##### 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 September 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.)

|                                         |  |           
|---------------------------------------- |  | ----------
|195 The West Mall                        |  | M9C 5K1   
|Toronto, Ontario, Canada                 |  | (Zip Code)
|(Address of principal executive offices) |  |           

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










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##### 










TABLE OF CONTENTS


PART I


FINANCIAL INFORMATION


|                                |  |                                                                                           |    |      |    |  |  | 
|------------------------------- |  | ----------------------------------------------------------------------------------------- | -- | ---- | -- |  |  | 
|                                |  |                                                                                           |    | PAGE |   
|                                |  |                                                                                           |    |      |   
|ITEM 1.                         |  | Condensed Consolidated Financial Statements
    (unaudited)                               |    |      | 1  | 
|ITEM 2.                         |  | Managements Discussion and Analysis
    of Financial Condition and Results of Operations |    |      | 50 | 
|ITEM 3.                         |  | Quantitative and Qualitative Disclosures
    About Market Risk                            |    |      | 89 | 
|ITEM 4.                         |  | Controls and Procedures                                                                   |    |      | 90 | 
|PART II
      OTHER INFORMATION
|                               
|ITEM 1.                         |  | Legal Proceedings                                                                         |    |      | 94 | 
|ITEM 1A.                        |  | Risk Factors                                                                              |    |      | 95 | 
|ITEM 6.                         |  | Exhibits                                                                                  |    |      | 97 | 
|SIGNATURES                      |  |                                                                                           | 98 |     
|EX-10.4                        
|EX-10.5                        
|EX-31.1                        
|EX-31.2                        
|EX-32                          



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














i



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##### 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         |       |              | Nine Months Ended |  
|                                                                                                                                                     |          | September 30,              |       |              | September 30,     |  
|                                                                                                                                                     |          |                            |       |              |                   |  
|                                                                                                                                                     |          | 2006                       |       |              | 2005              |   |       | 2006  |              |   | 2005  |      
|                                                                                                                                                     |          |                            |       |              |                   |   |       |       |              |   |       |      
|                                                                                                                                                     |          |                            |       | As restated* |                   |   |       |       | As restated* |  
|                                                                                                                                                     |          | (Millions of U.S. dollars) |      
|Revenues:                                                                                                                                            |          |                            |       |              |                   |   |       |       |              |   |       |       |      |   |       |      
|                                                                                                                                                     | Products |                            | $     | 2,640        |                   |   | $     | 2,193 |              |   | $     | 7,141 |      |   | $     | 6,684 |    
|                                                                                                                                                     | Services |                            |       | 315          |                   |   |       | 325   |              |   |       | 940   |      |   |       | 842   |    
|                                                                                                                                                     |          |                            |       |              |                   |   |       |       |              |   |       |      
|Total revenues                                                                                                                                       |          |                            | 2,955 |              |                   |   | 2,518 |       |              |   | 8,081 |       |      |   | 7,526 |      
|Cost of Revenues:                                                                                                                                    |          |                            |       |              |                   |   |       |       |              |   |       |       |      |   |       |      
|                                                                                                                                                     | Products |                            |       | 1,654        |                   |   |       | 1,361 |              |   |       | 4,460 |      |   |       | 3,980 |    
|                                                                                                                                                     | Services |                            |       | 184          |                   |   |       | 190   |              |   |       | 529   |      |   |       | 461   |    
|                                                                                                                                                     |          |                            |       |              |                   |   |       |       |              |   |       |      
|Total cost of revenues                                                                                                                               |          |                            | 1,838 |              |                   |   | 1,551 |       |              |   | 4,989 |       |      |   | 4,441 |      
|                                                                                                                                                     |          |                            |       |              |                   |   |       |       |              |   |       |      
|Gross profit                                                                                                                                         |          |                            | 1,117 |              |                   |   | 967   |       |              |   | 3,092 |       |      |   | 3,085 |      
|Selling, general and administrative expense                                                                                                          |          |                            | 603   |              |                   |   | 565   |       |              |   | 1,791 |       |      |   | 1,724 |      
|Research and development expense                                                                                                                     |          |                            | 476   |              |                   |   | 438   |       |              |   | 1,434 |       |      |   | 1,392 |      
|Amortization of intangibles                                                                                                                          |          |                            | 8     |              |                   |   | 7     |       |              |   | 19    |       |      |   | 11    |      
|In-process research and development expense                                                                                                          |          |                            |       |              |                   |   |      |       |              |   | 16    |       |      |   |      |      
|Special charges                                                                                                                                      |          |                            | 24    |              |                   |   | 39    |       |              |   | 74    |       |      |   | 145   |      
|(Gain) loss on sale of businesses and assets                                                                                                         |          |                            | (16   | )            |                   |   | 3     |       |              |   | (42   | )     |      |   | 36    |      
|                                                                                                                                                     |          |                            |       |              |                   |   |       |       |              |   |       |      
|Operating earnings (loss)                                                                                                                            |          |                            | 22    |              |                   |   | (85   | )     |              |   | (200  | )     |      |   | (223  | )    
|Other income  net                                                                                                                                   |          |                            | 46    |              |                   |   | 52    |       |              |   | 169   |       |      |   | 184   |      
|Interest expense                                                                                                                                     |          |                            |       |              |                   |   |       |       |              |   |       |       |      |   |       |      
|                                                                                                                                                     |          | Long-term debt             |       |              | (62               | ) |       |       | (32          | ) |       |       | (125 | ) |       |       | (91 | )
|                                                                                                                                                     |          | Other                      |       |              | (6                | ) |       |       | (2           | ) |       |       | (29  | ) |       |       | (4  | )
|                                                                                                                                                     |          |                            |       |              |                   |   |       |       |              |   |       |      
|Earnings (loss) from continuing operations before income taxes,
    minority interests and equity in net earnings (loss) of
    associated companies |          |                            |      |              |                   |   | (67   | )     |              |   | (185  | )     |      |   | (134  | )    
|Income tax expense                                                                                                                                   |          |                            | (9    | )            |                   |   | (40   | )     |              |   | (59   | )     |      |   | (46   | )    
|                                                                                                                                                     |          |                            |       |              |                   |   |       |       |              |   |       |      
|                                                                                                                                                     |          |                            | (9    | )            |                   |   | (107  | )     |              |   | (244  | )     |      |   | (180  | )    
|Minority interests  net of tax                                                                                                                      |          |                            | (4    | )            |                   |   | (5    | )     |              |   | 31    |       |      |   | (18   | )    
|Equity in net earnings (loss) of associated
    companies  net of tax                                                                               |          |                            | (1    | )            |                   |   | 1     |       |              |   | (5    | )     |      |   | 3     |      
|                                                                                                                                                     |          |                            |       |              |                   |   |       |       |              |   |       |      
|Net earnings (loss) from continuing operations                                                                                                       |          |                            | (14   | )            |                   |   | (111  | )     |              |   | (218  | )     |      |   | (195  | )    
|Net earnings (loss) from discontinued operations  net
    of tax                                                                                    |          |                            |      |              |                   |   | 2     |       |              |   |      |       |      |   | 3     |      
|                                                                                                                                                     |          |                            |       |              |                   |   |       |       |              |   |       |      
|Net earnings (loss) before cumulative effect of accounting change                                                                                    |          |                            | (14   | )            |                   |   | (109  | )     |              |   | (218  | )     |      |   | (192  | )    
|Cumulative effect of accounting change  net of tax
    (note 2)                                                                                     |          |                            |      |              |                   |   |      |       |              |   | 9     |       |      |   |      |      
|                                                                                                                                                     |          |                            |       |              |                   |   |       |       |              |   |       |      
|Net earnings (loss)                                                                                                                                  |          |                            | (14   | )            |                   |   | (109  | )     |              |   | (209  | )     |      |   | (192  | )    
|Dividends on preferred shares                                                                                                                        |          |                            | 15    |              |                   |   | 9     |       |              |   | 40    |       |      |   | 28    |      
|                                                                                                                                                     |          |                            |       |              |                   |   |       |       |              |   |       |      
|Net earnings (loss) applicable to common shares                                                                                                      |          | $                          | (29   | )            |                   | $ | (118  | )     |              | $ | (249  | )     |      | $ | (220  | )    
|                                                                                                                                                     |          |                            |       |              |                   |   |       |       |              |   |       |      






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

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


1



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##### Table of Contents



NORTEL NETWORKS LIMITED


Condensed Consolidated Balance Sheets (unaudited)


|                                                                                                                                                                                             |                                         |                            |         |       |              |   |         |       | 
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | --------------------------------------- | -------------------------- | ------- | ----- | ------------ | - | ------- | ----- | 
|                                                                                                                                                                                             |                                         | September 30,              |         |       | December 31, |  
|                                                                                                                                                                                             |                                         | 2006                       |         |       | 2005         |  
|                                                                                                                                                                                             |                                         |                            |         |       |              |  
|                                                                                                                                                                                             |                                         | (Millions of U.S. dollars, |        
|                                                                                                                                                                                             |                                         | except for share amounts)  |        
|ASSETS                                                                                                                                                                                      
|Current assets                                                                                                                                                                               |                                         |                            |         |       |              |   |         |      
|                                                                                                                                                                                             | Cash and cash equivalents               |                            | $       | 2,594 |              |   | $       | 2,876 | 
|                                                                                                                                                                                             | Restricted cash and cash equivalents    |                            |         | 42    |              |   |         | 77    | 
|                                                                                                                                                                                             | Accounts receivable  net               |                            |         | 3,714 |              |   |         | 3,166 | 
|                                                                                                                                                                                             | Inventories  net                       |                            |         | 1,834 |              |   |         | 1,804 | 
|                                                                                                                                                                                             | Deferred income taxes  net             |                            |         | 405   |              |   |         | 377   | 
|                                                                                                                                                                                             | Other current assets                    |                            |         | 529   |              |   |         | 567   | 
|                                                                                                                                                                                             |                                         |                            |         |       |              |  
|Total current assets                                                                                                                                                                         |                                         |                            | 9,118   |       |              |   | 8,867   |      
|Investments                                                                                                                                                                                  |                                         |                            | 212     |       |              |   | 244     |      
|Plant and equipment  net                                                                                                                                                                    |                                         |                            | 1,555   |       |              |   | 1,559   |      
|Goodwill                                                                                                                                                                                     |                                         |                            | 2,411   |       |              |   | 2,412   |      
|Intangible assets  net                                                                                                                                                                      |                                         |                            | 184     |       |              |   | 172     |      
|Deferred income taxes  net                                                                                                                                                                  |                                         |                            | 3,651   |       |              |   | 3,629   |      
|Other assets                                                                                                                                                                                 |                                         |                            | 967     |       |              |   | 1,026   |      
|                                                                                                                                                                                             |                                         |                            |         |       |              |  
|Total assets                                                                                                                                                                                 |                                         | $                          | 18,098  |       |              | $ | 17,909  |      
|                                                                                                                                                                                             |                                         |                            |         |       |              |  
|                                                                                                                                                                                            
|LIABILITIES AND SHAREHOLDERS EQUITY                                                                                                                                                        
|Current liabilities                                                                                                                                                                          |                                         |                            |         |       |              |   |         |      
|                                                                                                                                                                                             | Trade and other accounts payable        |                            | $       | 946   |              |   | $       | 1,178 | 
|                                                                                                                                                                                             | Payroll and benefit-related liabilities |                            |         | 790   |              |   |         | 799   | 
|                                                                                                                                                                                             | Contractual liabilities                 |                            |         | 233   |              |   |         | 346   | 
|                                                                                                                                                                                             | Restructuring liabilities               |                            |         | 93    |              |   |         | 95    | 
|                                                                                                                                                                                             | Other accrued liabilities               |                            |         | 3,524 |              |   |         | 3,365 | 
|                                                                                                                                                                                             | Long-term debt due within one year      |                            |         | 18    |              |   |         | 1,446 | 
|                                                                                                                                                                                             |                                         |                            |         |       |              |  
|Total current liabilities                                                                                                                                                                    |                                         |                            | 5,604   |       |              |   | 7,229   |      
|Long-term debt                                                                                                                                                                               |                                         |                            | 2,646   |       |              |   | 639     |      
|Deferred income taxes  net                                                                                                                                                                  |                                         |                            | 107     |       |              |   | 104     |      
|Other liabilities                                                                                                                                                                            |                                         |                            | 3,701   |       |              |   | 4,037   |      
|                                                                                                                                                                                             |                                         |                            |         |       |              |  
|Total liabilities                                                                                                                                                                            |                                         |                            | 12,058  |       |              |   | 12,009  |      
|                                                                                                                                                                                             |                                         |                            |         |       |              |  
|Minority interests in subsidiary companies                                                                                                                                                   |                                         |                            | 206     |       |              |   | 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 September 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
    September 30, 2006 and 1,460,978,638 as of
    December 31, 2005 |                                         |                            | 1,211   |       |              |   | 1,211   |      
|Additional paid-in capital                                                                                                                                                                   |                                         |                            | 22,268  |       |              |   | 22,193  |      
|Accumulated deficit                                                                                                                                                                          |                                         |                            | (17,646 | )     |              |   | (17,397 | )    
|Accumulated other comprehensive loss                                                                                                                                                         |                                         |                            | (535    | )     |              |   | (887    | )    
|                                                                                                                                                                                             |                                         |                            |         |       |              |  
|Total shareholders equity                                                                                                                                                                   |                                         |                            | 5,834   |       |              |   | 5,656   |      
|                                                                                                                                                                                             |                                         |                            |         |       |              |  
|Total liabilities and shareholders equity                                                                                                                                                   |                                         | $                          | 18,098  |       |              | $ | 17,909  |      
|                                                                                                                                                                                             |                                         |                            |         |       |              |  

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


2



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##### Table of Contents



NORTEL NETWORKS LIMITED


Condensed Consolidated Statements of Cash Flows
(unaudited)


|                                                                            |                                                                                                                                                                                                   |                                                                             |       |              |        |   |       |      |      |  
|--------------------------------------------------------------------------- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | --------------------------------------------------------------------------- | ----- | ------------ | ------ | - | ----- | ---- | ---- | -
|                                                                            |                                                                                                                                                                                                   | Nine Months Ended                                                           |      
|                                                                            |                                                                                                                                                                                                   | September 30,                                                               |      
|                                                                            |                                                                                                                                                                                                   |                                                                             |      
|                                                                            |                                                                                                                                                                                                   | 2006                                                                        |       |              | 2005   |  
|                                                                            |                                                                                                                                                                                                   |                                                                             |       |              |        |  
|                                                                            |                                                                                                                                                                                                   |                                                                             |       | As restated* |       
|                                                                            |                                                                                                                                                                                                   | (Millions of U.S. dollars)                                                  |      
|Cash flows from (used in) operating activities                              |                                                                                                                                                                                                   |                                                                             |       |              |        |   |       |     
|                                                                            | Net earnings (loss)                                                                                                                                                                               |                                                                             | $     | (209         | )      |   | $     | (192 | )   
|                                                                            | 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                                               |       |              | 222    |   |       |      | 232  |  
|                                                                            |                                                                                                                                                                                                   | Non-cash portion of special charges and related asset write downs           |       |              | 12     |   |       |      | 3    |  
|                                                                            |                                                                                                                                                                                                   | Non-cash portion of in-process research and development expense             |       |              | 16     |   |       |      |     |  
|                                                                            |                                                                                                                                                                                                   | Equity in net (earnings) loss of associated companies                       |       |              | 5      |   |       |      | (3   | )
|                                                                            |                                                                                                                                                                                                   | Stock option compensation                                                   |       |              | 83     |   |       |      | 58   |  
|                                                                            |                                                                                                                                                                                                   | Deferred income taxes                                                       |       |              | 74     |   |       |      | 56   |  
|                                                                            |                                                                                                                                                                                                   | Cumulative effect of accounting change                                      |       |              | (9     | ) |       |      |     |  
|                                                                            |                                                                                                                                                                                                   | Net (earnings) from discontinued operations                                 |       |              |       |   |       |      | (3   | )
|                                                                            |                                                                                                                                                                                                   | Other liabilities                                                           |       |              | 239    |   |       |      | 256  |  
|                                                                            |                                                                                                                                                                                                   | (Gain) loss on sale or write down of investments, businesses and
    assets |       |              | (36    | ) |       |      | 20   |  
|                                                                            |                                                                                                                                                                                                   | Other  net                                                                 |       |              | 278    |   |       |      | (44  | )
|                                                                            |                                                                                                                                                                                                   | Change in operating assets and liabilities                                  |       |              | (1,514 | ) |       |      | (676 | )
|                                                                            |                                                                                                                                                                                                   |                                                                             |       |              |        |  
|                                                                            | Net cash from (used in) operating activities of continuing
    operations                                                                                                                         |                                                                             |       | (839         | )      |   |       | (293 | )   
|                                                                            |                                                                                                                                                                                                   |                                                                             |       |              |        |  
|Cash flows from (used in) investing activities                              |                                                                                                                                                                                                   |                                                                             |       |              |        |   |       |     
|                                                                            | Expenditures for plant and equipment                                                                                                                                                              |                                                                             |       | (260         | )      |   |       | (175 | )   
|                                                                            | Proceeds on disposals of plant and equipment                                                                                                                                                      |                                                                             |       | 125          |        |   |       | 10   |     
|                                                                            | Restricted cash and cash equivalents  net                                                                                                                                                        |                                                                             |       | 38           |        |   |       | 9    |     
|                                                                            | Acquisitions of investments and businesses  net of
    cash acquired                                                                                                                             |                                                                             |       | (134         | )      |   |       | (449 | )   
|                                                                            | Proceeds on sale of investments and businesses                                                                                                                                                    |                                                                             |       | 196          |        |   |       | 308  |     
|                                                                            |                                                                                                                                                                                                   |                                                                             |       |              |        |  
|                                                                            | Net cash from (used in) investing activities of continuing
    operations                                                                                                                         |                                                                             |       | (35          | )      |   |       | (297 | )   
|                                                                            |                                                                                                                                                                                                   |                                                                             |       |              |        |  
|Cash flows from (used in) financing activities                              |                                                                                                                                                                                                   |                                                                             |       |              |        |   |       |     
|                                                                            | Dividends paid                                                                                                                                                                                    |                                                                             |       | (46          | )      |   |       | (33  | )   
|                                                                            | Increase in notes payable                                                                                                                                                                         |                                                                             |       | 88           |        |   |       | 59   |     
|                                                                            | Decrease in notes payable                                                                                                                                                                         |                                                                             |       | (30          | )      |   |       | (64  | )   
|                                                                            | Proceeds from issuance of long-term debt                                                                                                                                                          |                                                                             |       | 3,300        |        |   |       |     |     
|                                                                            | Repayment of long-term debt                                                                                                                                                                       |                                                                             |       | (2,725       | )      |   |       |     |     
|                                                                            | Debt issuance cost                                                                                                                                                                                |                                                                             |       | (42          | )      |   |       |     |     
|                                                                            | Decrease in capital leases payable                                                                                                                                                                |                                                                             |       | (12          | )      |   |       | (7   | )   
|                                                                            |                                                                                                                                                                                                   |                                                                             |       |              |        |  
|                                                                            | Net cash from (used in) financing activities of continuing
    operations                                                                                                                         |                                                                             |       | 533          |        |   |       | (45  | )   
|                                                                            |                                                                                                                                                                                                   |                                                                             |       |              |        |  
|Effect of foreign exchange rate changes on cash and cash
    equivalents    |                                                                                                                                                                                                   |                                                                             | 59    |              |        |   | (86   | )   
|                                                                            |                                                                                                                                                                                                   |                                                                             |       |              |        |  
|Net cash from (used in) continuing operations                               |                                                                                                                                                                                                   |                                                                             | (282  | )            |        |   | (721  | )   
|Net cash from (used in) operating activities of discontinued
    operations |                                                                                                                                                                                                   |                                                                             |      |              |        |   | 34    |     
|                                                                            |                                                                                                                                                                                                   |                                                                             |       |              |        |  
|Net increase (decrease) in cash and cash equivalents                        |                                                                                                                                                                                                   |                                                                             | (282  | )            |        |   | (687  | )   
|Cash and cash equivalents at beginning of period                            |                                                                                                                                                                                                   |                                                                             | 2,876 |              |        |   | 3,606 |     
|                                                                            |                                                                                                                                                                                                   |                                                                             |       |              |        |  
|Cash and cash equivalents at end of period                                  |                                                                                                                                                                                                   | $                                                                           | 2,594 |              |        | $ | 2,919 |     
|                                                                            |                                                                                                                                                                                                   |                                                                             |       |              |        |  






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

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


3



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##### 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

4



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##### Table of Contents



NORTEL NETWORKS LIMITED


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




|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|    | Extinguishments of Liabilities
    (SFAS 140), to eliminate certain restrictions
    on passive derivative financial instruments that a qualifying
    special-purpose entity can hold. 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 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 June 2006, the FASB issued FASB Interpretation No.
    (FIN) 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. The
    evaluation of tax positions under FIN 48 will be a two-step
    process, whereby (1) Nortel determines whether it is more
    likely than not that the tax positions will be sustained based
    on the technical merits of the position; and, (2) for those
    tax positions that meet the more-likely-than-not recognition
    threshold, Nortel would recognize the largest amount of tax
    benefit that is greater than fifty percent likely of being
    realized upon ultimate settlement with the related tax
    authority. 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.
|   
|(d) | In June 2006, the United States Emerging Issues Task Force
    (EITF) reached a consensus on EITF Issue
    No. 06-2 Accounting for Sabbatical Leave and Other
    Similar Benefits Pursuant to FASB Statement No. 43,
    Accounting for Compensated Absences
    (EITF 06-2).
    EITF 06-2 provides
    clarification surrounding the accounting for benefits in the
    form of compensated absences, whereby an employee is entitled to
    paid time off after working for a specified period of time.
    EITF 06-2 is
    effective for fiscal years beginning after June 28, 2006.
    Nortel will adopt the provisions of
    EITF 06-2 on
    January 1, 2007. Nortel does not expect the adoption of
    EITF 06-2 to have
    a material impact on its results of operations and financial
    condition.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|   
|(e) | In June 2006, the EITF reached a consensus on EITF Issue
    No. 06-3 How
    Taxes Collected from Customers and Remitted to Governmental
    Authorities Should Be Presented in the Income Statement (That
    Is, Gross Versus Net Presentation)
    (EITF 06-3).
    EITF 06-3 provides
    guidance on how taxes directly imposed on revenue producing
    transactions between a seller and customer that are remitted to
    governmental authorities should be presented in the income
    statement (i.e. gross versus net presentation).
    EITF 06-3 is
    effective for interim and annual reporting periods beginning
    after December 15, 2006. Nortel will adopt the provisions
    of EITF 06-3 on
    January 1, 2007. Nortel is currently in the process of
    assessing the impact of
    EITF 06-3 on the
    presentation of its results of operations and financial
    condition.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|   
|(f) | In September 2006, the FASB issued SFAS No. 157
    Fair Value Measurements (SFAS 157).
    SFAS 157 provides accounting guidance on the definition of
    fair value and establishes a framework for measuring fair value
    in U.S. GAAP and expands disclosures about fair value
    measurements. SFAS 157 is effective for financial
    statements issued for fiscal years beginning after
    November 15, 2007. Nortel plans to adopt the provisions of
    SFAS 157 on January 1, 2008. Nortel is currently
    assessing the impact of the adoption of SFAS 157 on its
    results of operations and financial condition.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|   
|(g) | In September 2006, the FASB issued SFAS No. 158
    Employers Accounting for Defined Benefit Pension and
    Other Postretirement Plans  An Amendment of FASB
    Statements No. 87, 88, 106, and 132(R)
    (SFAS 158).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      

5



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##### Table of Contents



NORTEL NETWORKS LIMITED


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




| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | SFAS 158 requires an employer to recognize the overfunded
    or underfunded status of a defined benefit pension and
    post-retirement plan (other than a multiemployer plan) as an
    asset or liability in its statement of financial position and to
    recognize changes in that funded status in the year in which the
    changes occur through comprehensive income of a business entity
    or changes in unrestricted net assets of a not-for-profit
    organization. SFAS 158 also requires an employer to measure
    the funded status of a plan as of the date of its year-end
    statement of financial position, with limited exceptions. Nortel
    is required to initially recognize the funded status of its
    defined benefit pension and post-retirement plans and to provide
    the required disclosures as of December 31, 2006. The
    requirement to measure plan assets and benefit obligations as of
    the date of the employers fiscal year end statement of
    financial position is effective for Nortel for its fiscal year
    ending December 31, 2008. As a result of the Nortel Board
    of Directors approving pension and other post-retirement benefit
    plan design changes in the U.S. and Canada, Nortel re-measured
    the U.S. and Canadian pension and other post-retirement benefit
    plans that were impacted by the design change.



| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Nortel uses a measurement date of September 30 to measure
    plan assets and benefit obligations annually. Changes in key
    assumptions used for the September 30 measurement could
    have a material impact on the unfunded status of Nortels
    pension and other post-retirement benefit plans. Nortel is
    currently assessing the impact of the adoption of SFAS 158
    on its results of operations and financial condition; however,
    as Nortel has currently recognized a certain amount representing
    additional minimum liabilities in accordance with FASB Statement
    No. 87, Employers Accounting for
    Pensions, the impact of the adoption of SFAS 158 is
    expected to be offset by these previously recognized amounts.
    Based on the funded status of Nortels pension and
    post-retirement benefit plans as of the September 30, 2005
    measurement date, using Nortels estimate of the current
    discount rates and adjusting for the impact of announced changes
    to the North American pension and post- retirement plans, the
    adoption of SFAS 158 would have the estimated effect of
    increasing Nortels net liabilities for pension and
    post-retirement benefits, and a decrease in shareholders
    equity of approximately $400. The actual impact of SFAS 158
    on Nortels financial position as at December 31, 2006
    will ultimately be based on the assumptions used at that time
    and as such, may differ significantly from the most recent
    measurement date. For additional information on Nortels
    pension and post-retirement plans see note 8.



|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(h) | In September 2006, the SEC issued Staff Accounting Bulletin
    (SAB) No. 108 (SAB 108), which
    addresses the process for considering the effects of prior year
    misstatements when quantifying misstatements in current year
    financial statements. SAB 108 expresses the SEC
    Staffs views regarding the process of quantifying
    financial statement misstatements. The interpretations in
    SAB 108 intended to address diversity in practice in
    quantifying financial statement misstatements and the potential
    under current practice for the
    build-up of improper
    balance sheet amounts. The application of SAB 108 is
    effective for financial statements issued for an interim period
    of the first fiscal year ending after November 15, 2006.
    Nortel will adopt the interpretations of SAB 108 on
    October 1, 2006. Nortel is currently assessing the impact
    of the interpretation of SAB 108 on its results of
    operations and financial condition.



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



|    |                                                                                           
|--- | ------------------------------------------------------------------------------------------
|(a) | Determining the Variability to be Considered in Applying
    FASB Interpretation No. 46(R)

46(R)-6, 46(R)-6). 46(R)-6




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

03-1, 03-1), 115-1 124-1, 115-1 124-1). 115-1 124-1


6



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##### Table of Contents



NORTEL NETWORKS LIMITED


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




|    |                
|--- | ---------------
|(c) | Inventory Costs





|    |                    
|--- | -------------------
|(d) | Share-Based Payment





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





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

04-13, 04-13). 04-13




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



7



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##### Table of Contents



NORTEL NETWORKS LIMITED


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


10-K


97-2),


percentage-of 81-1, 81-1),




| |   |                                                                                                                                                                                                                                                                                                                                                                                              
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | 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.                                                                                                                         





8



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##### Table of Contents



NORTEL NETWORKS LIMITED


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


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


|                                                                                                                                                     |                |               |       |     |             |   |      |             |  |   |       |     |  
|---------------------------------------------------------------------------------------------------------------------------------------------------- | -------------- | ------------- | ----- | --- | ----------- | - | ---- | ----------- |  | - | ----- | --- | -
|                                                                                                                                                     |                | As Previously |       |     |             |   |     
|                                                                                                                                                     |                | Reported      |       |     | Adjustments |   |      | As Restated | 
|                                                                                                                                                     |                |               |       |     |             |   |      |             | 
|Revenues                                                                                                                                             |                | $             | 2,655 |     |             | $ | (137 | )           |  | $ | 2,518 |    
|Cost of revenues                                                                                                                                     |                |               | 1,660 |     |             |   | (109 | )           |  |   | 1,551 |    
|                                                                                                                                                     |                |               |       |     |             |   |      |             | 
|Gross profit                                                                                                                                         |                |               | 995   |     |             |   | (28  | )           |  |   | 967   |    
|Selling, general and administrative expense                                                                                                          |                |               | 570   |     |             |   | (5   | )           |  |   | 565   |    
|Research and development expense                                                                                                                     |                |               | 445   |     |             |   | (7   | )           |  |   | 438   |    
|Amortization of intangibles                                                                                                                          |                |               | 6     |     |             |   | 1    |             |  |   | 7     |    
|Special charges                                                                                                                                      |                |               | 37    |     |             |   | 2    |             |  |   | 39    |    
|(Gain) loss on sale of businesses and assets                                                                                                         |                |               | 4     |     |             |   | (1   | )           |  |   | 3     |    
|                                                                                                                                                     |                |               |       |     |             |   |      |             | 
|Operating earnings (loss)                                                                                                                            |                |               | (67   | )   |             |   | (18  | )           |  |   | (85   | )  
|Other income  net                                                                                                                                   |                |               | 67    |     |             |   | (15  | )           |  |   | 52    |    
|Interest expense                                                                                                                                     |                |               |       |     |             |   |      |             |  |   |       |    
|                                                                                                                                                     | Long-term debt |               |       | (32 | )           |   |      |            |  |   |       | (32 | )
|                                                                                                                                                     | Other          |               |       | (2  | )           |   |      |            |  |   |       | (2  | )
|                                                                                                                                                     |                |               |       |     |             |   |      |             | 
|Earnings (loss) from continuing operations before income taxes,
    minority interests and equity in net earnings (loss) of
    associated companies |                |               | (34   | )   |             |   | (33  | )           |  |   | (67   | )  
|Income tax benefit (expense)                                                                                                                         |                |               | (40   | )   |             |   |     |             |  |   | (40   | )  
|                                                                                                                                                     |                |               |       |     |             |   |      |             | 
|                                                                                                                                                     |                |               | (74   | )   |             |   | (33  | )           |  |   | (107  | )  
|Minority interests  net of tax                                                                                                                      |                |               | (5    | )   |             |   |     |             |  |   | (5    | )  
|Equity in net earnings (loss) of associated
    companies  net of tax                                                                               |                |               | 1     |     |             |   |     |             |  |   | 1     |    
|                                                                                                                                                     |                |               |       |     |             |   |      |             | 
|Net earnings (loss) from continuing operations                                                                                                       |                |               | (78   | )   |             |   | (33  | )           |  |   | (111  | )  
|Net loss from discontinued operations  net of tax                                                                                                   |                |               | 1     |     |             |   | 1    |             |  |   | 2     |    
|                                                                                                                                                     |                |               |       |     |             |   |      |             | 
|Net earnings (loss)                                                                                                                                  |                |               | (77   | )   |             |   | (32  | )           |  |   | (109  | )  
|Dividends on preferred shares                                                                                                                        |                |               | 9     |     |             |   |     |             |  |   | 9     |    
|                                                                                                                                                     |                |               |       |     |             |   |      |             | 
|Net earnings (loss) applicable to common shares                                                                                                      |                | $             | (86   | )   |             | $ | (32  | )           |  | $ | (118  | )  
|                                                                                                                                                     |                |               |       |     |             |   |      |             | 

9



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##### Table of Contents



NORTEL NETWORKS LIMITED


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


Condensed Consolidated Statement of Operations
(unaudited) for the nine months ended September 30,
2005


|                                                                                                                                                     |                |               |       |     |             |   |      |             |  |   |       |     |  
|---------------------------------------------------------------------------------------------------------------------------------------------------- | -------------- | ------------- | ----- | --- | ----------- | - | ---- | ----------- |  | - | ----- | --- | -
|                                                                                                                                                     |                | As Previously |       |     |             |   |     
|                                                                                                                                                     |                | Reported      |       |     | Adjustments |   |      | As Restated | 
|                                                                                                                                                     |                |               |       |     |             |   |      |             | 
|Revenues                                                                                                                                             |                | $             | 8,046 |     |             | $ | (520 | )           |  | $ | 7,526 |    
|Cost of revenues                                                                                                                                     |                |               | 4,787 |     |             |   | (346 | )           |  |   | 4,441 |    
|                                                                                                                                                     |                |               |       |     |             |   |      |             | 
|Gross profit                                                                                                                                         |                |               | 3,259 |     |             |   | (174 | )           |  |   | 3,085 |    
|Selling, general and administrative expense                                                                                                          |                |               | 1,716 |     |             |   | 8    |             |  |   | 1,724 |    
|Research and development expense                                                                                                                     |                |               | 1,390 |     |             |   | 2    |             |  |   | 1,392 |    
|Amortization of intangibles                                                                                                                          |                |               | 10    |     |             |   | 1    |             |  |   | 11    |    
|Special charges                                                                                                                                      |                |               | 148   |     |             |   | (3   | )           |  |   | 145   |    
|(Gain) loss on sale of businesses and assets                                                                                                         |                |               | 41    |     |             |   | (5   | )           |  |   | 36    |    
|                                                                                                                                                     |                |               |       |     |             |   |      |             | 
|Operating earnings (loss)                                                                                                                            |                |               | (46   | )   |             |   | (177 | )           |  |   | (223  | )  
|Other income  net                                                                                                                                   |                |               | 175   |     |             |   | 9    |             |  |   | 184   |    
|Interest expense                                                                                                                                     |                |               |       |     |             |   |      |             |  |   |       |    
|                                                                                                                                                     | Long-term debt |               |       | (91 | )           |   |      |            |  |   |       | (91 | )
|                                                                                                                                                     | Other          |               |       | (4  | )           |   |      |            |  |   |       | (4  | )
|                                                                                                                                                     |                |               |       |     |             |   |      |             | 
|Earnings (loss) from continuing operations before income taxes,
    minority interests and equity in net earnings (loss) of
    associated companies |                |               | 34    |     |             |   | (168 | )           |  |   | (134  | )  
|Income tax benefit (expense)                                                                                                                         |                |               | (48   | )   |             |   | 2    |             |  |   | (46   | )  
|                                                                                                                                                     |                |               |       |     |             |   |      |             | 
|                                                                                                                                                     |                |               | (14   | )   |             |   | (166 | )           |  |   | (180  | )  
|Minority interests  net of tax                                                                                                                      |                |               | (18   | )   |             |   |     |             |  |   | (18   | )  
|Equity in net earnings (loss) of associated
    companies  net of tax                                                                               |                |               | 3     |     |             |   |     |             |  |   | 3     |    
|                                                                                                                                                     |                |               |       |     |             |   |      |             | 
|Net earnings (loss) from continuing operations                                                                                                       |                |               | (29   | )   |             |   | (166 | )           |  |   | (195  | )  
|Net earnings from discontinued operations  net of tax                                                                                               |                |               | 2     |     |             |   | 1    |             |  |   | 3     |    
|                                                                                                                                                     |                |               |       |     |             |   |      |             | 
|Net earnings (loss)                                                                                                                                  |                |               | (27   | )   |             |   | (165 | )           |  |   | (192  | )  
|Dividends on preferred shares                                                                                                                        |                |               | 28    |     |             |   |     |             |  |   | 28    |    
|                                                                                                                                                     |                |               |       |     |             |   |      |             | 
|Net earnings (loss) applicable to common shares                                                                                                      |                | $             | (55   | )   |             | $ | (165 | )           |  | $ | (220  | )  
|                                                                                                                                                     |                |               |       |     |             |   |      |             | 

10



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##### Table of Contents



NORTEL NETWORKS LIMITED


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


Adjustments




|                                                                          |  |               |       |   |               |   |       |  
|------------------------------------------------------------------------- |  | ------------- | ----- | - | ------------- | - | ----- | -
|                                                                          |  | Three Months  |       |   | Nine Months   |  
|                                                                          |  | Ended         |       |   | Ended         |  
|                                                                          |  | September 30, |       |   | September 30, |  
|                                                                          |  | 2005          |       |   | 2005          |  
|                                                                          |  |               |       |   |               |  
|Revenues  as previously reported                                         |  | $             | 2,655 |   |               | $ | 8,046 |  
|Adjustments:                                                              |  |               |       |   |               |   |       |  
|Application of SOP 81-1                                                   |  |               | (13   | ) |               |   | 46    |  
|Interaction between multiple revenue recognition accounting
    standards |  |               | (70   | ) |               |   | (408  | )
|Application of SAB 104 and SOP 97-2                                       |  |               | (62   | ) |               |   | (160  | )
|Other revenue recognition adjustments                                     |  |               | 8     |   |               |   | 2     |  
|                                                                          |  |               |       |   |               |  
|Revenues  as restated                                                    |  | $             | 2,518 |   |               | $ | 7,526 |  
|                                                                          |  |               |       |   |               |  
|Net earnings (loss)  as previously reported                              |  | $             | (77   | ) |               | $ | (27   | )
|Adjustments:                                                              |  |               |       |   |               |   |       |  
|Application of SOP 81-1                                                   |  |               | (6    | ) |               |   | (9    | )
|Interaction between multiple revenue recognition accounting
    standards |  |               | (7    | ) |               |   | (45   | )
|Application of SAB 104 and SOP 97-2                                       |  |               | (22   | ) |               |   | (73   | )
|Other revenue recognition adjustments                                     |  |               | 6     |   |               |   | (47   | )
|(Gain) loss on sale of businesses                                         |  |               |      |   |               |   | 4     |  
|Foreign
    exchange(i)                                                   |  |               | (5    | ) |               |   | 8     |  
|Other                                                                     |  |               | 2     |   |               |   | (3    | )
|                                                                          |  |               |       |   |               |  
|Net earnings (loss)  as restated                                         |  | $             | (109  | ) |               | $ | (192  | )
|                                                                          |  |               |       |   |               |  






|    |                                                                                                                                                                
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------
|(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 81-1. percentage-of


11



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##### Table of Contents



NORTEL NETWORKS LIMITED


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




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

81-1, 97-2 00-21.


percentage-of 81-1 97-2.


00-21 97-2 00-21 97-2 81-1 97-2 97-2


percentage-of 97-2




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

97-2


97-2,




12



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##### 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





13



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##### Table of Contents



NORTEL NETWORKS LIMITED


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






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

|                                                 |  |               |    |   |               |   |    |      |  |   |      |   |  |   |     | 
|------------------------------------------------ |  | ------------- | -- | - | ------------- | - | -- | ---- |  | - | ---- | - |  | - | --- | 
|                                                 |  | Three Months  |    |   | Nine Months   |  
|                                                 |  | Ended         |    |   | Ended         |  
|                                                 |  | September 30, |    |   | September 30, |  
|                                                 |  |               |    |   |               |  
|                                                 |  | 2006          |    |   | 2005          |   |    | 2006 |  |   | 2005 |  
|                                                 |  |               |    |   |               |   |    |      |  |   |      |  
|Interest and dividend income                     |  | $             | 30 |   |               | $ | 26 |      |  | $ | 84   |   |  | $ | 74  | 
|Gain (loss) on sale or write down of investments |  |               | (7 | ) |               |   |   |      |  |   | (6   | ) |  |   | 16  | 
|Currency exchange gains (losses)                 |  |               | (3 | ) |               |   | 16 |      |  |   | 20   |   |  |   | 65  | 
|Other  net                                      |  |               | 26 |   |               |   | 10 |      |  |   | 71   |   |  |   | 29  | 
|                                                 |  |               |    |   |               |   |    |      |  |   |      |  
|Other income  net                               |  | $             | 46 |   |               | $ | 52 |      |  | $ | 169  |   |  | $ | 184 | 
|                                                 |  |               |    |   |               |   |    |      |  |   |      |  





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



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

|                                      |  |               |       |   |              |   |       |  
|------------------------------------- |  | ------------- | ----- | - | ------------ | - | ----- | -
|                                      |  | September 30, |       |   | December 31, |  
|                                      |  | 2006          |       |   | 2005         |  
|                                      |  |               |       |   |              |  
|Trade receivables                     |  | $             | 2,237 |   |              | $ | 2,570 |  
|Notes receivable                      |  |               | 1,075 |   |              |   | 122   |  
|Contracts in process                  |  |               | 500   |   |              |   | 611   |  
|                                      |  |               |       |   |              |  
|                                      |  |               | 3,812 |   |              |   | 3,303 |  
|Less: provision for doubtful accounts |  |               | (98   | ) |              |   | (137  | )
|                                      |  |               |       |   |              |  
|Accounts receivable  net             |  | $             | 3,714 |   |              | $ | 3,166 |  
|                                      |  |               |       |   |              |  



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

|                                      |  |               |        |   |              |   |        |  
|------------------------------------- |  | ------------- | ------ | - | ------------ | - | ------ | -
|                                      |  | September 30, |        |   | December 31, |  
|                                      |  | 2006          |        |   | 2005         |  
|                                      |  |               |        |   |              |  
|Raw materials                         |  | $             | 772    |   |              | $ | 777    |  
|Work in process                       |  |               | 8      |   |              |   | 50     |  
|Finished goods                        |  |               | 790    |   |              |   | 819    |  
|Deferred costs                        |  |               | 2,050  |   |              |   | 2,014  |  
|                                      |  |               |        |   |              |  
|                                      |  |               | 3,620  |   |              |   | 3,660  |  
|Less: provision for inventory         |  |               | (1,067 | ) |              |   | (1,039 | )
|                                      |  |               |        |   |              |  
|Inventories  net                     |  |               | 2,553  |   |              |   | 2,621  |  
|Less: long-term deferred
    costs(a) |  |               | (719   | ) |              |   | (817   | )
|                                      |  |               |        |   |              |  
|Current inventories  net             |  | $             | 1,834  |   |              | $ | 1,804  |  
|                                      |  |               |        |   |              |  






|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(a) | Long-term portion of deferred costs is included in other assets.
    Deferred costs include inventory related substantially to
    multi-element arrangements where title and risk of loss was
    transferred to customers but revenue was deferred due to other
    revenue recognition criteria not being met. Once the revenue
    recognition criteria are satisfied, the deferred costs are
    relieved from inventory into cost of revenues at the same time
    revenue is recognized.

14



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NORTEL NETWORKS LIMITED


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




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

|                         |  |               |     |  |              |   |     | 
|------------------------ |  | ------------- | --- |  | ------------ | - | --- | 
|                         |  | September 30, |     |  | December 31, |  
|                         |  | 2006          |     |  | 2005         |  
|                         |  |               |     |  |              |  
|Prepaid expenses         |  | $             | 194 |  |              | $ | 198 | 
|Income taxes recoverable |  |               | 56  |  |              |   | 68  | 
|Other                    |  |               | 279 |  |              |   | 301 | 
|                         |  |               |     |  |              |  
|Other current assets     |  | $             | 529 |  |              | $ | 567 | 
|                         |  |               |     |  |              |  



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

|                                 |                         |               |        |        |              |   |        |        |  
|-------------------------------- | ----------------------- | ------------- | ------ | ------ | ------------ | - | ------ | ------ | -
|                                 |                         | September 30, |        |        | December 31, |  
|                                 |                         | 2006          |        |        | 2005         |  
|                                 |                         |               |        |        |              |  
|Cost:                            |                         |               |        |        |              |   |        |       
|                                 | Land                    |               | $      | 38     |              |   | $      | 45     |  
|                                 | Buildings               |               |        | 1,190  |              |   |        | 1,265  |  
|                                 | Machinery and equipment |               |        | 2,304  |              |   |        | 2,180  |  
|                                 | Capital lease assets    |               |        | 215    |              |   |        | 213    |  
|                                 | Sale lease-back assets  |               |        | 100    |              |   |        | 80     |  
|                                 |                         |               |        |        |              |  
|                                 |                         |               | 3,847  |        |              |   | 3,783  |       
|                                 |                         |               |        |        |              |  
|Less accumulated depreciation:   |                         |               |        |        |              |   |        |       
|                                 | Buildings               |               |        | (463   | )            |   |        | (455   | )
|                                 | Machinery and equipment |               |        | (1,718 | )            |   |        | (1,674 | )
|                                 | Capital lease assets    |               |        | (93    | )            |   |        | (78    | )
|                                 | Sale lease-back assets  |               |        | (18    | )            |   |        | (17    | )
|                                 |                         |               |        |        |              |  
|                                 |                         |               | (2,292 | )      |              |   | (2,224 | )     
|                                 |                         |               |        |        |              |  
|Plant and equipment 
    net(a) |                         | $             | 1,555  |        |              | $ | 1,559  |       
|                                 |                         |               |        |        |              |  






|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(a) | Included are assets held for sale with a carrying value of $117
    and $136 as of September 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 assets held for sale during the
    remainder of 2006 and 2007. See note 9 for additional
    information on the assets held for sale as a result of the
    proposed UMTS access business divestiture.



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



|                                   |                  |            |     |              |          |   |       |           |   |   |          |     |   |       |     |     |       |   |     |    |       |   |       |     |  
|---------------------------------- | ---------------- | ---------- | --- | ------------ | -------- | - | ----- | --------- | - | - | -------- | --- | - | ----- | --- | --- | ----- | - | --- | -- | ----- | - | ----- | --- | -
|                                   |                  |            |     | Mobility and |          |   |       |           |   |   |          |     |  
|                                   |                  |            |     | Converged    |          |   | Metro |           |   |   |          |     |   |      
|                                   |                  | Enterprise |     |              | Core     |   |       | Ethernet  |   |   | Global   |     |   |       |     |    
|                                   |                  | Solutions  |     |              | Networks |   |       | Solutions |   |   | Services |     |   | Other |     |     | Total |  
|                                   |                  |            |     |              |          |   |       |           |   |   |          |     |   |       |     |     |       |  
|Balance  as of December 31, 2005  |                  | $          | 412 |              |          | $ | 64    |           |   | $ | 772      |     |   | $     | 886 |     |       | $ | 278 |    |       | $ | 2,412 |    
|Change:                            |                  |            |     |              |          |   |       |           |   |   |          |     |   |       |     |     |       |   |     |    |       |   |       |    
|                                   | Additions(a)     |            |     | 9            |          |   |       |          |   |   |          | 16  |   |       |     | 18  |       |   |     |   |       |   |       | 43  |  
|                                   | Disposals(b)     |            |     | (8           | )        |   |       | (3        | ) |   |          | (16 | ) |       |     | (19 | )     |   |     |   |       |   |       | (46 | )
|                                   | Foreign exchange |            |     | 1            |          |   |       | 3         |   |   |          | 4   |   |       |     | 4   |       |   |     |    |       |   |       | 12  |  
|                                   | Other            |            |     | (1           | )        |   |       | (1        | ) |   |          | (1  | ) |       |     | (1  | )     |   |     | (6 | ) (c) |   |       | (10 | )
|                                   |                  |            |     |              |          |   |       |           |   |   |          |     |   |       |     |     |       |  
|Balance  as of September 30, 2006 |                  | $          | 413 |              |          | $ | 63    |           |   | $ | 775      |     |   | $     | 888 |     |       | $ | 272 |    |       | $ | 2,411 |    
|                                   |                  |            |     |              |          |   |       |           |   |   |          |     |   |       |     |     |       |  






|    |                                                                                                                                                                                                               
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(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) | 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.            
|(c) | 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.     

15



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NORTEL NETWORKS LIMITED


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








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

|                               |  |               |     |  |              |   |     | 
|------------------------------ |  | ------------- | --- |  | ------------ | - | --- | 
|                               |  | September 30, |     |  | December 31, |  
|                               |  | 2006          |     |  | 2005         |  
|                               |  |               |     |  |              |  
|Other intangible
    assets(a) |  | $             | 159 |  |              | $ | 135 | 
|Pension intangible assets      |  |               | 25  |  |              |   | 37  | 
|                               |  |               |     |  |              |  
|Intangible assets  net        |  | $             | 184 |  |              | $ | 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:

|                                                                              |  |               |       |  |              |   |       | 
|----------------------------------------------------------------------------- |  | ------------- | ----- |  | ------------ | - | ----- | 
|                                                                              |  | September 30, |       |  | December 31, |  
|                                                                              |  | 2006          |       |  | 2005         |  
|                                                                              |  |               |       |  |              |  
|Outsourcing and selling, general and administrative related
    provisions    |  | $             | 280   |  |              | $ | 255   | 
|Customer deposits                                                             |  |               | 80    |  |              |   | 38    | 
|Product related provisions                                                    |  |               | 56    |  |              |   | 42    | 
|Warranty provisions (note 11)                                                 |  |               | 225   |  |              |   | 206   | 
|Deferred revenue                                                              |  |               | 1,482 |  |              |   | 1,289 | 
|Miscellaneous taxes                                                           |  |               | 78    |  |              |   | 65    | 
|Income taxes payable                                                          |  |               | 35    |  |              |   | 81    | 
|Interest payable                                                              |  |               | 63    |  |              |   | 40    | 
|Advance billings in excess of revenues recognized to date on
    contracts(a) |  |               | 1,054 |  |              |   | 1,194 | 
|Other                                                                         |  |               | 171   |  |              |   | 155   | 
|                                                                              |  |               |       |  |              |  
|Other accrued liabilities                                                     |  | $             | 3,524 |  |              | $ | 3,365 | 
|                                                                              |  |               |       |  |              |  






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



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

|                                                                 |  |               |       |  |              |   |       | 
|---------------------------------------------------------------- |  | ------------- | ----- |  | ------------ | - | ----- | 
|                                                                 |  | September 30, |       |  | December 31, |  
|                                                                 |  | 2006          |       |  | 2005         |  
|                                                                 |  |               |       |  |              |  
|Pension, post-employment and post-retirement benefit liabilities |  | $             | 2,261 |  |              | $ | 2,459 | 
|Restructuring liabilities (note 6)                               |  |               | 183   |  |              |   | 203   | 
|Deferred revenue                                                 |  |               | 1,011 |  |              |   | 1,073 | 
|Other long-term provisions                                       |  |               | 246   |  |              |   | 302   | 
|                                                                 |  |               |       |  |              |  
|Other liabilities                                                |  | $             | 3,701 |  |              | $ | 4,037 | 
|                                                                 |  |               |       |  |              |  

16



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NORTEL NETWORKS LIMITED


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




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



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

|                                                               |  |                   |        |   |      |   |      |  
|-------------------------------------------------------------- |  | ----------------- | ------ | - | ---- | - | ---- | -
|                                                               |  | Nine Months Ended |       
|                                                               |  | September 30,     |       
|                                                               |  |                   |       
|                                                               |  | 2006              |        |   | 2005 |  
|                                                               |  |                   |        |   |      |  
|Accounts receivable  net                                      |  | $                 | (386   | ) |      | $ | 21   |  
|Inventories  net                                              |  |                   | (115   | ) |      |   | (231 | )
|Income taxes                                                   |  |                   | (50    | ) |      |   | (49  | )
|Restructuring liabilities                                      |  |                   | (10    | ) |      |   | (111 | )
|Accounts payable, payroll, accrued and contractual liabilities |  |                   | (756   | ) |      |   | (459 | )
|Other operating assets and liabilities                         |  |                   | (197   | ) |      |   | 153  |  
|                                                               |  |                   |        |   |      |  
|Change in operating assets and liabilities                     |  | $                 | (1,514 | ) |      | $ | (676 | )
|                                                               |  |                   |        |   |      |  



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

|                                  |  |               |     |  |      |   |     | 
|--------------------------------- |  | ------------- | --- |  | ---- | - | --- | 
|                                  |  | Nine Months   |    
|                                  |  | Ended         |    
|                                  |  | September 30, |    
|                                  |  |               |    
|                                  |  | 2006          |     |  | 2005 |  
|                                  |  |               |     |  |      |  
|Cash interest paid                |  | $             | 122 |  |      | $ | 104 | 
|Cash taxes paid (recovered)  net |  | $             | 41  |  |      | $ | 44  | 



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



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







| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | MCCN 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 and to
    roam globally. In addition, Nortels carrier circuit and
    packet voice solutions provide a broad range of voice solutions
    to its service provider customers for business and residential
    subscribers, 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. On September 1, 2006,
    Nortel entered into a non-binding memorandum of understanding
    with Alcatel SA (Alcatel) for the sale of certain
    assets related to Nortels UMTS access business. See
    note 9 for additional information.

17



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NORTEL NETWORKS LIMITED


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




| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | ES provides (i) enterprise circuit and packet voice
    solutions, (ii) data networking and security solutions,
    which supply data, voice and multi-media communications
    solutions to Nortels enterprise customers and
    (iii) software solutions for multi-media messaging,
    conferencing and call centers. Nortels solutions for
    enterprises are used to build new networks and transform their
    existing communications networks into more cost effective,
    packet-based networks supporting data, voice and multi-media
    communications. Nortels ES customers consist of a broad
    range of enterprises around the world, including large
    businesses at their headquarters, data centers, call centers and
    their branch offices, small businesses and home offices, as well
    as government agencies, educational and other institutions and
    utility organizations.                                                                                                                                                                                                                                                                                                                                                                                                                                              
| |  | MEN combines Nortels optical networking solutions and the
    carrier portion of its data networking solutions, to transform
    Nortels carrier and large enterprise customers
    networks to be more scalable and reliable for the high speed
    delivery of diverse multi-media communications services. By
    combining Nortels optical expertise and data knowledge,
    Nortel creates solutions that help service providers and
    enterprises better manage increasing bandwidth demands. Nortel
    believes that ethernet technology is particularly suited to
    these solutions and is being integrated with Nortels
    optical technology. In addition to increased capacity and lower
    cost per bit, Nortel differentiates its MEN products on the
    basis of being able to deliver carrier-grade reliability. The
    metropolitan or metro network is a key focus area as bandwidth
    demands are increasing as a result of the growth of network
    based broadcast and on-demand video delivery, wireless
    back haul for a variety of data services including
    video as well as traditional business, internet, private line
    and voice services. MEN serves the long haul optical market
    using common products and technologies from the metro optical
    market.                                          
| |  | GS provides a broad range of services to address the
    requirements of Nortels carrier and enterprise customers
    throughout the entire lifecycle of their networks. The GS
    portfolio is organized into four main service groups:
    (i) network implementation services, consisting of network
    integration, planning, installation, optimization and security
    services, (ii) network support services, consisting of
    technical support, hardware maintenance, equipment spares
    logistics and on-site
    engineers, (iii) network managed services, consisting of
    services related to the monitoring and management of customer
    networks and providing a range of network managed service
    options and (iv) network application services, consisting
    of applications development, integration and web services.
    Nortels GS market mirrors that of its carrier and
    enterprise markets along with a broad range of customers in all
    geographic regions where Nortel conducts business, including
    small and medium-sized businesses, to large global enterprises
    and all levels of government. Revenues from network services
    consisting of network planning, engineering and installation are
    generally bundled with product sales and are not currently
    included in the revenues of GS.





18



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NORTEL NETWORKS LIMITED


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




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



|                                               |  |               |       |   |               |   |       |      |  |   |       |   |  |   |       |  
|---------------------------------------------- |  | ------------- | ----- | - | ------------- | - | ----- | ---- |  | - | ----- | - |  | - | ----- | -
|                                               |  | Three Months  |       |   | Nine Months   |  
|                                               |  | Ended         |       |   | Ended         |  
|                                               |  | September 30, |       |   | September 30, |  
|                                               |  |               |       |   |               |  
|                                               |  | 2006          |       |   | 2005          |   |       | 2006 |  |   | 2005  |  
|                                               |  |               |       |   |               |   |       |      |  |   |       |  
|Revenues                                       |  |               |       |   |               |   |       |      |  |   |       |   |  |   |       |  
|Mobility and Converged Core Networks           |  | $             | 1,540 |   |               | $ | 1,251 |      |  | $ | 4,255 |   |  | $ | 3,953 |  
|Enterprise Solutions                           |  |               | 609   |   |               |   | 534   |      |  |   | 1,523 |   |  |   | 1,608 |  
|Metro Ethernet Networks                        |  |               | 430   |   |               |   | 363   |      |  |   | 1,201 |   |  |   | 998   |  
|Global Services                                |  |               | 316   |   |               |   | 305   |      |  |   | 916   |   |  |   | 883   |  
|                                               |  |               |       |   |               |   |       |      |  |   |       |  
|Total reportable segments                      |  |               | 2,895 |   |               |   | 2,453 |      |  |   | 7,895 |   |  |   | 7,442 |  
|Other                                          |  |               | 60    |   |               |   | 65    |      |  |   | 186   |   |  |   | 84    |  
|                                               |  |               |       |   |               |   |       |      |  |   |       |  
|Total revenues                                 |  | $             | 2,955 |   |               | $ | 2,518 |      |  | $ | 8,081 |   |  | $ | 7,526 |  
|                                               |  |               |       |   |               |   |       |      |  |   |       |  
|Management EBT                                 |  |               |       |   |               |   |       |      |  |   |       |   |  |   |       |  
|Mobility and Converged Core Networks           |  | $             | 107   |   |               | $ | 38    |      |  | $ | 288   |   |  | $ | 284   |  
|Enterprise Solutions                           |  |               | 3     |   |               |   | 31    |      |  |   | (104  | ) |  |   | 126   |  
|Metro Ethernet Networks                        |  |               | 12    |   |               |   | (18   | )    |  |   | 26    |   |  |   | (103  | )
|Global Services                                |  |               | 89    |   |               |   | 85    |      |  |   | 270   |   |  |   | 268   |  
|                                               |  |               |       |   |               |   |       |      |  |   |       |  
|Total reportable segments                      |  |               | 211   |   |               |   | 136   |      |  |   | 480   |   |  |   | 575   |  
|Other                                          |  |               | (200  | ) |               |   | (158  | )    |  |   | (572  | ) |  |   | (532  | )
|                                               |  |               |       |   |               |   |       |      |  |   |       |  
|Total Management EBT                           |  |               | 11    |   |               |   | (22   | )    |  |   | (92   | ) |  |   | 43    |  
|                                               |  |               |       |   |               |   |       |      |  |   |       |  
|Amortization of intangibles                    |  |               | (8    | ) |               |   | (7    | )    |  |   | (19   | ) |  |   | (11   | )
|In-process research and development expense    |  |               |      |   |               |   |      |      |  |   | (16   | ) |  |   |      |  
|Special charges                                |  |               | (24   | ) |               |   | (39   | )    |  |   | (74   | ) |  |   | (145  | )
|Gain (loss) on sale of businesses and assets   |  |               | 16    |   |               |   | (3    | )    |  |   | 42    |   |  |   | (36   | )
|Income tax benefit (expense)                   |  |               | (9    | ) |               |   | (40   | )    |  |   | (59   | ) |  |   | (46   | )
|                                               |  |               |       |   |               |   |       |      |  |   |       |  
|Net earnings (loss) from continuing operations |  | $             | (14   | ) |               | $ | (111  | )    |  | $ | (218  | ) |  | $ | (195  | )
|                                               |  |               |       |   |               |   |       |      |  |   |       |  





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





19



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NORTEL NETWORKS LIMITED


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








|                                                 |                                        |           |    |            |           |   |           |             |   |   |              |       |               |             |       |               |      |   |    |    |  |   |    |    | 
|------------------------------------------------ | -------------------------------------- | --------- | -- | ---------- | --------- | - | --------- | ----------- | - | - | ------------ | ----- | ------------- | ----------- | ----- | ------------- | ---- | - | -- | -- |  | - | -- | -- | 
|                                                 |                                        |           |    | Contract   |           |   |           |             |   |   | Three Months |       |               | Nine Months |      
|                                                 |                                        |           |    | Settlement |           |   | Plant and |             |   |   |              | Ended |               |             | Ended |              
|                                                 |                                        | Workforce |    |            | and Lease |   |           | Equipment   |   |   |              |       | September 30, |             |       | September 30, |     
|                                                 |                                        | Reduction |    |            | Costs     |   |           | Write Downs |   |   | Total        |       |               | 2006        |       |               | 2006 |  
|                                                 |                                        |           |    |            |           |   |           |             |   |   |              |       |               |             |       |               |      |  
|2006 Restructuring Plan                          |                                        |           |    |            |           |   |           |             |   |   |              |       |               |             |       |               |      |   |    |    |  |   |    |   
|Provision balance as of December 31, 2005        |                                        | $         |   |            |           | $ |          |             |   | $ |             |       |               | $           |      |               |      |   |    |    |  |   |    |   
|                                                 | Other special charges                  |           |    | 49         |           |   |           |            |   |   |              | 1     |               |             |       | 50            |      |   | $  | 7  |  |   | $  | 50 | 
|                                                 | Revisions to prior accruals            |           |    |           |           |   |           |            |   |   |              |      |               |             |       |              |      |   |    |    |  |   |    |    | 
|                                                 | Cash drawdowns                         |           |    | (14        | )         |   |           |            |   |   |              |      |               |             |       | (14           | )    |   |    |    |  |   |    |    | 
|                                                 | Non-cash drawdowns                     |           |    |           |           |   |           |            |   |   |              | (1    | )             |             |       | (1            | )    |   |    |    |  |   |    |    | 
|                                                 | Foreign exchange and other adjustments |           |    |           |           |   |           |            |   |   |              |      |               |             |       |              |      |   |    |    |  |   |    |    | 
|                                                 |                                        |           |    |            |           |   |           |             |   |   |              |       |               |             |       |               |      |  
|Provision balance as of September 30, 2006       |                                        | $         | 35 |            |           | $ |          |             |   | $ |             |       |               | $           | 35    |               |      |   |    |    |  |   |    |   
|                                                 |                                        |           |    |            |           |   |           |             |   |   |              |       |               |             |       |               |      |  
|2004 Restructuring Plan                          |                                        |           |    |            |           |   |           |             |   |   |              |       |               |             |       |               |      |   |    |    |  |   |    |   
|Provision balance as of December 31, 2005        |                                        | $         | 21 |            |           | $ | 61        |             |   | $ |             |       |               | $           | 82    |               |      |   |    |    |  |   |    |   
|                                                 | Other special charges                  |           |    |           |           |   |           |            |   |   |              |      |               |             |       |              |      |   |    |    |  |   |    |    | 
|                                                 | Revisions to prior accruals            |           |    | 2          |           |   |           | 6           |   |   |              | 11    |               |             |       | 19            |      |   |    | 12 |  |   |    | 19 | 
|                                                 | Cash drawdowns                         |           |    | (19        | )         |   |           | (16         | ) |   |              |      |               |             |       | (35           | )    |   |    |    |  |   |    |    | 
|                                                 | Non-cash drawdowns                     |           |    |           |           |   |           |            |   |   |              | (11   | )             |             |       | (11           | )    |   |    |    |  |   |    |    | 
|                                                 | Foreign exchange and other adjustments |           |    | 1          |           |   |           | 3           |   |   |              |      |               |             |       | 4             |      |   |    |    |  |   |    |    | 
|                                                 |                                        |           |    |            |           |   |           |             |   |   |              |       |               |             |       |               |      |  
|Provision balance as of September 30, 2006       |                                        | $         | 5  |            |           | $ | 54        |             |   | $ |             |       |               | $           | 59    |               |      |   |    |    |  |   |    |   
|                                                 |                                        |           |    |            |           |   |           |             |   |   |              |       |               |             |       |               |      |  
|2001 Restructuring Plan                          |                                        |           |    |            |           |   |           |             |   |   |              |       |               |             |       |               |      |   |    |    |  |   |    |   
|Provision balance as of                          |                                        |           |    |            |           |   |           |             |   |   |              |       |               |             |       |               |      |   |    |    |  |   |    |   
|December 31, 2005                                |                                        | $         | 3  |            |           | $ | 213       |             |   | $ |             |       |               | $           | 216   |               |      |   |    |    |  |   |    |   
|                                                 | Other special charges                  |           |    |           |           |   |           |            |   |   |              |      |               |             |       |              |      |   |    |    |  |   |    |    | 
|                                                 | Revisions to prior accruals            |           |    | 1          |           |   |           | 4           |   |   |              |      |               |             |       | 5             |      |   |    | 5  |  |   |    | 5  | 
|                                                 | Cash drawdowns                         |           |    | (1         | )         |   |           | (40         | ) |   |              |      |               |             |       | (41           | )    |   |    |    |  |   |    |    | 
|                                                 | Non-cash drawdowns                     |           |    |           |           |   |           |            |   |   |              |      |               |             |       |              |      |   |    |    |  |   |    |    | 
|                                                 | Foreign exchange and other adjustments |           |    | (1         | )         |   |           | 3           |   |   |              |      |               |             |       | 2             |      |   |    |    |  |   |    |    | 
|                                                 |                                        |           |    |            |           |   |           |             |   |   |              |       |               |             |       |               |      |  
|Provision balance as of September 30, 2006       |                                        | $         | 2  |            |           | $ | 180       |             |   | $ |             |       |               | $           | 182   |               |      |   |    |    |  |   |    |   
|                                                 |                                        |           |    |            |           |   |           |             |   |   |              |       |               |             |       |               |      |  
|Total provision balance as of September 30, 2006 |                                        | $         | 42 |            |           | $ | 234       |             |   | $ |             |       |               | $           | 276   |               |      |   |    |    |  |   |    |   
|                                                 |                                        |           |    |            |           |   |           |             |   |   |              |       |               |             |       |               |      |  
|Total special charges                            |                                        |           |    |            |           |   |           |             |   |   |              |       |               |             |       |               |      | $ | 24 |    |  | $ | 74 |   
|                                                 |                                        |           |    |            |           |   |           |             |   |   |              |       |               |             |       |               |      |  



20



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##### Table of Contents



NORTEL NETWORKS LIMITED


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




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



| |                                               
| | ----------------------------------------------
| | Three and nine months ended September 30, 2006







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



|                                                                        |                                               |           |    |           |            |   |   |       |  |   |    |    | 
|----------------------------------------------------------------------- | --------------------------------------------- | --------- | -- | --------- | ---------- | - | - | ----- |  | - | -- | -- | 
|                                                                        |                                               |           |    | Plant and |            |   |  
|                                                                        |                                               | Workforce |    |           | Equipment  |   |   |      
|                                                                        |                                               | Reduction |    |           | Writedowns |   |   | Total | 
|                                                                        |                                               |           |    |           |            |   |   |       | 
|Mobility and Converged Core Networks                                    |                                               |           |    |           |            |   |   |       |  |   |    |   
|                                                                        | For the three months ended September 30, 2006 |           | $  | 4         |            |   | $ | 1     |  |   | $  | 5  | 
|                                                                        | For the nine months ended September 30, 2006  |           |    | 29        |            |   |   | 1     |  |   | $  | 30 | 
|Enterprise Solutions                                                    |                                               |           |    |           |            |   |   |       |  |   |    |   
|                                                                        | For the three months ended September 30, 2006 |           |    | 1         |            |   |   |      |  |   | $  | 1  | 
|                                                                        | For the nine months ended September 30, 2006  |           |    | 13        |            |   |   |      |  |   | $  | 13 | 
|Metro Ethernet Networks                                                 |                                               |           |    |           |            |   |   |       |  |   |    |   
|                                                                        | For the three months ended September 30, 2006 |           |    | 1         |            |   |   |      |  |   | $  | 1  | 
|                                                                        | For the nine months ended September 30, 2006  |           |    | 4         |            |   |   |      |  |   | $  | 4  | 
|Global Services                                                         |                                               |           |    |           |            |   |   |       |  |   |    |   
|                                                                        | For the three months ended September 30, 2006 |           |    |          |            |   |   |      |  |   | $  |   | 
|                                                                        | For the nine months ended September 30, 2006  |           |    | 3         |            |   |   |      |  |   | $  | 3  | 
|Other                                                                   |                                               |           |   |           |            |   |  |       |  | $ |   |   
|                                                                        |                                               |           |    |           |            |   |   |       | 
|Total special charges for the three months ended
    September 30, 2006 |                                               | $         | 6  |           |            | $ | 1 |       |  | $ | 7  |   
|                                                                        |                                               |           |    |           |            |   |   |       | 
|Total special charges for the nine months ended
    September 30, 2006  |                                               | $         | 49 |           |            | $ | 1 |       |  | $ | 50 |   
|                                                                        |                                               |           |    |           |            |   |   |       | 



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



| |                                               
| | ----------------------------------------------
| | Three and nine months ended September 30, 2006







21



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##### Table of Contents



NORTEL NETWORKS LIMITED


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






| |                                               
| | ----------------------------------------------
| | Three and nine months ended September 30, 2005









| |                                     
| | ------------------------------------
| | 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 September 30, 2006 |    | $          | (1        | ) |           | $           | 1 |   |       | $ | 5 |   |    | $ | 5 | 
|                                                                        |                         | For the nine months ended September 30, 2006  |    | $          | 1         |   |           | $           | 3 |   |       | $ | 5 |   |    | $ | 9 | 
|                                                                        | Enterprise Solutions    |                                               |    |            |           |   |           |             |   |   |       |   |   |   |    |   |  
|                                                                        |                         | For the three months ended September 30, 2006 |    | $          |          |   |           | $           |  |   |       | $ | 2 |   |    | $ | 2 | 
|                                                                        |                         | For the nine months ended September 30, 2006  |    | $          |          |   |           | $           | 1 |   |       | $ | 2 |   |    | $ | 3 | 
|                                                                        | Metro Ethernet Networks |                                               |    |            |           |   |           |             |   |   |       |   |   |   |    |   |  
|                                                                        |                         | For the three months ended September 30, 2006 |    | $          |          |   |           | $           | 1 |   |       | $ | 4 |   |    | $ | 5 | 
|                                                                        |                         | For the nine months ended September 30, 2006  |    | $          | 1         |   |           | $           | 2 |   |       | $ | 4 |   |    | $ | 7 | 
|                                                                        | Global Services         |                                               |    |            |           |   |           |             |   |   |       |   |   |   |    |   |  
|                                                                        |                         | For the three months ended September 30, 2006 |    | $          |          |   |           | $           |  |   |       | $ |  |   |    | $ |  | 
|                                                                        |                         | For the nine months ended September 30, 2006  |    | $          |          |   |           | $           |  |   |       | $ |  |   |    | $ |  | 
|                                                                        | Other                   |                                               | $  |           |           |   | $         |            |   |   | $     |  |   |   | $  |  |  
|                                                                        |                         |                                               |    |            |           |   |           |             |   |   |       |  
|Total special charges for the three months ended
    September 30, 2006 |                         | $                                             | (1 | )          |           | $ | 2         |             |   | $ | 11    |   |   | $ | 12 |  
|                                                                        |                         |                                               |    |            |           |   |           |             |   |   |       |  
|Total special charges for the nine months ended
    September 30, 2006  |                         | $                                             | 2  |            |           | $ | 6         |             |   | $ | 11    |   |   | $ | 19 |  
|                                                                        |                         |                                               |    |            |           |   |           |             |   |   |       |  

22



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NORTEL NETWORKS LIMITED


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


|                                                                        |                                      |                                               |    |            |           |   |           |             |    |   |       |   |   |   |     |   |     | 
|----------------------------------------------------------------------- | ------------------------------------ | --------------------------------------------- | -- | ---------- | --------- | - | --------- | ----------- | -- | - | ----- | - | - | - | --- | - | --- | 
|                                                                        |                                      |                                               |    | Contract   |           |   |           |             |   
|                                                                        |                                      |                                               |    | Settlement |           |   | Plant and |             |    |  
|                                                                        |                                      | Workforce                                     |    |            | and Lease |   |           | Equipment   |    |   |      
|                                                                        |                                      | Reduction                                     |    |            | Costs     |   |           | Write Downs |    |   | Total |  
|                                                                        |                                      |                                               |    |            |           |   |           |             |    |   |       |  
|                                                                        | Mobility and Converged Core Networks |                                               |    |            |           |   |           |             |    |   |       |   |   |   |     |   |    
|                                                                        |                                      | For the three months ended September 30, 2005 |    | $          | 8         |   |           | $           | 9  |   |       | $ | 1 |   |     | $ | 18  | 
|                                                                        |                                      | For the nine months ended September 30, 2005  |    | $          | 47        |   |           | $           | 50 |   |       | $ | 6 |   |     | $ | 103 | 
|                                                                        | Enterprise Solutions                 |                                               |    |            |           |   |           |             |    |   |       |   |   |   |     |   |    
|                                                                        |                                      | For the three months ended September 30, 2005 |    | $          | 2         |   |           | $           | 2  |   |       | $ |  |   |     | $ | 4   | 
|                                                                        |                                      | For the nine months ended September 30, 2005  |    | $          | 9         |   |           | $           | 8  |   |       | $ |  |   |     | $ | 17  | 
|                                                                        | Metro Ethernet Networks              |                                               |    |            |           |   |           |             |    |   |       |   |   |   |     |   |    
|                                                                        |                                      | For the three months ended September 30, 2005 |    | $          | 6         |   |           | $           | 6  |   |       | $ |  |   |     | $ | 12  | 
|                                                                        |                                      | For the nine months ended September 30, 2005  |    | $          | 11        |   |           | $           | 12 |   |       | $ | 1 |   |     | $ | 24  | 
|                                                                        | Global Services                      |                                               |    |            |           |   |           |             |    |   |       |   |   |   |     |   |    
|                                                                        |                                      | For the three months ended September 30, 2005 |    | $          | 1         |   |           | $           | 1  |   |       | $ |  |   |     | $ | 2   | 
|                                                                        |                                      | For the nine months ended September 30, 2005  |    | $          | 3         |   |           | $           | 2  |   |       | $ |  |   |     | $ | 5   | 
|                                                                        | Other                                |                                               | $  |           |           |   | $         |            |    |   | $     |  |   |   | $   |  |    
|                                                                        |                                      |                                               |    |            |           |   |           |             |    |   |       |  
|Total special charges for the three months ended
    September 30, 2005 |                                      | $                                             | 17 |            |           | $ | 18        |             |    | $ | 1     |   |   | $ | 36  |  
|                                                                        |                                      |                                               |    |            |           |   |           |             |    |   |       |  
|Total special charges for the nine months ended
    September 30, 2005  |                                      | $                                             | 70 |            |           | $ | 72        |             |    | $ | 7     |   |   | $ | 149 |  
|                                                                        |                                      |                                               |    |            |           |   |           |             |    |   |       |  



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



| |                                               
| | ----------------------------------------------
| | Three and nine months ended September 30, 2006









| |                                               
| | ----------------------------------------------
| | Three and nine months ended September 30, 2005









23



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NORTEL NETWORKS LIMITED


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




|                   |  |               |    |                     |  |                     |   |                     |  |               |     |   |  |   |   |  |  |   |    | 
|------------------ |  | ------------- | -- | ------------------- |  | ------------------- | - | ------------------- |  | ------------- | --- | - |  | - | - |  |  | - | -- | 
|                   |  | Accrued       |    | Costs During        |  | Payments During     |   | Adjustments During  |  | Accrued      
|                   |  | Balance as of |    | the Nine Months     |  | the Nine Months     |   | the Nine Months     |  | Balance as of
|                   |  | December 31,  |    | Ended September 30, |  | Ended September 30, |   | Ended September 30, |  | September 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 September 30, 2006 |   | $          |          |   |           | $           | 4 |       |   | $ |  |   |   | $ | 4 | 
|                                                                        |                                      | For the nine months ended September 30, 2006  |   | $          | 1         |   |           | $           | 4 |       |   | $ |  |   |   | $ | 5 | 
|                                                                        | Enterprise Solutions                 |                                               |   |            |           |   |           |             |   |       |   |   |   |   |   |   |  
|                                                                        |                                      | For the three months ended September 30, 2006 |   | $          |          |   |           | $           | 1 |       |   | $ |  |   |   | $ | 1 | 
|                                                                        |                                      | For the nine months ended September 30, 2006  |   | $          |          |   |           | $           |  |       |   | $ |  |   |   | $ |  | 
|                                                                        | Metro Ethernet Networks              |                                               |   |            |           |   |           |             |   |       |   |   |   |   |   |   |  
|                                                                        |                                      | For the three months ended September 30, 2006 |   | $          |          |   |           | $           |  |       |   | $ |  |   |   | $ |  | 
|                                                                        |                                      | For the nine months ended September 30, 2006  |   | $          |          |   |           | $           |  |       |   | $ |  |   |   | $ |  | 
|                                                                        | Global Services                      |                                               |   |            |           |   |           |             |   |       |   |   |   |   |   |   |  
|                                                                        |                                      | For the three months ended September 30, 2006 |   | $          |          |   |           | $           |  |       |   | $ |  |   |   | $ |  | 
|                                                                        |                                      | For the nine months ended September 30, 2006  |   | $          |          |   |           | $           |  |       |   | $ |  |   |   | $ |  | 
|                                                                        | Other                                |                                               | $ |           |           |   | $         |            |   |       | $ |  |   |   | $ |  |  
|                                                                        |                                      |                                               |   |            |           |   |           |             |   |       |   |  
|Total special charges for the three months ended
    September 30, 2006 |                                      | $                                             |  |            |           | $ | 5         |             |   | $     |  |   |   | $ | 5 |  
|                                                                        |                                      |                                               |   |            |           |   |           |             |   |       |   |  
|Total special charges for the nine months ended
    September 30, 2006  |                                      | $                                             | 1 |            |           | $ | 4         |             |   | $     |  |   |   | $ | 5 |  
|                                                                        |                                      |                                               |   |            |           |   |           |             |   |       |   |  

24



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##### Table of Contents



NORTEL NETWORKS LIMITED


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


|                                                                        |                                      |                                               |    |            |           |   |           |             |   |   |       |   |    |   |    |   |    |  
|----------------------------------------------------------------------- | ------------------------------------ | --------------------------------------------- | -- | ---------- | --------- | - | --------- | ----------- | - | - | ----- | - | -- | - | -- | - | -- | -
|                                                                        |                                      |                                               |    | Contract   |           |   |           |             |  
|                                                                        |                                      |                                               |    | Settlement |           |   | Plant and |             |   |  
|                                                                        |                                      | Workforce                                     |    |            | and Lease |   |           | Equipment   |   |   |      
|                                                                        |                                      | Reduction                                     |    |            | Costs     |   |           | Write Downs |   |   | Total |  
|                                                                        |                                      |                                               |    |            |           |   |           |             |   |   |       |  
|                                                                        | Mobility and Converged Core Networks |                                               |    |            |           |   |           |             |   |   |       |   |    |   |    |   |   
|                                                                        |                                      | For the three months ended September 30, 2005 |    | $          |          |   |           | $           | 2 |   |       | $ |   |   |    | $ | 2  |  
|                                                                        |                                      | For the nine months ended September 30, 2005  |    | $          | (3        | ) |           | $           | 3 |   |       | $ | 4  |   |    | $ | 4  |  
|                                                                        | Enterprise Solutions                 |                                               |    |            |           |   |           |             |   |   |       |   |    |   |    |   |   
|                                                                        |                                      | For the three months ended September 30, 2005 |    | $          |          |   |           | $           | 1 |   |       | $ |   |   |    | $ | 1  |  
|                                                                        |                                      | For the nine months ended September 30, 2005  |    | $          | (2        | ) |           | $           | 1 |   |       | $ | 1  |   |    | $ |   |  
|                                                                        | Metro Ethernet Networks              |                                               |    |            |           |   |           |             |   |   |       |   |    |   |    |   |   
|                                                                        |                                      | For the three months ended September 30, 2005 |    | $          |          |   |           | $           |  |   |       | $ |   |   |    | $ |   |  
|                                                                        |                                      | For the nine months ended September 30, 2005  |    | $          |          |   |           | $           |  |   |       | $ | (8 | ) |    | $ | (8 | )
|                                                                        | Global Services                      |                                               |    |            |           |   |           |             |   |   |       |   |    |   |    |   |   
|                                                                        |                                      | For the three months ended September 30, 2005 |    | $          |          |   |           | $           |  |   |       | $ |   |   |    | $ |   |  
|                                                                        |                                      | For the nine months ended September 30, 2005  |    | $          |          |   |           | $           |  |   |       | $ |   |   |    | $ |   |  
|                                                                        | Other                                |                                               | $  |           |           |   | $         |            |   |   | $     |  |    |   | $  |  |   
|                                                                        |                                      |                                               |    |            |           |   |           |             |   |   |       |  
|Total special charges for the three months ended
    September 30, 2005 |                                      | $                                             |   |            |           | $ | 3         |             |   | $ |      |   |    | $ | 3  |  
|                                                                        |                                      |                                               |    |            |           |   |           |             |   |   |       |  
|Total special charges for the nine months ended
    September 30, 2005  |                                      | $                                             | (5 | )          |           | $ | 4         |             |   | $ | (3    | ) |    | $ | (4 | )
|                                                                        |                                      |                                               |    |            |           |   |           |             |   |   |       |  





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









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NORTEL NETWORKS LIMITED


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










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









26



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NORTEL NETWORKS LIMITED


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






|                    |                                                                 |               |    |      |               |   |    |      |   |   |      |      |   |   |     |      |  
|------------------- | --------------------------------------------------------------- | ------------- | -- | ---- | ------------- | - | -- | ---- | - | - | ---- | ---- | - | - | --- | ---- | -
|                    |                                                                 | Three Months  |    |      | Nine Months   |  
|                    |                                                                 | Ended         |    |      | Ended         |  
|                    |                                                                 | September 30, |    |      | September 30, |  
|                    |                                                                 |               |    |      |               |  
|                    |                                                                 | 2006          |    |      | 2005          |   |    | 2006 |   |   | 2005 |     
|                    |                                                                 |               |    |      |               |   |    |      |   |   |      |     
|Pension expense:    |                                                                 |               |    |      |               |   |    |      |   |   |      |      |   |   |     |     
|                    | Service cost                                                    |               | $  | 31   |               |   | $  | 32   |   |   | $    | 102  |   |   | $   | 97   |  
|                    | Interest cost                                                   |               |    | 118  |               |   |    | 112  |   |   |      | 347  |   |   |     | 342  |  
|                    | Expected return on plan assets                                  |               |    | (117 | )             |   |    | (105 | ) |   |      | (345 | ) |   |     | (321 | )
|                    | Amortization of prior service cost and transition               |               |    |     |               |   |    | 1    |   |   |      | 2    |   |   |     | 3    |  
|                    | Amortization of net losses (gains)                              |               |    | 35   |               |   |    | 24   |   |   |      | 98   |   |   |     | 72   |  
|                    | Curtailment, contractual and special termination losses (gains) |               |    | (5   | )             |   |    | 1    |   |   |      | 4    |   |   |     | 26   |  
|                    |                                                                 |               |    |      |               |   |    |      |   |   |      |     
|Net pension expense |                                                                 | $             | 62 |      |               | $ | 65 |      |   | $ | 208  |      |   | $ | 219 |     
|                    |                                                                 |               |    |      |               |   |    |      |   |   |      |     



|                                 |                                    |               |     |     |               |   |    |      |   |   |      |     |   |   |    |    |  
|-------------------------------- | ---------------------------------- | ------------- | --- | --- | ------------- | - | -- | ---- | - | - | ---- | --- | - | - | -- | -- | -
|                                 |                                    | Three Months  |     |     | Nine Months   |  
|                                 |                                    | Ended         |     |     | Ended         |  
|                                 |                                    | September 30, |     |     | September 30, |  
|                                 |                                    |               |     |     |               |  
|                                 |                                    | 2006          |     |     | 2005          |   |    | 2006 |   |   | 2005 |    
|                                 |                                    |               |     |     |               |   |    |      |   |   |      |    
|Post-retirement benefit cost:    |                                    |               |     |     |               |   |    |      |   |   |      |     |   |   |    |   
|                                 | Service cost                       |               | $   | 1   |               |   | $  | 2    |   |   | $    | 6   |   |   | $  | 6  |  
|                                 | Interest cost                      |               |     | 10  |               |   |    | 10   |   |   |      | 31  |   |   |    | 31 |  
|                                 | Amortization of prior service cost |               |     | (1  | )             |   |    | (1   | ) |   |      | (3  | ) |   |    | (3 | )
|                                 | Curtailment loss (gain)            |               |     | (32 | )             |   |    |     |   |   |      | (32 | ) |   |    |   |  
|                                 |                                    |               |     |     |               |   |    |      |   |   |      |    
|Net post-retirement benefit cost |                                    | $             | (22 | )   |               | $ | 11 |      |   | $ | 2    |     |   | $ | 34 |   
|                                 |                                    |               |     |     |               |   |    |      |   |   |      |    





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



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



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





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NORTEL NETWORKS LIMITED


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




non-contractual






|                                  |                                  |   |     |    | 
|--------------------------------- | -------------------------------- | - | --- | -- | 
|Purchase price                    |                                  | $ | 99  |   
|                                  |                                  |   |    
|Assets acquired:                  |                                  |   |     |   
|                                  | Other assets  net               |   | $   | 6  | 
|                                  | 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.





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



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NORTEL NETWORKS LIMITED


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






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



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









| |                                 
| | --------------------------------
| | UMTS access business divestiture



29



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NORTEL NETWORKS LIMITED


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




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

10-Q




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

one-year




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

semi-annually






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NORTEL NETWORKS LIMITED


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








one-time








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



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NORTEL NETWORKS LIMITED


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












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





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







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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



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NORTEL NETWORKS LIMITED


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














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









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NORTEL NETWORKS LIMITED


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




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



|                                 |                   |   |     |      |  
|-------------------------------- | ----------------- | - | --- | ---- | -
|Balance as of December 31, 2005  |                   | $ | 206 |     
|                                 | Payments          |   |     | (191 | )
|                                 | Warranties issued |   |     | 205  |  
|                                 | Revisions         |   |     | 5    |  
|                                 |                   |   |    
|Balance as of September 30, 2006 |                   | $ | 225 |     
|                                 |                   |   |    



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





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





|                                               |  |               |     |  |              |   |     | 
|---------------------------------------------- |  | ------------- | --- |  | ------------ | - | --- | 
|                                               |  | September 30, |     |  | December 31, |  
|                                               |  | 2006          |     |  | 2005         |  
|                                               |  |               |     |  |              |  
|Bid and performance related
    bonds(a)       |  | $             | 265 |  |              | $ | 222 | 
|Other
    bonds(b)                             |  |               | 31  |  |              |   | 44  | 
|                                               |  |               |     |  |              |  
|Total bid, performance related and other bonds |  | $             | 296 |  |              | $ | 266 | 
|                                               |  |               |     |  |              |  






|    |                                                                                                                                        
|--- | ---------------------------------------------------------------------------------------------------------------------------------------
|(a) | Net of restricted cash and cash equivalent amounts of $6 and $36
    as of September 30, 2006 and December 31, 2005,
    respectively. 
|(b) | Net of restricted cash and cash equivalent amounts of $31 and
    $31 as of September 30, 2006 and December 31, 2005,
    respectively.



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

start-ups




| |                                          
| | -----------------------------------------
| | Nortel and Microsoft Corporation Alliance

go-to


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NORTEL NETWORKS LIMITED


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










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



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



|                                   |  |               |     |   |              |   |     |  
|---------------------------------- |  | ------------- | --- | - | ------------ | - | --- | -
|                                   |  | September 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) | Includes 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.





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NORTEL NETWORKS LIMITED


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




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















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



|                                               |                                                                        |               |     |     |               |   |      |      |  |   |      |     |   |   |      |      |  
|---------------------------------------------- | ---------------------------------------------------------------------- | ------------- | --- | --- | ------------- | - | ---- | ---- |  | - | ---- | --- | - | - | ---- | ---- | -
|                                               |                                                                        | Three Months  |     |     | Nine Months   |  
|                                               |                                                                        | Ended         |     |     | Ended         |  
|                                               |                                                                        | September 30, |     |     | September 30, |  
|                                               |                                                                        |               |     |     |               |  
|                                               |                                                                        | 2006          |     |     | 2005          |   |      | 2006 |  |   | 2005 |    
|                                               |                                                                        |               |     |     |               |   |      |      |  |   |      |    
|Net earnings (loss)                            |                                                                        | $             | (14 | )   |               | $ | (109 | )    |  | $ | (209 | )   |   | $ | (192 | )   
|Other comprehensive income (loss) adjustments: |                                                                        |               |     |     |               |   |      |      |  |   |      |     |   |   |      |     
|                                               | Change in foreign currency translation adjustment                      |               |     | 71  |               |   |      | 34   |  |   |      | 214 |   |   |      | (128 | )
|                                               | Unrealized gain (loss) on investments 
    net(a)                     |               |     | 18  |               |   |      | 20   |  |   |      | 2   |   |   |      | (3   | )
|                                               | Minimum pension liability adjustment  net                             |               |     | 141 |               |   |      |     |  |   |      | 140 |   |   |      | 2    |  
|                                               | Unrealized derivative gain (loss) on cash flow
    hedges 
    net(b) |               |     | (7  | )             |   |      | 12   |  |   |      | (4  | ) |   |      | (7   | )
|                                               |                                                                        |               |     |     |               |   |      |      |  |   |      |    
|Comprehensive income (loss)                    |                                                                        | $             | 209 |     |               | $ | (43  | )    |  | $ | 143  |     |   | $ | (328 | )   
|                                               |                                                                        |               |     |     |               |   |      |      |  |   |      |    






|    |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|--- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(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 nine
    months ended September 30, 2006 and 2005, respectively.                                                                                                    
|   
|(b) |  | During the three and nine months ended September 30, 2006,
    $4 and $13, respectively, of net derivative gains (losses) were
    reclassified to other income  net. During the three
    and nine months ended September 30, 2005, $1 and $14,
    respectively, of net derivative gains (losses) were reclassified
    to other income  net. Nortel estimates that $3 of net
    derivative gains (losses) included in accumulated other
    comprehensive income (loss) will be reclassified into net
    earnings (loss) within the next 12 months.

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NORTEL NETWORKS LIMITED


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




|    |                                                 
|--- | ------------------------------------------------
|15. | Capital stock and stock-based compensation plans



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









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NORTEL NETWORKS LIMITED


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






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









|                              |  |             |        |           |               |   |            |                  |  |  |     | 
|----------------------------- |  | ----------- | ------ | --------- | ------------- | - | ---------- | ---------------- |  |  | --- | 
|                              |  |             |        | Weighted- |               |   | Weighted   |                 
|                              |  | Outstanding |        |           | Average       |   |            | Average          | 
|                              |  | RSU Awards  |        |           | Grant Date    |   |            | Remaining        | 
|                              |  | Granted     |        |           | Fair Value(a) |   |            | Contractual Life | 
|                              |  |             |        |           |               |   |            |                  | 
|                              |  | (Thousands) |        |           |               |   | (In Years) |                 
|Balance at December 31, 2005  |  |             | 6,897  |           |               | $ | 3.15       |                  |  |  | 9.7 | 
|Granted RSU awards            |  |             | 7,735  |           |               | $ | 2.11       |                  |  |  |     | 
|Awards exercised              |  |             | (1,080 | )         |               | $ | 3.24       |                  |  |  |     | 
|Awards forfeited              |  |             | (170   | )         |               | $ | 2.90       |                  |  |  |     | 
|Awards expired                |  |             |       |           |               | $ |           |                  |  |  |     | 
|                              |  |             |        |           |               |   |            |                  | 
|Balance at September 30, 2006 |  |             | 13,382 |           |               | $ | 2.56       |                  |  |  | 9.4 | 
|                              |  |             |        |           |               |   |            |                  | 






|    |  |                                                                                                                                                                                                                 
|--- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(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.



39



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NORTEL NETWORKS LIMITED


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




|                              |  |             |       |           |               |   |            |                  |  |  |     | 
|----------------------------- |  | ----------- | ----- | --------- | ------------- | - | ---------- | ---------------- |  |  | --- | 
|                              |  |             |       | Weighted- |               |   | Weighted   |                 
|                              |  | Outstanding |       |           | Average       |   |            | Average          | 
|                              |  | PSU Awards  |       |           | Grant Date    |   |            | Remaining        | 
|                              |  | Granted     |       |           | Fair Value(a) |   |            | Contractual Life | 
|                              |  |             |       |           |               |   |            |                  | 
|                              |  | (Thousands) |       |           |               |   | (In Years) |                 
|Balance at December 31, 2005  |  |             |      |           |               | $ |           |                  |  |  |    | 
|Granted PSU awards            |  |             | 4,640 |           |               | $ | 2.25       |                  |  |  |     | 
|Awards exercised              |  |             |      |           |               | $ |           |                  |  |  |     | 
|Awards forfeited              |  |             |      |           |               | $ |           |                  |  |  |     | 
|Awards expired                |  |             |      |           |               | $ |           |                  |  |  |     | 
|                              |  |             |       |           |               |   |            |                  | 
|Balance at September 30, 2006 |  |             | 4,640 |           |               | $ | 2.26       |                  |  |  | 9.7 | 
|                              |  |             |       |           |               |   |            |                  | 






|    |  |                                                                                                                                                                                                                             
|--- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(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







123R-3,


40



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NORTEL NETWORKS LIMITED


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




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



|                                                                |                                             |               |      |     |               |   |      |     |  
|--------------------------------------------------------------- | ------------------------------------------- | ------------- | ---- | --- | ------------- | - | ---- | --- | -
|                                                                |                                             | Three Months  |      |     | Nine Months   |  
|                                                                |                                             | Ended         |      |     | Ended         |  
|                                                                |                                             | September 30, |      |     | September 30, |  
|                                                                |                                             | 2005          |      |     | 2005          |  
|                                                                |                                             |               |      |     |               |  
|Net earnings (loss) applicable to common shares 
    reported  |                                             | $             | (118 | )   |               | $ | (220 | )  
|                                                                | Stock-based compensation  reported         |               |      | 21  |               |   |      | 57  |  
|                                                                | Stock-based compensation  pro
    forma(a) |               |      | (21 | )             |   |      | (64 | )
|                                                                |                                             |               |      |     |               |  
|Net earnings (loss) applicable to common shares  pro
    forma |                                             | $             | (118 | )   |               | $ | (227 | )  
|                                                                |                                             |               |      |     |               |  






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



|                                                     |                      |               |    |    |               |   |    |      |  |   |      |    |     |   |    |    | 
|---------------------------------------------------- | -------------------- | ------------- | -- | -- | ------------- | - | -- | ---- |  | - | ---- | -- | --- | - | -- | -- | 
|                                                     |                      | Three Months  |    |    | Nine Months   |  
|                                                     |                      | Ended         |    |    | Ended         |  
|                                                     |                      | September 30, |    |    | September 30, |  
|                                                     |                      |               |    |    |               |  
|                                                     |                      | 2006          |    |    | 2005          |   |    | 2006 |  |   | 2005 |   
|                                                     |                      |               |    |    |               |   |    |      |  |   |      |   
|Stock-based compensation:                            |                      |               |    |    |               |   |    |      |  |   |      |    |     |   |    |   
|                                                     | Stock option expense |               | $  | 26 |               |   | $  | 21   |  |   | $    | 67 | (b) |   | $  | 58 | 
|                                                     | RSU
    expense(a)   |               |    | 3  |               |   |    |     |  |   |      | 6  |     |   |    |   | 
|                                                     | PSU expense          |               |    | 1  |               |   |    |     |  |   |      | 1  |     |   |    |   | 
|                                                     | DSU
    expense(a)   |               |    |   |               |   |    | 1    |  |   |      |   |     |   |    |   | 
|                                                     |                      |               |    |    |               |   |    |      |  |   |      |   
|Total stock-based compensation reported  net of tax |                      | $             | 30 |    |               | $ | 22 |      |  | $ | 74   |    |     | $ | 58 |   
|                                                     |                      |               |    |    |               |   |    |      |  |   |      |   






|    |                                                                                                                                                                                                                     
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(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.



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NORTEL NETWORKS LIMITED


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




|                                                                |                                      |               |      |       |               |   |      |               |   |   |               |       |   |   |      |       |  
|--------------------------------------------------------------- | ------------------------------------ | ------------- | ---- | ----- | ------------- | - | ---- | ------------- | - | - | ------------- | ----- | - | - | ---- | ----- | -
|                                                                |                                      | Three Months  |      |       | Three Months  |   |      | Nine Months   |   |   | Nine Months   |      
|                                                                |                                      | Ended         |      |       | Ended         |   |      | Ended         |   |   | Ended         |      
|                                                                |                                      | September 30, |      |       | September 30, |   |      | September 30, |   |   | September 30, |      
|                                                                |                                      |               |      |       |               |   |      |               |   |   |               |      
|                                                                |                                      | 2006          |      |       | 2005          |   |      | 2006          |   |   | 2005          |      
|                                                                |                                      |               |      |       |               |   |      |               |   |   |               |      
|Black-Scholes weighted-average assumptions                      |                                      |               |      |       |               |   |      |               |   |   |               |       |   |   |      |      
|                                                                | Expected dividend yield              |               |      | 0.00  | %             |   |      | 0.00          | % |   |               | 0.00  | % |   |      | 0.00  | %
|                                                                | Expected
    volatility(a)           |               |      | 67.11 | %             |   |      | 86.40         | % |   |               | 73.85 | % |   |      | 86.40 | %
|                                                                | Risk-free interest
    rate(b)       |               |      | 4.72  | %             |   |      | 4.06          | % |   |               | 5.01  | % |   |      | 4.06  | %
|                                                                | Expected option life in
    years(c) |               |      | 4     |               |   |      | 4             |   |   |               | 4     |   |   |      | 4     |  
|Weighted-average stock option fair value per option
    granted |                                      | $             | 1.14 |       |               | $ | 1.86 |               |   | $ | 1.22          |       |   | $ | 1.86 |      






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



|                        |                                        |               |  |               |               |  |  |               | 
|----------------------- | -------------------------------------- | ------------- |  | ------------- | ------------- |  |  | ------------- | 
|                        |                                        | Three Months  |  |               | Nine Months   | 
|                        |                                        | Ended         |  |               | Ended         | 
|                        |                                        | September 30, |  |               | September 30, | 
|                        |                                        |               |  |               |               | 
|                        |                                        | 2006          |  |               | 2006          | 
|                        |                                        |               |  |               |               | 
|Monte Carlo assumptions |                                        |               |  |               |               |  |  |              
|                        | Beta (range)                           |               |  | 2.0           |               |  |  | 2.0 - 2.1     | 
|                        | Risk-free interest rate
    (range)(a) |               |  | 4.79% - 4.87% |               |  |  | 4.79% - 5.10% | 
|                        | Equity risk premium                    |               |  | 5.00%         |               |  |  | 5.00%         | 






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











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



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NORTEL NETWORKS LIMITED


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






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





|           |                                              |               |     |    |               |   |    |      |  |   |      |     |  |   |    |    | 
|---------- | -------------------------------------------- | ------------- | --- | -- | ------------- | - | -- | ---- |  | - | ---- | --- |  | - | -- | -- | 
|           |                                              | Three Months  |     |    | Nine Months   |  
|           |                                              | Ended         |     |    | Ended         |  
|           |                                              | September 30, |     |    | September 30, |  
|           |                                              |               |     |    |               |  
|           |                                              | 2006          |     |    | 2005          |   |    | 2006 |  |   | 2005 |    
|           |                                              |               |     |    |               |   |    |      |  |   |      |    
|Revenues:  |                                              |               |     |    |               |   |    |      |  |   |      |     |  |   |    |   
|           | LG Electronics
    Inc.(a)                   |               | $   | 21 |               |   | $  |     |  |   | $    | 22  |  |   | $  |   | 
|           | Other                                        |               |     | 3  |               |   |    | 1    |  |   |      | 7   |  |   |    | 2  | 
|           |                                              |               |     |    |               |   |    |      |  |   |      |    
|           | Total                                        |               | $   | 24 |               |   | $  | 1    |  |   | $    | 29  |  |   | $  | 2  | 
|           |                                              |               |     |    |               |   |    |      |  |   |      |    
|Purchases: |                                              |               |     |    |               |   |    |      |  |   |      |     |  |   |    |   
|           | Bookham                                      |               | $   | 10 |               |   | $  | 7    |  |   | $    | 22  |  |   | $  | 12 | 
|           | LG Electronics
    Inc.(a)                   |               |     | 61 |               |   |    |     |  |   |      | 172 |  |   |    |   | 
|           | Sasken Communications Technology
    Ltd.(b) |               |     | 7  |               |   |    | 7    |  |   |      | 25  |  |   |    | 11 | 
|           | GN Tel
    LG-Nortel(c)                      |               |     | 32 |               |   |    |      |  |   |      | 53  |  |   |    |    | 
|           | Other                                        |               |     | 3  |               |   |    | 1    |  |   |      | 3   |  |   |    | 3  | 
|           |                                              |               |     |    |               |   |    |      |  |   |      |    
|Total      |                                              | $             | 113 |    |               | $ | 15 |      |  | $ | 275  |     |  | $ | 26 |   
|           |                                              |               |     |    |               |   |    |      |  |   |      |    






|    |                                                                                                                                                                                                                                                                                                                                       
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(a) | LG holds a minority interest in LG-Nortel. Nortels sales
    and purchases relate primarily to certain inventory related
    items. As of September 30, 2006, accounts payable to LG
    were $54, 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
    September 30, 2006, accounts payable to Sasken were $3,
    compared to $2 as at December 31, 2005.
|(c) | Nortel holds a minority interest in GN Tel through its joint
    venture LG-Nortel. Nortels purchases from GN Tel LG-Nortel
    relate primarily to installation and warranty services.                                                                                                                                              



|                            |  |               |     |   |              |   |     |  
|--------------------------- |  | ------------- | --- | - | ------------ | - | --- | -
|                            |  | September 30, |     |   | December 31, |  
|                            |  | 2006          |     |   | 2005         |  
|                            |  |               |     |   |              |  
|Consolidated balance sheets |  |               |     |   |              |   |     |  
|Owing from NNC              |  | $             | 799 |   |              | $ | 206 |  
|Owing from NNC subsidiaries |  |               | 111 |   |              |   | 98  |  
|Other related parties       |  |               | (58 | ) |              |   | (18 | )
|                            |  |               |     |   |              |  
|Related party receivables   |  | $             | 852 |   |              | $ | 286 |  
|                            |  |               |     |   |              |  



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NORTEL NETWORKS LIMITED


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










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









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NORTEL NETWORKS LIMITED


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














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NORTEL NETWORKS LIMITED


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






mark-to








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NORTEL NETWORKS LIMITED


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










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NORTEL NETWORKS LIMITED


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












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



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NORTEL NETWORKS LIMITED


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










de minimis de minimis de
minimis




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|        |                                                                    
|------- | -------------------------------------------------------------------
|ITEM 2. | MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL
    CONDITION AND

RESULTS OF OPERATIONS  TABLE OF CONTENTS


|                                                       |                                                                                      |                                                          |                         |    |    |    | 
|------------------------------------------------------ | ------------------------------------------------------------------------------------ | -------------------------------------------------------- | ----------------------- | -- | -- | -- | 
|Executive Overview                                     |                                                                                      |                                                          | 52                      |   
|                                                       | Our Business                                                                         |                                                          |                         | 52 |   
|                                                       | Our Segments                                                                         |                                                          |                         | 52 |   
|                                                       | How We Measure Performance                                                           |                                                          |                         | 54 |   
|                                                       | Our Strategy                                                                         |                                                          |                         | 54 |   
|                                                       | Third Quarter Financial Highlights                                                   |                                                          |                         | 55 |   
|                                                       | Significant Business Developments in
    2006                                        |                                                          |                         | 56 |   
|                                                       |                                                                                      | Proposed Divestiture of our UMTS Access
    Business     |                         |    | 56 |   
|                                                       |                                                                                      | Credit Facility and Senior Notes                         |                         |    | 56 |   
|                                                       |                                                                                      | 2006 Restructuring and Employee Benefit
    Plan Changes |                         |    | 57 |   
|                                                       |                                                                                      | Global Class Action
    Settlement                       |                         |    | 57 |   
|                                                       |                                                                                      | Acquisitions                                             |                         |    | 58 |   
|                                                       |                                                                                      | Evolution of Our Supply Chain
    Strategy               |                         |    | 58 |   
|                                                       |                                                                                      | Microsoft Alliance                                       |                         |    | 58 |   
|Restatements; Material Weaknesses;
    Related Matters |                                                                                      |                                                          | 58                      |   
|                                                       | First and Second Restatements, Independent
    Review and Revenue Independent Review |                                                          |                         | 58 |   
|                                                       | Material Weaknesses in Internal Control
    over Financial Reporting                 |                                                          |                         | 59 |   
|                                                       | Third Restatement                                                                    |                                                          |                         | 59 |   
|                                                       |                                                                                      | Third Restatement Impacts                                |                         |    | 61 |   
|                                                       | Regulatory Actions                                                                   |                                                          |                         | 61 |   
|Results of Operations 
    Continuing Operations      |                                                                                      |                                                          | 61                      |   
|                                                       | Consolidated Information                                                             |                                                          |                         | 61 |   
|                                                       |                                                                                      | Revenues                                                 |                         |    | 61 |   
|                                                       | Gross Profit and Gross Margin                                                        |                                                          |                         | 63 |   
|                                                       | Operating Expenses                                                                   |                                                          |                         | 63 |   
|                                                       |                                                                                      | Selling, General and Administrative
    Expense          |                         |    | 63 |   
|                                                       |                                                                                      | Research and Development Expense                         |                         |    | 64 |   
|                                                       |                                                                                      | Special Charges                                          |                         |    | 64 |   
|                                                       | Gain/Loss on Sale of Businesses and
    Assets                                       |                                                          |                         | 66 |   
|                                                       | Other Income  Net                                                                   |                                                          |                         | 66 |   
|                                                       | Interest Expense                                                                     |                                                          |                         | 67 |   
|                                                       | Income Tax Benefit (Expense)                                                         |                                                          |                         | 67 |   
|                                                       | Segment Information                                                                  |                                                          |                         | 68 |   
|                                                       |                                                                                      | Mobility and Converged Core
    Networks                 |                         |    | 68 |   
|                                                       |                                                                                      | Enterprise Solutions                                     |                         |    | 69 |   
|                                                       |                                                                                      | Metro Ethernet Networks                                  |                         |    | 70 |   
|                                                       |                                                                                      | Global Services                                          |                         |    | 71 |   
|                                                       |                                                                                      | Other                                                    |                         |    | 72 |   
|Liquidity and Capital Resources                        |                                                                                      |                                                          | 72                      |   
|                                                       | Cash Flow                                                                            |                                                          |                         | 72 |   
|                                                       |                                                                                      | Operating Activities                                     |                         |    | 73 |   
|                                                       |                                                                                      |                                                          | Working capital metrics |    |    | 73 | 
|                                                       |                                                                                      | Investing Activities                                     |                         |    | 73 |   
|                                                       |                                                                                      | Financing Activities                                     |                         |    | 74 |   
|                                                       |                                                                                      | Senior Notes                                             |                         |    | 74 |   

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|                                                              |                                                                           |                                                            |    |    |    | 
|------------------------------------------------------------- | ------------------------------------------------------------------------- | ---------------------------------------------------------- | -- | -- | -- | 
|                                                              | Future Uses and Sources of
    Liquidity                                  |                                                            |    | 75 |   
|                                                              | Future Uses of Liquidity                                                  |                                                            |    | 75 |   
|                                                              |                                                                           | Contractual cash obligations                               |    |    | 76 | 
|                                                              | Future Sources of Liquidity                                               |                                                            |    | 76 |   
|                                                              |                                                                           | Available support facility                                 |    |    | 76 | 
|                                                              |                                                                           | Shelf registration statement and base
    shelf prospectus |    |    | 77 | 
|                                                              |                                                                           | Uncertainties Regarding Our
    Liquidity                  |    |    | 77 | 
|                                                              | Credit Ratings                                                            |                                                            |    | 78 |   
|Off-Balance Sheet Arrangements                                |                                                                           |                                                            | 78 |   
|                                                              | Bid, Performance Related and Other Bonds                                  |                                                            |    | 78 |   
|                                                              | Receivables Securitization and Certain
    Variable Interest Transactions |                                                            |    | 79 |   
|Application of Critical Accounting
    Policies and Estimates |                                                                           |                                                            | 79 |   
|                                                              | Provisions for Doubtful Accounts                                          |                                                            |    | 80 |   
|                                                              | Provisions for Inventory                                                  |                                                            |    | 80 |   
|                                                              | Provisions for Product Warranties                                         |                                                            |    | 81 |   
|                                                              | Tax Asset Valuation                                                       |                                                            |    | 81 |   
|                                                              | Goodwill Valuation                                                        |                                                            |    | 82 |   
|                                                              | Special Charges                                                           |                                                            |    | 83 |   
|                                                              | Pension and Post-retirement Benefits                                      |                                                            |    | 83 |   
|Accounting Changes and Recent Accounting
    Pronouncements   |                                                                           |                                                            | 83 |   
|                                                              | Accounting Changes                                                        |                                                            |    | 83 |   
|                                                              | Recent Accounting Pronouncements                                          |                                                            |    | 84 |   
|Outstanding Share Data                                        |                                                                           |                                                            | 86 |   
|Market Risk                                                   |                                                                           |                                                            | 86 |   
|Equity Price Risk                                             |                                                                           |                                                            | 86 |   
|Environmental Matters                                         |                                                                           |                                                            | 86 |   
|Legal Proceedings                                             |                                                                           |                                                            | 87 |   
|Cautionary Notice Regarding
    Forward-Looking Information   |                                                                           |                                                            | 87 |   

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MANAGEMENTS DISCUSSION AND ANALYSIS OF


FINANCIAL CONDITION AND RESULTS OF OPERATIONS


You should read this Managements Discussion and
Analysis of Financial Condition and Results of 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 which we believe are reasonable but
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, our Annual
Report on
Form 10-K for the
year ended December 31, 2005, or
2005 10-K, our
current report on
Form 8-K dated
June 16, 2006, or 2006
Form 8-K (the 2006
Form 8-K and
2005 10-K together
the 2005 Annual Report), and our Quarterly Reports on
Form 10-Q for the
quarters ended March 31, 2006 and June 30, 2006, or
the 2006 First Quarter Report and 2006 Second Quarter Report,
respectively, could cause actual results or events to differ
materially from those contemplated in forward-looking
statements. 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
NNL.





Executive Overview





Our Business







Our Segments




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| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | MCCN 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 and to
    roam globally. In addition, our carrier circuit and packet voice
    solutions provide a broad range of voice solutions to our
    service provider customers for their business and residential
    subscribers, 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. On September 1, 2006 we
    entered into a non-binding memorandum of understanding with
    Alcatel SA, or Alcatel, for the sale of certain assets related
    to our UMTS access business. See Significant Business
    Developments  Proposed Divestiture of our UMTS Access
    Business for additional information.
| |  | ES provides (i) enterprise circuit and packet voice
    solutions, (ii) data networking and security solutions,
    which supply data, voice and multimedia communications solutions
    to Nortels enterprise customers and (iii) software
    solutions for multi-media messaging, conferencing and call
    centers. Our solutions for enterprises are used to build new
    networks and to transform existing communications networks into
    more cost effective, packet-based networks supporting data,
    voice and multimedia communications. Our ES customers consist of
    a broad range of enterprises around the world, including large
    businesses at their headquarters, data centers, call centers and
    branch offices, small businesses and home offices, as well as
    government agencies, educational and other institutions and
    utility organizations.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
| |  | MEN combines our optical networking solutions and the carrier
    portion of its data networking solutions to transform our
    carrier and large enterprise customers networks to be more
    scalable and reliable for the high speed delivery of diverse
    multi-media communications services. By combining our optical
    expertise and data knowledge, we create solutions that help
    service providers and enterprises better manage increasing
    bandwidth demands. We believe that ethernet technology is
    particularly suited to these solutions and is being integrated
    with our optical technology. In addition to increased capacity
    and lower cost per bit, we differentiate our MEN products on the
    basis of being able to deliver carrier-grade reliability. The
    metropolitan or metro network is a key focus area as bandwidth
    demands are increasing as a result of the growth of network
    based broadcast and on-demand video delivery, wireless
    back haul for a variety of data services including
    video as well as traditional business, internet, private line
    and voice services. MEN serves the long haul optical market
    using common products and technologies from the metro optical
    market.                                                                                                                                                                                                                                                                                    
| |  | GS provides a broad range of services to address the
    requirements of our carrier and enterprise customers throughout
    the entire lifecycle of their networks. The GS portfolio is
    organized into four main service groups: (i) network
    implementation services, consisting of network integration,
    planning, installation, optimization and security services
    (ii) network support services, consisting of technical
    support, hardware maintenance, equipment spares logistics and
    on-site engineers
    (iii) network managed services, consisting of services
    related to the monitoring and management of customer networks
    and providing a range of network managed service options and
    (iv) network application services, consisting of
    applications development, integration and web services. Our GS
    market mirrors that of our carrier and enterprise markets along
    with a broad range of customers in all geographic markets where
    we conduct business, including small and medium-sized businesses
    to large global enterprises and all levels of government.
    Revenues from network services consisting of planning,
    engineering and installation are generally bundled with product
    sales and are not currently included in the revenues of GS.                                                                                                                                                                                                                                



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How We Measure Performance







Our Strategy










end-to




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Third Quarter Financial Highlights




|                           |  |                            |       |   |                           |  |      |               |  |   |          |   |  |               |      |   |          |   |       |               |  |  |          |   |  |   |       |   |  |  |      |  
|-------------------------- |  | -------------------------- | ----- | - | ------------------------- |  | ---- | ------------- |  | - | -------- | - |  | ------------- | ---- | - | -------- | - | ----- | ------------- |  |  | -------- | - |  | - | ----- | - |  |  | ---- | -
|                           |  | For the Three Months Ended |       |   | For the Nine Months Ended | 
|                           |  |                            |       |   |                           | 
|                           |  | September 30,              |       |   | % of                      |  |      | September 30, |  |   | % of     |   |  | September 30, |      |   | % of     |   |       | September 30, |  |  | % of     |  
|                           |  | 2006                       |       |   | Revenues                  |  |      | 2005          |  |   | Revenues |   |  | 2006          |      |   | Revenues |   |       | 2005          |  |  | Revenues |  
|                           |  |                            |       |   |                           |  |      |               |  |   |          |   |  |               |      |   |          |   |       |               |  |  |          |  
|Revenues                   |  | $                          | 2,955 |   |                           |  |      |               |  | $ | 2,518    |   |  |               |      |   |          | $ | 8,081 |               |  |  |          |   |  | $ | 7,526 |   |  |  |      |  
|Gross profit               |  |                            | 1,117 |   |                           |  | 37.8 |               |  |   | 967      |   |  |               | 38.4 |   |          |   | 3,092 |               |  |  | 38.3     |   |  |   | 3,085 |   |  |  | 41.0 |  
|Operating expenses
    (a) |  |                            | 1,103 |   |                           |  | 37.3 |               |  |   | 1,042    |   |  |               | 41.4 |   |          |   | 3,299 |               |  |  | 40.8     |   |  |   | 3,261 |   |  |  | 43.3 |  
|Operating earnings (loss)  |  |                            | 22    |   |                           |  | 0.7  |               |  |   | (85      | ) |  |               | (3.4 | ) |          |   | (200  | )             |  |  | (2.5     | ) |  |   | (223  | ) |  |  | (3.0 | )
|Other income  net         |  |                            | 46    |   |                           |  | 1.6  |               |  |   | 52       |   |  |               | 2.1  |   |          |   | 169   |               |  |  | 2.1      |   |  |   | 184   |   |  |  | 2.4  |  
|Interest expense           |  |                            | 68    |   |                           |  | 2.3  |               |  |   | 34       |   |  |               | 1.4  |   |          |   | 154   |               |  |  | 1.9      |   |  |   | 95    |   |  |  | 1.3  |  
|Net earnings (loss)        |  | $                          | (14   | ) |                           |  | (0.5 | )             |  | $ | (109     | ) |  |               | (4.3 | ) |          | $ | (209  | )             |  |  | (2.6     | ) |  | $ | (192  | ) |  |  | (2.6 | )
|                           |  |                            |       |   |                           |  |      |               |  |   |          |   |  |               |      |   |          |   |       |               |  |  |          |  
|Management EBT             |  | $                          | 11    |   |                           |  | 0.4  |               |  | $ | (22      | ) |  |               | (0.9 | ) |          | $ | (92   | )             |  |  | (1.1     | ) |  | $ | 43    |   |  |  | 0.6  |  
|                           |  |                            |       |   |                           |  |      |               |  |   |          |   |  |               |      |   |          |   |       |               |  |  |          |  






|    |                                                                
|--- | ---------------------------------------------------------------
|(a) | Operating expenses includes SG&A, R&D, and Special
    Charges.













55



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Significant Business Developments in 2006







| |                                                 
| | ------------------------------------------------
| | Proposed Divestiture of our UMTS Access Business










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





56



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| |                                                         
| | --------------------------------------------------------
| | 2006 Restructuring and Employee Benefit Plan
    Changes








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







57



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##### Table of Contents










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








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








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

go-to











Restatements; Material Weaknesses; Related Matters





First and Second Restatements, Independent Review and Revenue
Independent Review




58



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##### Table of Contents



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;                                                                                                                                                       
| |  | 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


97-2,


percentage-of 81-1,


59



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81-1,




| |   |                                                                                                                                                                                                                                                                                                                                                                                                                     
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | 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 10-K/ 10-K/




|                                                                          |  |               |       |   |               |   |       |  
|------------------------------------------------------------------------- |  | ------------- | ----- | - | ------------- | - | ----- | -
|                                                                          |  | Three         |       |   | Nine          |  
|                                                                          |  | Months Ended  |       |   | Months Ended  |  
|                                                                          |  | September 30, |       |   | September 30, |  
|                                                                          |  | 2005          |       |   | 2005          |  
|                                                                          |  |               |       |   |               |  
|Revenues  as previously reported                                         |  | $             | 2,655 |   |               | $ | 8,046 |  
|Adjustments:                                                              |  |               |       |   |               |   |       |  
|Application of SOP 81-1                                                   |  |               | (13   | ) |               |   | 46    |  
|Interaction between multiple revenue recognition accounting
    standards |  |               | (70   | ) |               |   | (408  | )
|Application of SAB 104 and SOP 97-2                                       |  |               | (62   | ) |               |   | (160  | )
|Other revenue recognition adjustments                                     |  |               | 8     |   |               |   | 2     |  
|                                                                          |  |               |       |   |               |  
|Revenues  as restated                                                    |  | $             | 2,518 |   |               | $ | 7,526 |  
|                                                                          |  |               |       |   |               |  
|Net earnings (loss)  as previously reported                              |  | $             | (77   | ) |               | $ | (27   | )
|Adjustments:                                                              |  |               |       |   |               |   |       |  
|Application of SOP 81-1                                                   |  |               | (6    | ) |               |   | (9    | )
|Interaction between multiple revenue recognition accounting
    standards |  |               | (7    | ) |               |   | (45   | )
|Application of SAB 104 and SOP 97-2                                       |  |               | (22   | ) |               |   | (73   | )
|Other revenue recognition adjustments                                     |  |               | 6     |   |               |   | (47   | )
|(Gain) loss on sale of businesses                                         |  |               |      |   |               |   | 4     |  
|Foreign
    exchange(a)                                                   |  |               | (5    | ) |               |   | 8     |  
|Other                                                                     |  |               | 2     |   |               |   | (3    | )
|                                                                          |  |               |       |   |               |  
|Net earnings (loss)  as restated                                         |  | $             | (109  | ) |               | $ | (192  | )
|                                                                          |  |               |       |   |               |  






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



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

10-K 10-K/ 10-Q




| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | we and NNC 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 and NNCs 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







Results of Operations  Continuing Operations





Consolidated Information





Revenues




|              |  |                            |       |   |                           |   |       |        |  |   |        |   |  |      |     |   |      |   |       |        |  |   |        |  |  |   |      |   |  |  |    |  
|------------- |  | -------------------------- | ----- | - | ------------------------- | - | ----- | ------ |  | - | ------ | - |  | ---- | --- | - | ---- | - | ----- | ------ |  | - | ------ |  |  | - | ---- | - |  |  | -- | -
|              |  | For the Three Months Ended |       |   | For the Nine Months Ended |  
|              |  | September 30,              |       |   | September 30,             |  
|              |  |                            |       |   |                           |  
|              |  |                            |       | $ |                           |   | %     |        |  |   |        | $ |  |      | %   |  
|              |  | 2006                       |       |   | 2005                      |   |       | Change |  |   | Change |   |  | 2006 |     |   | 2005 |   |       | Change |  |   | Change | 
|              |  |                            |       |   |                           |   |       |        |  |   |        |   |  |      |     |   |      |   |       |        |  |   |        | 
|United States |  | $                          | 1,311 |   |                           | $ | 1,254 |        |  | $ | 57     |   |  |      | 5   |   |      | $ | 3,557 |        |  | $ | 3,846  |  |  | $ | (289 | ) |  |  | (8 | )
|EMEA(a)       |  |                            | 809   |   |                           |   | 618   |        |  |   | 191    |   |  |      | 31  |   |      |   | 2,334 |        |  |   | 1,956  |  |  |   | 378  |   |  |  | 19 |  
|Canada        |  |                            | 224   |   |                           |   | 160   |        |  |   | 64     |   |  |      | 40  |   |      |   | 522   |        |  |   | 438    |  |  |   | 84   |   |  |  | 19 |  
|Asia          |  |                            | 474   |   |                           |   | 312   |        |  |   | 162    |   |  |      | 52  |   |      |   | 1,224 |        |  |   | 861    |  |  |   | 363  |   |  |  | 42 |  
|CALA(b)       |  |                            | 137   |   |                           |   | 174   |        |  |   | (37    | ) |  |      | (21 | ) |      |   | 444   |        |  |   | 425    |  |  |   | 19   |   |  |  | 4  |  
|              |  |                            |       |   |                           |   |       |        |  |   |        |   |  |      |     |   |      |   |       |        |  |   |        | 
|Total         |  | $                          | 2,955 |   |                           | $ | 2,518 |        |  | $ | 437    |   |  |      | 17  |   |      | $ | 8,081 |        |  | $ | 7,526  |  |  | $ | 555  |   |  |  | 7  |  
|              |  |                            |       |   |                           |   |       |        |  |   |        |   |  |      |     |   |      |   |       |        |  |   |        | 






|    |                                                 
|--- | ------------------------------------------------
|(a) | Europe, Middle East and Africa, or EMEA, region.
|(b) | Caribbean and Latin America, or CALA, region.   

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| |                    
| | -------------------
| | Q3 2006 vs. Q3 2005



| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | 5% increase in revenues in the U.S. primarily due to
    substantial increases in CDMA solutions as a result of higher
    EV-DO Rev A volume. We
    also saw substantial increases in our circuit and packet voice
    solutions primarily due to the recognition of previously
    deferred packet-based solutions revenue resulting from a
    contract renegotiation. These increases were partially offset by
    a substantial decline in GSM and UMTS solutions and optical
    networking solutions and a decrease in GS revenues.                                                                                                                
|
| |  | 31% increase in revenues in EMEA primarily due to substantial
    increases in GSM and UMTS solutions and CDMA solutions as a
    result of the completion of certain contract deliverables
    resulting in the recognition of previously deferred revenues. We
    also saw substantial increases in carrier data networking and
    security solutions, and a significant increase in GS revenues
    due to the recognition of previously deferred revenues. These
    increases were partially offset by a substantial decline in
    enterprise circuit and packet voice solutions due to decreased
    volumes.                                     
|
| |  | 40% increase in revenues in Canada primarily due to substantial
    increases in revenues from CDMA solutions as a result of higher
    EV-DO Rev A volume.
    Enterprise circuit and packet voice solutions and optical
    networking solutions realized modest increases due to increased
    volume. These increases were partially offset by a decline in
    revenues from GSM and UMTS solutions.                                                                                                                                                                                                                                                  
|
| |  | 52% increase in revenues in Asia due to substantial increases in
    enterprise circuit and packet voice solutions, optical
    networking solutions, and CDMA solutions, partially offset by
    substantial declines in data networking and security solutions.
    A significant portion of the growth was due to the increase in
    enterprise circuit and packet voice solutions related primarily
    to the impact of the consolidation of the
    LG-Nortel joint venture
    and the increase in optical networking solutions due to the
    delivery of a software upgrade which resulted in the recognition
    of previously deferred revenue.
|
| |  | 21% decrease in revenues in CALA primarily due to substantial
    decreases in CDMA solutions, partially offset by increases in
    optical networking solutions and circuit and packet voice
    solutions.                                                                                                                                                                                                                                                                                                                                                                                                                                               



| |                                                        
| | -------------------------------------------------------
| | First nine months of 2006 vs. first nine months of 2005



| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | 8% decrease in revenues in the U.S. primarily due to
    substantial declines in our MCCN and ES segments. MCCN saw
    significant declines in both our GSM and UMTS solutions, and our
    ES portfolio had a significant decline in circuit and
    packet voice solutions due to decreased volumes. These declines
    were partially offset by a significant increase in circuit and
    packet voice solutions in the MCCN segment and the impact of
    revenues from the acquisition of NGS.                                                                                                                                                                                                                                                                                                                                                
|
| |  | 19% increase in revenues in EMEA primarily due to increases in
    our MCCN and MEN segments. CDMA solutions and GSM and UMTS
    solutions increased primarily as a result of the recognition of
    previously deferred revenue due to a contract renegotiation and
    the completion of certain contract deliverables. Our optical
    solutions and carrier data networking solutions saw substantial
    increases driven by increased volumes and the delivery of
    software upgrades which triggered the recognition of revenue.
    The increases were partially offset by significant decreases in
    enterprise circuit and packet voice solutions and data
    networking and security solutions due to decreased volumes and
    shipment delays related to compliance with the European Union
    Environmental Directive, or EUED.
|
| |  | 19% increase in revenues in Canada primarily due to substantial
    increases in CDMA solutions, circuit and packet voice solutions,
    and optical networking solutions and a significant increase in
    GS revenue. These increases were partially offset by a
    substantial decline in data networking and security solutions.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|
| |  | 42% increase in revenues in Asia due to substantial growth
    across most product portfolios including enterprise circuit and
    packet voice solutions, optical solutions, and GSM solutions. A
    significant portion of the growth was due to the delivery of
    software upgrades which triggered the recognition of previously
    deferred optical and GSM revenue, the impact of the
    consolidation of the
    LG-Nortel joint
    venture, and increased volumes.                                                                                                                                                                                                                                                                                                                                                                    
|
| |  | 4% increase in revenues in CALA primarily due to a substantial
    increase in GSM solutions due to new contracts and existing
    customer expansion, partially offset by declines in CDMA
    solutions and enterprise circuit and packet voice solutions.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        

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Gross Profit and Gross Margin


|             |  |                            |       |   |                           |   |      |        |  |   |          |   |  |      |    |  |      |   |       |        |  |   |          |   |  |   |          |   |  |  |   | 
|------------ |  | -------------------------- | ----- | - | ------------------------- | - | ---- | ------ |  | - | -------- | - |  | ---- | -- |  | ---- | - | ----- | ------ |  | - | -------- | - |  | - | -------- | - |  |  | - | 
|             |  | For the Three Months Ended |       |   | For the Nine Months Ended |  
|             |  | September 30,              |       |   | September 30,             |  
|             |  |                            |       |   |                           |  
|             |  | 2006                       |       |   | 2005                      |   |      | Change |  |   | % Change |   |  | 2006 |    |  | 2005 |   |       | Change |  |   | % Change |  
|             |  |                            |       |   |                           |   |      |        |  |   |          |   |  |      |    |  |      |   |       |        |  |   |          |  
|Gross profit |  | $                          | 1,117 |   |                           | $ | 967  |        |  | $ | 150      |   |  |      | 16 |  |      | $ | 3,092 |        |  | $ | 3,085    |   |  | $ | 7        |   |  |  | 0 | 
|Gross margin |  |                            | 37.8  | % |                           |   | 38.4 | %      |  |   | (0.6 pts | ) |  |      |    |  |      |   | 38.3  | %      |  |   | 41.0     | % |  |   | (2.7 pts | ) |  |  |   | 
|             |  |                            |       |   |                           |   |      |        |  |   |          |   |  |      |    |  |      |   |       |        |  |   |          |  





| |   |                                                                                                                                                                                                                                                                                                                                     
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | an increase of approximately $215 due to overall higher sales
    volumes;                                                                                                                                                                                                                                                          
| |  | an increase of approximately $60 due to project losses related
    to the Bharat Sanchar Nigam Limited, or BSNL, contract in India
    that were incurred in 2005 and not repeated in 2006;                                                                                                                                         
| |  | an increase of approximately $55 due to continued improvements
    in our cost structure; and                                                                                                                                                                                                                                       
| |  | an increase of approximately $10 primarily due to lower
    inventory provisions in the third quarter of 2006 partially
    offset by higher product and warranty costs; partially offset by                                                                                                                                        
| |  | a decrease of approximately $180 primarily as a result of
    (i) pricing pressures due to increased competition
    primarily in EMEA and emerging markets; (ii) unfavorable
    product mix and unfavorable customer mix; and
    (iii) increased costs associated with European Union
    Environmental Directive compliance; and
| |  | a decrease of approximately $10 related to expenses incurred in
    the third quarter of 2006 in connection with our employee bonus
    plans that were not incurred in the third quarter of 2005.                                                                                                                                  





| |   |                                                                                                                                                                                                                                                                                                                                         
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | an increase of approximately $285 due to overall higher sales
    volumes;                                                                                                                                                                                                                                                              
| |  | an increase of $105 due to continued improvements in our cost
    structure;                                                                                                                                                                                                                                                            
| |  | an increase of approximately $70 due to project losses related
    to the Bharat Sanchar Nigam Limited, or BSNL, contract in India
    that were incurred in 2005 and not repeated in 2006; and                                                                                                                                         
| |  | an increase of $5 related to expenses incurred in the 2005 in
    connection with our employee bonus plans that were not incurred
    to the same magnitude in 2006; partially offset by                                                                                                                                                
| |  | a decrease of $413 for the first nine months of 2006 primarily
    as a result of (i) pricing pressures due to increased
    competition primarily in EMEA and emerging markets;
    (ii) unfavorable product and customer mix; and
    (iii) increased costs associated with European Union
    Environmental Directive compliance; and
| |  | a decrease of $45 primarily due to higher product and warranty
    costs in 2006 and recoveries in inventory provisions due to sale
    of inventory in the first nine months of 2005 not repeated to
    same extent in the first nine months of 2006.                                                                                 




Operating Expenses







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

|                 |  |                            |      |   |                           |   |      |          |  |   |          |   |  |      |   |  |      |   |       |          |  |   |          |   |  |   |          |   |  |  |   | 
|---------------- |  | -------------------------- | ---- | - | ------------------------- | - | ---- | -------- |  | - | -------- | - |  | ---- | - |  | ---- | - | ----- | -------- |  | - | -------- | - |  | - | -------- | - |  |  | - | 
|                 |  | For the Three Months Ended |      |   | For the Nine Months Ended |  
|                 |  | September 30,              |      |   | September 30,             |  
|                 |  |                            |      |   |                           |  
|                 |  | 2006                       |      |   | 2005                      |   |      | $ Change |  |   | % Change |   |  | 2006 |   |  | 2005 |   |       | $ Change |  |   | % Change |  
|                 |  |                            |      |   |                           |   |      |          |  |   |          |   |  |      |   |  |      |   |       |          |  |   |          |  
|SG&A expense     |  | $                          | 603  |   |                           | $ | 565  |          |  | $ | 38       |   |  |      | 7 |  |      | $ | 1,791 |          |  | $ | 1,724    |   |  | $ | 67       |   |  |  | 4 | 
|As % of revenues |  |                            | 20.4 | % |                           |   | 22.4 | %        |  |   | (2.0 pts | ) |  |      |   |  |      |   | 22.2  | %        |  |   | 22.9     | % |  |   | (0.7 pts | ) |  |  |   | 
|                 |  |                            |      |   |                           |   |      |          |  |   |          |   |  |      |   |  |      |   |       |          |  |   |          |  





| |   |                                                                                                                                                                                                                     
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | incremental costs of approximately $21 ($90 for the first nine
    months of 2006) related to our acquisition of NGS and the
    consolidation of the
    LG-Nortel joint venture;                                  
| |  | higher costs of approximately $4 ($34 for the first nine months
    of 2006) related to our internal control remedial measures,
    investment in our finance processes and business transformation
    initiatives;
| |  | unfavorable foreign exchange impacts primarily in the first half
    of 2006 associated with the strengthening of the Canadian dollar
    against the U.S. dollar; and                                              
| |  | higher costs associated with our employee bonus plans; partially
    offset by                                                                                                                                      

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| |   |                                                                                     
| | - | ------------------------------------------------------------------------------------
| |  | cost savings associated with the changes made to our employee
    benefit plans; and
| |  | lower costs related to our restatement related activities.                          






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

|                 |  |                            |      |   |                           |   |      |          |  |   |          |   |  |      |   |  |      |   |       |          |  |   |          |   |  |   |          |   |  |  |   | 
|---------------- |  | -------------------------- | ---- | - | ------------------------- | - | ---- | -------- |  | - | -------- | - |  | ---- | - |  | ---- | - | ----- | -------- |  | - | -------- | - |  | - | -------- | - |  |  | - | 
|                 |  | For the Three Months Ended |      |   | For the Nine Months Ended |  
|                 |  | September 30,              |      |   | September 30,             |  
|                 |  |                            |      |   |                           |  
|                 |  | 2006                       |      |   | 2005                      |   |      | $ Change |  |   | % Change |   |  | 2006 |   |  | 2005 |   |       | $ Change |  |   | % Change |  
|                 |  |                            |      |   |                           |   |      |          |  |   |          |   |  |      |   |  |      |   |       |          |  |   |          |  
|R&D expense      |  | $                          | 476  |   |                           | $ | 438  |          |  | $ | 38       |   |  |      | 9 |  |      | $ | 1,434 |          |  | $ | 1,392    |   |  | $ | 42       |   |  |  | 3 | 
|As % of revenues |  |                            | 16.1 | % |                           |   | 17.4 | %        |  |   | (1.3 pts | ) |  |      |   |  |      |   | 17.7  | %        |  |   | 18.5     | % |  |   | (0.8 pts | ) |  |  |   | 
|                 |  |                            |      |   |                           |   |      |          |  |   |          |   |  |      |   |  |      |   |       |          |  |   |          |  





| |   |                                                                                                                                                                       
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | incremental costs of approximately $20 ($63 for the first nine
    months of 2006) related to our consolidation of the
    LG-Nortel joint venture;                   
| |  | unfavorable foreign exchange impacts primarily in the first half
    of 2006 associated with the strengthening of the Canadian dollar
    against the U.S. dollar; and
| |  | higher costs associated with our employee bonus plans; partially
    offset by                                                                                        
| |  | cost savings associated with the changes made to our employee
    benefit plans.                                                                                      




Special
Charges










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##### 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        |                                        | $         |   |            |           | $ |          |             |   | $ |      |     |   | $ |    |    
|                                                 | Other special charges                  |           |    | 49         |           |   |           |            |   |   |       | 1   |   |   |     | 50  |  
|                                                 | Revisions to prior accruals            |           |    |           |           |   |           |            |   |   |       |    |   |   |     |    |  
|                                                 | Cash drawdowns                         |           |    | (14        | )         |   |           |            |   |   |       |    |   |   |     | (14 | )
|                                                 | Non-cash drawdowns                     |           |    |           |           |   |           |            |   |   |       | (1  | ) |   |     | (1  | )
|                                                 | Foreign exchange and other adjustments |           |    |           |           |   |           |            |   |   |       |    |   |   |     |    |  
|                                                 |                                        |           |    |            |           |   |           |             |   |   |       |    
|Provision balance as of September 30, 2006       |                                        | $         | 35 |            |           | $ |          |             |   | $ |      |     |   | $ | 35  |    
|                                                 |                                        |           |    |            |           |   |           |             |   |   |       |    
|2004 Restructuring Plan                          |                                        |           |    |            |           |   |           |             |   |   |       |     |   |   |     |    
|Provision balance as of December 31, 2005        |                                        | $         | 21 |            |           | $ | 61        |             |   | $ |      |     |   | $ | 82  |    
|                                                 | Other special charges                  |           |    |           |           |   |           |            |   |   |       |    |   |   |     |    |  
|                                                 | Revisions to prior accruals            |           |    | 2          |           |   |           | 6           |   |   |       | 11  |   |   |     | 19  |  
|                                                 | Cash drawdowns                         |           |    | (19        | )         |   |           | (16         | ) |   |       |    |   |   |     | (35 | )
|                                                 | Non-cash drawdowns                     |           |    |           |           |   |           |            |   |   |       | (11 | ) |   |     | (11 | )
|                                                 | Foreign exchange and other adjustments |           |    | 1          |           |   |           | 3           |   |   |       |    |   |   |     | 4   |  
|                                                 |                                        |           |    |            |           |   |           |             |   |   |       |    
|Provision balance as of September 30, 2006       |                                        | $         | 5  |            |           | $ | 54        |             |   | $ |      |     |   | $ | 59  |    
|                                                 |                                        |           |    |            |           |   |           |             |   |   |       |    
|2001 Restructuring Plan                          |                                        |           |    |            |           |   |           |             |   |   |       |     |   |   |     |    
|Provision balance as of December 31, 2005        |                                        | $         | 3  |            |           | $ | 213       |             |   | $ |      |     |   | $ | 216 |    
|                                                 | Other special charges                  |           |    |           |           |   |           |            |   |   |       |    |   |   |     |    |  
|                                                 | Revisions to prior accruals            |           |    | 1          |           |   |           | 4           |   |   |       |    |   |   |     | 5   |  
|                                                 | Cash drawdowns                         |           |    | (1         | )         |   |           | (40         | ) |   |       |    |   |   |     | (41 | )
|                                                 | Non-cash drawdowns                     |           |    |           |           |   |           |            |   |   |       |    |   |   |     |    |  
|                                                 | Foreign exchange and other adjustments |           |    | (1         | )         |   |           | 3           |   |   |       |    |   |   |     | 2   |  
|                                                 |                                        |           |    |            |           |   |           |             |   |   |       |    
|Provision balance as of September 30, 2006       |                                        | $         | 2  |            |           | $ | 180       |             |   | $ |      |     |   | $ | 182 |    
|                                                 |                                        |           |    |            |           |   |           |             |   |   |       |    
|Total provision balance as of September 30, 2006 |                                        | $         | 42 |            |           | $ | 234       |             |   | $ |      |     |   | $ | 276 |    
|                                                 |                                        |           |    |            |           |   |           |             |   |   |       |    



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|                            |                                      |                                 |    |               |      |   |               |   |   |      |    |   |      |   |     |      |    |   |   |   |    |   |    |   |    |  
|--------------------------- | ------------------------------------ | ------------------------------- | -- | ------------- | ---- | - | ------------- | - | - | ---- | -- | - | ---- | - | --- | ---- | -- | - | - | - | -- | - | -- | - | -- | -
|                            |                                      | 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    |   |     | $    | 18 |   |   | $ |   |   |    | $ | (2 | )
|                            |                                      | Three months ended June 30      |    |               | 25   |   |               |   |  |      |    |   | 1    |   |     |      | 67 |   |   |   | 1  |   |    |   | 4  |  
|                            |                                      | Three months ended September 30 |    |               | 5    |   |               |   |  |      |    |   | 5    |   |     |      | 18 |   |   |   | 4  |   |    |   | 2  |  
|                            | Enterprise Solutions                 |                                 |    |               |      |   |               |   |   |      |    |   |      |   |     |      |    |   |   |   |    |   |    |   |   
|                            |                                      | Three months ended March 31     |    |               |     |   |               |   |  |      |    |   | 1    |   |     |      | 4  |   |   |   | (1 | ) |    |   | (1 | )
|                            |                                      | Three months ended June 30      |    |               | 12   |   |               |   |  |      |    |   |     |   |     |      | 9  |   |   |   |   |   |    |   |   |  
|                            |                                      | Three months ended September 30 |    |               | 1    |   |               |   |  |      |    |   | 2    |   |     |      | 4  |   |   |   | 1  |   |    |   | 1  |  
|                            | Metro Ethernet Networks              |                                 |    |               |      |   |               |   |   |      |    |   |      |   |     |      |    |   |   |   |    |   |    |   |   
|                            |                                      | Three months ended March 31     |    |               |     |   |               |   |  |      |    |   | 2    |   |     |      | 2  |   |   |   |   |   |    |   | (8 | )
|                            |                                      | Three months ended June 30      |    |               | 3    |   |               |   |  |      |    |   |     |   |     |      | 10 |   |   |   |   |   |    |   |   |  
|                            |                                      | Three months ended September 30 |    |               | 1    |   |               |   |  |      |    |   | 5    |   |     |      | 12 |   |   |   |   |   |    |   |   |  
|                            | Global Services                      |                                 |    |               |      |   |               |   |   |      |    |   |      |   |     |      |    |   |   |   |    |   |    |   |   
|                            |                                      | Three months ended March 31     |    |               |     |   |               |   |  |      |    |   |     |   |     |      | 1  |   |   |   |   |   |    |   |   |  
|                            |                                      | Three months ended June 30      |    |               | 3    |   |               |   |  |      |    |   |     |   |     |      | 2  |   |   |   |   |   |    |   |   |  
|                            |                                      | Three months ended September 30 |    |               |     |   |               |   |  |      |    |   |     |   |     |      | 2  |   |   |   |   |   |    |   |   |  
|                            |                                      |                                 |    |               |      |   |               |   |   |      |    |   |      |   |     |      |    |  
|Total special charges       |                                      | $                               | 50 |               |      | $ |              |   |   | $    | 19 |   |      | $ | 149 |      |    | $ | 5 |   |    | $ | (4 | )
|                            |                                      |                                 |    |               |      |   |               |   |   |      |    |   |      |   |     |      |    |  






Gain/ Loss on Sale of Businesses and Assets











Other Income  Net




|                                                 |  |               |    |   |               |   |    |      |  |   |      |   |  |   |     | 
|------------------------------------------------ |  | ------------- | -- | - | ------------- | - | -- | ---- |  | - | ---- | - |  | - | --- | 
|                                                 |  | For the       |    |   | For the       |  
|                                                 |  | Three Months  |    |   | Nine Months   |  
|                                                 |  | Ended         |    |   | Ended         |  
|                                                 |  | September 30, |    |   | September 30, |  
|                                                 |  |               |    |   |               |  
|                                                 |  | 2006          |    |   | 2005          |   |    | 2006 |  |   | 2005 |  
|                                                 |  |               |    |   |               |   |    |      |  |   |      |  
|Interest and dividend
    income(a)              |  | $             | 30 |   |               | $ | 26 |      |  | $ | 84   |   |  | $ | 74  | 
|Gain (loss) on sale or write down of investments |  |               | (7 | ) |               |   |   |      |  |   | (6   | ) |  |   | 16  | 
|Currency exchange gains
    (losses)(b)          |  |               | (3 | ) |               |   | 16 |      |  |   | 20   |   |  |   | 65  | 
|Other  net                                      |  |               | 26 |   |               |   | 10 |      |  |   | 71   |   |  |   | 29  | 
|                                                 |  |               |    |   |               |   |    |      |  |   |      |  
|Other income  net                               |  | $             | 46 |   |               | $ | 52 |      |  | $ | 169  |   |  | $ | 184 | 
|                                                 |  |               |    |   |               |   |    |      |  |   |      |  






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

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| |   |                                                                                                                                              
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------
| |  | gain of $23 related to changes in fair value of derivative
    financial instruments that did not meet the criteria for hedge
    accounting;
| |  | income of $10 on royalties from patented technology; and                                                                                     
| |  | income of $6 related to the sub-lease of certain facilities;
    partially offset by                                                         
| |  | expenses of $5 related to various litigation and settlements
    costs; and                                                                  
| |  | loss of $7 related to the write down of an investment.                                                                                       





| |   |                                                                                                                                              
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------
| |  | gain of $26 related to the sale of a note receivable from
    Bookham, Inc.;                                                                 
| |  | gain of $24 related to changes in fair value of derivative
    financial instruments that did not meet the criteria for hedge
    accounting;
| |  | income of $17 on royalties from patented technology; and                                                                                     
| |  | income of $16 related to the sub-lease of certain facilities;
    partially offset by                                                        
| |  | expenses of $5 related to various litigation and settlement
    costs;                                                                       
| |  | expense of $13 from the securitization of certain
    receivables; and                                                                       
| |  | loss of $7 related to the write down of an investment.                                                                                       







| |   |                                                                                                                                             
| | - | --------------------------------------------------------------------------------------------------------------------------------------------
| |  | gain of $21 related to the sale of our remaining Arris Group
    Inc. shares;                                                               
| |  | gain of $17 related to a customer exclusivity clause settlement;                                                                            
| |  | income of $16 related to the sub-lease of certain
    facilities; and                                                                       
| |  | gain of $10 on customer financing arrangements; partially offset
    by                                                                     
| |  | loss of $18 from the sale of certain accounts
    receivables; and                                                                          
| |  | loss of $6 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)








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Segment Information







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



|               |                                    |                            |       |     |                           |   |       |        |  |   |        |     |  |      |     |    |      |   |       |        |  |   |        |       |  |   |     |     |  |  |   |    | 
|-------------- | ---------------------------------- | -------------------------- | ----- | --- | ------------------------- | - | ----- | ------ |  | - | ------ | --- |  | ---- | --- | -- | ---- | - | ----- | ------ |  | - | ------ | ----- |  | - | --- | --- |  |  | - | -- | 
|               |                                    | For the Three Months Ended |       |     | For the Nine Months Ended |  
|               |                                    | September 30,              |       |     | September 30,             |  
|               |                                    |                            |       |     |                           |  
|               |                                    |                            |       | $   |                           |   | %     |        |  |   |        | $   |  |      | %   |   
|               |                                    | 2006                       |       |     | 2005                      |   |       | Change |  |   | Change |     |  | 2006 |     |    | 2005 |   |       | Change |  |   | Change |      
|               |                                    |                            |       |     |                           |   |       |        |  |   |        |     |  |      |     |    |      |   |       |        |  |   |        |      
|Revenue        |                                    |                            |       |     |                           |   |       |        |  |   |        |     |  |      |     |    |      |   |       |        |  |   |        |       |  |   |     |     |  |  |   |   
|               | CDMA solutions                     |                            | $     | 704 |                           |   | $     | 514    |  |   | $      | 190 |  |      |     | 37 |      |   | $     | 1,722  |  |   | $      | 1,606 |  |   | $   | 116 |  |  |   | 7  | 
|               | GSM and UMTS solutions             |                            |       | 563 |                           |   |       | 522    |  |   |        | 41  |  |      |     | 8  |      |   |       | 1,796  |  |   |        | 1,704 |  |   |     | 92  |  |  |   | 5  | 
|               | Circuit and packet voice solutions |                            |       | 273 |                           |   |       | 215    |  |   |        | 58  |  |      |     | 27 |      |   |       | 737    |  |   |        | 643   |  |   |     | 94  |  |  |   | 15 | 
|               |                                    |                            |       |     |                           |   |       |        |  |   |        |     |  |      |     |    |      |   |       |        |  |   |        |      
|Total Revenue  |                                    | $                          | 1,540 |     |                           | $ | 1,251 |        |  | $ | 289    |     |  |      | 23  |    |      | $ | 4,255 |        |  | $ | 3,953  |       |  | $ | 302 |     |  |  | 8 |   
|               |                                    |                            |       |     |                           |   |       |        |  |   |        |     |  |      |     |    |      |   |       |        |  |   |        |      
|Management EBT |                                    | $                          | 107   |     |                           | $ | 38    |        |  | $ | 69     |     |  |      | 182 |    |      | $ | 288   |        |  | $ | 284    |       |  | $ | 4   |     |  |  | 1 |   
|               |                                    |                            |       |     |                           |   |       |        |  |   |        |     |  |      |     |    |      |   |       |        |  |   |        |      



| |                    
| | -------------------
| | Q3 2006 vs. Q3 2005

EV-DO








LG-Nortel






| |                                                        
| | -------------------------------------------------------
| | First nine months of 2006 vs. first nine months of 2005





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| |                     
| | --------------------
| | Enterprise Solutions



|               |                                        |                            |     |     |                           |   |     |        |  |   |        |    |  |      |     |    |      |   |       |        |  |   |        |       |  |   |      |     |   |  |      |    |  
|-------------- | -------------------------------------- | -------------------------- | --- | --- | ------------------------- | - | --- | ------ |  | - | ------ | -- |  | ---- | --- | -- | ---- | - | ----- | ------ |  | - | ------ | ----- |  | - | ---- | --- | - |  | ---- | -- | -
|               |                                        | For the Three Months Ended |     |     | For the Nine Months Ended |  
|               |                                        | September 30,              |     |     | September 30,             |  
|               |                                        |                            |     |     |                           |  
|               |                                        |                            |     | $   |                           |   | %   |        |  |   |        | $  |  |      | %   |   
|               |                                        | 2006                       |     |     | 2005                      |   |     | Change |  |   | Change |    |  | 2006 |     |    | 2005 |   |       | Change |  |   | Change |      
|               |                                        |                            |     |     |                           |   |     |        |  |   |        |    |  |      |     |    |      |   |       |        |  |   |        |      
|Revenue        |                                        |                            |     |     |                           |   |     |        |  |   |        |    |  |      |     |    |      |   |       |        |  |   |        |       |  |   |      |     |   |  |      |   
|               | Circuit and packet voice solutions     |                            | $   | 430 |                           |   | $   | 357    |  |   | $      | 73 |  |      |     | 20 |      |   | $     | 1,054  |  |   | $      | 1,122 |  |   | $    | (68 | ) |  |      | (6 | )
|               | Data networking and security solutions |                            |     | 179 |                           |   |     | 177    |  |   |        | 2  |  |      |     | 1  |      |   |       | 469    |  |   |        | 486   |  |   |      | (17 | ) |  |      | (3 | )
|               |                                        |                            |     |     |                           |   |     |        |  |   |        |    |  |      |     |    |      |   |       |        |  |   |        |      
|Total Revenue  |                                        | $                          | 609 |     |                           | $ | 534 |        |  | $ | 75     |    |  |      | 14  |    |      | $ | 1,523 |        |  | $ | 1,608  |       |  | $ | (85  | )   |   |  | (5   | ) 
|               |                                        |                            |     |     |                           |   |     |        |  |   |        |    |  |      |     |    |      |   |       |        |  |   |        |      
|Management EBT |                                        | $                          | 3   |     |                           | $ | 31  |        |  | $ | (28    | )  |  |      | (90 | )  |      | $ | (104  | )      |  | $ | 126    |       |  | $ | (230 | )   |   |  | (183 | ) 
|               |                                        |                            |     |     |                           |   |     |        |  |   |        |    |  |      |     |    |      |   |       |        |  |   |        |      



| |                    
| | -------------------
| | Q3 2006 vs. Q3 2005















| |                                                        
| | -------------------------------------------------------
| | First nine months of 2006 vs. first nine months of 2005





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| |                        
| | -----------------------
| | Metro Ethernet Networks



|               |                                        |                            |     |     |                           |   |     |        |  |   |        |    |  |      |     |    |      |   |       |        |  |   |        |     |  |   |     |     |  |  |     |    | 
|-------------- | -------------------------------------- | -------------------------- | --- | --- | ------------------------- | - | --- | ------ |  | - | ------ | -- |  | ---- | --- | -- | ---- | - | ----- | ------ |  | - | ------ | --- |  | - | --- | --- |  |  | --- | -- | 
|               |                                        | For the Three Months Ended |     |     | For the Nine Months Ended |  
|               |                                        | September 30,              |     |     | September 30,             |  
|               |                                        |                            |     |     |                           |  
|               |                                        |                            |     | $   |                           |   | %   |        |  |   |        | $  |  |      | %   |   
|               |                                        | 2006                       |     |     | 2005                      |   |     | Change |  |   | Change |    |  | 2006 |     |    | 2005 |   |       | Change |  |   | Change |    
|               |                                        |                            |     |     |                           |   |     |        |  |   |        |    |  |      |     |    |      |   |       |        |  |   |        |    
|Revenue        |                                        |                            |     |     |                           |   |     |        |  |   |        |    |  |      |     |    |      |   |       |        |  |   |        |     |  |   |     |     |  |  |     |   
|               | Optical Networking Solutions           |                            | $   | 312 |                           |   | $   | 259    |  |   | $      | 53 |  |      |     | 20 |      |   | $     | 828    |  |   | $      | 709 |  |   | $   | 119 |  |  |     | 17 | 
|               | Data Networking and Security Solutions |                            |     | 118 |                           |   |     | 104    |  |   |        | 14 |  |      |     | 13 |      |   |       | 373    |  |   |        | 289 |  |   |     | 84  |  |  |     | 29 | 
|               |                                        |                            |     |     |                           |   |     |        |  |   |        |    |  |      |     |    |      |   |       |        |  |   |        |    
|Total Revenue  |                                        | $                          | 430 |     |                           | $ | 363 |        |  | $ | 67     |    |  |      | 18  |    |      | $ | 1,201 |        |  | $ | 998    |     |  | $ | 203 |     |  |  | 20  |   
|               |                                        |                            |     |     |                           |   |     |        |  |   |        |    |  |      |     |    |      |   |       |        |  |   |        |    
|Management EBT |                                        | $                          | 12  |     |                           | $ | (18 | )      |  | $ | 30     |    |  |      | 167 |    |      | $ | 26    |        |  | $ | (103   | )   |  | $ | 129 |     |  |  | 125 |   
|               |                                        |                            |     |     |                           |   |     |        |  |   |        |    |  |      |     |    |      |   |       |        |  |   |        |    



| |                    
| | -------------------
| | Q3 2006 vs. Q3 2005















| |                                                        
| | -------------------------------------------------------
| | First nine months of 2006 vs. first nine months of 2005





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| |                
| | ---------------
| | Global Services



|                              |  |                            |     |   |                           |   |     |        |  |   |        |   |  |      |   |  |      |   |     |        |  |   |        |  |  |   |    |  |  |  |   | 
|----------------------------- |  | -------------------------- | --- | - | ------------------------- | - | --- | ------ |  | - | ------ | - |  | ---- | - |  | ---- | - | --- | ------ |  | - | ------ |  |  | - | -- |  |  |  | - | 
|                              |  | For the Three Months Ended |     |   | For the Nine Months Ended |  
|                              |  | September 30,              |     |   | September 30,             |  
|                              |  |                            |     |   |                           |  
|                              |  |                            |     | $ |                           |   | %   |        |  |   |        | $ |  |      | % | 
|                              |  | 2006                       |     |   | 2005                      |   |     | Change |  |   | Change |   |  | 2006 |   |  | 2005 |   |     | Change |  |   | Change | 
|                              |  |                            |     |   |                           |   |     |        |  |   |        |   |  |      |   |  |      |   |     |        |  |   |        | 
|Total Global Services Revenue |  | $                          | 316 |   |                           | $ | 305 |        |  | $ | 11     |   |  |      | 4 |  |      | $ | 916 |        |  | $ | 883    |  |  | $ | 33 |  |  |  | 4 | 
|                              |  |                            |     |   |                           |   |     |        |  |   |        |   |  |      |   |  |      |   |     |        |  |   |        | 
|Management EBT                |  | $                          | 89  |   |                           | $ | 85  |        |  | $ | 4      |   |  |      | 5 |  |      | $ | 270 |        |  | $ | 268    |  |  | $ | 2  |  |  |  | 1 | 
|                              |  |                            |     |   |                           |   |     |        |  |   |        |   |  |      |   |  |      |   |     |        |  |   |        | 



| |                    
| | -------------------
| | Q3 2006 vs. Q3 2005











| |                                                        
| | -------------------------------------------------------
| | First nine months of 2006 vs. first nine months of 2005







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

|                    |  |                            |      |   |                           |   |      |        |  |   |        |   |  |      |     |   |      |   |      |        |  |   |        |   |  |   |     |   |  |  |     |  
|------------------- |  | -------------------------- | ---- | - | ------------------------- | - | ---- | ------ |  | - | ------ | - |  | ---- | --- | - | ---- | - | ---- | ------ |  | - | ------ | - |  | - | --- | - |  |  | --- | -
|                    |  | For the Three Months Ended |      |   | For the Nine Months Ended |  
|                    |  | September 30,              |      |   | September 30,             |  
|                    |  |                            |      |   |                           |  
|                    |  |                            |      | $ |                           |   | %    |        |  |   |        | $ |  |      | %   |  
|                    |  | 2006                       |      |   | 2005                      |   |      | Change |  |   | Change |   |  | 2006 |     |   | 2005 |   |      | Change |  |   | Change |  
|                    |  |                            |      |   |                           |   |      |        |  |   |        |   |  |      |     |   |      |   |      |        |  |   |        |  
|Total Other Revenue |  | $                          | 60   |   |                           | $ | 65   |        |  | $ | (5     | ) |  |      | (8  | ) |      | $ | 186  |        |  | $ | 84     |   |  | $ | 102 |   |  |  | 121 |  
|                    |  |                            |      |   |                           |   |      |        |  |   |        |   |  |      |     |   |      |   |      |        |  |   |        |  
|Management EBT      |  | $                          | (200 | ) |                           | $ | (158 | )      |  | $ | (42    | ) |  |      | (27 | ) |      | $ | (572 | )      |  | $ | (532   | ) |  | $ | (40 | ) |  |  | (8  | )
|                    |  |                            |      |   |                           |   |      |        |  |   |        |   |  |      |     |   |      |   |      |        |  |   |        |  







| |                    
| | -------------------
| | Q3 2006 vs. Q3 2005









| |                                                        
| | -------------------------------------------------------
| | First nine months of 2006 vs. first nine months of 2005






Liquidity and Capital Resources





Cash Flow




|                                                                            |  |                           |       |   |      |   |       |        |  |   |      |  
|--------------------------------------------------------------------------- |  | ------------------------- | ----- | - | ---- | - | ----- | ------ |  | - | ---- | -
|                                                                            |  | For the Nine Months Ended |      
|                                                                            |  | September 30,             |      
|                                                                            |  |                           |      
|                                                                            |  | 2006                      |       |   | 2005 |   |       | Change | 
|                                                                            |  |                           |       |   |      |   |       |        | 
|Net cash from (used in) operating activities of continuing
    operations   |  | $                         | (839  | ) |      | $ | (293  | )      |  | $ | (546 | )
|Net cash from (used in) investing activities of continuing
    operations   |  |                           | (35   | ) |      |   | (297  | )      |  |   | 262  |  
|Net cash from (used in) financing activities of continuing
    operations   |  |                           | 533   |   |      |   | (45   | )      |  |   | 578  |  
|Effect of foreign exchange rate changes on cash and cash
    equivalents    |  |                           | 59    |   |      |   | (86   | )      |  |   | 145  |  
|                                                                            |  |                           |       |   |      |   |       |        | 
|Net cash from (used in) continuing operations                               |  |                           | (282  | ) |      |   | (721  | )      |  |   | 439  |  
|Net cash from (used in) operating activities of discontinued
    operations |  |                           |      |   |      |   | 34    |        |  |   | (34  | )
|                                                                            |  |                           |       |   |      |   |       |        | 
|Net increase (decrease) in cash and cash equivalents                        |  |                           | (282  | ) |      |   | (687  | )      |  |   | 405  |  
|Cash and cash equivalents at beginning of period                            |  |                           | 2,876 |   |      |   | 3,606 |        |  |   | (730 | )
|                                                                            |  |                           |       |   |      |   |       |        | 
|Cash and cash equivalents at end of period                                  |  | $                         | 2,594 |   |      | $ | 2,919 |        |  | $ | (325 | )
|                                                                            |  |                           |       |   |      |   |       |        | 

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| |                     
| | --------------------
| | Operating Activities
















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



|                                                                |  |         |     |  |         |  |    |        |  |  |     |  
|--------------------------------------------------------------- |  | ------- | --- |  | ------- |  | -- | ------ |  |  | --- | -
|                                                                |  | Q3 2006 |     |  | Q4 2005 |  |    | Change | 
|                                                                |  |         |     |  |         |  |    |        | 
|Days sales outstanding in accounts receivable
    (DSO)(a)      |  |         | 113 |  |         |  | 95 |        |  |  | 18  |  
|Net inventory days
    (NID)(b)                                 |  |         | 27  |  |         |  | 36 |        |  |  | (9  | )
|Days of purchases outstanding in accounts payable (DPO)
    (c) |  |         | 43  |  |         |  | 58 |        |  |  | (15 | )
|                                                                |  |         |     |  |         |  |    |        | 






|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(a) | DSO is the average number of days our receivables are
    outstanding based on a 90 day cycle. DSO is a metric that
    approximates the measure of the average number of days from when
    we recognize revenue until we collect cash from our customers.
    DSO for each quarter is calculated by dividing the quarter end
    accounts receivable-net balance by revenues for the quarter, in
    each case as determined in accordance with U.S. GAAP, and
    multiplying by 90 days.
|(b) | NID is the average number of days from procurement to sale of
    our product based on a 90 day cycle. NID for each quarter
    is calculated by dividing the average of the current quarter and
    prior quarter inventories  net (excluding deferred
    costs) by the cost of revenues for the quarter and multiplying
    by 90 days.                                                                                                                                                 
|(c) | DPO is the average number of days from when we receive purchased
    goods and services until we pay our suppliers based on a
    90 day cycle. DPO for each quarter is calculated by
    dividing the quarter end trade and other accounts payable by the
    cost of revenues for the quarter, in each case, as determined in
    accordance with U.S. GAAP, and multiplying by 90 days.                                                                                                  








| |                     
| | --------------------
| | Investing Activities



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| |                     
| | --------------------
| | Financing Activities














| |             
| | ------------
| | Senior Notes







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| |                                     
| | ------------------------------------
| | 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, in cash payable by NNC related
    to the Global Class Action Settlement. The cash amount
    bears interest at a prescribed rate, was placed in escrow on
    June 1, 2006 by NNC pending satisfactory completion of all
    conditions to the Global Class Action Settlement and has
    been classified as restricted cash and cash equivalents on
    NNCs condensed consolidated balance sheet. On
    March 17, 2006, NNC announced that it and the lead
    plaintiffs reached an agreement on the related Global
    Class Action Settlement insurance and corporate governance
    matters including its insurers agreeing to pay $228.5 in cash
    towards the settlement and NNC agreeing with its insurers to
    certain indemnification obligations. NNCs management
    believes that these indemnification obligations will be unlikely
    to materially increase its total cash payment obligations under
    the Global Class Action Settlement. On April 3, 2006,
    the proceeds from NNCs insurance were placed into escrow
    by the insurers. The insurance payments would not reduce the
    amounts payable by NNC. For more information, see
    Executive Overview  Significant Business
    Developments in 2006  Global Class Action
    Settlement;
| |  | we expect cash contributions for pension, post retirement and
    post employment funding to be approximately $440;                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| |  | capital expenditures of approximately $300;                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      

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| |   |                                                                                                                                                                       
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | costs related to workforce reduction and other restructuring
    activities for all restructuring plans of approximately
    $130; 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










| |                            
| | ---------------------------
| | Future Sources of Liquidity












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





| |   |                                                                                                                                                                
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | $300 of committed revolving support for performance bonds or
    similar instruments, of which $143 was outstanding; and                                       
| |  | $450 of uncommitted support for performance bonds or similar
    instruments and/or receivables sales and/or securitizations, of
    which $32 was outstanding.





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

10-K, 10-K/







| |                                      
| | -------------------------------------
| | Uncertainties regarding our liquidity





| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | We expect our ability to increase revenue and generate positive
    cash from operating activities to be a primary uncertainty
    regarding our liquidity. In recent years, our operating results
    have produced negative cash flow from operations due in large
    part to our inability to reduce operating expenses as a
    percentage of revenue and the continued negative impact on gross
    margin due to competitive pressures, product mix and other
    factors discussed throughout our MD&A. If capital spending
    by our customers changes or pricing and margins change from what
    we currently expect, our revenues and cash flows may be
    materially lower and we may be required to further reduce our
    investments or take other measures in order to meet our cash
    requirements;                                                                                                                   
| |  | We are under continuing regulatory and criminal investigations,
    and subject to litigation proceedings and as a result, any fines
    or other penalties or judgments or settlements in connection
    with our pending civil litigation not encompassed by the Global
    Class Action Settlement or regulatory or criminal
    investigations related to the restatements, could have a
    material adverse effect on our business, results of operations,
    financial condition and liquidity, other than anticipated
    professional fees and expenses;                                                                                                                                                                                                                                                                                                                                                                          
| |  | The Global Class Action Settlement, if approved and all
    other related conditions are satisfied, will have a material
    impact on our and NNCs liquidity as a result of the $575,
    plus accrued interest, cash payment by NNC. The cash amount
    bears interest at a prescribed rate and was placed in escrow by
    NNC on June 1, 2006, pending satisfactory completion of all
    of the conditions related to the Global Class Action
    Settlement. Amounts placed in escrow are included in NNCs
    restricted cash and cash equivalents. We also expect that the
    issuance of 628,667,750 Nortel Networks Corporation common
    shares (which represented 14.5% of NNCs equity as of
    February 7, 2006) as part of the Global Class Action
    Settlement will result in a significant dilution of existing
    shareholder equity positions and may adversely affect NNCs
    ability to finance using equity

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| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |   | and equity related securities in the future. In the event of a
    share consolidation of Nortel Networks Corporation common
    shares, the number of Nortel Networks Corporation common shares
    to be issued pursuant to the Global Class Action Settlement
    would be adjusted accordingly; and                                                                                                                                                                                                                                                                                   
| |  | Our ability and willingness to access the capital markets is
    based on many factors including market conditions and our
    overall financial objectives. Currently, our ability is limited
    by our and NNCs credit ratings. We cannot provide any
    assurance that our net cash requirements will be as we currently
    expect, that we will continue to have access to the EDC Support
    Facility when and as needed, that we will be able to refinance
    any maturing debt as it comes due or that financings will be
    available to us on acceptable terms, or at all.




Credit Ratings


|                                  |  |                             |    |  |                            |  |      |             |  |  |                    | 
|--------------------------------- |  | --------------------------- | -- |  | -------------------------- |  | ---- | ----------- |  |  | ------------------ | 
|                                  |  | Rating on Long-Term Debt    |    |  |                            |  |     
|                                  |  | Issued or Guaranteed by     |    |  | Rating on Preferred Shares |  |      |            
|                                  |  | Nortel Networks Limited/    |    |  | Issued by                  |  |      |            
|Rating Agency                     |  | Nortel Networks Corporation |    |  | Nortel Networks Limited    |  |      | Last Update | 
|                                  |  |                             |    |  |                            |  |      |             | 
|Standard & Poors Ratings Service |  |                             | B- |  |                            |  | CCC- |             |  |  | June 16, 2006      | 
|Moodys Investors Service, Inc.   |  |                             | B3 |  |                            |  | Caa3 |             |  |  | September 26, 2006 | 






Off-Balance Sheet Arrangements





Bid, Performance Related and Other Bonds






|                                               |  |               |     |  |              |   |     | 
|---------------------------------------------- |  | ------------- | --- |  | ------------ | - | --- | 
|                                               |  | September 30, |     |  | December 31, |  
|                                               |  | 2006          |     |  | 2005         |  
|                                               |  |               |     |  |              |  
|Bid and performance related
    bonds(a)       |  | $             | 265 |  |              | $ | 222 | 
|Other
    bonds(b)                             |  |               | 31  |  |              |   | 44  | 
|                                               |  |               |     |  |              |  
|Total bid, performance related and other bonds |  | $             | 296 |  |              | $ | 266 | 
|                                               |  |               |     |  |              |  






|    |                                                                                                                                         
|--- | ----------------------------------------------------------------------------------------------------------------------------------------
|(a) | Net of restricted cash and cash equivalents amounts of $6 and
    $36 as of September 30, 2006 and December 31, 2005,
    respectively. 
|(b) | Net of restricted cash and cash equivalents amounts of $31 and
    $31 as of September 30, 2006 and December 31, 2005,
    respectively.





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Receivables Securitization and Certain Variable Interest
Transactions















Application of Critical Accounting Policies and Estimates










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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.                                                                







|                                                                                  |  |               |       |   |              |   |       |  
|--------------------------------------------------------------------------------- |  | ------------- | ----- | - | ------------ | - | ----- | -
|                                                                                  |  | September 30, |       |   | December 31, |  
|                                                                                  |  | 2006          |       |   | 2005         |  
|                                                                                  |  |               |       |   |              |  
|Gross accounts receivable                                                         |  | $             | 3,812 |   |              | $ | 3,303 |  
|Provision for doubtful accounts                                                   |  |               | (98   | ) |              |   | (137  | )
|                                                                                  |  |               |       |   |              |  
|Accounts receivable  net                                                         |  | $             | 3,714 |   |              | $ | 3,166 |  
|                                                                                  |  |               |       |   |              |  
|Accounts receivable provision as a percentage of gross accounts
    receivable    |  |               | 3     | % |              |   | 4     | %
|Gross long-term receivables                                                       |  | $             | 38    |   |              | $ | 57    |  
|Provision for doubtful accounts                                                   |  |               | (32   | ) |              |   | (33   | )
|                                                                                  |  |               |       |   |              |  
|Net long-term receivables                                                         |  | $             | 6     |   |              | $ | 24    |  
|                                                                                  |  |               |       |   |              |  
|Long-term receivable provision as a percentage of gross
    long-term receivables |  |               | 84    | % |              |   | 58    | %




Provisions for Inventory








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|                                                        |  |               |        |   |              |   |        |  
|------------------------------------------------------- |  | ------------- | ------ | - | ------------ | - | ------ | -
|                                                        |  | September 30, |        |   | December 31, |  
|                                                        |  | 2006          |        |   | 2005         |  
|                                                        |  |               |        |   |              |  
|Gross inventory                                         |  | $             | 3,620  |   |              | $ | 3,660  |  
|Inventory provisions                                    |  |               | (1,067 | ) |              |   | (1,039 | )
|                                                        |  |               |        |   |              |  
|Inventories 
    net(a)                                |  | $             | 2,553  |   |              | $ | 2,621  |  
|                                                        |  |               |        |   |              |  
|Inventory provisions as a percentage of gross inventory |  |               | 29     | % |              |   | 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          |   |     | (191 | )
|                                 | Warranties issued |   |     | 205  |  
|                                 | Revisions         |   |     | 5    |  
|                                 |                   |   |    
|Balance as of September 30, 2006 |                   | $ | 225 |     
|                                 |                   |   |    






Tax Asset Valuation




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| |   |                                                                                  
| | - | ---------------------------------------------------------------------------------
| |  | 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








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Special Charges







Pension and Post-retirement Benefits







Accounting Changes and Recent Accounting Pronouncements





Accounting Changes






| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Determining the Variability to be Considered in Applying FASB
    Interpretation No. 46(R)  As of July 1,
    2006, we adopted 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).
    The adoption of FSP
    FIN 46(R)-6 did
    not have a material impact on our results of operations and
    financial condition.                                                                                                                                                              
|
| |  | The Meaning of Other-than-Temporary Impairment and its
    Application to Certain Investments  As of
    January 1, 2006, we adopted EITF Issue No.
    03-1, The Meaning
    of Other-Than-Temporary Impairment and Its Application to
    Certain Investments
    (EITF 03-1),
    re-titled FSP
    FAS 115-1 and
    FAS 124-1,
    The Meaning of Other-Than-Temporary Impairment and Its
    Application to Certain Investments (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 SFAS No. 151, Inventory Costs
    (SFAS 151). The adoption of SFAS 151 did
    not have a material impact on our results of operations and
    financial condition.                                                                                                                                                                                                                                                                                                                                                                                                           

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| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Share-Based Payment  In December 2004, the
    FASB issued SFAS No. 123 (Revised 2004),
    Share-Based Payment (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 Nortel 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 (SFAS 148). SEC
    Staff Accounting Bulletin (SAB) 107,
    Share-Based Payment (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 disclosure
    related to SFAS 123R, see note 16.
|
| |  | Accounting Changes and Error Corrections  In
    May 2005, the FASB issued SFAS No. 154,
    Accounting Changes and Error Corrections
    (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, which we adopted
    as of January 1, 2006, is effective for accounting changes
    and corrections of errors made in fiscal years beginning after
    December 15, 2005. 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
    (EITF 04-13).
    The adoption of
    EITF 04-13 did not
    have a material impact on our results of operations and
    financial condition.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   




Recent Accounting Pronouncements






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06-2 06-2). 06-2 06-2 06-2 06-2


06-3 06-3). 06-3 06-3 06-3 06-3






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build-up





Outstanding Share Data







Market Risk







Equity Price Risk







Environmental Matters










86



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Legal Proceedings







Cautionary Notice Regarding Forward-Looking Information




87



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











89



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|        |                        
|------- | -----------------------
|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 and June 30, 2006 were
    not effective, included in Item 4 of our 2006 First
    Quarter Report and 2006 Second 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.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    









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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.                                                                                             







| |   |                                                                                                                                                                                                                                                                                 
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | 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






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| |   |                                                                                                                                                                        
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | establishing standards of conduct to be enforced through
    appropriate discipline;                                                                                   
| |  | infusing strong technical skills and experience into the finance
    organization;                                                                                     
| |  | requiring comprehensive, on-going training on increasingly
    complex accounting standards;                                                                           
| |  | strengthening and improving internal controls and processes;                                                                                                           
| |  | establishing a compliance program throughout the Company which
    is appropriately staffed and funded;                                                                
| |  | requiring management to provide clear and concise information,
    in a timely manner, to the Board 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.











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Changes in Internal Control Over Financial Reporting






| |   |                                                                                                                                                                                                                                                                                                                               
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | We implemented a global enterprise resource planning system that
    has automated and standardized many human resource activities,
    resulting in some changes to our internal control over financial
    reporting, such as compensation, time and vacation management,
    benefits selection and performance management.
| |  | We implemented a global process which provides guidance as to
    when consultation with our global technical accounting
    organization relating to non-revenue impacting transactions is
    required and establishes guidelines related to the documentation
    and approval of such consultations.                      
| |  | We enhanced our account reconciliation process by implementing a
    globally consistent process for timely reconciliation and
    resolution of adjusting items in balance sheet accounts.                                                                                                                                   

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PART II


OTHER INFORMATION







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







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

10-Q






Risks Relating to Our Business




| |                                                                                                                                                                                                                                                                                                                                                                                                                   
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | We continue to restructure and transform our business to
    respond to industry and market conditions and to address our
    biggest operational and strategic challenges. The assumptions
    underlying these efforts may prove to be inaccurate, or we may
    fail to achieve the expected benefits from these efforts, and we
    may have to restructure or transform our business again in the
    future.







| |   |                                                                                                                                                                                                     
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | the estimates and assumptions used in asset valuations, which
    are based on our forecasts of future business
    performance; and                                                                
| |  | accounting estimates related to the useful life and
    recoverability of the net book value of these assets, including
    inventory, goodwill, net deferred taxes and other intangible
    assets.



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

10-Q.


|            |    |             |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|----------- | -- | ----------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit No. |    | Description
|            |    |            
|            | 10 | .1*         |  | 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 | .2*         |  | 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 | .3*         |  | 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).                                                                                                                                                                                                                                                                                                                                                                     
|           
|            | 10 | .4          |  | Form of indemnity agreement entered into between Nortel Networks
    Corporation and members of the Board of Directors of Nortel
    Networks Corporation on or after September 6, 2006.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|           
|            | 10 | .5          |  | Summary statement of employment terms and conditions for Mike
    Zafirovski, President and Chief Executive Officer,
    November 15, 2005, as approved by the Joint Leadership
    Resources Committee of the Board of Directors of Nortel Networks
    Corporation and Nortel Networks Limited and the Independent
    members of the Board of Directors of Nortel Networks Corporation
    and Nortel Networks Limited on October 16, 2005, originally
    filed as Exhibit 10.71 to Nortel Networks
    Corporations Annual Report on Form 10-K for the year
    ended December 31, 2005, and form of instrument of award
    for restricted stock units and form of instrument of award for
    stock options granted on November 15, 2005 under the Nortel
    2005 Stock Incentive Plan to Mike Zafirovski, President and
    Chief Executive Officer.
|           
|            | 31 | .1          |  | Certification of the President 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 President 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.

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SIGNATURES




NORTEL NETWORKS LIMITED


(Registrant)


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



98