##### Table of Contents









UNITED STATES SECURITIES AND EXCHANGE COMMISSION


Washington, D.C. 20549


Form 10-Q


|   |  |                                                                                             
|-- |  | --------------------------------------------------------------------------------------------
|þ  |  | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
    SECURITIES EXCHANGE ACT OF 1934 
|   |  | For the Quarterly Period Ended June 30, 2005                                                
|OR
|  
|o  |  | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
    SECURITIES EXCHANGE ACT OF 1934
|   |  | For the Transition Period
    From           to                                             

Commission file number: 000-30758


Nortel Networks Limited


(Exact name of registrant as specified in its charter)


|                                                                   |  |                                         
|------------------------------------------------------------------ |  | ----------------------------------------
|Canada                                                             |  | 62-12-62580                             
|(State or other jurisdiction of
    incorporation or organization) |  | (I.R.S. Employer
    Identification No.)
|                                                                  
|8200 Dixie Road, Suite 100
     Brampton, Ontario, Canada          |  | L6T 5P6                                 
|(Address of principal executive offices)                           |  | (Zip Code)                              

Registrants telephone number including area code


(905) 863-0000




|      |  |     
|----- |  | ----
|Yes þ |  | No o

þ o




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










---










TABLE OF CONTENTS


PART I


FINANCIAL INFORMATION


|                              |  |                                                                                           |     |      |     | 
|----------------------------- |  | ----------------------------------------------------------------------------------------- | --- | ---- | --- | 
|                              |  |                                                                                           |     | Page |    
|                              |  |                                                                                           |     |      |    
|ITEM 1.                       |  | Consolidated Financial Statements
    (unaudited)                                         |     |      | 4   | 
|ITEM 2.                       |  | Managements Discussion and
    Analysis of Financial Condition and Results of Operations |     |      | 57  | 
|ITEM 3.                       |  | Quantitative and Qualitative
    Disclosures About Market Risk                            |     |      | 134 | 
|ITEM 4.                       |  | Controls and Procedures                                                                   |     |      | 135 | 
|PART II
    OTHER INFORMATION
|ITEM 1.                       |  | Legal Proceedings                                                                         |     |      | 142 | 
|ITEM 6.                       |  | Exhibits                                                                                  |     |      | 144 | 
|SIGNATURES                    |  |                                                                                           | 145 |     
|EX-10.1                      
|EX-10.2                      
|EX-10.4                      
|EX-10.5                      
|EX-10.6                      
|EX-10.9                      
|EX-31.1                      
|EX-31.2                      
|EX-32                        



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




| |                                                                                                                                                         
| | --------------------------------------------------------------------------------------------------------------------------------------------------------
| | NORTEL, NORTEL (Logo), NORTEL NETWORKS the GLOBEMARK, NT, and
    > THIS IS THE WAY > THIS IS NORTEL (designmark) are
    trademarks of Nortel Networks.











2



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##### Table of Contents






PART I


FINANCIAL INFORMATION


|        |  |                                                                                           |  |      |     | 
|------- |  | ----------------------------------------------------------------------------------------- |  | ---- | --- | 
|        |  |                                                                                           |  | Page |    
|        |  |                                                                                           |  |      |    
|ITEM 1. |  | Consolidated Financial Statements
    (unaudited)                                         |  |      | 4   | 
|ITEM 2. |  | Managements Discussion and
    Analysis of Financial Condition and Results of Operations |  |      | 57  | 
|ITEM 3. |  | Quantitative and Qualitative
    Disclosures About Market Risk                            |  |      | 134 | 
|ITEM 4. |  | Controls and Procedures                                                                   |  |      | 135 | 

3



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##### Table of Contents



NORTEL NETWORKS LIMITED


Consolidated Statements of Operations


|                                                                                                                                                     |                |                            |       |     |                |   |       |      |   |   |       |     |   |   |       |     |  
|---------------------------------------------------------------------------------------------------------------------------------------------------- | -------------- | -------------------------- | ----- | --- | -------------- | - | ----- | ---- | - | - | ----- | --- | - | - | ----- | --- | -
|                                                                                                                                                     |                | Three Months               |       |     | Six Months     |  
|                                                                                                                                                     |                | Ended June 30,             |       |     | Ended June 30, |  
|                                                                                                                                                     |                |                            |       |     |                |  
|                                                                                                                                                     |                | 2005                       |       |     | 2004           |   |       | 2005 |   |   | 2004  |    
|                                                                                                                                                     |                |                            |       |     |                |   |       |      |   |   |       |    
|                                                                                                                                                     |                | (Unaudited)                |      
|                                                                                                                                                     |                | (Millions of U.S. dollars) |      
|Revenues                                                                                                                                             |                | $                          | 2,855 |     |                | $ | 2,590 |      |   | $ | 5,391 |     |   | $ | 5,034 |    
|Cost of revenues                                                                                                                                     |                |                            | 1,650 |     |                |   | 1,538 |      |   |   | 3,127 |     |   |   | 2,910 |    
|                                                                                                                                                     |                |                            |       |     |                |   |       |      |   |   |       |    
|Gross profit                                                                                                                                         |                |                            | 1,205 |     |                |   | 1,052 |      |   |   | 2,264 |     |   |   | 2,124 |    
|Selling, general and administrative expense                                                                                                          |                |                            | 576   |     |                |   | 538   |      |   |   | 1,146 |     |   |   | 1,076 |    
|Research and development expense                                                                                                                     |                |                            | 474   |     |                |   | 489   |      |   |   | 945   |     |   |   | 955   |    
|Amortization of intangibles                                                                                                                          |                |                            | 2     |     |                |   | 2     |      |   |   | 4     |     |   |   | 5     |    
|Special charges                                                                                                                                      |                |                            | 90    |     |                |   | (1    | )    |   |   | 111   |     |   |   | 6     |    
|(Gain) loss on sale of businesses and
    assets(a)                                                                                                  |                |                            | 36    |     |                |   | (75   | )    |   |   | 37    |     |   |   | (75   | )  
|                                                                                                                                                     |                |                            |       |     |                |   |       |      |   |   |       |    
|Operating earnings (loss)                                                                                                                            |                |                            | 27    |     |                |   | 99    |      |   |   | 21    |     |   |   | 157   |    
|Other income (expense)  net                                                                                                                         |                |                            | 61    |     |                |   | (14   | )    |   |   | 108   |     |   |   | 74    |    
|Interest expense                                                                                                                                     |                |                            |       |     |                |   |       |      |   |   |       |     |   |   |       |    
|                                                                                                                                                     | Long-term debt |                            |       | (30 | )              |   |       | (22  | ) |   |       | (59 | ) |   |       | (46 | )
|                                                                                                                                                     | Other          |                            |       |    |                |   |       | (6   | ) |   |       | (2  | ) |   |       | (14 | )
|                                                                                                                                                     |                |                            |       |     |                |   |       |      |   |   |       |    
|Earnings (loss) from continuing operations before income taxes,
    minority interests and equity in net earnings (loss) of
    associated companies |                |                            | 58    |     |                |   | 57    |      |   |   | 68    |     |   |   | 171   |    
|Income tax benefit (expense)                                                                                                                         |                |                            | 7     |     |                |   | (7    | )    |   |   | (8    | )   |   |   | 2     |    
|                                                                                                                                                     |                |                            |       |     |                |   |       |      |   |   |       |    
|                                                                                                                                                     |                |                            | 65    |     |                |   | 50    |      |   |   | 60    |     |   |   | 173   |    
|Minority interests  net of tax                                                                                                                      |                |                            | (8    | )   |                |   | (1    | )    |   |   | (13   | )   |   |   | (7    | )  
|Equity in net earnings (loss) of associated
    companies  net of tax                                                                               |                |                            | 1     |     |                |   | (1    | )    |   |   | 2     |     |   |   | (2    | )  
|                                                                                                                                                     |                |                            |       |     |                |   |       |      |   |   |       |    
|Net earnings (loss) from continuing operations                                                                                                       |                |                            | 58    |     |                |   | 48    |      |   |   | 49    |     |   |   | 164   |    
|Net earnings (loss) from discontinued operations  net
    of tax                                                                                    |                |                            | (1    | )   |                |   | 6     |      |   |   | 1     |     |   |   | 7     |    
|                                                                                                                                                     |                |                            |       |     |                |   |       |      |   |   |       |    
|Net earnings (loss)                                                                                                                                  |                |                            | 57    |     |                |   | 54    |      |   |   | 50    |     |   |   | 171   |    
|Dividends on preferred shares                                                                                                                        |                |                            | 10    |     |                |   | 7     |      |   |   | 19    |     |   |   | 16    |    
|                                                                                                                                                     |                |                            |       |     |                |   |       |      |   |   |       |    
|Net earnings (loss) applicable to common shares                                                                                                      |                | $                          | 47    |     |                | $ | 47    |      |   | $ | 31    |     |   | $ | 155   |    
|                                                                                                                                                     |                |                            |       |     |                |   |       |      |   |   |       |    






|    |                        
|--- | -----------------------
|(a) | Includes related costs.



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NORTEL NETWORKS LIMITED


Consolidated Balance Sheets


|                                                                                                                                                                                    |                                         |                            |         |       |              |   |         |       | 
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | --------------------------------------- | -------------------------- | ------- | ----- | ------------ | - | ------- | ----- | 
|                                                                                                                                                                                    |                                         | June 30,                   |         |       | December 31, |  
|                                                                                                                                                                                    |                                         | 2005                       |         |       | 2004         |  
|                                                                                                                                                                                    |                                         |                            |         |       |              |  
|                                                                                                                                                                                    |                                         | (Unaudited)                |        
|                                                                                                                                                                                    |                                         | (Millions of U.S. dollars, |        
|                                                                                                                                                                                    |                                         | except for share amounts)  |        
|ASSETS                                                                                                                                                                             
|Current assets                                                                                                                                                                      |                                         |                            |         |       |              |   |         |      
|                                                                                                                                                                                    | Cash and cash equivalents               |                            | $       | 2,979 |              |   | $       | 3,607 | 
|                                                                                                                                                                                    | Restricted cash and cash equivalents    |                            |         | 73    |              |   |         | 80    | 
|                                                                                                                                                                                    | Accounts receivable  net               |                            |         | 3,017 |              |   |         | 2,800 | 
|                                                                                                                                                                                    | Inventories  net                       |                            |         | 1,315 |              |   |         | 1,414 | 
|                                                                                                                                                                                    | Deferred income taxes  net             |                            |         | 259   |              |   |         | 255   | 
|                                                                                                                                                                                    | Other current assets                    |                            |         | 519   |              |   |         | 355   | 
|                                                                                                                                                                                    |                                         |                            |         |       |              |  
|Total current assets                                                                                                                                                                |                                         |                            | 8,162   |       |              |   | 8,511   |      
|Investments                                                                                                                                                                         |                                         |                            | 154     |       |              |   | 159     |      
|Plant and equipment  net                                                                                                                                                           |                                         |                            | 1,577   |       |              |   | 1,646   |      
|Goodwill                                                                                                                                                                            |                                         |                            | 2,342   |       |              |   | 2,123   |      
|Intangible assets  net                                                                                                                                                             |                                         |                            | 154     |       |              |   | 78      |      
|Deferred income taxes  net                                                                                                                                                         |                                         |                            | 3,632   |       |              |   | 3,736   |      
|Other assets                                                                                                                                                                        |                                         |                            | 557     |       |              |   | 691     |      
|                                                                                                                                                                                    |                                         |                            |         |       |              |  
|Total assets                                                                                                                                                                        |                                         | $                          | 16,578  |       |              | $ | 16,944  |      
|                                                                                                                                                                                    |                                         |                            |         |       |              |  
|                                                                                                                                                                                   
|LIABILITIES AND SHAREHOLDERS EQUITY                                                                                                                                               
|Current liabilities                                                                                                                                                                 |                                         |                            |         |       |              |   |         |      
|                                                                                                                                                                                    | Trade and other accounts payable        |                            | $       | 1,142 |              |   | $       | 995   | 
|                                                                                                                                                                                    | Payroll and benefit-related liabilities |                            |         | 591   |              |   |         | 512   | 
|                                                                                                                                                                                    | Contractual liabilities                 |                            |         | 436   |              |   |         | 568   | 
|                                                                                                                                                                                    | Restructuring liabilities               |                            |         | 143   |              |   |         | 254   | 
|                                                                                                                                                                                    | Other accrued liabilities               |                            |         | 2,607 |              |   |         | 2,788 | 
|                                                                                                                                                                                    | Long-term debt due within one year      |                            |         | 1,449 |              |   |         | 15    | 
|                                                                                                                                                                                    |                                         |                            |         |       |              |  
|Total current liabilities                                                                                                                                                           |                                         |                            | 6,368   |       |              |   | 5,132   |      
|Long-term debt                                                                                                                                                                      |                                         |                            | 638     |       |              |   | 2,062   |      
|Deferred income taxes  net                                                                                                                                                         |                                         |                            | 150     |       |              |   | 143     |      
|Other liabilities                                                                                                                                                                   |                                         |                            | 3,328   |       |              |   | 3,189   |      
|                                                                                                                                                                                    |                                         |                            |         |       |              |  
|Total liabilities                                                                                                                                                                   |                                         |                            | 10,484  |       |              |   | 10,526  |      
|                                                                                                                                                                                    |                                         |                            |         |       |              |  
|Minority interests in subsidiary companies                                                                                                                                          |                                         |                            | 100     |       |              |   | 94      |      
|                                                                                                                                                                                   
|Guarantees, commitments and contingencies (notes 10, 11
    and 16)                                                                                                                 |                                         |                            |         |       |              |   |         |      
|                                                                                                                                                                                   
|SHAREHOLDERS EQUITY                                                                                                                                                                |                                         |                            |         |       |              |   |         |      
|Preferred shares, without par value  Authorized
    shares: unlimited; Issued and outstanding shares: 30,000,000 as
    of June 30, 2005 and 30,000,000 as of December 31, 2004    |                                         |                            | 536     |       |              |   | 536     |      
|Common shares, without par value  Authorized shares:
    unlimited; Issued and outstanding shares: 1,460,978,638 as of
    June 30, 2005 and 1,460,978,638 as of December 31, 2004 |                                         |                            | 1,211   |       |              |   | 1,211   |      
|Additional paid-in capital                                                                                                                                                          |                                         |                            | 22,144  |       |              |   | 22,107  |      
|Accumulated deficit                                                                                                                                                                 |                                         |                            | (16,961 | )     |              |   | (16,992 | )    
|Accumulated other comprehensive income (loss)                                                                                                                                       |                                         |                            | (936    | )     |              |   | (538    | )    
|                                                                                                                                                                                    |                                         |                            |         |       |              |  
|Total shareholders equity                                                                                                                                                          |                                         |                            | 5,994   |       |              |   | 6,324   |      
|                                                                                                                                                                                    |                                         |                            |         |       |              |  
|Total liabilities and shareholders equity                                                                                                                                          |                                         | $                          | 16,578  |       |              | $ | 16,944  |      
|                                                                                                                                                                                    |                                         |                            |         |       |              |  



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NORTEL NETWORKS LIMITED


Consolidated Statements of Cash Flows


|                                                                            |                                                                                                                                                                                                   |                                                                             |       |      |      |   |       |      |      |  
|--------------------------------------------------------------------------- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | --------------------------------------------------------------------------- | ----- | ---- | ---- | - | ----- | ---- | ---- | -
|                                                                            |                                                                                                                                                                                                   | Six Months Ended                                                            |      
|                                                                            |                                                                                                                                                                                                   | June 30,                                                                    |      
|                                                                            |                                                                                                                                                                                                   |                                                                             |      
|                                                                            |                                                                                                                                                                                                   | 2005                                                                        |       |      | 2004 |  
|                                                                            |                                                                                                                                                                                                   |                                                                             |       |      |      |  
|                                                                            |                                                                                                                                                                                                   | (Unaudited)                                                                 |      
|                                                                            |                                                                                                                                                                                                   | (Millions of                                                                |      
|                                                                            |                                                                                                                                                                                                   | U.S. dollars)                                                               |      
|Cash flows from (used in) operating activities                              |                                                                                                                                                                                                   |                                                                             |       |      |      |   |       |     
|                                                                            | Net earnings (loss) from continuing operations                                                                                                                                                    |                                                                             | $     | 49   |      |   | $     | 164  |     
|                                                                            | Adjustments to reconcile net earnings (loss) from continuing
    operations to net cash from (used in) operating activities, net
    of effects from acquisitions and divestitures of businesses: |                                                                             |       |      |      |   |       |      |     
|                                                                            |                                                                                                                                                                                                   | Amortization and depreciation                                               |       |      | 160  |   |       |      | 171  |  
|                                                                            |                                                                                                                                                                                                   | Non-cash portion of special charges and related asset write downs           |       |      | 2    |   |       |      |     |  
|                                                                            |                                                                                                                                                                                                   | Equity in net (earnings) loss of associated
    companies  net of tax      |       |      | (2   | ) |       |      | 2    |  
|                                                                            |                                                                                                                                                                                                   | Stock option compensation                                                   |       |      | 37   |   |       |      | 36   |  
|                                                                            |                                                                                                                                                                                                   | Deferred income taxes                                                       |       |      | 14   |   |       |      | (2   | )
|                                                                            |                                                                                                                                                                                                   | Other liabilities                                                           |       |      | 179  |   |       |      | 113  |  
|                                                                            |                                                                                                                                                                                                   | (Gain) loss on sale or write down of investments, businesses and
    assets |       |      | 21   |   |       |      | (109 | )
|                                                                            |                                                                                                                                                                                                   | Other  net                                                                 |       |      | (82  | ) |       |      | 99   |  
|                                                                            |                                                                                                                                                                                                   | Change in operating assets and liabilities                                  |       |      | (538 | ) |       |      | (694 | )
|                                                                            |                                                                                                                                                                                                   |                                                                             |       |      |      |  
|                                                                            | Net cash from (used in) operating activities of continuing
    operations                                                                                                                         |                                                                             |       | (160 | )    |   |       | (220 | )   
|                                                                            |                                                                                                                                                                                                   |                                                                             |       |      |      |  
|Cash flows from (used in) investing activities                              |                                                                                                                                                                                                   |                                                                             |       |      |      |   |       |     
|                                                                            | Expenditures for plant and equipment                                                                                                                                                              |                                                                             |       | (119 | )    |   |       | (102 | )   
|                                                                            | Proceeds on disposals of plant and equipment                                                                                                                                                      |                                                                             |       | 10   |      |   |       | 10   |     
|                                                                            | Restricted cash and cash equivalents                                                                                                                                                              |                                                                             |       | 9    |      |   |       | 10   |     
|                                                                            | Acquisitions of investments and businesses  net of
    cash acquired                                                                                                                             |                                                                             |       | (448 | )    |   |       | (6   | )   
|                                                                            | Proceeds on sale of investments and businesses                                                                                                                                                    |                                                                             |       | 167  |      |   |       | 132  |     
|                                                                            |                                                                                                                                                                                                   |                                                                             |       |      |      |  
|                                                                            | Net cash from (used in) investing activities of continuing
    operations                                                                                                                         |                                                                             |       | (381 | )    |   |       | 44   |     
|                                                                            |                                                                                                                                                                                                   |                                                                             |       |      |      |  
|Cash flows from (used in) financing activities                              |                                                                                                                                                                                                   |                                                                             |       |      |      |   |       |     
|                                                                            | Dividends paid                                                                                                                                                                                    |                                                                             |       | (24  | )    |   |       | (16  | )   
|                                                                            | Increase in notes payable                                                                                                                                                                         |                                                                             |       | 38   |      |   |       | 41   |     
|                                                                            | Decrease in notes payable                                                                                                                                                                         |                                                                             |       | (46  | )    |   |       | (26  | )   
|                                                                            | Repayments of long-term debt                                                                                                                                                                      |                                                                             |       |     |      |   |       | (98  | )   
|                                                                            | Repayments of capital leases payable                                                                                                                                                              |                                                                             |       | (4   | )    |   |       | (8   | )   
|                                                                            |                                                                                                                                                                                                   |                                                                             |       |      |      |  
|                                                                            | Net cash from (used in) financing activities of continuing
    operations                                                                                                                         |                                                                             |       | (36  | )    |   |       | (107 | )   
|                                                                            |                                                                                                                                                                                                   |                                                                             |       |      |      |  
|Effect of foreign exchange rate changes on cash and cash
    equivalents    |                                                                                                                                                                                                   |                                                                             | (85   | )    |      |   | (9    | )   
|                                                                            |                                                                                                                                                                                                   |                                                                             |       |      |      |  
|Net cash from (used in) continuing operations                               |                                                                                                                                                                                                   |                                                                             | (662  | )    |      |   | (292  | )   
|Net cash from (used in) operating activities of discontinued
    operations |                                                                                                                                                                                                   |                                                                             | 34    |      |      |   | 11    |     
|                                                                            |                                                                                                                                                                                                   |                                                                             |       |      |      |  
|Net increase (decrease) in cash and cash equivalents                        |                                                                                                                                                                                                   |                                                                             | (628  | )    |      |   | (281  | )   
|Cash and cash equivalents at beginning of period                            |                                                                                                                                                                                                   |                                                                             | 3,607 |      |      |   | 3,928 |     
|                                                                            |                                                                                                                                                                                                   |                                                                             |       |      |      |  
|Cash and cash equivalents at end of period                                  |                                                                                                                                                                                                   | $                                                                           | 2,979 |      |      | $ | 3,647 |     
|                                                                            |                                                                                                                                                                                                   |                                                                             |       |      |      |  





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NORTEL NETWORKS LIMITED


Notes to Consolidated Financial Statements (unaudited)


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




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



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









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





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



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NORTEL NETWORKS LIMITED


Notes to Consolidated Financial
Statements  (Continued)












8



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NORTEL NETWORKS LIMITED


Notes to Consolidated Financial
Statements  (Continued)






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



|    |                            
|--- | ---------------------------
|(a) | Implicit Variable Interests





|    |                                                                                                     
|--- | ----------------------------------------------------------------------------------------------------
|(b) | Accounting for Certain Financial Instruments with
    Characteristics of both Liabilities and Equity







|   |                                         
|-- | ----------------------------------------
|3. | Consolidated financial statement details





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



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NORTEL NETWORKS LIMITED


Notes to Consolidated Financial
Statements  (Continued)






| |                              
| | -----------------------------
| | Other income (expense)  net:

|                                                 |  |              |    |  |            |   |     |      |  |   |      |  |  |   |    | 
|------------------------------------------------ |  | ------------ | -- |  | ---------- | - | --- | ---- |  | - | ---- |  |  | - | -- | 
|                                                 |  | Three Months |    |  | Six Months |  
|                                                 |  | Ended        |    |  | Ended      |  
|                                                 |  | June 30,     |    |  | June 30,   |  
|                                                 |  |              |    |  |            |  
|                                                 |  | 2005         |    |  | 2004       |   |     | 2005 |  |   | 2004 | 
|                                                 |  |              |    |  |            |   |     |      |  |   |      | 
|Interest income                                  |  | $            | 14 |  |            | $ | 16  |      |  | $ | 28   |  |  | $ | 31 | 
|Gain (loss) on sale or write down of investments |  |              | 21 |  |            |   | (1  | )    |  |   | 16   |  |  |   | 32 | 
|Currency exchange gains (losses)                 |  |              | 9  |  |            |   | (1  | )    |  |   | 35   |  |  |   |   | 
|Other  net                                      |  |              | 17 |  |            |   | (28 | )    |  |   | 29   |  |  |   | 11 | 
|                                                 |  |              |    |  |            |   |     |      |  |   |      | 
|Other income (expense)  net                     |  | $            | 61 |  |            | $ | (14 | )    |  | $ | 108  |  |  | $ | 74 | 
|                                                 |  |              |    |  |            |   |     |      |  |   |      | 





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



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

|                                      |  |          |       |   |              |   |       |  
|------------------------------------- |  | -------- | ----- | - | ------------ | - | ----- | -
|                                      |  | June 30, |       |   | December 31, |  
|                                      |  | 2005     |       |   | 2004         |  
|                                      |  |          |       |   |              |  
|Trade receivables                     |  | $        | 2,195 |   |              | $ | 2,259 |  
|Notes receivable                      |  |          | 140   |   |              |   | 42    |  
|Contracts in process                  |  |          | 785   |   |              |   | 608   |  
|                                      |  |          |       |   |              |  
|                                      |  |          | 3,120 |   |              |   | 2,909 |  
|Less: provision for doubtful accounts |  |          | (103  | ) |              |   | (109  | )
|                                      |  |          |       |   |              |  
|Accounts receivable  net             |  | $        | 3,017 |   |              | $ | 2,800 |  
|                                      |  |          |       |   |              |  

10



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NORTEL NETWORKS LIMITED


Notes to Consolidated Financial
Statements  (Continued)




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

|                                 |  |          |        |   |              |   |        |  
|-------------------------------- |  | -------- | ------ | - | ------------ | - | ------ | -
|                                 |  | June 30, |        |   | December 31, |  
|                                 |  | 2005     |        |   | 2004         |  
|                                 |  |          |        |   |              |  
|Raw materials                    |  | $        | 843    |   |              | $ | 935    |  
|Work in process                  |  |          | 69     |   |              |   | 125    |  
|Finished goods                   |  |          | 1,821  |   |              |   | 1,863  |  
|                                 |  |          |        |   |              |  
|                                 |  |          | 2,733  |   |              |   | 2,923  |  
|Less: provision for inventory    |  |          | (1,041 | ) |              |   | (1,141 | )
|                                 |  |          |        |   |              |  
|Inventories  net                |  |          | 1,692  |   |              |   | 1,782  |  
|Less: long-term
    inventory(a) |  |          | (377   | ) |              |   | (368   | )
|                                 |  |          |        |   |              |  
|Current inventories  net        |  | $        | 1,315  |   |              | $ | 1,414  |  
|                                 |  |          |        |   |              |  






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





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

|                                                 |  |          |     |  |              |   |     | 
|------------------------------------------------ |  | -------- | --- |  | ------------ | - | --- | 
|                                                 |  | June 30, |     |  | December 31, |  
|                                                 |  | 2005     |     |  | 2004         |  
|                                                 |  |          |     |  |              |  
|Prepaid expenses                                 |  | $        | 218 |  |              | $ | 175 | 
|Income taxes recoverable                         |  |          | 37  |  |              |   | 38  | 
|Current assets of discontinued
    operations(a) |  |          | 13  |  |              |   | 14  | 
|Other                                            |  |          | 251 |  |              |   | 128 | 
|                                                 |  |          |     |  |              |  
|Other current assets                             |  | $        | 519 |  |              | $ | 355 | 
|                                                 |  |          |     |  |              |  






|    |                                                                                                                                                                         
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(a) | Includes accounts receivable of $1 and $3 and inventories of $56
    and $58 as of June 30, 2005 and December 31, 2004,
    respectively, which were fully provided for.

11



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NORTEL NETWORKS LIMITED


Notes to Consolidated Financial
Statements  (Continued)




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

|                                 |                                                |          |        |        |              |   |        |        |  
|-------------------------------- | ---------------------------------------------- | -------- | ------ | ------ | ------------ | - | ------ | ------ | -
|                                 |                                                | June 30, |        |        | December 31, |  
|                                 |                                                | 2005     |        |        | 2004         |  
|                                 |                                                |          |        |        |              |  
|Cost:                            |                                                |          |        |        |              |   |        |       
|                                 | Land                                           |          | $      | 54     |              |   | $      | 63     |  
|                                 | Buildings                                      |          |        | 1,300  |              |   |        | 1,514  |  
|                                 | Machinery and equipment                        |          |        | 2,308  |              |   |        | 2,439  |  
|                                 | Capital lease assets  machinery and equipment |          |        | 205    |              |   |        | 42     |  
|                                 |                                                |          |        |        |              |  
|                                 |                                                |          | 3,867  |        |              |   | 4,058  |       
|                                 |                                                |          |        |        |              |  
|Less accumulated depreciation:   |                                                |          |        |        |              |   |        |       
|                                 | Buildings                                      |          |        | (433   | )            |   |        | (502   | )
|                                 | Machinery and equipment                        |          |        | (1,788 | )            |   |        | (1,878 | )
|                                 | Capital lease assets  machinery and equipment |          |        | (69    | )            |   |        | (32    | )
|                                 |                                                |          |        |        |              |  
|                                 |                                                |          | (2,290 | )      |              |   | (2,412 | )     
|                                 |                                                |          |        |        |              |  
|Plant and equipment 
    net(a) |                                                | $        | 1,577  |        |              | $ | 1,646  |       
|                                 |                                                |          |        |        |              |  






|    |                                                                                                                                                                                                                                                                                                                                                                                                                        
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(a) | Includes assets held for sale with a carrying value of $6 and
    $29 as of June 30, 2005 and December 31, 2004,
    respectively, related to owned facilities that were being
    actively marketed. These assets were written down to their
    estimated fair values less costs to sell. The write downs were
    included in special charges. Nortel expects to dispose of all of
    these facilities during 2005.



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



|                                      |                   |          |     |     |          |   |         |          |   |   |            |    |   |       |       |     |   |   |       |     |  
|------------------------------------- | ----------------- | -------- | --- | --- | -------- | - | ------- | -------- | - | - | ---------- | -- | - | ----- | ----- | --- | - | - | ----- | --- | -
|                                      |                   | Carrier  |     |     |          |   | GSM and |          |   |   |            |   
|                                      |                   | Packet   |     |     | CDMA     |   |         | UMTS     |   |   | Enterprise |    |   |      
|                                      |                   | Networks |     |     | Networks |   |         | Networks |   |   | Networks   |    |   | Total |      
|                                      |                   |          |     |     |          |   |         |          |   |   |            |    |   |       |      
|Balance  net as of December 31, 2004 |                   | $        | 528 |     |          | $ | 28      |          |   | $ | 9          |    |   | $     | 1,558 |     |   | $ | 2,123 |    
|Changes:                              |                   |          |     |     |          |   |         |          |   |   |            |    |   |       |       |     |   |   |       |    
|                                      | Addition (note 8) |          |     |    |          |   |         |         |   |   |            |   |   |       |       | 271 |   |   |       | 271 |  
|                                      | Disposal          |          |     | (38 | )        |   |         |         |   |   |            |   |   |       |       |    |   |   |       | (38 | )
|                                      | Foreign exchange  |          |     | (7  | )        |   |         | (2       | ) |   |            | (1 | ) |       |       | (4  | ) |   |       | (14 | )
|                                      |                   |          |     |     |          |   |         |          |   |   |            |    |   |       |      
|Balance  net as of June 30, 2005     |                   | $        | 483 |     |          | $ | 26      |          |   | $ | 8          |    |   | $     | 1,825 |     |   | $ | 2,342 |    
|                                      |                   |          |     |     |          |   |         |          |   |   |            |    |   |       |      





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

|                               |  |          |     |  |              |   |    | 
|------------------------------ |  | -------- | --- |  | ------------ | - | -- | 
|                               |  | June 30, |     |  | December 31, |  
|                               |  | 2005     |     |  | 2004         |  
|                               |  |          |     |  |              |  
|Other intangible
    assets(a) |  | $        | 115 |  |              | $ | 38 | 
|Pension intangible assets      |  |          | 39  |  |              |   | 40 | 
|                               |  |          |     |  |              |  
|Intangible assets  net        |  | $        | 154 |  |              | $ | 78 | 
|                               |  |          |     |  |              |  






|    |                                                                                                        
|--- | -------------------------------------------------------------------------------------------------------
|(a) | Includes intangible assets related to an acquisition during the
    second quarter of 2005, see note 8.

12



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NORTEL NETWORKS LIMITED


Notes to Consolidated Financial
Statements  (Continued)






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

|                                                                           |  |          |       |  |              |   |       | 
|-------------------------------------------------------------------------- |  | -------- | ----- |  | ------------ | - | ----- | 
|                                                                           |  | June 30, |       |  | December 31, |  
|                                                                           |  | 2005     |       |  | 2004         |  
|                                                                           |  |          |       |  |              |  
|Outsourcing and selling, general and administrative related
    provisions |  | $        | 254   |  |              | $ | 321   | 
|Customer deposits                                                          |  |          | 28    |  |              |   | 28    | 
|Product related provisions                                                 |  |          | 51    |  |              |   | 57    | 
|Warranty provisions (note 10)                                              |  |          | 232   |  |              |   | 271   | 
|Deferred revenue                                                           |  |          | 1,110 |  |              |   | 1,210 | 
|Miscellaneous taxes                                                        |  |          | 68    |  |              |   | 52    | 
|Income taxes payable                                                       |  |          | 71    |  |              |   | 110   | 
|Current liabilities of discontinued operations                             |  |          | 1     |  |              |   |      | 
|Interest payable                                                           |  |          | 42    |  |              |   | 40    | 
|Advance billings in excess of revenues recognized to date on
    contracts |  |          | 621   |  |              |   | 581   | 
|Other                                                                      |  |          | 129   |  |              |   | 118   | 
|                                                                           |  |          |       |  |              |  
|Other accrued liabilities                                                  |  | $        | 2,607 |  |              | $ | 2,788 | 
|                                                                           |  |          |       |  |              |  



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

|                                                                 |  |          |       |  |              |   |       | 
|---------------------------------------------------------------- |  | -------- | ----- |  | ------------ | - | ----- | 
|                                                                 |  | June 30, |       |  | December 31, |  
|                                                                 |  | 2005     |       |  | 2004         |  
|                                                                 |  |          |       |  |              |  
|Pension, post-employment and post-retirement benefit liabilities |  | $        | 2,166 |  |              | $ | 2,208 | 
|Restructuring liabilities (note 5)                               |  |          | 226   |  |              |   | 209   | 
|Deferred revenue                                                 |  |          | 492   |  |              |   | 509   | 
|Other long-term provisions                                       |  |          | 444   |  |              |   | 263   | 
|                                                                 |  |          |       |  |              |  
|Other liabilities                                                |  | $        | 3,328 |  |              | $ | 3,189 | 
|                                                                 |  |          |       |  |              |  



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



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

|                                                      |  |                |      |   |      |   |      |  
|----------------------------------------------------- |  | -------------- | ---- | - | ---- | - | ---- | -
|                                                      |  | Six Months     |     
|                                                      |  | Ended June 30, |     
|                                                      |  |                |     
|                                                      |  | 2005           |      |   | 2004 |  
|                                                      |  |                |      |   |      |  
|Accounts receivable  net                             |  |                | (223 | ) |      |   | 60   |  
|Inventories  net                                     |  |                | 40   |   |      |   | (90  | )
|Income taxes                                          |  |                | (33  | ) |      |   | (36  | )
|Restructuring liabilities                             |  |                | (92  | ) |      |   | (128 | )
|Accounts payable, payroll and contractual liabilities |  |                | (268 | ) |      |   | (417 | )
|Other operating assets and liabilities                |  |                | 38   |   |      |   | (83  | )
|                                                      |  |                |      |   |      |  
|Change in operating assets and liabilities            |  | $              | (538 | ) |      | $ | (694 | )
|                                                      |  |                |      |   |      |  

13



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NORTEL NETWORKS LIMITED


Notes to Consolidated Financial
Statements  (Continued)




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

|                                  |  |            |    |  |      |   |    | 
|--------------------------------- |  | ---------- | -- |  | ---- | - | -- | 
|                                  |  | Six Months |   
|                                  |  | Ended      |   
|                                  |  | June 30,   |   
|                                  |  |            |   
|                                  |  | 2005       |    |  | 2004 |  
|                                  |  |            |    |  |      |  
|Cash interest paid                |  | $          | 58 |  |      | $ | 53 | 
|Cash taxes paid (recovered)  net |  | $          | 29 |  |      | $ | 21 | 



|   |                    
|-- | -------------------
|4. | Segment information



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







| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Carrier Packet Networks provides: (i) circuit and packet
    voice solutions, (ii) data networking and security
    solutions and (iii) optical long-haul and metropolitan
    optical network solutions. Together, these solutions provide or
    transport data, voice and multimedia communications solutions to
    Nortels service provider customers that operate wireline
    networks. These service provider customers include local and
    long distance telephone companies, wireless service providers
    (for the wireline portion of their networks), cable operators
    and other communication service providers.
|
| |  | CDMA Networks provides communication network solutions to
    wireless service provider customers based on CDMA and Time
    Division Multiple Access (TDMA) technologies to
    enable those customers to offer their customers, the subscribers
    for wireless communication services, the ability to be mobile
    while they send and receive voice and data communications using
    wireless devices, such as cellular telephones, personal digital
    assistants and other computing and communications devices.                                                                                                         
|
| |  | GSM and UMTS Networks also provides communication network
    solutions to Nortels wireless service provider customers;
    however, these solutions are based on GSM and UMTS technologies.                                                                                                                                                                                                                                                                                                                                                                                                                                        
|
| |  | Enterprise Networks provides: (i) circuit and packet voice
    solutions and (ii) data networking and security solutions
    which provide data, voice and multimedia communications
    solutions to Nortels enterprise customers. Nortels
    Enterprise Networks customers consist of a broad range of
    enterprise                                                                                                                                                                                                                                                                                                           

14



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NORTEL NETWORKS LIMITED


Notes to Consolidated Financial
Statements  (Continued)




| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |   | customers around the world, including large businesses and their
    branch offices, small businesses and home offices, as well as
    government agencies, educational and other institutions and
    utility organizations.                                                                                                                                                                                                                                                                                                        
|
| |  | Other represents miscellaneous business activities
    and corporate functions. None of these activities meet the
    quantitative criteria to be disclosed separately as reportable
    segments. Costs associated with shared services and other
    corporate costs are allocated to the segments based on usage
    determined generally by headcount. Costs not allocated to the
    segments are primarily related to Nortels corporate
    compliance and other non-operational activities and are included
    in Other.



15



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NORTEL NETWORKS LIMITED


Notes to Consolidated Financial
Statements  (Continued)




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



|                                               |  |              |       |   |            |   |       |      |  |   |       |   |  |   |       |  
|---------------------------------------------- |  | ------------ | ----- | - | ---------- | - | ----- | ---- |  | - | ----- | - |  | - | ----- | -
|                                               |  | Three Months |       |   | Six Months |  
|                                               |  | Ended        |       |   | Ended      |  
|                                               |  | June 30,     |       |   | June 30,   |  
|                                               |  |              |       |   |            |  
|                                               |  | 2005         |       |   | 2004       |   |       | 2005 |  |   | 2004  |  
|                                               |  |              |       |   |            |   |       |      |  |   |       |  
|Revenues                                       |  |              |       |   |            |   |       |      |  |   |       |   |  |   |       |  
|Carrier Packet Networks                        |  | $            | 743   |   |            | $ | 724   |      |  | $ | 1,407 |   |  | $ | 1,407 |  
|CDMA Networks                                  |  |              | 662   |   |            |   | 567   |      |  |   | 1,197 |   |  |   | 1,136 |  
|GSM and UMTS Networks                          |  |              | 719   |   |            |   | 711   |      |  |   | 1,507 |   |  |   | 1,367 |  
|Enterprise Networks                            |  |              | 730   |   |            |   | 578   |      |  |   | 1,277 |   |  |   | 1,112 |  
|                                               |  |              |       |   |            |   |       |      |  |   |       |  
|Total reportable segments                      |  |              | 2,854 |   |            |   | 2,580 |      |  |   | 5,388 |   |  |   | 5,022 |  
|Other(a)                                       |  |              | 1     |   |            |   | 10    |      |  |   | 3     |   |  |   | 12    |  
|                                               |  |              |       |   |            |   |       |      |  |   |       |  
|Total Revenues                                 |  | $            | 2,855 |   |            | $ | 2,590 |      |  | $ | 5,391 |   |  | $ | 5,034 |  
|                                               |  |              |       |   |            |   |       |      |  |   |       |  
|Management EBT                                 |  |              |       |   |            |   |       |      |  |   |       |   |  |   |       |  
|Carrier Packet Networks                        |  | $            | 26    |   |            | $ | (46   | )    |  | $ | (5    | ) |  | $ | (105  | )
|CDMA Networks                                  |  |              | 203   |   |            |   | 173   |      |  |   | 371   |   |  |   | 386   |  
|GSM and UMTS Networks                          |  |              | 27    |   |            |   | (9    | )    |  |   | 80    |   |  |   | (5    | )
|Enterprise Networks                            |  |              | 111   |   |            |   | 31    |      |  |   | 143   |   |  |   | 56    |  
|                                               |  |              |       |   |            |   |       |      |  |   |       |  
|Total reportable segments                      |  |              | 367   |   |            |   | 149   |      |  |   | 589   |   |  |   | 332   |  
|Other(a)                                       |  |              | (188  | ) |            |   | (168  | )    |  |   | (380  | ) |  |   | (234  | )
|                                               |  |              |       |   |            |   |       |      |  |   |       |  
|Total Management EBT                           |  |              | 179   |   |            |   | (19   | )    |  |   | 209   |   |  |   | 98    |  
|                                               |  |              |       |   |            |   |       |      |  |   |       |  
|Amortization of intangibles                    |  |              | (2    | ) |            |   | (2    | )    |  |   | (4    | ) |  |   | (5    | )
|Special charges                                |  |              | (90   | ) |            |   | 1     |      |  |   | (111  | ) |  |   | (6    | )
|Gain (loss) on sale of businesses and assets   |  |              | (36   | ) |            |   | 75    |      |  |   | (37   | ) |  |   | 75    |  
|Income tax benefit (expense)                   |  |              | 7     |   |            |   | (7    | )    |  |   | (8    | ) |  |   | 2     |  
|                                               |  |              |       |   |            |   |       |      |  |   |       |  
|Net earnings (loss) from continuing operations |  | $            | 58    |   |            | $ | 48    |      |  | $ | 49    |   |  | $ | 164   |  
|                                               |  |              |       |   |            |   |       |      |  |   |       |  






|    |                                                                                                                                           
|--- | ------------------------------------------------------------------------------------------------------------------------------------------
|(a) | Other represents miscellaneous business activities
    and corporate functions and includes interest attributable to
    long-term debt.



|   |                
|-- | ---------------
|5. | Special charges







16



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NORTEL NETWORKS LIMITED


Notes to Consolidated Financial
Statements  (Continued)






|                                                   |                                                       |                                           |     |            |           |   |           |       |     |                 |       |              |       |               |            |       |               |   |    |   |    |   |     |   |    |  
|-------------------------------------------------- | ----------------------------------------------------- | ----------------------------------------- | --- | ---------- | --------- | - | --------- | ----- | --- | --------------- | ----- | ------------ | ----- | ------------- | ---------- | ----- | ------------- | - | -- | - | -- | - | --- | - | -- | -
|                                                   |                                                       |                                           |     |            |           |   |           |       |     | Special Charges |      
|                                                   |                                                       |                                           |     | Contract   |           |   | Plant and |       |     |                 |       |              |      
|                                                   |                                                       |                                           |     | Settlement |           |   | Equipment |       |     |                 |       | Three Months |       |               | Six Months |      
|                                                   |                                                       | Workforce                                 |     |            | and Lease |   |           | Write |     |                 |       |              | Ended |               |            | Ended |              
|                                                   |                                                       | Reduction                                 |     |            | Costs     |   |           | Downs |     |                 | Total |              |       | June 30, 2005 |            |       | June 30, 2005 |  
|                                                   |                                                       |                                           |     |            |           |   |           |       |     |                 |       |              |       |               |            |       |               |  
|2001 Restructuring Plan                            |                                                       |                                           |     |            |           |   |           |       |     |                 |       |              |       |               |            |       |               |   |    |   |    |   |     |  
|Provision balance as of December 31, 2004
    (a)  |                                                       | $                                         | 15  |            |           | $ | 326       |       |     | $               |      |              |       | $             | 341        |       |               |   |    |   |    |   |     |  
|                                                   | Revisions to prior accruals:                          |                                           |     |            |           |   |           |       |     |                 |       |              |       |               |            |       |               |   |    |   |    |   |     |   |   
|                                                   |                                                       | For the three months ended March 31, 2005 |     |            | (3        | ) |           |       |    |                 |       |              | (1    | )             |            |       | (4            | ) |    | $ |   |   |     | $ | (4 | )
|                                                   |                                                       | For the three months ended June 30, 2005  |     |            | (2        | ) |           |       | 4   |                 |       |              | (2    | )             |            |       |              |   |    |   |   |   |     |   |   |  
|                                                   | Cumulative provision (drawdowns) adjustments in 2005: |                                           |     |            |           |   |           |       |     |                 |       |              |       |               |            |       |               |   |    |   |    |   |     |   |   
|                                                   |                                                       | Cash drawdowns                            |     |            | (4        | ) |           |       | (65 | )               |       |              |      |               |            |       | (69           | ) |    |   |    |   |     |   |    |  
|                                                   |                                                       | Non-cash drawdowns                        |     |            |          |   |           |       |    |                 |       |              | 3     |               |            |       | 3             |   |    |   |    |   |     |   |    |  
|                                                   |                                                       | Foreign exchange and other adjustments    |     |            | (1        | ) |           |       | (8  | )               |       |              |      |               |            |       | (9            | ) |    |   |    |   |     |   |    |  
|                                                   |                                                       |                                           |     |            |           |   |           |       |     |                 |       |              |       |               |            |       |               |  
|Provision balance as of June 30, 2005              |                                                       | $                                         | 5   |            |           | $ | 257       |       |     | $               |      |              |       | $             | 262        |       |               |   |    |   |    |   |     |  
|                                                   |                                                       |                                           |     |            |           |   |           |       |     |                 |       |              |       |               |            |       |               |  
|2004 Restructuring Plan                            |                                                       |                                           |     |            |           |   |           |       |     |                 |       |              |       |               |            |       |               |   |    |   |    |   |     |  
|Provision balance as of December 31, 2004
    (a)  |                                                       | $                                         | 122 |            |           | $ |          |       |     | $               |      |              |       | $             | 122        |       |               |   |    |   |    |   |     |  
|                                                   | Other special charges:                                |                                           |     |            |           |   |           |       |     |                 |       |              |       |               |            |       |               |   |    |   |    |   |     |   |   
|                                                   |                                                       | For the three months ended March 31, 2005 |     |            | 18        |   |           |       | 8   |                 |       |              | 1     |               |            |       | 27            |   |    |   |   |   |     |   | 27 |  
|                                                   |                                                       | For the three months ended June 30, 2005  |     |            | 32        |   |           |       | 46  |                 |       |              | 4     |               |            |       | 82            |   |    |   | 82 |   |     |   | 82 |  
|                                                   | Revisions to prior accruals:                          |                                           |     |            |           |   |           |       |     |                 |       |              |       |               |            |       |               |   |    |   |    |   |     |   |   
|                                                   |                                                       | For the three months ended March 31, 2005 |     |            | (2        | ) |           |       |    |                 |       |              |      |               |            |       | (2            | ) |    |   |   |   |     |   | (2 | )
|                                                   |                                                       | For the three months ended June 30, 2005  |     |            | 7         |   |           |       |    |                 |       |              | 1     |               |            |       | 8             |   |    |   | 8  |   |     |   | 8  |  
|                                                   | Cumulative provision (drawdowns) adjustments in 2005: |                                           |     |            |           |   |           |       |     |                 |       |              |       |               |            |       |               |   |    |   |    |   |     |   |   
|                                                   |                                                       | Cash drawdowns                            |     |            | (119      | ) |           |       | (3  | )               |       |              |      |               |            |       | (122          | ) |    |   |    |   |     |   |    |  
|                                                   |                                                       | Non-cash drawdowns                        |     |            |          |   |           |       |    |                 |       |              | (5    | )             |            |       | (5            | ) |    |   |    |   |     |   |    |  
|                                                   |                                                       | Foreign exchange and other adjustments    |     |            | (1        | ) |           |       |    |                 |       |              | (2    | )             |            |       | (3            | ) |    |   |    |   |     |   |    |  
|                                                   |                                                       |                                           |     |            |           |   |           |       |     |                 |       |              |       |               |            |       |               |  
|Provision balance as of June 30, 2005              |                                                       | $                                         | 57  |            |           | $ | 51        |       |     | $               | (1    | )            |       | $             | 107        |       |               |   |    |   |    |   |     |  
|                                                   |                                                       |                                           |     |            |           |   |           |       |     |                 |       |              |       |               |            |       |               |  
|Total provision balance as of June 30,
    2005(a) |                                                       | $                                         | 62  |            |           | $ | 308       |       |     | $               | (1    | )            |       | $             | 369        |       |               |   |    |   |    |   |     |  
|                                                   |                                                       |                                           |     |            |           |   |           |       |     |                 |       |              |       |               |            |       |               |  
|Total special charges                              |                                                       |                                           |     |            |           |   |           |       |     |                 |       |              |       |               |            |       |               | $ | 90 |   |    | $ | 111 |  
|                                                   |                                                       |                                           |     |            |           |   |           |       |     |                 |       |              |       |               |            |       |               |  






|    |  |                                                                                                                                                                                              
|--- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(a) |  | As of June 30, 2005 and December 31, 2004, the
    short-term provision balance was $143 and $254, respectively,
    and the long-term provision balance was $226 and $209,
    respectively.

17



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NORTEL NETWORKS LIMITED


Notes to Consolidated Financial
Statements  (Continued)




|                                                       |                |                         |  |    |             |  |  |       |  |  |  |     | 
|------------------------------------------------------ | -------------- | ----------------------- |  | -- | ----------- |  |  | ----- |  |  |  | --- | 
|                                                       |                | Employees (Approximate) | 
|                                                       |                |                         | 
|                                                       |                | Direct(a)               |  |    | Indirect(b) |  |  | Total | 
|                                                       |                |                         |  |    |             |  |  |       | 
|RFT employee notifications for the three months ended: |                |                         |  |    |             |  |  |       |  |  |  |    
|                                                       | March 31, 2005 |                         |  | 20 |             |  |  | 220   |  |  |  | 240 | 
|                                                       | June 30, 2005  |                         |  | 15 |             |  |  | 445   |  |  |  | 460 | 






|    |  |                                                                                                                                                                       
|--- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(a) |  | Direct employees included employees performing manufacturing,
    assembly, testing and inspection activities associated with the
    production of Nortels products.
|(b) |  | Indirect employees included employees performing manufacturing,
    management, sales, marketing, research and development and
    administrative activities.         



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



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









| |                                         
| | ----------------------------------------
| | Three and six months ended June 30, 2004







18



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NORTEL NETWORKS LIMITED


Notes to Consolidated Financial
Statements  (Continued)




|                   |  |                   |    |                  |               |             |                |  |             |               |    |   |                 |   |   |  |  |   |    | 
|------------------ |  | ----------------- | -- | ---------------- | ------------- | ----------- | -------------- |  | ----------- | ------------- | -- | - | --------------- | - | - |  |  | - | -- | 
|                   |  |                   |    |                  |               | Payments    |                |  | Adjustments |               |    |  
|                   |  |                   |    | Costs During the |               | Made During |                |  | During the  |               |    |  
|                   |  | Accrued Balance   |    |                  | Six Months    |             | the Six Months |  |             | Six Months    |    |   | Accrued Balance |  
|                   |  | as of             |    |                  | Ended         |             | Ended          |  |             | Ended         |    |   | as of           |  
|                   |  | December 31, 2004 |    |                  | June 30, 2005 |             | June 30, 2005  |  |             | June 30, 2005 |    |   | June 30, 2005   |  
|                   |  |                   |    |                  |               |             |                |  |             |               |    |   |                 |  
|Lease
    costs(a) |  | $                 | 31 |                  |               | $           |               |  |             | $             | (3 | ) |                 | $ | 3 |  |  | $ | 31 | 






|    |  |                                                                                                                                                                                                                                    
|--- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(a) |  | Total estimated costs, net of estimated sublease income,
    associated with these accruals are $69, of which $19 was drawn
    down by cash payments of $21 and offset by non-cash adjustments
    of $2 prior to January 1, 2005.



| |                             
| | ----------------------------
| | Special charges  by segment



|                                                             |                          |                                           |    |            |           |   |           |             |    |   |       |   |    |   |    |   |    |  
|------------------------------------------------------------ | ------------------------ | ----------------------------------------- | -- | ---------- | --------- | - | --------- | ----------- | -- | - | ----- | - | -- | - | -- | - | -- | -
|                                                             |                          |                                           |    | Contract   |           |   |           |             |   
|                                                             |                          |                                           |    | Settlement |           |   | Plant and |             |    |  
|                                                             |                          | Workforce                                 |    |            | and Lease |   |           | Equipment   |    |   |      
|                                                             |                          | Reduction                                 |    |            | Costs     |   |           | Write Downs |    |   | Total |  
|                                                             |                          |                                           |    |            |           |   |           |             |    |   |       |  
|2001 Restructuring Plan                                      |                          |                                           |    |            |           |   |           |             |    |   |       |   |    |   |    |  
|                                                             | Carrier Packet Networks: |                                           |    |            |           |   |           |             |    |   |       |   |    |   |    |   |   
|                                                             |                          | For the three months ended March 31, 2005 |    | $          | (1        | ) |           | $           |   |   |       | $ | (1 | ) |    | $ | (2 | )
|                                                             |                          | For the three months ended June 30, 2005  |    |            | (1        | ) |           |             | 2  |   |       |   | (1 | ) |    |   |   |  
|                                                             | GSM and UMTS Networks:   |                                           |    |            |           |   |           |             |    |   |       |   |    |   |    |   |   
|                                                             |                          | For the three months ended March 31, 2005 |    |            | (1        | ) |           |             |   |   |       |   |   |   |    |   | (1 | )
|                                                             |                          | For the three months ended June 30, 2005  |    |            | (1        | ) |           |             | 1  |   |       |   | (1 | ) |    |   | (1 | )
|                                                             | Enterprise Networks:     |                                           |    |            |           |   |           |             |    |   |       |   |    |   |    |   |   
|                                                             |                          | For the three months ended March 31, 2005 |    |            | (1        | ) |           |             |   |   |       |   |   |   |    |   | (1 | )
|                                                             |                          | For the three months ended June 30, 2005  |    |            |          |   |           |             | 1  |   |       |   |   |   |    |   | 1  |  
|                                                             | Other:                   |                                           |    |            |           |   |           |             |    |   |       |   |    |   |    |   |   
|                                                             |                          | For the three months ended June 30, 2005  |    |            |          |   |           |             |   |   |       |   |   |   |    |   |   |  
|                                                             |                          |                                           |    |            |           |   |           |             |    |   |       |  
|Total special charges for the six months ended June 30, 2005 |                          | $                                         | (5 | )          |           | $ | 4         |             |    | $ | (3    | ) |    | $ | (4 | )
|                                                             |                          |                                           |    |            |           |   |           |             |    |   |       |  
|                                                             | Carrier Packet Networks: |                                           |    |            |           |   |           |             |    |   |       |   |    |   |    |   |   
|                                                             |                          | For the three months ended March 31, 2004 |    | $          | 6         |   |           | $           | 1  |   |       | $ |   |   |    | $ | 7  |  
|                                                             |                          | For the three months ended June 30, 2004  |    |            |          |   |           |             | (1 | ) |       |   |   |   |    |   | (1 | )
|                                                             |                          |                                           |    |            |           |   |           |             |    |   |       |  
|Total special charges for the six months ended June 30, 2004 |                          | $                                         | 6  |            |           | $ |          |             |    | $ |      |   |    | $ | 6  |  
|                                                             |                          |                                           |    |            |           |   |           |             |    |   |       |  



19



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NORTEL NETWORKS LIMITED


Notes to Consolidated Financial
Statements  (Continued)




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



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









| |                             
| | ----------------------------
| | Special charges  by segment



|                                                             |                          |                                           |    |            |           |   |           |             |    |   |       |   |   |   |     |   |    | 
|------------------------------------------------------------ | ------------------------ | ----------------------------------------- | -- | ---------- | --------- | - | --------- | ----------- | -- | - | ----- | - | - | - | --- | - | -- | 
|                                                             |                          |                                           |    | Contract   |           |   |           |             |   
|                                                             |                          |                                           |    | Settlement |           |   | Plant and |             |    |  
|                                                             |                          | Workforce                                 |    |            | and Lease |   |           | Equipment   |    |   |      
|                                                             |                          | Reduction                                 |    |            | Costs     |   |           | Write Downs |    |   | Total |  
|                                                             |                          |                                           |    |            |           |   |           |             |    |   |       |  
|2004 Restructuring Plan                                      |                          |                                           |    |            |           |   |           |             |    |   |       |   |   |   |     |  
|                                                             | Carrier Packet Networks: |                                           |    |            |           |   |           |             |    |   |       |   |   |   |     |   |   
|                                                             |                          | For the three months ended March 31, 2005 |    | $          | 9         |   |           | $           | 1  |   |       | $ | 1 |   |     | $ | 11 | 
|                                                             |                          | For the three months ended June 30, 2005  |    |            | 28        |   |           |             | 36 |   |       |   | 4 |   |     |   | 68 | 
|                                                             | CDMA Networks:           |                                           |    |            |           |   |           |             |    |   |       |   |   |   |     |   |   
|                                                             |                          | For the three months ended March 31, 2005 |    |            | 1         |   |           |             |   |   |       |   |  |   |     |   | 1  | 
|                                                             |                          | For the three months ended June 30, 2005  |    |            | 2         |   |           |             | 1  |   |       |   |  |   |     |   | 3  | 
|                                                             | GSM and UMTS Networks:   |                                           |    |            |           |   |           |             |    |   |       |   |   |   |     |   |   
|                                                             |                          | For the three months ended March 31, 2005 |    |            | 3         |   |           |             |   |   |       |   |  |   |     |   | 3  | 
|                                                             |                          | For the three months ended June 30, 2005  |    |            | 6         |   |           |             | 6  |   |       |   | 1 |   |     |   | 13 | 
|                                                             | Enterprise Networks:     |                                           |    |            |           |   |           |             |    |   |       |   |   |   |     |   |   
|                                                             |                          | For the three months ended March 31, 2005 |    |            | 3         |   |           |             | 7  |   |       |   |  |   |     |   | 10 | 
|                                                             |                          | For the three months ended June 30, 2005  |    |            | 3         |   |           |             | 3  |   |       |   |  |   |     |   | 6  | 
|                                                             |                          |                                           |    |            |           |   |           |             |    |   |       |  
|Total special charges for the six months ended June 30, 2005 |                          | $                                         | 55 |            |           | $ | 54        |             |    | $ | 6     |   |   | $ | 115 |  
|                                                             |                          |                                           |    |            |           |   |           |             |    |   |       |  



|   |             
|-- | ------------
|6. | Income taxes



20



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NORTEL NETWORKS LIMITED


Notes to Consolidated Financial
Statements  (Continued)


















21



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NORTEL NETWORKS LIMITED


Notes to Consolidated Financial
Statements  (Continued)










|   |                       
|-- | ----------------------
|7. | Employee benefit plans







22



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NORTEL NETWORKS LIMITED


Notes to Consolidated Financial
Statements  (Continued)




|                    |                                                                  |                |    |      |                |   |    |      |   |   |      |      |   |   |     |      |  
|------------------- | ---------------------------------------------------------------- | -------------- | -- | ---- | -------------- | - | -- | ---- | - | - | ---- | ---- | - | - | --- | ---- | -
|                    |                                                                  | Three Months   |    |      | Six Months     |  
|                    |                                                                  | Ended June 30, |    |      | Ended June 30, |  
|                    |                                                                  |                |    |      |                |  
|                    |                                                                  | 2005           |    |      | 2004           |   |    | 2005 |   |   | 2004 |     
|                    |                                                                  |                |    |      |                |   |    |      |   |   |      |     
|Pension expense:    |                                                                  |                |    |      |                |   |    |      |   |   |      |      |   |   |     |     
|                    | Service cost                                                     |                | $  | 30   |                |   | $  | 30   |   |   | $    | 65   |   |   | $   | 60   |  
|                    | Interest cost                                                    |                |    | 114  |                |   |    | 103  |   |   |      | 230  |   |   |     | 207  |  
|                    | Expected return on plan assets                                   |                |    | (107 | )              |   |    | (101 | ) |   |      | (216 | ) |   |     | (203 | )
|                    | Amortization of prior service cost                               |                |    | 1    |                |   |    | 1    |   |   |      | 2    |   |   |     | 2    |  
|                    | Amortization of net losses (gains)                               |                |    | 25   |                |   |    | 19   |   |   |      | 48   |   |   |     | 38   |  
|                    | Curtailment, contractual, and special termination losses (gains) |                |    | 23   |                |   |    |     |   |   |      | 24   |   |   |     |     |  
|                    |                                                                  |                |    |      |                |   |    |      |   |   |      |     
|Net pension expense |                                                                  | $              | 86 |      |                | $ | 52 |      |   | $ | 153  |      |   | $ | 104 |     
|                    |                                                                  |                |    |      |                |   |    |      |   |   |      |     





|                                 |                                    |                |    |    |                |   |    |      |   |   |      |    |   |   |    |    |  
|-------------------------------- | ---------------------------------- | -------------- | -- | -- | -------------- | - | -- | ---- | - | - | ---- | -- | - | - | -- | -- | -
|                                 |                                    | Three Months   |    |    | Six Months     |  
|                                 |                                    | Ended June 30, |    |    | Ended June 30, |  
|                                 |                                    |                |    |    |                |  
|                                 |                                    | 2005           |    |    | 2004           |   |    | 2005 |   |   | 2004 |   
|                                 |                                    |                |    |    |                |   |    |      |   |   |      |   
|Post-retirement benefit cost:    |                                    |                |    |    |                |   |    |      |   |   |      |    |   |   |    |   
|                                 | Service cost                       |                | $  | 2  |                |   | $  | 2    |   |   | $    | 4  |   |   | $  | 5  |  
|                                 | Interest cost                      |                |    | 11 |                |   |    | 11   |   |   |      | 21 |   |   |    | 21 |  
|                                 | Expected return on plan assets     |                |    | (1 | )              |   |    | (1   | ) |   |      | (2 | ) |   |    | (1 | )
|                                 | Amortization of prior service cost |                |    | (1 | )              |   |    | (1   | ) |   |      | (2 | ) |   |    | (2 | )
|                                 | Amortization of net losses (gains) |                |    |   |                |   |    | 1    |   |   |      |   |   |   |    | 2  |  
|                                 |                                    |                |    |    |                |   |    |      |   |   |      |   
|Net post-retirement benefit cost |                                    | $              | 11 |    |                | $ | 12 |      |   | $ | 21   |    |   | $ | 25 |   
|                                 |                                    |                |    |    |                |   |    |      |   |   |      |   





|   |                                                     
|-- | ----------------------------------------------------
|8. | Acquisitions, divestitures and change in investments



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



| |                    
| | -------------------
| | PEC Solutions, Inc.



23



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NORTEL NETWORKS LIMITED


Notes to Consolidated Financial
Statements  (Continued)












|                                  |                                         |   |     |     | 
|--------------------------------- | --------------------------------------- | - | --- | --- | 
|Purchase price                    |                                         | $ | 449 |    
|                                  |                                         |   |    
|Assets acquired:                  |                                         |   |     |    
|                                  | Cash and cash equivalents               |   | $   | 26  | 
|                                  | Accounts recievable  net               |   |     | 65  | 
|                                  | Other current assets                    |   |     | 34  | 
|                                  | Investments                             |   |     | 8   | 
|                                  | Plant and equipment                     |   |     | 32  | 
|                                  | Other intangible assets                 |   |     | 84  | 
|                                  | Goodwill                                |   |     | 271 | 
|                                  | Other assets                            |   |     | 5   | 
|                                  |                                         |   |    
|                                  |                                         |   | 525 |    
|                                  |                                         |   |    
|Less liabilities assumed:         |                                         |   |     |    
|                                  | Trade and other accounts payable        |   |     | 6   | 
|                                  | Payroll and benefit-related liabilities |   |     | 15  | 
|                                  | Other accrued liabilities               |   |     | 19  | 
|                                  | Long-term debt                          |   |     | 33  | 
|                                  | Other liabilities                       |   |     | 3   | 
|                                  |                                         |   |    
|                                  |                                         |   | 76  |    
|                                  |                                         |   |    
|Fair value of net assets acquired |                                         | $ | 449 |    
|                                  |                                         |   |    

24



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NORTEL NETWORKS LIMITED


Notes to Consolidated Financial
Statements  (Continued)






|                                     |  |            |    |              |                |  |    | 
|------------------------------------ |  | ---------- | -- | ------------ | -------------- |  | -- | 
|                                     |  |            |    | Amortization |               
|                                     |  | Fair Value |    |              | Period (Years) | 
|                                     |  |            |    |              |                | 
|Trade name                           |  | $          | 7  |              |                |  | 4  | 
|Software licenses                    |  |            | 1  |              |                |  | 10 | 
|Customer contracts and relationships |  |            | 76 |              |                |  | 10 | 
|                                     |  |            |    |              |                | 
|Total intangible assets              |  | $          | 84 |              |                |  |    | 
|                                     |  |            |    |              |                | 



|                                                |  |                |       |  |                |   |       |      |  |   |       |  |  |   |       | 
|----------------------------------------------- |  | -------------- | ----- |  | -------------- | - | ----- | ---- |  | - | ----- |  |  | - | ----- | 
|                                                |  | Three Months   |       |  | Six Months     |  
|                                                |  | Ended June 30, |       |  | Ended June 30, |  
|                                                |  |                |       |  |                |  
|                                                |  | 2005           |       |  | 2004           |   |       | 2005 |  |   | 2004  | 
|                                                |  |                |       |  |                |   |       |      |  |   |       | 
|Revenues                                        |  | $              | 2,900 |  |                | $ | 2,635 |      |  | $ | 5,500 |  |  | $ | 5,123 | 
|Net earnings (loss) applicable to common shares |  | $              | 35    |  |                | $ | 47    |      |  | $ | 24    |  |  | $ | 151   | 



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



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







25



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##### Table of Contents



NORTEL NETWORKS LIMITED


Notes to Consolidated Financial
Statements  (Continued)












| |                      
| | ---------------------
| | Change in investments







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



26



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NORTEL NETWORKS LIMITED


Notes to Consolidated Financial
Statements  (Continued)






|   |                                      
|-- | -------------------------------------
|9. | Long-term debt and support facilities







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











27



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NORTEL NETWORKS LIMITED


Notes to Consolidated Financial
Statements  (Continued)






|    |           
|--- | ----------
|10. | Guarantees





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











28



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NORTEL NETWORKS LIMITED


Notes to Consolidated Financial
Statements  (Continued)




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







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







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







|    |                                                                                           
|--- | ------------------------------------------------------------------------------------------
|(e) | Indemnification of banks and agents under EDC Support
    Facility and security agreements



29



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NORTEL NETWORKS LIMITED


Notes to Consolidated Financial
Statements  (Continued)
















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





30



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NORTEL NETWORKS LIMITED


Notes to Consolidated Financial
Statements  (Continued)






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



|                                |                   |   |     |      |  
|------------------------------- | ----------------- | - | --- | ---- | -
|Balance as of December 31, 2004 |                   | $ | 271 |     
|                                | Payments          |   |     | (129 | )
|                                | Warranties issued |   |     | 96   |  
|                                | Revisions         |   |     | (6   | )
|                                |                   |   |    
|Balance as of June 30, 2005     |                   | $ | 232 |     
|                                |                   |   |    



|    |            
|--- | -----------
|11. | Commitments



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



|                                               |  |          |     |  |              |   |     | 
|---------------------------------------------- |  | -------- | --- |  | ------------ | - | --- | 
|                                               |  | June 30, |     |  | December 31, |  
|                                               |  | 2005     |     |  | 2004         |  
|                                               |  |          |     |  |              |  
|Bid and performance related
    bonds(a)       |  | $        | 264 |  |              | $ | 362 | 
|Other
    bonds(b)                             |  |          | 46  |  |              |   | 68  | 
|                                               |  |          |     |  |              |  
|Total bid, performance related and other bonds |  | $        | 310 |  |              | $ | 430 | 
|                                               |  |          |     |  |              |  






|    |  |                                                                                                                                   
|--- |  | ----------------------------------------------------------------------------------------------------------------------------------
|(a) |  | Net of restricted cash and cash equivalent amounts of $37 and
    $36 as of June 30, 2005 and December 31, 2004,
    respectively.
|(b) |  | Net of restricted cash and cash equivalent amounts of $28 and
    $28 as of June 30, 2005 and December 31, 2004,
    respectively.



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



31



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NORTEL NETWORKS LIMITED


Notes to Consolidated Financial
Statements  (Continued)




|    |                       
|--- | ----------------------
|12. | Financing arrangements



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



|                                   |  |          |     |   |              |   |     |  
|---------------------------------- |  | -------- | --- | - | ------------ | - | --- | -
|                                   |  | June 30, |     |   | December 31, |  
|                                   |  | 2005     |     |   | 2004         |  
|                                   |  |          |     |   |              |  
|Drawn and outstanding  gross      |  | $        | 56  |   |              | $ | 118 |  
|Provisions for doubtful accounts   |  |          | (39 | ) |              |   | (38 | )
|                                   |  |          |     |   |              |  
|Drawn and outstanding 
    net(a) |  |          | 17  |   |              |   | 80  |  
|Undrawn commitments                |  |          | 54  |   |              |   | 69  |  
|                                   |  |          |     |   |              |  
|Total customer financing           |  | $        | 71  |   |              | $ | 149 |  
|                                   |  |          |     |   |              |  






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









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



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NORTEL NETWORKS LIMITED


Notes to Consolidated Financial
Statements  (Continued)












|    |                               
|--- | ------------------------------
|13. | Stock-based compensation plans





33



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NORTEL NETWORKS LIMITED


Notes to Consolidated Financial
Statements  (Continued)








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



|                                                                  |                                             |                |    |     |                |   |    |      |   |   |      |     |   |   |     |      |  
|----------------------------------------------------------------- | ------------------------------------------- | -------------- | -- | --- | -------------- | - | -- | ---- | - | - | ---- | --- | - | - | --- | ---- | -
|                                                                  |                                             | Three Months   |    |     | Six Months     |  
|                                                                  |                                             | Ended June 30, |    |     | Ended June 30, |  
|                                                                  |                                             |                |    |     |                |  
|                                                                  |                                             | 2005           |    |     | 2004           |   |    | 2005 |   |   | 2004 |    
|                                                                  |                                             |                |    |     |                |   |    |      |   |   |      |    
|Net earnings (loss) applicable to common shares  as
    reported |                                             | $              | 47 |     |                | $ | 47 |      |   | $ | 31   |     |   | $ | 155 |     
|                                                                  | Stock-based compensation  reported         |                |    | 18  |                |   |    | 20   |   |   |      | 36  |   |   |     | 78   |  
|                                                                  | Stock-based compensation  pro
    forma(a) |                |    | (18 | )              |   |    | (35  | ) |   |      | (43 | ) |   |     | (108 | )
|                                                                  |                                             |                |    |     |                |   |    |      |   |   |      |    
|Net earnings (loss) applicable to common shares  pro
    forma   |                                             | $              | 47 |     |                | $ | 32 |      |   | $ | 24   |     |   | $ | 125 |     
|                                                                  |                                             |                |    |     |                |   |    |      |   |   |      |    






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



|                                                     |                                       |                |    |    |                |   |    |      |   |   |      |    |   |   |    |    | 
|---------------------------------------------------- | ------------------------------------- | -------------- | -- | -- | -------------- | - | -- | ---- | - | - | ---- | -- | - | - | -- | -- | 
|                                                     |                                       | Three Months   |    |    | Six Months     |  
|                                                     |                                       | Ended June 30, |    |    | Ended June 30, |  
|                                                     |                                       |                |    |    |                |  
|                                                     |                                       | 2005           |    |    | 2004           |   |    | 2005 |   |   | 2004 |   
|                                                     |                                       |                |    |    |                |   |    |      |   |   |      |   
|Stock-based compensation:                            |                                       |                |    |    |                |   |    |      |   |   |      |    |   |   |    |   
|                                                     | Stock option expense                  |                | $  | 18 |                |   | $  | 21   |   |   | $    | 37 |   |   | $  | 36 | 
|                                                     | Employer portion of
    ESPPs(a)      |                |    |   |                |   |    |     |   |   |      |   |   |   |    |   | 
|                                                     | Restricted Stock Units
    expense(a) |                |    |   |                |   |    |     |   |   |      |   |   |   |    | 41 | 
|                                                     | Deferred Stock Units
    expense(a)   |                |    |   |                |   |    | (1   | ) |   |      | (1 | ) |   |    | 1  | 
|                                                     |                                       |                |    |    |                |   |    |      |   |   |      |   
|Total stock-based compensation reported  net of tax |                                       | $              | 18 |    |                | $ | 20 |      |   | $ | 36   |    |   | $ | 78 |   
|                                                     |                                       |                |    |    |                |   |    |      |   |   |      |   






|    |  |                                                                                                                                                                   
|--- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(a) |  | Compensation related to employer portion of ESPPs, Restricted
    Stock Units (RSUs) and Deferred Stock Units
    (DSUs) was net of tax of nil in each period.

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NORTEL NETWORKS LIMITED


Notes to Consolidated Financial
Statements  (Continued)




|                                                                |                               |          |      |       |  
|--------------------------------------------------------------- | ----------------------------- | -------- | ---- | ----- | -
|                                                                |                               | June 30,
|                                                                |                               | 2004    
|                                                                |                               |         
|Black-Scholes weighted-average assumptions                      |                               |          |      |      
|                                                                | Expected dividend yield       |          |      | 0.00  | %
|                                                                | Expected volatility           |          |      | 94.47 | %
|                                                                | Risk-free interest rate       |          |      | 2.96  | %
|                                                                | Expected option life in years |          |      | 4     |  
|Weighted-average stock option fair value per option
    granted |                               | $        | 5.21 |      



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



|                                               |                                                                        |                |     |      |                |   |     |      |   |   |      |      |   |   |     |     |  
|---------------------------------------------- | ---------------------------------------------------------------------- | -------------- | --- | ---- | -------------- | - | --- | ---- | - | - | ---- | ---- | - | - | --- | --- | -
|                                               |                                                                        | Three Months   |     |      | Six Months     |  
|                                               |                                                                        | Ended June 30, |     |      | Ended June 30, |  
|                                               |                                                                        |                |     |      |                |  
|                                               |                                                                        | 2005           |     |      | 2004           |   |     | 2005 |   |   | 2004 |     
|                                               |                                                                        |                |     |      |                |   |     |      |   |   |      |     
|Net earnings (loss)                            |                                                                        | $              | 57  |      |                | $ | 54  |      |   | $ | 50   |      |   | $ | 171 |    
|Other comprehensive income (loss) adjustments: |                                                                        |                |     |      |                |   |     |      |   |   |      |      |   |   |     |    
|                                               | Change in foreign currency translation
    adjustment(a)               |                |     | (101 | )              |   |     | (68  | ) |   |      | (359 | ) |   |     | (72 | )
|                                               | Unrealized gain (loss) on investments 
    net(b)                     |                |     | (16  | )              |   |     | (41  | ) |   |      | (23  | ) |   |     | (60 | )
|                                               | Minimum pension liability adjustment  net                             |                |     | 1    |                |   |     |     |   |   |      | 3    |   |   |     | 1   |  
|                                               | Unrealized derivative gain (loss) on cash flow
    hedges 
    net(c) |                |     | (11  | )              |   |     | (6   | ) |   |      | (19  | ) |   |     | (12 | )
|                                               |                                                                        |                |     |      |                |   |     |      |   |   |      |     
|Comprehensive income (loss)                    |                                                                        | $              | (70 | )    |                | $ | (61 | )    |   | $ | (348 | )    |   | $ | 28  |    
|                                               |                                                                        |                |     |      |                |   |     |      |   |   |      |     






|    |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|--- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(a) |  | The change in the foreign currency translation adjustment was
    not adjusted for income taxes since it related to indefinite
    term investments in non-U.S. subsidiaries. The change in
    foreign currency translation adjustment includes $187 released
    due to a divestiture in the first half of 2005.                                                                                                                                                                                                                                     
|(b) |  | Certain securities deemed available-for-sale by Nortel were
    measured at fair value. Unrealized holding gains (losses)
    related to these securities were excluded from net earnings
    (loss) and were included in accumulated other comprehensive
    income (loss) until realized. Unrealized gain (loss) on
    investments was net of tax of nil and nil for the three and six
    months ended June 30, 2005 and 2004, respectively.                                                                                                       
|(c) |  | During the three and six months ended June 30, 2005, $5 and
    $13 of net derivative gains (losses) were reclassified to other
    income (expense)  net, respectively. During the three
    and six months ended June 30, 2004, nil and $3 of net
    derivative gains (losses) were reclassified to other income
    (expense)  net, respectively. Nortel estimates that
    $1 of net derivative gains (losses) included in accumulated
    other comprehensive loss will be reclassified into net earnings
    (loss) within the next 12 months.



|    |                           
|--- | --------------------------
|15. | Related party transactions



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NORTEL NETWORKS LIMITED


Notes to Consolidated Financial
Statements  (Continued)




|                             |  |          |     |  |              |   |     |  
|---------------------------- |  | -------- | --- |  | ------------ | - | --- | -
|                             |  | June 30, |     |  | December 31, |  
|                             |  | 2005     |     |  | 2004         |  
|                             |  |          |     |  |              |  
|Consolidated balance sheets  |  |          |     |  |              |   |     |  
|Owing from NNC               |  | $        | 107 |  |              | $ | 134 |  
|Owing from NNC subsidiaries  |  |          | 175 |  |              |   | 114 |  
|Other related
    parties(a) |  |          |    |  |              |   | (5  | )
|                             |  |          |     |  |              |  
|Related party receivables    |  | $        | 282 |  |              | $ | 243 |  
|                             |  |          |     |  |              |  






|    |  |                                                                                                                                                                                                                                                                                                                                                
|--- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(a) |  | Nortel purchases certain inventory for its Carrier Packet
    Networks business from Bookham, Inc. (Bookham), a
    related party due to Nortels equity interest in Bookham.
    Nortel has certain notes receivable due from Bookham with a
    carrying amount of $20 and $20 as of June 30, 2005 and
    December 31, 2004, respectively.









|    |              
|--- | -------------
|16. | Contingencies



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NORTEL NETWORKS LIMITED


Notes to Consolidated Financial
Statements  (Continued)










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NORTEL NETWORKS LIMITED


Notes to Consolidated Financial
Statements  (Continued)






38



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NORTEL NETWORKS LIMITED


Notes to Consolidated Financial
Statements  (Continued)














39



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NORTEL NETWORKS LIMITED


Notes to Consolidated Financial
Statements  (Continued)


















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





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NORTEL NETWORKS LIMITED


Notes to Consolidated Financial
Statements  (Continued)












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







|    |                                               
|--- | ----------------------------------------------
|17. | Reconciliation from U.S. GAAP to Canadian GAAP



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NORTEL NETWORKS LIMITED


Notes to Consolidated Financial
Statements  (Continued)






|                    |                                        |                                       |   |    |                |   |   |      |   |  |      |         |     |   |   |         |     |  
|------------------- | -------------------------------------- | ------------------------------------- | - | -- | -------------- | - | - | ---- | - |  | ---- | ------- | --- | - | - | ------- | --- | -
|                    |                                        | Three Months                          |   |    | Six Months     |  
|                    |                                        | Ended June 30,                        |   |    | Ended June 30, |  
|                    |                                        |                                       |   |    |                |  
|                    |                                        | 2005                                  |   |    | 2004           |   |   | 2005 |   |  | 2004 |        
|                    |                                        |                                       |   |    |                |   |   |      |   |  |      |        
|Net earnings (loss) |                                        |                                       |   |    |                |   |   |      |   |  |      |         |     |   |   |        
|                    | U.S. GAAP                              |                                       | $ | 57 |                |   | $ | 54   |   |  | $    | 50      |     |   | $ | 171     |    
|                    |                                        | Derivative
    accounting (b)((h)(i)) |   |    | (7             | ) |   |      |  |  |      |         | (11 | ) |   |         | 26  |  
|                    |                                        | Other                                 |   |    | (1             | ) |   |      | 1 |  |      |         | 1   |   |   |         | 5   |  
|                    |                                        |                                       |   |    |                |   |   |      |   |  |      |        
|                    | Canadian GAAP                          |                                       | $ | 49 |                |   | $ | 55   |   |  | $    | 40      |     |   | $ | 202     |    
|                    |                                        |                                       |   |    |                |   |   |      |   |  |      |        
|Accumulated deficit |                                        |                                       |   |    |                |   |   |      |   |  |      |         |     |   |   |        
|                    | Balance at the beginning of the period |                                       |   |    |                |   |   |      |   |  | $    | (18,558 | )   |   | $ | (18,656 | )  
|                    |                                        | Net earnings (loss)                   |   |    |                |   |   |      |   |  |      |         | 40  |   |   |         | 202 |  
|                    |                                        | Dividends on preferred shares         |   |    |                |   |   |      |   |  |      |         | (19 | ) |   |         | (16 | )
|                    |                                        |                                       |   |    |                |   |   |      |   |  |      |        
|                    | Deficit at the end of the period       |                                       |   |    |                |   |   |      |   |  | $    | (18,537 | )   |   | $ | (18,470 | )  
|                    |                                        |                                       |   |    |                |   |   |      |   |  |      |        

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NORTEL NETWORKS LIMITED


Notes to Consolidated Financial
Statements  (Continued)




|                                            |  |               |        |  |                   |   |          |      |  |      |        |  |  |             |          |  |      |   |        |   |  |   |        | 
|------------------------------------------- |  | ------------- | ------ |  | ----------------- | - | -------- | ---- |  | ---- | ------ |  |  | ----------- | -------- |  | ---- | - | ------ | - |  | - | ------ | 
|                                            |  | June 30, 2005 |        |  | December 31, 2004 |  
|                                            |  |               |        |  |                   |  
|                                            |  | U.S.          |        |  |                   |   | Canadian |      |  | U.S. |        |  |  |             | Canadian | 
|                                            |  | GAAP          |        |  | Adjustments       |   |          | GAAP |  |      | GAAP   |  |  | Adjustments |          |  | GAAP |  
|                                            |  |               |        |  |                   |   |          |      |  |      |        |  |  |             |          |  |      |  
|ASSETS                                     
|Current
    assets(f)                       |  | $             | 8,162  |  |                   | $ | (5       | )    |  | $    | 8,157  |  |  | $           | 8,511    |  |      | $ | 5      |   |  | $ | 8,516  | 
|Investments(c)(f)                           |  |               | 154    |  |                   |   | 7        |      |  |      | 161    |  |  |             | 159      |  |      |   | (16    | ) |  |   | 143    | 
|Plant and equipment  net                   |  |               | 1,577  |  |                   |   | (4       | )    |  |      | 1,573  |  |  |             | 1,646    |  |      |   | (1     | ) |  |   | 1,645  | 
|Goodwill(a)                                 |  |               | 2,342  |  |                   |   | (896     | )    |  |      | 1,446  |  |  |             | 2,123    |  |      |   | (910   | ) |  |   | 1,213  | 
|Intangible assets 
    net(g)              |  |               | 154    |  |                   |   | (39      | )    |  |      | 115    |  |  |             | 78       |  |      |   | (40    | ) |  |   | 38     | 
|Deferred income taxes 
    net(g)          |  |               | 3,632  |  |                   |   | (205     | )    |  |      | 3,427  |  |  |             | 3,736    |  |      |   | (220   | ) |  |   | 3,516  | 
|Other
    assets(b)(g)                      |  |               | 557    |  |                   |   | 28       |      |  |      | 585    |  |  |             | 691      |  |      |   | (20    | ) |  |   | 671    | 
|                                            |  |               |        |  |                   |   |          |      |  |      |        |  |  |             |          |  |      |  
|Total assets                                |  | $             | 16,578 |  |                   | $ | (1,114   | )    |  | $    | 15,464 |  |  | $           | 16,944   |  |      | $ | (1,202 | ) |  | $ | 15,742 | 
|                                            |  |               |        |  |                   |   |          |      |  |      |        |  |  |             |          |  |      |  
|                                           
|LIABILITIES AND SHAREHOLDERS EQUITY       
|Current
    liabilities(f)                  |  | $             | 6,368  |  |                   | $ | (87      | )    |  | $    | 6,281  |  |  | $           | 5,132    |  |      | $ | (42    | ) |  | $ | 5,090  | 
|Long-term
    debt(b)                       |  |               | 638    |  |                   |   | (6       | )    |  |      | 632    |  |  |             | 2,062    |  |      |   | (26    | ) |  |   | 2,036  | 
|Deferred income taxes 
    net(g)          |  |               | 150    |  |                   |   | 12       |      |  |      | 162    |  |  |             | 143      |  |      |   | 14     |   |  |   | 157    | 
|Other
    liabilities(b)(g)                 |  |               | 3,328  |  |                   |   | (1,225   | )    |  |      | 2,103  |  |  |             | 3,189    |  |      |   | (1,362 | ) |  |   | 1,827  | 
|                                            |  |               |        |  |                   |   |          |      |  |      |        |  |  |             |          |  |      |  
|Total liabilities                           |  |               | 10,484 |  |                   |   | (1,306   | )    |  |      | 9,178  |  |  |             | 10,526   |  |      |   | (1,416 | ) |  |   | 9,110  | 
|                                            |  |               |        |  |                   |   |          |      |  |      |        |  |  |             |          |  |      |  
|Minority interests in subsidiary companies  |  |               | 100    |  |                   |   |         |      |  |      | 100    |  |  |             | 94       |  |      |   |       |   |  |   | 94     | 
|Total shareholders equity
    (b)(c)(f)(g) |  |               | 5,994  |  |                   |   | 192      |      |  |      | 6,186  |  |  |             | 6,324    |  |      |   | 214    |   |  |   | 6,538  | 
|                                            |  |               |        |  |                   |   |          |      |  |      |        |  |  |             |          |  |      |  
|Total liabilities and shareholders equity  |  | $             | 16,578 |  |                   | $ | (1,114   | )    |  | $    | 15,464 |  |  | $           | 16,944   |  |      | $ | (1,202 | ) |  | $ | 15,742 | 
|                                            |  |               |        |  |                   |   |          |      |  |      |        |  |  |             |          |  |      |  





|    |                      
|--- | ---------------------
|(a) | Business combinations



43



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NORTEL NETWORKS LIMITED


Notes to Consolidated Financial
Statements  (Continued)








|    |                      
|--- | ---------------------
|(b) | Derivative accounting







|    |            
|--- | -----------
|(c) | Investments



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NORTEL NETWORKS LIMITED


Notes to Consolidated Financial
Statements  (Continued)




|    |                                                   
|--- | --------------------------------------------------
|(d) | Other financial statement presentation differences





|                                                                            |  |                |       |   |                |   |       |      |  |   |       |   |  |   |       |  
|--------------------------------------------------------------------------- |  | -------------- | ----- | - | -------------- | - | ----- | ---- |  | - | ----- | - |  | - | ----- | -
|                                                                            |  | Three Months   |       |   | Six Months     |  
|                                                                            |  | Ended June 30, |       |   | Ended June 30, |  
|                                                                            |  |                |       |   |                |  
|                                                                            |  | 2005           |       |   | 2004           |   |       | 2005 |  |   | 2004  |  
|                                                                            |  |                |       |   |                |   |       |      |  |   |       |  
|Net cash from (used in) operating activities of continuing
    operations   |  | $              | 64    |   |                | $ | 89    |      |  | $ | (158  | ) |  | $ | (204  | )
|Net cash from (used in) investing activities of continuing
    operations   |  |                | (409  | ) |                |   | 29    |      |  |   | (381  | ) |  |   | 44    |  
|Net cash from (used in) financing activities of continuing
    operations   |  |                | (15   | ) |                |   | 5     |      |  |   | (38   | ) |  |   | (107  | )
|Effect of foreign exchange rate changes on cash and cash
    equivalents    |  |                | (50   | ) |                |   | (22   | )    |  |   | (85   | ) |  |   | (9    | )
|                                                                            |  |                |       |   |                |   |       |      |  |   |       |  
|Net cash from (used in) continuing operations                               |  |                | (410  | ) |                |   | 101   |      |  |   | (662  | ) |  |   | (276  | )
|Net cash from (used in) operating activities of discontinued
    operations |  |                | (2    | ) |                |   | 14    |      |  |   | 34    |   |  |   | (4    | )
|                                                                            |  |                |       |   |                |   |       |      |  |   |       |  
|Net increase (decrease) in cash and cash equivalents                        |  |                | (412  | ) |                |   | 115   |      |  |   | (628  | ) |  |   | (280  | )
|Cash and cash equivalents at beginning of period                            |  |                | 3,395 |   |                |   | 3,537 |      |  |   | 3,611 |   |  |   | 3,932 |  
|                                                                            |  |                |       |   |                |   |       |      |  |   |       |  
|Cash and cash equivalents at end of period                                  |  | $              | 2,983 |   |                | $ | 3,652 |      |  | $ | 2,983 |   |  | $ | 3,652 |  
|                                                                            |  |                |       |   |                |   |       |      |  |   |       |  



|    |      
|--- | -----
|(e) | Other





|    |               
|--- | --------------
|(f) | Joint ventures



45



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NORTEL NETWORKS LIMITED


Notes to Consolidated Financial
Statements  (Continued)




|    |                                           
|--- | ------------------------------------------
|(g) | Pension and other post-retirement benefits





|    |                   
|--- | ------------------
|(h) | Accounting changes



| |                              
| | -----------------------------
| | (i)     Derivative accounting







| |                                                                 
| | ----------------------------------------------------------------
| | (ii)     Determining whether an
    arrangement contains a lease





| |                                                                  
| | -----------------------------------------------------------------
| | (iii)     Financial
    instruments  presentation and disclosure





| |                                                                                                                  
| | -----------------------------------------------------------------------------------------------------------------
| | (iv)     Accounting by a customer
    (including a reseller) for certain consideration received from a
    vendor



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NORTEL NETWORKS LIMITED


Notes to Consolidated Financial
Statements  (Continued)






|    |                                          
|--- | -----------------------------------------
|(i) | Recently issued accounting pronouncements





|    |                                                 
|--- | ------------------------------------------------
|18. | Supplemental consolidating financial information









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NORTEL NETWORKS LIMITED


Notes to Consolidated Financial
Statements  (Continued)












48



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NORTEL NETWORKS LIMITED


Notes to Consolidated Financial
Statements  (Continued)




|                                                                                                                                                     |                |                            |       |     |              |   |       |              |   |   |              |    |   |       |        |   |  |   |       |     |  
|---------------------------------------------------------------------------------------------------------------------------------------------------- | -------------- | -------------------------- | ----- | --- | ------------ | - | ----- | ------------ | - | - | ------------ | -- | - | ----- | ------ | - |  | - | ----- | --- | -
|                                                                                                                                                     |                | Nortel                     |       |     |              |   | Non-  |              |   |   |              |   
|                                                                                                                                                     |                | Networks                   |       |     | Guarantor    |   |       | Guarantor    |   |   |              |    |  
|                                                                                                                                                     |                | Limited                    |       |     | Subsidiaries |   |       | Subsidiaries |   |   | Eliminations |    |   | Total |       
|                                                                                                                                                     |                |                            |       |     |              |   |       |              |   |   |              |    |   |       |       
|                                                                                                                                                     |                | (Millions of U.S. dollars) |      
|Revenues                                                                                                                                             |                | $                          | 1,392 |     |              | $ | 1,923 |              |   | $ | 958          |    |   | $     | (1,418 | ) |  | $ | 2,855 |    
|Cost of revenues                                                                                                                                     |                |                            | 557   |     |              |   | 1,667 |              |   |   | 844          |    |   |       | (1,418 | ) |  |   | 1,650 |    
|                                                                                                                                                     |                |                            |       |     |              |   |       |              |   |   |              |    |   |       |       
|Gross profit                                                                                                                                         |                |                            | 835   |     |              |   | 256   |              |   |   | 114          |    |   |       |       |   |  |   | 1,205 |    
|Selling, general and administrative expense                                                                                                          |                |                            | 109   |     |              |   | 349   |              |   |   | 118          |    |   |       |       |   |  |   | 576   |    
|Research and development expense                                                                                                                     |                |                            | 356   |     |              |   | 51    |              |   |   | 67           |    |   |       |       |   |  |   | 474   |    
|Amortization of intangibles                                                                                                                          |                |                            |      |     |              |   |      |              |   |   | 2            |    |   |       |       |   |  |   | 2     |    
|Special charges                                                                                                                                      |                |                            | (3    | )   |              |   | 82    |              |   |   | 11           |    |   |       |       |   |  |   | 90    |    
|(Gain) loss on sale of businesses and assets                                                                                                         |                |                            | 33    |     |              |   | 2     |              |   |   | 1            |    |   |       |       |   |  |   | 36    |    
|                                                                                                                                                     |                |                            |       |     |              |   |       |              |   |   |              |    |   |       |       
|Operating earnings (loss)                                                                                                                            |                |                            | 340   |     |              |   | (228  | )            |   |   | (85          | )  |   |       |       |   |  |   | 27    |    
|Other income (expense)  net                                                                                                                         |                |                            |      |     |              |   | 61    |              |   |   |             |    |   |       |       |   |  |   | 61    |    
|Interest expense                                                                                                                                     |                |                            |       |     |              |   |       |              |   |   |              |    |   |       |        |   |  |   |       |    
|                                                                                                                                                     | Long-term debt |                            |       | (20 | )            |   |       | (3           | ) |   |              | (7 | ) |       |        |  |  |   |       | (30 | )
|                                                                                                                                                     | Other          |                            |       | (5  | )            |   |       | (11          | ) |   |              | 16 |   |       |        |  |  |   |       |    |  
|                                                                                                                                                     |                |                            |       |     |              |   |       |              |   |   |              |    |   |       |       
|Earnings (loss) from continuing operations before income taxes,
    minority interests and equity in net earnings (loss) of
    associated companies |                |                            | 315   |     |              |   | (181  | )            |   |   | (76          | )  |   |       |       |   |  |   | 58    |    
|Income tax benefit (expense)                                                                                                                         |                |                            | (49   | )   |              |   | (3    | )            |   |   | 59           |    |   |       |       |   |  |   | 7     |    
|                                                                                                                                                     |                |                            |       |     |              |   |       |              |   |   |              |    |   |       |       
|                                                                                                                                                     |                |                            | 266   |     |              |   | (184  | )            |   |   | (17          | )  |   |       |       |   |  |   | 65    |    
|Minority interests  net of tax                                                                                                                      |                |                            |      |     |              |   |      |              |   |   | (8           | )  |   |       |       |   |  |   | (8    | )  
|Equity in net earnings (loss) of associated
    companies  net of tax                                                                               |                |                            | (208  | )   |              |   | 72    |              |   |   | 30           |    |   |       | 107    |   |  |   | 1     |    
|                                                                                                                                                     |                |                            |       |     |              |   |       |              |   |   |              |    |   |       |       
|Net earnings (loss) from continuing operations                                                                                                       |                |                            | 58    |     |              |   | (112  | )            |   |   | 5            |    |   |       | 107    |   |  |   | 58    |    
|Net earnings (loss) from discontinued
    operations  net of tax                                                                                    |                |                            | (1    | )   |              |   | (1    | )            |   |   |             |    |   |       | 1      |   |  |   | (1    | )  
|                                                                                                                                                     |                |                            |       |     |              |   |       |              |   |   |              |    |   |       |       
|Net earnings (loss)                                                                                                                                  |                |                            | 57    |     |              |   | (113  | )            |   |   | 5            |    |   |       | 108    |   |  |   | 57    |    
|Dividends on preferred shares                                                                                                                        |                |                            | 10    |     |              |   |      |              |   |   |             |    |   |       |       |   |  |   | 10    |    
|                                                                                                                                                     |                |                            |       |     |              |   |       |              |   |   |              |    |   |       |       
|Net earnings (loss) applicable to common shares                                                                                                      |                | $                          | 47    |     |              | $ | (113  | )            |   | $ | 5            |    |   | $     | 108    |   |  | $ | 47    |    
|                                                                                                                                                     |                |                            |       |     |              |   |       |              |   |   |              |    |   |       |       

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##### Table of Contents



NORTEL NETWORKS LIMITED


Notes to Consolidated Financial
Statements  (Continued)




|                                                                                                                                                     |                |                            |      |     |              |   |       |              |   |   |              |    |   |       |      |   |  |   |       |     |  
|---------------------------------------------------------------------------------------------------------------------------------------------------- | -------------- | -------------------------- | ---- | --- | ------------ | - | ----- | ------------ | - | - | ------------ | -- | - | ----- | ---- | - |  | - | ----- | --- | -
|                                                                                                                                                     |                | Nortel                     |      |     |              |   | Non-  |              |   |   |              |   
|                                                                                                                                                     |                | Networks                   |      |     | Guarantor    |   |       | Guarantor    |   |   |              |    |  
|                                                                                                                                                     |                | Limited                    |      |     | Subsidiaries |   |       | Subsidiaries |   |   | Eliminations |    |   | Total |     
|                                                                                                                                                     |                |                            |      |     |              |   |       |              |   |   |              |    |   |       |     
|                                                                                                                                                     |                | (Millions of U.S. dollars) |     
|Revenues                                                                                                                                             |                | $                          | 766  |     |              | $ | 1,803 |              |   | $ | 922          |    |   | $     | (901 | ) |  | $ | 2,590 |    
|Cost of revenues                                                                                                                                     |                |                            | 521  |     |              |   | 1,167 |              |   |   | 751          |    |   |       | (901 | ) |  |   | 1,538 |    
|                                                                                                                                                     |                |                            |      |     |              |   |       |              |   |   |              |    |   |       |     
|Gross profit                                                                                                                                         |                |                            | 245  |     |              |   | 636   |              |   |   | 171          |    |   |       |     |   |  |   | 1,052 |    
|Selling, general and administrative expense                                                                                                          |                |                            | 109  |     |              |   | 314   |              |   |   | 115          |    |   |       |     |   |  |   | 538   |    
|Research and development expense                                                                                                                     |                |                            | 230  |     |              |   | 190   |              |   |   | 69           |    |   |       |     |   |  |   | 489   |    
|Amortization of intangibles                                                                                                                          |                |                            |     |     |              |   |      |              |   |   | 2            |    |   |       |     |   |  |   | 2     |    
|Special charges                                                                                                                                      |                |                            | 1    |     |              |   | (4    | )            |   |   | 2            |    |   |       |     |   |  |   | (1    | )  
|(Gain) loss on sale of businesses and assets                                                                                                         |                |                            |     |     |              |   | (1    | )            |   |   | (74          | )  |   |       |     |   |  |   | (75   | )  
|                                                                                                                                                     |                |                            |      |     |              |   |       |              |   |   |              |    |   |       |     
|Operating earnings (loss)                                                                                                                            |                |                            | (95  | )   |              |   | 137   |              |   |   | 57           |    |   |       |     |   |  |   | 99    |    
|Other income (expense)  net                                                                                                                         |                |                            | (18  | )   |              |   | 21    |              |   |   | (17          | )  |   |       |     |   |  |   | (14   | )  
|Interest expense                                                                                                                                     |                |                            |      |     |              |   |       |              |   |   |              |    |   |       |      |   |  |   |       |    
|                                                                                                                                                     | Long-term debt |                            |      | (16 | )            |   |       |             |   |   |              | (6 | ) |       |      |  |  |   |       | (22 | )
|                                                                                                                                                     | Other          |                            |      | (1  | )            |   |       | (17          | ) |   |              | 12 |   |       |      |  |  |   |       | (6  | )
|                                                                                                                                                     |                |                            |      |     |              |   |       |              |   |   |              |    |   |       |     
|Earnings (loss) from continuing operations before income taxes,
    minority interests and equity in net earnings (loss) of
    associated companies |                |                            | (130 | )   |              |   | 141   |              |   |   | 46           |    |   |       |     |   |  |   | 57    |    
|Income tax benefit (expense)                                                                                                                         |                |                            | 9    |     |              |   | (1    | )            |   |   | (15          | )  |   |       |     |   |  |   | (7    | )  
|                                                                                                                                                     |                |                            |      |     |              |   |       |              |   |   |              |    |   |       |     
|                                                                                                                                                     |                |                            | (121 | )   |              |   | 140   |              |   |   | 31           |    |   |       |     |   |  |   | 50    |    
|Minority interests  net of tax                                                                                                                      |                |                            |     |     |              |   |      |              |   |   | (1           | )  |   |       |     |   |  |   | (1    | )  
|Equity in net earnings (loss) of associated
    companies  net of tax                                                                               |                |                            | 169  |     |              |   | 287   |              |   |   | (8           | )  |   |       | (449 | ) |  |   | (1    | )  
|                                                                                                                                                     |                |                            |      |     |              |   |       |              |   |   |              |    |   |       |     
|Net earnings (loss) from continuing operations                                                                                                       |                |                            | 48   |     |              |   | 427   |              |   |   | 22           |    |   |       | (449 | ) |  |   | 48    |    
|Net earnings (loss) from discontinued
    operations  net of tax                                                                                    |                |                            | 6    |     |              |   | 3     |              |   |   |             |    |   |       | (3   | ) |  |   | 6     |    
|                                                                                                                                                     |                |                            |      |     |              |   |       |              |   |   |              |    |   |       |     
|Net earnings (loss)                                                                                                                                  |                |                            | 54   |     |              |   | 430   |              |   |   | 22           |    |   |       | (452 | ) |  |   | 54    |    
|Dividends on preferred shares                                                                                                                        |                |                            | 7    |     |              |   |      |              |   |   |             |    |   |       |     |   |  |   | 7     |    
|                                                                                                                                                     |                |                            |      |     |              |   |       |              |   |   |              |    |   |       |     
|Net earnings (loss) applicable to common shares                                                                                                      |                | $                          | 47   |     |              | $ | 430   |              |   | $ | 22           |    |   | $     | (452 | ) |  | $ | 47    |    
|                                                                                                                                                     |                |                            |      |     |              |   |       |              |   |   |              |    |   |       |     

50



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##### Table of Contents



NORTEL NETWORKS LIMITED


Notes to Consolidated Financial
Statements  (Continued)




|                                                                                                                                                     |                |                            |       |     |              |   |       |              |   |   |              |     |   |       |        |   |  |   |       |     |  
|---------------------------------------------------------------------------------------------------------------------------------------------------- | -------------- | -------------------------- | ----- | --- | ------------ | - | ----- | ------------ | - | - | ------------ | --- | - | ----- | ------ | - |  | - | ----- | --- | -
|                                                                                                                                                     |                | Nortel                     |       |     |              |   | Non-  |              |   |   |              |    
|                                                                                                                                                     |                | Networks                   |       |     | Guarantor    |   |       | Guarantor    |   |   |              |     |  
|                                                                                                                                                     |                | Limited                    |       |     | Subsidiaries |   |       | Subsidiaries |   |   | Eliminations |     |   | Total |       
|                                                                                                                                                     |                |                            |       |     |              |   |       |              |   |   |              |     |   |       |       
|                                                                                                                                                     |                | (Millions of U.S. dollars) |      
|Revenues                                                                                                                                             |                | $                          | 1,906 |     |              | $ | 3,543 |              |   | $ | 1,984        |     |   | $     | (2,042 | ) |  | $ | 5,391 |    
|Cost of revenues                                                                                                                                     |                |                            | 947   |     |              |   | 2,632 |              |   |   | 1,590        |     |   |       | (2,042 | ) |  |   | 3,127 |    
|                                                                                                                                                     |                |                            |       |     |              |   |       |              |   |   |              |     |   |       |       
|Gross profit                                                                                                                                         |                |                            | 959   |     |              |   | 911   |              |   |   | 394          |     |   |       |       |   |  |   | 2,264 |    
|Selling, general and administrative expense                                                                                                          |                |                            | 247   |     |              |   | 667   |              |   |   | 232          |     |   |       |       |   |  |   | 1,146 |    
|Research and development expense                                                                                                                     |                |                            | 393   |     |              |   | 414   |              |   |   | 138          |     |   |       |       |   |  |   | 945   |    
|Amortization of intangibles                                                                                                                          |                |                            |      |     |              |   |      |              |   |   | 4            |     |   |       |       |   |  |   | 4     |    
|Special charges                                                                                                                                      |                |                            | 2     |     |              |   | 91    |              |   |   | 18           |     |   |       |       |   |  |   | 111   |    
|(Gain) loss on sale of businesses and assets                                                                                                         |                |                            | 33    |     |              |   | 4     |              |   |   |             |     |   |       |       |   |  |   | 37    |    
|                                                                                                                                                     |                |                            |       |     |              |   |       |              |   |   |              |     |   |       |       
|Operating earnings (loss)                                                                                                                            |                |                            | 284   |     |              |   | (265  | )            |   |   | 2            |     |   |       |       |   |  |   | 21    |    
|Other income (expense)  net                                                                                                                         |                |                            | 21    |     |              |   | 80    |              |   |   | 7            |     |   |       |       |   |  |   | 108   |    
|Interest expense                                                                                                                                     |                |                            |       |     |              |   |       |              |   |   |              |     |   |       |        |   |  |   |       |    
|                                                                                                                                                     | Long-term debt |                            |       | (39 | )            |   |       | (6           | ) |   |              | (14 | ) |       |        |  |  |   |       | (59 | )
|                                                                                                                                                     | Other          |                            |       | (7  | )            |   |       | (23          | ) |   |              | 28  |   |       |        |  |  |   |       | (2  | )
|                                                                                                                                                     |                |                            |       |     |              |   |       |              |   |   |              |     |   |       |       
|Earnings (loss) from continuing operations before income taxes,
    minority interests and equity in net earnings (loss) of
    associated companies |                |                            | 259   |     |              |   | (214  | )            |   |   | 23           |     |   |       |       |   |  |   | 68    |    
|Income tax benefit (expense)                                                                                                                         |                |                            | (51   | )   |              |   | (15   | )            |   |   | 58           |     |   |       |       |   |  |   | (8    | )  
|                                                                                                                                                     |                |                            |       |     |              |   |       |              |   |   |              |     |   |       |       
|                                                                                                                                                     |                |                            | 208   |     |              |   | (229  | )            |   |   | 81           |     |   |       |       |   |  |   | 60    |    
|Minority interests  net of tax                                                                                                                      |                |                            |      |     |              |   |      |              |   |   | (13          | )   |   |       |       |   |  |   | (13   | )  
|Equity in net earnings (loss) of associated
    companies  net of tax                                                                               |                |                            | (159  | )   |              |   | 172   |              |   |   | 44           |     |   |       | (55    | ) |  |   | 2     |    
|                                                                                                                                                     |                |                            |       |     |              |   |       |              |   |   |              |     |   |       |       
|Net earnings (loss) from continuing operations                                                                                                       |                |                            | 49    |     |              |   | (57   | )            |   |   | 112          |     |   |       | (55    | ) |  |   | 49    |    
|Net earnings (loss) from discontinued
    operations  net of tax                                                                                    |                |                            | 1     |     |              |   |      |              |   |   |             |     |   |       |       |   |  |   | 1     |    
|                                                                                                                                                     |                |                            |       |     |              |   |       |              |   |   |              |     |   |       |       
|Net earnings (loss)                                                                                                                                  |                |                            | 50    |     |              |   | (57   | )            |   |   | 112          |     |   |       | (55    | ) |  |   | 50    |    
|Dividends on preferred shares                                                                                                                        |                |                            | 19    |     |              |   |      |              |   |   |             |     |   |       |       |   |  |   | 19    |    
|                                                                                                                                                     |                |                            |       |     |              |   |       |              |   |   |              |     |   |       |       
|Net earnings (loss) applicable to common shares                                                                                                      |                | $                          | 31    |     |              | $ | (57   | )            |   | $ | 112          |     |   | $     | (55    | ) |  | $ | 31    |    
|                                                                                                                                                     |                |                            |       |     |              |   |       |              |   |   |              |     |   |       |       

51



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##### Table of Contents



NORTEL NETWORKS LIMITED


Notes to Consolidated Financial
Statements  (Continued)




|                                                                                                                                                     |                |                            |       |     |              |   |       |              |   |   |              |     |   |       |        |   |  |   |       |     |  
|---------------------------------------------------------------------------------------------------------------------------------------------------- | -------------- | -------------------------- | ----- | --- | ------------ | - | ----- | ------------ | - | - | ------------ | --- | - | ----- | ------ | - |  | - | ----- | --- | -
|                                                                                                                                                     |                | Nortel                     |       |     |              |   | Non-  |              |   |   |              |    
|                                                                                                                                                     |                | Networks                   |       |     | Guarantor    |   |       | Guarantor    |   |   |              |     |  
|                                                                                                                                                     |                | Limited                    |       |     | Subsidiaries |   |       | Subsidiaries |   |   | Eliminations |     |   | Total |       
|                                                                                                                                                     |                |                            |       |     |              |   |       |              |   |   |              |     |   |       |       
|                                                                                                                                                     |                | (Millions of U.S. dollars) |      
|Revenues                                                                                                                                             |                | $                          | 1,664 |     |              | $ | 3,481 |              |   | $ | 1,824        |     |   | $     | (1,935 | ) |  | $ | 5,034 |    
|Cost of revenues                                                                                                                                     |                |                            | 1,008 |     |              |   | 2,355 |              |   |   | 1,482        |     |   |       | (1,935 | ) |  |   | 2,910 |    
|                                                                                                                                                     |                |                            |       |     |              |   |       |              |   |   |              |     |   |       |       
|Gross profit                                                                                                                                         |                |                            | 656   |     |              |   | 1,126 |              |   |   | 342          |     |   |       |       |   |  |   | 2,124 |    
|Selling, general and administrative expense                                                                                                          |                |                            | 213   |     |              |   | 644   |              |   |   | 219          |     |   |       |       |   |  |   | 1,076 |    
|Research and development expense                                                                                                                     |                |                            | 424   |     |              |   | 391   |              |   |   | 140          |     |   |       |       |   |  |   | 955   |    
|Amortization of intangibles                                                                                                                          |                |                            |      |     |              |   |      |              |   |   | 5            |     |   |       |       |   |  |   | 5     |    
|Special charges                                                                                                                                      |                |                            | 4     |     |              |   | (4    | )            |   |   | 6            |     |   |       |       |   |  |   | 6     |    
|(Gain) loss on sale of businesses and assets                                                                                                         |                |                            |      |     |              |   | (1    | )            |   |   | (74          | )   |   |       |       |   |  |   | (75   | )  
|                                                                                                                                                     |                |                            |       |     |              |   |       |              |   |   |              |     |   |       |       
|Operating earnings (loss)                                                                                                                            |                |                            | 15    |     |              |   | 96    |              |   |   | 46           |     |   |       |       |   |  |   | 157   |    
|Other income (expense)  net                                                                                                                         |                |                            | 15    |     |              |   | 81    |              |   |   | (22          | )   |   |       |       |   |  |   | 74    |    
|Interest expense                                                                                                                                     |                |                            |       |     |              |   |       |              |   |   |              |     |   |       |        |   |  |   |       |    
|                                                                                                                                                     | Long-term debt |                            |       | (32 | )            |   |       | (1           | ) |   |              | (13 | ) |       |        |  |  |   |       | (46 | )
|                                                                                                                                                     | Other          |                            |       | (1  | )            |   |       | (37          | ) |   |              | 24  |   |       |        |  |  |   |       | (14 | )
|                                                                                                                                                     |                |                            |       |     |              |   |       |              |   |   |              |     |   |       |       
|Earnings (loss) from continuing operations before income taxes,
    minority interests and equity in net earnings (loss) of
    associated companies |                |                            | (3    | )   |              |   | 139   |              |   |   | 35           |     |   |       |       |   |  |   | 171   |    
|Income tax benefit (expense)                                                                                                                         |                |                            | 46    |     |              |   | (26   | )            |   |   | (18          | )   |   |       |       |   |  |   | 2     |    
|                                                                                                                                                     |                |                            |       |     |              |   |       |              |   |   |              |     |   |       |       
|                                                                                                                                                     |                |                            | 43    |     |              |   | 113   |              |   |   | 17           |     |   |       |       |   |  |   | 173   |    
|Minority interests  net of tax                                                                                                                      |                |                            |      |     |              |   |      |              |   |   | (7           | )   |   |       |       |   |  |   | (7    | )  
|Equity in net earnings (loss) of associated
    companies  net of tax                                                                               |                |                            | 121   |     |              |   | 174   |              |   |   | (6           | )   |   |       | (291   | ) |  |   | (2    | )  
|                                                                                                                                                     |                |                            |       |     |              |   |       |              |   |   |              |     |   |       |       
|Net earnings (loss) from continuing operations                                                                                                       |                |                            | 164   |     |              |   | 287   |              |   |   | 4            |     |   |       | (291   | ) |  |   | 164   |    
|Net earnings (loss) from discontinued
    operations  net of tax                                                                                    |                |                            | 7     |     |              |   | 4     |              |   |   |             |     |   |       | (4     | ) |  |   | 7     |    
|                                                                                                                                                     |                |                            |       |     |              |   |       |              |   |   |              |     |   |       |       
|Net earnings (loss)                                                                                                                                  |                |                            | 171   |     |              |   | 291   |              |   |   | 4            |     |   |       | (295   | ) |  |   | 171   |    
|Dividends on preferred shares                                                                                                                        |                |                            | 16    |     |              |   |      |              |   |   |             |     |   |       |       |   |  |   | 16    |    
|                                                                                                                                                     |                |                            |       |     |              |   |       |              |   |   |              |     |   |       |       
|Net earnings (loss) applicable to common shares                                                                                                      |                | $                          | 155   |     |              | $ | 291   |              |   | $ | 4            |     |   | $     | (295   | ) |  | $ | 155   |    
|                                                                                                                                                     |                |                            |       |     |              |   |       |              |   |   |              |     |   |       |       

52



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##### Table of Contents



NORTEL NETWORKS LIMITED


Notes to Consolidated Financial
Statements  (Continued)




|                                              |                                                |                            |         |        |              |   |         |              |  |   |              |       |  |       |        |        |   |   |         |       | 
|--------------------------------------------- | ---------------------------------------------- | -------------------------- | ------- | ------ | ------------ | - | ------- | ------------ |  | - | ------------ | ----- |  | ----- | ------ | ------ | - | - | ------- | ----- | 
|                                              |                                                | Nortel                     |         |        |              |   | Non-    |              |  |   |              |      
|                                              |                                                | Networks                   |         |        | Guarantor    |   |         | Guarantor    |  |   |              |       | 
|                                              |                                                | Limited                    |         |        | Subsidiaries |   |         | Subsidiaries |  |   | Eliminations |       |  | Total |       
|                                              |                                                |                            |         |        |              |   |         |              |  |   |              |       |  |       |       
|                                              |                                                | (Millions of U.S. dollars) |        
|ASSETS                                       
|Current assets                                |                                                |                            |         |        |              |   |         |              |  |   |              |       |  |       |        |        |   |   |         |      
|                                              | Cash and cash equivalents                      |                            | $       | 34     |              |   | $       | 1,846        |  |   | $            | 1,099 |  |       | $      |       |   |   | $       | 2,979 | 
|                                              | Restricted cash and cash equivalents           |                            |         | 44     |              |   |         | 21           |  |   |              | 8     |  |       |        |       |   |   |         | 73    | 
|                                              | Accounts receivable  net                      |                            |         | 727    |              |   |         | 1,234        |  |   |              | 774   |  |       |        |       |   |   |         | 2,735 | 
|                                              | Intercompany/related party accounts receivable |                            |         | 521    |              |   |         | 969          |  |   |              | 769   |  |       |        | (1,977 | ) |   |         | 282   | 
|                                              | Inventories  net                              |                            |         | 222    |              |   |         | 627          |  |   |              | 466   |  |       |        |       |   |   |         | 1,315 | 
|                                              | Deferred income taxes  net                    |                            |         | 44     |              |   |         | 215          |  |   |              |      |  |       |        |       |   |   |         | 259   | 
|                                              | Other current assets                           |                            |         | 88     |              |   |         | 200          |  |   |              | 231   |  |       |        |       |   |   |         | 519   | 
|                                              |                                                |                            |         |        |              |   |         |              |  |   |              |       |  |       |       
|Total current assets                          |                                                |                            | 1,680   |        |              |   | 5,112   |              |  |   | 3,347        |       |  |       | (1,977 | )      |   |   | 8,162   |      
|Investments                                   |                                                |                            | 1,879   |        |              |   | (6,483  | )            |  |   | 585          |       |  |       | 4,173  |        |   |   | 154     |      
|Intercompany advances                         |                                                |                            | 403     |        |              |   | 1,073   |              |  |   | 2,088        |       |  |       | (3,564 | )      |   |   |        |      
|Plant and equipment  net                     |                                                |                            | 451     |        |              |   | 745     |              |  |   | 381          |       |  |       |       |        |   |   | 1,577   |      
|Goodwill                                      |                                                |                            |        |        |              |   | 1,907   |              |  |   | 435          |       |  |       |       |        |   |   | 2,342   |      
|Intangible assets  net                       |                                                |                            | 36      |        |              |   | 1       |              |  |   | 117          |       |  |       |       |        |   |   | 154     |      
|Deferred income taxes  net                   |                                                |                            | 1,786   |        |              |   | 1,770   |              |  |   | 76           |       |  |       |       |        |   |   | 3,632   |      
|Other assets                                  |                                                |                            | (52     | )      |              |   | 269     |              |  |   | 340          |       |  |       |       |        |   |   | 557     |      
|                                              |                                                |                            |         |        |              |   |         |              |  |   |              |       |  |       |       
|Total assets                                  |                                                | $                          | 6,183   |        |              | $ | 4,394   |              |  | $ | 7,369        |       |  | $     | (1,368 | )      |   | $ | 16,578  |      
|                                              |                                                |                            |         |        |              |   |         |              |  |   |              |       |  |       |       
|                                             
|LIABILITIES AND SHAREHOLDERS EQUITY         
|Current liabilities                           |                                                |                            |         |        |              |   |         |              |  |   |              |       |  |       |        |        |   |   |         |      
|                                              | Trade and other accounts payable               |                            | $       | 580    |              |   | $       | 527          |  |   | $            | 35    |  |       | $      |       |   |   | $       | 1,142 | 
|                                              | Intercompany/related party accounts payable    |                            |         | (3,732 | )            |   |         | 3,529        |  |   |              | 2,180 |  |       |        | (1,977 | ) |   |         |      | 
|                                              | Payroll and benefit-related liabilities        |                            |         | 87     |              |   |         | 371          |  |   |              | 133   |  |       |        |       |   |   |         | 591   | 
|                                              | Contractual liabilities                        |                            |         | 121    |              |   |         | 146          |  |   |              | 169   |  |       |        |       |   |   |         | 436   | 
|                                              | Restructuring liabilities                      |                            |         | 13     |              |   |         | 113          |  |   |              | 17    |  |       |        |       |   |   |         | 143   | 
|                                              | Other accrued liabilities                      |                            |         | 332    |              |   |         | 1,644        |  |   |              | 631   |  |       |        |       |   |   |         | 2,607 | 
|                                              | Long-term debt due within one year             |                            |         | 1,297  |              |   |         | 12           |  |   |              | 140   |  |       |        |       |   |   |         | 1,449 | 
|                                              |                                                |                            |         |        |              |   |         |              |  |   |              |       |  |       |       
|Total current liabilities                     |                                                |                            | (1,302  | )      |              |   | 6,342   |              |  |   | 3,305        |       |  |       | (1,977 | )      |   |   | 6,368   |      
|Long-term debt                                |                                                |                            | 224     |        |              |   | 116     |              |  |   | 298          |       |  |       |       |        |   |   | 638     |      
|Deferred income taxes  net                   |                                                |                            |        |        |              |   | 112     |              |  |   | 38           |       |  |       |       |        |   |   | 150     |      
|Other liabilities                             |                                                |                            | 1,267   |        |              |   | 1,832   |              |  |   | 229          |       |  |       |       |        |   |   | 3,328   |      
|Intercompany advances                         |                                                |                            |        |        |              |   | 297     |              |  |   | 3,267        |       |  |       | (3,564 | )      |   |   |        |      
|                                              |                                                |                            |         |        |              |   |         |              |  |   |              |       |  |       |       
|Total liabilities                             |                                                |                            | 189     |        |              |   | 8,699   |              |  |   | 7,137        |       |  |       | (5,541 | )      |   |   | 10,484  |      
|                                              |                                                |                            |         |        |              |   |         |              |  |   |              |       |  |       |       
|Minority interests in subsidiary companies    |                                                |                            |        |        |              |   |        |              |  |   | 100          |       |  |       |       |        |   |   | 100     |      
|                                             
|SHAREHOLDERS EQUITY                         
|Preferred shares                              |                                                |                            | 536     |        |              |   | 237     |              |  |   |             |       |  |       | (237   | )      |   |   | 536     |      
|Common shares                                 |                                                |                            | 1,211   |        |              |   | 5,416   |              |  |   | 1,626        |       |  |       | (7,042 | )      |   |   | 1,211   |      
|Additional paid-in capital                    |                                                |                            | 22,144  |        |              |   | 799     |              |  |   | 4,658        |       |  |       | (5,457 | )      |   |   | 22,144  |      
|Accumulated deficit                           |                                                |                            | (16,961 | )      |              |   | (11,256 | )            |  |   | (6,296       | )     |  |       | 17,552 |        |   |   | (16,961 | )    
|Accumulated other comprehensive income (loss) |                                                |                            | (936    | )      |              |   | 499     |              |  |   | 144          |       |  |       | (643   | )      |   |   | (936    | )    
|                                              |                                                |                            |         |        |              |   |         |              |  |   |              |       |  |       |       
|Total shareholders equity                    |                                                |                            | 5,994   |        |              |   | (4,305  | )            |  |   | 132          |       |  |       | 4,173  |        |   |   | 5,994   |      
|                                              |                                                |                            |         |        |              |   |         |              |  |   |              |       |  |       |       
|Total liabilities and shareholders equity    |                                                | $                          | 6,183   |        |              | $ | 4,394   |              |  | $ | 7,369        |       |  | $     | (1,368 | )      |   | $ | 16,578  |      
|                                              |                                                |                            |         |        |              |   |         |              |  |   |              |       |  |       |       

53



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##### Table of Contents



NORTEL NETWORKS LIMITED


Notes to Consolidated Financial
Statements  (Continued)




|                                              |                                                |                            |         |        |              |   |         |              |  |   |              |       |   |       |        |        |   |   |         |       | 
|--------------------------------------------- | ---------------------------------------------- | -------------------------- | ------- | ------ | ------------ | - | ------- | ------------ |  | - | ------------ | ----- | - | ----- | ------ | ------ | - | - | ------- | ----- | 
|                                              |                                                | Nortel                     |         |        |              |   | Non-    |              |  |   |              |      
|                                              |                                                | Networks                   |         |        | Guarantor    |   |         | Guarantor    |  |   |              |       |  
|                                              |                                                | Limited                    |         |        | Subsidiaries |   |         | Subsidiaries |  |   | Eliminations |       |   | Total |       
|                                              |                                                |                            |         |        |              |   |         |              |  |   |              |       |   |       |       
|                                              |                                                | (Millions of U.S. dollars) |        
|ASSETS                                       
|Current assets                                |                                                |                            |         |        |              |   |         |              |  |   |              |       |   |       |        |        |   |   |         |      
|                                              | Cash and cash equivalents                      |                            | $       | (2     | )            |   | $       | 2,414        |  |   | $            | 1,195 |   |       | $      |       |   |   | $       | 3,607 | 
|                                              | Restricted cash and cash equivalents           |                            |         | 52     |              |   |         | 20           |  |   |              | 8     |   |       |        |       |   |   |         | 80    | 
|                                              | Accounts receivable  net                      |                            |         | 476    |              |   |         | 1,244        |  |   |              | 831   |   |       |        |       |   |   |         | 2,551 | 
|                                              | Intercompany/related party accounts receivable |                            |         | 541    |              |   |         | 1,135        |  |   |              | 776   |   |       |        | (2,203 | ) |   |         | 249   | 
|                                              | Inventories  net                              |                            |         | 298    |              |   |         | 608          |  |   |              | 508   |   |       |        |       |   |   |         | 1,414 | 
|                                              | Deferred income taxes  net                    |                            |         | 45     |              |   |         | 211          |  |   |              | (1    | ) |       |        |       |   |   |         | 255   | 
|                                              | Other current assets                           |                            |         | 33     |              |   |         | 166          |  |   |              | 156   |   |       |        |       |   |   |         | 355   | 
|                                              |                                                |                            |         |        |              |   |         |              |  |   |              |       |   |       |       
|Total current assets                          |                                                |                            | 1,443   |        |              |   | 5,798   |              |  |   | 3,473        |       |   |       | (2,203 | )      |   |   | 8,511   |      
|Investments                                   |                                                |                            | 2,222   |        |              |   | (6,772  | )            |  |   | 508          |       |   |       | 4,201  |        |   |   | 159     |      
|Intercompany advances                         |                                                |                            | 346     |        |              |   | 1,102   |              |  |   | 2,066        |       |   |       | (3,514 | )      |   |   |        |      
|Plant and equipment  net                     |                                                |                            | 480     |        |              |   | 771     |              |  |   | 395          |       |   |       |       |        |   |   | 1,646   |      
|Goodwill                                      |                                                |                            |        |        |              |   | 1,946   |              |  |   | 177          |       |   |       |       |        |   |   | 2,123   |      
|Intangible assets  net                       |                                                |                            | 37      |        |              |   | 1       |              |  |   | 40           |       |   |       |       |        |   |   | 78      |      
|Deferred income taxes  net                   |                                                |                            | 1,824   |        |              |   | 1,814   |              |  |   | 98           |       |   |       |       |        |   |   | 3,736   |      
|Other assets                                  |                                                |                            | 80      |        |              |   | 288     |              |  |   | 323          |       |   |       |       |        |   |   | 691     |      
|                                              |                                                |                            |         |        |              |   |         |              |  |   |              |       |   |       |       
|Total assets                                  |                                                | $                          | 6,432   |        |              | $ | 4,948   |              |  | $ | 7,080        |       |   | $     | (1,516 | )      |   | $ | 16,944  |      
|                                              |                                                |                            |         |        |              |   |         |              |  |   |              |       |   |       |       
|                                             
|LIABILITIES AND SHAREHOLDERS EQUITY         
|Current liabilities                           |                                                |                            |         |        |              |   |         |              |  |   |              |       |   |       |        |        |   |   |         |      
|                                              | Trade and other accounts payable               |                            | $       | 486    |              |   | $       | 391          |  |   | $            | 118   |   |       | $      |       |   |   | $       | 995   | 
|                                              | Intercompany/related party accounts payable    |                            |         | (3,561 | )            |   |         | 3,626        |  |   |              | 2,138 |   |       |        | (2,203 | ) |   |         |      | 
|                                              | Payroll and benefit-related liabilities        |                            |         | 68     |              |   |         | 306          |  |   |              | 138   |   |       |        |       |   |   |         | 512   | 
|                                              | Contractual liabilities                        |                            |         | 175    |              |   |         | 218          |  |   |              | 175   |   |       |        |       |   |   |         | 568   | 
|                                              | Restructuring liabilities                      |                            |         | 32     |              |   |         | 184          |  |   |              | 38    |   |       |        |       |   |   |         | 254   | 
|                                              | Other accrued liabilities                      |                            |         | 380    |              |   |         | 1,642        |  |   |              | 766   |   |       |        |       |   |   |         | 2,788 | 
|                                              | Long-term debt due within one year             |                            |         | 13     |              |   |         | 12           |  |   |              | (10   | ) |       |        |       |   |   |         | 15    | 
|                                              |                                                |                            |         |        |              |   |         |              |  |   |              |       |   |       |       
|Total current liabilities                     |                                                |                            | (2,407  | )      |              |   | 6,379   |              |  |   | 3,363        |       |   |       | (2,203 | )      |   |   | 5,132   |      
|Long-term debt                                |                                                |                            | 1,520   |        |              |   | 120     |              |  |   | 422          |       |   |       |       |        |   |   | 2,062   |      
|Deferred income taxes  net                   |                                                |                            |        |        |              |   | 108     |              |  |   | 35           |       |   |       |       |        |   |   | 143     |      
|Other liabilities                             |                                                |                            | 995     |        |              |   | 1,928   |              |  |   | 266          |       |   |       |       |        |   |   | 3,189   |      
|Intercompany advances                         |                                                |                            |        |        |              |   | 297     |              |  |   | 3,217        |       |   |       | (3,514 | )      |   |   |        |      
|                                              |                                                |                            |         |        |              |   |         |              |  |   |              |       |   |       |       
|Total liabilities                             |                                                |                            | 108     |        |              |   | 8,832   |              |  |   | 7,303        |       |   |       | (5,717 | )      |   |   | 10,526  |      
|                                              |                                                |                            |         |        |              |   |         |              |  |   |              |       |   |       |       
|Minority interests in subsidiary companies    |                                                |                            |        |        |              |   |        |              |  |   | 94           |       |   |       |       |        |   |   | 94      |      
|                                             
|SHAREHOLDERS EQUITY                         
|Preferred shares                              |                                                |                            | 536     |        |              |   | 237     |              |  |   |             |       |   |       | (237   | )      |   |   | 536     |      
|Common shares                                 |                                                |                            | 1,211   |        |              |   | 5,417   |              |  |   | 1,622        |       |   |       | (7,039 | )      |   |   | 1,211   |      
|Additional paid-in capital                    |                                                |                            | 22,107  |        |              |   | 775     |              |  |   | 4,243        |       |   |       | (5,018 | )      |   |   | 22,107  |      
|Accumulated deficit                           |                                                |                            | (16,992 | )      |              |   | (10,931 | )            |  |   | (6,450       | )     |   |       | 17,381 |        |   |   | (16,992 | )    
|Accumulated other comprehensive income (loss) |                                                |                            | (538    | )      |              |   | 618     |              |  |   | 268          |       |   |       | (886   | )      |   |   | (538    | )    
|                                              |                                                |                            |         |        |              |   |         |              |  |   |              |       |   |       |       
|Total shareholders equity                    |                                                |                            | 6,324   |        |              |   | (3,884  | )            |  |   | (317         | )     |   |       | 4,201  |        |   |   | 6,324   |      
|                                              |                                                |                            |         |        |              |   |         |              |  |   |              |       |   |       |       
|Total liabilities and shareholders equity    |                                                | $                          | 6,432   |        |              | $ | 4,948   |              |  | $ | 7,080        |       |   | $     | (1,516 | )      |   | $ | 16,944  |      
|                                              |                                                |                            |         |        |              |   |         |              |  |   |              |       |   |       |       

54



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##### Table of Contents



NORTEL NETWORKS LIMITED


Notes to Consolidated Financial
Statements  (Continued)




|                                                                            |                                                                                                                                                                                                   |                                                                             |    |     |              |   |       |              |      |   |              |      |      |       |   |     |    |   |       |      |      |  
|--------------------------------------------------------------------------- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | --------------------------------------------------------------------------- | -- | --- | ------------ | - | ----- | ------------ | ---- | - | ------------ | ---- | ---- | ----- | - | --- | -- | - | ----- | ---- | ---- | -
|                                                                            |                                                                                                                                                                                                   | Nortel                                                                      |    |     |              |   | Non-  |              |      |   |              |     
|                                                                            |                                                                                                                                                                                                   | Networks                                                                    |    |     | Guarantor    |   |       | Guarantor    |      |   |              |      |     
|                                                                            |                                                                                                                                                                                                   | Limited                                                                     |    |     | Subsidiaries |   |       | Subsidiaries |      |   | Eliminations |      |      | Total |  
|                                                                            |                                                                                                                                                                                                   |                                                                             |    |     |              |   |       |              |      |   |              |      |      |       |  
|                                                                            |                                                                                                                                                                                                   | (Millions of U.S. dollars)                                                  |   
|Cash flows from (used in) operating activities                              |                                                                                                                                                                                                   |                                                                             |    |     |              |   |       |              |      |   |              |      |      |       |   |     |    |   |       |     
|                                                                            | Net earnings (loss) from continuing operations                                                                                                                                                    |                                                                             | $  | 49  |              |   | $     | (57          | )    |   | $            | 112  |      |       | $ | (55 | )  |   | $     | 49   |     
|                                                                            | Adjustments to reconcile net earnings (loss) from continuing
    operations to net cash from (used in) operating activities, net
    of effects from acquisitions and divestitures of businesses: |                                                                             |    |     |              |   |       |              |      |   |              |      |      |       |   |     |    |   |       |      |     
|                                                                            |                                                                                                                                                                                                   | Amortization and depreciation                                               |    |     | 21           |   |       |              | 91   |   |              |      | 48   |       |   |     |   |   |       |      | 160  |  
|                                                                            |                                                                                                                                                                                                   | Non-cash portion of special charges and related asset write downs           |    |     | (8           | ) |       |              | 7    |   |              |      | 3    |       |   |     |   |   |       |      | 2    |  
|                                                                            |                                                                                                                                                                                                   | Equity in net earnings (loss) of associated
    companies  net of tax      |    |     | 159          |   |       |              | (172 | ) |              |      | (44  | )     |   |     | 55 |   |       |      | (2   | )
|                                                                            |                                                                                                                                                                                                   | Stock option compensation                                                   |    |     | 6            |   |       |              | 23   |   |              |      | 8    |       |   |     |   |   |       |      | 37   |  
|                                                                            |                                                                                                                                                                                                   | Deferred income taxes                                                       |    |     |             |   |       |              | 10   |   |              |      | 4    |       |   |     |   |   |       |      | 14   |  
|                                                                            |                                                                                                                                                                                                   | Other liabilities                                                           |    |     | 50           |   |       |              | 122  |   |              |      | 7    |       |   |     |   |   |       |      | 179  |  
|                                                                            |                                                                                                                                                                                                   | (Gain) loss on sale or write down of investments, businesses and
    assets |    |     | 33           |   |       |              | (13  | ) |              |      | 1    |       |   |     |   |   |       |      | 21   |  
|                                                                            |                                                                                                                                                                                                   | Other  net                                                                 |    |     | (159         | ) |       |              | 117  |   |              |      | (40  | )     |   |     |   |   |       |      | (82  | )
|                                                                            |                                                                                                                                                                                                   | Change in operating assets and liabilities                                  |    |     | (154         | ) |       |              | (186 | ) |              |      | (198 | )     |   |     |   |   |       |      | (538 | )
|                                                                            |                                                                                                                                                                                                   | Intercompany/related party activity                                         |    |     | (95          | ) |       |              | (436 | ) |              |      | 531  |       |   |     |   |   |       |      |     |  
|                                                                            |                                                                                                                                                                                                   |                                                                             |    |     |              |   |       |              |      |   |              |      |      |       |  
|                                                                            | Net cash from (used in) operating activities of continuing
    operations                                                                                                                         |                                                                             |    | (98 | )            |   |       | (494         | )    |   |              | 432  |      |       |   |    |    |   |       | (160 | )   
|                                                                            |                                                                                                                                                                                                   |                                                                             |    |     |              |   |       |              |      |   |              |      |      |       |  
|Cash flows from (used in) investing activities                              |                                                                                                                                                                                                   |                                                                             |    |     |              |   |       |              |      |   |              |      |      |       |   |     |    |   |       |     
|                                                                            | Expenditures for plant and equipment                                                                                                                                                              |                                                                             |    | (10 | )            |   |       | (68          | )    |   |              | (41  | )    |       |   |    |    |   |       | (119 | )   
|                                                                            | Proceeds on disposals of plant and equipment                                                                                                                                                      |                                                                             |    | 9   |              |   |       | 1            |      |   |              |     |      |       |   |    |    |   |       | 10   |     
|                                                                            | Restricted cash and cash equivalents                                                                                                                                                              |                                                                             |    | 9   |              |   |       |             |      |   |              |     |      |       |   |    |    |   |       | 9    |     
|                                                                            | Acquisitions of investments and businesses-net of cash acquired                                                                                                                                   |                                                                             |    |    |              |   |       | (8           | )    |   |              | (440 | )    |       |   |    |    |   |       | (448 | )   
|                                                                            | Proceeds on sale of investments and businesses                                                                                                                                                    |                                                                             |    | 131 |              |   |       | 36           |      |   |              |     |      |       |   |    |    |   |       | 167  |     
|                                                                            |                                                                                                                                                                                                   |                                                                             |    |     |              |   |       |              |      |   |              |      |      |       |  
|                                                                            | Net cash from (used in) investing activities of continuing
    operations                                                                                                                         |                                                                             |    | 139 |              |   |       | (39          | )    |   |              | (481 | )    |       |   |    |    |   |       | (381 | )   
|                                                                            |                                                                                                                                                                                                   |                                                                             |    |     |              |   |       |              |      |   |              |      |      |       |  
|Cash flows from (used in) financing activities                              |                                                                                                                                                                                                   |                                                                             |    |     |              |   |       |              |      |   |              |      |      |       |   |     |    |   |       |     
|                                                                            | Dividends paid                                                                                                                                                                                    |                                                                             |    | (19 | )            |   |       |             |      |   |              | (5   | )    |       |   |    |    |   |       | (24  | )   
|                                                                            | Increase in notes payable                                                                                                                                                                         |                                                                             |    |    |              |   |       |             |      |   |              | 38   |      |       |   |    |    |   |       | 38   |     
|                                                                            | Decrease in notes payable                                                                                                                                                                         |                                                                             |    |    |              |   |       |             |      |   |              | (46  | )    |       |   |    |    |   |       | (46  | )   
|                                                                            | Repayments of capital leases payable                                                                                                                                                              |                                                                             |    | 2   |              |   |       | (4           | )    |   |              | (2   | )    |       |   |    |    |   |       | (4   | )   
|                                                                            |                                                                                                                                                                                                   |                                                                             |    |     |              |   |       |              |      |   |              |      |      |       |  
|                                                                            | Net cash from (used in) financing activities of continuing
    operations                                                                                                                         |                                                                             |    | (17 | )            |   |       | (4           | )    |   |              | (15  | )    |       |   |    |    |   |       | (36  | )   
|                                                                            |                                                                                                                                                                                                   |                                                                             |    |     |              |   |       |              |      |   |              |      |      |       |  
|Effect of foreign exchange rate changes on cash and cash
    equivalents    |                                                                                                                                                                                                   |                                                                             | (1 | )   |              |   | (53   | )            |      |   | (31          | )    |      |       |  |     |    |   | (85   | )   
|                                                                            |                                                                                                                                                                                                   |                                                                             |    |     |              |   |       |              |      |   |              |      |      |       |  
|Net cash from (used in) continuing operations                               |                                                                                                                                                                                                   |                                                                             | 23 |     |              |   | (590  | )            |      |   | (95          | )    |      |       |  |     |    |   | (662  | )   
|Net cash from (used in) operating activities of discontinued
    operations |                                                                                                                                                                                                   |                                                                             | 13 |     |              |   | 22    |              |      |   | (1           | )    |      |       |  |     |    |   | 34    |     
|                                                                            |                                                                                                                                                                                                   |                                                                             |    |     |              |   |       |              |      |   |              |      |      |       |  
|Net increase (decrease) in cash and cash equivalents                        |                                                                                                                                                                                                   |                                                                             | 36 |     |              |   | (568  | )            |      |   | (96          | )    |      |       |  |     |    |   | (628  | )   
|Cash and cash equivalents at beginning of period                            |                                                                                                                                                                                                   |                                                                             | (2 | )   |              |   | 2,414 |              |      |   | 1,195        |      |      |       |  |     |    |   | 3,607 |     
|                                                                            |                                                                                                                                                                                                   |                                                                             |    |     |              |   |       |              |      |   |              |      |      |       |  
|Cash and cash equivalents at end of period                                  |                                                                                                                                                                                                   | $                                                                           | 34 |     |              | $ | 1,846 |              |      | $ | 1,099        |      |      | $     |  |     |    | $ | 2,979 |     
|                                                                            |                                                                                                                                                                                                   |                                                                             |    |     |              |   |       |              |      |   |              |      |      |       |  

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NORTEL NETWORKS LIMITED


Notes to Consolidated Financial
Statements  (Continued)




|                                                                            |                                                                                                                                                                                                   |                                                                             |    |     |              |   |       |              |      |   |              |     |     |       |   |      |     |   |       |      |      |  
|--------------------------------------------------------------------------- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | --------------------------------------------------------------------------- | -- | --- | ------------ | - | ----- | ------------ | ---- | - | ------------ | --- | --- | ----- | - | ---- | --- | - | ----- | ---- | ---- | -
|                                                                            |                                                                                                                                                                                                   | Nortel                                                                      |    |     |              |   | Non-  |              |      |   |              |    
|                                                                            |                                                                                                                                                                                                   | Networks                                                                    |    |     | Guarantor    |   |       | Guarantor    |      |   |              |     |    
|                                                                            |                                                                                                                                                                                                   | Limited                                                                     |    |     | Subsidiaries |   |       | Subsidiaries |      |   | Eliminations |     |     | Total |  
|                                                                            |                                                                                                                                                                                                   |                                                                             |    |     |              |   |       |              |      |   |              |     |     |       |  
|                                                                            |                                                                                                                                                                                                   | (Millions of U.S. dollars)                                                  |   
|Cash flows from (used in) operating activities                              |                                                                                                                                                                                                   |                                                                             |    |     |              |   |       |              |      |   |              |     |     |       |   |      |     |   |       |     
|                                                                            | Net earnings (loss) from continuing operations                                                                                                                                                    |                                                                             | $  | 164 |              |   | $     | 287          |      |   | $            | 4   |     |       | $ | (291 | )   |   | $     | 164  |     
|                                                                            | Adjustments to reconcile net earnings (loss) from continuing
    operations to net cash from (used in) operating activities, net
    of effects from acquisitions and divestitures of businesses: |                                                                             |    |     |              |   |       |              |      |   |              |     |     |       |   |      |     |   |       |      |     
|                                                                            |                                                                                                                                                                                                   | Amortization and depreciation                                               |    |     | 21           |   |       |              | 85   |   |              |     | 65  |       |   |      |    |   |       |      | 171  |  
|                                                                            |                                                                                                                                                                                                   | Equity in net earnings (loss) of associated
    companies  net of tax      |    |     | (121         | ) |       |              | (174 | ) |              |     | 6   |       |   |      | 291 |   |       |      | 2    |  
|                                                                            |                                                                                                                                                                                                   | Stock option compensation                                                   |    |     | 16           |   |       |              | 14   |   |              |     | 6   |       |   |      |    |   |       |      | 36   |  
|                                                                            |                                                                                                                                                                                                   | Deferred income taxes                                                       |    |     | (1           | ) |       |              | 9    |   |              |     | (10 | )     |   |      |    |   |       |      | (2   | )
|                                                                            |                                                                                                                                                                                                   | Other liabilities                                                           |    |     | 40           |   |       |              | 61   |   |              |     | 12  |       |   |      |    |   |       |      | 113  |  
|                                                                            |                                                                                                                                                                                                   | (Gain) loss on sale or write down of investments, businesses and
    assets |    |     |             |   |       |              | (35  | ) |              |     | (74 | )     |   |      |    |   |       |      | (109 | )
|                                                                            |                                                                                                                                                                                                   | Other  net                                                                 |    |     | 2            |   |       |              | 9    |   |              |     | 88  |       |   |      |    |   |       |      | 99   |  
|                                                                            |                                                                                                                                                                                                   | Change in operating assets and liabilities                                  |    |     | (297         | ) |       |              | (306 | ) |              |     | (91 | )     |   |      |    |   |       |      | (694 | )
|                                                                            |                                                                                                                                                                                                   | Intercompany/related party activity                                         |    |     | 236          |   |       |              | (199 | ) |              |     | (37 | )     |   |      |    |   |       |      |     |  
|                                                                            |                                                                                                                                                                                                   |                                                                             |    |     |              |   |       |              |      |   |              |     |     |       |  
|                                                                            | Net cash from (used in) operating activities of continuing
    operations                                                                                                                         |                                                                             |    | 60  |              |   |       | (249         | )    |   |              | (31 | )   |       |   |     |     |   |       | (220 | )   
|                                                                            |                                                                                                                                                                                                   |                                                                             |    |     |              |   |       |              |      |   |              |     |     |       |  
|Cash flows from (used in) investing activities                              |                                                                                                                                                                                                   |                                                                             |    |     |              |   |       |              |      |   |              |     |     |       |   |      |     |   |       |     
|                                                                            | Expenditures for plant and equipment                                                                                                                                                              |                                                                             |    | (15 | )            |   |       | (70          | )    |   |              | (17 | )   |       |   |     |     |   |       | (102 | )   
|                                                                            | Proceeds on disposals of plant and equipment                                                                                                                                                      |                                                                             |    | 4   |              |   |       | 1            |      |   |              | 5   |     |       |   |     |     |   |       | 10   |     
|                                                                            | Restricted cash and cash equivalents                                                                                                                                                              |                                                                             |    | 1   |              |   |       |             |      |   |              | 9   |     |       |   |     |     |   |       | 10   |     
|                                                                            | Acquisitions of investments and businesses  net of
    cash acquired                                                                                                                             |                                                                             |    | (1  | )            |   |       | (5           | )    |   |              |    |     |       |   |     |     |   |       | (6   | )   
|                                                                            | Proceeds on sale of investments and businesses                                                                                                                                                    |                                                                             |    | 1   |              |   |       | 55           |      |   |              | 76  |     |       |   |     |     |   |       | 132  |     
|                                                                            |                                                                                                                                                                                                   |                                                                             |    |     |              |   |       |              |      |   |              |     |     |       |  
|                                                                            | Net cash from (used in) investing activities of continuing
    operations                                                                                                                         |                                                                             |    | (10 | )            |   |       | (19          | )    |   |              | 73  |     |       |   |     |     |   |       | 44   |     
|                                                                            |                                                                                                                                                                                                   |                                                                             |    |     |              |   |       |              |      |   |              |     |     |       |  
|Cash flows from (used in) financing activities                              |                                                                                                                                                                                                   |                                                                             |    |     |              |   |       |              |      |   |              |     |     |       |   |      |     |   |       |     
|                                                                            | Dividends paid                                                                                                                                                                                    |                                                                             |    | (16 | )            |   |       |             |      |   |              |    |     |       |   |     |     |   |       | (16  | )   
|                                                                            | Increase in notes payable                                                                                                                                                                         |                                                                             |    |    |              |   |       |             |      |   |              | 41  |     |       |   |     |     |   |       | 41   |     
|                                                                            | Decrease in notes payable                                                                                                                                                                         |                                                                             |    |    |              |   |       |             |      |   |              | (26 | )   |       |   |     |     |   |       | (26  | )   
|                                                                            | Repayments of long-term debt                                                                                                                                                                      |                                                                             |    |    |              |   |       | (85          | )    |   |              | (13 | )   |       |   |     |     |   |       | (98  | )   
|                                                                            | Repayments of capital leases payable                                                                                                                                                              |                                                                             |    | (1  | )            |   |       | (7           | )    |   |              |    |     |       |   |     |     |   |       | (8   | )   
|                                                                            |                                                                                                                                                                                                   |                                                                             |    |     |              |   |       |              |      |   |              |     |     |       |  
|                                                                            | Net cash from (used in) financing activities of continuing
    operations                                                                                                                         |                                                                             |    | (17 | )            |   |       | (92          | )    |   |              | 2   |     |       |   |     |     |   |       | (107 | )   
|                                                                            |                                                                                                                                                                                                   |                                                                             |    |     |              |   |       |              |      |   |              |     |     |       |  
|Effect of foreign exchange rate changes on cash and cash
    equivalents    |                                                                                                                                                                                                   |                                                                             |   |     |              |   | (4    | )            |      |   | (5           | )   |     |       |  |      |     |   | (9    | )   
|                                                                            |                                                                                                                                                                                                   |                                                                             |    |     |              |   |       |              |      |   |              |     |     |       |  
|Net cash from (used in) continuing operations                               |                                                                                                                                                                                                   |                                                                             | 33 |     |              |   | (364  | )            |      |   | 39           |     |     |       |  |      |     |   | (292  | )   
|Net cash from (used in) operating activities of discontinued
    operations |                                                                                                                                                                                                   |                                                                             | 15 |     |              |   | (4    | )            |      |   |             |     |     |       |  |      |     |   | 11    |     
|                                                                            |                                                                                                                                                                                                   |                                                                             |    |     |              |   |       |              |      |   |              |     |     |       |  
|Net increase (decrease) in cash and cash equivalents                        |                                                                                                                                                                                                   |                                                                             | 48 |     |              |   | (368  | )            |      |   | 39           |     |     |       |  |      |     |   | (281  | )   
|Cash and cash equivalents at beginning of period                            |                                                                                                                                                                                                   |                                                                             | (8 | )   |              |   | 2,963 |              |      |   | 973          |     |     |       |  |      |     |   | 3,928 |     
|                                                                            |                                                                                                                                                                                                   |                                                                             |    |     |              |   |       |              |      |   |              |     |     |       |  
|Cash and cash equivalents at end of period                                  |                                                                                                                                                                                                   | $                                                                           | 40 |     |              | $ | 2,595 |              |      | $ | 1,012        |     |     | $     |  |      |     | $ | 3,647 |     
|                                                                            |                                                                                                                                                                                                   |                                                                             |    |     |              |   |       |              |      |   |              |     |     |       |  

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|        |                                                                                                                  
|------- | -----------------------------------------------------------------------------------------------------------------
|ITEM 2. | Managements Discussion and Analysis of Financial
    Condition and Results of Operations  Table of
    Contents

|                                              |                                                                              |                                                                      |    |    |    | 
|--------------------------------------------- | ---------------------------------------------------------------------------- | -------------------------------------------------------------------- | -- | -- | -- | 
|Business overview                             |                                                                              |                                                                      | 59 |   
|                                              | Our business                                                                 |                                                                      |    | 59 |   
|                                              | Our segments                                                                 |                                                                      |    | 59 |   
|                                              | Our strategy and outlook                                                     |                                                                      |    | 61 |   
|                                              |                                                                              | Strategy                                                             |    |    | 61 | 
|                                              |                                                                              | Financial targets                                                    |    |    | 61 | 
|                                              |                                                                              | 2005 Outlook                                                         |    |    | 62 | 
|                                              | Evolution of our supply chain
    strategy                                   |                                                                      |    | 62 |   
|Developments in 2005                          |                                                                              |                                                                      | 64 |   
|                                              | First half 2005 consolidated results
    summary                             |                                                                      |    | 64 |   
|                                              | Significant business developments                                            |                                                                      |    | 65 |   
|                                              |                                                                              | Acquisitions                                                         |    |    | 65 | 
|                                              |                                                                              | Joint ventures                                                       |    |    | 66 | 
|                                              |                                                                              | Optical components operations                                        |    |    | 66 | 
|                                              |                                                                              | Bharat Sanchar Nigram Limited contract                               |    |    | 66 | 
|                                              | Nortel Audit Committee Independent
    Review; restatements; related matters |                                                                      |    | 67 |   
|                                              |                                                                              | Restatements and Independent Review                                  |    |    | 67 | 
|                                              |                                                                              | Revenue Independent Review                                           |    |    | 67 | 
|                                              |                                                                              | Material weaknesses in internal control
    over financial reporting |    |    | 68 | 
|                                              |                                                                              | EDC Support Facility                                                 |    |    | 68 | 
|                                              |                                                                              | Debt securities                                                      |    |    | 69 | 
|                                              |                                                                              | Regulatory actions and pending
    litigation                        |    |    | 69 | 
|                                              |                                                                              | Stock-based compensation plans                                       |    |    | 70 | 
|Results of operations  continuing operations |                                                                              |                                                                      | 71 |   
|                                              | Consolidated information                                                     |                                                                      |    | 71 |   
|                                              | Revenues                                                                     |                                                                      |    | 71 |   
|                                              | Geographic revenues                                                          |                                                                      |    | 71 |   
|                                              | Gross profit and gross margin                                                |                                                                      |    | 74 |   
|                                              | Operating expenses                                                           |                                                                      |    | 74 |   
|                                              |                                                                              | Selling, general and administrative
    expense                      |    |    | 74 | 
|                                              |                                                                              | Research and development expense                                     |    |    | 75 | 
|                                              |                                                                              | Special charges                                                      |    |    | 76 | 
|                                              | Gain (loss) on sale of businesses and
    assets                             |                                                                      |    | 81 |   
|                                              | Other income (expense) 
    net                                             |                                                                      |    | 81 |   
|                                              | Interest expense                                                             |                                                                      |    | 82 |   
|                                              | Income tax benefit (expense)                                                 |                                                                      |    | 82 |   
|                                              | Net earnings (loss) from continuing
    operations                           |                                                                      |    | 83 |   
|                                              | Segment information                                                          |                                                                      |    | 83 |   
|                                              |                                                                              | Carrier Packet Networks                                              |    |    | 84 | 
|                                              |                                                                              | CDMA Networks                                                        |    |    | 87 | 
|                                              |                                                                              | GSM and UMTS Networks                                                |    |    | 88 | 
|                                              |                                                                              | Enterprise Networks                                                  |    |    | 90 | 
|                                              |                                                                              | Other                                                                |    |    | 92 | 

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|                                                              |                                                            |                                                            |     |     |     | 
|------------------------------------------------------------- | ---------------------------------------------------------- | ---------------------------------------------------------- | --- | --- | --- | 
|Liquidity and capital resources                               |                                                            |                                                            | 93  |    
|                                                              | Cash flows                                                 |                                                            |     | 93  |    
|                                                              |                                                            | Operating activities                                       |     |     | 93  | 
|                                                              |                                                            | Investing activities                                       |     |     | 96  | 
|                                                              |                                                            | Financing activities                                       |     |     | 96  | 
|                                                              | Uses of liquidity                                          |                                                            |     | 97  |    
|                                                              |                                                            | Contractual cash obligations                               |     |     | 97  | 
|                                                              |                                                            | Customer financing                                         |     |     | 98  | 
|                                                              |                                                            | Acquisitions                                               |     |     | 98  | 
|                                                              | Sources of liquidity                                       |                                                            |     | 98  |    
|                                                              |                                                            | Credit facilities                                          |     |     | 99  | 
|                                                              |                                                            | Available support facility                                 |     |     | 99  | 
|                                                              |                                                            | Shelf registration statement and base shelf
    prospectus |     |     | 100 | 
|                                                              | Credit ratings                                             |                                                            |     | 101 |    
|Off-balance sheet arrangements                                |                                                            |                                                            | 101 |    
|                                                              | Bid, performance related and other
    bonds               |                                                            |     | 101 |    
|                                                              | Receivables securitization
    transactions                |                                                            |     | 102 |    
|Application of critical accounting
    policies and estimates |                                                            |                                                            | 102 |    
|                                                              | Provisions for doubtful accounts                           |                                                            |     | 102 |    
|                                                              | Provisions for inventory                                   |                                                            |     | 103 |    
|                                                              | Provisions for product warranties                          |                                                            |     | 104 |    
|                                                              | Tax asset valuation                                        |                                                            |     | 105 |    
|                                                              | Goodwill valuation                                         |                                                            |     | 106 |    
|                                                              | Special charges                                            |                                                            |     | 106 |    
|Accounting changes and recent accounting
    pronouncements   |                                                            |                                                            | 106 |    
|                                                              | Accounting changes                                         |                                                            |     | 106 |    
|                                                              | Recent accounting pronouncements                           |                                                            |     | 106 |    
|Canadian supplement                                           |                                                            |                                                            | 108 |    
|                                                              | Accounting changes                                         |                                                            |     | 108 |    
|                                                              | Outstanding share data                                     |                                                            |     | 109 |    
|Market risk                                                   |                                                            |                                                            | 109 |    
|Equity price risk                                             |                                                            |                                                            | 110 |    
|Environmental matters                                         |                                                            |                                                            | 110 |    
|Legal proceedings                                             |                                                            |                                                            | 110 |    
|Risk factors/forward looking
    statements                   |                                                            |                                                            | 111 |    
|                                                              | Risks relating to our restatements and
    related matters |                                                            |     | 111 |    
|                                                              | Risks relating to our business                             |                                                            |     | 118 |    

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Managements Discussion and Analysis of


Financial Condition and Results of Operations


You should read this Managements Discussion and
Analysis of Financial Condition and Results of Operation, or
MD&A, in combination with the accompanying unaudited
consolidated financial statements prepared in accordance with
accounting principles generally accepted in the United States,
or U.S. GAAP. A number of our and Nortel Networks
Corporations past filings with the United States
Securities and Exchange Commission, or SEC, remain subject to
ongoing review by the SECs Division of Corporation
Finance. Ongoing SEC review may require us to amend this
Quarterly Report on Form 10-Q or our other public filings
further. See Risk factors/forward looking
statements.


This section contains forward looking statements and should
be read in conjunction with the risk factors described below
under Risk factors/forward looking statements. All
dollar amounts in this MD&A are in millions of United
States, or U.S., dollars unless otherwise stated.


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





Business overview







| |             
| | ------------
| | Our business










| |             
| | ------------
| | Our segments



59



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| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Carrier Packet Networks provides: (i) circuit and packet
    voice solutions, (ii) data networking and security
    solutions and (iii) optical long-haul and metropolitan
    optical network solutions. Together, these solutions provide or
    transport data, voice and multimedia communications solutions to
    our service provider customers that operate wireline networks.
    These service provider customers include local and long distance
    telephone companies, wireless service providers (for the
    wireline portion of their networks), cable operators and other
    communication service providers.
|
| |  | CDMA Networks provides communication network solutions to
    wireless service provider customers based on CDMA and Time
    Division Multiple Access, or TDMA, technologies to enable those
    customers to offer their customers, the subscribers for wireless
    communication services, the ability to be mobile while they send
    and receive voice and data communications using wireless
    devices, such as cellular telephones, personal digital
    assistants and other computing and communications devices.                                                                                                   
|
| |  | GSM and UMTS Networks also provides communication network
    solutions to our wireless service provider customers; however,
    these solutions are based on GSM and UMTS technologies.                                                                                                                                                                                                                                                                                                                                                                                                                                        
|
| |  | Enterprise Networks provides: (i) circuit and packet voice
    solutions and (ii) data networking and security solutions
    which provide data, voice and multimedia communications
    solutions to our enterprise customers. Our Enterprise Networks
    customers consist of a broad range of enterprise customers
    around the world, including large businesses and their branch
    offices, small businesses and home offices, as well as
    government agencies, educational and other institutions and
    utility organizations.                                                                                  
|
| |  | Other represents miscellaneous business activities
    and corporate functions. None of these activities meet the
    quantitative criteria to be disclosed separately as reportable
    segments. Costs associated with shared services and other
    corporate costs are allocated to the segments based on usage
    determined generally by headcount. Costs not allocated to the
    segments are primarily related to our corporate compliance and
    other non-operational activities and are included in
    other.                                                                                                



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| |                         
| | ------------------------
| | Our strategy and outlook






| |         
| | --------
| | Strategy







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










| |                  
| | -----------------
| | Financial targets







61



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| |             
| | ------------
| | 2005 Outlook














| |                                       
| | --------------------------------------
| | Evolution of our supply chain strategy



62



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63



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Developments in 2005







| |                                             
| | --------------------------------------------
| | First half 2005 consolidated results summary



|                                                                                                                                                     |                |                            |       |     |                          |  |       |          |   |   |          |     |   |          |       |      |          |   |       |          |   |  |          |      |   |   |       |     |   |  |       |      |  
|---------------------------------------------------------------------------------------------------------------------------------------------------- | -------------- | -------------------------- | ----- | --- | ------------------------ |  | ----- | -------- | - | - | -------- | --- | - | -------- | ----- | ---- | -------- | - | ----- | -------- | - |  | -------- | ---- | - | - | ----- | --- | - |  | ----- | ---- | -
|                                                                                                                                                     |                | For the Three Months Ended |       |     | For the Six Months Ended | 
|                                                                                                                                                     |                |                            |       |     |                          | 
|                                                                                                                                                     |                | June 30,                   |       |     | % of                     |  |       | June 30, |   |   | % of     |     |   | June 30, |       |      | % of     |   |       | June 30, |   |  | % of     |     
|                                                                                                                                                     |                | 2005                       |       |     | Revenues                 |  |       | 2004     |   |   | Revenues |     |   | 2005     |       |      | Revenues |   |       | 2004     |   |  | Revenues |     
|                                                                                                                                                     |                |                            |       |     |                          |  |       |          |   |   |          |     |   |          |       |      |          |   |       |          |   |  |          |     
|                                                                                                                                                     |                | (Millions of U.S. dollars) |      
|Revenues                                                                                                                                             |                | $                          | 2,855 |     |                          |  | 100.0 |          |   | $ | 2,590    |     |   |          | 100.0 |      |          | $ | 5,391 |          |   |  | 100.0    |      |   | $ | 5,034 |     |   |  | 100.0 |     
|Cost of revenues                                                                                                                                     |                |                            | 1,650 |     |                          |  | 57.8  |          |   |   | 1,538    |     |   |          | 59.4  |      |          |   | 3,127 |          |   |  | 58.0     |      |   |   | 2,910 |     |   |  | 57.8  |     
|                                                                                                                                                     |                |                            |       |     |                          |  |       |          |   |   |          |     |   |          |       |      |          |   |       |          |   |  |          |     
|Gross profit                                                                                                                                         |                |                            | 1,205 |     |                          |  | 42.2  |          |   |   | 1,052    |     |   |          | 40.6  |      |          |   | 2,264 |          |   |  | 42.0     |      |   |   | 2,124 |     |   |  | 42.2  |     
|Selling, general and administrative expense                                                                                                          |                |                            | 576   |     |                          |  | 20.2  |          |   |   | 538      |     |   |          | 20.8  |      |          |   | 1,146 |          |   |  | 21.3     |      |   |   | 1,076 |     |   |  | 21.4  |     
|Research and development expense                                                                                                                     |                |                            | 474   |     |                          |  | 16.6  |          |   |   | 489      |     |   |          | 18.9  |      |          |   | 945   |          |   |  | 17.5     |      |   |   | 955   |     |   |  | 19.0  |     
|Amortization of intangibles                                                                                                                          |                |                            | 2     |     |                          |  |      |          |   |   | 2        |     |   |          |      |      |          |   | 4     |          |   |  |         |      |   |   | 5     |     |   |  |      |     
|Special charges                                                                                                                                      |                |                            | 90    |     |                          |  | 3.2   |          |   |   | (1       | )   |   |          |      |      |          |   | 111   |          |   |  | 2.1      |      |   |   | 6     |     |   |  | 0.1   |     
|(Gain) loss on sale of businesses and assets                                                                                                         |                |                            | 36    |     |                          |  | 1.3   |          |   |   | (75      | )   |   |          | (2.8  | )    |          |   | 37    |          |   |  | 0.7      |      |   |   | (75   | )   |   |  | (1.4  | )   
|                                                                                                                                                     |                |                            |       |     |                          |  |       |          |   |   |          |     |   |          |       |      |          |   |       |          |   |  |          |     
|Operating earnings (loss)                                                                                                                            |                |                            | 27    |     |                          |  | 0.9   |          |   |   | 99       |     |   |          | 3.7   |      |          |   | 21    |          |   |  | 0.4      |      |   |   | 157   |     |   |  | 3.1   |     
|Other income (expense)  net                                                                                                                         |                |                            | 61    |     |                          |  | 2.1   |          |   |   | (14      | )   |   |          | (0.5  | )    |          |   | 108   |          |   |  | 2.0      |      |   |   | 74    |     |   |  | 1.5   |     
|Interest expense                                                                                                                                     |                |                            |       |     |                          |  |       |          |   |   |          |     |   |          |       |      |          |   |       |          |   |  |          |      |   |   |       |     |   |  |       |     
|                                                                                                                                                     | Long-term debt |                            |       | (30 | )                        |  |       | (1.0     | ) |   |          | (22 | ) |          |       | (0.8 | )        |   |       | (59      | ) |  |          | (1.1 | ) |   |       | (46 | ) |  |       | (0.9 | )
|                                                                                                                                                     | Other          |                            |       |    |                          |  |       |         |   |   |          | (6  | ) |          |       | (0.2 | )        |   |       | (2       | ) |  |          |     |   |   |       | (14 | ) |  |       | (0.3 | )
|                                                                                                                                                     |                |                            |       |     |                          |  |       |          |   |   |          |     |   |          |       |      |          |   |       |          |   |  |          |     
|Earnings (loss) from continuing operations before income
    taxes, minority interests and equity in net earnings
    (loss) of associated companies |                |                            | 58    |     |                          |  | 2.0   |          |   |   | 57       |     |   |          | 2.2   |      |          |   | 68    |          |   |  | 1.3      |      |   |   | 171   |     |   |  | 3.4   |     
|Income tax benefit (expense)                                                                                                                         |                |                            | 7     |     |                          |  | 0.2   |          |   |   | (7       | )   |   |          | (0.3  | )    |          |   | (8    | )        |   |  | (0.2     | )    |   |   | 2     |     |   |  |      |     
|                                                                                                                                                     |                |                            |       |     |                          |  |       |          |   |   |          |     |   |          |       |      |          |   |       |          |   |  |          |     
|                                                                                                                                                     |                |                            | 65    |     |                          |  | 2.2   |          |   |   | 50       |     |   |          | 1.9   |      |          |   | 60    |          |   |  | 1.1      |      |   |   | 173   |     |   |  | 3.4   |     
|Minority interests  net of tax                                                                                                                      |                |                            | (8    | )   |                          |  | (0.2  | )        |   |   | (1       | )   |   |          |      |      |          |   | (13   | )        |   |  | (0.2     | )    |   |   | (7    | )   |   |  | (0.1  | )   
|Equity in net earnings (loss) of associated
    companies  net of tax                                                                               |                |                            | 1     |     |                          |  |      |          |   |   | (1       | )   |   |          |      |      |          |   | 2     |          |   |  |         |      |   |   | (2    | )   |   |  |      |     
|                                                                                                                                                     |                |                            |       |     |                          |  |       |          |   |   |          |     |   |          |       |      |          |   |       |          |   |  |          |     
|Net earnings (loss) from continuing operations                                                                                                       |                |                            | 58    |     |                          |  | 2.0   |          |   |   | 48       |     |   |          | 1.9   |      |          |   | 49    |          |   |  | 0.9      |      |   |   | 164   |     |   |  | 3.3   |     
|Net earnings (loss) from discontinued
    operations  net of tax                                                                                    |                |                            | (1    | )   |                          |  |      |          |   |   | 6        |     |   |          | 0.2   |      |          |   | 1     |          |   |  |         |      |   |   | 7     |     |   |  | 0.1   |     
|                                                                                                                                                     |                |                            |       |     |                          |  |       |          |   |   |          |     |   |          |       |      |          |   |       |          |   |  |          |     
|Net earnings (loss)                                                                                                                                  |                |                            | 57    |     |                          |  | 2.0   |          |   |   | 54       |     |   |          | 2.1   |      |          |   | 50    |          |   |  | 0.9      |      |   |   | 171   |     |   |  | 3.4   |     
|Dividends on preferred shares                                                                                                                        |                |                            | 10    |     |                          |  | 0.4   |          |   |   | 7        |     |   |          | 0.3   |      |          |   | 19    |          |   |  | 0.3      |      |   |   | 16    |     |   |  | 0.3   |     
|                                                                                                                                                     |                |                            |       |     |                          |  |       |          |   |   |          |     |   |          |       |      |          |   |       |          |   |  |          |     
|Net earnings (loss) applicable to common shares                                                                                                      |                | $                          | 47    |     |                          |  | 1.6   |          |   | $ | 47       |     |   |          | 1.8   |      |          | $ | 31    |          |   |  | 0.6      |      |   | $ | 155   |     |   |  | 3.1   |     
|                                                                                                                                                     |                |                            |       |     |                          |  |       |          |   |   |          |     |   |          |       |      |          |   |       |          |   |  |          |     



64



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65



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| |                                  
| | ---------------------------------
| | Significant business developments






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














| |               
| | --------------
| | Joint ventures



66



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| |                              
| | -----------------------------
| | Optical components operations








| |                                       
| | --------------------------------------
| | Bharat Sanchar Nigram Limited contract










| |                                                                             
| | ----------------------------------------------------------------------------
| | Nortel Audit Committee Independent Review; restatements;
    related matters






| |                                    
| | -----------------------------------
| | Restatements and Independent Review



67



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| |                           
| | --------------------------
| | Revenue Independent Review








| |                                                                     
| | --------------------------------------------------------------------
| | 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;

68



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| |   |                                                                                                                                                                                                                                                                                                                                                                      
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | lack of compliance with Nortel procedures for appropriately
    applying applicable GAAP to the initial recording of certain
    liabilities including those described in SFAS No. 5,
    Accounting for Contingencies, or
    SFAS No. 5, and to foreign currency translation as
    described in SFAS No. 52, Foreign Currency
    Translation, or SFAS No. 52;
|
| |  | lack of sufficient personnel with appropriate knowledge,
    experience and training in U.S. GAAP and lack of sufficient
    analysis and documentation of the application of U.S. GAAP
    to transactions, including but not limited to revenue
    transactions;                                                                                                  
|
| |  | lack of a clear organization and accountability structure within
    the accounting function, including insufficient review and
    supervision, combined with financial reporting systems that are
    not integrated and which require extensive manual
    interventions; and                                                                                     
|
| |  | lack of sufficient awareness of, and timely and appropriate
    remediation of, internal control issues by Nortel personnel.                                                                                                                                                                                                                                         












| |                     
| | --------------------
| | EDC Support Facility









69



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| |                
| | ---------------
| | Debt securities








| |                                          
| | -----------------------------------------
| | Regulatory actions and pending litigation














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



70



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Results of operations  continuing
operations


Consolidated information







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











| |                    
| | -------------------
| | Geographic revenues



|              |  |                                     |       |  |                                   |   |       |          |  |   |          |   |  |      |     |   |      |   |       |          |  |   |          |  |  |   |     |  |  |  |    | 
|------------- |  | ----------------------------------- | ----- |  | --------------------------------- | - | ----- | -------- |  | - | -------- | - |  | ---- | --- | - | ---- | - | ----- | -------- |  | - | -------- |  |  | - | --- |  |  |  | -- | 
|              |  | For the Three Months Ended June 30, |       |  | For the Six Months Ended June 30, |  
|              |  |                                     |       |  |                                   |  
|              |  | 2005                                |       |  | 2004                              |   |       | $ Change |  |   | % Change |   |  | 2005 |     |   | 2004 |   |       | $ Change |  |   | % Change | 
|              |  |                                     |       |  |                                   |   |       |          |  |   |          |   |  |      |     |   |      |   |       |          |  |   |          | 
|United States |  | $                                   | 1,397 |  |                                   | $ | 1,322 |          |  | $ | 75       |   |  |      | 6   |   |      | $ | 2,543 |          |  | $ | 2,539    |  |  | $ | 4   |  |  |  | 0  | 
|EMEA(a)       |  |                                     | 721   |  |                                   |   | 643   |          |  |   | 78       |   |  |      | 12  |   |      |   | 1,443 |          |  |   | 1,239    |  |  |   | 204 |  |  |  | 16 | 
|Canada        |  |                                     | 183   |  |                                   |   | 137   |          |  |   | 46       |   |  |      | 34  |   |      |   | 297   |          |  |   | 291      |  |  |   | 6   |  |  |  | 2  | 
|Asia Pacific  |  |                                     | 412   |  |                                   |   | 330   |          |  |   | 82       |   |  |      | 25  |   |      |   | 814   |          |  |   | 677      |  |  |   | 137 |  |  |  | 20 | 
|CALA(b)       |  |                                     | 142   |  |                                   |   | 158   |          |  |   | (16      | ) |  |      | (10 | ) |      |   | 294   |          |  |   | 288      |  |  |   | 6   |  |  |  | 2  | 
|              |  |                                     |       |  |                                   |   |       |          |  |   |          |   |  |      |     |   |      |   |       |          |  |   |          | 
|Consolidated  |  | $                                   | 2,855 |  |                                   | $ | 2,590 |          |  | $ | 265      |   |  |      | 10  |   |      | $ | 5,391 |          |  | $ | 5,034    |  |  | $ | 357 |  |  |  | 7  | 
|              |  |                                     |       |  |                                   |   |       |          |  |   |          |   |  |      |     |   |      |   |       |          |  |   |          | 






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

Q2
2005 vs. Q2 2004 and first half of 2005 vs. first half of
2004






71



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Q2
2005 vs. Q1 2005






72



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2005








| |   |                                                                                                                                                                                                                                          
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | continued growth in our voice over packet technologies and our
    3G wireless technologies; however, the timing of when service
    provider customers will deploy packet-based technologies on a
    wider scale is still unclear;     
|
| |  | build-out of the BSNL contract in the Asia Pacific region. For
    further information related to the BSNL contract, see
    Developments in 2005  Significant business
    developments  Bharat Sanchar Nigram Limited
    contract;
|
| |  | expansion and enhancement of existing networks by our customers
    due to subscriber growth and competitive pressures;                                                                                                                  
|
| |  | anticipated growth in our Enterprise Networks business,
    particularly in our converged networks products;                                                                                                                             
|
| |  | a focus by our customers on new technologies that create
    opportunities to optimize existing networks while limiting
    capital expenditures and operating costs;                                                                    
|
| |  | expected continued growth in metro optical and carrier
    VoIP; and                                                                                                                                                                     
|
| |  | expected focus on new product areas, such as Wireless Local Area
    Networks, or WLAN, and carrier routing.                                                                                                                             





| |   |                                                                                                                                                                          
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | customers limiting their investment in mature technologies as
    they focus on maximizing return on invested capital;                                                   
|
| |  | pricing pressures on sales of certain of our products as a
    result of increased competition, particularly from low cost
    suppliers;                                
|
| |  | consolidation of service providers which may reduce overall
    spending on telecommunications equipment, including to date in
    our GSM and UMTS Networks segment; and

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| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | the impact of our financial restatement activities and the
    internal restructuring and realignment programs that were
    initiated in August 2004. For additional information, see
    Developments in 2005  Nortel Audit Committee
    Independent Review; restatements; related matters. While
    customer support generally remains strong, we believe that these
    activities will continue to have an adverse impact on business
    performance in 2005.








| |                              
| | -----------------------------
| | Gross profit and gross margin

|             |  |                                     |       |   |                                   |   |       |        |  |   |          |  |  |      |    |  |      |   |       |        |  |   |          |   |  |   |          |   |  |  |   | 
|------------ |  | ----------------------------------- | ----- | - | --------------------------------- | - | ----- | ------ |  | - | -------- |  |  | ---- | -- |  | ---- | - | ----- | ------ |  | - | -------- | - |  | - | -------- | - |  |  | - | 
|             |  | For the Three Months Ended June 30, |       |   | For the Six Months Ended June 30, |  
|             |  |                                     |       |   |                                   |  
|             |  | 2005                                |       |   | 2004                              |   |       | Change |  |   | % Change |  |  | 2005 |    |  | 2004 |   |       | Change |  |   | % Change |  
|             |  |                                     |       |   |                                   |   |       |        |  |   |          |  |  |      |    |  |      |   |       |        |  |   |          |  
|Gross profit |  | $                                   | 1,205 |   |                                   | $ | 1,052 |        |  | $ | 153      |  |  |      | 15 |  |      | $ | 2,264 |        |  | $ | 2,124    |   |  | $ | 140      |   |  |  | 7 | 
|Gross margin |  |                                     | 42.2  | % |                                   |   | 40.6  | %      |  |   | 1.6 pts  |  |  |      |    |  |      |   | 42.0  | %      |  |   | 42.2     | % |  |   | (0.2 pts | ) |  |  |   | 





| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                    
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | an increase of approximately $135 ($185 for the first half of
    2005) due to overall higher sales volumes;                                                                                                                                                                                                                                                                                                                       
|
| |  | an increase of approximately $85 ($165 for the first half of
    2005) due to continued improvements in our cost structure
    primarily as a result of lower material pricing; and                                                                                                                                                                                                                                                
|
| |  | an increase of approximately $35 ($75 for the first half of
    2005) primarily due to recoveries in inventory provisions due to
    sale of inventory and lower warranty costs as a result of
    improved product quality; partially offset by                                                                                                                                                                                   
|
| |  | a decrease of approximately $57 ($235 for the first half of
    2005) primarily as a result of (i) pricing pressures on
    certain of our products due to increased competition for service
    provider and enterprise customers; and (ii) unfavorable
    product mix associated with increased sales of our next
    generation products which typically have lower gross margins in
    the early stages of product evolution;
|
| |  | a decrease of approximately $27 ($32 for the first half of 2005)
    related to a contract in India with BSNL and its adverse impact
    on our overall gross margin mix. For further information related
    to the BSNL contract, see Developments in 2005 
    Significant business developments  Bharat Sanchar
    Nigram Limited contract; and                                                                           
|
| |  | a decrease of $18 ($18 for the first half of 2005) related to
    our employee bonus plans.                                                                                                                                                                                                                                                                                                                                        



74



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| |                   
| | ------------------
| | Operating expenses






| |                                            
| | -------------------------------------------
| | Selling, general and administrative expense

|                 |  |                                     |      |   |                                   |   |      |          |  |   |          |   |  |      |   |  |      |   |       |          |  |   |          |   |  |   |          |   |  |  |   | 
|---------------- |  | ----------------------------------- | ---- | - | --------------------------------- | - | ---- | -------- |  | - | -------- | - |  | ---- | - |  | ---- | - | ----- | -------- |  | - | -------- | - |  | - | -------- | - |  |  | - | 
|                 |  | For the Three Months Ended June 30, |      |   | For the Six Months Ended June 30, |  
|                 |  |                                     |      |   |                                   |  
|                 |  | 2005                                |      |   | 2004                              |   |      | $ Change |  |   | % Change |   |  | 2005 |   |  | 2004 |   |       | $ Change |  |   | % Change |  
|                 |  |                                     |      |   |                                   |   |      |          |  |   |          |   |  |      |   |  |      |   |       |          |  |   |          |  
|SG&A expense     |  | $                                   | 576  |   |                                   | $ | 538  |          |  | $ | 38       |   |  |      | 7 |  |      | $ | 1,146 |          |  | $ | 1,076    |   |  | $ | 70       |   |  |  | 7 | 
|As % of revenues |  |                                     | 20.2 | % |                                   |   | 20.8 | %        |  |   | (0.6 pts | ) |  |      |   |  |      |   | 21.3  | %        |  |   | 21.4     | % |  |   | (0.1 pts | ) |  |  |   | 





| |   |                                                                                                                                                                                            
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | costs related to our restatement and related activities of
    approximately $24 in the second quarter of 2005 compared to
    approximately $14 for the same period in 2004;              
|
| |  | increased investments in our finance organization;                                                                                                                                         
|
| |  | increased expenses of $20 related to our employee bonus plans;                                                                                                                             
|
| |  | significant unfavorable foreign exchange rate fluctuation
    impacts associated with the strengthening of the Canadian
    dollar, euro and British pound against the
    U.S. dollar; and
|
| |  | an increase in bad debt expense; partially offset by                                                                                                                                       
|
| |  | cost savings associated with our 2004 Restructuring Plan.                                                                                                                                  





| |   |                                                                                                                                                                                                                                                 
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | costs related to our restatement and related activities of
    approximately $62 in the first half of 2005 compared to
    approximately $20 for the same period in 2004;                                                                       
|
| |  | increased investments in our finance organization;                                                                                                                                                                                              
|
| |  | increased expenses of $20 related to our employee bonus plans;                                                                                                                                                                                  
|
| |  | significant unfavorable foreign exchange rate fluctuation
    impacts associated with the strengthening of the Canadian
    dollar, euro and British pound against the
    U.S. dollar; and                                                     
|
| |  | an increase in bad debt expense; partially offset by                                                                                                                                                                                            
|
| |  | a decrease of approximately $42 in our stock based compensation
    primarily related to a payout under our RSU program in the first
    half of 2004 that was not repeated in the first half of 2005 as
    the RSU program was terminated; and
|
| |  | cost savings associated with our 2004 Restructuring Plan.                                                                                                                                                                                       








| |                                 
| | --------------------------------
| | Research and development expense

|                 |  |                                     |      |   |                                   |   |      |          |  |   |          |   |  |      |    |   |      |   |      |          |  |   |          |   |  |   |          |   |  |  |    |  
|---------------- |  | ----------------------------------- | ---- | - | --------------------------------- | - | ---- | -------- |  | - | -------- | - |  | ---- | -- | - | ---- | - | ---- | -------- |  | - | -------- | - |  | - | -------- | - |  |  | -- | -
|                 |  | For the Three Months Ended June 30, |      |   | For the Six Months Ended June 30, |  
|                 |  |                                     |      |   |                                   |  
|                 |  | 2005                                |      |   | 2004                              |   |      | $ Change |  |   | % Change |   |  | 2005 |    |   | 2004 |   |      | $ Change |  |   | % Change |  
|                 |  |                                     |      |   |                                   |   |      |          |  |   |          |   |  |      |    |   |      |   |      |          |  |   |          |  
|R&D expense      |  | $                                   | 474  |   |                                   | $ | 489  |          |  | $ | (15      | ) |  |      | (3 | ) |      | $ | 945  |          |  | $ | 955      |   |  | $ | (10      | ) |  |  | (1 | )
|As % of revenues |  |                                     | 16.6 | % |                                   |   | 18.9 | %        |  |   | (2.3 pts | ) |  |      |    |   |      |   | 17.5 | %        |  |   | 19.0     | % |  |   | (1.5 pts | ) |  |  |    |  

75



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| |   |                                                                                                                                                           
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | cost savings associated with our 2004 Restructuring Plan;
    partially offset by                                                                         
|
| |  | increased investments in targeted product areas;                                                                                                          
|
| |  | unfavorable foreign exchange impacts associated with the
    strengthening of the Canadian dollar, euro and British pound
    against the U.S. dollar; and
|
| |  | increased expense of approximately $18 related to our employee
    bonus plans.                                                                           







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










| |                
| | ---------------
| | Special charges







76



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77



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|                                                      |                                           |           |     |            |           |   |           |             |   |                 |              |       |          |            |       |          |      |   |    |    |  |   |     |    |  
|----------------------------------------------------- | ----------------------------------------- | --------- | --- | ---------- | --------- | - | --------- | ----------- | - | --------------- | ------------ | ----- | -------- | ---------- | ----- | -------- | ---- | - | -- | -- |  | - | --- | -- | -
|                                                      |                                           |           |     |            |           |   |           |             |   | Special Charges |             
|                                                      |                                           |           |     |            |           |   |           |             |   |                 |             
|                                                      |                                           |           |     | Contract   |           |   |           |             |   |                 | Three months |       |          | Six months |      
|                                                      |                                           |           |     | Settlement |           |   | Plant and |             |   |                 |              | ended |          |            | ended |         
|                                                      |                                           | Workforce |     |            | and Lease |   |           | Equipment   |   |                 |              |       | June 30, |            |       | June 30, |     
|                                                      |                                           | Reduction |     |            | Costs     |   |           | Write Downs |   |                 | Total        |       |          | 2005       |       |          | 2005 |  
|                                                      |                                           |           |     |            |           |   |           |             |   |                 |              |       |          |            |       |          |      |  
|2001 Restructuring Plan                               |                                           |           |     |            |           |   |           |             |   |                 |              |       |          |            |       |          |      |   |    |    |  |   |     |   
|Provision balance as of December 31,
    2004(a)      |                                           | $         | 15  |            |           | $ | 326       |             |   | $               |             |       |          | $          | 341   |          |      |   |    |    |  |   |     |   
|Revisions to prior accruals:                          |                                           |           |     |            |           |   |           |             |   |                 |              |       |          |            |       |          |      |   |    |    |  |   |     |   
|                                                      | For the three months ended March 31, 2005 |           |     | (3         | )         |   |           |            |   |                 |              | (1    | )        |            |       | (4       | )    |   | $  |   |  |   | $   | (4 | )
|                                                      | For the three months ended June 30, 2005  |           |     | (2         | )         |   |           | 4           |   |                 |              | (2    | )        |            |       |         |      |   |    |   |  |   |     |   |  
|Cumulative provision (drawdowns) adjustments in 2005: |                                           |           |     |            |           |   |           |             |   |                 |              |       |          |            |       |          |      |   |    |    |  |   |     |   
|                                                      | Cash drawdowns                            |           |     | (4         | )         |   |           | (65         | ) |                 |              |      |          |            |       | (69      | )    |   |    |    |  |   |     |    |  
|                                                      | Non-cash drawdowns                        |           |     |           |           |   |           |            |   |                 |              | 3     |          |            |       | 3        |      |   |    |    |  |   |     |    |  
|                                                      | Foreign exchange and other adjustments    |           |     | (1         | )         |   |           | (8          | ) |                 |              |      |          |            |       | (9       | )    |   |    |    |  |   |     |    |  
|                                                      |                                           |           |     |            |           |   |           |             |   |                 |              |       |          |            |       |          |      |  
|Provision balance as of June 30, 2005                 |                                           | $         | 5   |            |           | $ | 257       |             |   | $               |             |       |          | $          | 262   |          |      |   |    |    |  |   |     |   
|                                                      |                                           |           |     |            |           |   |           |             |   |                 |              |       |          |            |       |          |      |  
|2004 Restructuring Plan                               |                                           |           |     |            |           |   |           |             |   |                 |              |       |          |            |       |          |      |   |    |    |  |   |     |   
|Provision balance as of December 31,
    2004(a)      |                                           | $         | 122 |            |           | $ |          |             |   | $               |             |       |          | $          | 122   |          |      |   |    |    |  |   |     |   
|Other special charges:                                |                                           |           |     |            |           |   |           |             |   |                 |              |       |          |            |       |          |      |   |    |    |  |   |     |   
|                                                      | For the three months ended March 31, 2005 |           |     | 18         |           |   |           | 8           |   |                 |              | 1     |          |            |       | 27       |      |   |    |   |  |   |     | 27 |  
|                                                      | For the three months ended June 30, 2005  |           |     | 32         |           |   |           | 46          |   |                 |              | 4     |          |            |       | 82       |      |   |    | 82 |  |   |     | 82 |  
|Revisions to prior accruals:                          |                                           |           |     |            |           |   |           |             |   |                 |              |       |          |            |       |          |      |   |    |    |  |   |     |   
|                                                      | For the three months ended March 31, 2005 |           |     | (2         | )         |   |           |            |   |                 |              |      |          |            |       | (2       | )    |   |    |   |  |   |     | (2 | )
|                                                      | For the three months ended June 30, 2005  |           |     | 7          |           |   |           |            |   |                 |              | 1     |          |            |       | 8        |      |   |    | 8  |  |   |     | 8  |  
|Cumulative provision (drawdowns) adjustments in 2005: |                                           |           |     |            |           |   |           |             |   |                 |              |       |          |            |       |          |      |   |    |    |  |   |     |   
|                                                      | Cash drawdowns                            |           |     | (119       | )         |   |           | (3          | ) |                 |              |      |          |            |       | (122     | )    |   |    |    |  |   |     |    |  
|                                                      | Non-cash drawdowns                        |           |     |           |           |   |           |            |   |                 |              | (5    | )        |            |       | (5       | )    |   |    |    |  |   |     |    |  
|                                                      | Foreign exchange and other adjustments    |           |     | (1         | )         |   |           |            |   |                 |              | (2    | )        |            |       | (3       | )    |   |    |    |  |   |     |    |  
|                                                      |                                           |           |     |            |           |   |           |             |   |                 |              |       |          |            |       |          |      |  
|Provision balance as of June 30, 2005                 |                                           | $         | 57  |            |           | $ | 51        |             |   | $               | (1           | )     |          | $          | 107   |          |      |   |    |    |  |   |     |   
|                                                      |                                           |           |     |            |           |   |           |             |   |                 |              |       |          |            |       |          |      |  
|Total provision balance as of June 30,
    2005(a)    |                                           | $         | 62  |            |           | $ | 308       |             |   | $               | (1           | )     |          | $          | 369   |          |      |   |    |    |  |   |     |   
|                                                      |                                           |           |     |            |           |   |           |             |   |                 |              |       |          |            |       |          |      |  
|Total special charges                                 |                                           |           |     |            |           |   |           |             |   |                 |              |       |          |            |       |          |      | $ | 90 |    |  | $ | 111 |   
|                                                      |                                           |           |     |            |           |   |           |             |   |                 |              |       |          |            |       |          |      |  






|    |                                                                                                                                                                                              
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(a) | As of June 30, 2005 and December 31, 2004, the
    short-term provision balance was $143 and $254, respectively,
    and the long-term provision balance was $226 and $209,
    respectively.

78



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2001 Restructuring Plan




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









| |                                         
| | ----------------------------------------
| | Three and six months ended June 30, 2004







79



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| |                             
| | ----------------------------
| | Special charges  by segment



|                                                             |                                           |           |    |            |           |   |           |             |   |   |       |    |   |   |    |    |  
|------------------------------------------------------------ | ----------------------------------------- | --------- | -- | ---------- | --------- | - | --------- | ----------- | - | - | ----- | -- | - | - | -- | -- | -
|                                                             |                                           |           |    | Contract   |           |   |           |             |  
|                                                             |                                           |           |    | Settlement |           |   | Plant and |             |   |  
|                                                             |                                           | Workforce |    |            | and Lease |   |           | Equipment   |   |   |      
|                                                             |                                           | Reduction |    |            | Costs     |   |           | Write Downs |   |   | Total |   
|                                                             |                                           |           |    |            |           |   |           |             |   |   |       |   
|2001 Restructuring Plan                                      |                                           |           |    |            |           |   |           |             |   |   |       |    |   |   |    |   
|Carrier Packet Networks:                                     |                                           |           |    |            |           |   |           |             |   |   |       |    |   |   |    |   
|                                                             | For the three months ended March 31, 2005 |           | $  | (1         | )         |   | $         |            |   |   | $     | (1 | ) |   | $  | (2 | )
|                                                             | For the three months ended June 30, 2005  |           |    | (1         | )         |   |           | 2           |   |   |       | (1 | ) |   |    |   |  
|GSM and UMTS Networks:                                       |                                           |           |    |            |           |   |           |             |   |   |       |    |   |   |    |   
|                                                             | For the three months ended March 31, 2005 |           |    | (1         | )         |   |           |            |   |   |       |   |   |   |    | (1 | )
|                                                             | For the three months ended June 30, 2005  |           |    | (1         | )         |   |           | 1           |   |   |       | (1 | ) |   |    | (1 | )
|Enterprise Networks:                                         |                                           |           |    |            |           |   |           |             |   |   |       |    |   |   |    |   
|                                                             | For the three months ended March 31, 2005 |           |    | (1         | )         |   |           |            |   |   |       |   |   |   |    | (1 | )
|                                                             | For the three months ended June 30, 2005  |           |    |           |           |   |           | 1           |   |   |       |   |   |   |    | 1  |  
|                                                             |                                           |           |    |            |           |   |           |             |   |   |       |   
|Total special charges for the six months ended June 30, 2005 |                                           | $         | (5 | )          |           | $ | 4         |             |   | $ | (3    | )  |   | $ | (4 | ) 
|                                                             |                                           |           |    |            |           |   |           |             |   |   |       |   
|Carrier Packet Networks:                                     |                                           |           |    |            |           |   |           |             |   |   |       |    |   |   |    |   
|                                                             | For the three months ended March 31, 2004 |           | $  | 6          |           |   | $         | 1           |   |   | $     |   |   |   | $  | 7  |  
|                                                             | For the three months ended June 30, 2004  |           |    |           |           |   |           | (1          | ) |   |       |   |   |   |    | (1 | )
|                                                             |                                           |           |    |            |           |   |           |             |   |   |       |   
|Total special charges for the six months ended June 30, 2004 |                                           | $         | 6  |            |           | $ |          |             |   | $ |      |    |   | $ | 6  |   
|                                                             |                                           |           |    |            |           |   |           |             |   |   |       |   



2004 Restructuring Plan




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







80



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| |                             
| | ----------------------------
| | Special charges  by segment



|                                                       |                                           |           |    |            |           |   |           |             |  |   |       |   |  |   |     |    | 
|------------------------------------------------------ | ----------------------------------------- | --------- | -- | ---------- | --------- | - | --------- | ----------- |  | - | ----- | - |  | - | --- | -- | 
|                                                       |                                           |           |    | Contract   |           |   |           |             | 
|                                                       |                                           |           |    | Settlement |           |   | Plant and |             |  |  
|                                                       |                                           | Workforce |    |            | and Lease |   |           | Equipment   |  |   |      
|                                                       |                                           | Reduction |    |            | Costs     |   |           | Write Downs |  |   | Total |  
|                                                       |                                           |           |    |            |           |   |           |             |  |   |       |  
|2004 Restructuring Plan                                |                                           |           |    |            |           |   |           |             |  |   |       |   |  |   |     |   
|Carrier Packet Networks:                               |                                           |           |    |            |           |   |           |             |  |   |       |   |  |   |     |   
|                                                       | For the three months ended March 31, 2005 |           | $  | 9          |           |   | $         | 1           |  |   | $     | 1 |  |   | $   | 11 | 
|                                                       | For the three months ended June 30, 2005  |           |    | 28         |           |   |           | 36          |  |   |       | 4 |  |   |     | 68 | 
|CDMA Networks:                                         |                                           |           |    |            |           |   |           |             |  |   |       |   |  |   |     |   
|                                                       | For the three months ended March 31, 2005 |           |    | 1          |           |   |           |            |  |   |       |  |  |   |     | 1  | 
|                                                       | For the three months ended June 30, 2005  |           |    | 2          |           |   |           | 1           |  |   |       |  |  |   |     | 3  | 
|GSM and UMTS Networks:                                 |                                           |           |    |            |           |   |           |             |  |   |       |   |  |   |     |   
|                                                       | For the three months ended March 31, 2005 |           |    | 3          |           |   |           |            |  |   |       |  |  |   |     | 3  | 
|                                                       | For the three months ended June 30, 2005  |           |    | 6          |           |   |           | 6           |  |   |       | 1 |  |   |     | 13 | 
|Enterprise Networks:                                   |                                           |           |    |            |           |   |           |             |  |   |       |   |  |   |     |   
|                                                       | For the three months ended March 31, 2005 |           |    | 3          |           |   |           | 7           |  |   |       |  |  |   |     | 10 | 
|                                                       | For the three months ended June 30, 2005  |           |    | 3          |           |   |           | 3           |  |   |       |  |  |   |     | 6  | 
|                                                       |                                           |           |    |            |           |   |           |             |  |   |       |  
|Special charges for the six months ended June 30, 2005 |                                           | $         | 55 |            |           | $ | 54        |             |  | $ | 6     |   |  | $ | 115 |   
|                                                       |                                           |           |    |            |           |   |           |             |  |   |       |  








| |                                             
| | --------------------------------------------
| | Gain (loss) on sale of businesses and assets










| |                             
| | ----------------------------
| | Other income (expense)  net



|                                                 |  |                |    |  |                |   |     |      |  |   |      |  |  |   |    | 
|------------------------------------------------ |  | -------------- | -- |  | -------------- | - | --- | ---- |  | - | ---- |  |  | - | -- | 
|                                                 |  | For the Three  |    |  | For the Six    |  
|                                                 |  | Months         |    |  | Months         |  
|                                                 |  | Ended June 30, |    |  | Ended June 30, |  
|                                                 |  |                |    |  |                |  
|                                                 |  | 2005           |    |  | 2004           |   |     | 2005 |  |   | 2004 | 
|                                                 |  |                |    |  |                |   |     |      |  |   |      | 
|Interest
    income(a)                           |  | $              | 14 |  |                | $ | 16  |      |  | $ | 28   |  |  | $ | 31 | 
|Gain (loss) on sale or write down of investments |  |                | 21 |  |                |   | (1  | )    |  |   | 16   |  |  |   | 32 | 
|Currency exchange gains
    (losses)(b)          |  |                | 9  |  |                |   | (1  | )    |  |   | 35   |  |  |   |   | 
|Other  net                                      |  |                | 17 |  |                |   | (28 | )    |  |   | 29   |  |  |   | 11 | 
|                                                 |  |                |    |  |                |   |     |      |  |   |      | 
|Total other income (expense)  net               |  | $              | 61 |  |                | $ | (14 | )    |  | $ | 108  |  |  | $ | 74 | 
|                                                 |  |                |    |  |                |   |     |      |  |   |      | 






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

81



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| |   |                                                                                                                                                                                                                                                                                                                   
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | dividend income of $11 on our short-term investments;                                                                                                                                                                                                                                                             
|
| |  | gain of $21 related to the sale of our remaining Arris Group,
    Inc., or Arris Group, shares. For additional information on our
    investment in Arris Group, see Acquisitions, divestitures
    and change in investments in note 8 of the
    accompanying unaudited consolidated financial statements; and
|
| |  | gain of $17 related to a customer exclusivity clause
    settlement; partially offset by                                                                                                                                                                                                                          
|
| |  | loss of $4 related to changes in fair value of derivative
    financial instruments that did not meet the criteria for hedge
    accounting.                                                                                                                                                                      





| |   |                                                                                                                                                                                   
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | loss of $20 related to changes in fair value of derivative
    financial instruments that did not meet the criteria for hedge
    accounting; and                                 
|
| |  | loss of $12 related to the prepaid equity forward purchase
    contracts that were entered into in connection with the issuance
    of restricted stock units; partially offset by
|
| |  | dividend income of $4 on our short-term investments.                                                                                                                              





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





| |   |                                                                                                                                                               
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | gain of $18 related to the sale of our remaining 7 million
    common shares of Entrust Inc.;                                                                 
|
| |  | dividend income of $9 on our short-term investments;                                                                                                          
|
| |  | gain of $11 related to prepaid equity forward purchase contracts
    that were entered into in connection with the issuance of
    restricted stock units; and
|
| |  | gain of $13 related to the sale of Arris Group shares; partially
    offset by                                                                                
|
| |  | loss of $18 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)



82



---



##### Table of Contents


















| |                                               
| | ----------------------------------------------
| | Net earnings (loss) from continuing operations








| |                    
| | -------------------
| | Segment information



83



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##### Table of Contents





|                                               |  |                                     |       |   |                                   |   |       |        |  |   |        |   |  |      |        |   |      |   |       |        |  |   |        |   |  |   |      |   |  |  |        |  
|---------------------------------------------- |  | ----------------------------------- | ----- | - | --------------------------------- | - | ----- | ------ |  | - | ------ | - |  | ---- | ------ | - | ---- | - | ----- | ------ |  | - | ------ | - |  | - | ---- | - |  |  | ------ | -
|                                               |  | For the Three Months Ended June 30, |       |   | For the Six Months Ended June 30, |  
|                                               |  |                                     |       |   |                                   |  
|                                               |  |                                     |       | $ |                                   |   | %     |        |  |   |        | $ |  |      | %      |  
|                                               |  | 2005                                |       |   | 2004                              |   |       | Change |  |   | Change |   |  | 2005 |        |   | 2004 |   |       | Change |  |   | Change |  
|                                               |  |                                     |       |   |                                   |   |       |        |  |   |        |   |  |      |        |   |      |   |       |        |  |   |        |  
|Revenues                                       |  |                                     |       |   |                                   |   |       |        |  |   |        |   |  |      |        |   |      |   |       |        |  |   |        |   |  |   |      |   |  |  |        |  
|Carrier Packet Networks                        |  | $                                   | 743   |   |                                   | $ | 724   |        |  | $ | 19     |   |  |      | 3      |   |      | $ | 1,407 |        |  | $ | 1,407  |   |  | $ |     |   |  |  |       |  
|CDMA Networks                                  |  |                                     | 662   |   |                                   |   | 567   |        |  |   | 95     |   |  |      | 17     |   |      |   | 1,197 |        |  |   | 1,136  |   |  |   | 61   |   |  |  | 5      |  
|GSM and UMTS Networks                          |  |                                     | 719   |   |                                   |   | 711   |        |  |   | 8      |   |  |      | 1      |   |      |   | 1,507 |        |  |   | 1,367  |   |  |   | 140  |   |  |  | 10     |  
|Enterprise Networks                            |  |                                     | 730   |   |                                   |   | 578   |        |  |   | 152    |   |  |      | 26     |   |      |   | 1,277 |        |  |   | 1,112  |   |  |   | 165  |   |  |  | 15     |  
|                                               |  |                                     |       |   |                                   |   |       |        |  |   |        |   |  |      |        |   |      |   |       |        |  |   |        |  
|Total revenues of reportable segments          |  |                                     | 2,854 |   |                                   |   | 2,580 |        |  |   | 274    |   |  |      | 11     |   |      |   | 5,388 |        |  |   | 5,022  |   |  |   | 366  |   |  |  | 7      |  
|Other(a)                                       |  |                                     | 1     |   |                                   |   | 10    |        |  |   | (9     | ) |  |      | (90    | ) |      |   | 3     |        |  |   | 12     |   |  |   | (9   | ) |  |  | (75    | )
|                                               |  |                                     |       |   |                                   |   |       |        |  |   |        |   |  |      |        |   |      |   |       |        |  |   |        |  
|Total revenues                                 |  | $                                   | 2,855 |   |                                   | $ | 2,590 |        |  | $ | 265    |   |  |      | 10     |   |      | $ | 5,391 |        |  | $ | 5,034  |   |  | $ | 357  |   |  |  | 7      |  
|                                               |  |                                     |       |   |                                   |   |       |        |  |   |        |   |  |      |        |   |      |   |       |        |  |   |        |  
|Segment Management EBT                         |  |                                     |       |   |                                   |   |       |        |  |   |        |   |  |      |        |   |      |   |       |        |  |   |        |   |  |   |      |   |  |  |        |  
|Carrier Packet Networks                        |  | $                                   | 26    |   |                                   | $ | (46   | )      |  | $ | 72     |   |  |      | 157    |   |      | $ | (5    | )      |  | $ | (105   | ) |  | $ | 100  |   |  |  | 95     |  
|CDMA Networks                                  |  |                                     | 203   |   |                                   |   | 173   |        |  |   | 30     |   |  |      | 17     |   |      |   | 371   |        |  |   | 386    |   |  |   | (15  | ) |  |  | (4     | )
|GSM and UMTS Networks                          |  |                                     | 27    |   |                                   |   | (9    | )      |  |   | 36     |   |  |      | 400    |   |      |   | 80    |        |  |   | (5     | ) |  |   | 85   |   |  |  | 1,700  |  
|Enterprise Networks                            |  |                                     | 111   |   |                                   |   | 31    |        |  |   | 80     |   |  |      | 258    |   |      |   | 143   |        |  |   | 56     |   |  |   | 87   |   |  |  | 155    |  
|                                               |  |                                     |       |   |                                   |   |       |        |  |   |        |   |  |      |        |   |      |   |       |        |  |   |        |  
|Total management EBT of reportable segments    |  |                                     | 367   |   |                                   |   | 149   |        |  |   | 218    |   |  |      | 146    |   |      |   | 589   |        |  |   | 332    |   |  |   | 257  |   |  |  | 77     |  
|Other(a)                                       |  |                                     | (188  | ) |                                   |   | (168  | )      |  |   | (20    | ) |  |      | (12    | ) |      |   | (380  | )      |  |   | (234   | ) |  |   | (146 | ) |  |  | (62    | )
|                                               |  |                                     |       |   |                                   |   |       |        |  |   |        |   |  |      |        |   |      |   |       |        |  |   |        |  
|Total segment Management EBT                   |  |                                     | 179   |   |                                   |   | (19   | )      |  |   | 198    |   |  |      | 1,042  |   |      |   | 209   |        |  |   | 98     |   |  |   | 111  |   |  |  | 113    |  
|Amortization of intangibles                    |  |                                     | (2    | ) |                                   |   | (2    | )      |  |   |       |   |  |      |       |   |      |   | (4    | )      |  |   | (5     | ) |  |   | 1    |   |  |  | 20     |  
|Special charges                                |  |                                     | (90   | ) |                                   |   | 1     |        |  |   | (91    | ) |  |      | (9,100 | ) |      |   | (111  | )      |  |   | (6     | ) |  |   | (105 | ) |  |  | (1,750 | )
|Gain (loss) on sale of businesses and assets   |  |                                     | (36   | ) |                                   |   | 75    |        |  |   | (111   | ) |  |      | (148   | ) |      |   | (37   | )      |  |   | 75     |   |  |   | (112 | ) |  |  | (149   | )
|Income tax benefit (expense)                   |  |                                     | 7     |   |                                   |   | (7    | )      |  |   | 14     |   |  |      | 200    |   |      |   | (8    | )      |  |   | 2      |   |  |   | (10  | ) |  |  | (500   | )
|                                               |  |                                     |       |   |                                   |   |       |        |  |   |        |   |  |      |        |   |      |   |       |        |  |   |        |  
|Net earnings (loss) from continuing operations |  | $                                   | 58    |   |                                   | $ | 48    |        |  | $ | 10     |   |  |      | 21     |   |      | $ | 49    |        |  | $ | 164    |   |  | $ | (115 | ) |  |  | (70    | )
|                                               |  |                                     |       |   |                                   |   |       |        |  |   |        |   |  |      |        |   |      |   |       |        |  |   |        |  






|    |  |                                                                                  
|--- |  | ---------------------------------------------------------------------------------
|(a) |  | Other represents miscellaneous business activities
    and corporate functions.





|                                    |  |                                          |     |   |                                        |   |       |     |  |       |          |   |       |        |    |   |        |       |     |      |       |   |     |   |  |          |     |   |        |   |     |   |  |   |    |   |  |   |      |  
|----------------------------------- |  | ---------------------------------------- | --- | - | -------------------------------------- | - | ----- | --- |  | ----- | -------- | - | ----- | ------ | -- | - | ------ | ----- | --- | ---- | ----- | - | --- | - |  | -------- | --- | - | ------ | - | --- | - |  | - | -- | - |  | - | ---- | -
|                                    |  | For the Three Months Ended June 30, 2005 |     |   | For the Six Months Ended June 30, 2005 |  
|                                    |  |                                          |     |   |                                        |  
|                                    |  | Gross                                    |     |   |                                        |   | Other |     |  | Total |          |   | Gross |        |    |   |        | Other |     |      | Total |  
|                                    |  | Profit                                   |     |   | SG&A                                   |   |       | R&D |  |       | Items(b) |   |       | Change |    |   | Profit |       |     | SG&A |       |   | R&D |   |  | Items(b) |     |   | Change |  
|                                    |  |                                          |     |   |                                        |   |       |     |  |       |          |   |       |        |    |   |        |       |     |      |       |   |     |   |  |          |     |   |        |  
|Carrier Packet Networks             |  | $                                        | 42  |   |                                        | $ | 13    |     |  | $     | 18       |   |       | $      | (1 | ) |        | $     | 72  |      |       | $ | 55  |   |  | $        | 20  |   |        | $ | 29  |   |  | $ | (4 | ) |  | $ | 100  |  
|CDMA Networks                       |  |                                          | 35  |   |                                        |   | 3     |     |  |       | (6       | ) |       |        | (2 | ) |        |       | 30  |      |       |   | (25 | ) |  |          | 8   |   |        |   |    |   |  |   | 2  |   |  |   | (15  | )
|GSM and UMTS Networks               |  |                                          | 11  |   |                                        |   | (1    | )   |  |       | 10       |   |       |        | 16 |   |        |       | 36  |      |       |   | 56  |   |  |          | 2   |   |        |   | 10  |   |  |   | 17 |   |  |   | 85   |  
|Enterprise Networks                 |  |                                          | 91  |   |                                        |   | (7    | )   |  |       | (6       | ) |       |        | 2  |   |        |       | 80  |      |       |   | 106 |   |  |          | (16 | ) |        |   | (9  | ) |  |   | 6  |   |  |   | 87   |  
|                                    |  |                                          |     |   |                                        |   |       |     |  |       |          |   |       |        |    |   |        |       |     |      |       |   |     |   |  |          |     |   |        |  
|Total Change of reportable segments |  |                                          | 179 |   |                                        |   | 8     |     |  |       | 16       |   |       |        | 15 |   |        |       | 218 |      |       |   | 192 |   |  |          | 14  |   |        |   | 30  |   |  |   | 21 |   |  |   | 257  |  
|Other(a)                            |  |                                          | (26 | ) |                                        |   | (46   | )   |  |       | (1       | ) |       |        | 53 |   |        |       | (20 | )    |       |   | (52 | ) |  |          | (84 | ) |        |   | (20 | ) |  |   | 10 |   |  |   | (146 | )
|                                    |  |                                          |     |   |                                        |   |       |     |  |       |          |   |       |        |    |   |        |       |     |      |       |   |     |   |  |          |     |   |        |  
|Total Change                        |  | $                                        | 153 |   |                                        | $ | (38   | )   |  | $     | 15       |   |       | $      | 68 |   |        | $     | 198 |      |       | $ | 140 |   |  | $        | (70 | ) |        | $ | 10  |   |  | $ | 31 |   |  | $ | 111  |  
|                                    |  |                                          |     |   |                                        |   |       |     |  |       |          |   |       |        |    |   |        |       |     |      |       |   |     |   |  |          |     |   |        |  






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

84



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Carrier Packet Networks




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








| |                                                                      
| | ---------------------------------------------------------------------
| | Q2 2005 vs. Q2 2004 and first half of 2005 vs. first half of
    2004









85



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##### Table of Contents





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





| |                    
| | -------------------
| | Q2 2005 vs. Q2 2004





| |   |                                                                                                                                                                                       
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | recovery in inventory provisions due to sale of inventory that
    was previously fully provided for;                                                                                 
|
| |  | continued improvements in our cost structure primarily as a
    result of lower material pricing; and                                                                                 
|
| |  | lower warranty costs; partially offset by                                                                                                                                             
|
| |  | increased expenses related to our employee bonus plan;                                                                                                                                
|
| |  | unfavorable product mix associated with increased sales of our
    next generation products which typically have lower gross
    margins in the early stages of product evolution; and
|
| |  | continued pricing pressures on certain of our products due to
    increased competition.                                                                                              





| |   |                                                                                                                                                                                               
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | the continued impact of our workforce reductions across all
    regions and associated reductions in other related costs such as
    information services and real estate; partially offset by
|
| |  | unfavorable foreign exchange rate fluctuation impacts associated
    with the strengthening of the Canadian dollar, British pound and
    euro against the U.S. dollar;                       
|
| |  | increase in legal fees related to patent litigation; and                                                                                                                                      
|
| |  | increased expenses related to our employee bonus plan.                                                                                                                                        





| |   |                                                                                                                                                                              
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | the continued impact of our workforce reductions that targeted a
    level of R&D expense that was more representative of the
    volume of our business; partially offset by
|
| |  | increased expenses related to our employee bonus plan;                                                                                                                       
|
| |  | investment in targeted programs to increase the feature content
    in our Carrier Packet Networks portfolio; and                                                            
|
| |  | unfavorable foreign exchange rate fluctuation impacts associated
    with the strengthening of the Canadian dollar and British pound
    against the U.S. dollar.            



| |                                          
| | -----------------------------------------
| | First half of 2005 vs. first half of 2004





| |   |                                                                                                                                                                                       
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | recovery in inventory provisions due to sale of inventory that
    was previously fully provided for;                                                                                 
|
| |  | continued improvements in our cost structure primarily as a
    result of lower material pricing; and                                                                                 
|
| |  | lower warranty costs; partially offset by                                                                                                                                             
|
| |  | increased expenses related to our employee bonus plan;                                                                                                                                
|
| |  | unfavorable product mix associated with increased sales of our
    next generation products which typically have lower gross
    margins in the early stages of product evolution; and

86



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| |   |                                                                                         
| | - | ----------------------------------------------------------------------------------------
| |  | continued pricing pressures on certain of our products due to
    increased competition.





| |   |                                                                                                                                                                                               
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | the continued impact of our workforce reductions across all
    regions and associated reductions in other related costs such as
    information services and real estate; partially offset by
|
| |  | unfavorable foreign exchange rate fluctuation impacts associated
    with the strengthening of the Canadian dollar, British pound and
    euro against the U.S. dollar;                       
|
| |  | increase in legal fees related to patent litigation;                                                                                                                                          
|
| |  | increased expenses related to our employee bonus plan; and                                                                                                                                    
|
| |  | lower net trade and customer financing receivable recoveries.                                                                                                                                 





| |   |                                                                                                                                                                              
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | the continued impact of our workforce reductions that targeted a
    level of R&D expense that was more representative of the
    volume of our business; partially offset by
|
| |  | increased expenses related to our employee bonus plan;                                                                                                                       
|
| |  | investment in targeted programs to increase the feature content
    in our Carrier Packet Networks portfolio; and                                                            
|
| |  | unfavorable foreign exchange rate fluctuation impacts associated
    with the strengthening of the Canadian dollar and British pound
    against the U.S. dollar.            




CDMA Networks




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








| |                                                                      
| | ---------------------------------------------------------------------
| | Q2 2005 vs. Q2 2004 and first half of 2005 vs. first half of
    2004





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



87



---



##### Table of Contents





| |                    
| | -------------------
| | Q2 2005 vs. Q2 2004





| |   |                                                                                                                                                                                                           
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | unfavorable product mix associated with increased sales of our
    next generation products which typically have lower gross
    margins in the early stages of product evolution; partially
    offset by
|
| |  | overall higher sales volume; and                                                                                                                                                                          
|
| |  | continued improvements in our cost structure primarily as a
    result of lower material pricing.                                                                                                         





| |   |                                                                                         
| | - | ----------------------------------------------------------------------------------------
| |  | the ongoing focus on efficiencies and cost reduction activities;
    partially offset by
|
| |  | increase in bad debts expense; and                                                      
|
| |  | increased expenses related to our employee bonus plan.                                  





| |   |                                                                                                                                                                    
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | incremental investment in targeted new programs;                                                                                                                   
|
| |  | increased expenses related to our employee bonus plan; and                                                                                                         
|
| |  | unfavorable foreign exchange rate fluctuation impacts associated
    with the strengthening of the Canadian dollar against the
    U.S. dollar; partially offset by
|
| |  | reduced spending due to project timing and completions.                                                                                                            



| |                                          
| | -----------------------------------------
| | First half of 2005 vs. first half of 2004





| |   |                                                                                                                                                                                       
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | unfavorable product mix associated with increased sales of our
    next generation products which typically have lower gross
    margins in the early stages of product evolution; and
|
| |  | pricing pressures on certain of our products due to increased
    competition for service provider customers; partially offset by                                                     
|
| |  | continued improvements in our cost structure primarily as a
    result of lower material pricing.                                                                                     





| |   |                                                                                         
| | - | ----------------------------------------------------------------------------------------
| |  | decreases in selling and marketing expenses in our Asia Pacific
    region; and         
|
| |  | the ongoing focus on efficiencies and cost reduction activities;
    partially offset by
|
| |  | increases in bad debts expense; and                                                     
|
| |  | increased expenses related to our employee bonus plan.                                  





| |   |                                                                                                                                                          
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | incremental investment in targeted new programs; and                                                                                                     
|
| |  | unfavorable foreign exchange rate fluctuation impacts associated
    with the strengthening of the Canadian dollar against the
    U.S. dollar; offset by
|
| |  | reduced spending due to project timing and completions.                                                                                                  

88



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##### Table of Contents






GSM and UMTS Networks









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



| |                                                                      
| | ---------------------------------------------------------------------
| | Q2 2005 vs. Q2 2004 and first half of 2005 vs. first half of
    2004







Management EBT




Q2 2005 vs. Q2 2004 and first
half of 2005 vs. first half of 2004






| |   |                                                                                                                                                                   
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | overall higher sales volumes;                                                                                                                                     
|
| |  | a decrease in contract-related costs including a reduction in
    losses incurred from customer trials in the second quarter of
    2004 not repeated in 2005; and

89



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| |   |                                                                                                                                              
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------
| |  | continued improvements in our cost structure primarily as a
    result of lower material pricing; partially offset by                        
|
| |  | loss of approximately $27 in the second quarter of 2005 and $32
    in the first half of 2005 related to our contract in India with
    BSNL;
|
| |  | contractual release of penalties related to customer contracts
    in 2004 not repeated in 2005; and                                         
|
| |  | pricing pressures on certain of our products due to increased
    competition for service provider customers.                                





| |   |                                                                               
| | - | ------------------------------------------------------------------------------
| |  | higher net trade and customer financing receivable
    expenses; and          
|
| |  | increased expenses related to our employee bonus plan; partially
    offset by
|
| |  | decrease in employee related expenses.                                        





| |   |                                                                                                                                 
| | - | --------------------------------------------------------------------------------------------------------------------------------
| |  | decreases in employee related expenses; partially offset by                                                                     
|
| |  | increased expenses related to our employee bonus plan; and                                                                      
|
| |  | unfavorable foreign exchange rate fluctuation impacts associated
    with the strengthening of the euro against the U.S. dollar.





| |   |                                                                                                                                                                                                                                   
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | the impact of our workforce reductions across all regions and
    associated reductions in other related costs such as information
    services and real estate, resulting in program spending
    reductions; partially offset by
|
| |  | unfavorable foreign exchange rate impacts associated with the
    strengthening of the euro and Canadian dollar against the
    U.S. dollar;                                                                                      
|
| |  | increased expenses related to our employee bonus plan.                                                                                                                                                                            





| |   |                                                                                                                                                                    
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | a cash settlement of $17 in connection with the release of an
    exclusivity commitment agreement which has been recorded as a
    gain in other income (expense).

90



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Enterprise Networks









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



| |                                                                      
| | ---------------------------------------------------------------------
| | Q2 2005 vs. Q2 2004 and first half of 2005 vs. first half of
    2004









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





| |                    
| | -------------------
| | Q2 2005 vs. Q2 2004





| |   |                                                                                                                      
| | - | ---------------------------------------------------------------------------------------------------------------------
| |  | increased revenues from software upgrades that typically have
    higher margins; and                                
|
| |  | continued improvements in our cost structure primarily as a
    result of lower material pricing; partially offset by
|
| |  | pricing pressures on our data products due to increased
    competition for enterprise customers primarily in EMEA.  

91



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| |   |                                                                                                                                        
| | - | ---------------------------------------------------------------------------------------------------------------------------------------
| |  | increases in sales and marketing expenses primarily related to
    our PEC acquisition;                                                
|
| |  | unfavorable foreign exchange rate impacts associated with the
    strengthening of the Canadian dollar against the
    U.S. dollar; and
|
| |  | increases in employee related expenses; partially offset by                                                                            
|
| |  | the continued impact of our workforce reductions.                                                                                      





| |   |                                                                                             
| | - | --------------------------------------------------------------------------------------------
| |  | acceleration of R&D programs related to IP
    technologies; and                            
|
| |  | increased expenses related to our employee bonus plan; partially
    offset by              
|
| |  | effectively prioritizing investment in data products and
    increased outsourcing activity.



| |                                          
| | -----------------------------------------
| | First half of 2005 vs. first half of 2004





| |   |                                                                                                                      
| | - | ---------------------------------------------------------------------------------------------------------------------
| |  | higher sales volumes of software upgrades that typically have
    higher margins; and                                
|
| |  | continued improvements in our cost structure primarily as a
    result of lower material pricing; partially offset by
|
| |  | pricing pressures on our data products due to increased
    competition for enterprise customers primarily in EMEA.  





| |   |                                                                                                                                    
| | - | -----------------------------------------------------------------------------------------------------------------------------------
| |  | an increase in bad debt expense;                                                                                                   
|
| |  | increases in sales and marketing expenses primarily related to
    our PEC acquisition;                                            
|
| |  | unfavorable foreign exchange rate impacts associated with the
    strengthening of the Canadian dollar against the
    U.S. dollar;
|
| |  | increased expenses related to our employee bonus plan; and                                                                         
|
| |  | increases in employee related expenses; partially offset by                                                                        
|
| |  | the continued impact of our workforce reductions.                                                                                  





| |   |                                                                                             
| | - | --------------------------------------------------------------------------------------------
| |  | increased expenses related to our employee bonus plan; and                                  
|
| |  | acceleration of R&D programs related to IP technologies;
    partially offset by            
|
| |  | effectively prioritizing investment in data products and
    increased outsourcing activity.




Other




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



92



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##### Table of Contents





| |                    
| | -------------------
| | Q2 2005 vs. Q2 2004





| |   |                                                                                                                                             
| | - | --------------------------------------------------------------------------------------------------------------------------------------------
| |  | costs associated with our restatement activities and additional
    investment in our finance organization; and                             
|
| |  | unfavorable foreign exchange rate impacts associated with the
    strengthening of the Canadian dollar and euro against the
    U.S. dollar.







| |   |                                                                                                                                                                                                                     
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | gains related to the sale of investments in the second quarter
    of 2005 compared to a loss in the second quarter of 2004
    primarily related to the sale of shares in Arris Group;                             
|
| |  | foreign exchange gains of $9 primarily related to day-to-day
    transactional activities; and                                                                                                                      
|
| |  | losses related to changes in fair value of derivative financial
    instruments that do not meet the criteria for hedge accounting
    in the second quarter of 2004 not repeated in the second quarter
    of 2005.



| |                                          
| | -----------------------------------------
| | First half of 2005 vs. first half of 2004





| |   |                                                                                                                                                                                                                      
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | costs associated with our restatement activities and additional
    investment in our finance organization; and                                                                                                      
|
| |  | unfavorable foreign exchange rate impacts associated with the
    strengthening of the Canadian dollar and euro against the
    U.S. dollar; partially offset by                                                     
|
| |  | a decrease in stock based compensation in the first quarter of
    2005 due to the RSU expense that was incurred in the first
    quarter of 2004 and not repeated in 2005 as the program was
    terminated in 2004.







| |   |                                                                                                                                                                               
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | foreign exchange gains of $34 primarily related to day-to-day
    transactional activities; partially offset by                                                               
|
| |  | lower gains related to the sale of investments in the first half
    of 2005 primarily related to the sale of shares in Arris Group
    and Entrust in the first half of 2004.




Liquidity and capital resources




93



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| |           
| | ----------
| | Cash flows



|                                                                          |  |      |       |   |      |   |       |  
|------------------------------------------------------------------------- |  | ---- | ----- | - | ---- | - | ----- | -
|                                                                          |  | 2005 |       |   | 2004 |  
|                                                                          |  |      |       |   |      |  
|Net cash from (used in) operating activities of continuing
    operations |  | $    | (160  | ) |      | $ | (220  | )
|Net cash from (used in) investing activities of continuing
    operations |  |      | (381  | ) |      |   | 44    |  
|Net cash from (used in) financing activities of continuing
    operations |  |      | (36   | ) |      |   | (107  | )
|Effect of foreign exchange rate changes on cash and cash
    equivalents  |  |      | (85   | ) |      |   | (9    | )
|                                                                          |  |      |       |   |      |  
|Net cash from (used in) continuing operations                             |  |      | (662  | ) |      |   | (292  | )
|Net cash from (used in) discontinued operations                           |  |      | 34    |   |      |   | 11    |  
|                                                                          |  |      |       |   |      |  
|Net increase (decrease) in cash and cash equivalents                      |  |      | (628  | ) |      |   | (281  | )
|Cash and cash equivalents at beginning of period                          |  |      | 3,607 |   |      |   | 3,928 |  
|                                                                          |  |      |       |   |      |  
|Cash and cash equivalents at end of period                                |  | $    | 2,979 |   |      | $ | 3,647 |  
|                                                                          |  |      |       |   |      |  






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







| |                                            
| | -------------------------------------------
| | Changes in operating assets and liabilities









| |   |                                                                                                                                                                                                                                   
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | income tax payments of $29 in the first half of 2005 compared to
    $21 in the first half of 2004 primarily due to an increase in
    income in certain taxable jurisdictions; and                                               
|
| |  | a decrease of $292 from other changes in operating assets and
    liabilities primarily due to a reduction in liabilities,
    including the deferred revenue balance and project loss
    associated with the contract with BSNL.





94



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





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



(a)










|    |  |                                                                                                                                                                                                                        
|--- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(a) |  | 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 GAAP, and multiplying
    by 90 days.





| |   |                                                                                                                                                                                                                                       
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | an increase of approximately 4 days due to a note
    receivable that resulted from the transfer of one of our
    manufacturing facilities to Flextronics, which did not have a
    corresponding revenue impact; partially offset by
|
| |  | recognition of revenue that was previously deferred for which
    there was no corresponding increase in accounts receivable.                                                                                                         





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



95



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(a)










|    |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|--- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(a) |  | NID for each quarter is calculated by dividing the average of
    the current quarter and prior quarter inventories 
    net by the cost of revenues for the quarter, in each case as
    determined in accordance with U.S. GAAP, and multiplying by
    90 days. Finished goods inventory includes certain direct
    and incremental costs associated with arrangements where title
    and risk of loss was transferred to the customer but revenue was
    deferred due to other revenue recognition criteria not being
    met. As of June 30, 2005 and June 30, 2004, these
    deferred costs totaled $779 and $495, respectively.









| |                                                  
| | -------------------------------------------------
| | Days of purchases outstanding in accounts payable



(a)










|    |  |                                                                                                                                                                                                                                      
|--- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(a) |  | 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 GAAP,
    and multiplying by 90 days.





96



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










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











97



---



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| |                  
| | -----------------
| | Uses of liquidity





| |   |                                                                                                                                                                                        
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | debt service, including repayment of our debt of $1,275 due in
    February 2006 and $150 due in June 2006;                                                                            
|
| |  | capital expenditures;                                                                                                                                                                  
|
| |  | investments in certain businesses, including planned joint
    ventures in Asia Pacific;                                                                                               
|
| |  | costs relating to workforce reduction and other restructuring
    activities;                                                                                                          
|
| |  | pension and post-retirement benefits;                                                                                                                                                  
|
| |  | our finance transformation project which will include, among
    other things, implementing SAP to provide an integrated global
    financial system; and                              
|
| |  | costs in relation to the restatement activities, matters related
    to the Revenue Independent Review and other related matters,
    including regulatory and other legal proceedings.












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



98



---



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



|                                   |  |          |     |   |              |   |     |  
|---------------------------------- |  | -------- | --- | - | ------------ | - | --- | -
|                                   |  | June 30, |     |   | December 31, |  
|                                   |  | 2005     |     |   | 2004         |  
|                                   |  |          |     |   |              |  
|Drawn and outstanding  gross      |  | $        | 56  |   |              | $ | 118 |  
|Provisions for doubtful accounts   |  |          | (39 | ) |              |   | (38 | )
|                                   |  |          |     |   |              |  
|Drawn and outstanding 
    net(a) |  |          | 17  |   |              |   | 80  |  
|Undrawn commitments                |  |          | 54  |   |              |   | 69  |  
|                                   |  |          |     |   |              |  
|Total customer financing           |  | $        | 71  |   |              | $ | 149 |  
|                                   |  |          |     |   |              |  






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










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










| |                     
| | --------------------
| | Sources of liquidity



99



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| |                  
| | -----------------
| | Credit facilities








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





| |   |                                                                                                                                         
| | - | ----------------------------------------------------------------------------------------------------------------------------------------
| |  | $300 of committed revolving support for performance bonds or
    similar instruments, of which $144 was outstanding;                    
|
| |  | $150 of uncommitted support for receivables sales and/or
    securitizations, of which none was utilized; and                           
|
| |  | $300 of uncommitted support for performance bonds and/or
    receivables sales and/or securitizations, of which $69 was
    outstanding.







100



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| |   |                                                                                                                          
| | - | -------------------------------------------------------------------------------------------------------------------------
| |  | pledges of substantially all of our assets and those of most of
    its U.S. and Canadian subsidiaries; and              
|
| |  | guarantees by certain of our wholly owned subsidiaries organized
    in the U.S., Canada, England, Ireland and Hong Kong.










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



101



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| |               
| | --------------
| | Credit ratings

|                                  |  |                          |    |  |                  |  |      |             |  |  |              | 
|--------------------------------- |  | ------------------------ | -- |  | ---------------- |  | ---- | ----------- |  |  | ------------ | 
|                                  |  | Rating on Long-Term Debt |    |  | Rating on        |  |      |            
|                                  |  | Issued or Guaranteed by  |    |  | Preferred Shares |  |      |            
|                                  |  | Nortel Networks          |    |  | Issued by        |  |      |            
|                                  |  | Limited/Nortel Networks  |    |  | Nortel Networks  |  |      |            
|Rating Agency                     |  | Corporation              |    |  | Limited          |  |      | Last Update | 
|                                  |  |                          |    |  |                  |  |      |             | 
|Standard & Poors Ratings Service |  |                          | B |  |                  |  | CCC |             |  |  | June 1, 2005 | 
|Moodys Investors Service, Inc.   |  |                          | B3 |  |                  |  | Caa3 |             |  |  | July 6, 2005 | 






Off-balance sheet arrangements







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





|                                               |  |          |     |  |              |   |     | 
|---------------------------------------------- |  | -------- | --- |  | ------------ | - | --- | 
|                                               |  | June 30, |     |  | December 31, |  
|                                               |  | 2005     |     |  | 2004         |  
|                                               |  |          |     |  |              |  
|Bid and performance related
    bonds(a)       |  | $        | 264 |  |              | $ | 362 | 
|Other
    bonds(b)                             |  |          | 46  |  |              |   | 68  | 
|                                               |  |          |     |  |              |  
|Total bid, performance related and other bonds |  | $        | 310 |  |              | $ | 430 | 
|                                               |  |          |     |  |              |  






|    |  |                                                                                                                                    
|--- |  | -----------------------------------------------------------------------------------------------------------------------------------
|(a) |  | Net of restricted cash and cash equivalents amounts of $37 and
    $36 as of June 30, 2005 and December 31, 2004,
    respectively.
|(b) |  | Net of restricted cash and cash equivalents amounts of $28 and
    $28 as of June 30, 2005 and December 31, 2004,
    respectively.



102



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| |                                        
| | ---------------------------------------
| | Receivables securitization transactions






Application of critical accounting policies and estimates















| |                                 
| | --------------------------------
| | Provisions for doubtful accounts



103



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| |   |                                                                                        
| | - | ---------------------------------------------------------------------------------------
| |  | a customers ability to meet and sustain its financial
    commitments;                
|
| |  | a customers current and projected financial condition;                                
|
| |  | the positive or negative effects of the current and projected
    industry outlook; and
|
| |  | the economy in general.                                                                





|                                                                                  |  |          |       |   |              |   |       |  
|--------------------------------------------------------------------------------- |  | -------- | ----- | - | ------------ | - | ----- | -
|                                                                                  |  | June 30, |       |   | December 31, |  
|                                                                                  |  | 2005     |       |   | 2004         |  
|                                                                                  |  |          |       |   |              |  
|Gross accounts receivable                                                         |  | $        | 3,120 |   |              | $ | 2,909 |  
|Provision for doubtful accounts                                                   |  |          | (103  | ) |              |   | (109  | )
|                                                                                  |  |          |       |   |              |  
|Accounts receivable  net                                                         |  | $        | 3,017 |   |              | $ | 2,800 |  
|                                                                                  |  |          |       |   |              |  
|Accounts receivable provision as a percentage of gross accounts
    receivables   |  |          | 3     | % |              |   | 4     | %
|Gross long-term receivables                                                       |  | $        | 96    |   |              | $ | 159   |  
|Provision for doubtful accounts                                                   |  |          | (64   | ) |              |   | (65   | )
|                                                                                  |  |          |       |   |              |  
|Net long-term receivables                                                         |  | $        | 32    |   |              | $ | 94    |  
|                                                                                  |  |          |       |   |              |  
|Long-term receivable provision as a percentage of gross
    long-term receivables |  |          | 67    | % |              |   | 41    | %
|                                                                                  |  |          |       |   |              |  






| |                         
| | ------------------------
| | Provisions for inventory





104



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|                                                        |  |          |        |   |              |   |        |  
|------------------------------------------------------- |  | -------- | ------ | - | ------------ | - | ------ | -
|                                                        |  | June 30, |        |   | December 31, |  
|                                                        |  | 2005     |        |   | 2004         |  
|                                                        |  |          |        |   |              |  
|Gross inventory                                         |  | $        | 2,733  |   |              | $ | 2,923  |  
|Inventory provisions                                    |  |          | (1,041 | ) |              |   | (1,141 | )
|                                                        |  |          |        |   |              |  
|Inventories 
    net(a)                                |  | $        | 1,692  |   |              | $ | 1,782  |  
|                                                        |  |          |        |   |              |  
|Inventory provisions as a percentage of gross inventory |  |          | 38     | % |              |   | 39     | %
|                                                        |  |          |        |   |              |  






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








| |                                  
| | ---------------------------------
| | Provisions for product warranties







|                                |                   |          |     |      |  
|------------------------------- | ----------------- | -------- | --- | ---- | -
|                                |                   | June 30, |    
|                                |                   | 2005     |    
|                                |                   |          |    
|Balance as of December 31, 2004 |                   | $        | 271 |     
|                                | Payments          |          |     | (129 | )
|                                | Warranties issued |          |     | 96   |  
|                                | Revisions         |          |     | (6   | )
|                                |                   |          |    
|Balance as of June 30, 2005     |                   | $        | 232 |     
|                                |                   |          |    



105



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| |                    
| | -------------------
| | Tax asset valuation







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









106



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| |                   
| | ------------------
| | Goodwill valuation










| |                
| | ---------------
| | Special charges






Accounting changes and recent accounting pronouncements







| |                   
| | ------------------
| | Accounting changes





| |   |                                                                                                                                                                                                                                                                                                                                                                                         
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Implicit Variable Interests  the adoption of
    Financial Accounting Standards Board, or FASB Staff Position, or
    FSP, FASB Interpretation No., or FIN, 46R-5, Implicit
    Variable Interests under FIN 46 (Revised December 2003),
    Consolidation of Variable Interest Entities in 2005 did
    not have an impact on our results of operations and financial
    condition.
|
| |  | Accounting for certain financial instruments with
    characteristics of both liabilities and equity  the
    adoption of SFAS No. 150, Accounting for Certain
    Financial Instruments with Characteristics of both Liabilities
    and Equity in 2003 did not have a material impact on our
    results of operations and financial condition.                                    






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



107



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108



---



##### Table of Contents








Canadian supplement













| |                   
| | ------------------
| | Accounting changes





| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Derivative accounting  Effective January 1,
    2004, we adopted Accounting Guideline 13, Hedging
    Relationships, or AcG-13, which establishes specific
    criteria for derivatives to qualify for hedge accounting. We had
    been previously applying these criteria under U.S. GAAP;
    therefore, there was no impact on adoption of AcG-13. Concurrent
    with the adoption of AcG-13, we also adopted the Canadian
    Institute of Chartered Accountants, or CICAs, Emerging
    Issues Committee, or EIC, 128, Accounting for Trading,
    Speculative or Non-Hedging Derivative Financial
    Instruments, or EIC 128. As a result of the adoption of
    EIC 128, certain warrants, which had been previously recorded at
    cost under Canadian GAAP, are required to be recorded at fair
    value consistent with U.S. GAAP. The impact of this
    accounting change, which had been recorded prospectively as at
    January 1, 2004, was an increase to investments and other
    income of $23 for the six months ended June 30, 2004.
|
| |  | Determining whether an arrangement contains a lease 
    In December 2004, the EIC issued abstract 150, Determining
    Whether an Arrangement Contains a Lease, or EIC 150. EIC
    150 provides guidance on how to determine whether an arrangement
    contains a lease that is within the scope of CICA Handbook
    Section 3065, Leases. The guidance in EIC 150
    is based on whether the arrangement conveys to the purchaser the
    right to use a tangible asset, and is effective for us for
    arrangements entered into or modified after January 1,
    2005. We have already adopted equivalent guidance under
    U.S. GAAP. The adoption of EIC 150 did not have any
    material impact on our results of operations and financial
    condition.                                                                                                                                                                                                                                                                                         
|
| |  | Financial Instruments  Presentation and
    Disclosure  In January 2004, the CICA issued
    amendments to CICA Handbook Section 3860, Financial
    Instruments  Presentation and Disclosure, or
    Section 3860, to require obligations that must be or may be
    settled, at the issuers option, by a variable number of
    the issuers own equity instruments to be presented as
    liabilities. Thus, securities issued by an enterprise that give
    the issuer unrestricted rights to settle the principal                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        

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| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |   | amount in cash or in the equivalent value of its own equity
    instruments will no longer be presented as equity. The
    amendments to Section 3860 are applicable to us beginning
    January 1, 2005 on a retroactive basis. The adoption of the
    amendments to Section 3860 did not have any material impact
    on our results of operations and financial condition.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|
| |  | Accounting by a customer (including a reseller) for certain
    consideration received from a vendor  In January
    2005, the EIC issued amended abstract 144, Accounting by a
    Customer (including a Reseller) for Certain Consideration
    Received from a Vendor. The amendment is effective
    retroactively for periods commencing on or after
    February 15, 2005. The amendment requires companies to
    recognize the benefit of non-discretionary rebates for achieving
    specified cumulative purchasing levels as a reduction of the
    cost of purchases over the relevant period, provided the rebate
    is probable and reasonably estimable. Otherwise, the rebates
    would be recognized as purchasing milestones are achieved. The
    adoption of the new amendment did not have a material impact on
    our results of operations and financial condition.






| |                       
| | ----------------------
| | Outstanding share data






Market risk










110



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Equity price risk







Environmental matters











Legal proceedings




111



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Risk factors/forward looking statements


You should carefully consider the risks described below
before investing in our securities. The risks described below
are not the only ones facing us. Additional risks not currently
known to us or that we currently believe are immaterial may also
impair our business, results of operations, financial condition
and liquidity. Unless required by applicable securities laws, we
do not have any intention or obligation to publicly update or
revise any forward looking statements, whether as a result of
new information, future events or otherwise.


Certain statements in this Quarterly Report on Form 10-Q
contain words such as could, expects,
may, anticipates, believes,
intends, estimates, plans,
envisions, seeks and other similar
language and are considered forward looking statements. These
statements are based on our current expectations, estimates,
forecasts and projections about the operating environment,
economies and markets in which we operate. In addition, other
written or oral statements which are considered forward looking
may be made by us or others on our behalf. These statements are
subject to important risks, uncertainties and assumptions, which
are difficult to predict and the actual outcome may be
materially different. In particular, the risks described below
could cause actual events to differ materially from those
contemplated in forward looking statements.





Risks relating to our restatements and related matters




| |                                                                                                                                                               
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Our two restatements of our consolidated financial
    statements and related events have had, and will continue to
    have, a material adverse effect on us.









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| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | We are subject to ongoing regulatory and criminal investigations
    in the U.S. and Canada, which could require us to pay
    substantial fines or other penalties.                                                                                                                                                                                                                                                                                                 
|
| |  | We are subject to significant pending civil litigation, which if
    decided against us or as a result of settlement, could require
    us to pay substantial judgments, settlements or other penalties.                                                                                                                                                                                                                                                             
|
| |  | Material adverse legal judgments, fines, penalties or
    settlements could have a material adverse effect on our
    business, results of operations, financial condition and
    liquidity, which could be very significant.                                                                                                                                                                                                                                       
|
| |  | We cannot predict the outcome of the Revenue Independent Review
    being undertaken by our Audit Committee.                                                                                                                                                                                                                                                                                                                                                         
|
| |  | We and our independent auditors have identified a number of
    material weaknesses related to our internal control over
    financial reporting and concluded that our internal control over
    financial reporting was ineffective as of December 31,
    2004. These material weaknesses remain unremedied, which could
    continue to impact our ability to report our results of
    operations and financial condition accurately and in a timely
    manner.
|
| |  | The governing principles of the Independent Review particularly
    as they relate to remedial measures may take time to implement.                                                                                                                                                                                                                                                                                                                                  
|
| |  | Our credit ratings have been downgraded and we are currently
    unable to access, in its current form, our shelf registration
    statement filed with the SEC, each of which may adversely affect
    our liquidity.                                                                                                                                                                                                                                               
|
| |  | Continuing negative publicity has and may adversely affect our
    business.                                                                                                                                                                                                                                                                                                                                                                                         
|
| |  | We may not be able to attract or retain the personnel necessary
    to achieve our business objectives.                                                                                                                                                                                                                                                                                                                                                              
|
| |  | Ongoing SEC review may require us to amend our public
    disclosures further.                                                                                                                                                                                                                                                                                                                                                                                       
|
| |  | Any future delays in filing our periodic reports could cause us
    to breach our public debt indentures and our obligations under
    the EDC Support Facility and seek waivers from EDC under the EDC
    Support Facility. In such circumstances, it is possible that the
    holders of our public debt would seek to accelerate the maturity
    of that debt and EDC would not grant us further waivers.                                                       
|
| |  | Any future breach of the continued listing requirements of the
    NYSE and TSX could cause the NYSE and/or the TSX to commence
    suspension or delisting procedures in respect of Nortel Networks
    Corporations common shares or other of our or NNCs
    listed securities.                                                                                                                                                                                 



| |                                                                                                                                                                     
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | We are subject to ongoing regulatory and criminal
    investigations in the U.S. and Canada, which could require us to
    pay substantial fines or other penalties.







113



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| |                                                                                                                                                                                                             
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | We are subject to significant pending civil litigation,
    which if decided against us or as a result of settlement, could
    require us to pay substantial judgments, settlements or other
    penalties.







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



114



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



| |                                                                                                             
| | ------------------------------------------------------------------------------------------------------------
| | We cannot predict the outcome of the Revenue Independent
    Review being undertaken by our Audit Committee.





| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | We and our independent auditors have identified a number
    of material weaknesses related to our internal control over
    financial reporting and concluded that our internal control over
    financial reporting was ineffective as at December 31,
    2004. These material weaknesses remain unremedied, which could
    continue to impact our ability to report our results of
    operations and financial condition accurately and in a timely
    manner.





| |   |                                                                                                                                                                                                                    
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | 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;

115



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| |   |                                                                                                                                                                                                                                                                                 
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | lack of compliance with Nortel procedures for 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.                                                                                                                                                    









| |                                                                                                                                        
| | ---------------------------------------------------------------------------------------------------------------------------------------
| | The governing principles of the Independent Review
    particularly as they relate to remedial measures may take time
    to implement.





| |                                                                                                                                                                                                                       
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Our credit ratings have been downgraded and we are
    currently unable to access, in its current form, our shelf
    registration statement filed with the SEC, each of which may
    adversely affect our liquidity.



116



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| |                                                                             
| | ----------------------------------------------------------------------------
| | Continuing negative publicity has and may adversely affect
    our business.





| |                                                                                                        
| | -------------------------------------------------------------------------------------------------------
| | We may not be able to attract or retain the personnel
    necessary to achieve our business objectives.



117



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| |                                                                               
| | ------------------------------------------------------------------------------
| | Ongoing SEC review may require us to amend our public
    disclosures further.



118



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| |                                                                                                                                                                                                                                                                                                                                                                                                                   
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Any future delays in filing our periodic reports could
    cause us to breach our public debt indentures and our
    obligations under the EDC Support Facility and seek waivers from
    EDC under the EDC Support Facility. In such circumstances, it is
    possible that the holders of our public debt would seek to
    accelerate the maturity of that debt and EDC would not grant us
    further waivers.





| |                                                                                                                                                                                                                                                                                  
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Any future breach of the continued listing requirements of
    the NYSE or TSX could cause the NYSE and/or the TSX to commence
    suspension or delisting procedures in respect of Nortel Networks
    Corporation common shares or other of our or NNCs listed
    securities.








Risks relating to our business




| |                                                                                                                                                                                                                                                   
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | We continue to restructure our business to respond to
    industry and market conditions. The assumptions underlying our
    restructuring efforts may prove to be inaccurate and we may have
    to restructure our business again in the future.





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





| |                                                                                                                                             
| | --------------------------------------------------------------------------------------------------------------------------------------------
| | Our operating results have historically been subject to
    yearly and quarterly fluctuations and are expected to continue
    to fluctuate.





| |   |                                                                                                                                                                                                                                                                                                                                                                               
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | our ability to execute our strategic plan, including the planned
    workforce reductions, without negatively impacting our
    relationships with our customers, the delivery of products based
    on new and developing technologies at competitive prices, the
    effectiveness of our internal processes and organizations and
    the retention of qualified personnel;
|
| |  | our ability to focus on the day-to-day operation of our business
    while implementing improvements in our internal controls and
    procedures, including our accounting systems, and addressing the
    civil litigation actions and investigations related to our
    restatements;                                                                                       
|
| |  | our ability to successfully implement programs to stimulate
    customer spending by anticipating and offering the kinds of
    products and services customers will require in the future to
    increase the efficiency and profitability of their networks;                                                                                                                
|
| |  | our ability to successfully complete programs on a timely basis
    to reduce our cost structure, including fixed costs, to
    streamline our operations and to reduce product costs;                                                                                                                                                                                        
|
| |  | our ability to successfully manage our manufacturing operations,
    which are substantially outsourced to contract manufacturers;                                                                                                                                                                                                                                            
|
| |  | our ability to successfully comply with increased and complex
    regulations;                                                                                                                                                                                                                                                                                                
|
| |  | our ability to focus our business on what we believe to be
    potentially higher growth, higher margin businesses and to
    dispose of or exit non-core businesses;                                                                                                                                                                                                         
|
| |  | increased price and product competition in the networking
    industry, including from low cost competitors;                                                                                                                                                                                                                                                                  
|
| |  | our ability to compete with low cost competitors, including
    those offering attractive customer financing arrangements;                                                                                                                                                                                                                                                    
|
| |  | the inherent uncertainties of using forecasts, estimates and
    assumptions for asset valuations and in determining the amounts
    of accrued liabilities, provisions and other items in our
    unaudited consolidated financial statements;                                                                                                                               
|
| |  | the impact of changes in global capital markets and interest
    rates on our pension plan assets and obligations;                                                                                                                                                                                                                                                            
|
| |  | fluctuations in our gross margins;                                                                                                                                                                                                                                                                                                                                            
|
| |  | the development, introduction and market acceptance of new
    technologies, and integrated networking solutions, as well as
    the adoption of new networking standards;                                                                                                                                                                                                    

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| |   |                                                                                                                                                                
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | the overall trend toward industry consolidation and
    rationalization among our customers, competitors and suppliers;                                        
|
| |  | our ability to make investments, including acquisitions, to
    strengthen our business;                                                                       
|
| |  | the ability of our customers and suppliers to obtain financing
    to fund capital expenditures;                                                               
|
| |  | variations in sales channels, product costs and the mix of
    products sold;                                                                                  
|
| |  | the size and timing of customer orders and shipments;                                                                                                          
|
| |  | our ability to obtain payment from customers on a timely basis;                                                                                                
|
| |  | our ability to continue to obtain customer performance bonds and
    contracts;                                                                                
|
| |  | our ability to maintain appropriate inventory levels;                                                                                                          
|
| |  | the impact of acquired businesses and technologies;                                                                                                            
|
| |  | our ability to fund and sustain our research and development
    activities;                                                                                   
|
| |  | the impact of our product development schedules, product quality
    variances, manufacturing capacity and lead times required to
    produce our products; and
|
| |  | the impact of higher insurance premiums and deductibles and
    greater limitations on insurance coverage.                                                     











| |                                                                                                                                                                                                            
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Global economic conditions and other trends and factors
    affecting the telecommunications industry are beyond our control
    and may result in reduced demand and pricing pressure on our
    products.





| |   |                                                                                                                                                                                                                               
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | adverse changes in the public and private equity and debt
    markets and our ability, as well as the ability of our customers
    and suppliers, to obtain financing or to fund working capital
    and capital expenditures;
|
| |  | adverse changes in the credit quality of our customers and
    suppliers;                                                                                                                                                     
|
| |  | adverse changes in the market conditions in our industry and the
    specific markets for our products;                                                                                                                       

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| |   |                                                                                                                                                                                                                   
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | the trend towards the sale of converged networking solutions,
    which could lead to reduced capital spending on multiple
    networks by our customers;                                                         
|
| |  | visibility to, and the actual size and timing of, capital
    expenditures by our customers;                                                                                                                      
|
| |  | inventory practices, including the timing of product and service
    deployment, of our customers;                                                                                                                
|
| |  | the amount of network capacity and the network capacity
    utilization rates of our customers, and the amount of sharing
    and/or acquisition of new and/or existing network capacity by
    our customers;    
|
| |  | policies of our customers regarding utilization of single or
    multiple vendors for the products they purchase;                                                                                                 
|
| |  | the overall trend toward industry consolidation and
    rationalization among our customers, competitors and suppliers;                                                                                           
|
| |  | conditions in the broader market for communications products,
    including data networking products and computerized information
    access equipment and services;                                              
|
| |  | increased price competition, particularly from low cost
    competitors;                                                                                                                                          
|
| |  | changes in legislation or accounting rules and governmental and
    environmental regulation or intervention affecting
    communications or data networking;                                                     
|
| |  | computer viruses, break-ins and similar disruptions from
    unauthorized tampering with our computer systems; and                                                                                                
|
| |  | acts of war or terrorism that could lead to disruptions in
    general global economic activity, changes in logistics and
    security arrangements and reduced customer demand for our
    products and services.





| |                                                                             
| | ----------------------------------------------------------------------------
| | Our gross margins may decline, which would reduce our
    operating results.





| |   |                                                                                                                                                                    
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | increased price competition, particularly from low cost
    competitors;                                                                                           
|
| |  | increased industry consolidation among our customers, which may
    lead to decreased demand for, and downward pricing pressure on
    the prices of, our products;
|
| |  | changes in product and geographic mix;                                                                                                                             
|
| |  | customer and contract settlement costs;                                                                                                                            
|
| |  | higher product, material or labor costs;                                                                                                                           
|
| |  | increased inventory provisions or contract and customer
    settlement costs;                                                                                      
|
| |  | warranty costs;                                                                                                                                                    
|
| |  | obsolescence charges;                                                                                                                                              
|
| |  | loss of cost savings on future inventory purchases as a result
    of high inventory levels;                                                                       
|
| |  | introduction of new products and costs of entering new markets;                                                                                                    
|
| |  | increased levels of customer services;                                                                                                                             
|
| |  | changes in distribution channels;                                                                                                                                  
|
| |  | excess capacity or excess fixed assets;                                                                                                                            
|
| |  | accruals for employee incentive bonuses;                                                                                                                           

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| |   |                                                                                                                                                                   
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | further restructuring costs; and                                                                                                                                  
|
| |  | costs related to our restatements, including the possibility of
    substantial fines, settlements and/or damages or other
    penalties, and/or remedial actions.





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









| |                                                                                                                                                                                                                                                                                                         
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | We may be materially and adversely affected by cautious
    capital spending by our customers. Increased consolidation among
    our customers and the loss of customers in certain markets could
    have a material adverse effect on our business, results of
    operations and financial condition.



123



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| |                                                                                     
| | ------------------------------------------------------------------------------------
| | Our business may be materially and adversely affected by
    our high level of debt.







| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | we may have difficulty borrowing money in the future or
    accessing other sources of funding;                                                                                                                                                                                                                                                                                                                                                
|
| |  | a high debt level may affect our ability to refinance our
    existing debt, including the debt of $1,275 relating to our
    6.125% Notes due February 2006 and the debt of $150
    relating to 7.40% Notes due June 15, 2006 issued by an
    indirect wholly owned subsidiary of us, should we decide to do
    so;                                                                                                                        
|
| |  | we may need to use a large portion of our cash flow from
    operations to pay principal and interest on our indebtedness,
    which would reduce the amount of cash available to finance our
    operations and other business activities;                                                                                                                                                                                                    
|
| |  | a high debt level, arduous or restrictive terms and conditions,
    or lower than expected cash flows would make us more vulnerable
    to economic downturns and adverse developments in our
    business; and                                                                                                                                                                                                                                
|
| |  | if operating cash flows are not sufficient to meet our operating
    expenses, capital expenditures and debt service requirements as
    they become due, we may be required, in order to meet our debt
    service obligations, to delay or reduce capital expenditures or
    the introduction of new products, sell assets and/or forego
    business opportunities including acquisitions, R&D projects
    or product design enhancements.



| |                                                                                                                                                                                                                                    
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | An increased portion of our cash and cash equivalents may
    be restricted as cash collateral if we are unable to secure
    alternative support for certain obligations arising out of our
    normal course business activities.



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| |                                                                                                                                                      
| | -----------------------------------------------------------------------------------------------------------------------------------------------------
| | An inability of our subsidiaries to provide us with
    funding in sufficient amounts could adversely affect our ability
    to meet our obligations.





| |                                                                                         
| | ----------------------------------------------------------------------------------------
| | We may need to make larger contributions to our defined
    benefit plans in the future.







| |                                                                                                                                                                                                        
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | If market conditions deteriorate or future results of
    operations are less than expected, an additional valuation
    allowance may be required for all or a portion of our deferred
    tax assets.





| |                                                                                                                                                        
| | -------------------------------------------------------------------------------------------------------------------------------------------------------
| | Our performance may be materially and adversely affected
    if our expectations regarding market demand for particular
    products prove to be wrong.



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| |                                                                                                                                                                                                                                                               
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | We have made, and may continue to make, strategic
    acquisitions. If we are not successful in operating or
    integrating these acquisitions, our business, results of
    operations and financial condition may be materially and
    adversely affected.





| |   |                                                                                                                                                 
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------
| |  | the industry may develop in a different direction than
    anticipated and the technologies we acquire may not prove to be
    those we need;   
|
| |  | the future valuations of acquired businesses may decrease from
    the market price we paid for these acquisitions;                             
|
| |  | the revenues of acquired businesses may not offset increased
    operating expenses associated with these acquisitions;                         
|
| |  | potential difficulties in completing in-process research and
    development projects and delivering high quality products to our
    customers;

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| |   |                                                                                                                                                                           
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | potential difficulties in integrating new products, software,
    businesses and operations in an efficient and effective manner;                                         
|
| |  | our customers or customers of the acquired businesses may defer
    purchase decisions as they evaluate the impact of the
    acquisitions on our future product strategy;
|
| |  | potential loss of key employees of the acquired businesses;                                                                                                               
|
| |  | diversion of the attention of our senior management from the
    operation of our daily business;                                                                         
|
| |  | entering new markets in which we have limited experience and
    where competitors may have a stronger market presence;                                                   
|
| |  | the potential adverse effect on our cash position as a result of
    all or a portion of an acquisition purchase price being paid in
    cash; and                        
|
| |  | potential assumption of liabilities.                                                                                                                                      







| |                                                                                                                                                                                                                
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | We operate in highly dynamic and volatile industries
    characterized by rapidly changing technologies, evolving
    industry standards, frequent new product introductions and short
    product life cycles.





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| |                                                                                                                                            
| | -------------------------------------------------------------------------------------------------------------------------------------------
| | We face significant competition and may not be able to
    maintain our market share and may suffer from competitive
    pricing practices.









| |                                                                       
| | ----------------------------------------------------------------------
| | We face certain barriers in our efforts to expand
    internationally.





| |   |                                                                              
| | - | -----------------------------------------------------------------------------
| |  | reversals or delays in the opening of foreign markets to new
    competitors;
|
| |  | trade protection measures;                                                   
|
| |  | exchange controls;                                                           
|
| |  | currency fluctuations;                                                       
|
| |  | investment policies;                                                         
|
| |  | restrictions on repatriation of cash;                                        

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| |   |                                                                 
| | - | ----------------------------------------------------------------
| |  | nationalization of local industry;                              
|
| |  | economic, social and political risks;                           
|
| |  | taxation;                                                       
|
| |  | interest rates;                                                 
|
| |  | challenges in staffing and managing international opportunities;
|
| |  | other factors, depending on the country involved; and           
|
| |  | acts of war or terrorism.                                       





| |                                                                                                                                             
| | --------------------------------------------------------------------------------------------------------------------------------------------
| | Fluctuations in foreign currency exchange rates could
    negatively impact our business, results of operations and
    financial condition.





| |                                                                                                                                                                                                                                                                                                         
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | If we fail to protect our intellectual property rights, or
    if we are subject to adverse judgments or settlements arising
    out of disputes regarding intellectual property rights, our
    business, results of operations and financial condition could be
    materially and adversely affected.



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| |                                                                                                               
| | --------------------------------------------------------------------------------------------------------------
| | Rationalization and consolidation in the industry may lead
    to increased competition and harm our business.





| |                                                                                                                                                                                                                                                   
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Changes in regulation of the Internet and/or other aspects
    of the industry may affect the manner in which we conduct our
    business and may materially and adversely affect our business,
    results of operations and financial condition.







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| |                                                                                                                                                                                                                                        
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Industry concerns could continue and increase our exposure
    to our customers credit risk and the risk that our
    customers will not be able to fulfill their payment obligations
    to us under customer financing arrangements.









| |                                                                                                                                                                                                                                                                                                                                                                                                      
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Negative developments associated with our supply contracts
    and contract manufacturing agreements including in our Carrier
    Packet Networks segment as a result of using a sole supplier for
    key optical components of our Carrier Packet Networks solutions
    may materially and adversely affect our business, results of
    operations, financial condition and supply relationships.







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| |                                                                                                                                                                                                                                                                                                        
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Many of our current and planned products are highly
    complex and may contain defects or errors that are detected only
    after deployment in telecommunications networks, which could
    harm our reputation and adversely affect our business, results
    of operations and financial condition.





| |                                                                           
| | --------------------------------------------------------------------------
| | Our business may suffer if our strategic alliances are not
    successful.



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| |                                                                                                                                                                                                                       
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | In addition to the investigations and litigation arising
    out of our restatements, we are also subject to numerous class
    actions and other lawsuits as well as lawsuits in the ordinary
    course of business.



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|        |                                                               
|------- | --------------------------------------------------------------
|ITEM 3. | Quantitative and Qualitative Disclosures About Market
    Risk



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|        |                        
|------- | -----------------------
|ITEM 4. | Controls and Procedures

Management Conclusions Concerning Disclosure Controls and
Procedures








| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                  
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | the Second Restatement and the revisions to our preliminary
    unaudited results for the year ended December 31, 2003;                                                                                                                                                                                                                                                                                                                          
|
| |  | 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 WCPHD and Huron Consulting Services
    LLC, or the Independent Review Summary, included in Item 9A
    of our 2003 Annual Report;                                                                                                
|
| |  | the terminations for cause of our former president and chief
    executive officer, former chief financial officer, former
    controller and seven additional senior finance employees during
    the course of the Independent Review and the reasons therefor as
    described in the Independent Review Summary;                                                                                                                             
|
| |  | the material weaknesses in our internal control over financial
    reporting that we and our external auditor, Deloitte, have
    identified (as more fully described below);                                                                                                                                                                                                                                                                    
|
| |  | the measures we have identified, developed and begun to
    implement, beginning in November 2003, to remedy those material
    weaknesses (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, 2004, 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, included in Item 8 and Item 9A of our 2004
    Annual Report;
|
| |  | the conclusion of the CEO and CFO that our disclosure controls
    and procedures as at March 31, 2005 and as at May 31,
    2005 were not effective, included in Item 4 of our
    Quarterly Report on Form 10-Q for the first quarter of
    2005, or the 2005 First Quarter Report; and                                                                                                                                                       
|
| |  | the decision of the Audit Committee to undertake the Revenue
    Independent Review (as more fully described below).                                                                                                                                                                                                                                                                                                                             







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Material Weaknesses in Internal Control Over Financial
Reporting






| |   |                                                                                                                                                                                                                                                                                                                  
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | 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 applicable 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;

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









Changes in Internal Control Over Financial Reporting and
Remedial Measures






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

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| |   |                                                                                
| | - | -------------------------------------------------------------------------------
| |  | Appointment of New Senior Leadership with High Ethical and
    Moral Standards.



| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | In April 2004, we terminated for cause our former president and
    chief executive officer, former chief financial officer and
    former controller (the former chief financial officer and former
    controller having been placed on paid leaves of absence in March
    2004), and in August 2004, we terminated for cause seven
    additional senior finance employees with significant
    responsibilities for our financial reporting as a whole or for
    their respective business units and geographic regions.
|
| |  | We appointed new senior leadership with high ethical and moral
    standards: In April 2004, we appointed a new permanent CEO, and
    in March 2004, we appointed an interim CFO and Controller, who
    each became permanent in April 2004. Since then we appointed a
    new CFO, Peter Currie, in February 2005, and a new
    controller, Paul W. Karr, in May 2005, all of which is more
    fully described below.                                                                                                    



| |   |                                                                       
| | - | ----------------------------------------------------------------------
| |  | Emphasis by New Senior Management of Honesty and Ethical
    Behavior.



| |   |                                                                                                                                                                                                                                                                                                                                                       
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | In August 2004, we adopted a new strategic plan that includes a
    renewed commitment to best corporate practices and ethical
    conduct, including the establishment of the office of a chief
    ethics and compliance officer, which has now been filled with
    the permanent appointment of Susan E. Shepard, effective
    February 21, 2005.



| |   |                                                              
| | - | -------------------------------------------------------------
| |  | Emphasis on Reliable and Transparent Financial
    Reporting.



| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Over the course of and subsequent to the Second Restatement
    process, our current CEO, William A. Owens, our CFO through
    the Second Restatement process, William R. Kerr, and starting
    February 14, 2005, our current CFO, Peter Currie, have
    communicated to employees the importance of the Second
    Restatement process and the ongoing need for reliable and
    transparent financial reporting and ethical conduct. Those
    communications included formal presentations as part of our
    annual executive conference in November 2004. Additionally, our
    CFO through the Second Restatement process encouraged and our
    current CFO encourages finance personnel to bring matters of
    concern to managements attention without fear of
    retribution.
|
| |  | Beginning in July 2004, we have emphasized the importance of
    internal control over financial reporting throughout the
    organization, including through numerous education sessions, to
    various levels of management.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|
| |  | Beginning in September 2004, we implemented mandatory training
    procedures for senior management with respect to our internal
    back-up certification process, with an emphasis on                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     

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| |   |                                                                                                                                                                                     
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |   | the accountability of senior management both for their
    individual areas of responsibility and for the business as a
    whole as members of the senior leadership team.         
|
| |  | Beginning in 2004, we implemented a process to increase
    visibility to management after the close of a financial period
    of potential adjustments to the financial statements.



| |   |                                                                        
| | - | -----------------------------------------------------------------------
| |  | Alignment of Leadership Compensation with Financial
    Accountability.



| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | In June 2004, management recommended, the joint leadership
    resources committee recommended and the Board of Directors
    subsequently approved, the inclusion of financial accountability
    as a key qualitative factor in the individual leadership
    performance objectives for determination of incentive cash
    awards under our annual incentive plan.                                                                                                                         
|
| |  | In January 2005, we received notification from certain senior
    executives that they would as a matter of corporate leadership
    and integrity pay an amount equal to their Return to
    Profitability bonuses (net of tax withheld at source),
    conveying their deep disappointment over the circumstances that
    led to the Second Restatement and their determination to make it
    clear to employees, investors and others that such activities
    are unacceptable to them.



| |   |                                                                                                                                                                                                            
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Extended Balance Sheet Reviews. In March 2005, we
    implemented extended and enhanced balance sheet review
    procedures for financial periods beginning with the third
    quarter of 2004, as follows:



| |   |                                                                                                                                                                                          
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | We have scheduled regular balance sheet reviews across all
    segments and major statutory entities in advance of our periodic
    report filings; and                                  
|
| |  | We clarified accountability within Nortel for review of
    significant balance sheet accounts and required specific focus
    on accounts involving significant estimates and judgments.



| |   |                                                                                                                                                                                                                                                                                                                    
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Finance Department Organizational Structure. We
    announced, and have begun to implement, plans to transform our
    finance organization, which include a renewed commitment to
    transparency, accuracy, accountability and competency as
    fundamental goals. Measures we have begun to implement include:



| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | In the first quarter of 2004, we began to enhance our global
    technical accounting group and established global revenue
    governance and global finance governance teams.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|
| |  | In March 2004, we began hiring additional full-time finance
    personnel (with a focus on qualified accounting professionals)
    as part of an initiative introduced by the CFO at that time,
    William R. Kerr, and the controller at that time,
    MaryAnne E. Pahapill. This initiative is aimed at both
    strengthening the finance organizations technical skills
    and experience, including at a senior level, and addressing
    employee attrition.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|
| |  | In May 2005, we appointed Paul W. Karr, an experienced financial
    and accounting executive and an expert in U.S. GAAP, as
    controller.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|
| |  | We established a global corporate finance Sarbanes-Oxley
    compliance group, or Global SOX Group, beginning in
    the third quarter of 2004.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|
| |  | In the third quarter of 2004, we engaged Accenture, Inc., or
    Accenture, a global management consulting and technology
    services firm, to assess the finance organizations
    structure, processes and systems. The Accenture assessment was
    completed in February 2005. In the first quarter of 2005, we
    appointed a senior Nortel executive as global finance
    transformation leader. In the second quarter of 2005, we further
    engaged Accenture to assist us with the design phase of the
    processes and systems component of the finance transformation
    project, which design phase commenced in the second quarter of
    2005. We expect the implementation of our finance transformation
    project will continue into 2007 and will include, among other
    things, implementing an information technology platform
    (SAP) to provide an integrated global financial system. In
    addition, a more detailed assessment by management, with the
    assistance of Accenture, of the

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| |   |                                                                                                                                                                                                                                                                                                                                                                                                      
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |   | organizational and accountability structure within the finance
    function commenced in the second quarter of 2005, with the
    recommendations from this assessment and the initial
    implementation of such recommendations expected later this year.                                                                                                                                          
|
| |  | In connection with our assessment of internal control over
    financial reporting pursuant to SOX 404, we began to modify
    or enhance existing processes and implement new control
    activities, including improved levels of documentation, and
    enhanced monitoring and supervision of processes such as
    reconciliation of account balances and compliance with internal
    policies.



| |   |                      
| | - | ---------------------
| |  | Training Initiatives.



| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | In the second quarter of 2004, we re-established our formal
    training group (led by the global finance governance team
    described above) to implement ongoing training programs for
    finance personnel globally to strengthen the finance
    organizations technical skills and experience. The
    groups focus includes training with respect to accounting
    for contingencies; accounting for hedging and derivatives;
    revenue recognition, accruals and provisions; and foreign
    currency translation.
|
| |  | In the first quarter of 2005, the global revenue governance team
    provided additional training sessions for selected finance and
    non-finance personnel with a more in-depth focus on revenue
    recognition guidelines and U.S. GAAP. In the second quarter
    of 2005, the global revenue governance team provided additional
    revenue recognition training through an external expert for
    selected finance personnel who regularly work with revenue
    recognition matters.                                 
|
| |  | In the second quarter of 2005, the Global SOX Group commenced
    company-wide employee SOX 404 information sessions to increase
    employee awareness of this legislation and to emphasize the
    importance of internal control over financial reporting and
    company and employee responsibilities with respect to internal
    control over financial reporting.                                                                                                                                                       



| |   |                
| | - | ---------------
| |  | Internal Audit.



| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                 
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | In the first quarter of 2004, we modified the mandate of our
    internal audit function to place a greater emphasis on the
    adequacy of, and compliance with, procedures relating to
    internal control over financial reporting.                                                                                                                                                                                         
|
| |  | In October 2004, we engaged outside consultants to conduct a
    strategic performance review of the internal audit function. The
    objective of this review was to ensure that internal audit meets
    professional internal audit standards and moves towards audit
    best practices. The strategic review has been completed and
    management has begun to implement certain of the recommendations
    of the review.
|
| |  | In July 2005, we appointed Robert J. Bartzokas, an experienced
    accounting and auditing professional and an expert in
    U.S. GAAP, as vice-president, audit.                                                                                                                                                                                                                                                               



| |   |                                
| | - | -------------------------------
| |  | Manual Journal Entry Processes.



| |   |                                                                                                                                                                                                                                                                                                                                                  
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | We developed new procedures related to manual journal entries,
    which focus on approvals, more stringent documentation
    processes, and restricted user access to manual journal entry
    functions to specific approved users. We continue to work
    towards achieving full implementation of these manual journal
    entry procedures.



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| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | The appointment of our new controller, Paul W. Karr, which is
    more fully described above.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|
| |  | We continue to implement changes to our existing enterprise
    resource planning system, or ERP System, including
    interfaces with our supporting accounting applications in
    connection with the portions of the Flextronics transaction that
    have closed and in anticipation of future closings. For a
    description of the Flextronics transaction, see Business
    Overview  Evolution of our supply chain
    strategy in the MD&A section of this report. In
    addition, we have had to implement a number of compensating
    manual processes and detective controls as a result of these ERP
    System changes and continue to monitor whether any additional
    compensating controls are required.





Revenue Independent Review




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PART II


OTHER INFORMATION







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









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



|            |      |             |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|----------- | ---- | ----------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit No. |      | Description
|            |      |            
|            | 10.1 |             |  | The Nortel 2005 Stock Incentive Plan (as filed with the 2005
    Proxy Statement).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|            | 10.2 |             |  | Summary statement of the interest payable on the special pension
    benefits for the Vice-Chairman and Chief Executive Officer of
    Nortel Networks Corporation and Nortel Networks Limited 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
    May 27, 2005.                                                                                                                                                                                   
|            | 10.3 | *           |  | Master Facility Agreement dated as of February 13, 2003,
    and amended July 10, 2003, between Nortel Networks Limited
    and Export Development Canada, and as further amended by letter
    agreements dated March 29, 2004, May 28, 2004,
    August 20, 2004, September 29, 2004, October 29,
    2004, November 19, 2004, December 10, 2004,
    January 14, 2005, February 15, 2005, March 15,
    2005, April 29, 2005 (filed as Exhibit 99.2 to Nortel
    Networks Corporations Current Report on Form 8-K dated
    April 29, 2005) and May 31, 2005 (filed as
    Exhibit 99.2 to Nortel Networks Corporations Current
    Report on Form 8-K dated June 1, 2005).
|            | 10.4 |             |  | Form of Indemnity Agreement effective on or as of June 29,
    2005 entered into between Nortel Networks Corporation and each
    of the following Directors: Harry J. Pearce, Ronald W. Osborne,
    Richard D. McCormick, John A. MacNaughton, James B.
    Hunt, Jr. and Jalynn H. Bennett.                                                                                                                                                                                                                                                                                                                                                                                   
|            | 10.5 |             |  | Summary of remuneration, retirement compensation and group life
    insurance of the Chairman of the Board, Directors and Chairman
    of Nortel Networks Limited Committees effective June 29,
    2005.                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|            | 10.6 |             |  | Nortel Networks Limited Directors Deferred Share
    Compensation Plan effective June 30, 1998 as amended and
    restated May 1, 2000, as further amended and restated
    effective January 1, 2002, as amended and restated
    May 29, 2003, as amended and restated December 18,
    2003 effective January 1, 2004, as amended June 29,
    2005 effective immediately.                                                                                                                                                                                                                                                                                                   
|            | 10.7 | *           |  | Nortel Networks Corporation 1986 Stock Option Plan, as Amended
    and Restated, as amended effective April 30, 1992,
    April 27, 1995, December 28, 1995, April 8, 1998,
    February 25, 1999, April 29, 1999, September 1,
    1999, December 16, 1999, May 1, 2000 and
    January 31, 2002 (filed as Exhibit 10.1 to Nortel
    Networks Corporations Quarterly Report on Form 10-Q
    for the quarter ended March 31, 2002).                                                                                                                                                                                                                                           
|            | 10.8 | *           |  | Nortel Networks Corporation 2000 Stock Option Plan as amended
    effective May 1, 2000 and January 31, 2002 (filed as
    Exhibit 10.2 to Nortel Networks Corporations
    Quarterly Report on Form 10-Q for the quarter ended
    March 31, 2002).                                                                                                                                                                                                                                                                                                                                                                                                                            
|            | 10.9 |             |  | Forms of Instruments of Grant generally provided to optionees
    granted options under the Nortel Networks Corporation 1986 Stock
    Option Plan, as Amended and Restated or the Nortel Networks
    Corporation 2000 Stock Option Plan.                                                                                                                                                                                                                                                                                                                                                                                                                                       
|            | 31.1 |             |  | Certification of the Vice-Chairman and Chief Executive Officer
    pursuant to 18 U.S.C. Section 1350 as Adopted Pursuant
    to Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|            | 31.2 |             |  | Certification of the Executive Vice-President and Chief
    Financial Officer pursuant to 18 U.S.C. Section 1350
    as Adopted Pursuant to Section 302 of the Sarbanes-Oxley
    Act of 2002.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|            | 32   |             |  | Certification of the Vice-Chairman and Chief Executive Officer
    and Executive Vice-President and Chief Financial Officer
    pursuant to 18 U.S.C. Section 1350 as Adopted Pursuant
    to Section 906 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                                                                                                                                                                                                                                     






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

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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



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