increase in GSM and UMTS solutions revenues as a result of the
    recognition of previously deferred revenues due to a contract
    renegotiation and substantial increases in CDMA solutions and
    data networking and security solutions as a result of revenue
    recognized on the delivery of software upgrades, partially
    offset by price erosion and shipment deferrals.
| |  | 17% decrease in revenues in Canada primarily due to a
    substantial decline in CDMA revenues due to a decrease in
    volumes, and declines in our ESPN portfolio primarily related to
    reductions in data networking and security solutions and
    enterprise circuit and packet voice solutions.                                                                                                                                                   
| |  | 58% increase in revenues in Asia due to substantial growth
    across most product portfolios including optical networking and
    GSM solutions which were positively impacted by the recognition
    of revenue previously deferred due to software deliveries and
    the impact of the consolidation of the LG-Nortel joint venture.                                                                                                                   
| |  | 14% increase in revenues in CALA primarily due to substantial
    increases in GSM solutions and CDMA networking solutions due to
    new customer contracts and existing customer network expansion,
    partially offset by decreases in the ESPN portfolio due to
    volume decreases and local political and business events.                                                                                                                         





| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | 13% decrease in revenues in the U.S. primarily due to
    substantial declines in GSM and UMTS solutions and enterprise
    circuit and packet voice solutions and a significant decline in
    CDMA solutions. These declines were partially offset by revenues
    related to our acquisition of NGS.                                                                                                                                                                                                                            
| |  | 14% increase in revenues in EMEA primarily due to substantial
    increases in CDMA solutions and GSM and UMTS solutions as a
    result of the recognition of previously deferred revenue due to
    a contract renegotiation and increases in data networking and
    security solutions.                                                                                                                                                                                                                                        
| |  | 6% increase in revenues in Canada primarily due to a substantial
    increase in optical networking revenues primarily due to the
    negative impact of shipping delays on our optical networking
    solutions revenues in the first quarter of 2005 not repeated in
    the first quarter of 2006 and a substantial increase in our
    carrier circuit and packet voice solutions, partially offset by
    a significant decrease in CDMA revenues and a substantial
    decline in our data networking and security solutions.
| |  | 37% increase in revenues in Asia due to substantial growth
    across most product portfolios including Optical and GSM
    solutions which were positively impacted by the recognition of
    revenue previously deferred due to software deliveries and the
    impact of the consolidation of the LG-Nortel joint venture.                                                                                                                                                                                                      
| |  | 22% increase in revenues in CALA was primarily due to a
    substantial increase in GSM solutions due to new contracts and
    existing customer expansion, partially offset by decreases in
    the ESPN portfolio due to volume decreases and local political
    and business events.                                                                                                                                                                                                                                           

58



---



##### Table of Contents



Gross Profit and Gross Margin


|             |  |                |       |   |      |   |       |        |                |   |          |   |  |      |    |   |      |   |       |        |  |   |          |   |  |   |          |   |  |  |    |  
|------------ |  | -------------- | ----- | - | ---- | - | ----- | ------ | -------------- | - | -------- | - |  | ---- | -- | - | ---- | - | ----- | ------ |  | - | -------- | - |  | - | -------- | - |  |  | -- | -
|             |  | For the        |       |   |      |   |       |        | For the        |   |          |   |  |     
|             |  | Three Months   |       |   |      |   |       |        | Six Months     |   |          |   |  |     
|             |  | Ended June 30, |       |   |      |   |       |        | Ended June 30, |   |          |   |  |     
|             |  |                |       |   |      |   |       |        |                |   |          |   |  |     
|             |  | 2006           |       |   | 2005 |   |       | Change |                |   | % Change |   |  | 2006 |    |   | 2005 |   |       | Change |  |   | % Change |  
|             |  |                |       |   |      |   |       |        |                |   |          |   |  |      |    |   |      |   |       |        |  |   |          |  
|Gross profit |  | $              | 1,066 |   |      | $ | 1,104 |        |                | $ | (38      | ) |  |      | (3 | ) |      | $ | 1,975 |        |  | $ | 2,118    |   |  | $ | (143     | ) |  |  | (7 | )
|Gross margin |  |                | 38.8  | % |      |   | 42.2  | %      |                |   | (3.4 pts | ) |  |      |    |   |      |   | 38.5  | %      |  |   | 42.3     | % |  |   | (3.8 pts | ) |  |  |    |  
|             |  |                |       |   |      |   |       |        |                |   |          |   |  |      |    |   |      |   |       |        |  |   |          |  





| |   |                                                                                                                                                                                                                                                                                                                                                                                                            
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | a decrease of approximately $156 ($257 for the first half of
    2006) primarily as a result of (i) pricing pressures due to
    increased competition; (ii) unfavorable product and
    geographic mixes associated with a greater proportion of our
    revenue earned outside of North America; and
    (iii) increased costs associated with European Union
    Environmental Directive compliance; and
| |  | a decrease of approximately $15 ($55 for the first half of 2006)
    primarily due to higher product and warranty costs and
    recoveries in inventory provisions due to sale of inventory in
    the first half of 2005 not repeated in the first half of 2006;
    partially offset by                                                                                                                  
| |  | an increase of approximately $85 ($80 for the first half of
    2006) due to overall higher sales volumes;                                                                                                                                                                                                                                                                                                 
| |  | an increase of approximately $20 ($26 for the first half of
    2006) due to project losses related to the Bharat Sanchar Nigam
    Limited, or BSNL, contract in India that were incurred in 2005
    not repeated in 2006;                                                                                                                                                                               
| |  | an increase of approximately $13 ($13 for the first half of
    2006) related to our employee bonus plans incurred in 2005 not
    repeated to the same extent in the first half of 2006; and                                                                                                                                                                                                              
| |  | an increase of approximately $15 ($50 for the first half of
    2006) due to continued improvements in our cost structure.                                                                                                                                                                                                                                                                                 

Operating Expenses




| |                                            
| | -------------------------------------------
| | Selling, General and Administrative Expense

|             |                  |                |     |      |      |   |     |          |                |   |          |          |   |      |   |  |      |   |       |          |   |   |          |      |   |   |    |          |   |  |   |  | 
|------------ | ---------------- | -------------- | --- | ---- | ---- | - | --- | -------- | -------------- | - | -------- | -------- | - | ---- | - |  | ---- | - | ----- | -------- | - | - | -------- | ---- | - | - | -- | -------- | - |  | - |  | 
|             |                  | For the        |     |      |      |   |     |          | For the        |   |          |          |   |     
|             |                  | Three Months   |     |      |      |   |     |          | Six Months     |   |          |          |   |     
|             |                  | Ended June 30, |     |      |      |   |     |          | Ended June 30, |   |          |          |   |     
|             |                  |                |     |      |      |   |     |          |                |   |          |          |   |     
|             |                  | 2006           |     |      | 2005 |   |     | $ Change |                |   | % Change |          |   | 2006 |   |  | 2005 |   |       | $ Change |   |   | % Change |     
|             |                  |                |     |      |      |   |     |          |                |   |          |          |   |      |   |  |      |   |       |          |   |   |          |     
|SG&A expense |                  | $              | 594 |      |      | $ | 585 |          |                | $ | 9        |          |   |      | 2 |  |      | $ | 1,188 |          |   | $ | 1,159    |      |   | $ | 29 |          |   |  | 3 | 
|             | As % of revenues |                |     | 21.6 | %    |   |     | 22.3     | %              |   |          | (0.7 pts | ) |      |   |  |      |   |       | 23.2     | % |   |          | 23.1 | % |   |    | (0.1 pts | ) |  |   |  | 
|             |                  |                |     |      |      |   |     |          |                |   |          |          |   |      |   |  |      |   |       |          |   |   |          |     





| |   |                                                                                                                                                                                                                  
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | incremental costs of approximately $31 ($69 for the first half
    of 2006) related to our acquisition of NGS and the formation of
    the LG-Nortel joint venture;                                              
| |  | higher costs of approximately $5 ($32 for the first half of
    2006) related to our internal control remedial measures,
    investment in our finance processes and business transformation
    initiatives; and
| |  | unfavorable foreign exchange impacts primarily in the second
    quarter of 2006 associated with the strengthening of the
    Canadian dollar against the U.S. dollar; partially offset by                       
| |  | lower bonus accruals and cost containment initiatives; and                                                                                                                                                       
| |  | lower costs related to our restatement related activities.                                                                                                                                                       





| |                                 
| | --------------------------------
| | Research and Development Expense

|            |                  |                |     |      |      |   |     |          |                |   |          |          |   |      |   |  |      |   |     |          |   |   |          |      |   |   |   |          |   |  |   |  | 
|----------- | ---------------- | -------------- | --- | ---- | ---- | - | --- | -------- | -------------- | - | -------- | -------- | - | ---- | - |  | ---- | - | --- | -------- | - | - | -------- | ---- | - | - | - | -------- | - |  | - |  | 
|            |                  | For the        |     |      |      |   |     |          | For the        |   |          |          |   |     
|            |                  | Three Months   |     |      |      |   |     |          | Six Months     |   |          |          |   |     
|            |                  | Ended June 30, |     |      |      |   |     |          | Ended June 30, |   |          |          |   |     
|            |                  |                |     |      |      |   |     |          |                |   |          |          |   |     
|            |                  | 2006           |     |      | 2005 |   |     | $ Change |                |   | % Change |          |   | 2006 |   |  | 2005 |   |     | $ Change |   |   | % Change |     
|            |                  |                |     |      |      |   |     |          |                |   |          |          |   |      |   |  |      |   |     |          |   |   |          |     
|R&D expense |                  | $              | 484 |      |      | $ | 483 |          |                | $ | 1        |          |   |      | 0 |  |      | $ | 958 |          |   | $ | 954      |      |   | $ | 4 |          |   |  | 0 | 
|            | As % of revenues |                |     | 17.6 | %    |   |     | 18.4     | %              |   |          | (0.8 pts | ) |      |   |  |      |   |     | 18.7     | % |   |          | 19.0 | % |   |   | (0.3 pts | ) |  |   |  | 
|            |                  |                |     |      |      |   |     |          |                |   |          |          |   |      |   |  |      |   |     |          |   |   |          |     

59



---



##### Table of Contents







| |   |                                                                                                                                                       
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | incremental costs of approximately $23 ($44 for the first half
    of 2006) related to our consolidation of the
    LG-Nortel joint venture;          
| |  | unfavorable foreign exchange impacts associated with the
    strengthening of the Canadian dollar against the
    U.S. dollar; substantially offset by
| |  | cost savings associated with our 2004 Restructuring Plan and
    cost containment initiatives.                                                        



| |                
| | ---------------
| | Special Charges









60



---



##### Table of Contents





|                                                   |                                        |           |    |            |           |   |           |             |   |       |   |   |  |   |     |     |  
|-------------------------------------------------- | -------------------------------------- | --------- | -- | ---------- | --------- | - | --------- | ----------- | - | ----- | - | - |  | - | --- | --- | -
|                                                   |                                        |           |    | Contract   |           |   |           |             |  
|                                                   |                                        |           |    | settlement |           |   | Plant and |             |  
|                                                   |                                        | Workforce |    |            | and lease |   |           | equipment   |   |      
|                                                   |                                        | reduction |    |            | costs     |   |           | write downs |   | Total |  
|                                                   |                                        |           |    |            |           |   |           |             |   |       |  
|2006 Restructuring Plan                            |                                        |           |    |            |           |   |           |             |   |       |   |   |  |   |     |    
|Provision balance as of December 31,
    2005(a)   |                                        | $         |   |            |           | $ |          |             |   | $     |  |   |  | $ |    |    
|                                                   | Other special charges                  |           |    | 43         |           |   |           |            |   |       |   |  |  |   |     | 43  |  
|                                                   | Revisions to prior accruals            |           |    |           |           |   |           |            |   |       |   |  |  |   |     |    |  
|                                                   | Cash drawdowns                         |           |    | (3         | )         |   |           |            |   |       |   |  |  |   |     | (3  | )
|                                                   | Non-cash drawdowns                     |           |    |           |           |   |           |            |   |       |   |  |  |   |     |    |  
|                                                   | Foreign exchange and other adjustments |           |    |           |           |   |           |            |   |       |   |  |  |   |     |    |  
|                                                   |                                        |           |    |            |           |   |           |             |   |       |   |  
|Provision balance as of June 30, 2006              |                                        | $         | 40 |            |           | $ |          |             |   | $     |  |   |  | $ | 40  |    
|                                                   |                                        |           |    |            |           |   |           |             |   |       |   |  
|2004 Restructuring Plan                            |                                        |           |    |            |           |   |           |             |   |       |   |   |  |   |     |    
|Provision balance as of December 31,
    2005(a)   |                                        | $         | 21 |            |           | $ | 61        |             |   | $     |  |   |  | $ | 82  |    
|                                                   | Other special charges                  |           |    |           |           |   |           |            |   |       |   |  |  |   |     |    |  
|                                                   | Revisions to prior accruals            |           |    | 3          |           |   |           | 4           |   |       |   |  |  |   |     | 7   |  
|                                                   | Cash drawdowns                         |           |    | (17        | )         |   |           | (11         | ) |       |   |  |  |   |     | (28 | )
|                                                   | Non-cash drawdowns                     |           |    |           |           |   |           |            |   |       |   |  |  |   |     |    |  
|                                                   | Foreign exchange and other adjustments |           |    |           |           |   |           | 2           |   |       |   |  |  |   |     | 2   |  
|                                                   |                                        |           |    |            |           |   |           |             |   |       |   |  
|Provision balance as of June 30, 2006              |                                        | $         | 7  |            |           | $ | 56        |             |   | $     |  |   |  | $ | 63  |    
|                                                   |                                        |           |    |            |           |   |           |             |   |       |   |  
|2001 Restructuring Plan                            |                                        |           |    |            |           |   |           |             |   |       |   |   |  |   |     |    
|Provision balance as of December 31,
    2005(a)   |                                        | $         | 3  |            |           | $ | 213       |             |   | $     |  |   |  | $ | 216 |    
|                                                   | Other special charges                  |           |    |           |           |   |           |            |   |       |   |  |  |   |     |    |  
|                                                   | Revisions to prior accruals            |           |    | 1          |           |   |           | (1          | ) |       |   |  |  |   |     |    |  
|                                                   | Cash drawdowns                         |           |    | (1         | )         |   |           | (32         | ) |       |   |  |  |   |     | (33 | )
|                                                   | Non-cash drawdowns                     |           |    |           |           |   |           |            |   |       |   |  |  |   |     |    |  
|                                                   | Foreign exchange and other adjustments |           |    | (1         | )         |   |           | 4           |   |       |   |  |  |   |     | 3   |  
|                                                   |                                        |           |    |            |           |   |           |             |   |       |   |  
|Provision balance as of June 30, 2006              |                                        | $         | 2  |            |           | $ | 184       |             |   | $     |  |   |  | $ | 186 |    
|                                                   |                                        |           |    |            |           |   |           |             |   |       |   |  
|Total provision balance as of June 30,
    2006(a) |                                        | $         | 49 |            |           | $ | 240       |             |   | $     |  |   |  | $ | 289 |    
|                                                   |                                        |           |    |            |           |   |           |             |   |       |   |  






|    |                                                                                                                                                                                         
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(a) | As of June 30, 2006 and December 31, 2005, the
    short-term provision balance was $111 and $95, respectively, and
    the long-term provision balance was $178 and $203, respectively.



61



---



##### Table of Contents





|                            |                                          |               |    |               |      |   |               |   |  |      |   |   |      |   |     |      |  |   |   |    |   |   |    |     |  
|--------------------------- | ---------------------------------------- | ------------- | -- | ------------- | ---- | - | ------------- | - |  | ---- | - | - | ---- | - | --- | ---- |  | - | - | -- | - | - | -- | --- | -
|                            |                                          | 2006          |    | 2004          |      |   | 2001          |  
|                            |                                          | Restructuring |    | Restructuring |      |   | Restructuring |  
|                            |                                          | Plan          |    | Plan          |      |   | Plan          |  
|                            |                                          |               |    |               |      |   |               |  
|                            |                                          | 2006          |    |               | 2005 |   | 2006          |   |  | 2005 |   |   | 2006 |   |     | 2005 | 
|                            |                                          |               |    |               |      |   |               |   |  |      |   |   |      |   |     |      | 
|Special charges by segment: |                                          |               |    |               |      |   |               |   |  |      |   |   |      |   |     |      |  |   |   |    |   |   |    |    
|                            | Mobility and Converged Core Networks     |               |    |               |      |   |               |   |  |      |   |   |      |   |     |      |  |   |   |    |   |   |    |     |  
|                            | Three months ended March 31              |               | $  |              |      |   | $             |  |  |      | $ | 3 |      |   | $   | 13   |  |   | $ |   |   |   | $  | (1  | )
|                            | Three months ended June 30               |               |    | 27            |      |   |               |  |  |      |   | 1 |      |   |     | 60   |  |   |   |   |   |   |    | 3   |  
|                            | Enterprise Solutions and Packet Networks |               |    |               |      |   |               |   |  |      |   |   |      |   |     |      |  |   |   |    |   |   |    |     |  
|                            | Three months ended March 31              |               |    |              |      |   |               |  |  |      |   | 3 |      |   |     | 12   |  |   |   | (1 | ) |   |    | (10 | )
|                            | Three months ended June 30               |               |    | 16            |      |   |               |  |  |      |   |  |      |   |     | 29   |  |   |   | 1  |   |   |    |    |  
|                            | Other                                    |               |    |               |      |   |               |   |  |      |   |   |      |   |     |      |  |   |   |    |   |   |    |     |  
|                            | Three months ended March 31              |               |    |              |      |   |               |  |  |      |   |  |      |   |     |     |  |   |   |   |   |   |    |    |  
|                            | Three months ended June 30               |               |    |              |      |   |               |  |  |      |   |  |      |   |     |     |  |   |   |   |   |   |    |    |  
|                            |                                          |               |    |               |      |   |               |   |  |      |   |   |      |   |     |      |  |  
|Total special charges       |                                          | $             | 43 |               |      | $ |              |   |  | $    | 7 |   |      | $ | 114 |      |  | $ |  |    |   | $ | (8 | )  
|                            |                                          |               |    |               |      |   |               |   |  |      |   |   |      |   |     |      |  |  



(Gain) Loss on Sale of Businesses and Assets








Other Income  Net




|                                                 |  |               |    |  |              |   |    |      |  |   |      |  |  |   |     | 
|------------------------------------------------ |  | ------------- | -- |  | ------------ | - | -- | ---- |  | - | ---- |  |  | - | --- | 
|                                                 |  | For the Three |    |  | For the Six  |  
|                                                 |  | Months Ended  |    |  | Months Ended |  
|                                                 |  | June 30,      |    |  | June 30,     |  
|                                                 |  |               |    |  |              |  
|                                                 |  | 2006          |    |  | 2005         |   |    | 2006 |  |   | 2005 | 
|                                                 |  |               |    |  |              |   |    |      |  |   |      | 
|Interest
    income(a)                           |  | $             | 16 |  |              | $ | 14 |      |  | $ | 31   |  |  | $ | 28  | 
|Gain (loss) on sale or write down of investments |  |               | 2  |  |              |   | 21 |      |  |   | 1    |  |  |   | 16  | 
|Currency exchange
    gains(b)                   |  |               | 14 |  |              |   | 20 |      |  |   | 23   |  |  |   | 49  | 
|Other  net                                      |  |               | 21 |  |              |   | 22 |      |  |   | 68   |  |  |   | 39  | 
|                                                 |  |               |    |  |              |   |    |      |  |   |      | 
|Other income  net                               |  | $             | 53 |  |              | $ | 77 |      |  | $ | 123  |  |  | $ | 132 | 
|                                                 |  |               |    |  |              |   |    |      |  |   |      | 






|    |                                                                                               
|--- | ----------------------------------------------------------------------------------------------
|(a) | Interest income on our short-term investments.                                                
|   
|(b) | Currency exchange gains were primarily related to
    day-to-day
    transactional activities.





| |   |                                                                                     
| | - | ------------------------------------------------------------------------------------
| |  | dividend income of $10 on our short-term investments; and                           
| |  | income of $6 related to the sub-lease of certain facilities;
    partially offset by
| |  | expenses of $13 related to the securitization of certain
    receivables.           

62



---



##### Table of Contents







| |   |                                                                                   
| | - | ----------------------------------------------------------------------------------
| |  | dividend income of $23 on our short-term investments;                             
| |  | a gain of $26 related to the sale of a note receivable from
    Bookham, Inc.; and
| |  | income of $10 related to the sub-lease of facilities; partially
    offset by     
| |  | expenses of $13 from the securitization of certain receivables.                   





| |   |                                                                                                                                                                                                                                                                                                  
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | dividend income of $11 on our short-term investments;                                                                                                                                                                                                                                            
| |  | gain of $21 related to the sale of our remaining Arris Group,
    Inc., or Arris Group, shares. For additional information on our
    investment in Arris Group, see Acquisitions, divestitures
    and closures in note 9 of the accompanying unaudited
    consolidated financial statements;
| |  | gain of $17 related to a customer exclusivity clause
    settlement; and                                                                                                                                                                                                                         
| |  | a gain of $6 related to the sub-lease of facilities; partially
    offset by                                                                                                                                                                                                                     
| |  | a loss of $9 from the sale of certain receivables.                                                                                                                                                                                                                                               





| |   |                                                                                                                                             
| | - | --------------------------------------------------------------------------------------------------------------------------------------------
| |  | dividend income of $20 on our short-term investments;                                                                                       
| |  | gain of $21 related to the sale of our remaining Arris Group
    shares;                                                                    
| |  | gain of $17 related to a customer exclusivity clause settlement;                                                                            
| |  | a gain of $11 related to the sub-lease of certain
    facilities; and                                                                       
| |  | gain of $10 on customer financing arrangements; partially offset
    by                                                                     
| |  | loss of $12 from the sale of certain account
    receivables; and                                                                           
| |  | loss of $5 related to changes in fair value of derivative
    financial instruments that did not meet the criteria for hedge
    accounting.

Interest Expense




Income Tax Benefit (Expense)








63



---



##### Table of Contents



Segment Information






|                                               |  |                |       |   |      |   |       |          |                |   |          |   |  |      |      |   |      |   |       |          |  |   |          |   |  |   |      |   |  |  |      |  
|---------------------------------------------- |  | -------------- | ----- | - | ---- | - | ----- | -------- | -------------- | - | -------- | - |  | ---- | ---- | - | ---- | - | ----- | -------- |  | - | -------- | - |  | - | ---- | - |  |  | ---- | -
|                                               |  | For the        |       |   |      |   |       |          | For the        |   |          |   |  |     
|                                               |  | Three Months   |       |   |      |   |       |          | Six Months     |   |          |   |  |     
|                                               |  | Ended June 30, |       |   |      |   |       |          | Ended June 30, |   |          |   |  |     
|                                               |  |                |       |   |      |   |       |          |                |   |          |   |  |     
|Revenues                                       |  | 2006           |       |   | 2005 |   |       | $ Change |                |   | % Change |   |  | 2006 |      |   | 2005 |   |       | $ Change |  |   | % Change |  
|                                               |  |                |       |   |      |   |       |          |                |   |          |   |  |      |      |   |      |   |       |          |  |   |          |  
|Mobility and Converged Core Networks           |  | $              | 1,591 |   |      | $ | 1,484 |          |                | $ | 107      |   |  |      | 7    |   |      | $ | 3,017 |          |  | $ | 2,970    |   |  | $ | 47   |   |  |  | 2    |  
|Enterprise Solutions and Packet Networks       |  |                | 1,068 |   |      |   | 1,074 |          |                |   | (6       | ) |  |      | (1   | ) |      |   | 1,939 |          |  |   | 1,952    |   |  |   | (13  | ) |  |  | (1   | )
|                                               |  |                |       |   |      |   |       |          |                |   |          |   |  |      |      |   |      |   |       |          |  |   |          |  
|Total reportable segments                      |  |                | 2,659 |   |      |   | 2,558 |          |                |   | 101      |   |  |      | 4    |   |      |   | 4,956 |          |  |   | 4,922    |   |  |   | 34   |   |  |  | 1    |  
|Other(a)                                       |  |                | 85    |   |      |   | 61    |          |                |   | 24       |   |  |      | 39   |   |      |   | 170   |          |  |   | 86       |   |  |   | 84   |   |  |  | 98   |  
|                                               |  |                |       |   |      |   |       |          |                |   |          |   |  |      |      |   |      |   |       |          |  |   |          |  
|Total revenues                                 |  | $              | 2,744 |   |      | $ | 2,619 |          |                | $ | 125      |   |  |      | 5    |   |      | $ | 5,126 |          |  | $ | 5,008    |   |  | $ | 118  |   |  |  | 2    |  
|                                               |  |                |       |   |      |   |       |          |                |   |          |   |  |      |      |   |      |   |       |          |  |   |          |  
|Management EBT                                 |  |                |       |   |      |   |       |          |                |   |          |   |  |      |      |   |      |   |       |          |  |   |          |   |  |   |      |   |  |  |      |  
|Mobility and Converged Core Networks           |  | $              | 168   |   |      | $ | 170   |          |                | $ | (2       | ) |  |      | (1   | ) |      | $ | 286   |          |  | $ | 360      |   |  | $ | (74  | ) |  |  | (21  | )
|Enterprise Solutions and Packet Networks       |  |                | 19    |   |      |   | 75    |          |                |   | (56      | ) |  |      | (75  | ) |      |   | (24   | )        |  |   | 51       |   |  |   | (75  | ) |  |  | (147 | )
|                                               |  |                |       |   |      |   |       |          |                |   |          |   |  |      |      |   |      |   |       |          |  |   |          |  
|Total reportable segments                      |  |                | 187   |   |      |   | 245   |          |                |   | (58      | ) |  |      | (24  | ) |      |   | 262   |          |  |   | 411      |   |  |   | (149 | ) |  |  | (36  | )
|Other(a)                                       |  |                | (172  | ) |      |   | (169  | )        |                |   | (3       | ) |  |      | (2   | ) |      |   | (365  | )        |  |   | (346     | ) |  |   | (19  | ) |  |  | (5   | )
|                                               |  |                |       |   |      |   |       |          |                |   |          |   |  |      |      |   |      |   |       |          |  |   |          |  
|Total management EBT                           |  | $              | 15    |   |      | $ | 76    |          |                | $ | (61      | ) |  |      | (80  | ) |      | $ | (103  | )        |  | $ | 65       |   |  | $ | (168 | ) |  |  | (258 | )
|                                               |  |                |       |   |      |   |       |          |                |   |          |   |  |      |      |   |      |   |       |          |  |   |          |  
|Amortization of intangibles                    |  | $              | (6    | ) |      | $ | (2    | )        |                | $ | (4       | ) |  |      | (200 | ) |      | $ | (11   | )        |  | $ | (4       | ) |  | $ | (7   | ) |  |  | (175 | )
|In-process research and development expense    |  |                | (16   | ) |      |   |      |          |                |   | (16      | ) |  |      |     |   |      |   | (16   | )        |  |   |         |   |  |   | (16  | ) |  |  |     |  
|Special charges                                |  |                | (45   | ) |      |   | (92   | )        |                |   | 47       |   |  |      | 51   |   |      |   | (50   | )        |  |   | (106     | ) |  |   | 56   |   |  |  | 53   |  
|Gain (loss) on sale of businesses and assets   |  |                | (16   | ) |      |   | (11   | )        |                |   | (5       | ) |  |      | (45  | ) |      |   | 26    |          |  |   | (33      | ) |  |   | 59   |   |  |  | 179  |  
|Shareholder litigation settlement expense      |  |                |      |   |      |   |      |          |                |   |         |   |  |      |     |   |      |   |      |          |  |   |         |   |  |   |     |   |  |  |     |  
|Income tax benefit (expense)                   |  |                | (27   | ) |      |   | 9     |          |                |   | (36      | ) |  |      | (400 | ) |      |   | (50   | )        |  |   | (6       | ) |  |   | (44  | ) |  |  | (733 | )
|                                               |  |                |       |   |      |   |       |          |                |   |          |   |  |      |      |   |      |   |       |          |  |   |          |  
|Net earnings (loss) from continuing operations |  | $              | (95   | ) |      | $ | (20   | )        |                | $ | (75      | ) |  |      | (375 | ) |      | $ | (204  | )        |  | $ | (84      | ) |  | $ | (120 | ) |  |  | (143 | )
|                                               |  |                |       |   |      |   |       |          |                |   |          |   |  |      |      |   |      |   |       |          |  |   |          |  



|                                         |  |                                          |     |   |                                        |   |       |     |  |         |          |   |       |        |     |   |        |       |     |      |         |   |      |   |  |          |     |   |        |   |    |   |  |   |     |   |  |   |      |  
|---------------------------------------- |  | ---------------------------------------- | --- | - | -------------------------------------- | - | ----- | --- |  | ------- | -------- | - | ----- | ------ | --- | - | ------ | ----- | --- | ---- | ------- | - | ---- | - |  | -------- | --- | - | ------ | - | -- | - |  | - | --- | - |  | - | ---- | -
|                                         |  | For The Three Months Ended June 30, 2006 |     |   | For The Six Months Ended June 30, 2006 |  
|                                         |  |                                          |     |   |                                        |  
|                                         |  | Gross                                    |     |   |                                        |   | Other |     |  | Total $ |          |   | Gross |        |     |   |        | Other |     |      | Total $ |  
|                                         |  | Profit                                   |     |   | SG&A                                   |   |       | R&D |  |         | Items(a) |   |       | Change |     |   | Profit |       |     | SG&A |         |   | R&D  |   |  | Items(a) |     |   | Change |  
|                                         |  |                                          |     |   |                                        |   |       |     |  |         |          |   |       |        |     |   |        |       |     |      |         |   |      |   |  |          |     |   |        |  
|Mobility and Converged Core Networks     |  | $                                        | 15  |   |                                        | $ | (7    | )   |  | $       |         |   |       | $      | (10 | ) |        | $     | (2  | )    |         | $ | (78  | ) |  | $        | (7  | ) |        | $ | 3  |   |  | $ | 8   |   |  | $ | (74  | )
|Enterprise Solutions and Packet Networks |  |                                          | (61 | ) |                                        |   | (17   | )   |  |         | 8        |   |       |        | 14  |   |        |       | (56 | )    |         |   | (88  | ) |  |          | (12 | ) |        |   | 2  |   |  |   | 23  |   |  |   | (75  | )
|                                         |  |                                          |     |   |                                        |   |       |     |  |         |          |   |       |        |     |   |        |       |     |      |         |   |      |   |  |          |     |   |        |  
|Total reportable segments                |  |                                          | (46 | ) |                                        |   | (24   | )   |  |         | 8        |   |       |        | 4   |   |        |       | (58 | )    |         |   | (166 | ) |  |          | (19 | ) |        |   | 5  |   |  |   | 31  |   |  |   | (149 | )
|Other                                    |  |                                          | 8   |   |                                        |   | 15    |     |  |         | (9       | ) |       |        | (17 | ) |        |       | (3  | )    |         |   | 23   |   |  |          | (10 | ) |        |   | (9 | ) |  |   | (23 | ) |  |   | (19  | )
|                                         |  |                                          |     |   |                                        |   |       |     |  |         |          |   |       |        |     |   |        |       |     |      |         |   |      |   |  |          |     |   |        |  
|Total change                             |  | $                                        | (38 | ) |                                        | $ | (9    | )   |  | $       | (1       | ) |       | $      | (13 | ) |        | $     | (61 | )    |         | $ | (143 | ) |  | $        | (29 | ) |        | $ | (4 | ) |  | $ | 8   |   |  | $ | (168 | )
|                                         |  |                                          |     |   |                                        |   |       |     |  |         |          |   |       |        |     |   |        |       |     |      |         |   |      |   |  |          |     |   |        |  






|    |                                                                                                                                                                                                                                                                                                                  
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(a) | Other items is comprised of interest expense, other
    income (expense)  net, minority interests 
    net of tax and equity in net loss of associated
    companies  net of tax. Interest attributable to
    long-term debt has not been allocated to a reportable segment
    and is included in Other.



64



---



##### Table of Contents





| |                                     
| | ------------------------------------
| | Mobility and Converged Core Networks



| |         
| | --------
| | Revenues








| |                    
| | -------------------
| | Q2 2006 vs. Q2 2005







| |                                          
| | -----------------------------------------
| | First half of 2006 vs. first half of 2005







| |               
| | --------------
| | Management EBT



| |                    
| | -------------------
| | Q2 2006 vs. Q2 2005





LG-Nortel LG-Nortel




65



---



##### Table of Contents







| |                                          
| | -----------------------------------------
| | First half of 2006 vs. first half of 2005





| |                                         
| | ----------------------------------------
| | Enterprise Solutions and Packet Networks



| |         
| | --------
| | Revenues








| |                   
| | ------------------
| | Q2 2006 vs.Q2 2005







| |                                          
| | -----------------------------------------
| | First half of 2006 vs. first half of 2005







| |               
| | --------------
| | Management EBT



| |                    
| | -------------------
| | Q2 2006 vs. Q2 2005





66



---



##### Table of Contents













| |                                       
| | --------------------------------------
| | First half of 2006 vs. first half 2005













| |      
| | -----
| | Other



| |               
| | --------------
| | Management EBT





| |                    
| | -------------------
| | Q2 2006 vs. Q2 2005









| |                                          
| | -----------------------------------------
| | First half of 2006 vs. first half of 2005



67



---



##### Table of Contents



Liquidity and Capital Resources


Cash Flow






|                                                                            |  |                  |       |   |      |   |       |  
|--------------------------------------------------------------------------- |  | ---------------- | ----- | - | ---- | - | ----- | -
|                                                                            |  | For the          |      
|                                                                            |  | Six Months Ended |      
|                                                                            |  | June 30,         |      
|                                                                            |  |                  |      
|                                                                            |  | 2006             |       |   | 2005 |  
|                                                                            |  |                  |       |   |      |  
|Net cash from (used in) operating activities of continuing
    operations   |  | $                | (792  | ) |      | $ | (154  | )
|Net cash from (used in) investing activities of continuing
    operations   |  |                  | (89   | ) |      |   | (386  | )
|Net cash from (used in) financing activities of continuing
    operations   |  |                  | (150  | ) |      |   | (36   | )
|Effect of foreign exchange rate changes on cash and cash
    equivalents    |  |                  | 53    |   |      |   | (85   | )
|                                                                            |  |                  |       |   |      |  
|Net cash from (used in) continuing operations                               |  |                  | (978  | ) |      |   | (661  | )
|Net cash from (used in) operating activities of discontinued
    operations |  |                  |      |   |      |   | 34    |  
|Net increase (decrease) in cash and cash equivalents                        |  |                  | (978  | ) |      |   | (627  | )
|Cash and cash equivalents at beginning of period                            |  |                  | 2,876 |   |      |   | 3,606 |  
|                                                                            |  |                  |       |   |      |  
|Cash and cash equivalents at end of period                                  |  | $                | 1,898 |   |      | $ | 2,979 |  
|                                                                            |  |                  |       |   |      |  



| |                     
| | --------------------
| | Operating activities













| |                                            
| | -------------------------------------------
| | Changes in Operating Assets and Liabilities



68



---



##### Table of Contents













| |                        
| | -----------------------
| | Working capital metrics



|                                                  |  |         |     |  |         |  |     | 
|------------------------------------------------- |  | ------- | --- |  | ------- |  | --- | 
|                                                  |  | Q2 2006 |     |  | Q4 2005 | 
|                                                  |  |         |     |  |         | 
|Days sales outstanding in accounts receivable     |  |         | 120 |  |         |  | 86  | 
|Net inventory days                                |  |         | 145 |  |         |  | 132 | 
|Days of purchases outstanding in accounts payable |  |         | 54  |  |         |  | 58  | 
|                                                  |  |         |     |  |         | 









69



---



##### Table of Contents











| |                     
| | --------------------
| | Investing activities







| |                     
| | --------------------
| | Financing activities











| |                                 
| | --------------------------------
| | Credit Facility and Senior Notes





70



---



##### Table of Contents







carve-outs






Future Uses and Sources of Liquidity




Future Uses of Liquidity






| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | costs in relation to restatement related and remedial measure
    activities, regulatory and other legal proceedings, including
    the $575, (plus accrued interest) cash payment payable by NNC
    related to the Global Class Action Settlement. The cash
    amount bears interest commencing March 23, 2006 at a
    prescribed rate and was placed in escrow on June 1, 2006
    pending satisfactory completion of all conditions to the Global
    Class Action Settlement;

71



---



##### Table of Contents



| |   |                                                                                                                                                                       
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | pension and post-retirement and post-employment benefit funding
    of approximately $455;                                                                            
| |  | capital expenditures of approximately $300;                                                                                                                           
| |  | costs related to workforce reduction and other restructuring
    activities of approximately $100; and                                                                
| |  | costs related to our finance transformation project which will
    include, among other things, implementing SAP to provide an
    integrated global financial system.





| |                             
| | ----------------------------
| | Contractual cash obligations







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



Future Sources of Liquidity






72



---



##### Table of Contents











| |                           
| | --------------------------
| | Available support facility





| |   |                                                                                                                                                                
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | $300 of committed revolving support for performance bonds or
    similar instruments, of which $147 was outstanding; and                                       
| |  | $450 of uncommitted support for performance bonds or similar
    instruments and/or receivables sales and/or securitizations, of
    which $46 was outstanding.













| |                                                           
| | ----------------------------------------------------------
| | Shelf registration statement and base shelf
    prospectus



73



---



##### Table of Contents





Credit Ratings


|                                  |  |                          |    |                  |  |             |      |  |  |  |               | 
|--------------------------------- |  | ------------------------ | -- | ---------------- |  | ----------- | ---- |  |  |  | ------------- | 
|                                  |  | Rating on long-term debt |    | Rating on        |  |            
|                                  |  | issued or guaranteed by  |    | preferred shares |  |            
|                                  |  | Nortel Networks          |    | issued by Nortel |  |            
|                                  |  | Limited/Nortel Networks  |    | Networks         |  |            
|Rating agency                     |  | Corporation              |    | Limited          |  | Last update
|                                  |  |                          |    |                  |  |            
|Standard & Poors Ratings Service |  |                          | B- |                  |  |             | CCC- |  |  |  | June 16, 2006 | 
|Moodys Investors Service, Inc.   |  |                          | B3 |                  |  |             | Caa3 |  |  |  | June 16, 2006 | 



Off-Balance Sheet Arrangements


Bid, Performance Related and Other Bonds






|                                               |  |          |     |  |              |   |     | 
|---------------------------------------------- |  | -------- | --- |  | ------------ | - | --- | 
|                                               |  | June 30, |     |  | December 31, |  
|                                               |  | 2006     |     |  | 2005         |  
|                                               |  |          |     |  |              |  
|Bid and performance related
    bonds(a)       |  | $        | 242 |  |              | $ | 222 | 
|Other
    bonds(b)                             |  |          | 40  |  |              |   | 44  | 
|                                               |  |          |     |  |              |  
|Total bid, performance related and other bonds |  | $        | 282 |  |              | $ | 266 | 
|                                               |  |          |     |  |              |  






|    |                                                                                                                                    
|--- | -----------------------------------------------------------------------------------------------------------------------------------
|(a) | Net of restricted cash and cash equivalents amounts of $25 and
    $36 as of June 30, 2006 and December 31, 2005,
    respectively.
|   
|(b) | Net of restricted cash and cash equivalents amounts of $31 and
    $31 as of June 30, 2006 and December 31, 2005,
    respectively.





74



---



##### Table of Contents



Receivables Securitization and Certain Variable Interest
Transactions
















Application of Critical Accounting Policies and Estimates








75



---



##### Table of Contents





Provisions for Doubtful Accounts






| |   |                                                                                        
| | - | ---------------------------------------------------------------------------------------
| |  | age of the receivables;                                                                
| |  | customers ability to meet and sustain its financial
    commitments;                  
| |  | customers current and projected financial condition;                                  
| |  | collection experience with the customer;                                               
| |  | historical bad debt experience with the customer;                                      
| |  | the positive or negative effects of the current and projected
    industry outlook; and
| |  | the economy in general.                                                                







|                                                                                  |  |          |       |   |              |   |       |  
|--------------------------------------------------------------------------------- |  | -------- | ----- | - | ------------ | - | ----- | -
|                                                                                  |  | June 30, |       |   | December 31, |  
|                                                                                  |  | 2006     |       |   | 2005         |  
|                                                                                  |  |          |       |   |              |  
|Gross accounts receivable                                                         |  | $        | 3,755 |   |              | $ | 3,303 |  
|Provision for doubtful accounts                                                   |  |          | (101  | ) |              |   | (137  | )
|                                                                                  |  |          |       |   |              |  
|Accounts receivable  net                                                         |  | $        | 3,654 |   |              | $ | 3,166 |  
|                                                                                  |  |          |       |   |              |  
|Accounts receivable provision as a percentage of gross accounts
    receivables   |  |          | 3     | % |              |   | 4     | %
|Gross long-term receivables                                                       |  | $        | 52    |   |              | $ | 57    |  
|Provision for doubtful accounts                                                   |  |          | (30   | ) |              |   | (33   | )
|                                                                                  |  |          |       |   |              |  
|Net long-term receivables                                                         |  | $        | 22    |   |              | $ | 24    |  
|                                                                                  |  |          |       |   |              |  
|Long-term receivable provision as a percentage of gross
    long-term receivables |  |          | 58    | % |              |   | 58    | %

Provisions for Inventory






76



---



##### Table of Contents







|                                                        |  |          |        |   |              |   |        |  
|------------------------------------------------------- |  | -------- | ------ | - | ------------ | - | ------ | -
|                                                        |  | June 30, |        |   | December 31, |  
|                                                        |  | 2006     |        |   | 2005         |  
|                                                        |  |          |        |   |              |  
|Gross inventory                                         |  | $        | 3,835  |   |              | $ | 3,660  |  
|Inventory provisions                                    |  |          | (1,070 | ) |              |   | (1,039 | )
|                                                        |  |          |        |   |              |  
|Inventories 
    net(a)                                |  | $        | 2,765  |   |              | $ | 2,621  |  
|                                                        |  |          |        |   |              |  
|Inventory provisions as a percentage of gross inventory |  |          | 28     | % |              |   | 28     | %






|    |                                                                                                          
|--- | ---------------------------------------------------------------------------------------------------------
|(a) | Includes long-term portion of inventory related to deferred
    costs, which is included in other assets.



Provisions for Product Warranties








|                                |                   |   |     |      |  
|------------------------------- | ----------------- | - | --- | ---- | -
|Balance as of December 31, 2005 |                   | $ | 206 |     
|                                | Payments          |   |     | (140 | )
|                                | Warranties issued |   |     | 138  |  
|                                | Revisions         |   |     | 5    |  
|                                |                   |   |    
|Balance as of June 30, 2006     |                   | $ | 209 |     
|                                |                   |   |    



Tax Asset Valuation




77



---



##### Table of Contents











| |   |                                                                                  
| | - | ---------------------------------------------------------------------------------
| |  | cumulative losses in recent years;                                               
| |  | history of loss carryforwards and other tax assets expiring;                     
| |  | the carryforward period associated with the deferred tax assets;                 
| |  | the nature of the income that can be used to realize the
    deferred tax assets;
| |  | our net earnings (loss); and                                                     
| |  | future earnings potential determined through the use of internal
    forecasts.  







Goodwill Valuation






Special Charges




78



---



##### Table of Contents





Accounting Changes and Recent Accounting Pronouncements


Accounting Changes






| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | The Meaning of Other-than-Temporary Impairment and its
    Application to Certain Investments  As of
    January 1, 2006, we adopted the United States Emerging
    Issues Task Force EITF Issue No.
    03-1, The Meaning
    of Other-Than-Temporary Impairment and Its Application to
    Certain Investments, or
    EITF 03-1,
    re-titled FASB Staff Position (FSP), FSP
    FAS 115-1 and FAS 124-1, The Meaning of
    Other-Than-Temporary Impairment and Its Application to Certain
    Investments, or FSP FAS 115-1 and FAS 124-1. The
    adoption of FSP FAS 115-1 and FAS 124-1 did not have a
    material impact on our results of operations and financial
    condition.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| |  | Inventory Costs  As of January 1, 2006, we adopted
    FASB SFAS No. 151, Inventory Costs, or
    SFAS 151. The adoption of SFAS 151 did not have a
    material impact on our results of operations and financial
    condition.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| |  | Share-Based Payment  In December 2004, the FASB
    issued SFAS No. 123 (Revised 2004), Share-Based
    Payment, or SFAS 123R, which requires all share-based
    payments to employees, including grants of employee stock
    options, to be recognized as compensation expense in the
    consolidated financial statements based on their fair values.
    SFAS 123R also modifies certain measurement and expense
    recognition provisions of SFAS 123 that will impact us,
    including the requirement to estimate employee forfeitures each
    period when recognizing compensation expense and requiring that
    the initial and subsequent measurement of the cost of
    liability-based awards each period be based on the fair value
    (instead of the intrinsic value) of the award. This statement is
    effective for us as of January 1, 2006. We previously
    elected to expense employee stock-based compensation using the
    fair value method prospectively for all awards granted or
    modified on or after January 1, 2003 in accordance with
    SFAS No. 148, Accounting for Stock Based
    Compensation  Transition and Disclosure, or
    SFAS 148. SAB 107, Share-Based Payment, or
    SAB 107, was issued by the SEC in March 2005, and provides
    supplemental SFAS 123R application guidance based on the
    views of the SEC. As a result of the adoption of SFAS 123R
    in the first quarter of 2006. We recorded a gain of $9 as a
    cumulative effect of an accounting change. There were no other
    material impacts on our results of operations and financial
    condition as a result of the adoption of SFAS 123R. For
    additional disclosures related to SFAS 123R, see
    note 15 of the accompanying unaudited financial statements.
| |  | Accounting Changes and Error Corrections  In May
    2005, the FASB issued SFAS No. 154, Accounting
    Changes and Error Corrections, or SFAS 154, which
    replaces Accounting Principles Board (APB) Opinion
    No. 20, Accounting Changes, and
    SFAS No. 3, Reporting Accounting Changes in
    Interim Financial Statements  An Amendment of APB
    Opinion No. 28. SFAS 154 provides guidance on
    the accounting for and reporting of changes in accounting
    principles and error corrections. SFAS 154 requires
    retrospective application to prior period financial statements
    of voluntary changes in accounting principles and changes
    required by new accounting standards when the standard does not
    include specific transition provisions, unless it is
    impracticable to do so. SFAS 154 also requires certain
    disclosures for restatements due to correction of an error.
    SFAS 154 is effective for accounting changes and
    corrections of errors made in fiscal years beginning after
    December 15, 2005, and was adopted by us as of
    January 1, 2006. The impact that the adoption of
    SFAS 154 will have on our consolidated results of
    operations and financial condition will depend on the nature of
    future accounting changes adopted by us and the nature of
    transitional guidance provided in future accounting
    pronouncements.                                                                                                                                                                                                                                                                                                                                                                                
| |  | Accounting for Purchases and Sales of Inventory with the same
    Counterparty  As of April 1 2006, we adopted
    EITF Issue No. 04-13, Accounting for Purchases and
    Sales of Inventory with the Same Counterparty, or
    EITF 04-13. The
    adoption of
    EITF 04-13 did not
    have a material impact on our results of operations and
    financial condition.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       

79



---



##### Table of Contents



Recent Accounting Pronouncements










Outstanding Share Data




Market Risk




80



---



##### Table of Contents



Equity Price Risk




Environmental Matters












Legal Proceedings




Cautionary Notice Regarding Forward Looking Information




81



---



##### Table of Contents





82



---



##### Table of Contents








|        |                                                           
|------- | ----------------------------------------------------------
|ITEM 3. | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK











83



---



##### Table of Contents








|        |                        
|------- | -----------------------
|ITEM 4. | CONTROLS AND PROCEDURES



| |                                                                         
| | ------------------------------------------------------------------------
| | Management Conclusions Concerning Disclosure Controls and
    Procedures

13a-15






|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | our successive restatements of our financial statements,
    including the Third Restatement;                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| | the findings of the Independent Review summarized in the
    Summary of Findings and of Recommended Remedial Measures
    of the Independent Review, submitted to the Audit
    Committee in January 2005 by WilmerHale and Huron Consulting
    Services LLC, or the Independent Review Summary, included in
    Item 9A of our 2003 Annual Report;                                                                                                                                                                                                                                     
| | the material weaknesses in our internal control over financial
    reporting that we and our independent registered chartered
    accountants, Deloitte, have identified (as more fully described
    below);                                                                                                                                                                                                                                                                                                                                                                              
| | managements assessment of our internal control over
    financial reporting and conclusion that our internal control
    over financial reporting was not effective as at
    December 31, 2005 (including the matters disclosed under
    Managements Assessment and Observations
    included in Item 9A of our 2005 Annual Report), and
    Deloittes attestation report with respect to that
    assessment and conclusion, each pursuant to the requirements of
    Section 404 of the Sarbanes-Oxley Act of 2002, or SOX 404,
    included in Item 9A of our 2005 Annual Report;
| | the conclusion of the CEO and CFO that our disclosure controls
    and procedures, as at March 31, 2006 were not effective,
    included in Item 4 of our 2006 First Quarter Report;                                                                                                                                                                                                                                                                                                                                                                                                       
| | the findings of the Revenue Independent Review included in
    Item 9A of our 2005 Annual Report;                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
| | the findings of the Internal Audit Review included in
    Item 4 of our 2006 First Quarter Report; and                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| | the remedial measures we have identified, developed and begun to
    implement to address these issues.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    







| |                                                                     
| | --------------------------------------------------------------------
| | Material Weaknesses in Internal Control Over Financial
    Reporting

13a-15(f) 15d-15(f)




|  |                                                                                                                                                                                                                                                                                                            
|- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | pertain to the maintenance of records that, in reasonable
    detail, accurately and fairly reflect the transactions and
    dispositions of our assets;                                                                                                                                                   
| | provide reasonable assurance that transactions are recorded as
    necessary to permit preparation of financial statements in
    accordance with U.S. GAAP, and that receipts and
    expenditures are being made only in accordance with
    authorizations of management and the Board of Directors; and
| | provide reasonable assurance regarding prevention or timely
    detection of unauthorized acquisition, use or disposition of our
    assets that could have a material effect on the financial
    statements.                                                                                             

84



---



##### Table of Contents









|  |                                                                                                                                                                                                                                                                                 
|- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | 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,
    and to foreign currency translation as described in
    SFAS No. 52;                 
| | lack of sufficient personnel with appropriate knowledge,
    experience and training in U.S. GAAP and lack of sufficient
    analysis and documentation of the application of U.S. GAAP
    to transactions, including, but not limited to, revenue
    transactions;           
| | lack of a clear organization and accountability structure within
    the accounting function, including insufficient review and
    supervision, combined with financial reporting systems that are
    not integrated and which require extensive manual
    interventions; and
| | lack of sufficient awareness of, and timely and appropriate
    remediation of, internal control issues by Nortel personnel.                                                                                                                                                    





Remedial Measures








|  |                                                                                                                                                                        
|- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | establishing standards of conduct to be enforced through
    appropriate discipline;                                                                                   
| | infusing strong technical skills and experience into the finance
    organization;                                                                                     
| | requiring comprehensive, on-going training on increasingly
    complex accounting standards;                                                                           
| | strengthening and improving internal controls and processes;                                                                                                           
| | establishing a compliance program throughout the Company which
    is appropriately staffed and funded;                                                                
| | requiring management to provide clear and concise information,
    in a timely manner, to the Board of Directors to facilitate its
    decision-making; and            
| | implementing an information technology platform that improves
    the reliability of financial reporting and reduces the
    opportunities for manipulation of results.



85



---



##### Table of Contents















86



---



##### Table of Contents



Changes in Internal Control Over Financial Reporting






|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | As part of the completion of the portion of the Flextronics
    transaction related to the manufacturing activities in Calgary,
    Canada, as described in greater detail under Business
    Overview  Evaluation of Our Supply Chain
    Strategy in the MD&A section of this report, in the
    second quarter of 2006 we transferred existing accounts payable
    and supply chain functions related to there activities to SAP As
    well as, approximately 650 employees from various business
    functions located primarily in Calgary In relation to these
    activities, we have modified our internal control over financial
    reporting to accommodate changes in our business processes and
    implemented certain compensating manual processes and controls
    that we continue to monitor.
| | NGS consolidated its various enterprise resource planning
    systems and supporting accounting applications into one system,
    reducing certain manual processes and we are monitoring this new
    system.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       




PART II


OTHER INFORMATION







|        |                  
|------- | -----------------
|ITEM 1. | Legal Proceedings










|         |             
|-------- | ------------
|ITEM 1A. | Risk Factors

10-Q




Risks Relating to Our Restatements and Related Matters




| |                                                                                                                                                                                                                                                                                  
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Material adverse legal judgments, fines, penalties or
    settlements, including the Global Class Action Settlement,
    could have a material adverse effect on our business, results of
    operations, financial condition and liquidity, which could be
    very significant.



87



---



##### Table of Contents









| |   |                                                                                                                                                                                                                                                                                                                                                                          
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | requiring us to dedicate a substantial portion of our cash
    and/or cash flow from operations to payments of such judgments,
    fines, penalties or settlements, thereby reducing the
    availability of our cash and/or cash flow to fund working
    capital, capital expenditures, R&D efforts and other general
    corporate purposes, including debt reduction;
| |  | making it more difficult for us to satisfy our payment
    obligations with respect to our outstanding indebtedness;                                                                                                                                                                                                                                                     
| |  | increasing the difficulty and/or cost to us of refinancing our
    indebtedness, should we decide to do so;                                                                                                                                                                                                                                                              
| |  | adversely affecting our credit ratings;                                                                                                                                                                                                                                                                                                                                  
| |  | increasing our vulnerability to general adverse economic and
    industry conditions;                                                                                                                                                                                                                                                                                    
| |  | limiting our flexibility in planning for, or reacting to,
    changes in our businesses and the industries in which we operate;                                                                                                                                                                                                                                          
| |  | making it more difficult or more costly for us to make
    acquisitions and investments;                                                                                                                                                                                                                                                                                 
| |  | limiting our ability to obtain, and/or increasing the cost of
    obtaining, directors and officers liability
    insurance and/or other types of insurance; and                                                                                                                                                                                                       
| |  | restricting our ability to introduce new technologies and
    products and/or exploit business opportunities.                                                                                                                                                                                                                                                            

Risks Relating to Our Liquidity, Financing Arrangements and
Capital




| |                                                                                                                                                                                                                                          
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Cash flow fluctuations may affect our ability to fund our
    working capital requirements or achieve our business objectives
    in a timely manner. Additional sources of funds may not be
    available on acceptable terms or at all.



88



---



##### Table of Contents







| |   |                                                                                                                                                                                                                                                            
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | a greater than expected slowdown in capital spending by service
    providers and other customers, increased pricing and product
    margin pressures, or other changes to our business model could
    result in materially lower revenues and cash flows;
| |  | costs incurred in connection with restructuring efforts may be
    higher than originally planned and may not lead to the
    anticipated cost savings;                                                                                                    
| |  | changes in market demand for networking products, which may
    require increased expenditures to develop and market different
    technologies;                                                                                                           
| |  | we may need to make larger contributions to our defined benefit
    plans in North America and the U.K. and retirement plans in
    other countries;                                                                                                       
| |  | an increased portion of our cash and cash equivalents may be
    restricted as cash collateral for customer performance bonds and
    contracts if the industry or our current condition deteriorates;
    and                                             
| |  | an inability of our subsidiaries to provide us with funding in
    sufficient amounts could adversely affect our ability to meet
    our obligations.                                                                                                      





| |   |                                                                                                                                                                                                                                                    
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | make it more difficult for us to satisfy our obligations under
    our outstanding debt and other obligations and to pay any
    judgments, fines, penalties or settlements in connection with
    our pending civil litigation and investigations;
| |  | require us to delay or reduce capital expenditures or the
    introduction of new products, sell assets and/or forego business
    opportunities such as acquisitions, R&D projects or product
    design enhancements;                            
| |  | increase our vulnerability to economic downturns, adverse
    industry conditions and adverse developments in our business,
    and limit our flexibility in planning for or reacting to such
    changes; and                                     
| |  | place us at a competitive disadvantage compared to competitors
    that have greater liquidity.                                                                                                                                                    



| |                                                                                                                                             
| | --------------------------------------------------------------------------------------------------------------------------------------------
| | Our high level of debt could materially and adversely
    affect our business, results of operations, financial condition
    and liquidity.



89



---



##### Table of Contents







| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | it could be more difficult for us to satisfy our obligations
    under our outstanding debt and other obligations;                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
| |  | we may have difficulty borrowing money in the future or
    accessing other sources of funding;                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| |  | we may have difficulty refinancing our existing debt, should we
    decide to do so;                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
| |  | we may need to dedicate a substantial portion of our cash and
    cash flow from operations to debt payments, thereby
    significantly reducing the availability of our cash and cash
    flow from operations for other purposes, including payments of
    judgments, settlements, fines or other penalties and our
    operational needs (for example, in order to meet our debt
    service obligations, we may be required to delay or reduce
    capital expenditures or the introduction of new products, sell
    assets and/or forego business opportunities such as
    acquisitions, R&D projects or product design enhancements);
| |  | increase our vulnerability to economic downturns, adverse
    industry conditions and adverse developments in our business,
    and limit our flexibility in planning for or reacting to such
    changes; and                                                                                                                                                                                                                                                                                                                                                                                                                                
| |  | place us at a competitive disadvantage compared to competitors
    that have less debt.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       



| |                                                                                                                                                                                                  
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Covenants in the indenture governing certain of our senior
    notes impose operating and financial restrictions on us, which
    may prevent us from capitalizing on business
    opportunities.







90



---



##### Table of Contents








|        |         
|------- | --------
|ITEM 6. | Exhibits

10-Q.


|        |    |             |  |                                                                                                                                                                                                                                                                                                                                                                                                                           
|------- | -- | ----------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |    |            
|No.     |    | Description
|        |    |            
|        | 10 | .1          |  | Nortel Networks Limited SUCCESS Plan as amended on March 9,
    2006 with effect from January 1, 2006.                                                                                                                                                                                                                                                                                                                    
|        | 10 | .2          |  | Fourth Amending Agreement to Asset Purchase Agreement dated as
    of May 8, 2006 among Nortel Networks Limited, Flextronics
    International Ltd. and Flextronics Telecom Systems, Ltd.                                                                                                                                                                                                                                 
|       
|        | 10 | .3          |  | Fifth Amending Agreement to Asset Purchase Agreement dated as of
    May 8, 2006 among Nortel Networks Limited, Flextronics
    International Ltd. and Flextronics Telecom Systems, Ltd.                                                                                                                                                                                                                                  
|       
|        | 10 | .4**        |  | Second Amending Agreement to Amended and Restated Master
    Contract Manufacturing Services Agreement dated as of
    May 8, 2006 between Nortel Networks Limited and Flextronics
    Telecom Systems, Ltd.                                                                                                                                                                                                              
|       
|        | 10 | .5          |  | Second Amending Agreement to Master Repair Services Agreement
    dated as of May 8, 2006 between Nortel Networks Limited and
    Flextronics Telecom Systems, Ltd.                                                                                                                                                                                                                                                       
|       
|        | 10 | .6**        |  | Amended and Restated Letter Agreement dated as of May 8,
    2006 between Nortel Networks Limited and Flextronics Telecom
    Systems, Ltd.                                                                                                                                                                                                                                                                               
|       
|        | 10 | .7*         |  | Amendment No. 1 and Waiver dated May 9, 2006 among
    Nortel Networks Inc., JPMorgan Chase Bank, N.A., as
    Administrative Agent and Lender, and Citicorp USA, Inc., Royal
    Bank of Canada and Export Development Canada, as Lenders (filed
    as Exhibit 10.1 to Nortel Networks Limiteds Current
    Report on Form 8-K dated May 11, 2006).                                                                    
|       
|        | 10 | .8*         |  | Amendment No. 1 and Waiver dated May 9, 2006 between
    Nortel Networks Limited and Export Development Canada (filed as
    Exhibit 10.2 to Nortel Networks Limiteds Current
    Report on Form 8-K dated May 11, 2006).                                                                                                                                                                                                
|       
|        | 10 | .9*         |  | Amendment No. 2 dated as of May 19, 2006 among Nortel
    Networks Inc., Nortel Networks Corporation, Nortel Networks
    Limited, JPMorgan Chase Bank, N.A., as Administrative Agent, and
    the Lenders party thereto (filed as Exhibit 10.1 to Nortel
    Networks Limiteds Current Report on Form 8-K dated
    May 19, 2006).                                                                                      
|       
|        | 10 | .10**       |  | Stipulation and Agreement of Settlement, dated June 20,
    2006, in the matter captioned In re Nortel Networks Corp.
    Securities Litigation, United States District Court for the
    Southern District of New York, Consolidated Civil Action No. 01
    Civ. 1855 (RMB).                                                                                                                                            
|       
|        | 10 | .11**       |  | Stipulation and Agreement of Settlement, dated June 20,
    2006, in the matter captioned In re Nortel Networks Corp.
    Securities Litigation, United States District Court for the
    Southern District of New York, Master
    File No. 05-MD-1659 (LAP).                                                                                                                                                            
|       
|        | 10 | .12         |  | Court Order, dated June 20, 2006, in the matter captioned
    Frohlinger et. al. v. Nortel Networks Corporation et.
    al., Ontario Superior Court of Justice, Court File No.
    02-CL-4605 (Ont.Sup.Ct.J.).                                                                                                                                                                                                            
|       
|        | 10 | .13         |  | Court Order, dated June 20, 2006, in the matter captioned
    Association de Protection des Épargnants et. al.
    Investisseurs du Québec v. Corporation Nortel
    Networks, Superior Court of Quebec, District of Montreal,
    No. 500-06-000126-017.                                                                                                                                                                 
|       
|        | 10 | .14         |  | Court Order, dated June 20, 2006, in the matter captioned
    Jeffery et. al. v. Nortel Networks Corporation et.
    al., Supreme Court of British Columbia, Vancouver Registry
    Court File No. S015159 (B.C.S.C.).                                                                                                                                                                                                    
|       
|        | 10 | .15         |  | Court Order, dated June 20, 2006, in the matter captioned
    Gallardi v. Nortel Networks Corporation et. al.,
    Ontario Superior Court of Justice, Court File No. 05-CV-285606CP
    (Ont.Sup.Ct.J.).                                                                                                                                                                                                                  
|       
|        | 10 | .16         |  | Court Order, dated June 20, 2006, in the matter captioned
    Skarstedt v. Corporation Nortel Networks, Superior
    Court of Quebec, District of Montreal,
    No. 500-06-000277-059.                                                                                                                                                                                                                                    
|       
|        | 10 | .17         |  | Resolution effective June 28, 2006 for Mike Zafirovski,
    President and Chief Executive Officer of NNC and NNL outlining
    acceptance by Boards of Directors of Nortel Networks Corporation
    and Nortel Networks Limited of the voluntary reduction by
    Mr. Zafirovski of a special lifetime annual pension benefit
    by 29% resulting in a payout of US$355,000 per year rather
    than US$500,000 per year.

91



---



##### Table of Contents



|        |    |             |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|------- | -- | ----------- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |    |            
|No.     |    | Description
|        |    |            
|       
|        | 10 | .18*        |  | Amended and Restated Shareholders Rights Plan Agreement dated as
    of February 28, 2006 effective June 29, 2006, pursuant
    to an amended and restated shareholder rights plan agreement
    dated as of February 28, 2006 between Nortel Networks
    Corporation and Computershare Trust Company of Canada, as Rights
    Agent (filed as Exhibit 3 to Nortel Networks Limiteds
    Form 8-A12B/A dated June 29, 2006).                                                           
|       
|        | 10 | .19*        |  | Indenture dated as of July 5, 2006 among Nortel Networks
    Limited, Nortel Networks Corporation, Nortel Networks Inc. and
    The Bank of New York, as trustee (filed as Exhibit 4.1 to
    Nortel Networks Limiteds Current Report on Form 8-K
    dated July 6, 2006).                                                                                                                                                                                                              
|       
|        | 10 | .20*        |  | First Supplemental Indenture dated as of July 5, 2006 among
    Nortel Networks Limited, Nortel Networks Corporation, Nortel
    Networks Inc. and The Bank of New York, as trustee (filed as
    Exhibit 4.2 to Nortel Networks Limiteds Current
    Report on Form 8-K dated July 6, 2006).                                                                                                                                                                                           
|       
|        | 10 | .21*        |  | Purchase Agreement dated June 29, 2006 among Nortel
    Networks Limited, Nortel Networks Corporation, Nortel Networks
    Inc. and the representative of the initial purchasers with
    regards to U.S.$1,000,000,000 Floating Rate Senior Notes due
    2011, U.S.$550,000,000 10.125% Senior Notes due 2013,
    U.S.$450,000,000 10.750% Senior Notes due 2016 (filed as
    Exhibit 10.1 to Nortel Networks Limiteds Current
    Report on Form 8-K dated July 6, 2006).          
|       
|        | 10 | .22*        |  | Registration Rights Agreement dated July 5, 2006 among
    Nortel Networks Limited, Nortel Networks Corporation, Nortel
    Networks Inc. and the representative of the initial purchasers
    with regards to U.S.$1,000,000,000 Floating Rate Senior Notes
    due 2011, U.S.$550,000,000 10.125% Senior Notes due 2013,
    U.S.$450,000,000 10.750% Senior Notes due 2016 (filed as
    Exhibit 10.2 to Nortel Networks Limiteds Current
    Report on Form 8-K dated July 6, 2006).
|       
|        | 31 | .1          |  | Certification of the Vice-Chairman and Chief Executive Officer
    pursuant to 18 U.S.C. Section 1350 as Adopted Pursuant
    to Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                                                                                                          
|       
|        | 31 | .2          |  | Certification of the Executive Vice-President and Chief
    Financial Officer pursuant to 18 U.S.C. Section 1350
    as Adopted Pursuant to Section 302 of the Sarbanes-Oxley
    Act of 2002.                                                                                                                                                                                                                                                                                           
|       
|        | 32 |             |  | Certification of the Vice-Chairman and Chief Executive Officer
    and Executive Vice-President and Chief Financial Officer
    pursuant to 18 U.S.C. Section 1350 as Adopted Pursuant
    to Section 906 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                                             






| |   |                           
| | - | --------------------------
| | * | Incorporated by reference.



|   |                                                                                                                                                                                                                     
|-- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|** | Certain portions of this Exhibit have been omitted based upon a
    request for confidential treatment. These portions have been
    filed separately with the United States Securities and Exchange
    Commission.

92



---



##### Table of Contents






SIGNATURES




NORTEL NETWORKS LIMITED


(Registrant)


|                            |  |                         
|--------------------------- |  | ------------------------
|Chief Financial Officer     |  | Chief Accounting Officer
|                           
|                           
|/s/ Peter W. Currie         |  | /s/ Paul W. Karr        
|                            |  |                         
|Peter W. Currie             |  | Paul W. Karr            
|Executive Vice-President    |  | Controller              
|and Chief Financial Officer |  |                         



93