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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

|      |  |                                                                                                                                      | 
|----- |  | ------------------------------------------------------------------------------------------------------------------------------------ | 
|X box |  | Quarterly Report Pursuant to Section 13 or 15(d) of
the Securities Exchange Act of 1934
For the Quarterly Period Ended June 30, 2002

OR

|    |  |                                                                                                                             | 
|--- |  | --------------------------------------------------------------------------------------------------------------------------- | 
|Box |  | 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

Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
filing requirements for the past 90 days.

|          |  |   
|--------- |  | --
|Yes Check |  | No

Indicate the number of shares outstanding of each of the issuers classes of
common stock, as at July 31, 2002

1,460,978,635 common shares without nominal or par value



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TABLE OF CONTENTS

PART I
FINANCIAL INFORMATION

|           |  |                                                                                           |  |      |    | 
|---------- |  | ----------------------------------------------------------------------------------------- |  | ---- | -- | 
|           |  |                                                                                           |  | PAGE
|           |  |                                                                                           |  |     
|ITEM 1.    |  | Consolidated Financial Statements (unaudited)                                             |  |      | 3  | 
|          
|          
|          
|          
|ITEM 2.    |  | Managements Discussion and Analysis of
    Financial Condition and Results of Operations |  |      | 29 | 
|          
|          
|          
|          
|ITEM 3.    |  | Quantitative and Qualitative Disclosures About
    Market Risk                            |  |      | 60 | 
|          
|           |  | PART II
OTHER INFORMATION                                                                 |  |      |    | 
|          
|ITEM 1.    |  | Legal Proceedings                                                                         |  |      | 61 | 
|          
|          
|          
|          
|ITEM 2.    |  | Changes in Securities and Use of Proceeds                                                 |  |      | 61 | 
|          
|          
|          
|          
|ITEM 4.    |  | Submissions of Matters to a Vote of Security Holders                                      |  |      | 61 | 
|          
|          
|          
|          
|ITEM 6.    |  | Exhibits and Reports on Form 8-K                                                          |  |      | 62 | 
|          
|          
|          
|          
|Signatures |  |                                                                                           |  |      | 64 | 

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

BAY NETWORKS is a trademark of Nortel Networks.
CLARIFY is a trademark of Amdocs Software Systems Limited.
NORTEL NETWORKS, NT are trademarks of Nortel Networks.
QTERA is a trademark of Qtera Corporation.
S&P 500 is a trademark of The McGraw-Hill Companies, Inc.

2



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##### 



PART I
FINANCIAL INFORMATION

|        |  |                                               |  |      |   | 
|------- |  | --------------------------------------------- |  | ---- | - | 
|ITEM 1. |  | Consolidated Financial Statements (unaudited) |  |      |   | 
|       
|        |  | Contents of Consolidated Financial Statements |  |      |   | 
|        |  |                                               |  | PAGE
|        |  |                                               |  |     
|       
|       
|       
|       
|        |  | Consolidated Statements of Operations         |  |      | 4 | 
|       
|       
|       
|       
|        |  | Consolidated Balance Sheets                   |  |      | 5 | 
|       
|       
|       
|       
|        |  | Consolidated Statements of Cash Flows         |  |      | 6 | 
|       
|       
|       
|       
|        |  | Notes to Consolidated Financial Statements    |  |      | 7 | 

3



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##### 



NORTEL NETWORKS LIMITED
Consolidated Statements of Operations (unaudited)
(millions of U.S. dollars)

|                                                          |                     |   |                    |     |                  |      |        |     |      |   |        |      |   |   |        |       |  
|--------------------------------------------------------- | ------------------- | - | ------------------ | --- | ---------------- | ---- | ------ | --- | ---- | - | ------ | ---- | - | - | ------ | ----- | -
|                                                         
|                                                          |                     |   | Three months ended |     | Six months ended
|                                                          |                     |   | June 30,           |     | June 30,        
|                                                          |                     |   | 2002               |     |                  | 2001 |        |     | 2002 |   |        | 2001
|                                                         
|Revenues                                                  |                     | $ | 2,770              |     |                  | $    | 4,571  |     |      | $ | 5,680  |      |   | $ | 10,260 |      
|                                                         
|                                                         
|                                                         
|                                                         
|Cost of revenues                                          |                     |   | 1,870              |     |                  |      | 4,206  |     |      |   | 4,099  |      |   |   | 8,081  |      
|                                                         
|Gross profit                                              |                     |   | 900                |     |                  |      | 365    |     |      |   | 1,581  |      |   |   | 2,179  |      
|                                                         
|Selling, general and administrative expense               |                     |   | 764                |     |                  |      | 1,603  |     |      |   | 1,504  |      |   |   | 2,911  |      
|                                                         
|                                                         
|                                                         
|                                                         
|Research and development expense                          |                     |   | 567                |     |                  |      | 870    |     |      |   | 1,144  |      |   |   | 1,776  |      
|                                                         
|                                                         
|                                                         
|                                                         
|Amortization of intangibles                               |                     |   |                    |     |                  |      |        |     |      |   |        |      |   |   |        |      
|                                                         
|                                                         
|                                                         
|                                                         
|                                                          | Acquired technology |   |                    | 6   |                  |      |        | 203 |      |   |        | 11   |   |   |        | 406   |  
|                                                         
|                                                         
|                                                         
|                                                         
|                                                          | Goodwill            |   |                    |    |                  |      |        | 679 |      |   |        |     |   |   |        | 1,361 |  
|                                                         
|                                                         
|                                                         
|                                                         
|Special charges                                           |                     |   | 307                |     |                  |      | 3,275  |     |      |   | 750    |      |   |   | 3,630  |      
|                                                         
|                                                         
|                                                         
|                                                         
|Gain on sale of businesses                                |                     |   |                   |     |                  |      |       |     |      |   | (3     | )    |   |   |       |      
|                                                         
|Operating loss                                            |                     |   | (744               | )   |                  |      | (6,265 | )   |      |   | (1,825 | )    |   |   | (7,905 | )    
|                                                         
|Equity in net loss of associated companies                |                     |   | (10                | )   |                  |      | (116   | )   |      |   | (14    | )    |   |   | (132   | )    
|                                                         
|                                                         
|                                                         
|                                                         
|Other income (expense)  net                              |                     |   | 6                  |     |                  |      | (44    | )   |      |   | (8     | )    |   |   | 61     |      
|                                                         
|                                                         
|                                                         
|                                                         
|Interest expense                                          |                     |   |                    |     |                  |      |        |     |      |   |        |      |   |   |        |      
|                                                         
|                                                         
|                                                         
|                                                         
|                                                          | Long-term debt      |   |                    | (34 | )                |      |        | (45 | )    |   |        | (70  | ) |   |        | (84   | )
|                                                         
|                                                         
|                                                         
|                                                         
|                                                          | Other               |   |                    | (9  | )                |      |        | (44 | )    |   |        | (21  | ) |   |        | (62   | )
|                                                         
|Loss from continuing operations before income taxes       |                     |   | (791               | )   |                  |      | (6,514 | )   |      |   | (1,938 | )    |   |   | (8,122 | )    
|                                                         
|                                                         
|                                                         
|                                                         
|Income tax benefit                                        |                     |   | 222                |     |                  |      | 1,133  |     |      |   | 584    |      |   |   | 1,390  |      
|                                                         
|Net loss from continuing operations                       |                     |   | (569               | )   |                  |      | (5,381 | )   |      |   | (1,354 | )    |   |   | (6,732 | )    
|                                                         
|                                                         
|                                                         
|                                                         
|Net loss from discontinued operations  net of tax        |                     |   |                   |     |                  |      | (2,351 | )   |      |   |       |      |   |   | (2,538 | )    
|                                                         
|Net loss before cumulative effect of accounting change    |                     |   | (569               | )   |                  |      | (7,732 | )   |      |   | (1,354 | )    |   |   | (9,270 | )    
|                                                         
|                                                         
|                                                         
|                                                         
|Cumulative effect of accounting change  net of tax of $9 |                     |   |                   |     |                  |      |       |     |      |   |       |      |   |   | 15     |      
|                                                         
|Net loss                                                  |                     |   | (569               | )   |                  |      | (7,732 | )   |      |   | (1,354 | )    |   |   | (9,255 | )    
|                                                         
|                                                         
|                                                         
|                                                         
|Dividends on preferred shares                             |                     |   | (5                 | )   |                  |      | (7     | )   |      |   | (10    | )    |   |   | (15    | )    
|                                                         
|Net loss applicable to common shares                      |                     | $ | (574               | )   |                  | $    | (7,739 | )   |      | $ | (1,364 | )    |   | $ | (9,270 | )    
|                                                         

See notes to unaudited consolidated financial statements.

4



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##### 



NORTEL NETWORKS LIMITED
Consolidated Balance Sheets (unaudited)
(millions of U.S. dollars)

|                                                                                            |                                                                                           |   |          |       |              |   |         |       |      
|------------------------------------------------------------------------------------------- | ----------------------------------------------------------------------------------------- | - | -------- | ----- | ------------ | - | ------- | ----- | -----
|                                                                                           
|                                                                                            |                                                                                           |   | June 30, |       | December 31,
|                                                                                            |                                                                                           |   | 2002     |       | 2001        
|                                                                                           
|ASSETS                                                                                      |                                                                                           |   |          |       |              |   |        
|                                                                                           
|                                                                                           
|                                                                                           
|                                                                                           
|Current assets                                                                              |                                                                                           |   |          |       |              |   |        
|                                                                                           
|                                                                                           
|                                                                                           
|                                                                                           
|                                                                                            | Cash and cash equivalents                                                                 |   |          | $     | 4,122        |   |         | $     | 3,457
|                                                                                           
|                                                                                           
|                                                                                           
|                                                                                           
|                                                                                            | Accounts receivable (less provisions of $574 at June 30, 2002; $655 at December 31, 2001) |   |          |       | 2,345        |   |         |       | 2,923
|                                                                                           
|                                                                                           
|                                                                                           
|                                                                                           
|                                                                                            | Inventories  net                                                                         |   |          |       | 1,449        |   |         |       | 1,563
|                                                                                           
|                                                                                           
|                                                                                           
|                                                                                           
|                                                                                            | Income taxes recoverable                                                                  |   |          |       | 55           |   |         |       | 790  
|                                                                                           
|                                                                                           
|                                                                                           
|                                                                                           
|                                                                                            | Deferred income taxes  net                                                               |   |          |       | 1,248        |   |         |       | 1,401
|                                                                                           
|                                                                                           
|                                                                                           
|                                                                                           
|                                                                                            | Other current assets                                                                      |   |          |       | 851          |   |         |       | 847  
|                                                                                           
|                                                                                           
|                                                                                           
|                                                                                           
|                                                                                            | Current assets of discontinued operations                                                 |   |          |       | 329          |   |         |       | 698  
|                                                                                           
|Total current assets                                                                        |                                                                                           |   | 10,399   |       |              |   | 11,679  |      
|                                                                                           
|Long-term receivables (less provisions of $841 at June 30, 2002; $828 at December 31, 2001) |                                                                                           |   | 254      |       |              |   | 203     |      
|                                                                                           
|                                                                                           
|                                                                                           
|                                                                                           
|Investments at cost and associated companies at equity                                      |                                                                                           |   | 233      |       |              |   | 263     |      
|                                                                                           
|                                                                                           
|                                                                                           
|                                                                                           
|Plant and equipment  net                                                                   |                                                                                           |   | 1,997    |       |              |   | 2,459   |      
|                                                                                           
|                                                                                           
|                                                                                           
|                                                                                           
|Goodwill                                                                                    |                                                                                           |   | 2,283    |       |              |   | 2,283   |      
|                                                                                           
|                                                                                           
|                                                                                           
|                                                                                           
|Intangible assets  net                                                                     |                                                                                           |   | 8        |       |              |   | 20      |      
|                                                                                           
|                                                                                           
|                                                                                           
|                                                                                           
|Deferred income taxes  net                                                                 |                                                                                           |   | 2,506    |       |              |   | 2,106   |      
|                                                                                           
|                                                                                           
|                                                                                           
|                                                                                           
|Other assets                                                                                |                                                                                           |   | 656      |       |              |   | 697     |      
|                                                                                           
|                                                                                           
|                                                                                           
|                                                                                           
|Long-term assets of discontinued operations                                                 |                                                                                           |   | 105      |       |              |   | 283     |      
|                                                                                           
|Total assets                                                                                |                                                                                           | $ | 18,441   |       |              | $ | 19,993  |      
|                                                                                           
|LIABILITIES AND SHAREHOLDERS EQUITY                                                        |                                                                                           |   |          |       |              |   |        
|                                                                                           
|                                                                                           
|                                                                                           
|                                                                                           
|Current liabilities                                                                         |                                                                                           |   |          |       |              |   |         |      
|                                                                                           
|                                                                                           
|                                                                                           
|                                                                                           
|                                                                                            | Notes payable                                                                             |   |          | $     | 340          |   |         | $     | 426  
|                                                                                           
|                                                                                           
|                                                                                           
|                                                                                           
|                                                                                            | Trade and other accounts payable                                                          |   |          |       | 1,857        |   |         |       | 2,248
|                                                                                           
|                                                                                           
|                                                                                           
|                                                                                           
|                                                                                            | Payroll and benefit-related liabilities                                                   |   |          |       | 556          |   |         |       | 613  
|                                                                                           
|                                                                                           
|                                                                                           
|                                                                                           
|                                                                                            | Other accrued liabilities                                                                 |   |          |       | 5,097        |   |         |       | 5,347
|                                                                                           
|                                                                                           
|                                                                                           
|                                                                                           
|                                                                                            | Income taxes payable                                                                      |   |          |       | 102          |   |         |       | 143  
|                                                                                           
|                                                                                           
|                                                                                           
|                                                                                           
|                                                                                            | Long-term debt due within one year                                                        |   |          |       | 325          |   |         |       | 384  
|                                                                                           
|                                                                                           
|                                                                                           
|                                                                                           
|                                                                                            | Current liabilities of discontinued operations                                            |   |          |       | 135          |   |         |       | 384  
|                                                                                           
|Total current liabilities                                                                   |                                                                                           |   | 8,412    |       |              |   | 9,545   |      
|                                                                                           
|Deferred income                                                                             |                                                                                           |   | 123      |       |              |   | 153     |      
|                                                                                           
|                                                                                           
|                                                                                           
|                                                                                           
|Long-term debt                                                                              |                                                                                           |   | 2,325    |       |              |   | 2,293   |      
|                                                                                           
|                                                                                           
|                                                                                           
|                                                                                           
|Deferred income taxes  net                                                                 |                                                                                           |   | 515      |       |              |   | 477     |      
|                                                                                           
|                                                                                           
|                                                                                           
|                                                                                           
|Other liabilities                                                                           |                                                                                           |   | 1,477    |       |              |   | 1,452   |      
|                                                                                           
|                                                                                           
|                                                                                           
|                                                                                           
|Minority interest in subsidiary companies                                                   |                                                                                           |   | 68       |       |              |   | 100     |      
|                                                                                           
|                                                                                            |                                                                                           |   | 12,920   |       |              |   | 14,020  |      
|                                                                                           
|Commitments and contingencies (notes 12 and 13)                                             |                                                                                           |   |          |       |              |   |         |      
|                                                                                           
|SHAREHOLDERS EQUITY                                                                        |                                                                                           |   |          |       |              |   |        
|                                                                                           
|                                                                                           
|                                                                                           
|                                                                                           
|Preferred shares, without par value  Authorized shares: unlimited; Issued and              |                                                                                           |   |          |       |              |   |         |      
|                                                                                            | outstanding shares: 30,000,000 at June 30, 2002 and December 31, 2001, respectively       |   |          | 536   |              |   |         | 536   |      
|                                                                                           
|                                                                                           
|                                                                                           
|                                                                                           
|Common shares, without par value  Authorized shares: unlimited; Issued and                 |                                                                                           |   |          |       |              |   |         |      
|                                                                                            | outstanding shares: 1,460,978,635 at June 30, 2002 and 1,460,978,634 at December 31, 2001 |   |          | 2,111 |              |   |         | 2,111 |      
|                                                                                           
|                                                                                           
|                                                                                           
|                                                                                           
|Additional paid-in capital                                                                  |                                                                                           |   | 19,606   |       |              |   | 18,797  |      
|                                                                                           
|                                                                                           
|                                                                                           
|                                                                                           
|Deficit                                                                                     |                                                                                           |   | (15,871  | )     |              |   | (14,507 | )    
|                                                                                           
|                                                                                           
|                                                                                           
|                                                                                           
|Accumulated other comprehensive loss                                                        |                                                                                           |   | (861     | )     |              |   | (964    | )    
|                                                                                           
|Total shareholders equity                                                                  |                                                                                           |   | 5,521    |       |              |   | 5,973   |      
|                                                                                           
|Total liabilities and shareholders equity                                                  |                                                                                           | $ | 18,441   |       |              | $ | 19,993  |      
|                                                                                           

See notes to unaudited consolidated financial statements.

5



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##### 



NORTEL NETWORKS LIMITED
Consolidated Statements of Cash Flows (unaudited)
(millions of U.S. dollars)

|                                                                                   |                                                                                                                                                                         |                                                                   |                                          |      |                  |      |        |        |       |       |  
|---------------------------------------------------------------------------------- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ----------------------------------------------------------------- | ---------------------------------------- | ---- | ---------------- | ---- | ------ | ------ | ----- | ----- | -
|                                                                                  
|                                                                                   |                                                                                                                                                                         |                                                                   |                                          |      | Six months ended
|                                                                                   |                                                                                                                                                                         |                                                                   |                                          |      | June 30,        
|                                                                                   |                                                                                                                                                                         |                                                                   |                                          |      | 2002             |      |        | 2001  
|                                                                                  
|Cash flows from (used in) operating activities
Net loss from continuing operations |                                                                                                                                                                         | $                                                                 | (1,354                                   | )    |                  | $    | (6,732 | )     
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                   | Adjustments to reconcile net loss from continuing operations to net cash used in
operating activities, net of effects from acquisitions and divestitures of businesses: |                                                                   |                                          |      |                  |      |        |        |      
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                   |                                                                                                                                                                         | Amortization and depreciation                                     |                                          |      | 304              |      |        |        | 2,096 |      
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                   |                                                                                                                                                                         | Non-cash portion of special charges and related asset write downs |                                          |      | 264              |      |        |        | 2,607 |      
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                   |                                                                                                                                                                         | Equity in net earnings of associated companies                    |                                          |      | 14               |      |        |        | 132   |      
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                   |                                                                                                                                                                         | Tax benefit from stock options                                    |                                          |      |                 |      |        |        | 34    |      
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                   |                                                                                                                                                                         | Deferred income taxes                                             |                                          |      | (206             | )    |        |        | (936  | )    
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                   |                                                                                                                                                                         | Other liabilities                                                 |                                          |      | (47              | )    |        |        | (18   | )    
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                   |                                                                                                                                                                         | Gain on sale of investments and businesses                        |                                          |      | (15              | )    |        |        | (24   | )    
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                   |                                                                                                                                                                         | Other  net                                                       |                                          |      | 284              |      |        |        | 66    |      
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                   |                                                                                                                                                                         | Change in operating assets and liabilities:                       |                                          |      |                  |      |        |        |       |      
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                   |                                                                                                                                                                         |                                                                   | Accounts receivable                      |      |                  | 539  |        |        |       | 2,344 |  
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                   |                                                                                                                                                                         |                                                                   | Inventories                              |      |                  | 114  |        |        |       | 1,208 |  
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                   |                                                                                                                                                                         |                                                                   | Income taxes                             |      |                  | 694  |        |        |       | (887  | )
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                   |                                                                                                                                                                         |                                                                   | Accounts payable and accrued liabilities |      |                  | (725 | )      |        |       | (580  | )
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                   |                                                                                                                                                                         |                                                                   | Other operating assets and liabilities   |      |                  | (44  | )      |        |       | 184   |  
|                                                                                  
|                                                                                   | Net cash used in operating activities of continuing operations                                                                                                          |                                                                   |                                          | (178 | )                |      |        | (506   | )    
|                                                                                  
|                                                                                  
|Cash flows from (used in) investing activities                                     |                                                                                                                                                                         |                                                                   |                                          |      |                  |      |        |       
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                   | Expenditures for plant and equipment                                                                                                                                    |                                                                   |                                          | (208 | )                |      |        | (821   | )    
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                   | Proceeds on disposals of plant and equipment                                                                                                                            |                                                                   |                                          | 76   |                  |      |        | 20     |      
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                   | Increase in long-term receivables                                                                                                                                       |                                                                   |                                          | (210 | )                |      |        | (502   | )    
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                   | Decrease in long-term receivables                                                                                                                                       |                                                                   |                                          | 105  |                  |      |        | 92     |      
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                   | Acquisitions of investments and businesses  net of cash acquired                                                                                                       |                                                                   |                                          | (25  | )                |      |        | (74    | )    
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                   | Proceeds on sale of investments and businesses                                                                                                                          |                                                                   |                                          | 38   |                  |      |        | 64     |      
|                                                                                  
|                                                                                   | Net cash used in investing activities of continuing operations                                                                                                          |                                                                   |                                          | (224 | )                |      |        | (1,221 | )    
|                                                                                  
|                                                                                  
|Cash flows from (used in) financing activities                                     |                                                                                                                                                                         |                                                                   |                                          |      |                  |      |        |       
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                   | Dividends on preferred shares                                                                                                                                           |                                                                   |                                          | (10  | )                |      |        | (15    | )    
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                   | Increase (decrease) in notes payable  net                                                                                                                              |                                                                   |                                          | (77  | )                |      |        | 1,421  |      
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                   | Proceeds from long-term debt                                                                                                                                            |                                                                   |                                          | 31   |                  |      |        | 1,505  |      
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                   | Repayments of long-term debt                                                                                                                                            |                                                                   |                                          | (6   | )                |      |        | (412   | )    
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                   | Decrease in capital leases payable                                                                                                                                      |                                                                   |                                          | (4   | )                |      |        | (24    | )    
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                   | Issuance of common share                                                                                                                                                |                                                                   |                                          | 800  |                  |      |        |       |      
|                                                                                  
|                                                                                   | Net cash from financing activities of continuing operations                                                                                                             |                                                                   |                                          | 734  |                  |      |        | 2,475  |      
|                                                                                  
|                                                                                   | Effect of foreign exchange rate changes on cash and cash equivalents                                                                                                    |                                                                   |                                          | 46   |                  |      |        | (17    | )    
|                                                                                  
|                                                                                   | Net cash from continuing operations                                                                                                                                     |                                                                   |                                          | 378  |                  |      |        | 731    |      
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                   | Net cash from (used in) discontinued operations                                                                                                                         |                                                                   |                                          | 287  |                  |      |        | (421   | )    
|                                                                                  
|Net increase in cash and cash equivalents                                          |                                                                                                                                                                         |                                                                   | 665                                      |      |                  |      | 310    |       
|                                                                                  
|Cash and cash equivalents at beginning of period  net                             |                                                                                                                                                                         |                                                                   | 3,457                                    |      |                  |      | 1,567  |       
|                                                                                  
|Cash and cash equivalents at end of period  net                                   |                                                                                                                                                                         | $                                                                 | 4,122                                    |      |                  | $    | 1,877  |       
|                                                                                  

See notes to unaudited consolidated financial statements.

6



---



##### 



NORTEL NETWORKS LIMITED
Notes to Consolidated Financial Statements (unaudited)
(millions of U.S. dollars, unless otherwise stated)



|1. |  | Nortel Networks Limited                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|-- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|  
|   |  | Effective May 1, 2000, Nortel Networks Limited (Old Nortel) and a newly
formed Canadian corporation (New Nortel) participated in a Canadian
court-approved plan of arrangement (the Arrangement) with BCE Inc. As a
result of the Arrangement: Old Nortel and its subsidiaries became direct
and indirect subsidiaries, respectively, of New Nortel; New Nortel assumed
the name Nortel Networks Corporation; New Nortels common shares began to
trade publicly on the New York and Toronto stock exchanges under the symbol
NT; Old Nortel was renamed Nortel Networks Limited; and 100 percent of
Old Nortels common shares were acquired by New Nortel and ceased to be
publicly traded. The preferred shares and debt securities of Old Nortel
outstanding immediately prior to the Arrangement remained outstanding and
continued to be obligations of Old Nortel immediately after the
Arrangement. All of the business and operations conducted by Old Nortel
and its subsidiaries immediately prior to the effective date of the
Arrangement continued to be conducted by Old Nortel and its subsidiaries as
subsidiaries of New Nortel immediately after the Arrangement. All
acquisitions completed prior to May 1, 2000 were consummated by Old Nortel
or its subsidiaries. Since May 1, 2000, acquisitions involving any share
consideration have been consummated by New Nortel, while acquisitions not
involving share consideration have continued to be consummated by Old
Nortel or its subsidiaries.
|  
|2. |  | Basis of presentation                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|  
|   |  | The accompanying unaudited Consolidated Financial Statements of Nortel
Networks Limited (Nortel Networks) include all majority owned
subsidiaries over which Nortel Networks exercises control, and have been
prepared in accordance with the rules and regulations of the United States
Securities and Exchange Commission (the SEC) for the preparation of
interim financial information. Accordingly, they do not include all
information and notes as required by United States generally accepted
accounting principles (GAAP) in the preparation of annual consolidated
financial statements. The accounting policies used in the preparation of
the accompanying unaudited Consolidated Financial Statements are the same
as those described in Nortel Networks audited Consolidated Financial
Statements prepared in accordance with GAAP for the three years ended
December 31, 2001, except as described in note 3. Although Nortel Networks
is headquartered in Canada, the accompanying unaudited Consolidated
Financial Statements are expressed in United States dollars as the greater
part of Nortel Networks financial results and net assets are denominated in
United States dollars.                                                                                                                                                                                                                                                                                                                      
|  
|   |  | In the opinion of management, all adjustments necessary to effect a fair
statement of the results for the periods presented have been made and all
such adjustments are of a normal recurring nature. The financial results
for the three months and six months ended June 30, 2002, are not
necessarily indicative of financial results for the full year. The
accompanying unaudited Consolidated Financial Statements should be read in
conjunction with Nortel Networks Annual Report on Form 10-K for the year
ended December 31, 2001 (the 2001 10-K) and Current Report on Form 8-K
dated May 13, 2002, which includes certain supplemental financial
disclosure and disclosure related to certain events that occurred
subsequent to the filing of the original historical audited consolidated
financial statements.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|  
|   |  | The preparation of Nortel Networks Consolidated Financial Statements
requires management to make estimates and assumptions that affect the
reported amounts of assets and liabilities and disclosures of contingent
assets and liabilities at the date of the financial statements and the
reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates. Estimates are used when
accounting for items and matters such as long-term contracts, allowance for
uncollectible accounts receivable and customer financings, inventory
obsolescence, product warranty, amortization, asset valuations, employee
benefits, taxes, restructuring and other provisions, in-process research
and development (IPR&D), and contingencies.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|  
|   |  | Certain 2001 figures in the accompanying unaudited Consolidated Financial
Statements have been reclassified to conform to the 2002 presentation.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    

7



---



##### 





|3. |  | Accounting changes
|-- |  | ------------------



| | (a) |  | Accounting for goodwill and other intangible assets                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
| | --- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |     |  | In July 2001, the Financial Accounting Standards Board (the FASB)
issued Statement of Financial Accounting Standard (SFAS) No. 142,
Goodwill and Other Intangible Assets (SFAS 142), effective for
fiscal years beginning after December 15, 2001. SFAS 142 changed the
accounting for goodwill from an amortization method to an
impairment-only approach. Thus, amortization of goodwill, including
goodwill recorded in past business combinations, and amortization of
intangibles with an indefinite life, ceased upon adoption of this
Statement. For any acquisitions completed after June 30, 2001, goodwill
and intangible assets with an indefinite life are not amortized.
|
| |     |  | Nortel Networks adopted the provisions of SFAS 142 effective January 1,
2002. Nortel Networks completed the first of the required SFAS 142
transitional impairment tests during the second quarter of 2002 and
concluded that there was no impairment of recorded goodwill, as the fair
value of its reporting units exceeded their carrying amount as of
January 1, 2002. Therefore the second step of the transitional
impairment test under SFAS 142 was not required to be performed. There
can be no assurance that future goodwill impairment tests will not
result in a charge to net earnings (loss).                                                                                
|
| |     |  | Acquired technology will continue to be amortized and carried at cost
less accumulated amortization. Amortization is computed over the
estimated useful lives of the respective assets, generally two to three
years.                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|
| |     |  | The following tables present the impact on net loss from both continuing
and discontinued operations for the three months and six months ended
June 30, 2002 and 2001, and for the years ended December 31, 2001, 2000,
and 1999, of the SFAS 142 requirement to cease the amortization of
goodwill as if the standard had been in effect beginning January 1,
1999:                                                                                                                                                                                                                                                                                                                         



|                      |                                                                     |   |                    |      |                  |      |        |        |      |   |        |        |   |   |        |        |  
|--------------------- | ------------------------------------------------------------------- | - | ------------------ | ---- | ---------------- | ---- | ------ | ------ | ---- | - | ------ | ------ | - | - | ------ | ------ | -
|                     
|                      |                                                                     |   | Three months ended |      | Six months ended
|                      |                                                                     |   | June 30,           |      | June 30,        
|                      |                                                                     |   | 2002               |      |                  | 2001 |        |        | 2002 |   |        | 2001  
|                     
|Reported results:     |                                                                     |   |                    |      |                  |      |        |        |      |   |        |        |   |   |        |       
|                     
|                     
|                     
|                     
|                      | Net loss from continuing operations                                 |   | $                  | (569 | )                |      | $      | (5,381 | )    |   | $      | (1,354 | ) |   | $      | (6,732 | )
|                     
|                     
|                     
|                     
|                      | Net loss from discontinued operations  net of tax                  |   |                    |     |                  |      |        | (2,351 | )    |   |        |       |   |   |        | (2,538 | )
|                     
|                     
|                     
|                     
|                      | Cumulative effect of accounting change  net of tax of $9           |   |                    |     |                  |      |        |       |      |   |        |       |   |   |        | 15     |  
|                     
|Net loss  reported   |                                                                     | $ | (569               | )    |                  | $    | (7,732 | )      |      | $ | (1,354 | )      |   | $ | (9,255 | )     
|                     
|Adjustments:          |                                                                     |   |                    |      |                  |      |        |        |      |   |        |        |   |   |        |       
|                     
|                     
|                     
|                     
|                      | Amortization of goodwill from continuing
operations  net of tax(a) |   | $                  |     |                  |      | $      | 684    |      |   | $      |       |   |   | $      | 1,370  |  
|                     
|                     
|                     
|                     
|                      | Amortization of goodwill from discontinued operations               |   |                    |     |                  |      |        | 59     |      |   |        |       |   |   |        | 121    |  
|                     
|Total net adjustments |                                                                     | $ |                   |      |                  | $    | 743    |        |      | $ |       |        |   | $ | 1,491  |       
|                     
|Adjusted results:     |                                                                     |   |                    |      |                  |      |        |        |      |   |        |        |   |   |        |       
|                     
|                     
|                     
|                     
|                      | Net loss from continuing operations                                 |   | $                  | (569 | )                |      | $      | (4,697 | )    |   | $      | (1,354 | ) |   | $      | (5,362 | )
|                     
|                     
|                     
|                     
|                      | Net loss from discontinued operations  net of tax                  |   |                    |     |                  |      |        | (2,292 | )    |   |        |       |   |   |        | (2,417 | )
|                     
|                     
|                     
|                     
|                      | Cumulative effect of accounting change  net of tax of $9           |   |                    |     |                  |      |        |       |      |   |        |       |   |   |        | 15     |  
|                     
|Net loss  adjusted   |                                                                     | $ | (569               | )    |                  | $    | (6,989 | )      |      | $ | (1,354 | )      |   | $ | (7,764 | )     
|                     
|                     
|                     
|                     
|                     



| | (a) |  | Includes goodwill amortization of equity accounted
investments, net of tax of $2 and $5 for the three months and six
months ended June 30, 2001, respectively.
| | --- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------

8



---



##### 





| |  | The following historical financial information is provided in accordance
with the SECs June 2002 announcement on SFAS 142 transition
disclosures:
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------



|                               |                                                                     |   |                         |         |   |      |        |       |      |   |       |       |  
|------------------------------ | ------------------------------------------------------------------- | - | ----------------------- | ------- | - | ---- | ------ | ----- | ---- | - | ----- | ----- | -
|                              
|                               |                                                                     |   | Year ended December 31,
|                               |                                                                     |   | 2001                    |         |   | 2000 |        |       | 1999
|                              
|Reported results:              |                                                                     |   |                         |         |   |      |        |       |      |   |       |      
|                              
|                              
|                              
|                              
|                               | Net loss from continuing operations                                 |   | $                       | (11,555 | ) |      | $      | (871  | )    |   | $     | (230  | )
|                              
|                              
|                              
|                              
|                               | Net loss from discontinued operations  net of tax                  |   |                         | (2,538  | ) |      |        | (414  | )    |   |       | (94   | )
|                              
|                              
|                              
|                              
|                               | Cumulative effect of accounting change  net of tax of $9           |   |                         | 15      |   |      |        |      |      |   |       |      |  
|                              
|Net loss  reported            |                                                                     | $ | (14,078                 | )       |   | $    | (1,285 | )     |      | $ | (324  | )    
|                              
|Adjustments:                   |                                                                     |   |                         |         |   |      |        |       |      |   |       |      
|                              
|                              
|                              
|                              
|                               | Amortization of goodwill from continuing
operations  net of tax(a) |   | $                       | 2,091   |   |      | $      | 2,507 |      |   | $     | 1,178 |  
|                              
|                              
|                              
|                              
|                               | Amortization of goodwill from discontinued operations               |   |                         | 121     |   |      |        | 195   |      |   |       | 29    |  
|                              
|Total net adjustments          |                                                                     | $ | 2,212                   |         |   | $    | 2,702  |       |      | $ | 1,207 |      
|                              
|Adjusted results:              |                                                                     |   |                         |         |   |      |        |       |      |   |       |      
|                              
|                              
|                              
|                              
|                               | Net earnings (loss) from continuing operations                      |   | $                       | (9,464  | ) |      | $      | 1,636 |      |   | $     | 948   |  
|                              
|                              
|                              
|                              
|                               | Net loss from discontinued operations  net of tax                  |   |                         | (2,417  | ) |      |        | (219  | )    |   |       | (65   | )
|                              
|                              
|                              
|                              
|                               | Cumulative effect of accounting change  net of tax of $9           |   |                         | 15      |   |      |        |      |      |   |       |      |  
|                              
|Net earnings (loss)  adjusted |                                                                     | $ | (11,866                 | )       |   | $    | 1,417  |       |      | $ | 883   |      
|                              



| | (a) |  | Includes goodwill amortization of equity accounted
investments, net of tax of $5, $7 and nil for the years ended
December 31, 2001, 2000 and 1999, respectively.
| | --- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------
|

| | (b) |  | Impairment or disposal of long-lived assets                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
| | --- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |     |  | In August 2001, the FASB issued SFAS No. 144, Accounting for the
Impairment or Disposal of Long-Lived Assets (SFAS 144), which
addresses financial accounting and reporting for the impairment or
disposal of long-lived assets. SFAS 144 applies to certain long-lived
assets, including discontinued operations, and develops one accounting
model for long-lived assets to be disposed of by sale. This Statement
supersedes SFAS No. 121, Accounting for the Impairment of Long-lived
Assets and for Long-lived Assets to be Disposed Of, and the accounting
and reporting provisions of Accounting Principles Board Opinion (APB)
No. 30, Reporting the Results of Operations  Reporting the Effects of
Disposal of a Segment of a Business, and Extraordinary, Unusual and
Infrequently Occurring Events and Transactions (APB 30), for the
disposal of a segment of a business.
|
| |     |  | SFAS 144 requires that long-lived assets to be disposed of by sale be
measured at the lower of carrying amount or fair value less cost to
sell, whether reported in continuing operations or in discontinued
operations. Discontinued operations will no longer be measured at net
realizable value or include amounts for operating losses that have not
yet been incurred. SFAS 144 also broadens the reporting of discontinued
operations to include the disposal of a component of an entity provided
that the operations and cash flows of the component will be eliminated
from the ongoing operations of the entity and the entity will not have
any significant continuing involvement in the operations of the
component.                                                                                                                                                                 
|
| |     |  | Nortel Networks adopted the provisions of SFAS 144 effective January 1,
2002. The adoption of SFAS 144 did not have a material effect on the
business, results of operations, and financial condition of Nortel
Networks.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          



|4. |  | Discontinued operations                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|-- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|  
|   |  | On June 14, 2001, Nortel Networks Board of Directors approved a plan to
discontinue Nortel Networks access solutions operations consisting of all
of Nortel Networks narrowband and broadband solutions, including copper,
cable, and fixed wireless solutions, as well as Nortel Networks then
current consolidated membership interest in Arris Interactive LLC (Arris)
and equity investment in Elastic Networks Inc. (Elastic Networks). Also
affected by the decision were Nortel Networks prior acquisitions of
Promatory Communications, Inc. (Promatory), Aptis Communications, Inc.
(Aptis), and Broadband Networks Inc.

9



---



##### 





| |  | Pursuant to APB 30, the revenues, costs and expenses, assets and
liabilities, and cash flows of Nortel Networks access solutions operations
have been segregated in the accompanying unaudited Consolidated Statements
of Operations, unaudited Consolidated Balance Sheets, and unaudited
Consolidated Statements of Cash Flows, and are reported as discontinued
operations.
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  | The results of discontinued operations for the three months and six months
ended June 30, presented in the accompanying unaudited Consolidated
Statements of Operations, were as follows:                                                                                                                                                                                       



|                                                   |  |   |                    |    |                  |      |        |     |      |   |   |      |  |   |        |     | 
|-------------------------------------------------- |  | - | ------------------ | -- | ---------------- | ---- | ------ | --- | ---- | - | - | ---- |  | - | ------ | --- | 
|                                                  
|                                                   |  |   | Three months ended |    | Six months ended
|                                                   |  |   | June 30,           |    | June 30,        
|                                                   |  |   | 2002               |    |                  | 2001 |        |     | 2002 |   |   | 2001
|                                                  
|Revenues                                           |  |   | $                  | 70 |                  |      | $      | 287 |      |   | $ | 138  |  |   | $      | 711 | 
|                                                  
|                                                  
|Loss from discontinued operations  net of tax(a)  |  | $ |                   |    |                  | $    | (167   | )   |      | $ |  |      |  | $ | (354   | )  
|                                                  
|                                                  
|                                                  
|                                                  
|Loss on disposal of operations  net of tax(b)     |  |   |                   |    |                  |      | (2,184 | )   |      |   |  |      |  |   | (2,184 | )  
|                                                  
|Net loss from discontinued operations  net of tax |  | $ |                   |    |                  | $    | (2,351 | )   |      | $ |  |      |  | $ | (2,538 | )  
|                                                  



| | (a) |  | Loss from discontinued operations was net of applicable income
tax recovery of nil and $60 for the three months ended June 30,
2002 and 2001, respectively, and an income tax recovery of nil and
$122 for the six months ended June 30, 2002 and 2001, respectively.
| | --- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| | (b) |  | Loss on disposal of operations was net of applicable income tax
recovery of $596 for the three months and six months ended June 30,
2001.                                                                                                                            



| |  | During the three months ended June 30, 2002, Arris Group Inc. (Arris
Group) completed a secondary public offering of 15 million common shares
held by Nortel Networks. Following the closing of the offering on June 25,
2002, Nortel Networks owned 22 million shares, or approximately 27 percent
of Arris Groups common shares. The cash proceeds received were $67 and a
gain of approximately $15 was recorded as a result of this transaction,
which is included in the estimated remaining provisions required for
discontinued operations. During the three months ended March 31, 2002,
Nortel Networks recorded a gain of approximately $13 due to the reduction
of Nortel Networks ownership interest in Arris Group, received for Nortel
Networks original interest in Arris, from approximately 49 percent to
approximately 46 percent as a result of Arris Groups issuance of common
 shares in connection with its acquisition of another company, which is
included in the estimated remaining provisions required for discontinued
operations.
| |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | On April 21, 2002, Nortel Networks entered into an agreement with Aastra
Technologies Limited to sell certain assets which were included in
discontinued operations, associated with Nortel Networks prior acquisition
of Aptis. The transaction was completed during the three months ended June
30, 2002. The consideration primarily consisted of approximately $16 in
cash, as well as contingent cash consideration of up to $60 over four years
based on the achievement of certain revenue targets by the business.
Nortel Networks recorded a loss of approximately $43 on the transaction,
which reduced the estimated provisions required for discontinued
operations.
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | On March 5, 2002, Nortel Networks divested its approximately 46 percent
ownership interest in Elastic Networks to Paradyne Networks, Inc.
(Paradyne) in exchange for an approximately 8 percent ownership interest
in Paradyne. Nortel Networks recorded a gain of approximately $7 on the
transaction, which is included in the estimated remaining provisions
required for discontinued operations.
| |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | In connection with the decision to discontinue the access solutions
operations on June 14, 2001, Nortel Networks recorded a pre-tax loss on
disposal of the access solutions operations of $2,780 in the second quarter
of 2001, which reflected the estimated costs directly associated with
Nortel Networks plan of disposition. The loss reflected: the write-off of
goodwill associated with the acquisition of Promatory in the amount of
$417; provisions for both short-term and long-term receivables of $600; a
provision for inventories of $381; other asset write-offs totaling $151;
future contractual obligations and estimated liabilities of $1,059; and
estimated operating losses during the planned period of disposition of
$172.
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

10



---



##### 





| |  | During the six months ended June 30, 2002, Nortel Networks has continued to
actively wind down the access solutions operations and there has been no
change to the initial disposal strategy or intent to exit the business
since June 14, 2001. However, the continued deterioration in industry and
market conditions has delayed certain disposal activities beyond the
original planned timeframe of one year. In particular, actions involving
negotiations with customers, who have also been affected by industry
conditions, are taking longer than expected. Therefore, although disposal
activities continue beyond the one-year period generally contemplated under
APB 30, Nortel Networks continues to present the access solutions
operations as discontinued operations in the Consolidated Financial
Statements. Nortel Networks has disposed of or transitioned the ownership
of certain operations, and operations not disposed of or so transitioned
are expected to be closed. Nortel Networks now expects to complete this
plan by the end of 2002 or early 2003, subject to the closing of specific
transactions, the timing of which may continue to be impacted by customer
issues, any applicable regulatory requirements, and business issues.
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | At June 30, 2002, the remaining accruals of $128 related to the above-noted
future contractual obligations and estimated liabilities, and estimated
operating losses during the planned period of disposition were included in
current liabilities of discontinued operations. The remaining accruals are
expected to be substantially drawn down by cash payments over the period of
disposition, the impact of which is expected to be offset by proceeds from
the sale of certain remaining assets to be disposed of.
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | The assets and liabilities of discontinued operations presented in the
accompanying unaudited Consolidated Balance Sheets were as follows:
| |  | ------------------------------------------------------------------------------------------------------------------------------------------

|                                                      |  |          |     |  |              |   |     | 
|----------------------------------------------------- |  | -------- | --- |  | ------------ | - | --- | 
|                                                     
|                                                      |  | June 30, |     |  | December 31,
|                                                      |  | 2002     |     |  | 2001        
|                                                     
|                                                     
|Accounts receivable  net                             |  | $        | 25  |  |              | $ | 109 | 
|                                                     
|                                                     
|                                                     
|                                                     
|Inventories  net                                     |  |          |    |  |              |   | 66  | 
|                                                     
|                                                     
|                                                     
|                                                     
|Deferred income taxes                                 |  |          | 205 |  |              |   | 348 | 
|                                                     
|                                                     
|                                                     
|                                                     
|Other current assets                                  |  |          | 99  |  |              |   | 175 | 
|                                                     
|Total current assets of discontinued operations       |  |          | 329 |  |              |   | 698 | 
|                                                     
|Intangible assets  net                               |  |          |    |  |              |   | 17  | 
|                                                     
|                                                     
|                                                     
|                                                     
|Other long-term assets                                |  |          | 105 |  |              |   | 266 | 
|                                                     
|Total assets of discontinued operations               |  | $        | 434 |  |              | $ | 981 | 
|                                                     
|                                                     
|Current liabilities                                   |  | $        | 135 |  |              | $ | 384 | 
|                                                     
|                                                     
|                                                     
|                                                     
|Long-term liabilities (included in Other liabilities) |  |          | 2   |  |              |   | 11  | 
|                                                     
|Total liabilities of discontinued operations          |  | $        | 137 |  |              | $ | 395 | 
|                                                     



| |  | The net cash from (used in) discontinued operations for the six months
ended June 30, 2002 and 2001, presented in the accompanying unaudited
Consolidated Statements of Cash Flows, was as follows:
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                                                  |                      |   |      |     |  |      |      |      |  
|------------------------------------------------- | -------------------- | - | ---- | --- |  | ---- | ---- | ---- | -
|                                                 
|                                                  |                      |   | 2002 |     |  | 2001
|                                                 
|Cash flows from (used in) discontinued operations |                      |   |      |     |  |      |      |     
|                                                 
|                                                 
|                                                 
|                                                 
|                                                  | Operating activities |   | $    | 207 |  |      | $    | (316 | )
|                                                 
|                                                 
|                                                 
|                                                 
|                                                  | Investing activities |   |      | 80  |  |      |      | (105 | )
|                                                 
|Net cash from (used in) discontinued operations   |                      | $ | 287  |     |  | $    | (421 | )   
|                                                 

11



---



##### 





|5. |  | Consolidated financial statement details   
|-- |  | -------------------------------------------
|  
|   |  | Consolidated balance sheets                
|  
|   |  | The following tables provide details as at:
|  
|   |  | Inventories  net:                         

|                     |  |          |       |  |              |   |       | 
|-------------------- |  | -------- | ----- |  | ------------ | - | ----- | 
|                    
|                     |  | June 30, |       |  | December 31,
|                     |  | 2002     |       |  | 2001        
|                    
|                    
|Raw materials        |  | $        | 574   |  |              | $ | 744   | 
|                    
|                    
|                    
|                    
|Work in process      |  |          | 460   |  |              |   | 576   | 
|                    
|                    
|                    
|                    
|Finished goods       |  |          | 415   |  |              |   | 243   | 
|                    
|Inventories  net(a) |  | $        | 1,449 |  |              | $ | 1,563 | 
|                    



| | (a) |  | Net of inventory provisions of $1,047 and $911 as at June 30,
2002 and December 31, 2001, respectively. Nortel Networks has also
accrued in other accrued liabilities $268 and $565 at June 30, 2002
and December 31, 2001, respectively, for cancellation charges, for
inventory in excess of future demand, and for the settlement of
certain other claims related to its contract manufacturers or
suppliers. | 
| | --- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | 



| |  | Goodwill:                                                                                                                  
| |  | ---------------------------------------------------------------------------------------------------------------------------
|
| |  | The changes in the carrying amount of goodwill by reportable segment for
the six months ended June 30, 2002 are as follows:

|                              |  |          |     |  |          |   |    |            |  |           |       |   |  |   |       | 
|----------------------------- |  | -------- | --- |  | -------- | - | -- | ---------- |  | --------- | ----- | - |  | - | ----- | 
|                             
|                              |  |          |     |  |          |   |    |            |  | Metro and |       |   |  |  
|                              |  | Optical  |     |  | Wireless |   |    | Enterprise |  |           |       |  
|                              |  | Networks |     |  | Networks |   |    | Networks   |  |           | Total
|                             
|                             
|Balance as at January 1, 2002 |  | $        | 258 |  |          | $ | 21 |            |  | $         | 2,004 |   |  | $ | 2,283 | 
|                             
|                             
|                             
|                             
|Change                        |  |          | 3   |  |          |   |   |            |  |           | (3    | ) |  |   |      | 
|                             
|Balance as at June 30, 2002   |  | $        | 261 |  |          | $ | 21 |            |  | $         | 2,001 |   |  | $ | 2,283 | 
|                             



| |  | Intangible assets  net:
| |  | ------------------------

|                               |  |          |        |   |              |   |        |  
|------------------------------ |  | -------- | ------ | - | ------------ | - | ------ | -
|                              
|                               |  | June 30, |        |   | December 31,
|                               |  | 2002     |        |   | 2001        
|                              
|                              
|Acquired technology            |  | $        | 5,201  |   |              | $ | 5,201  |  
|                              
|                              
|                              
|                              
|Less: accumulated amortization |  |          | (5,193 | ) |              |   | (5,181 | )
|                              
|Intangible assets  net        |  | $        | 8      |   |              | $ | 20     |  
|                              



| |  | The remaining intangible assets  net will be fully amortized by the end of
2002.
| |  | ---------------------------------------------------------------------------------

12



---



##### 





| |  | Consolidated statements of cash flows                                 
| |  | ----------------------------------------------------------------------
|
| |  | The following table provides details for the six months ended June 30:
|
| |  | Interest and income taxes paid (received):                            

|                             |  |      |        |   |      |   |     | 
|---------------------------- |  | ---- | ------ | - | ---- | - | --- | 
|                            
|                             |  | 2002 |        |   | 2001
|                            
|                            
|Interest paid                |  | $    | 101    |   |      | $ | 111 | 
|                            
|                            
|                            
|                            
|Income taxes paid (received) |  | $    | (1,237 | ) |      | $ | 386 | 
|                            



|6. |  | Special charges                 
|-- |  | --------------------------------
|  
|   |  | Special charges were as follows:

|                    |                 |   |               |     |                    |   |          |    |          |   |                      |     |               |   |          |     |  |   |      |      |   |   |      |      |   |   |       |     | 
|------------------- | --------------- | - | ------------- | --- | ------------------ | - | -------- | -- | -------- | - | -------------------- | --- | ------------- | - | -------- | --- |  | - | ---- | ---- | - | - | ---- | ---- | - | - | ----- | --- | 
|                   
|                    |                 |   | Provision     |     | Special charges    |   |          |    |          |   | 2002                 |     | Provision    
|                    |                 |   | Balance as at |     | Three months ended |   |          |    |          |   | Cumulative drawdowns |     | Balance as at |  
|                    |                 |   | December 31,  |     | March 31,          |   | June 30, |    |          |   |                      |     |               |   | June 30,
|                    |                 |   | 2001          |     | 2002               |   | 2002     |    | Subtotal |   | Cash                 |     | Non-cash      |   | 2002    
|                   
|                   
|Workforce reduction |                 | $ | 393           |     |                    | $ | 312      |    |          | $ | 117                  |     |               | $ | 822      |     |  | $ | (439 | )    |   | $ |     |      |   | $ | 383   |    
|                   
|                   
|                   
|                   
|Contract settlement |                 |   |               |     |                    |   |          |    |          |   |                      |     |               |   |          |     |  |   |      |      |   |   |      |      |   |   |       |    
|                    | and lease costs |   |               | 773 |                    |   |          | 56 |          |   |                      | 1   |               |   |          | 830 |  |   |      | (186 | ) |   |      |     |   |   |       | 644 | 
|                   
|                   
|                   
|                   
|Plant and equipment |                 |   |               |     |                    |   |          |    |          |   |                      |     |               |   |          |     |  |   |      |      |   |   |      |      |   |   |       |    
|                    | write downs     |   |               |    |                    |   |          | 75 |          |   |                      | 189 |               |   |          | 264 |  |   |      |     |   |   |      | (264 | ) |   |       |    | 
|                   
|                   
|                   
|                   
|Other               |                 |   | 31            |     |                    |   |         |    |          |   |                     |     |               |   | 31       |     |  |   | (9   | )    |   |   |     |      |   |   | 22    |    
|                   
|Total               |                 | $ | 1,197         |     |                    | $ | 443      |    |          | $ | 307                  |     |               | $ | 1,947    |     |  | $ | (634 | )    |   | $ | (264 | )    |   | $ | 1,049 |    
|                   



| |  | Three months and six months ended June 30, 2002                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  | For the three months and six months ended June 30, 2002, Nortel Networks
recorded special charges of $307 and $750, respectively, related to
restructuring costs associated with its work plan, which it began
implementing in 2001 and continued into the second quarter of 2002, to
streamline its operations and activities around its core markets and
leadership strategies.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|
| |  | Workforce reduction charges of $117 and $429 for the three months and six
months ended June 30, 2002, respectively, were related to the cost of
severance and benefits associated with approximately 1,900 and 5,900
employees notified of termination, respectively, across all of Nortel
Networks segments.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|
| |  | Contract settlement costs included negotiated settlements of approximately
$1 and $57 for the three months and six months ended June 30, 2002,
respectively, to either cancel contracts or renegotiate existing contracts
across all of Nortel Networks segments.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|
| |  | As part of its review of financial results during the six months ended June
30, 2002, Nortel Networks performed assessments of certain plant and
equipment assets, primarily in the Optical Networks segment, due to the
current market conditions and the delay in the anticipated recovery of that
segment. The conclusion of these assessments resulted in a write down of
certain plant and equipment assets within the Optical Networks segment of
approximately $189 during the three months ended June 30, 2002. These
plant and equipment assets continue to be held and used, and were written
down to estimated fair value based on market assessments. During the three
months ended March 31, 2002, the plant and equipment write down included
assets within the Optical Networks segment and within global operations, a
function that supports all of Nortel Networks segments, totaling
approximately $75.

13



---



##### 





| |  | Year ended December 31, 2001                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  | For the year ended December 31, 2001, Nortel Networks recorded
restructuring charges of $3,310, related to workforce reduction costs of
$1,343, contract settlement and lease costs of $883, plant and equipment
write downs of $939, and other costs of $145. During the year ended
December 31, 2001, there were cumulative cash and non-cash drawdowns
against the provision of $1,082 and $1,031, respectively, resulting in an
ending provision balance at December 31, 2001 of $1,197. The cash
drawdowns related primarily to workforce reduction payments, and the
non-cash drawdowns related primarily to the plant and equipment write
downs.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|
| |  | Period from January 1, 2001 to June 30, 2002                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|
| |  | Of the approximately 41,400 employees notified during the period from
January 1, 2001 to June 30, 2002, approximately 15,200 were direct
employees performing manufacturing, assembly, test and inspection
activities associated with the production of Nortel Networks products, and
approximately 26,200 were indirect sales, marketing, research and
development, and administrative employees, and manufacturing managers. The
workforce reduction was primarily in North America and the United Kingdom
and extended across all of Nortel Networks segments. As at June 30, 2002,
the workforce reduction provision balance has been drawn down by cumulative
cash payments of $1,403, resulting in an ending provision balance for
workforce reduction of $383. The remaining provision is expected to be
substantially drawn down by the second quarter of 2003.                                                                                                                                                                                                                                                                                                                                                                                                                                          
|
| |  | In conjunction with the above noted workforce reduction, Nortel Networks
identified a number of leased and owned facilities comprised of office,
warehouse and manufacturing space, as well as leased manufacturing
equipment, that were no longer required. As a result, Nortel Networks
recorded net lease costs of approximately $757. The costs primarily
related to Nortel Networks future contractual obligations under operating
leases. Offsetting the total lease charge is approximately $479 in
expected sublease revenue on leases that Nortel Networks cannot terminate.
The reduction in expected sublease revenue of $27 in the three months ended
June 30, 2002 was as a result of Nortel Networks ability to terminate
certain leases early and at a discount to the originally anticipated lease
costs associated with these leases. Nortel Networks expects to have
subleased substantially all of these properties by the end of 2004. In
addition, Nortel Networks wrote down the net carrying value of specific
owned facilities across all segments within North America and the United
Kingdom. The write down of approximately $95, which is included in plant
and equipment write downs, reflected the net realizable value based on
market assessments for general purpose facilities.
|
| |  | Contract settlement costs included negotiated settlements of approximately
$183, to either cancel contracts or renegotiate existing contracts across
all of Nortel Networks segments. As at June 30, 2002, the provision
balance for contract settlement and lease costs has been drawn down by
cumulative cash payments of $296, resulting in an ending provision balance
of $644. The remaining provision is now expected to be substantially drawn
down by the end of 2006.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|
| |  | Plant and equipment write downs of approximately $459 consisted of the
write down of leasehold improvements and certain information technology
equipment associated with the exiting of the above noted leased and owned
facilities.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|
| |  | In addition, as a result of the significant negative industry and economic
trends impacting Nortel Networks operations and expected future growth
rates, Nortel Networks has performed assessments of certain plant and
equipment assets as part of its review of financial results during 2001 and
the first six months of 2002. The conclusion of these assessments resulted
in write downs of certain plant and equipment assets totaling approximately
$649, as summarized below.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|
| |  | Within the Optical Networks segment, it was determined that there was
excess manufacturing equipment at a number of facilities that would no
longer be required, or the carrying value of which was not recoverable from
future cash flows, as a result of the industry and economic environment.
As a result, Nortel Networks recorded charges totaling approximately $470
to write down the value of this equipment to its net realizable value based
on the current fair market value for this type of specialized equipment.
Nortel Networks expects to dispose of this equipment, other than equipment
that it continues to hold and use, by the end of 2002. In 2001, Nortel
Networks also wrote down the net carrying value of a specialized
manufacturing facility within the Optical Networks segment for the
production of                                                                                                                                                                                                                                                                                                                                                                                                                                                                             

14



---



##### 





|   |  | optical components within North America. The write down of approximately
$91 reflects the net realizable value based on market assessments for a
general purpose facility.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|-- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|  
|   |  | Within global operations, it was determined that there was excess test
equipment at a number of system houses that would no longer be required as
a result of the industry and economic environment. As a result, Nortel
Networks recorded charges totaling approximately $88 to write down the
value of this equipment to its net realizable value based on the current
fair value for this type of specialized equipment. Nortel Networks expects
to dispose of this equipment by the end of 2002.                                                                                                                                                              
|  
|7. |  | Income taxes                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|  
|   |  | Nortel Networks effective tax benefit rate fluctuates from period to period
primarily as a result of the impact of IPR&D expense, stock option
compensation, goodwill write downs, certain non-tax deductible
restructuring charges, and non-tax deductible goodwill amortization prior
to January 1, 2002. Excluding these impacts as applicable, Nortel Networks
effective tax benefit rate was 30.3 percent and 32.0 percent for the three
months ended June 30, 2002 and 2001, respectively, and was 31.0 percent and
32.0 percent for the six months ended June 30, 2002 and 2001, respectively,
and reflected changes in the geographic earnings (loss) mix.
|  
|   |  | Recently approved tax legislation in the United States extended the net
operating loss carry-back period from two years to five years. As a
result, during the three months ended March 31, 2002, Nortel Networks
carried back available United States losses from 2001 and utilized
approximately $700 of previously recognized deferred income tax assets.                                                                                                                                                                                                                                                                                                      
|  
|   |  | Global investment tax credits of $29 and $10 for the three months ended
June 30, 2002 and 2001, respectively, and $54 and $46 for the six months
ended June 30, 2002 and 2001, respectively, have been incorporated into the
income tax benefit.                                                                                                                                                                                                                                                                                                                                                                                                                  
|  
|8. |  | Related party transactions                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|  
|   |  | Nortel Networks engages in certain transactions with Nortel Networks
Corporation and directly owned subsidiaries of Nortel Networks Corporation.
These transactions include cash borrowings between the parties in addition
to funding activities pursuant to reciprocal credit agreements. As at June
30, 2002 and December 31, 2001, the balance included in trade and other
accounts payable owing to Nortel Networks Corporation was $103 and $134,
respectively, and to directly owned subsidiaries of Nortel Networks
Corporation was $137 and $116, respectively.                                                                                          
|  
|9. |  | Common shares                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|  
|   |  | On June 28, 2002, Nortel Networks issued 1 common share to Nortel Networks
Corporation in exchange for cash consideration of $800. Nortel Networks
Corporation, as the holder of all of Nortel Networks issued and outstanding
common shares, approved a reduction in Nortel Networks legal stated capital
for its common shares in the amount of $800.                                                                                                                                                                                                                                                                                                           

15



---



##### 





|10. |  | Comprehensive loss                                                
|--- |  | ------------------------------------------------------------------
|   
|    |  | The components of comprehensive loss, net of tax, were as follows:

|                                   |                                                                   |   |                    |     |                  |      |        |    |      |   |        |      |   |   |        |      |  
|---------------------------------- | ----------------------------------------------------------------- | - | ------------------ | --- | ---------------- | ---- | ------ | -- | ---- | - | ------ | ---- | - | - | ------ | ---- | -
|                                  
|                                   |                                                                   |   | Three months ended |     | Six months ended
|                                   |                                                                   |   | June 30,           |     | June 30,        
|                                   |                                                                   |   | 2002               |     |                  | 2001 |        |    | 2002 |   |        | 2001
|                                  
|                                  
|Net loss                           |                                                                   | $ | (569               | )   |                  | $    | (7,732 | )  |      | $ | (1,354 | )    |   | $ | (9,255 | )   
|                                  
|                                  
|                                  
|                                  
|Other comprehensive income (loss): |                                                                   |   |                    |     |                  |      |        |    |      |   |        |      |   |   |        |     
|                                  
|                                  
|                                  
|                                  
|                                   | Change in foreign currency translation adjustment(a)              |   |                    | 140 |                  |      |        | 41 |      |   |        | 91   |   |   |        | (218 | )
|                                  
|                                  
|                                  
|                                  
|                                   | Unrealized gain (loss) on investments  net(b)                    |   |                    | (19 | )                |      |        | 14 |      |   |        | (3   | ) |   |        | (73  | )
|                                  
|                                  
|                                  
|                                  
|                                   | Unrealized derivative gains (losses) on cash flow hedges  net(c) |   |                    | 14  |                  |      |        | 17 |      |   |        | 15   |   |   |        | (6   | )
|                                  
|Comprehensive loss                 |                                                                   | $ | (434               | )   |                  | $    | (7,660 | )  |      | $ | (1,251 | )    |   | $ | (9,552 | )   
|                                  



| | (a) |  | The change in the foreign currency translation adjustment is not
adjusted for income taxes as it relates to indefinite investments in
non-United States subsidiaries.                                                                                                                                                                                                                                                                              
| | --- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| | (b) |  | Certain securities deemed available-for-sale by Nortel Networks
are measured at fair value. Unrealized holding gains and losses
related to these securities are excluded from net loss and are
included in comprehensive loss until they are realized.                                                                                                                                                                                             
|
| | (c) |  | Net derivative losses reclassified to selling, general and
administrative expense were $8 and $14, respectively, during the three
months and six months ended June 30, 2002, and nil and $5,
respectively, during the three months and six months ended June 30,
2001. Nortel Networks estimates that $2 of net derivative losses
included in other comprehensive loss will be reclassified into net
earnings (loss) within the next twelve months.



|11. |  | Segmented information                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|--- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   
|    |  | General description                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|   
|    |  | Nortel Networks operations are organized around three reportable segments;
Metro and Enterprise Networks (Metro and Enterprise), Wireless Networks
(Wireless), and Optical Networks (Optical, formerly named Optical
Long-Haul Networks). Nortel Networks reportable segments are focused on
providing seamless networking products and service capabilities across
Metro and Enterprise, Wireless, and Optical. These product and service
solutions are used by service provider and enterprise customers, including
incumbent and competitive local exchange carriers, interexchange carriers,
service providers with global businesses, wireless service providers,
Internet service providers, application service providers, hosting service
providers, resellers, cable television companies, other communication
service providers, large businesses and their branch offices, small
businesses, and home offices, as well as government, education, and utility
organizations. Metro and Enterprise includes data switching systems,
routers, and aggregation products to deliver services via Internet Protocol
(IP) and other protocol standards across local and wide area networks,
voice over IP solutions for both greenfield and circuit to packet network
transitions, and traditional voice circuit switching. Wireless includes
wireless mobility switching and access products for voice and data
communications that span most major global mobility standards. Optical
includes long-haul optical transmission products designed to provide
long-distance, high capacity dense wavelength division multiplexing
transport, metro optical transmission products, traditional optical
transmission systems that support most global transmission standards,
optical switch platforms, and optical components for long distance optical
networks.
|   
|    |  | Other represents miscellaneous business activities and corporate
functions. None of these activities meet the quantitative criteria to be
disclosed as reportable segments.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|   
|    |  | As described in note 4, Nortel Networks access solutions operations were
discontinued during the year ended December 31, 2001. These operations
were previously included as a separate segment within Other. The data
included below excludes amounts related to the operations of the access
solutions segment.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           

16



---



##### 





| |  | Nortel Networks President and Chief Executive Officer (CEO) has been
identified as the chief operating decision maker in assessing the
performance of the segments and the allocation of resources to the
segments. Each reportable segment is managed separately with each segment
manager reporting directly to the CEO. The CEO relies on the information
derived directly from Nortel Networks management reporting system.
Contribution margin represents the primary financial measure used by the
CEO in assessing performance and allocating resources, and includes the
cost of revenues, and selling, general and administrative expense, for
which the segment managers are held accountable. Costs associated with
shared services, and other corporate costs, are allocated to the segments
based on usage determined by headcount. Costs not allocated are primarily
related to Nortel Networks corporate compliance and other non-operational
activities and are included in Other. In addition, the CEO does not review
asset information on a segmented basis. The accounting policies of the
reportable segments are the same as those described in Nortel Networks
audited Consolidated Financial Statements for the year ended December 31,
2001 to the extent that the related items are included within contribution
margin.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  | Segments                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|
| |  | During the three months ended June 30, 2002, management shifted the
accountability for the metro optical portion of Metro and Enterprise to
Optical. Consequently, financial information for these two segments has
been reported on the new basis commencing in the three months ended June
30, 2002 and historical comparative financial information has been
restated. The following tables set forth information by segments:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   

|                                    |  |   |                    |       |                  |      |        |        |      |   |        |       |   |   |        |        |  
|----------------------------------- |  | - | ------------------ | ----- | ---------------- | ---- | ------ | ------ | ---- | - | ------ | ----- | - | - | ------ | ------ | -
|                                   
|                                    |  |   | Three months ended |       | Six months ended
|                                    |  |   | June 30,           |       | June 30,        
|                                    |  |   | 2002               |       |                  | 2001 |        |        | 2002 |   |        | 2001 
|                                   
|                                   
|Revenues                            |  |   |                    |       |                  |      |        |        |      |   |        |       |   |   |        |        |  
|                                   
|                                   
|                                   
|                                   
|Metro and Enterprise                |  | $ | 1,222              |       |                  | $    | 1,971  |        |      | $ | 2,576  |       |   | $ | 4,361  |       
|                                   
|                                   
|                                   
|                                   
|Wireless                            |  |   |                    | 1,123 |                  |      |        | 1,616  |      |   |        | 2,259 |   |   |        | 3,161  |  
|                                   
|                                   
|                                   
|                                   
|Optical                             |  |   |                    | 404   |                  |      |        | 744    |      |   |        | 809   |   |   |        | 2,298  |  
|                                   
|                                   
|                                   
|                                   
|Other                               |  |   |                    | 21    |                  |      |        | 240    |      |   |        | 36    |   |   |        | 440    |  
|                                   
|Total                               |  |   | $                  | 2,770 |                  |      | $      | 4,571  |      |   | $      | 5,680 |   |   | $      | 10,260 |  
|                                   
|Contribution margin                 |  |   |                    |       |                  |      |        |        |      |   |        |       |   |   |        |       
|                                   
|                                   
|                                   
|                                   
|Metro and Enterprise                |  | $ | 175                |       |                  | $    | 220    |        |      | $ | 353    |       |   | $ | 739    |       
|                                   
|                                   
|                                   
|                                   
|Wireless                            |  |   |                    | 241   |                  |      |        | (6     | )    |   |        | 485   |   |   |        | 173    |  
|                                   
|                                   
|                                   
|                                   
|Optical                             |  |   |                    | (240  | )                |      |        | (1,033 | )    |   |        | (598  | ) |   |        | (1,063 | )
|                                   
|                                   
|                                   
|                                   
|Other                               |  |   |                    | (40   | )                |      |        | (419   | )    |   |        | (163  | ) |   |        | (581   | )
|                                   
|Total                               |  |   |                    | 136   |                  |      |        | (1,238 | )    |   |        | 77    |   |   |        | (732   | )
|                                   
|Research and development expense    |  |   | (567               | )     |                  |      | (870   | )      |      |   | (1,144 | )     |   |   | (1,776 | )     
|                                   
|                                   
|                                   
|                                   
|Amortization of acquired technology |  |   | (6                 | )     |                  |      | (203   | )      |      |   | (11    | )     |   |   | (406   | )     
|                                   
|                                   
|                                   
|                                   
|Amortization of goodwill            |  |   |                   |       |                  |      | (679   | )      |      |   |       |       |   |   | (1,361 | )     
|                                   
|                                   
|                                   
|                                   
|Special charges                     |  |   | (307               | )     |                  |      | (3,275 | )      |      |   | (750   | )     |   |   | (3,630 | )     
|                                   
|                                   
|                                   
|                                   
|Gain on sale of businesses          |  |   |                   |       |                  |      |       |        |      |   | 3      |       |   |   |       |       
|                                   
|Consolidated operating loss         |  | $ | (744               | )     |                  | $    | (6,265 | )      |      | $ | (1,825 | )     |   | $ | (7,905 | )     
|                                   



|12. |  | Commitments                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|--- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   
|    |  | Nortel Networks enters into bid and performance bonds related to various
contracts, which generally have terms of less than two years. Potential
payments due under these bonds are related to performance under the
applicable contract. The total commercial commitments representing amounts
available and undrawn was $1,250 at June 30, 2002. Due to the current
general economic and industry environment, and Nortel Networks current
credit ratings, the basis under which performance bonds are obtained has
changed, resulting in (but not limited to) increased cash collateral
requirements and/or increased fees in connection with obtaining new
performance bonds. As at June 30, 2002, approximately $32 of cash and cash
equivalents was restricted as cash collateral for certain performance
bonds.

17



---



##### 





|13. |  | Contingencies                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|--- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   
|    |  | Subsequent to the February 15, 2001 announcement in which Nortel Networks
Corporation provided revised guidance for financial performance for the
2001 fiscal year and the first quarter of 2001, Nortel Networks Corporation
and certain of its then current officers and directors were named as
defendants in more than twenty-five purported class action lawsuits. These
lawsuits in the United States District Courts for the Eastern District of
New York, for the Southern District of New York and for the District of New
Jersey, and in the provinces of Ontario, Quebec, and British Columbia in
Canada, on behalf of shareholders who acquired Nortel Networks
Corporations securities as early as October 24, 2000 and as late as
February 15, 2001, allege, among other things, violations of United States
federal and Canadian provincial securities laws. Securities regulatory
authorities in Canada and the United States are also reviewing these
matters. See note 16 for further information regarding lawsuits in the
province of Ontario. On May 11, 2001, Nortel Networks Corporation filed
motions to dismiss and/or stay in connection with the three proceedings in
Quebec primarily based on the factual allegations lacking substantial
connection to Quebec and the inclusion of shareholders resident in Quebec
in the class claimed in the Ontario lawsuit. The plaintiffs in two of
these proceedings in Quebec obtained court approval for discontinuances of
their proceedings on January 17, 2002. The motion to dismiss and/or stay
the third proceeding was heard on November 6, 2001 and the court deferred
any determination on the motion to the judge who will hear the application
for authorization to commence a class proceeding. On December 6, 2001,
Nortel Networks Corporation filed a motion seeking leave to appeal that
decision. The motion for leave to appeal was dismissed on March 11, 2002.
On October 16, 2001, an order in the Southern District of New York was
filed consolidating twenty-five of the related United States class action
lawsuits into a single case, appointing class plaintiffs and counsel for
such plaintiffs. The plaintiffs served a consolidated amended complaint on
January 18, 2002. On December 17, 2001, the defendants in the British
Columbia action served notice of a motion requesting the court to decline
jurisdiction and to stay all proceedings on the ground that British
Columbia is an inappropriate forum.
|   
|    |  | A class action lawsuit was also filed in the United States District Court
for the Southern District of New York on behalf of shareholders who
acquired the securities of JDS Uniphase Corporation (JDS) between January
18, 2001 and February 15, 2001, alleging violations of the same United
States federal securities laws as the above-noted lawsuits.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|   
|    |  | On April 1, 2002, Nortel Networks Corporation filed a motion to dismiss
both the above consolidated United States shareholder class action and the
above JDS shareholder class action complaints on the grounds that they
failed to state a cause of action under United States federal securities
laws. With respect to the JDS shareholder class action complaint, Nortel
Networks Corporation also moved to dismiss on the separate basis that JDS
shareholders lacked standing to sue Nortel Networks Corporation.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|   
|    |  | A purported class action lawsuit was filed in the United States District
Court for the Middle District of Tennessee on December 21, 2001, on behalf
of participants and beneficiaries of the Nortel Networks Long-Term
Investment Plan (the Plan) at any time during the period of March 7, 2000
through the filing date and who made or maintained Plan investments in
Nortel Networks Corporation common shares, under the Employee Retirement
Income Security Act for Plan-wide relief and alleging, among other things,
material misrepresentations and omissions to induce Plan participants to
continue to invest in and maintain investments in Nortel Networks
Corporation common shares in the Plan. A second purported class action
lawsuit, on behalf of the Plan and Plan participants for whose individual
accounts the Plan purchased Nortel Networks Corporation common shares
during the period from October 27, 2000 to February 15, 2001, and making
similar allegations, was filed in the same court on March 12, 2002. A third
purported class action lawsuit, on behalf of persons who are or were Plan
participants or beneficiaries at any time since March 1, 1999 to the filing
date, and making similar allegations, was filed in the same court on March
21, 2002. The first and second purported class action lawsuits were
consolidated by a new purported class action complaint, filed on May 15,
2002 in the same court and making similar allegations, on behalf of Plan
participants and beneficiaries who directed the Plan to purchase or hold
shares of certain funds, which held primarily Nortel Networks Corporation
common shares, during the period of March 7, 2000 through December 21,
2000.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|   
|    |  | On February 12, 2001, Nortel Networks Inc. (NNI), a direct subsidiary of
Nortel Networks, was served with a consolidated amended class action
complaint (the First Complaint) that purported to add Nortel Networks
Corporation as a defendant to a lawsuit commenced in July 2000 against
Entrust, Inc. (formerly Entrust Technologies, Inc.) (Entrust) and two of
its then current officers in the United States District Court for the
Eastern District of Texas (Marshall Division) (the District Court). The First Complaint alleges
that Entrust, two officers of Entrust, and                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          

18



---



##### 





|    |  | Nortel Networks Corporation
violated the Securities Exchange Act of 1934 with respect to certain
statements made by Entrust. Nortel Networks Corporation is alleged to be a
controlling person of Entrust. On April 6, 2001, Nortel Networks
Corporation filed a motion to dismiss the First Complaint. On July 31,
2001, the First Complaint was dismissed without prejudice. On August 31,
2001, the plaintiffs filed a second amended class action complaint (the
Second Complaint) against the same defendants asserting claims
substantively similar to those in the First Complaint. On September 21,
2001, Nortel Networks Corporation filed a motion to dismiss the Second
Complaint. The motion is currently under consideration by the District
Court.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|--- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   
|    |  | On March 4, 1997, Bay Networks, Inc. (Bay Networks), a company acquired
on August 31, 1998, announced that shareholders had filed two separate
lawsuits in the United States District Court for the Northern District of
California (the Federal Court) and the California Superior Court, County
of Santa Clara (the California Court), against Bay Networks and ten of
Bay Networks then current and former officers and directors, purportedly
on behalf of a class of shareholders who purchased Bay Networks common
shares during the period of May 1, 1995 through October 14, 1996. On
August 17, 2000, the Federal Court granted the defendants motion to
dismiss the federal complaint. On August 1, 2001, the United States Court
of Appeals for the Ninth Circuit denied the plaintiffs appeal of that
decision. On April 18, 1997, a second lawsuit was filed in the California
Court, purportedly on behalf of a class of shareholders who acquired Bay
Networks common shares pursuant to the registration statement and
prospectus that became effective on November 15, 1995. The two actions in
the California Court were consolidated in April 1998; however, the
California Court denied the plaintiffs motion for class certification. In
January 2000, the California Court of Appeal rejected the plaintiffs
appeal of the decision. A petition for review was filed with the
California Supreme Court by the plaintiffs and was denied. In February
2000, new plaintiffs who allege to have been shareholders of Bay Networks
during the relevant periods, filed a motion for intervention in the
California Court seeking to become the representatives of a class of
shareholders. The motion was granted on June 8, 2001 and the new
plaintiffs filed their complaint-in-intervention on an individual and
purported class representative basis alleging misrepresentations made in
connection with the purchase and sale of securities of Bay Networks in
violation of California statutory and common law. On March 11, 2002, the
California Court granted the defendants motion to strike the class
allegations. The plaintiffs were permitted to proceed on their individual
claims. The plaintiffs are appealing the dismissal of their class
allegations.
|   
|    |  | Except as otherwise described herein or in note 16, in each of the matters
described above, plaintiffs are seeking an unspecified amount of money
damages.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|   
|    |  | Nortel Networks is also a defendant in various other suits, claims,
proceedings and investigations which arise in the normal course of
business.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|   
|    |  | Nortel Networks is unable to ascertain the ultimate aggregate amount of
monetary liability or financial impact of the above matters which seek
damages of material or indeterminate amounts, and therefore cannot
determine whether these actions, suits, claims, proceedings and
investigations will, individually or collectively, have a material adverse
effect on the business, results of operations, and financial condition of
Nortel Networks. Nortel Networks and any named directors and officers of
Nortel Networks intend to vigorously defend these actions, suits, claims,
proceedings and investigations.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|   
|14. |  | Credit facilities                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|   
|    |  | Effective April 8, 2002, Nortel Networks and NNI amended and extended the
364-day revolving syndicated credit agreements originally entered into on
April 12, 2000 and subsequently amended on April 11, 2001. The April 8,
2002 amendments reduced the size of the 364-day committed revolving
facilities to $1,175 from $1,750, extended the term to April 7, 2003 with
no additional term-out period thereafter, maintained the financial covenant
in the April 2001 facilities requiring Nortel Networks minimum consolidated
tangible net worth to be not less than $1,888, and included higher pricing
reflecting the then current credit and bank environment.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|   
|    |  | On June 27, 2002, Nortel Networks sold certain real estate in the United
Kingdom, which resulted in a reduction, effective July 2, 2002, in the
available commitments under the December 20, 2001 $1,575 credit facilities
by approximately $57.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       

19



---



##### 





|15. |  | Recent pronouncements                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|--- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   
|    |  | In August 2001, the FASB issued SFAS No. 143, Accounting for Asset
Retirement Obligations (SFAS 143), which is effective for financial
statements issued for fiscal years beginning after June 15, 2002. SFAS 143
addresses the recognition and remeasurement of obligations associated with
the retirement of a tangible long-lived asset. Nortel Networks has not yet
determined the effect that the adoption of SFAS 143 will have on the
business, results of operations, and financial condition of Nortel
Networks.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|   
|16. |  | Subsequent events                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|   
|    |  | On July 17, 2002, a purported class action lawsuit (the Ontario
Claim) was filed in the Ontario Superior Court of Justice, Commercial
List, naming Nortel Networks Corporation, certain of its current and
former officers and directors, and its auditor as defendants. The
factual allegations in the Ontario Claim are substantially similar to
the allegations in the consolidated amended complaint filed in the
United States District Court described in the first paragraph of note
13. The Ontario Claim is on behalf of all Canadian residents who
purchased Nortel Networks Corporation securities (including options on
Nortel Networks Corporation securities) between October 24, 2000 and
February 15, 2001. The plaintiffs claim damages of Cdn.$5,000, plus
punitive damages in the amount of Cdn.$1,000, prejudgment and
postjudgment interest, and costs of the action. Nortel Networks
Corporation and the named directors and officers of Nortel Networks
Corporation intend to vigorously defend the Ontario Claim.                                                                                                                                                                                                                                                                                   
|   
|17. |  | Supplemental consolidating financial information                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|   
|    |  | As a result of Nortel Networks current credit ratings, various liens,
pledges, and guarantees are effective under certain credit and security
agreements entered into by Nortel Networks and various of its subsidiaries.
In addition, in accordance with the covenants in the trust indentures for
all of Nortel Networks current consolidated public debt securities, which
represent primarily all of Nortel Networks consolidated long-term debt at
June 30, 2002, all such public debt securities are also secured equally and
ratably with the obligations under all of Nortel Networks and NNIs credit
agreements by liens on substantially all of the assets of Nortel Networks
and those of most of its United States and Canadian subsidiaries, and by
pledges of shares in certain of Nortel Networks other subsidiaries. In
addition, certain of Nortel Networks wholly owned subsidiaries have
guaranteed Nortel Networks obligations under the credit agreements and
outstanding public debt securities (the Guarantor Subsidiaries).
Non-guarantor subsidiaries (the Non-Guarantor Subsidiaries) represent
either wholly owned subsidiaries of Nortel Networks whose shares have been
pledged, or are the remaining subsidiaries of Nortel Networks which are not
providing liens, pledges, or guarantees.
|   
|    |  | The liens, pledges, and guarantees described above also apply equally and
ratably to the obligations under Nortel Networks Corporations $1,800 4.25
percent convertible senior notes due September 1, 2008.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|   
|    |  | The following supplemental consolidating financial data illustrates, in
separate columns, the composition of Nortel Networks Limited, the Guarantor
Subsidiaries, the Non-Guarantor Subsidiaries, eliminations, and the
consolidated total as at June 30, 2002 and December 31, 2001, and for the
three months and six months ended June 30, 2002 and 2001.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|   
|    |  | Investments in subsidiaries are accounted for by the equity method for
purposes of the supplemental consolidating financial data. Net earnings
(loss) of subsidiaries are, therefore, reflected in the investment accounts
and net loss. The principal elimination entries eliminate investments in
subsidiaries and intercompany balances and transactions. The financial data
may not necessarily be indicative of the results of operations or financial
position had the subsidiaries been operated as independent entities.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              

20



---



##### 



Supplemental
Consolidating Statements of Operations for the three months ended June 30,
2002:

|                                                    |                |   |          |     |   |              |       |    |              |      |      |              |   |   |              |   |  |   |       |     |  
|--------------------------------------------------- | -------------- | - | -------- | --- | - | ------------ | ----- | -- | ------------ | ---- | ---- | ------------ | - | - | ------------ | - |  | - | ----- | --- | -
|                                                   
|                                                    |                |   | Nortel   |     |   |              |       |    |              | Non- |      |              |   |   |              |   |  |  
|                                                    |                |   | Networks |     |   | Guarantor    |       |    | Guarantor    |      |      |              |   |   |              |   | 
|                                                    |                |   | Limited  |     |   | Subsidiaries |       |    | Subsidiaries |      |      | Eliminations |   |   | Consolidated
|                                                   
|Revenues                                            |                | $ | 848      |     |   | $            | 2,153 |    |              | $    | 663  |              |   | $ | (894         | ) |  | $ | 2,770 |    
|                                                   
|                                                   
|                                                   
|                                                   
|Cost of revenues                                    |                |   | 769      |     |   |              | 1,396 |    |              |      | 599  |              |   |   | (894         | ) |  |   | 1,870 |    
|                                                   
|Gross profit                                        |                |   | 79       |     |   |              | 757   |    |              |      | 64   |              |   |   |             |   |  |   | 900   |    
|                                                   
|Selling, general and administrative expense         |                |   | 101      |     |   |              | 499   |    |              |      | 164  |              |   |   |             |   |  |   | 764   |    
|                                                   
|                                                   
|                                                   
|                                                   
|Research and development expense                    |                |   | 241      |     |   |              | 248   |    |              |      | 78   |              |   |   |             |   |  |   | 567   |    
|                                                   
|                                                   
|                                                   
|                                                   
|Amortization of acquired technology                 |                |   |         |     |   |              | 6     |    |              |      |     |              |   |   |             |   |  |   | 6     |    
|                                                   
|                                                   
|                                                   
|                                                   
|Special charges                                     |                |   | 185      |     |   |              | 108   |    |              |      | 14   |              |   |   |             |   |  |   | 307   |    
|                                                   
|Operating loss                                      |                |   | (448     | )   |   |              | (104  | )  |              |      | (192 | )            |   |   |             |   |  |   | (744  | )  
|                                                   
|Equity in net loss of associated companies          |                |   | (355     | )   |   |              | (134  | )  |              |      | (7   | )            |   |   | 486          |   |  |   | (10   | )  
|                                                   
|                                                   
|                                                   
|                                                   
|Other income (expense)  net                        |                |   | 34       |     |   |              | (35   | )  |              |      | 7    |              |   |   |             |   |  |   | 6     |    
|                                                   
|                                                   
|                                                   
|                                                   
|Interest expense                                    |                |   |          |     |   |              |       |    |              |      |      |              |   |   |              |   |  |   |       |    
|                                                   
|                                                   
|                                                   
|                                                   
|                                                    | Long-term debt |   |          | (27 | ) |              |       |   |              |      |      | (7           | ) |   |              |  |  |   |       | (34 | )
|                                                   
|                                                   
|                                                   
|                                                   
|                                                    | Other          |   |          | (3  | ) |              |       | (4 | )            |      |      | (2           | ) |   |              |  |  |   |       | (9  | )
|                                                   
|Loss from continuing operations
before income taxes |                |   | (799     | )   |   |              | (277  | )  |              |      | (201 | )            |   |   | 486          |   |  |   | (791  | )  
|                                                   
|                                                   
|                                                   
|                                                   
|Income tax benefit (provision)                      |                |   | 230      |     |   |              | (16   | )  |              |      | 8    |              |   |   |             |   |  |   | 222   |    
|                                                   
|Net loss from continuing operations                 |                |   | (569     | )   |   |              | (293  | )  |              |      | (193 | )            |   |   | 486          |   |  |   | (569  | )  
|                                                   
|                                                   
|                                                   
|                                                   
|Net loss from discontinued operations
 net of tax  |                |   |         |     |   |              |      |    |              |      |     |              |   |   |             |   |  |   |      |    
|                                                   
|Net loss                                            |                |   | (569     | )   |   |              | (293  | )  |              |      | (193 | )            |   |   | 486          |   |  |   | (569  | )  
|                                                   
|                                                   
|                                                   
|                                                   
|Dividends on preferred shares                       |                |   | (5       | )   |   |              |      |    |              |      |     |              |   |   |             |   |  |   | (5    | )  
|                                                   
|Net loss applicable to common shares                |                | $ | (574     | )   |   | $            | (293  | )  |              | $    | (193 | )            |   | $ | 486          |   |  | $ | (574  | )  
|                                                   

21



---



##### 



Supplemental Consolidating Statements of Operations for the three months ended
June 30, 2001:

|                                                      |                     |   |          |     |   |              |        |     |              |      |        |              |   |   |              |   |  |   |        |     |  
|----------------------------------------------------- | ------------------- | - | -------- | --- | - | ------------ | ------ | --- | ------------ | ---- | ------ | ------------ | - | - | ------------ | - |  | - | ------ | --- | -
|                                                     
|                                                      |                     |   | Nortel   |     |   |              |        |     |              | Non- |        |              |   |   |              |   |  |  
|                                                      |                     |   | Networks |     |   | Guarantor    |        |     | Guarantor    |      |        |              |   |   |              |   | 
|                                                      |                     |   | Limited  |     |   | Subsidiaries |        |     | Subsidiaries |      |        | Eliminations |   |   | Consolidated
|                                                     
|                                                     
|Revenues                                              |                     | $ | 1,198    |     |   | $            | 3,273  |     |              | $    | 1,516  |              |   | $ | (1,416       | ) |  | $ | 4,571  |    
|                                                     
|                                                     
|                                                     
|                                                     
|Cost of revenues                                      |                     |   | 1,287    |     |   |              | 2,848  |     |              |      | 1,487  |              |   |   | (1,416       | ) |  |   | 4,206  |    
|                                                     
|Gross profit                                          |                     |   | (89      | )   |   |              | 425    |     |              |      | 29     |              |   |   |             |   |  |   | 365    |    
|                                                     
|Selling, general and administrative expense           |                     |   | 93       |     |   |              | 1,246  |     |              |      | 264    |              |   |   |             |   |  |   | 1,603  |    
|                                                     
|                                                     
|                                                     
|                                                     
|Research and development expense                      |                     |   | 339      |     |   |              | 429    |     |              |      | 102    |              |   |   |             |   |  |   | 870    |    
|                                                     
|                                                     
|                                                     
|                                                     
|Amortization of intangibles                           |                     |   |          |     |   |              |        |     |              |      |        |              |   |   |              |   |  |   |        |    
|                                                     
|                                                     
|                                                     
|                                                     
|                                                      | Acquired technology |   |          |    |   |              |        | 203 |              |      |        |             |   |   |              |  |  |   |        | 203 |  
|                                                     
|                                                     
|                                                     
|                                                     
|                                                      | Goodwill            |   |          | 4   |   |              |        | 458 |              |      |        | 217          |   |   |              |  |  |   |        | 679 |  
|                                                     
|                                                     
|                                                     
|                                                     
|Special charges                                       |                     |   | 159      |     |   |              | 1,597  |     |              |      | 1,519  |              |   |   |             |   |  |   | 3,275  |    
|                                                     
|                                                     
|                                                     
|                                                     
|Loss (gain) on sale of businesses                     |                     |   |         |     |   |              | (13    | )   |              |      | 13     |              |   |   |             |   |  |   |       |    
|                                                     
|Operating loss                                        |                     |   | (684     | )   |   |              | (3,495 | )   |              |      | (2,086 | )            |   |   |             |   |  |   | (6,265 | )  
|                                                     
|Equity
in net earnings (loss) of
associated companies |                     |   | (5,158   | )   |   |              | (1,068 | )   |              |      | 2      |              |   |   | 6,108        |   |  |   | (116   | )  
|                                                     
|                                                     
|                                                     
|                                                     
|Other income (expense)  net                          |                     |   | 14       |     |   |              | (106   | )   |              |      | 48     |              |   |   |             |   |  |   | (44    | )  
|                                                     
|                                                     
|                                                     
|                                                     
|Interest expense                                      |                     |   |          |     |   |              |        |     |              |      |        |              |   |   |              |   |  |   |        |    
|                                                     
|                                                     
|                                                     
|                                                     
|                                                      | Long-term debt      |   |          | (39 | ) |              |        | 1   |              |      |        | (7           | ) |   |              |  |  |   |        | (45 | )
|                                                     
|                                                     
|                                                     
|                                                     
|                                                      | Other               |   |          | (9  | ) |              |        | (32 | )            |      |        | (3           | ) |   |              |  |  |   |        | (44 | )
|                                                     
|Loss from continuing operations
before income taxes   |                     |   | (5,876   | )   |   |              | (4,700 | )   |              |      | (2,046 | )            |   |   | 6,108        |   |  |   | (6,514 | )  
|                                                     
|                                                     
|                                                     
|                                                     
|Income tax benefit                                    |                     |   | 495      |     |   |              | 392    |     |              |      | 246    |              |   |   |             |   |  |   | 1,133  |    
|                                                     
|Net loss from continuing operations                   |                     |   | (5,381   | )   |   |              | (4,308 | )   |              |      | (1,800 | )            |   |   | 6,108        |   |  |   | (5,381 | )  
|                                                     
|                                                     
|                                                     
|                                                     
|Net loss from discontinued operations
 net of tax    |                     |   | (2,351   | )   |   |              | (1,528 | )   |              |      |       |              |   |   | 1,528        |   |  |   | (2,351 | )  
|                                                     
|Net loss                                              |                     |   | (7,732   | )   |   |              | (5,836 | )   |              |      | (1,800 | )            |   |   | 7,636        |   |  |   | (7,732 | )  
|                                                     
|                                                     
|                                                     
|                                                     
|Dividends on preferred shares                         |                     |   | (7       | )   |   |              |       |     |              |      |       |              |   |   |             |   |  |   | (7     | )  
|                                                     
|Net loss applicable to common shares                  |                     | $ | (7,739   | )   |   | $            | (5,836 | )   |              | $    | (1,800 | )            |   | $ | 7,636        |   |  | $ | (7,739 | )  
|                                                     

22



---



##### 



Supplemental Consolidating Statements of Operations for the six months ended
June 30, 2002:

|                                                    |                |   |          |     |   |              |        |     |              |      |       |              |   |   |              |   |  |   |        |     |  
|--------------------------------------------------- | -------------- | - | -------- | --- | - | ------------ | ------ | --- | ------------ | ---- | ----- | ------------ | - | - | ------------ | - |  | - | ------ | --- | -
|                                                   
|                                                    |                |   | Nortel   |     |   |              |        |     |              | Non- |       |              |   |   |              |   |  |  
|                                                    |                |   | Networks |     |   | Guarantor    |        |     | Guarantor    |      |       |              |   |   |              |   | 
|                                                    |                |   | Limited  |     |   | Subsidiaries |        |     | Subsidiaries |      |       | Eliminations |   |   | Consolidated
|                                                   
|Revenues                                            |                | $ | 1,604    |     |   | $            | 4,191  |     |              | $    | 1,461 |              |   | $ | (1,576       | ) |  | $ | 5,680  |    
|                                                   
|                                                   
|                                                   
|                                                   
|Cost of revenues                                    |                |   | 1,462    |     |   |              | 2,935  |     |              |      | 1,278 |              |   |   | (1,576       | ) |  |   | 4,099  |    
|                                                   
|Gross profit                                        |                |   | 142      |     |   |              | 1,256  |     |              |      | 183   |              |   |   |             |   |  |   | 1,581  |    
|                                                   
|Selling, general and administrative expense         |                |   | 235      |     |   |              | 1,042  |     |              |      | 227   |              |   |   |             |   |  |   | 1,504  |    
|                                                   
|                                                   
|                                                   
|                                                   
|Research and development expense                    |                |   | 438      |     |   |              | 551    |     |              |      | 155   |              |   |   |             |   |  |   | 1,144  |    
|                                                   
|                                                   
|                                                   
|                                                   
|Amortization of acquired technology                 |                |   |         |     |   |              | 11     |     |              |      |      |              |   |   |             |   |  |   | 11     |    
|                                                   
|                                                   
|                                                   
|                                                   
|Special charges                                     |                |   | 263      |     |   |              | 334    |     |              |      | 153   |              |   |   |             |   |  |   | 750    |    
|                                                   
|                                                   
|                                                   
|                                                   
|Loss (gain) on sale of businesses                   |                |   | (1       | )   |   |              | (3     | )   |              |      | 1     |              |   |   |             |   |  |   | (3     | )  
|                                                   
|Operating loss                                      |                |   | (793     | )   |   |              | (679   | )   |              |      | (353  | )            |   |   |             |   |  |   | (1,825 | )  
|                                                   
|Equity in net loss of associated companies          |                |   | (887     | )   |   |              | (248   | )   |              |      | (6    | )            |   |   | 1,127        |   |  |   | (14    | )  
|                                                   
|                                                   
|                                                   
|                                                   
|Other income (expense)  net                        |                |   | 34       |     |   |              | (57    | )   |              |      | 15    |              |   |   |             |   |  |   | (8     | )  
|                                                   
|                                                   
|                                                   
|                                                   
|Interest expense                                    |                |   |          |     |   |              |        |     |              |      |       |              |   |   |              |   |  |   |        |    
|                                                   
|                                                   
|                                                   
|                                                   
|                                                    | Long-term debt |   |          | (56 | ) |              |        |    |              |      |       | (14          | ) |   |              |  |  |   |        | (70 | )
|                                                   
|                                                   
|                                                   
|                                                   
|                                                    | Other          |   |          | (3  | ) |              |        | (16 | )            |      |       | (2           | ) |   |              |  |  |   |        | (21 | )
|                                                   
|Loss from continuing operations
before income taxes |                |   | (1,705   | )   |   |              | (1,000 | )   |              |      | (360  | )            |   |   | 1,127        |   |  |   | (1,938 | )  
|                                                   
|                                                   
|                                                   
|                                                   
|Income tax benefit                                  |                |   | 351      |     |   |              | 135    |     |              |      | 98    |              |   |   |             |   |  |   | 584    |    
|                                                   
|Net loss from continuing operations                 |                |   | (1,354   | )   |   |              | (865   | )   |              |      | (262  | )            |   |   | 1,127        |   |  |   | (1,354 | )  
|                                                   
|                                                   
|                                                   
|                                                   
|Net loss from discontinued operations
 net of tax  |                |   |         |     |   |              |       |     |              |      |      |              |   |   |             |   |  |   |       |    
|                                                   
|Net loss                                            |                |   | (1,354   | )   |   |              | (865   | )   |              |      | (262  | )            |   |   | 1,127        |   |  |   | (1,354 | )  
|                                                   
|                                                   
|                                                   
|                                                   
|Dividends on preferred shares                       |                |   | (10      | )   |   |              |       |     |              |      |      |              |   |   |             |   |  |   | (10    | )  
|                                                   
|Net loss applicable to common shares                |                | $ | (1,364   | )   |   | $            | (865   | )   |              | $    | (262  | )            |   | $ | 1,127        |   |  | $ | (1,364 | )  
|                                                   

23



---



##### 



Supplemental Consolidating Statements of Operations for the six months
ended June 30, 2001:

|                                                          |                     |   |          |     |   |              |        |     |              |      |        |              |   |   |              |   |  |   |        |       |  
|--------------------------------------------------------- | ------------------- | - | -------- | --- | - | ------------ | ------ | --- | ------------ | ---- | ------ | ------------ | - | - | ------------ | - |  | - | ------ | ----- | -
|                                                         
|                                                          |                     |   | Nortel   |     |   |              |        |     |              | Non- |        |              |   |   |              |   |  |  
|                                                          |                     |   | Networks |     |   | Guarantor    |        |     | Guarantor    |      |        |              |   |   |              |   | 
|                                                          |                     |   | Limited  |     |   | Subsidiaries |        |     | Subsidiaries |      |        | Eliminations |   |   | Consolidated
|                                                         
|Revenues                                                  |                     | $ | 2,775    |     |   | $            | 7,783  |     |              | $    | 2,839  |              |   | $ | (3,137       | ) |  | $ | 10,260 |      
|                                                         
|                                                         
|                                                         
|                                                         
|Cost of revenues                                          |                     |   | 2,586    |     |   |              | 5,957  |     |              |      | 2,675  |              |   |   | (3,137       | ) |  |   | 8,081  |      
|                                                         
|Gross profit                                              |                     |   | 189      |     |   |              | 1,826  |     |              |      | 164    |              |   |   |             |   |  |   | 2,179  |      
|                                                         
|Selling, general and administrative expense               |                     |   | 425      |     |   |              | 2,066  |     |              |      | 420    |              |   |   |             |   |  |   | 2,911  |      
|                                                         
|                                                         
|                                                         
|                                                         
|Research and development expense                          |                     |   | (93      | )   |   |              | 1,692  |     |              |      | 177    |              |   |   |             |   |  |   | 1,776  |      
|                                                         
|                                                         
|                                                         
|                                                         
|Amortization of intangibles                               |                     |   |          |     |   |              |        |     |              |      |        |              |   |   |              |   |  |   |        |      
|                                                         
|                                                         
|                                                         
|                                                         
|                                                          | Acquired technology |   |          |    |   |              |        | 406 |              |      |        |             |   |   |              |  |  |   |        | 406   |  
|                                                         
|                                                         
|                                                         
|                                                         
|                                                          | Goodwill            |   |          | 9   |   |              |        | 917 |              |      |        | 435          |   |   |              |  |  |   |        | 1,361 |  
|                                                         
|                                                         
|                                                         
|                                                         
|Special charges                                           |                     |   | 245      |     |   |              | 1,847  |     |              |      | 1,538  |              |   |   |             |   |  |   | 3,630  |      
|Gain on sale of businesses                                |                     |   |         |     |   |              | (13    | )   |              |      | 13     |              |   |   |             |   |  |   |       |      
|                                                         
|Operating loss                                            |                     |   | (397     | )   |   |              | (5,089 | )   |              |      | (2,419 | )            |   |   |             |   |  |   | (7,905 | )    
|                                                         
|Equity in net earnings
(loss) of associated companies     |                     |   | (6,693   | )   |   |              | (1,290 | )   |              |      | 1      |              |   |   | 7,850        |   |  |   | (132   | )    
|                                                         
|                                                         
|                                                         
|                                                         
|Other income (expense)  net                              |                     |   | 40       |     |   |              | (31    | )   |              |      | 52     |              |   |   |             |   |  |   | 61     |      
|                                                         
|                                                         
|                                                         
|                                                         
|Interest expense                                          |                     |   |          |     |   |              |        |     |              |      |        |              |   |   |              |   |  |   |        |      
|                                                         
|                                                         
|                                                         
|                                                         
|                                                          | Long-term debt      |   |          | (70 | ) |              |        | 1   |              |      |        | (15          | ) |   |              |  |  |   |        | (84   | )
|                                                         
|                                                         
|                                                         
|                                                         
|                                                          | Other               |   |          | (19 | ) |              |        | (36 | )            |      |        | (7           | ) |   |              |  |  |   |        | (62   | )
|                                                         
|Loss from continuing operations
before income taxes       |                     |   | (7,139   | )   |   |              | (6,445 | )   |              |      | (2,388 | )            |   |   | 7,850        |   |  |   | (8,122 | )    
|                                                         
|                                                         
|                                                         
|                                                         
|Income tax benefit                                        |                     |   | 407      |     |   |              | 688    |     |              |      | 295    |              |   |   |             |   |  |   | 1,390  |      
|                                                         
|Net loss from continuing operations                       |                     |   | (6,732   | )   |   |              | (5,757 | )   |              |      | (2,093 | )            |   |   | 7,850        |   |  |   | (6,732 | )    
|                                                         
|                                                         
|                                                         
|                                                         
|Net loss from discontinued operations
 net of tax        |                     |   | (2,538   | )   |   |              | (1,650 | )   |              |      |       |              |   |   | 1,650        |   |  |   | (2,538 | )    
|                                                         
|Net loss before cumulative effect of
accounting change    |                     |   | (9,270   | )   |   |              | (7,407 | )   |              |      | (2,093 | )            |   |   | 9,500        |   |  |   | (9,270 | )    
|                                                         
|                                                         
|                                                         
|                                                         
|Cumulative effect of accounting change
 net of tax of $9 |                     |   | 15       |     |   |              |       |     |              |      |       |              |   |   |             |   |  |   | 15     |      
|                                                         
|Net loss                                                  |                     |   | (9,255   | )   |   |              | (7,407 | )   |              |      | (2,093 | )            |   |   | 9,500        |   |  |   | (9,255 | )    
|                                                         
|                                                         
|                                                         
|                                                         
|Dividends on preferred shares                             |                     |   | (15      | )   |   |              |       |     |              |      |       |              |   |   |             |   |  |   | (15    | )    
|                                                         
|Net loss applicable to common shares                      |                     | $ | (9,270   | )   |   | $            | (7,407 | )   |              | $    | (2,093 | )            |   | $ | 9,500        |   |  | $ | (9,270 | )    
|                                                         

24



---



##### 



Supplemental Consolidating Balance Sheets as at June 30, 2002:

|                                                       |                                                |   |          |       |  |              |         |       |              |      |        |              |  |   |              |        |   |   |         |       | 
|------------------------------------------------------ | ---------------------------------------------- | - | -------- | ----- |  | ------------ | ------- | ----- | ------------ | ---- | ------ | ------------ |  | - | ------------ | ------ | - | - | ------- | ----- | 
|                                                      
|                                                       |                                                |   | Nortel   |       |  |              |         |       |              | Non- |        |              |  |   |              |        |   |  
|                                                       |                                                |   | Networks |       |  | Guarantor    |         |       | Guarantor    |      |        |              |  |   |              |        |  
|                                                       |                                                |   | Limited  |       |  | Subsidiaries |         |       | Subsidiaries |      |        | Eliminations |  |   | Consolidated
|                                                      
|ASSETS                                                 |                                                |   |          |       |  |              |         |       |              |      |        |              |  |   |              |        |   |   |         |      
|                                                      
|                                                      
|                                                      
|                                                      
|Current assets                                         |                                                |   |          |       |  |              |         |       |              |      |        |              |  |   |              |        |   |   |         |      
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       | Cash and cash equivalents                      |   | $        | 681   |  |              | $       | 2,514 |              |      | $      | 927          |  |   | $            |       |   |   | $       | 4,122 | 
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       | Accounts receivable  net                      |   |          | 412   |  |              |         | 1,372 |              |      |        | 559          |  |   |              |       |   |   |         | 2,343 | 
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       | Intercompany accounts receivable               |   |          | 4,144 |  |              |         | 1,008 |              |      |        | 463          |  |   |              | (5,613 | ) |   |         | 2     | 
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       | Inventories  net                              |   |          | 742   |  |              |         | 449   |              |      |        | 258          |  |   |              |       |   |   |         | 1,449 | 
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       | Income taxes recoverable                       |   |          |      |  |              |         | 55    |              |      |        |             |  |   |              |       |   |   |         | 55    | 
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       | Deferred income taxes  net                    |   |          | 593   |  |              |         | 502   |              |      |        | 153          |  |   |              |       |   |   |         | 1,248 | 
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       | Other current assets                           |   |          | 170   |  |              |         | 532   |              |      |        | 149          |  |   |              |       |   |   |         | 851   | 
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       | Current assets of discontinued operations      |   |          | 115   |  |              |         | 214   |              |      |        |             |  |   |              |       |   |   |         | 329   | 
|                                                      
|Total current assets                                   |                                                |   | 6,857    |       |  |              | 6,646   |       |              |      | 2,509  |              |  |   | (5,613       | )      |   |   | 10,399  |      
|                                                      
|                                                      
|                                                      
|                                                      
|                                                      
|Long-term receivables  net                            |                                                |   | 190      |       |  |              | 1,665   |       |              |      | 583    |              |  |   | (2,184       | )      |   |   | 254     |      
|                                                      
|                                                      
|                                                      
|                                                      
|Investments at cost and associated
companies at equity |                                                |   | 2,071    |       |  |              | (8,219  | )     |              |      | 148    |              |  |   | 6,233        |        |   |   | 233     |      
|                                                      
|                                                      
|                                                      
|                                                      
|Plant and equipment  net                              |                                                |   | 473      |       |  |              | 1,197   |       |              |      | 327    |              |  |   |             |        |   |   | 1,997   |      
|                                                      
|                                                      
|                                                      
|                                                      
|Goodwill                                               |                                                |   | 33       |       |  |              | 2,131   |       |              |      | 119    |              |  |   |             |        |   |   | 2,283   |      
|                                                      
|                                                      
|                                                      
|                                                      
|Intangible assets  net                                |                                                |   |         |       |  |              | 8       |       |              |      |       |              |  |   |             |        |   |   | 8       |      
|                                                      
|                                                      
|                                                      
|                                                      
|Deferred income taxes  net                            |                                                |   | 640      |       |  |              | 1,745   |       |              |      | 121    |              |  |   |             |        |   |   | 2,506   |      
|                                                      
|                                                      
|                                                      
|                                                      
|Other assets                                           |                                                |   | 224      |       |  |              | 181     |       |              |      | 251    |              |  |   |             |        |   |   | 656     |      
|                                                      
|                                                      
|                                                      
|                                                      
|Long-term assets of discontinued operations            |                                                |   | 37       |       |  |              | 68      |       |              |      |       |              |  |   |             |        |   |   | 105     |      
|                                                      
|Total assets                                           |                                                | $ | 10,525   |       |  | $            | 5,422   |       |              | $    | 4,058  |              |  | $ | (1,564       | )      |   | $ | 18,441  |      
|                                                      
|LIABILITIES
AND SHAREHOLDERS EQUITY                   |                                                |   |          |       |  |              |         |       |              |      |        |              |  |   |              |        |   |   |         |      
|                                                      
|                                                      
|                                                      
|                                                      
|Current liabilities                                    |                                                |   |          |       |  |              |         |       |              |      |        |              |  |   |              |        |   |   |         |      
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       | Notes payable                                  |   | $        | 2     |  |              | $       | 163   |              |      | $      | 175          |  |   | $            |       |   |   | $       | 340   | 
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       | Trade and other accounts payable               |   |          | 464   |  |              |         | 994   |              |      |        | 153          |  |   |              |       |   |   |         | 1,611 | 
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       | Intercompany accounts payable                  |   |          | 112   |  |              |         | 3,572 |              |      |        | 2,175        |  |   |              | (5,613 | ) |   |         | 246   | 
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       | Payroll and benefit-related liabilities        |   |          | 31    |  |              |         | 432   |              |      |        | 93           |  |   |              |       |   |   |         | 556   | 
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       | Other accrued liabilities                      |   |          | 1,102 |  |              |         | 3,018 |              |      |        | 977          |  |   |              |       |   |   |         | 5,097 | 
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       | Income taxes payable                           |   |          | 16    |  |              |         | 10    |              |      |        | 76           |  |   |              |       |   |   |         | 102   | 
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       | Long-term debt due within one year             |   |          | 311   |  |              |         | 11    |              |      |        | 3            |  |   |              |        |   |   |         | 325   | 
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       | Current liabilities of discontinued operations |   |          | 47    |  |              |         | 88    |              |      |        |             |  |   |              |       |   |   |         | 135   | 
|                                                      
|Total current liabilities                              |                                                |   | 2,085    |       |  |              | 8,288   |       |              |      | 3,652  |              |  |   | (5,613       | )      |   |   | 8,412   |      
|                                                      
|Deferred income                                        |                                                |   | 1        |       |  |              | 119     |       |              |      | 3      |              |  |   |             |        |   |   | 123     |      
|                                                      
|                                                      
|                                                      
|                                                      
|Long-term debt                                         |                                                |   | 1,949    |       |  |              | 6       |       |              |      | 370    |              |  |   |             |        |   |   | 2,325   |      
|                                                      
|                                                      
|                                                      
|                                                      
|Deferred income taxes  net                            |                                                |   | 350      |       |  |              | 158     |       |              |      | 7      |              |  |   |             |        |   |   | 515     |      
|                                                      
|                                                      
|                                                      
|                                                      
|Other liabilities                                      |                                                |   | 619      |       |  |              | 1,110   |       |              |      | 1,932  |              |  |   | (2,184       | )      |   |   | 1,477   |      
|                                                      
|                                                      
|                                                      
|                                                      
|Minority interest in subsidiary companies              |                                                |   |         |       |  |              |        |       |              |      | 68     |              |  |   |             |        |   |   | 68      |      
|                                                      
|                                                       |                                                |   | 5,004    |       |  |              | 9,681   |       |              |      | 6,032  |              |  |   | (7,797       | )      |   |   | 12,920  |      
|                                                      
|                                                      
|SHAREHOLDERS EQUITY                                   |                                                |   |          |       |  |              |         |       |              |      |        |              |  |   |              |        |   |   |         |      
|                                                      
|                                                      
|                                                      
|                                                      
|Preferred shares                                       |                                                |   | 536      |       |  |              | 365     |       |              |      |       |              |  |   | (365         | )      |   |   | 536     |      
|                                                      
|                                                      
|                                                      
|                                                      
|Common shares                                          |                                                |   | 2,111    |       |  |              | 5,391   |       |              |      | 772    |              |  |   | (6,163       | )      |   |   | 2,111   |      
|                                                      
|                                                      
|                                                      
|                                                      
|Additional paid-in capital                             |                                                |   | 19,606   |       |  |              | 1,545   |       |              |      | 3,870  |              |  |   | (5,415       | )      |   |   | 19,606  |      
|                                                      
|                                                      
|                                                      
|                                                      
|Deficit                                                |                                                |   | (15,871  | )     |  |              | (12,517 | )     |              |      | (6,481 | )            |  |   | 18,998       |        |   |   | (15,871 | )    
|                                                      
|                                                      
|                                                      
|                                                      
|Accumulated other comprehensive income (loss)          |                                                |   | (861     | )     |  |              | 957     |       |              |      | (135   | )            |  |   | (822         | )      |   |   | (861    | )    
|                                                      
|Total shareholders equity                             |                                                |   | 5,521    |       |  |              | (4,259  | )     |              |      | (1,974 | )            |  |   | 6,233        |        |   |   | 5,521   |      
|                                                      
|Total liabilities and shareholders equity             |                                                | $ | 10,525   |       |  | $            | 5,422   |       |              | $    | 4,058  |              |  | $ | (1,564       | )      |   | $ | 18,441  |      
|                                                      

25



---



##### 



Supplemental Consolidating Balance Sheets as at
December 31, 2001:

|                                                       |                                                |   |          |       |   |              |         |       |              |      |        |              |  |   |              |        |   |   |         |       | 
|------------------------------------------------------ | ---------------------------------------------- | - | -------- | ----- | - | ------------ | ------- | ----- | ------------ | ---- | ------ | ------------ |  | - | ------------ | ------ | - | - | ------- | ----- | 
|                                                      
|                                                       |                                                |   | Nortel   |       |   |              |         |       |              | Non- |        |              |  |   |              |        |   |  
|                                                       |                                                |   | Networks |       |   | Guarantor    |         |       | Guarantor    |      |        |              |  |   |              |        |  
|                                                       |                                                |   | Limited  |       |   | Subsidiaries |         |       | Subsidiaries |      |        | Eliminations |  |   | Consolidated
|                                                      
|ASSETS                                                 |                                                |   |          |       |   |              |         |       |              |      |        |              |  |   |              |        |   |   |         |      
|                                                      
|                                                      
|                                                      
|                                                      
|Current assets                                         |                                                |   |          |       |   |              |         |       |              |      |        |              |  |   |              |        |   |   |         |      
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       | Cash and cash equivalents                      |   | $        | (41   | ) |              | $       | 2,340 |              |      | $      | 1,158        |  |   | $            |       |   |   | $       | 3,457 | 
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       | Accounts receivable  net                      |   |          | 409   |   |              |         | 2,032 |              |      |        | 480          |  |   |              |       |   |   |         | 2,921 | 
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       | Intercompany accounts receivable               |   |          | 4,952 |   |              |         | 1,054 |              |      |        | 588          |  |   |              | (6,592 | ) |   |         | 2     | 
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       | Inventories  net                              |   |          | 810   |   |              |         | 511   |              |      |        | 242          |  |   |              |       |   |   |         | 1,563 | 
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       | Income taxes recoverable                       |   |          | 343   |   |              |         | 442   |              |      |        | 5            |  |   |              |       |   |   |         | 790   | 
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       | Deferred income taxes  net                    |   |          | 287   |   |              |         | 1,080 |              |      |        | 34           |  |   |              |       |   |   |         | 1,401 | 
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       | Other current assets                           |   |          | 107   |   |              |         | 563   |              |      |        | 177          |  |   |              |       |   |   |         | 847   | 
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       | Current assets of discontinued operations      |   |          | 244   |   |              |         | 454   |              |      |        |             |  |   |              |       |   |   |         | 698   | 
|                                                      
|Total current assets                                   |                                                |   | 7,111    |       |   |              | 8,476   |       |              |      | 2,684  |              |  |   | (6,592       | )      |   |   | 11,679  |      
|                                                      
|Long-term receivables  net                            |                                                |   | 225      |       |   |              | 1,078   |       |              |      | 547    |              |  |   | (1,647       | )      |   |   | 203     |      
|                                                      
|                                                      
|                                                      
|                                                      
|Investments at cost and associated
companies at equity |                                                |   | 2,543    |       |   |              | (8,097  | )     |              |      | 516    |              |  |   | 5,301        |        |   |   | 263     |      
|                                                      
|                                                      
|                                                      
|                                                      
|Plant and equipment  net                              |                                                |   | 705      |       |   |              | 1,353   |       |              |      | 401    |              |  |   |             |        |   |   | 2,459   |      
|                                                      
|                                                      
|                                                      
|                                                      
|Goodwill  net                                         |                                                |   | 31       |       |   |              | 2,117   |       |              |      | 135    |              |  |   |             |        |   |   | 2,283   |      
|                                                      
|                                                      
|                                                      
|                                                      
|Intangible assets  net                                |                                                |   |         |       |   |              | 20      |       |              |      |       |              |  |   |             |        |   |   | 20      |      
|                                                      
|                                                      
|                                                      
|                                                      
|Deferred income taxes  net                            |                                                |   | 436      |       |   |              | 1,578   |       |              |      | 92     |              |  |   |             |        |   |   | 2,106   |      
|                                                      
|                                                      
|                                                      
|                                                      
|Other assets                                           |                                                |   | 132      |       |   |              | 313     |       |              |      | 252    |              |  |   |             |        |   |   | 697     |      
|                                                      
|                                                      
|                                                      
|                                                      
|Long-term assets of discontinued operations            |                                                |   | 99       |       |   |              | 184     |       |              |      |       |              |  |   |             |        |   |   | 283     |      
|                                                      
|Total assets                                           |                                                | $ | 11,282   |       |   | $            | 7,022   |       |              | $    | 4,627  |              |  | $ | (2,938       | )      |   | $ | 19,993  |      
|                                                      
|LIABILITIES
AND SHAREHOLDERS EQUITY                   |                                                |   |          |       |   |              |         |       |              |      |        |              |  |   |              |        |   |   |         |      
|                                                      
|                                                      
|                                                      
|                                                      
|Current liabilities                                    |                                                |   |          |       |   |              |         |       |              |      |        |              |  |   |              |        |   |   |         |      
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       | Notes payable                                  |   | $        | 2     |   |              | $       | 168   |              |      | $      | 256          |  |   | $            |       |   |   | $       | 426   | 
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       | Trade and other accounts payable               |   |          | 372   |   |              |         | 1,288 |              |      |        | 338          |  |   |              |       |   |   |         | 1,998 | 
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       | Intercompany accounts payable                  |   |          | 163   |   |              |         | 3,471 |              |      |        | 3,208        |  |   |              | (6,592 | ) |   |         | 250   | 
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       | Payroll and benefit-related liabilities        |   |          | 63    |   |              |         | 449   |              |      |        | 101          |  |   |              |       |   |   |         | 613   | 
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       | Other accrued liabilities                      |   |          | 1,355 |   |              |         | 3,240 |              |      |        | 752          |  |   |              |       |   |   |         | 5,347 | 
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       | Income taxes payable                           |   |          |      |   |              |         | 45    |              |      |        | 98           |  |   |              |       |   |   |         | 143   | 
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       | Long-term debt due within one year             |   |          | 313   |   |              |         | 63    |              |      |        | 8            |  |   |              |       |   |   |         | 384   | 
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       | Current liabilities of discontinued operations |   |          | 134   |   |              |         | 250   |              |      |        |             |  |   |              |       |   |   |         | 384   | 
|                                                      
|Total current liabilities                              |                                                |   | 2,402    |       |   |              | 8,974   |       |              |      | 4,761  |              |  |   | (6,592       | )      |   |   | 9,545   |      
|                                                      
|Deferred income                                        |                                                |   | 3        |       |   |              | 143     |       |              |      | 7      |              |  |   |             |        |   |   | 153     |      
|                                                      
|                                                      
|                                                      
|                                                      
|Long-term debt                                         |                                                |   | 1,928    |       |   |              | 8       |       |              |      | 357    |              |  |   |             |        |   |   | 2,293   |      
|                                                      
|                                                      
|                                                      
|                                                      
|Deferred income taxes  net                            |                                                |   | 360      |       |   |              | 100     |       |              |      | 17     |              |  |   |             |        |   |   | 477     |      
|                                                      
|                                                      
|                                                      
|                                                      
|Other liabilities                                      |                                                |   | 616      |       |   |              | 1,092   |       |              |      | 1,391  |              |  |   | (1,647       | )      |   |   | 1,452   |      
|                                                      
|                                                      
|                                                      
|                                                      
|Minority interest in subsidiary companies              |                                                |   |         |       |   |              |        |       |              |      | 100    |              |  |   |             |        |   |   | 100     |      
|                                                      
|                                                       |                                                |   | 5,309    |       |   |              | 10,317  |       |              |      | 6,633  |              |  |   | (8,239       | )      |   |   | 14,020  |      
|                                                      
|SHAREHOLDERS
EQUITY                                   |                                                |   |          |       |   |              |         |       |              |      |        |              |  |   |              |        |   |   |         |      
|                                                      
|                                                      
|                                                      
|                                                      
|Preferred shares                                       |                                                |   | 536      |       |   |              | 365     |       |              |      |       |              |  |   | (365         | )      |   |   | 536     |      
|                                                      
|                                                      
|                                                      
|                                                      
|Common shares                                          |                                                |   | 2,111    |       |   |              | 950     |       |              |      | 386    |              |  |   | (1,336       | )      |   |   | 2,111   |      
|                                                      
|                                                      
|                                                      
|                                                      
|Additional paid-in capital                             |                                                |   | 18,797   |       |   |              | 6,043   |       |              |      | 4,204  |              |  |   | (10,247      | )      |   |   | 18,797  |      
|                                                      
|                                                      
|                                                      
|                                                      
|Deficit                                                |                                                |   | (14,507  | )     |   |              | (11,605 | )     |              |      | (6,509 | )            |  |   | 18,114       |        |   |   | (14,507 | )    
|                                                      
|                                                      
|                                                      
|                                                      
|Accumulated other comprehensive income (loss)          |                                                |   | (964     | )     |   |              | 952     |       |              |      | (87    | )            |  |   | (865         | )      |   |   | (964    | )    
|                                                      
|Total shareholders equity                             |                                                |   | 5,973    |       |   |              | (3,295  | )     |              |      | (2,006 | )            |  |   | 5,301        |        |   |   | 5,973   |      
|                                                      
|Total liabilities and shareholders equity             |                                                | $ | 11,282   |       |   | $            | 7,022   |       |              | $    | 4,627  |              |  | $ | (2,938       | )      |   | $ | 19,993  |      
|                                                      

26



---



##### 



Supplemental Consolidating Statements of Cash Flows for the six months ended
June 30, 2002:

|                                                       |                                                                      |                                                                                                                                                                                |        |       |          |   |       |              |      |   |              |      |     |              |       |        |              |   |        |      |      |   | 
|------------------------------------------------------ | -------------------------------------------------------------------- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ | ------ | ----- | -------- | - | ----- | ------------ | ---- | - | ------------ | ---- | --- | ------------ | ----- | ------ | ------------ | - | ------ | ---- | ---- | - | 
|                                                      
|                                                       |                                                                      |                                                                                                                                                                                |        |       | Nortel   |   |       |              |      |   |              | Non- |     |              |       |        |              |   |        |     
|                                                       |                                                                      |                                                                                                                                                                                |        |       | Networks |   |       | Guarantor    |      |   | Guarantor    |      |     |              |       |        |              |   |       
|                                                       |                                                                      |                                                                                                                                                                                |        |       | Limited  |   |       | Subsidiaries |      |   | Subsidiaries |      |     | Eliminations |       |        | Consolidated
|                                                      
|                                                      
|                                                      
|Cash flows from (used in) operating activities         |                                                                      |                                                                                                                                                                                |        |       |          |   |       |              |      |   |              |      |     |              |       |        |              |   |        |     
|                                                      
|                                                      
|                                                      
|                                                      
|Net loss from continuing operations                    |                                                                      | $                                                                                                                                                                              | (1,354 | )     |          | $ | (865  | )            |      | $ | (262         | )    |     | $            | 1,127 |        |              | $ | (1,354 | )   
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       |                                                                      | Adjustments to reconcile net loss from continuing operations to
net cash from (used in) operating activities, net of effects from
acquisitions and divestitures of businesses: |        |       |          |   |       |              |      |   |              |      |     |              |       |        |              |   |        |      |      |  
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       |                                                                      | Amortization and depreciation                                                                                                                                                  |        | 47    |          |   |       | 238          |      |   |              | 19   |     |              |       |       |              |   |        | 304  |     
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       |                                                                      | Non-cash portion of special charges and related
asset write downs                                                                                                              |        |       | 155      |   |       |              | 101  |   |              |      | 8   |              |       |        |             |   |        |      | 264  |  
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       |                                                                      | Equity in net loss of associated companies                                                                                                                                     |        | 887   |          |   |       | 248          |      |   |              | 6    |     |              |       | (1,127 | )            |   |        | 14   |     
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       |                                                                      | Deferred income taxes                                                                                                                                                          |        | (518  | )        |   |       | 470          |      |   |              | (158 | )   |              |       |        |              |   |        | (206 | )   
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       |                                                                      | Other liabilities                                                                                                                                                              |        | (14   | )        |   |       | (33          | )    |   |              |     |     |              |       |       |              |   |        | (47  | )   
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       |                                                                      | Gain on sale of investments and businesses                                                                                                                                     |        | (10   | )        |   |       | (5           | )    |   |              |     |     |              |       |       |              |   |        | (15  | )   
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       |                                                                      | Other  net                                                                                                                                                                    |        | 25    |          |   |       | 153          |      |   |              | 106  |     |              |       |       |              |   |        | 284  |     
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       |                                                                      | Change in operating assets and liabilities:                                                                                                                                    |        |       |          |   |       |              |      |   |              |      |     |              |       |        |              |   |        |      |     
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       |                                                                      | Accounts receivable                                                                                                                                                            |        |       | (65      | ) |       |              | 606  |   |              |      | (2  | )            |       |        |             |   |        |      | 539  |  
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       |                                                                      | Inventories                                                                                                                                                                    |        |       | 68       |   |       |              | 62   |   |              |      | (16 | )            |       |        |             |   |        |      | 114  |  
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       |                                                                      | Income taxes                                                                                                                                                                   |        |       | 359      |   |       |              | 352  |   |              |      | (17 | )            |       |        |             |   |        |      | 694  |  
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       |                                                                      | Accounts payable and accrued liabilities                                                                                                                                       |        |       | (198     | ) |       |              | (562 | ) |              |      | 35  |              |       |        |             |   |        |      | (725 | )
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       |                                                                      | Other operating assets and liabilities                                                                                                                                         |        |       | 11       |   |       |              | (24  | ) |              |      | (31 | )            |       |        |             |   |        |      | (44  | )
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       |                                                                      | Intercompany activities                                                                                                                                                        |        |       | 348      |   |       |              | (606 | ) |              |      | 258 |              |       |        |             |   |        |      |     |  
|                                                      
|                                                       | Net cash from (used in) operating activities                         |                                                                                                                                                                                |        | (259) |          |   |       | 135          |      |   |              | (54) |     |              |       |       |              |   |        | (178 | )   
|                                                      
|                                                      
|Cash flows from (used in) investing activities         |                                                                      |                                                                                                                                                                                |        |       |          |   |       |              |      |   |              |      |     |              |       |        |              |   |        |     
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       | Expenditures for plant and equipment                                 |                                                                                                                                                                                |        | (15   | )        |   |       | (174         | )    |   |              | (19  | )   |              |       |       |              |   |        | (208 | )   
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       | Proceeds on disposals of plant and equipment                         |                                                                                                                                                                                |        |      |          |   |       | 76           |      |   |              |     |     |              |       |       |              |   |        | 76   |     
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       | Increase in long-term receivables                                    |                                                                                                                                                                                |        | 64    |          |   |       | (152         | )    |   |              | (122 | )   |              |       |       |              |   |        | (210 | )   
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       | Decrease in long-term receivables                                    |                                                                                                                                                                                |        | 18    |          |   |       | 83           |      |   |              | 4    |     |              |       |       |              |   |        | 105  |     
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       | Acquisitions of investments and businesses  net of cash acquired    |                                                                                                                                                                                |        | (3    | )        |   |       | (22          | )    |   |              |     |     |              |       |       |              |   |        | (25  | )   
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       | Proceeds on sale of investments and businesses                       |                                                                                                                                                                                |        | 20    |          |   |       | 18           |      |   |              |     |     |              |       |       |              |   |        | 38   |     
|                                                      
|                                                      
|                                                       | Net cash from (used in) investing activities                         |                                                                                                                                                                                |        | 84    |          |   |       | (171         | )    |   |              | (137 | )   |              |       |       |              |   |        | (224 | )   
|                                                      
|                                                      
|Cash flows from (used in) financing activities         |                                                                      |                                                                                                                                                                                |        |       |          |   |       |              |      |   |              |      |     |              |       |        |              |   |        |     
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       | Dividends on preferred shares                                        |                                                                                                                                                                                |        | (10   | )        |   |       |             |      |   |              |     |     |              |       |       |              |   |        | (10  | )   
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       | Increase (decrease) in notes payable  net                           |                                                                                                                                                                                |        |      |          |   |       | 1            |      |   |              | (78  | )   |              |       |       |              |   |        | (77  | )   
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       | Proceeds from long-term debt                                         |                                                                                                                                                                                |        |      |          |   |       |             |      |   |              | 31   |     |              |       |       |              |   |        | 31   |     
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       | Repayments of long-term debt                                         |                                                                                                                                                                                |        |      |          |   |       | (3           | )    |   |              | (3   | )   |              |       |       |              |   |        | (6   | )   
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       | Decrease in capital leases payable                                   |                                                                                                                                                                                |        | (1    | )        |   |       | (3           | )    |   |              |     |     |              |       |       |              |   |        | (4   | )   
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       | Issuance of common share                                             |                                                                                                                                                                                |        | 800   |          |   |       |             |      |   |              |     |     |              |       |       |              |   |        | 800  |     
|                                                      
|                                                       | Net cash from (used in) financing activities                         |                                                                                                                                                                                |        | 789   |          |   |       | (5           | )    |   |              | (50  | )   |              |       |       |              |   |        | 734  |     
|                                                      
|                                                       | Effect of foreign exchange rate changes on cash
and cash equivalents |                                                                                                                                                                                |        | 8     |          |   |       | 28           |      |   |              | 10   |     |              |       |       |              |   |        | 46   |     
|                                                      
|                                                       | Net cash from (used in) continuing operations                        |                                                                                                                                                                                |        | 622   |          |   |       | (13          | )    |   |              | (231 | )   |              |       |       |              |   |        | 378  |     
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       | Net cash from discontinued operations                                |                                                                                                                                                                                |        | 100   |          |   |       | 187          |      |   |              |     |     |              |       |       |              |   |        | 287  |     
|                                                      
|Net increase (decrease) in cash and cash equivalents   |                                                                      |                                                                                                                                                                                | 722    |       |          |   | 174   |              |      |   | (231         | )    |     |              |      |        |              |   | 665    |     
|                                                      
|Cash and cash equivalents at beginning of period  net |                                                                      |                                                                                                                                                                                | (41    | )     |          |   | 2,340 |              |      |   | 1,158        |      |     |              |      |        |              |   | 3,457  |     
|                                                      
|Cash and cash equivalents at end of period  net       |                                                                      | $                                                                                                                                                                              | 681    |       |          | $ | 2,514 |              |      | $ | 927          |      |     | $            |      |        |              | $ | 4,122  |     
|                                                      

27



---



##### 



Supplemental Consolidating Statements of Cash Flows for the six months ended
June 30, 2001:

|                                                       |                                                                                                                                                                                |                                                                   |     |        |          |   |       |              |       |   |              |        |       |              |   |       |              |   |       |        |       |   | 
|------------------------------------------------------ | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ | ----------------------------------------------------------------- | --- | ------ | -------- | - | ----- | ------------ | ----- | - | ------------ | ------ | ----- | ------------ | - | ----- | ------------ | - | ----- | ------ | ----- | - | 
|                                                      
|                                                       |                                                                                                                                                                                |                                                                   |     |        | Nortel   |   |       |              |       |   |              | Non-   |       |              |   |       |              |   |       |       
|                                                       |                                                                                                                                                                                |                                                                   |     |        | Networks |   |       | Guarantor    |       |   | Guarantor    |        |       |              |   |       |              |   |      
|                                                       |                                                                                                                                                                                |                                                                   |     |        | Limited  |   |       | Subsidiaries |       |   | Subsidiaries |        |       | Eliminations |   |       | Consolidated
|                                                      
|                                                      
|Cash flows from (used in) operating activities         |                                                                                                                                                                                |                                                                   |     |        |          |   |       |              |       |   |              |        |       |              |   |       |              |   |       |       
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       | Net loss from continuing operations                                                                                                                                            |                                                                   | $   | (6,732 | )        |   | $     | (5,757       | )     |   | $            | (2,093 | )     |              | $ | 7,850 |              |   | $     | (6,732 | )    
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       | Adjustments to reconcile net loss from continuing operations to
net cash from (used in) operating activities, net of effects from
acquisitions and divestitures of businesses: |                                                                   |     |        |          |   |       |              |       |   |              |        |       |              |   |       |              |   |       |        |      
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       |                                                                                                                                                                                | Amortization and depreciation                                     |     |        | 108      |   |       |              | 1,516 |   |              |        | 472   |              |   |       |             |   |       |        | 2,096 |  
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       |                                                                                                                                                                                | Non-cash portion of special charges and related
asset write downs |     |        | 42       |   |       |              | 1,136 |   |              |        | 1,429 |              |   |       |             |   |       |        | 2,607 |  
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       |                                                                                                                                                                                | Equity in net earnings (loss) of associated companies             |     |        | 6,693    |   |       |              | 1,290 |   |              |        | (1    | )            |   |       | (7,850       | ) |       |        | 132   |  
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       |                                                                                                                                                                                | Tax benefit from stock options                                    |     |        | 34       |   |       |              |      |   |              |        |      |              |   |       |             |   |       |        | 34    |  
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       |                                                                                                                                                                                | Deferred income taxes                                             |     |        | (798     | ) |       |              | (200  | ) |              |        | 62    |              |   |       |             |   |       |        | (936  | )
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       |                                                                                                                                                                                | Other liabilities                                                 |     |        | (52      | ) |       |              | 60    |   |              |        | (26   | )            |   |       |              |   |       |        | (18   | )
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       |                                                                                                                                                                                | Gain on sale of investments and businesses                        |     |        |         |   |       |              | (24   | ) |              |        |      |              |   |       |             |   |       |        | (24   | )
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       |                                                                                                                                                                                | Other  net                                                       |     |        | 78       |   |       |              | 272   |   |              |        | (284  | )            |   |       |             |   |       |        | 66    |  
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       |                                                                                                                                                                                | Change in operating assets and liabilities:                       |     |        |          |   |       |              |       |   |              |        |       |              |   |       |              |   |       |        |       |  
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       |                                                                                                                                                                                | Accounts receivable                                               |     |        | 183      |   |       |              | 2,045 |   |              |        | 116   |              |   |       |             |   |       |        | 2,344 |  
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       |                                                                                                                                                                                | Inventories                                                       |     |        | 239      |   |       |              | 785   |   |              |        | 184   |              |   |       |             |   |       |        | 1,208 |  
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       |                                                                                                                                                                                | Income taxes                                                      |     |        | (63      | ) |       |              | (708  | ) |              |        | (116  | )            |   |       |             |   |       |        | (887  | )
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       |                                                                                                                                                                                | Accounts payable and accrued liabilities                          |     |        | (556     | ) |       |              | 9     |   |              |        | (33   | )            |   |       |             |   |       |        | (580  | )
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       |                                                                                                                                                                                | Other operating assets and liabilities                            |     |        | 232      |   |       |              | (19   | ) |              |        | (29   | )            |   |       |             |   |       |        | 184   |  
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       |                                                                                                                                                                                | Intercompany activities                                           |     |        | (434     | ) |       |              | (75   | ) |              |        | 509   |              |   |       |             |   |       |        |      |  
|                                                      
|                                                       | Net cash from (used in) operating activities                                                                                                                                   |                                                                   |     | (1,026 | )        |   |       | 330          |       |   |              | 190    |       |              |   |      |              |   |       | (506   | )    
|                                                      
|                                                      
|Cash flows from (used in) investing activities         |                                                                                                                                                                                |                                                                   |     |        |          |   |       |              |       |   |              |        |       |              |   |       |              |   |       |       
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       | Expenditures for plant and equipment                                                                                                                                           |                                                                   |     | (260   | )        |   |       | (494         | )     |   |              | (67    | )     |              |   |      |              |   |       | (821   | )    
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       | Proceeds on disposals of plant and equipment                                                                                                                                   |                                                                   |     | 20     |          |   |       |             |       |   |              |       |       |              |   |      |              |   |       | 20     |      
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       | Increase in long-term receivables                                                                                                                                              |                                                                   |     | (169   | )        |   |       | (402         | )     |   |              | 69     |       |              |   |      |              |   |       | (502   | )    
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       | Decrease in long-term receivables                                                                                                                                              |                                                                   |     | 57     |          |   |       | 24           |       |   |              | 11     |       |              |   |      |              |   |       | 92     |      
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       | Acquisitions of investments and businesses  net of cash acquired                                                                                                              |                                                                   | (12 | )      |          |   | (62   | )            |       |   |             |        |       |              |  |       |              |   | (74   | )     
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       | Proceeds on sale of investments and businesses                                                                                                                                 |                                                                   |     |       |          |   |       | 31           |       |   |              | 33     |       |              |   |      |              |   |       | 64     |      
|                                                      
|                                                       | Net cash from (used in) investing activities                                                                                                                                   |                                                                   |     | (364   | )        |   |       | (903         | )     |   |              | 46     |       |              |   |      |              |   |       | (1,221 | )    
|                                                      
|                                                      
|Cash flows from (used in) financing activities         |                                                                                                                                                                                |                                                                   |     |        |          |   |       |              |       |   |              |        |       |              |   |       |              |   |       |       
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       | Dividends on preferred shares                                                                                                                                                  |                                                                   |     | (15    | )        |   |       |             |       |   |              |       |       |              |   |      |              |   |       | (15    | )    
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       | Increase in notes payable  net                                                                                                                                                |                                                                   |     | 294    |          |   |       | 1,053        |       |   |              | 74     |       |              |   |      |              |   |       | 1,421  |      
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       | Proceeds from long-term debt                                                                                                                                                   |                                                                   |     | 1,500  |          |   |       | 5            |       |   |              |       |       |              |   |      |              |   |       | 1,505  |      
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       | Repayments of long-term debt                                                                                                                                                   |                                                                   |     | (250   | )        |   |       | (5           | )     |   |              | (157   | )     |              |   |      |              |   |       | (412   | )    
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       | Decrease in capital leases payable                                                                                                                                             |                                                                   |     | (3     | )        |   |       | (14          | )     |   |              | (7     | )     |              |   |      |              |   |       | (24    | )    
|                                                      
|                                                       | Net cash from (used in) financing activities                                                                                                                                   |                                                                   |     | 1,526  |          |   |       | 1,039        |       |   |              | (90    | )     |              |   |      |              |   |       | 2,475  |      
|                                                      
|                                                       | Effect of foreign exchange rate changes on cash
and cash equivalents                                                                                                           |                                                                   |     | 1      |          |   |       | (11          | )     |   |              | (7     | )     |              |   |      |              |   |       | (17    | )    
|                                                      
|                                                       | Net cash from continuing operations                                                                                                                                            |                                                                   |     | 137    |          |   |       | 455          |       |   |              | 139    |       |              |   |      |              |   |       | 731    |      
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       | Net cash used in discontinued operations                                                                                                                                       |                                                                   |     | (149   | )        |   |       | (272         | )     |   |              |       |       |              |   |      |              |   |       | (421   | )    
|                                                      
|Net increase (decrease) in cash and cash equivalents   |                                                                                                                                                                                |                                                                   | (12 | )      |          |   | 183   |              |       |   | 139          |        |       |              |  |       |              |   | 310   |       
|                                                      
|Cash and cash equivalents at beginning of period  net |                                                                                                                                                                                |                                                                   | (73 | )      |          |   | 1,020 |              |       |   | 620          |        |       |              |  |       |              |   | 1,567 |       
|                                                      
|Cash and cash equivalents at end of period  net       |                                                                                                                                                                                | $                                                                 | (85 | )      |          | $ | 1,203 |              |       | $ | 759          |        |       | $            |  |       |              | $ | 1,877 |       
|                                                      

28



---



##### 





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

You should read this section in conjunction with the accompanying
unaudited consolidated financial statements prepared in accordance with United
States generally accepted accounting principles. This section provides
additional analysis of our operations and current financial condition and also
contains forward-looking statements and should be read in conjunction with the
factors set forth below under Forward-looking statements. All dollar amounts
in this Managements Discussion and Analysis of Financial Condition and Results
of Operations are in millions of United States dollars unless otherwise stated.

Where we say we, us, our, or Nortel Networks, we mean Nortel
Networks Limited and its subsidiaries.

Business overview

We are a leading global supplier of products and services that support the
Internet and other public and private data, voice, and multimedia
communications networks, using terrestrial and wireless technologies, which we
refer to as networking solutions. With our networking solutions, we are
focused on providing the infrastructure and applications for high performance
networks, as technology transforms the way we communicate and conduct business.
We have a technology focus, with a substantial portion of Nortel Networks
dedicated to research and development, forming a core strength and a factor
differentiating us from our competitors. Our research and development efforts
are focused on delivering carrier-grade infrastructure, enabling valuable
services for our customers, reducing network costs, and transforming
traditional voice-communications networks into cost-effective networks
supporting data, voice, and multimedia communications.

Our operations are focused on providing seamless networking products and
service capabilities across three core business areas and three segments: Metro
and Enterprise Networks; Wireless Networks; and Optical Networks (formerly
named Optical Long-Haul Networks). These products and service solutions are
used by service provider and enterprise customers, including incumbent and
competitive local exchange carriers, interexchange carriers, service providers
with global businesses, wireless service providers, Internet service providers,
application service providers, hosting service providers, resellers, cable
television companies, other communications service providers, large businesses
and their branch offices, small businesses, and home offices, as well as
government, education, and utility organizations.

Our Metro and Enterprise Networks segment includes a range of Optical
Ethernet solutions, Ethernet switching solutions, packet switching and routing solutions, such as data
switching systems, aggregation products, virtual private network gateways, and
routers, and circuit to packet network solutions, such as enterprise telephone
systems, digital switching systems, business solutions and applications, and
network management software, together with related professional services. Our
Wireless Networks segment solutions support the Time Division Multiple Access,
or TDMA, Code Division Multiple Access, or CDMA, Global System for Mobile
communications, or GSM, General Packet Radio Standard, or GPRS, and Universal
Mobile Telecommunications Systems, or UMTS, standards, to enable end users to
be mobile while they send and receive voice and data communications using a
wireless device, and include radio access network equipment, key network
elements of which are base station transceivers and base station controllers,
core network equipment, key network elements of which are mobile switching
centers and home location registers, and related professional services. Our
Optical Networks segment includes optical long-haul networking solutions as
well as metro optical solutions. Optical long-haul networking solutions are
designed to provide long-distance, high-capacity transport and switching of
data, voice, and multimedia communications signals for operators of land-based
and submarine communications networks, including Dense Wave Division
Multiplexing, or DWDM, solutions, synchronous optical transmission systems that
support most global transmission standards, optical switching solutions, and
network management software, optical components for long-distance optical
networks, and related engineering, installation, and support services. The
metro optical portion of the segment includes solutions designed to transport
data, voice, and multimedia communications between locations within a city or
between cities of close range by transmitting communication signals in the form
of light particles/waves through fiber optic cables.

Nortel Networks Corporations common shares are publicly-traded on the New
York and Toronto stock exchanges under the symbol NT. Nortel Networks
Corporation holds all of Nortel Networks Limiteds outstanding common shares
but none of its outstanding preferred shares. Acquisitions involving any share
consideration are completed by Nortel Networks Corporation, while acquisitions
involving only cash consideration are generally completed by Nortel Networks
Limited or one of its direct subsidiaries.

29



---



##### 



Developments in 2002

Filing of shelf registration statement and base shelf prospectus

In the three months ended June 30, 2002, Nortel Networks Corporation and
Nortel Networks Limited filed a shelf registration statement with the United
States Securities and Exchange Commission and a base shelf prospectus with the
applicable securities regulatory authorities in Canada, for the purpose of
qualifying the potential sale by Nortel Networks Corporation or Nortel Networks
Limited from time to time in the United States and/or Canada of up to an
aggregate of $2,500 of various types of securities. On June 12, 2002, Nortel
Networks Corporation utilized approximately $1,700 of the $2,500 in connection
with two concurrent equity offerings. On June 28, 2002, Nortel Networks
Corporation contributed approximately $800 of the proceeds from the equity
offerings to Nortel Networks Limited in return for one common share.

See
Liquidity and capital resources for additional information.

Optical Networks

On May 29, 2002, Nortel Networks Corporation announced plans to further
realign its Optical Networks business, including optical components, due to the
current market conditions given that we do not expect a meaningful recovery in
the long-haul optical market before late 2003 or early 2004. The plan includes
the potential sale and/or resizing of the optical components business.

Restructuring

In the three months ended June 30, 2002, we recorded special charges of
$307, primarily comprised of a $189 charge related to plant and equipment write
downs and a $117 charge related to workforce reduction. The approximately $189
write down of plant and equipment within the Optical Networks segment resulted
from our assessment of certain plant and equipment assets as part of our review
of financial results during the three months ended June 30, 2002. The
workforce reduction charges of $117 for the three months ended June 30, 2002,
were related to the cost of severance and benefits associated with
approximately 1,900 employees notified of termination during the period.

In the three months ended March 31, 2002, we recorded special charges of
$443, primarily related to the cost of severance and benefits associated with
the approximately 4,000 employees notified of termination during the period.

As of June 30, 2002, our workforce numbered approximately 44,700.
Following the completion of remaining reductions, primarily related to the
realignment of the Optical Networks segment, and previously announced European
work council activities, we expect to have a workforce of approximately 42,000.
We will continue to actively review our cost structure to reduce or redirect costs that are not warranted. Additional charges will be required in 2002 related to remaining announced
workforce reductions and related charges, and the restructuring of the Optical
Networks segment.

See Special charges for additional information.

Credit facilities

On April 10, 2002, Nortel Networks Corporation announced that, effective
April 8, 2002, Nortel Networks Limited and Nortel Networks Inc. amended and
extended their April 2001 364-day revolving syndicated credit facilities to
April 7, 2003 with no additional term-out period thereafter. The amendment
reduced the size of the 364-day committed revolving facilities to $1,175 from
$1,750. The amended facilities maintained the financial covenant in the April
2001 facilities requiring Nortel Networks Limiteds minimum consolidated
tangible net worth to be not less than $1,888 and included higher pricing
reflecting the then current credit and bank environment. As a result, total
borrowings permitted under the syndicated April 2002 364-day credit agreements
and the existing April 2000 five-year credit agreements are $1,925.

On June 27, 2002, we sold certain real estate in the United Kingdom, which
resulted in a reduction, effective July 2, 2002, in available commitments under
Nortel Networks Limiteds and Nortel Networks Inc.s December 20, 2001 credit
facilities from $1,575 to $1,518.

See Liquidity and capital resources for additional details on our credit
agreements.

30



---



##### 



Debt rating downgrades

On April 4, 2002, Moodys Investors Services, Inc. lowered Nortel Networks
Limiteds United States senior long-term debt rating below investment grade to
Ba3. On April 9, 2002, Standard & Poors Ratings Service also lowered their
credit rating for Nortel Networks Limited below investment grade to BB-. As a
result, various liens, pledges, and guarantees became effective under certain
credit and security agreements entered into by Nortel Networks Limited and
various of its subsidiaries. In accordance with the covenants in the trust
indentures for all of our current consolidated public debt securities, which
represent substantially all of our consolidated long-term debt at June 30,
2002, all such public debt securities are also secured equally and ratably with
the obligations under all of Nortel Networks Limited and Nortel Networks Inc.s
credit agreements by liens on substantially all of the assets of Nortel
Networks Limited and those of most of its United States and Canadian
subsidiaries, and by pledges of shares in certain of Nortel Networks Limiteds
other subsidiaries. In addition, certain of Nortel Networks Limiteds wholly
owned subsidiaries have guaranteed Nortel Networks Limiteds obligations under
the credit agreements and outstanding public debt securities.

The liens, pledges, and guarantees described above also apply equally and
ratably to the obligations under Nortel Networks Corporations $1,800 4.25
percent convertible senior notes due on September 1, 2008.

For additional financial information related to those subsidiaries
providing guarantees, see Supplemental consolidating financial information in
note 17 of the accompanying unaudited consolidated financial statements. For
additional financial information related to the three years ended December 31,
2001, see our Current Report on Form 8-K dated May 13, 2002.

In addition, see Liquidity and capital resources for additional details
on our credit ratings and the granting of security under our credit agreements.

Results of operations  continuing operations

Revenues

Segment revenues

During the three months ended June 30, 2002, we shifted the accountability
for the metro optical portion of the Metro and Enterprise Networks segment into
the Optical Networks segment (formerly named the Optical Long-haul Networks
segment). All reported and historical information has been restated to reflect
this realignment.

The following table sets forth revenues by segment for the three months
and six months ended June 30:

|                     |  |                             |       |                           |      |   |       |          |  |   |          |   |  |      |       |   |      |   |        |          |  |   |          |  |  |   |        |   |  |  |       |  
|-------------------- |  | --------------------------- | ----- | ------------------------- | ---- | - | ----- | -------- |  | - | -------- | - |  | ---- | ----- | - | ---- | - | ------ | -------- |  | - | -------- |  |  | - | ------ | - |  |  | ----- | -
|                    
|                     |  | Three months ended June 30, |       | Six months ended June 30,
|                     |  | 2001                        |       |                           | 2002 |   |       | $ Change |  |   | % Change |   |  | 2001 |       |   | 2002 |   |        | $ Change |  |   | % Change
|                    
|                    
|Metro and Enterprise |  | $                           | 1,971 |                           |      | $ | 1,222 |          |  | $ | (749     | ) |  |      | (38.0 | ) |      | $ | 4,361  |          |  | $ | 2,576    |  |  | $ | (1,785 | ) |  |  | (40.9 | )
|                    
|                    
|                    
|                    
|Wireless             |  |                             | 1,616 |                           |      |   | 1,123 |          |  |   | (493     | ) |  |      | (30.5 | ) |      |   | 3,161  |          |  |   | 2,259    |  |  |   | (902   | ) |  |  | (28.5 | )
|                    
|                    
|                    
|                    
|Optical              |  |                             | 744   |                           |      |   | 404   |          |  |   | (340     | ) |  |      | (45.7 | ) |      |   | 2,298  |          |  |   | 809      |  |  |   | (1,489 | ) |  |  | (64.8 | )
|                    
|                    
|                    
|                    
|Other(a)             |  |                             | 240   |                           |      |   | 21    |          |  |   | (219     | ) |  |      | (91.3 | ) |      |   | 440    |          |  |   | 36       |  |  |   | (404   | ) |  |  | (91.8 | )
|                    
|Consolidated         |  | $                           | 4,571 |                           |      | $ | 2,770 |          |  | $ | (1,801   | ) |  |      | (39.4 | ) |      | $ | 10,260 |          |  | $ | 5,680    |  |  | $ | (4,580 | ) |  |  | (44.6 | )
|                    
|                    

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

31



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##### 



Geographic revenues

The following table sets forth revenues by geographic region for the three
months and six months ended June 30:

|                     |  |                             |       |                           |      |   |       |          |  |   |          |   |  |      |       |   |      |   |        |          |  |   |          |  |  |   |        |   |  |  |       |  
|-------------------- |  | --------------------------- | ----- | ------------------------- | ---- | - | ----- | -------- |  | - | -------- | - |  | ---- | ----- | - | ---- | - | ------ | -------- |  | - | -------- |  |  | - | ------ | - |  |  | ----- | -
|                    
|                     |  | Three months ended June 30, |       | Six months ended June 30,
|                     |  | 2001                        |       |                           | 2002 |   |       | $ Change |  |   | % Change |   |  | 2001 |       |   | 2002 |   |        | $ Change |  |   | % Change
|                    
|                    
|External revenues(a) |  |                             |       |                           |      |   |       |          |  |   |          |   |  |      |       |   |      |   |        |          |  |   |          |  |  |   |        |   |  |  |       |  
|                    
|                    
|                    
|                    
|United States        |  | $                           | 2,225 |                           |      | $ | 1,511 |          |  | $ | (714     | ) |  |      | (32.1 | ) |      |   | 5,031  |          |  |   | 2,944    |  |  |   | (2,087 | ) |  |  | (41.5 | )
|                    
|                    
|                    
|                    
|Canada               |  |                             | 207   |                           |      |   | 177   |          |  |   | (30      | ) |  |      | (14.5 | ) |      |   | 518    |          |  |   | 367      |  |  |   | (151   | ) |  |  | (29.2 | )
|                    
|                    
|                    
|                    
|Other countries      |  |                             | 2,139 |                           |      |   | 1,082 |          |  |   | (1,057   | ) |  |      | (49.4 | ) |      |   | 4,711  |          |  |   | 2,369    |  |  |   | (2,342 | ) |  |  | (49.7 | )
|                    
|Consolidated         |  | $                           | 4,571 |                           |      | $ | 2,770 |          |  | $ | (1,801   | ) |  |      | (39.4 | ) |      | $ | 10,260 |          |  | $ | 5,680    |  |  | $ | (4,580 | ) |  |  | (44.6 | )
|                    



|(a) |  | Revenues are attributable to geographic areas based on the location of the
customer.
|--- |  | ------------------------------------------------------------------------------------

Consolidated

In 2001, the telecommunications industry, or the industry, underwent a
significant adjustment, particularly in the United States. Following a period
of rapid infrastructure build-out and strong economic growth in 1999 and 2000,
we saw a continued tightening in the capital markets and slowdown in the
industry throughout 2001. This resulted in lower capital spending by industry
participants and substantially less demand for our products and services as
service providers focused on maximizing their return on invested capital and,
as a result, our revenues declined sequentially during 2001. In the first six
months of 2002, we have continued to see constraints on capital expenditures by
industry participants. As a result, for the three months and six months ended
June 30, 2002, our consolidated revenues declined substantially compared to the
same periods in 2001. The substantial declines were due to a change in our
customers focus from building new networks to conserving capital and/or
increasing the capacity utilization rates and efficiency of existing networks,
and reducing costs. Our consolidated revenues for the three months ended June
30, 2002 were down slightly compared to the three months ended March 31, 2002.
We expect that the severe lack of available funding from the capital markets,
high debt levels of many service providers, bankruptcies and financial
difficulties of certain service providers, excess network assets, excess and
shared bandwidth capacity, and the compounding impact of economic concerns will
continue to constrain capital spending by service providers in 2003. As a
result, we expect that overall capital expenditures in the industry during 2003
will decline compared to the expected amount for the full year 2002. However,
it is difficult to predict the duration or severity of this industry
adjustment, as growth in industry spending is not expected to occur until
economic and financial concerns have subsided and the anticipated
rationalization of the industry is well underway. Market visibility remains
limited and we do not expect that results of operations for any quarter will
necessarily be consistent with our quarterly historical profile or indicative
of results to be expected for future quarters.

The substantial decline in revenues for the three months and six months
ended June 30, 2002 compared to the same periods in 2001 was the result of
considerable declines across all segments. The modest decline in revenues in
the three months ended June 30, 2002 compared to the three months ended March
31, 2002 was primarily due to a decline in Metro and Enterprise Networks and
flat revenues in both our Wireless Networks and Optical Networks segments.

The substantial decline in revenues in the three months ended June 30,
2002 compared to the same period in 2001 was due to considerable declines in
the United States, Europe, the Asia Pacific region, and the Caribbean and Latin
America region, and a significant decline in Canada. The substantial decline
in revenues in the six months ended June 30, 2002 compared to the same period
in 2001 was due to considerable declines across all geographic regions.
Compared to the three months ended March 31, 2002, revenues declined
significantly in Europe, substantially in the Caribbean and Latin America
region, and declined in the Asia Pacific region and Canada, partially offset by
an increase in the United States.

32



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Metro and Enterprise Networks

The following chart sets forth quarterly revenues for the Metro and
Enterprise Networks segment:

(BAR CHART)

The Metro and Enterprise Networks segment serves both service provider
customers as well as enterprise customers. Our service provider customers
include local and long-distance telephone companies, Internet service
providers, and other communications service providers. Our enterprise
customers include large businesses and their branch offices, small businesses,
and home offices, as well as government, education, and utility organizations.

The substantial decline in revenues in the three months and six months
ended June 30, 2002 compared to the same periods in 2001 was due to substantial
declines in all portions of this segment except for packet switching and
routing in the three months ended June 30, 2002, which declined significantly
compared to the same period in 2001. The substantial decrease in sales of the
circuit to packet voice networks portion of this segment was primarily the
result of continued reduced demand in the local exchange and
interexchange carrier markets due to
the significant adjustment in the industry, continued industry consolidation,
continued tightened capital markets, and the decline in traditional circuit
switching. The significant and considerable declines in sales of the packet
switching and routing portion of this segment in the three months and six
months ended June 30, 2002, respectively, compared to the same periods in 2001
were primarily due to a decline in demand for mature products in this portion
of the segment, compounded by the ongoing industry adjustment as our service
provider customers continue to reduce capital expenditures and our enterprise
customers continue to delay the purchase of next generation products due to
overall economic and technology evolution uncertainty. Circuit network voice
solutions continue to form a majority of the overall sales for the circuit to
packet voice networks portion of this segment. As data, voice, and multimedia
communications technologies continue to converge, and service providers, as
well as enterprises, look for ways to maximize the effectiveness of their
existing networks while reducing ongoing capital expenditures and operating
costs, we anticipate that communications networks will use packet-based
technologies. However, the timing of this progression in the short term is
unclear as a result of the continuing industry adjustment. The substantial
decline in overall segment revenues in the three months and six months ended
June 30, 2002 compared to the same periods in 2001 was due to considerable
declines across all geographic regions.

Overall Metro and Enterprise Networks segment revenues for the three
months ended June 30, 2002 declined compared to the three months ended March
31, 2002, primarily due to a decrease in demand for traditional circuit
switching and a significant decline in demand for the packet switching and
routing portion of this segment. A substantial decline in the Caribbean and
Latin America region, a significant decline in Europe, and modest decreases in
the United States and Canada were partially offset by a substantial increase in
the Asia Pacific region.

33



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Wireless Networks

The following chart sets forth quarterly revenues for the Wireless
Networks segment:

(BAR CHART)

The substantial decline in revenues in the three months and six months
ended June 30, 2002 compared to the same periods in 2001 was primarily due to
strong revenues in the first half of 2001 driven by growth in the United States
and the Asia Pacific region, as major customers completed the network expansion
programs they began in 2000. Wireless Networks segment revenues began to
decline in the second half of 2001, and have continued to decline into 2002, as
a result of deterioration in wireless service providers financial condition,
slowing subscriber growth and competition for end user customers by service
providers which has resulted in the decision of many wireless service providers
to delay capital expenditures. The substantial decrease in overall segment
revenues during the three months ended June 30, 2002 compared to the same
period in 2001 was primarily due to substantial decreases in the Asia Pacific
region and Europe, and a significant decline in the United States, partially
offset by a substantial increase in Canada. The substantial decrease in
overall segment revenues during the six months ended June 30, 2002 compared to
the same period in 2001 was due to substantial decreases in the Asia Pacific
region, the United States, Europe, and the Caribbean and Latin American region,
partially offset by a considerable increase in Canada.

Overall Wireless Networks segment revenues for the three months ended June
30, 2002 continue to be primarily generated by sales of Code Division Multiple
Access, or CDMA, and Global System for Mobile communications, or GSM,
technologies. Compared to the three months ended June 30, 2001, CDMA revenues
have increased as a percentage of total revenues, Universal Mobile
Telecommunications System, or UMTS, revenues have increased significantly as a
percentage of revenues, and GSM revenues have remained relatively flat, offset
by a substantial decrease in Time Division Multiple Access, or TDMA, revenues
as a percentage of total revenues. CDMA and UMTS technology sales are expected
to continue to represent a larger proportion of our total Wireless Networks
segment revenues as third generation, or 3G, technologies gain a greater
foothold in the market due to
increased wireless data traffic and requirements for greater wireless spectrum
efficiency. GSM sales will slow and are expected to
transition to GPRS and Edge 2.5G technologies and TDMA sales are
expected to decline.

As with the rest of the industry, our wireless customers are experiencing
significant pressure and are adapting to a new, more stringent spending
environment. We anticipate a slight decline in global capital expenditures for
wireless operators in 2003, compared to 2002, but cannot predict the complete
impact. We also expect there may be consolidation in this marketplace,
including a reduction in the number of service providers in certain regions due
to competition and/or adjustments in deployment plans and schedules. In
addition, the timing of changes in revenues from the different wireless
technologies has become increasingly difficult to predict as a result of the
complexities and potential for delays in the implementation of 3G network
deployments. All of these factors could affect Wireless Networks segment
revenues.

Overall Wireless Networks segment revenues for the three months ended June
30, 2002 were essentially flat compared to the three months ended March 31,
2002, primarily due to a substantial decline in the Asia Pacific region and a
significant decline in Canada, partially offset by a significant increase in
the United States and an increase in the Caribbean and Latin America region.

34



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##### 



Optical Networks

The following chart sets forth quarterly revenues for the Optical Networks
segment:

(BAR CHART)

The substantial decline in revenues in three months and six months ended
June 30, 2002 compared to the same periods in 2001 was primarily the result of
substantial reductions in capital spending, mainly by our major United States
and European customers.

The optical long-haul networks portion of our Optical Networks segment
revenues in the first quarter of 2001 reflected the then in-process network
build-outs that had begun in 2000. However, when the industry began
experiencing the significant adjustment and the capital markets tightened, our
customers reduced their purchases sharply as they focused on reducing existing
inventory levels to complete existing network build-outs and on improving the
efficiency of existing networks. Our major customers in this portion of the
segment are focused on maximizing return on invested capital by increasing the
capacity utilization rates and efficiency of existing networks, and we expect
that any additional capital spending by those customers will be increasingly
directed to opportunities that enhance customer performance, revenue
generation, and cost reduction in the near term. We expect that customers in
this portion of the segment will continue to focus on route by route
activities, adding channels to existing networks, and interconnect and
bandwidth issues in the short term, while building out networks for increased
bandwidth will remain longer term projects. Sales in this portion of the
segment are primarily based on network build-outs and, as such, generally
include a number of long-haul products packaged together in an end-to-end
solution. As a result, volatility in this portion of the segment typically
results in a corresponding increase or decline in overall optical long-haul
networks sales as almost all products within this portion of the segment are
generally affected in the same manner. Industry consolidation also contributed
to the reduction in service provider capital spending during 2001 and the first
half of 2002. The considerable decline in the optical long-haul networks
portion of the segment during the three months and six months ended June 30,
2002, compared to the same periods in 2001, is due to continued capital
spending constraints and, to a lesser extent, the large redeployment of assets
that has occurred in this segment of the industry in 2001 primarily due to
significant excess inventories, which has resulted in significant pricing
pressures throughout 2001 and the first half of 2002.

Sales in the metro optical portion of the segment are primarily driven by
demand for enterprise connectivity and storage solutions. The substantial
decline in sales of the metro optical portion of the segment for the three
months and six months ended June 30, 2002, compared to the same periods in
2001, was primarily due to a decline in demand for mature products in this
portion of the segment, compounded by the ongoing industry adjustment as
customers continue to focus on optimizing existing networks, which has delayed
the deployment of next generation products. Sales in the metro optical portion
of the segment increased as a percentage of total Optical Networks segment
sales for the six months ended June 30, 2002, compared to the same period in
2001.

Due to the severe reduction, in number and size, of new long-haul network
build-outs during 2001 and the first half of 2002 and due to the nature of the
long-haul portion of this segment, we do not expect a meaningful recovery in
the optical long-haul market before late 2003 or early 2004 and we expect that
it will be one of the last to recover from the significant adjustment in the
industry. However, we do anticipate that revenues of the metro optical portion
of the segment will continue to increase as a percentage of total Optical
Networks segment sales.

The substantial decline in Optical Networks segment revenues for the three
months ended June 30, 2002, compared to the same period in 2001, was due to
substantial declines in Europe, the Asia Pacific region, the Caribbean and
Latin

35



---



##### 



America region, and the United States, partially offset by a substantial
increase in Canada. The substantial decline in Optical Networks segment
revenues for the six months ended June 30, 2002, compared to the same period in
2001, was due to considerable declines in the United States, Europe, the Asia
Pacific region, and the Caribbean and Latin America region, and a significant
decline in Canada.

Overall Optical Networks segment revenues were flat for the three months
ended June 30, 2002 compared to the three months ended March 31, 2002,
primarily due to a decline in demand for the optical long-haul networks portion
of the segment, partially offset by a significant increase in demand for the
metro optical portion of the segment. The flat revenues were primarily due to
substantial increases in the United States and Canada, and a modest increase in
the Asia Pacific region, more than offset by considerable decreases in Europe
and the Caribbean and Latin America region.

Gross profit and gross margin

The following table sets forth gross profit and gross margin for the three
months and six months ended June 30:

|             |  |                             |      |                           |      |   |       |        |  |   |          |  |  |      |       |  |      |   |       |        |  |   |          |  |  |   |      |   |  |  |       |  
|------------ |  | --------------------------- | ---- | ------------------------- | ---- | - | ----- | ------ |  | - | -------- |  |  | ---- | ----- |  | ---- | - | ----- | ------ |  | - | -------- |  |  | - | ---- | - |  |  | ----- | -
|            
|             |  | Three months ended June 30, |      | Six months ended June 30,
|             |  | 2001                        |      |                           | 2002 |   |       | Change |  |   | % Change |  |  | 2001 |       |  | 2002 |   |       | Change |  |   | % Change
|            
|            
|Gross profit |  | $                           | 365  |                           |      | $ | 900   |        |  | $ | 535      |  |  |      | 146.6 |  |      | $ | 2,179 |        |  | $ | 1,581    |  |  | $ | (598 | ) |  |  | (27.4 | )
|            
|            
|            
|            
|Gross margin |  |                             | 8.0% |                           |      |   | 32.5% |        |  |   | 24.5     |  |  |      | 306.3 |  |      |   | 21.2% |        |  |   | 27.8%    |  |  |   | 6.6  |   |  |  | 31.1  |  
|            

The considerable increase in gross margin for the three months ended June
30, 2002 compared to the same period in 2001 was primarily due to approximately
$750 of incremental charges related to increased inventory provisions and
contract and customer settlements in the three months ended June 30, 2001.
Excluding these incremental charges, gross margin would have been approximately
24.4 percent for the three months ended June 30, 2001, which is also
considerably lower than the gross margin for the three months ended June 30,
2002, due to our now lower cost structure in relation to our revenue volume and
more favourable supplier pricing in 2002, offset by continuing pricing
pressures throughout the industry.

The substantial increase in gross margin for the six months ended June 30,
2002 compared to the same period in 2001 was primarily due to approximately
$750 of incremental charges related to increased inventory provisions and
contract and customer settlements in the three months ended June 30, 2001,
partially offset by $200 of incremental inventory provisions primarily related
to negotiations with all of our major suppliers in the three months ended March
31, 2002. Excluding these incremental charges, gross margin for the six months
ended June 30, 2002 and 2001 would have been approximately 31.4 percent and
28.5 percent, respectively, which represents a significant increase in gross
margin for the period, due to the sequential improvements in our cost structure
as we have reduced capacity in relation to our revenue volume during the six
months ended June 30, 2002.

While we cannot predict to what extent changes in product mix and pricing
pressures will have on our gross margin, we have begun to see the affects of
our work plan to create a cost structure that is more reflective of the current
industry and economic environment. We expect that gross margin will continue
to trend in the mid to high thirty percent range for the remainder of 2002 and
will be substantially higher for the full year 2002 compared to the full year
2001.

See Forward-looking statements for factors that may affect our gross
margins.

Operating expenses

Selling, general and administrative expense

The following table sets forth selling, general and administrative, or
SG&A, expense and SG&A expense as a percentage of revenues for the three months
and six months ended June 30:

|                   |  |                             |       |                           |      |   |       |          |  |   |          |   |  |      |       |   |      |   |       |          |  |   |          |  |  |   |        |   |  |  |       |  
|------------------ |  | --------------------------- | ----- | ------------------------- | ---- | - | ----- | -------- |  | - | -------- | - |  | ---- | ----- | - | ---- | - | ----- | -------- |  | - | -------- |  |  | - | ------ | - |  |  | ----- | -
|                  
|                   |  | Three months ended June 30, |       | Six months ended June 30,
|                   |  | 2001                        |       |                           | 2002 |   |       | $ Change |  |   | % Change |   |  | 2001 |       |   | 2002 |   |       | $ Change |  |   | % Change
|                  
|                  
|SG&A expense       |  | $                           | 1,603 |                           |      | $ | 764   |          |  | $ | (839     | ) |  |      | (52.3 | ) |      | $ | 2,911 |          |  | $ | 1,504    |  |  | $ | (1,407 | ) |  |  | (48.3 | )
|                  
|                  
|                  
|                  
|As a % of revenues |  |                             | 35.1% |                           |      |   | 27.6% |          |  |   | N/A      |   |  |      | N/A   |   |      |   | 28.4% |          |  |   | 26.5%    |  |  |   | N/A    |   |  |  | N/A   |  
|                  

36



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##### 



SG&A expense declined substantially in the three months and six months
ended June 30, 2002 compared to the same periods in 2001, reflecting the impact
of our work plan which began in 2001. SG&A expense increased slightly compared
to the three months ended March 31, 2002, primarily due to an incremental
charge of approximately $100 in the three months ended June 30, 2002 for
potentially uncollectible trade receivables, partially offset by decreases
reflecting our lower cost structure. Excluding the incremental charge of
approximately $100, SG&A was approximately $664, resulting in a sequential
improvement of $76, which primarily reflects the impact of workforce
reductions, which in turn has also resulted in a reduction in other related
costs such as information services and real estate. We expect that
quarterly SG&A
expense will decline to a level below $650 over the next few quarters.

Research and development expense

The following table sets forth research and development, or R&D, expense
and R&D expense as a percentage of revenues for the three months and six months
ended June 30:

|                   |  |                             |       |                           |      |   |       |          |  |   |          |   |  |      |       |   |      |   |       |          |  |   |          |  |  |   |      |   |  |  |       |  
|------------------ |  | --------------------------- | ----- | ------------------------- | ---- | - | ----- | -------- |  | - | -------- | - |  | ---- | ----- | - | ---- | - | ----- | -------- |  | - | -------- |  |  | - | ---- | - |  |  | ----- | -
|                  
|                   |  | Three months ended June 30, |       | Six months ended June 30,
|                   |  | 2001                        |       |                           | 2002 |   |       | $ Change |  |   | % Change |   |  | 2001 |       |   | 2002 |   |       | $ Change |  |   | % Change
|                  
|                   |  |                             |       |                           |      |   |       |          |  |   |          |   |  |      |       |   |      |   |       |          |  |   |          |  |  |   |      |   |  |  |       |  
|R&D expense        |  | $                           | 870   |                           |      | $ | 567   |          |  | $ | (303     | ) |  |      | (34.8 | ) |      | $ | 1,776 |          |  | $ | 1,144    |  |  | $ | (632 | ) |  |  | (35.6 | )
|                  
|                  
|                  
|                  
|As a % of revenues |  |                             | 19.0% |                           |      |   | 20.5% |          |  |   | N/A      |   |  |      | N/A   |   |      |   | 17.3% |          |  |   | 20.1%    |  |  |   | N/A  |   |  |  | N/A   |  
|                  

R&D expense decreased substantially in the three months and six months
ended June 30, 2002 compared to the same periods in 2001, reflecting the impact
of initiatives undertaken by us to focus our spending on key potential growth
areas. R&D expense represented our planned investment in our next generation
core products across all segments. R&D expense, in absolute dollars, will
decline substantially for the full year 2002, compared to the full year 2001,
as we improve process efficiencies. R&D expense was essentially flat in the
three months ended June 30, 2002 compared to the three months ended March 31,
2002. We expect quarterly R&D expense to continue below $600 for the remainder of 2002.
Our continuing strategic investments in R&D are aligned to maintain our
technology leadership in anticipated growth areas, consistent with the current
and future needs of our customers, while targeting a level of
R&D expense that is
representative of our overall cost structure.

Amortization of intangibles

The following table sets forth the amortization of intangibles for the
three months and six months ended June 30:

|                            |  |                             |     |                           |      |   |   |          |  |   |          |   |  |      |        |   |      |   |       |          |  |   |          |  |  |   |        |   |  |  |        |  
|--------------------------- |  | --------------------------- | --- | ------------------------- | ---- | - | - | -------- |  | - | -------- | - |  | ---- | ------ | - | ---- | - | ----- | -------- |  | - | -------- |  |  | - | ------ | - |  |  | ------ | -
|                           
|                            |  | Three months ended June 30, |     | Six months ended June 30,
|                            |  | 2001                        |     |                           | 2002 |   |   | $ Change |  |   | % Change |   |  | 2001 |        |   | 2002 |   |       | $ Change |  |   | % Change
|                           
|                            |  |                             |     |                           |      |   |   |          |  |   |          |   |  |      |        |   |      |   |       |          |  |   |          |  |  |   |        |   |  |  |        |  
|Amortization of intangibles |  |                             |     |                           |      |   |   |          |  |   |          |   |  |      |        |   |      |   |       |          |  |   |          |  |  |   |        |   |  |  |        |  
|                           
|                           
|                           
|                           
|Acquired technology         |  | $                           | 203 |                           |      | $ | 6 |          |  | $ | (197     | ) |  |      | (97.0  | ) |      | $ | 406   |          |  | $ | 11       |  |  | $ | (395   | ) |  |  | (97.3  | )
|                           
|                           
|                           
|                           
|Goodwill                    |  | $                           | 679 |                           |      | $ |  |          |  | $ | (679     | ) |  |      | (100.0 | ) |      | $ | 1,361 |          |  | $ |         |  |  | $ | (1,361 | ) |  |  | (100.0 | )
|                           

Amortization of intangibles

Acquired technology

The amortization of acquired technology for the three months and six
months ended June 30, 2001 primarily reflected the charge related to the
acquisition of Bay Networks, Inc. The substantial decline in the three months
and six months ended June 30, 2002 compared to the same period in 2001, is
primarily due to the completion of amortization associated with Bay Networks.
As at June 30, 2002 and December 31, 2001, the remaining carrying value of
acquired technology  net was $8 and $20, respectively.

Goodwill

In the three months ended March 31, 2002, we adopted the provisions of
Statement of Financial Accounting Standard No. 142, Goodwill and Other
Intangible Assets, or SFAS 142. Thus, amortization of goodwill,
including goodwill recorded in past business combinations, and amortization of
intangibles with an indefinite life ceased upon adoption

37



---



##### 



of this Statement. We completed the first of the required SFAS 142
transitional impairment tests during the three months ended June 30, 2002 and
concluded that there was no impairment of recorded goodwill as the fair values
of our reporting units exceeded their carrying amount as of January 1, 2002.
Therefore, the second step of the transitional impairment test under SFAS 142
was not required to be performed. There can be no assurance that future
goodwill impairment tests will not result in a charge to net earnings (loss).

The amortization of goodwill for the three months and six months ended
June 30, 2001 primarily reflected the charges related to the acquisitions of
Bay Networks, Qtera Corporation, and Clarify Inc.

As at June 30, 2002 and December 31, 2001, the carrying value of goodwill
 net was $2,283 and $2,283, respectively.

Special charges

Three months and six months June 30, 2002

For the three months and six months ended June 30, 2002, we recorded
special charges of $307 and $750, respectively, related to restructuring costs
associated with our work plan, which we began implementing in 2001 and
continued into the second quarter of 2002, to streamline our operations and
activities around our core markets and leadership strategies.

Workforce reduction charges of $117 and $429 for the three months and six
months ended June 30, 2002, respectively, were related to the cost of severance
and benefits associated with approximately 1,900 and 5,900 employees notified
of termination, respectively, across all of our segments.

Contract settlement costs included negotiated settlements of approximately
$1 and $57 for the three months and six months ended June 30, 2002,
respectively, to either cancel contracts or renegotiate existing contracts
across all of our segments.

As part of our review of financial results during the six months ended
June 30, 2002, we performed assessments of certain plant and equipment assets,
primarily in the Optical Networks segment, due to the current market conditions
and the delay in the anticipated recovery of that segment. The conclusion of
these assessments resulted in a write down of certain plant and equipment
assets within the Optical Networks segment of approximately $189, during the
three months ended June 30, 2002. These plant and equipment assets continue to
be held and used, and were written down to estimated fair value based on market
assessments. During the three months ended March 31, 2002 the plant and
equipment write down included assets within the Optical Networks segment and
within global operations, a function that supports all of our segments,
totaling approximately $75.

The ending provision balance of $1,049 at June 30, 2002 consists of
workforce reduction provisions of $383, contract settlement and lease costs of
$644 and other provisions of $22.

As of June 30, 2002, our workforce numbered approximately 44,700.
Following the completion of remaining reductions, primarily related to the
realignment of the Optical Networks segment, and previously announced European
work council activities, we expect to have a workforce of approximately 42,000.
We will continue to actively review our cost structure to reduce or
redirect costs that are not warranted. Additional charges will be required in 2002 related to remaining announced
workforce reductions and related charges, and the restructuring of the Optical
Networks segment.

Year ended December 31, 2001

For the year ended December 31, 2001, we recorded restructuring charges of
$3,310, related to workforce reduction costs of $1,343, contract settlement and
lease costs of $883, plant and equipment write downs of $939, and other costs
of $145. During the year ended December 31, 2001, there were cumulative cash
and non-cash drawdowns against the provision of $1,082 and $1,031,
respectively, resulting in an ending provision balance at December 31, 2001 of
$1,197. The cash drawdowns related primarily to workforce reduction payments,
and the non-cash drawdowns related primarily to the plant and equipment write
downs.

38



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Period from January 1, 2001 to June 30, 2002

Of the approximately 41,400 employees notified during the period from
January 1, 2001 to June 30, 2002, approximately 15,200 were direct employees
performing manufacturing, assembly, test and inspection activities associated
with the production of our products, and approximately 26,200 were indirect
sales, marketing, research and development, and administrative employees, and
manufacturing managers. The workforce reduction was primarily in North America
and the United Kingdom and extended across all of our segments. As at June 30,
2002, the workforce reduction provision balance has been drawn down by
cumulative cash payments of $1,403, resulting in an ending provision balance
for workforce reduction of $383. The remaining provision is expected to be
substantially drawn down by the second quarter of 2003.

In conjunction with the above noted workforce reduction, we identified a
number of leased and owned facilities comprised of office, warehouse and
manufacturing space, as well as leased manufacturing equipment, that were no
longer required. As a result, we recorded net lease costs of approximately
$757. The costs primarily related to our future contractual obligations under
operating leases. Offsetting the total lease charge is approximately $479 in
expected sublease revenue on leases that we cannot terminate. The reduction in
expected sublease revenue of $27 in the three months ended June 30, 2002 was as
a result of our ability to terminate certain leases early and at a discount to
the originally anticipated lease costs associated with these leases. We expect
to have subleased substantially all of these properties by the end of 2004. In
addition, we wrote down the net carrying value of specific owned facilities
across all segments within North America and the United Kingdom. The write
down of approximately $95, which is included in plant and equipment write
downs, reflected the net realizable value based on market assessments for
general purpose facilities.

Contract settlement costs included negotiated settlements of approximately
$183, to either cancel contracts or renegotiate existing contracts across all
of our segments. As at June 30, 2002, the provision balance for contract
settlement and lease costs has been drawn down by cumulative cash payments of
$296, resulting in an ending provision balance of $644. The remaining
provision is now expected to be substantially drawn down by the end of 2006.

Plant and equipment write downs of approximately $459 consisted of the
write down of leasehold improvements and certain information technology
equipment associated with the exiting of the above noted leased and owned
facilities.

In addition, as a result of the significant negative industry and economic
trends impacting our operations and expected future growth rates, we have
performed assessments of certain plant and equipment assets as part of our
review of financial results during 2001 and the first six months of 2002. The
conclusion of these assessments resulted in write downs of certain plant and
equipment assets totaling approximately $649, as summarized below.

Within the Optical Networks segment, it was determined that there was
excess manufacturing equipment at a number of facilities that would no longer
be required, or the carrying value of which was not recoverable from future
cash flows, as a result of the industry and economic environment. As a result,
we recorded charges totaling approximately $470 to write down the value of this
equipment to its net realizable value based on the current fair market value
for this type of specialized equipment. We expect to dispose of this
equipment, other than equipment that we continue to hold and use, by the end of
2002. In 2001, we also wrote down the net carrying value of a specialized
manufacturing facility within the Optical Networks segment for the production
of optical components within North America. The write down of approximately
$91 reflects the net realizable value based on market assessments for a general
purpose facility.

Within global operations, it was determined that there was excess test
equipment at a number of system houses that would no longer be required as a
result of the industry and economic environment. As a result, we recorded
charges totaling approximately $88 to write down the value of this equipment to
its net realizable value based on the current fair value for this type of
specialized equipment. We expect to dispose of this equipment by the end of
2002.

In the course of reviewing our financial results for the three months
ended June 30, 2001, we determined that the carrying values of intangible
assets significantly exceeded their estimated fair value. Given this
assessment, we determined that intangible assets, primarily composed of
goodwill from various acquisitions, exceeded their fair value by $2,133. The
write down was primarily associated with the acquisitions of Qtera within the
Optical Networks segment and Clarify within Other.

39



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For additional information related to these restructuring activities, see
Special charges in note 6 to the accompanying unaudited consolidated
financial statements.

Interest expense

The decrease in interest expense of $46 during the three months ended June
30, 2002 compared to the same period in 2001, was primarily related to a lower
level of short-term notes payable in 2002.

The decrease in interest expense of $55 during the six months ended June
30, 2002 compared to the same period in 2001, was primarily related to a lower
level of short-term notes payable in 2002.

Income tax benefit

Our effective tax benefit rates fluctuate from period to period primarily
as a result of the impact of stock option compensation, goodwill write downs,
certain non-tax deductible restructuring charges, and non-tax deductible
goodwill amortization prior to January 1, 2002. Excluding these impacts, as
applicable, our effective tax benefit rates were 30.3 percent and 31.0 percent
for the three months and six months ended June 30, 2002, respectively, compared
to 32.0 percent for the same periods in 2001, and reflected changes in the
geographic earnings (loss) mix.

Recently approved tax legislation in the United States extended the net
operating loss carry-back period from two years to five years. As a result,
during the three months ended March 31, 2002 we carried back available United
States losses from 2001 and utilized approximately $700 of previously
recognized deferred income tax assets.

See Liquidity and capital resources for additional information.

Net loss from continuing operations

|                                    |  |                             |        |                           |      |   |      |          |  |   |       |  |  |      |        |   |          |   |        |   |  |   |       | 
|----------------------------------- |  | --------------------------- | ------ | ------------------------- | ---- | - | ---- | -------- |  | - | ----- |  |  | ---- | ------ | - | -------- | - | ------ | - |  | - | ----- | 
|                                   
|                                    |  | Three months ended June 30, |        | Six months ended June 30,
|                                    |  | 2001                        |        |                           | 2002 |   |      | $ Change |  |   | 2001  |  |  | 2002 |        |   | $ Change
|                                   
|Reported results:                   |  |                             |        |                           |      |   |      |          |  |   |       |  |  |      |        |   |          |   |        |   |  |   |       | 
|                                   
|                                   
|                                   
|                                   
|Net loss from continuing operations |  | $                           | (5,381 | )                         |      | $ | (569 | )        |  | $ | 4,812 |  |  | $    | (6,732 | ) |          | $ | (1,354 | ) |  | $ | 5,378 | 
|                                   
|                                   
|Adjusted results:(a)                |  |                             |        |                           |      |   |      |          |  |   |       |  |  |      |        |   |          |   |        |   |  |   |       | 
|                                   
|                                   
|                                   
|                                   
|Net loss from continuing operations |  | $                           | (4,697 | )                         |      | $ | (569 | )        |  | $ | 4,128 |  |  | $    | (5,362 | ) |          | $ | (1,354 | ) |  | $ | 4,008 | 
|                                   
|                                   

|(a) |  | Reflects the implementation of Statement of Financial Accounting
Standards No. 142 Goodwill and Other Intangible Assets, or SFAS 142, had
the Statement been effective January 1, 2001.
|--- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

As a result principally of the foregoing factors, our reported net loss
from continuing operations improved by $4,812 and $5,378 in the three months
and six months ended June 30, 2002, respectively, compared to the same periods
in 2001.

For additional information related to results adjusted for the
implementation of SFAS 142, see Accounting changes in note 3 to the
accompanying unaudited consolidated financial statements.

Results of operations  discontinued operations

Revenues for our access solutions operations were $70 for the three months
ended June 30, 2002 and $138 for the six months ended June 30, 2002, compared
to $287 and $711, respectively, for the same periods in 2001. Access solutions
operations also generated net cash of $237 and $287 during the three months and
six months ended June 30, 2002, respectively.

During the three months ended June 30, 2002, Arris Group Inc., or Arris
Group, completed a secondary public offering of 15 million common shares held
by us. Following the closing of the offering on June 25, 2002, we owned 22
million shares, or approximately 27 percent of Arris Groups common shares. The
cash proceeds received were $67 and a gain of approximately $15 was recorded as
a result of this transaction, which is included in the estimated remaining
provisions required for discontinued operations. During the three months ended
March 31, 2002, we recorded a gain of approximately $13 due to the reduction of
our ownership interest in Arris Group, received for our original interest in
Arris

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Interactive LLC, from approximately 49 percent to approximately 46
percent as a result of Arris Groups issuance of
common shares in connection with its acquisition of another company, which
is included in the estimated remaining provisions required for discontinued
operations.

On April 21, 2002, we entered into an agreement with Aastra Technologies
Limited to sell certain assets, which were included in discontinued operations,
associated with our prior acquisition of Aptis Communications, Inc. The
transaction was completed during the three months ended June 30, 2002. The
consideration primarily consisted of approximately $16 in cash, as well as
contingent cash consideration of up to $60 over four years based on the
achievement of certain revenue targets by the business. We recorded a loss of
approximately $43 on the transaction, which reduced the estimated remaining
provisions required for discontinued operations.

On March 5, 2002, we divested our approximately 46 percent ownership
interest in Elastic Networks Inc. to Paradyne Networks, Inc., in exchange for
an approximately 8 percent ownership interest in Paradyne. We recorded a gain
of approximately $7 on the transaction, which is included in the estimated
remaining provision required for discontinued operations.

During the six months ended June 30, 2002, we have continued to actively
wind down the access solutions operations and there has been no change to the
initial disposal strategy or intent to exit the business since June 14, 2001.
However, the continued deterioration in industry and market conditions has
delayed certain disposal activities beyond the original planned timeframe of
one year. In particular, actions involving negotiations with customers, who
have also been affected by industry conditions, are taking longer than
expected. Therefore, although disposal activities continue beyond the one-year
period generally contemplated under APB 30, we continue to present the access
solutions operations as discontinued operations in the consolidated financial
statements. We have disposed of or transitioned the ownership of certain
operations, and operations not disposed of or so transitioned are expected to
be closed. We now expect to complete this plan by the end of 2002 or early
2003, subject to the closing of specific transactions, the timing of which may
continue to be impacted by customer issues, any applicable regulatory
requirements, and business issues.

For additional information, see Discontinued operations in note 4 to the
accompanying unaudited consolidated financial statements.

Critical accounting policies

Revenue recognition

Nortel Networks revenue recognition accounting policies are determined in
accordance with the standards and guidance provided by United States generally
accepted accounting principles. Our revenue streams are the result of a wide
range of activities, from custom design and installation over a long period of
time to out of the box solutions, with numerous variations in between. Our
solutions also cover a broad range of technologies and are offered on a global
basis. As a result, if we are selling products based on more established
technologies, our revenue recognition policies can differ between regions
depending on the level of knowledgeable installers within the region and
whether we are installing the equipment. Newer technologies within a segment
may also have different revenue recognition policies, depending on, among other
factors, the specific performance and acceptance criteria within the applicable
contract. Therefore, management must use judgment in determining how to apply
the current standards and interpretations, not only based on solution, but also
within solutions based on technology development and geographic region. As a
result, Nortel Networks revenues may fluctuate from period to period based on
the mix of solutions sold and in which geographic region they are sold. We
refer you to note 2(d) of our audited consolidated financial statements and
notes thereto for the three years ended December 31, 2001 in our Current Report
on Form 8-K dated May 13, 2002 for a detailed discussion of our revenue
recognition policies related to our material revenue streams.

Provisions for long-term receivables

In establishing the appropriate provisions for long-term receivables,
management must regularly review the financial stability of individual
customers. This analysis involves a judgment of a counterpartys ability to
meet and sustain its financial commitments, and takes into account a
counterpartys current and projected financial condition and the positive or
negative effects of the current and projected industry outlook, as well as that
of the economy in general. When all of these

41



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factors are fully considered, a
determination is made as to the probability of default. An appropriate
provision is then made, taking into account the severity of loss likely on the
receivable balance in recovery. A misinterpretation or misunderstanding
of these conditions, or other failure to estimate the counterpartys
projected financial condition, or uncertainty in the future outlook of our
industry or the economy could result in bad debts in excess of the provisions
determined to be appropriate as at the balance sheet date.

Provisions for inventory

In establishing the appropriate provisions for inventory, management must
make estimates about the future customer demand for our products, taking into
account both general economic conditions and growth prospects within our
customers ultimate marketplace, and the market acceptance of our current and
pending products. These judgments must be made in the context of our
customers shifting technology needs and changes in the geographic mix of our
customers. A misinterpretation or misunderstanding of these conditions or
uncertainty in the future outlook of our industry or the economy, or other
failure to estimate correctly, could result in inventory losses in excess of
the provisions determined to be appropriate as at the balance sheet date.

Tax asset valuation

As at June 30, 2002, we had net deferred tax assets of $3,239, comprised
of tax credit carryforwards, net operating loss carryforwards and other
deductible temporary differences, which can be utilized to reduce either
taxable income or taxes otherwise payable in future years. We assess
realization of these net deferred tax assets quarterly, and based on all
available evidence, both positive and negative, we have concluded that it is
more likely than not that these net deferred tax assets will be realized.
However, realization is not assured. If market conditions deteriorate further
or our results of operations do not continue to improve, future assessments may
result in a determination that these net deferred tax assets are not
realizable. As a result, we may need to establish additional valuation
allowances for all or a portion of the net deferred tax assets, which may have
a material adverse effect on our business, results of operations, and financial
condition.

Liquidity and capital resources

Cash flows

Cash and cash equivalents, or cash, were $4,122 at June 30, 2002, an
increase of $665 (including net cash from the access solutions operations of
$287) from December 31, 2001. The increase in cash was primarily due to $800
received from Nortel Networks Corporation on June 28, 2002, partially offset by
our results from operations.

Cash flows used in operating activities were $178 for the six months ended
June 30, 2002, due to a net loss of $756, adjusted for non-cash items. This
was partially offset by a net change in operating assets and liabilities due to
reductions in income tax, accounts receivable, and inventory balances,
partially offset by a reduction in accounts payable and accrued liabilities,
and changes in other operating assets and liabilities. The reduction in income
tax is due to the collection of income tax refunds during the period. The
reduction in the remaining operating assets and liabilities is due to the
decline in revenue volumes and the associated size of the business for the six
months ended June 30, 2002, and the utilization of certain contract
manufacturer and supplier provisions and restructuring provisions.

During the six months ended June 30, 2002, we received approximately
$1,273 in tax refunds. This represents primarily all of the income tax refunds
that we expect to receive for the remainder of 2002. Any future income tax
payments are expected to be minimal versus historical levels until we utilize
our available income tax loss carryforwards and tax credits.

Cash flows used in investing activities were $224 for the six months ended
June 30, 2002, and were primarily due to expenditures for plant and equipment
of $208 and an increase of $105 in net long-term receivables, partially offset
by net proceeds on the sale of investments and businesses of $38, and the
proceeds on disposal of certain plant and equipment of $76, primarily related
to the sale of certain real estate in the United Kingdom.

Cash flows generated from financing activities were $734 for the six
months ended June 30, 2002, primarily due to $800 received from Nortel Networks
Corporation on June 28, 2002 in return for one common share, offset partially
by a net decrease in notes payable of $77.

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Uses of liquidity

Our cash requirements for the next 12 months are primarily to fund
operations, research and development, capital expenditures, workforce reduction
and restructuring activities, debt service, and customer financings. The
following provides additional information related to our uses of liquidity.

Special charges

The remaining cash outlays of $383 related to workforce reduction
initiatives are expected to be substantially completed by the second quarter of
2003, and the remaining cash payments of $644 related to contract settlement
and lease costs are expected to be substantially completed by the end of 2006.
Additional charges will be required in 2002 related to remaining announced
workforce reductions and related charges, and the restructuring of the Optical
Networks segment.

See Special charges for additional information.

Cash obligations

Our contractual cash obligations for long-term debt, outsourcing contracts
and operating leases as at June 30, 2002 remain substantially unchanged from
the amounts disclosed as at December 31, 2001 in our Annual Report on Form 10-K
for the year then ended.

Commitments and guarantees

We enter into bid and performance bonds related to various contracts,
which generally have terms of less than two years. Potential payments due
under these bonds are related to performance under the applicable contract.
Historically, we have not had to make material payments under these types of
bonds and we currently do not anticipate that we will be required to make
material payments under the current bonds. The total commercial commitments
representing amounts available and undrawn were $1,250 and $1,177 at June 30,
2002 and December 31, 2001, respectively. Due to the current general economic
and industry environment, and our current credit ratings, the basis under which
performance bonds are obtained has changed, resulting in (but not limited to)
increased cash collateral requirements and/or increased fees in connection with
obtaining new performance bonds. However, we currently do not expect that the
requirements and/or fees to obtain performance bonds will have a material
adverse effect on our ability to win contracts from potential customers. As at
June 30, 2002, approximately $32 of cash was restricted as cash collateral for
certain performance bonds. We expect the amount of cash we restrict as a
result of cash collateral requirements for new performance bonds will increase
during the second half of 2002.

We have also entered into supply contracts with customers for products and
services, which in some cases involve new technologies currently being
developed, or which we have not yet commercially deployed, or which require us
to build and operate networks on a turnkey basis. We have also entered into
network outsourcing contracts with customers to operate their networks. Some
of these supply and network outsourcing contracts contain delivery and
installation timetables, performance criteria and other contractual obligations
which, if not met, could result in our having to pay substantial penalties or
liquidated damages, the termination of the related supply or network
outsourcing contract, and/or the reduction of shared revenues under a turnkey
arrangement, in certain circumstances. As is customary for the industry, these
supply and networking outsourcing contracts are highly customized to address
each customers particular needs and concerns and, therefore, the nature of the
events triggering, as well as the actual amounts of the penalties, vary greatly
and are based on a variety of complex, interrelated factors, and may vary
significantly in amount over the life of the contract. We have not experienced
material penalty payments in any recent reporting period.

Further, certain of our supply arrangements with our contract
manufacturers were negotiated prior to the current industry and economic
downturn and, depending upon the extent and duration of this downturn, the
terms of these arrangements may not be achievable. To the extent that we fail
to meet any of these arrangements, and if we are unable to successfully
renegotiate the applicable arrangement, we may be obligated to indemnify the
contract manufacturer for certain direct costs attributable to our failure to
so perform. The actual amount of any such indemnification, which could be
substantial, would be based on a variety of complex, interrelated factors. The
failure to reach a satisfactory resolution of any such matter could have a
material adverse effect on our business, results of operations, financial
condition, and supply relationships.

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Customer financing

The following table provides information related to customer financing
commitments as at:

|                         |  |          |       |  |              |   |       | 
|------------------------ |  | -------- | ----- |  | ------------ | - | ----- | 
|                        
|                         |  | June 30, |       |  | December 31,
|                         |  | 2002     |       |  | 2001        
|                        
|                        
|Drawn and outstanding(a) |  | $        | 481   |  |              | $ | 464   | 
|                        
|                        
|                        
|                        
|Undrawn commitments      |  |          | 1,636 |  |              |   | 1,611 | 
|                        
|Total customer financing |  | $        | 2,117 |  |              | $ | 2,075 | 
|                        
|                        

|(a) |  | Net of provisions of $875 and $887 as at June 30, 2002, and December 31,
2001, respectively.
|--- |  | --------------------------------------------------------------------------------------------

We currently have customer financing commitments and balances outstanding
in connection with the turnkey construction of new networks, particularly third
generation, or 3G, wireless networks, and we may commit to provide additional
funding in the future if such financings are strategic to our core business
activities. Generally, customer financing arrangements may include financing
in connection with the sale of our products and services, as well as funding
for certain non-product and service costs associated with network installation
and integration of our products and services, and financing for working capital
purposes and equity financing.

We continue to regularly assess the levels of our customer financing
provisions based on a loan-by-loan review to evaluate whether they reflect
current market conditions, as well as the ability of our customers to meet
their repayment obligations and determine our provisions accordingly. Any
misinterpretation or misunderstanding of these factors could result in losses
in excess of our provisions. We also continue to restructure financings in an
effort to minimize losses and reduce undrawn commitments where possible. In
addition to being highly selective in providing customer financing, we have
various programs in place to monitor and mitigate customer credit risk,
including performance milestones and other conditions of funding. Management
is focused on the strategic use of our customer financing capacity, on
revolving that capacity as quickly and efficiently as possible, and on managing
the absolute dollar amount of our customer financing exposure.

Our ability to place customer financing with third-party lenders has been
significantly reduced due to, among other factors, reduced demand for
telecommunications financings in capital and bank markets as a result of
bankruptcies and financial difficulties in the industry, our recent credit
ratings downgrade, adverse changes in the credit ratings of our customers, and
recent economic downturns in various countries. As a result, we are currently
directly supporting, and expect to be required to support in the future, more
of such commitments and outstanding balances of such customer financings. We
will continue to seek to arrange for third-party lenders to assume our customer
financing obligations and to fund customer financings from working capital and
conventional sources of external financing in the normal course. However, our
customer financing commitments and balances outstanding may increase
substantially as a result of us continuing to hold such customer financings.

See Forward-looking statements for additional factors that may impact
our customer financing arrangements.

Discontinued operations

At June 30, 2002, the remaining accruals totalled $128 and were related to
certain future contractual obligations and estimated liabilities of the
discontinued access solutions operations, and estimated operating losses during
the planned period of disposition. The remaining accruals are expected to be
substantially drawn down by cash payments over the period of disposition, the
impact of which is expected to be offset by proceeds from the sale of certain
remaining assets to be disposed of. During the six months ended June 30, 2002
we generated cash of approximately $80 on the disposition of various assets
from the access solutions operations.

For additional information related to discontinued operations, see
Discontinued operations in note 4 to the accompanying unaudited consolidated
financial statements.

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Sources of liquidity

On April 12, 2000, Nortel Networks Limited and Nortel Networks Inc.
entered into five-year syndicated credit agreements, which permit borrowings in
an aggregate amount of up to $750. Effective April 8, 2002, Nortel Networks
Limited and Nortel Networks Inc. amended and extended the 364-day revolving
syndicated credit agreements originally entered into on April 12, 2000 and
subsequently amended on April 11, 2001. The April 8, 2002 amendments reduced
the size of the 364-day committed revolving facilities to $1,175 from $1,750
and extended the term to April 7, 2003 with no additional term-out period
thereafter. As a result, total borrowings currently permitted under these
syndicated five-year and 364-day credit agreements are $1,925. The amended
364-day facilities maintain the financial covenant in the April 2001 facilities
requiring Nortel Networks Limiteds consolidated tangible net worth at any time
to be not less than $1,888 and include higher pricing reflecting the then
current credit and bank environment. These credit facilities can be used for
borrowings for general corporate purposes.

Nortel Networks Limited and Nortel Networks Inc. also have 364-day credit
agreements with certain banks which permit borrowing in an aggregate amount of
up to $1,518 to December 13, 2002, with a one-year term out option to convert
outstanding amounts under the credit agreements into term loans on the
termination date of the credit agreements. On June 27, 2002, we sold certain
real estate in the United Kingdom, which resulted in a reduction, effective
July 2, 2002, in available commitments under these credit agreements by $57 to
$1,518.

The credit agreements for the $1,518 committed facilities noted above
contain financial covenants that require (i) the maintenance of a minimum
consolidated tangible net worth at the consolidated Nortel Networks Limited
level, and (ii) the achievement of certain minimum consolidated earnings before
interest, taxes, depreciation and amortization, or EBITDA, thresholds at the
Nortel Networks level, which began in the first quarter of 2002. The
consolidated tangible net worth of Nortel Networks Limited may not be less than
$1,880. The consolidated EBITDA covenant requires that we achieve a cumulative
EBITDA of negative $700 or better for the nine months ended September 30, 2002
and negative $350 or better for the full year ended December 31, 2002. In
addition, there are minimum EBITDA covenants in place for the first three
quarters of 2003, tested in quarterly increments during the period. Compliance
with this covenant will require EBITDA improvements during the third and fourth
quarters of 2002, and further improvements in the year thereafter. Certain
business restructuring charges and other incremental charges and gains as
publicly disclosed are excluded from the calculation of EBITDA. In addition,
these credit agreements contain covenants restricting additional debt, the
payment of dividends, corporate events, liens, sale and leasebacks, and
investments, among others. Payments of dividends on the outstanding preferred
shares of Nortel Networks Limited is permitted provided that compliance with
certain covenants of the credit agreements is maintained.

Any amounts subsequently drawn under all of Nortel Networks Limiteds and
Nortel Networks Inc.s existing credit agreements will be secured equally and
ratably with all of our current outstanding public debt securities pursuant to
the security documents which became effective following Moodys Investors
Services, Inc.s downgrade of Nortel Networks Limiteds United States senior
long-term debt rating below investment grade on April 4, 2002. The security is
comprised of liens on substantially all of the assets of Nortel Networks
Limited and those of most of its United States and Canadian subsidiaries, and
pledges of shares in certain of Nortel Networks Limiteds other subsidiaries.
In addition, certain of Nortel Networks Limiteds wholly owned subsidiaries
have provided guarantees of Nortel Networks Limiteds obligations under these
credit agreements. The security would be released when Nortel Networks
Limiteds United States senior long-term debt ratings return to Baa2 (with a
stable outlook) and BBB (with a stable outlook), as determined by Moodys
Investors Services, Inc. and Standard & Poors Ratings Service, respectively.

The liens, pledges, and guarantees described above also apply equally and
ratably to the obligations under Nortel Networks Corporations $1,800 4.25
percent convertible senior notes due on September 1, 2008.

For additional financial information related to those subsidiaries
providing guarantees, see Supplemental consolidating financial information in
note 17 of the accompanying unaudited consolidated financial statements.

As at June 30, 2002, we were in compliance with the covenants of our
credit agreements and had no amounts outstanding under any of the above-noted
credit agreements. Refer to the discussion below regarding our debt ratings
and see Forward-looking statements for factors that may affect our ability to
comply with covenants and conditions in our credit agreements in the future.
The above-noted 364-day credit agreements are scheduled to expire in December
2002 and

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April 2003. If we are unable to renew, extend, and/or replace such
facilities, or to do so on terms or at commitment levels equivalent to our
current facilities, the liquidity available to us could be reduced.

During the three months ended June 30, 2002, Nortel Networks Corporation
and Nortel Networks Limited filed a shelf registration statement with the
United States Securities and Exchange Commission and a base shelf prospectus
with the applicable securities regulatory authorities in Canada, for the
purpose of qualifying the potential sale by Nortel Networks Corporation or
Nortel Networks Limited from time to time in the United States and/or Canada of
up to an aggregate of $2,500 of various types of securities, including common
shares, preferred shares, debt securities, warrants to purchase equity or debt
securities, share purchase contracts, and share purchase or equity units
(subject to certain approvals). As at June 30, 2002, approximately $1,700 of
the $2,500 available has been utilized under the shelf registration statement
and the base shelf prospectus. Concurrently with the filing of the above shelf
registration statement and base shelf prospectus, Nortel Networks Limited and
its financing subsidiary withdrew an existing shelf registration statement
filed with the United States Securities and Exchange Commission under which
they were previously eligible to issue up to an aggregate of $1,000 of debt
securities and warrants to purchase debt securities.

The total debt to total capitalization ratio of Nortel Networks was 35
percent at June 30, 2002, compared to 34 percent at December 31, 2001. The
increase in the ratio at June 30, 2002, compared to December 31, 2001, was due
to the increase in our deficit as a result of the net losses for the six months
ended June 30, 2002, offset by the $800 received from Nortel Networks
Corporation on June 28, 2002.

Credit ratings

|                                  |  |                                       |  |                         |  |                |  |               |  |  |  | 
|--------------------------------- |  | ------------------------------------- |  | ----------------------- |  | -------------- |  | ------------- |  |  |  | 
|                                 
|                                  |  |                                       |  | Rating on preferred     |  |                |  |              
|                                  |  | Rating on long-term debt issued or    |  | shares issued by Nortel |  |                |  |              
|Rating agency                     |  | guaranteed by Nortel Networks Limited |  | Networks Limited        |  |                |  | Last update  
|                                 
|                                 
|Standard & Poors Ratings Service |  |                                       |  | BB-                     |  | Global scale B |  | April 9, 2002
|                                 
|Moodys Investor Services, Inc.   |  |                                       |  | Ba3                     |  | B3             |  | April 4, 2002
|                                 

The ratings remain on negative outlook by Moodys and Standard & Poors.
There can be no assurance that our credit ratings will not be lowered further
or that such ratings agencies will not issue adverse commentaries, resulting in
higher financing costs under our credit facilities and for other financings
generally, and reduced access to the capital markets or our credit agreements.
Our credit ratings also affect our ability, and the cost, to securitize
receivables and to obtain performance bonds.

See Forward-looking statements for effects of changes in respect of our
debt ratings.

During 2001 and the first six months of 2002, we took actions to
strengthen our cash and liquidity positions and as of June 30, 2002, our
primary source of liquidity is our current cash and cash equivalents. We
believe this cash will be sufficient to meet our working capital,
restructuring, capital expenditure, and investment requirements through the
next 12 months. If our revenues and cash flows are materially lower than we
expect, we may be required to further reduce capital expenditures and
investments in order to meet our cash requirements. We may seek additional
funds from liquidity-generating transactions and other conventional sources of
external financing (which may include a variety of debt, convertible debt,
and/or equity financings). We cannot provide any assurance that our net cash
requirements will be as we currently expect, that we will continue to have
access to our credit facilities when and as needed, or that
liquidity-generating transactions or financings will be available to us on
acceptable terms or at all.

See Forward-looking statements for factors that may affect our revenues,
cash flows and debt levels.

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Legal proceedings

Subsequent to the February 15, 2001 announcement in which Nortel Networks
Corporation provided revised guidance for financial performance for the 2001
fiscal year and the first quarter of 2001, Nortel Networks Corporation and
certain of its then current officers and directors were named as defendants in
more than twenty-five purported class action lawsuits. These lawsuits in the
United States District Courts for the Eastern District of New York, for the
Southern District of New York and for the District of New Jersey, and in the
provinces of Ontario, Quebec, and British Columbia in Canada, on behalf of
shareholders who acquired Nortel Networks Corporations securities as early as
October 24, 2000 and as late as February 15, 2001, allege, among other things,
violations of United States federal and Canadian provincial securities laws.
Securities regulatory authorities in Canada and the United States are also
reviewing these matters. On May 11, 2001, Nortel Networks Corporation filed
motions to dismiss and/or stay in connection with the three proceedings in
Quebec primarily based on the factual allegations lacking substantial
connection to Quebec and the inclusion of shareholders resident in Quebec in
the class claimed in the Ontario lawsuit. The plaintiffs in two of these
proceedings in Quebec obtained court approval for discontinuances of their
proceedings on January 17, 2002. The motion to dismiss and/or stay the third
proceeding was heard on November 6, 2001 and the court deferred any
determination on the motion to the judge who will hear the application for
authorization to commence a class proceeding. On December 6, 2001, Nortel
Networks Corporation filed a motion seeking leave to appeal that decision. The
motion for leave to appeal was dismissed on March 11, 2002. On October 16,
2001, an order in the Southern District of New York was filed consolidating
twenty-five of the related United States class action lawsuits into a single
case, appointing class plaintiffs and counsel for such plaintiffs. The
plaintiffs served a consolidated amended complaint on January 18, 2002. On
December 17, 2001, the defendants in the British Columbia action served notice
of a motion requesting the court to decline jurisdiction and to stay all
proceedings on the ground that British Columbia is an inappropriate forum. On
July 17, 2002, a purported class action lawsuit was filed in the Ontario
Superior Court of Justice, Commercial List, naming Nortel Networks Corporation,
certain of its current and former officers and directors, and its auditors as
defendants. The factual allegations in this Ontario claim are substantially
similar to the allegations in the consolidated amended complaint filed in the
United States District Court described above. This Ontario claim is on behalf
of all Canadian residents who purchased Nortel Networks Corporations
securities (including options on Nortel Networks Corporations securities)
between October 24, 2000 and February 15, 2001. The plaintiffs claim damages
of Cdn. $5,000, plus punitive damages in the amount of Cdn. $1,000, prejudgment
and postjudgment interest, and costs of the action. Nortel Networks
Corporation and the named directors and officers of Nortel Networks Corporation
intend to vigorously defend this Ontario claim.

A class action lawsuit was also filed in the United States District Court
for the Southern District of New York on behalf of shareholders who acquired
the securities of JDS Uniphase Corporation between January 18, 2001 and
February 15, 2001, alleging violations of the same United States federal
securities laws as the above-noted lawsuits.

On April 1, 2002, Nortel Networks Corporation filed a motion to dismiss
both the above consolidated United States shareholder class action and the
above JDS Uniphase shareholder class action complaints on the grounds that they
failed to state a cause of action under United States federal securities laws.
With respect to the JDS Uniphase shareholder class action complaint, Nortel
Networks Corporation also moved to dismiss on the separate basis that JDS
Uniphase shareholders lacked standing to sue Nortel Networks Corporation.

A purported class action lawsuit was filed in the United States District
Court for the Middle District of Tennessee on December 21, 2001, on behalf of
participants and beneficiaries of the Nortel Networks Long-Term Investment
Plan, or the Plan, at any time during the period of March 7, 2000 through the
filing date and who made or maintained Plan investments in Nortel Networks
Corporations common shares, under the Employee Retirement Income Security Act
for Plan-wide relief and alleging, among other things, material
misrepresentations and omissions to induce Plan participants to continue to
invest in and maintain investments in Nortel Networks Corporations common
shares in the Plan. A second purported class action lawsuit, on behalf of the
Plan and Plan participants for whose individual accounts the Plan purchased
Nortel Networks Corporations common shares during the period from October 27,
2000 to February 15, 2001, and making similar allegations, was filed in the
same court on March 12, 2002. A third purported class action lawsuit, on behalf
of persons who are or were Plan participants or beneficiaries at any time since
March 1, 1999 to the filing date, and making similar allegations, was filed in
the same court on March 21, 2002. The first and second purported class action
lawsuits were consolidated by a new purported class action complaint, filed on
May 15, 2002 in the same court and making similar allegations, on behalf of
Plan participants and beneficiaries who directed the Plan to purchase or hold
shares of certain funds, which held primarily Nortel Networks Corporation
common shares, during the period of March 7, 2000 through December 31, 2000.

47



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On February 12, 2001, Nortel Networks Inc., a direct subsidiary of Nortel
Networks Limited, was served with a consolidated amended class action complaint
that purported to add Nortel Networks Corporation as a defendant to a lawsuit
commenced in July 2000 against Entrust, Inc. (formerly Entrust Technologies,
Inc.) and two of its then current officers in the United States District Court
for the Eastern District of Texas (Marshall Division), or the District Court.
This complaint alleges that Entrust, two officers of Entrust, and Nortel
Networks Corporation violated the Securities Exchange Act of 1934 with respect
to certain statements made by Entrust. Nortel Networks Corporation is alleged
to be a controlling person of Entrust. On April 6, 2001, Nortel Networks
Corporation filed a motion to dismiss the first complaint. On July 31, 2001,
the first complaint was dismissed without prejudice. On August 31, 2001, the
plaintiffs filed a second amended class action complaint against the same
defendants asserting claims substantively similar to those in the first
complaint. On September 21, 2001, Nortel Networks Corporation filed a motion
to dismiss this second complaint. The motion is currently under consideration
by the District Court.

On March 4, 1997, Bay Networks, Inc., a company acquired on August 31,
1998, announced that shareholders had filed two separate lawsuits in the United
States District Court for the Northern District of California, or the Federal
Court, and the California Superior Court, County of Santa Clara, or the
California Court, against Bay Networks and ten of Bay Networks then current
and former officers and directors, purportedly on behalf of a class of
shareholders who purchased Bay Networks common shares during the period of May
1, 1995 through October 14, 1996. On August 17, 2000, the Federal Court
granted the defendants motion to dismiss the federal complaint. On August 1,
2001, the United States Court of Appeals for the Ninth Circuit denied the
plaintiffs appeal of that decision. On April 18, 1997, a second lawsuit was
filed in the California Court, purportedly on behalf of a class of shareholders
who acquired Bay Networks common shares pursuant to the registration statement
and prospectus that became effective on November 15, 1995. The two actions in
the California Court were consolidated in April 1998; however, the California
Court denied the plaintiffs motion for class certification. In January 2000,
the California Court of Appeal rejected the plaintiffs appeal of the decision.
A petition for review was filed with the California Supreme Court by the
plaintiffs and was denied. In February 2000, new plaintiffs who allege to have
been shareholders of Bay Networks during the relevant periods, filed a motion
for intervention in the California Court seeking to become the representatives
of a class of shareholders. The motion was granted on June 8, 2001 and the new
plaintiffs filed their complaint-in-intervention on an individual and purported
class representative basis alleging misrepresentations made in connection with
the purchase and sale of securities of Bay Networks in violation of California
statutory and common law. On March 11, 2002, the California Court granted the
defendants motion to strike the class allegations. The plaintiffs were
permitted to proceed on their individual claims. The plaintiffs are appealing
the dismissal of their class allegations.

Except as disclosed above, in each of the matters described above,
plaintiffs are seeking an unspecified amount of money damages.

We are also a defendant in various other suits, claims, proceedings and
investigations which arise in the normal course of business.

We are unable to ascertain the ultimate aggregate amount of monetary
liability or financial impact of the above matters which seek damages of
material or indeterminate amounts, and therefore cannot determine whether these
actions, suits, claims, proceedings and investigations will, individually or
collectively, have a material adverse effect on our business, results of
operations, and financial condition. We and any of our named directors and
officers intend to vigorously defend these actions, suits, claims, proceedings
and investigations.

Environmental matters

We, primarily as a result of our manufacturing operations, are subject to
numerous environmental protection laws and regulations in various jurisdictions
around the world, and are exposed to liabilities and compliance costs arising
from our past and current generation, management and disposition of hazardous
substances and wastes.

We have remedial activities under way at five of our facilities and seven
previously occupied sites. An estimate of our anticipated remediation costs
associated with all such facilities and sites, to the extent probable and
reasonably estimable, is included in our environmental accruals in an
approximate amount of $29.

48



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For a discussion of Environmental matters, see Environmental matters in
note 17 to Nortel Networks Limiteds audited consolidated financial statements
and notes thereto for the year ended December 31, 2001.

Forward-looking statements

Certain information and statements contained in this Managements
Discussion and Analysis of Financial Condition and Results of Operations and
other sections of this report, including statements containing words such as
could, expects, may, anticipates, believes, intends, estimates,
plans, and similar expressions, are forward-looking statements. These
address our business, results of operations, and financial condition, and
include statements based on current expectations, estimates, forecasts, and
projections about the operating environment, economies and markets in which we
operate and our beliefs and assumptions regarding such operating environment,
economies and markets. In addition, we or others on our behalf may make other
written or oral statements which constitute forward-looking statements. This
information and such statements are subject to important risks, uncertainties,
and assumptions, which are difficult to predict. The results or events
predicted in these statements may differ materially from actual results or
events. Some of the factors which could cause results or events to differ from
current expectations include, but are not limited to, the factors set forth
below. Except as otherwise required by applicable securities laws, we disclaim
any intention or obligation to publicly update or revise any forward-looking
statements, whether as a result of new information, future events or otherwise.

We have restructured 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.

In response to changes in industry and market conditions, we have
restructured our business in the past, are currently restructuring our
business, and may again restructure our business in the future to achieve
certain cost savings and to strategically realign our resources. We have based
our work plan pertaining to the restructuring on certain assumptions regarding
the cost structure of our business and the nature, severity, and duration of
the current industry adjustment which may not prove to be accurate. We have
stated that we will continue to assess our work plan based on an ongoing
assessment of the industry adjustment.

While restructuring, we have assessed, and will continue to assess,
whether we should dispose of or otherwise exit businesses or further reduce our
workforce, as well as review the recoverability of our tangible and intangible
assets associated with those businesses. Any decision to further limit
investment or to dispose of or otherwise exit businesses may result in the
recording of additional charges, such as workforce reduction costs, facilities
reduction costs, asset write downs, and contractual settlements. Additionally,
estimates and assumptions used in asset valuations are subject to
uncertainties, as are accounting estimates with respect to the useful life and
ultimate recoverability of our carrying basis of assets, including goodwill and
other intangible assets. As a result, future market conditions may result in
further charges for the write down of tangible and intangible assets.

We may not be able to successfully implement the initiatives we have undertaken
in restructuring our business and, even if successfully implemented, these
initiatives may not be sufficient to meet the changes in industry and market
conditions and to achieve future profitability.

We must successfully implement our work plan if we are to adjust our cost
structure to reflect current and expected future economic conditions, market
demands and revenues, and to achieve future profitability. We must also manage
the potentially higher growth areas of our business, as well as the non-core
areas of our business, effectively in light of current and expected future
market demands and trends.

Under our work plan, we have also implemented a number of initiatives,
including exiting businesses and writing down our tangible and intangible
assets, to streamline our business, and to focus our investments on delivering
what we believe to be the key next-generation networking solutions. However,
our work plan, including workforce reductions, may not be sufficient to meet
the changes in industry and market conditions, and such conditions may continue
to deteriorate or last longer than we expect. In addition, we may not be able
to successfully implement our work plan and may be required to refine, expand
or extend our work plan. Furthermore, our workforce reductions may impair our
ability to realize our current or future business objectives. Lastly, costs
actually incurred in connection with restructuring actions may be higher than
the estimated costs of such actions and/or may not lead to the anticipated cost
savings. As a result, our restructuring efforts may not result in our return
to profitability within the currently expected timeframe.

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We may be materially and adversely affected by continued reductions in spending
on telecommunications infrastructure by our customers.

A continued slowdown in capital spending by service providers may affect
our revenues more than we currently expect. Moreover, the significant slowdown
in capital spending by service providers has created uncertainty as to market
demand. As a result, revenues and operating results for a particular period
can be difficult to predict. In addition, there can be no certainty as to the
severity or duration of the current industry adjustment. Many of our
traditional customers have already begun to invest in data networking and/or
are in the process of transitioning from voice-only networks to networks which
include data traffic. However, as a result of changes in industry and market
conditions, many of our customers have reduced their capital spending on
telecommunications infrastructure. Our revenues and operating results have
been and may continue to be materially and adversely affected by the continued
reductions in capital spending on telecommunications infrastructure by our
customers. If the reduction of capital spending continues longer than we
expect and we continue to incur net losses as a result, we may be unable to
comply with certain covenants under our current credit agreements. As well, we
have focused on the larger customers in our markets, which provide a
substantial portion of our revenues. A reduction or delay in business from one
or more of these customers, or a failure to achieve a significant market share
with these customers, could have a material adverse effect on our business,
results of operations, and financial condition.

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

Our operating results have historically been and are expected to continue
to be subject to quarterly and yearly fluctuations as a result of a number of
factors. These factors include:



| |  |  | 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 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;                                                                                                                                                                                                                                                                                                                                   
|
| |  |  | the inherent uncertainties of using estimates and assumptions for
asset valuations and in determining the amounts of accrued liabilities
and other items in our consolidated financial statements;                                                                                                                                                                                                    
|
| |  |  | our ability to implement our work plan without negatively impacting
our relationships with our customers, the delivery of products based on
new and developing technologies, the delivery of high quality robust
products at competitive prices, the maintenance of technological
leadership, the effectiveness of our internal processes and
organizations, and the retention of qualified personnel;
|
| |  |  | 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;                                                                                                                                                                                                                                    
|
| |  |  | variations in sales channels, product costs, and the mix of products sold;                                                                                                                                                                                                                                                                                                                            
|
| |  |  | the size and timing of customer orders and shipments;                                                                                                                                                                                                                                                                                                                                                 
|
| |  |  | our ability to maintain appropriate inventory levels;                                                                                                                                                                                                                                                                                                                                                 

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| |  |  | the impact of acquired businesses and technologies; and                                                                  
| | - |  | -------------------------------------------------------------------------------------------------------------------------
|
| |  |  | the impact of our product development schedules, manufacturing
capacity, and lead times required to produce our products.

Additionally, we are required to perform goodwill impairment tests on an
annual basis and between annual tests in certain circumstances, which may
result in a charge to net earnings (loss).

Significant fluctuations in our operating results could contribute to
volatility in the market price of Nortel Networks Corporations common shares.

Economic conditions in the United States, Canada, and globally, affecting the
telecommunications industry, as well other trends and factors affecting the
telecommunications industry, are beyond our control and may result in reduced
demand and pricing pressure on our products.

There are trends and factors affecting the telecommunications industry,
which are beyond our control and may affect our operations. Such trends and
factors include:



| |  |  | 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 our credit rating, or the credit ratings of our customers and suppliers;                                                                                                                       
|
| |  |  | adverse changes in the market conditions in our industry and the specific markets for our products;                                                                                                               
|
| |  |  | the trend towards the sale of integrated networking solutions;                                                                                                                                                    
|
| |  |  | 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;                                                      
|
| |  |  | governmental regulation or intervention affecting communications or
data networking; and                                                                                                                          
|
| |  |  | the effects of war and acts of terrorism, such as disruptions in
general global economic activity, changes in logistics and security
arrangements, and reduced customer demand for our products and services.     

Economic conditions affecting the telecommunications industry, which
affect market conditions in the telecommunications and networking industry, in
the United States, Canada and globally, affect our business. Reduced capital
spending and/or negative economic conditions in the United States, Canada,
Europe, Asia, Latin America and/or other areas of the world could result in
reduced demand for or pricing pressure on our products.

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Our gross margins may be negatively affected, which in turn would negatively
affect our operating results and could contribute to volatility in the market
price of Nortel Networks Corporations common shares.

Our gross margins may be negatively affected as a result of a number of factors, including:



| |  |  | increased price competition;                                                            
| | - |  | ----------------------------------------------------------------------------------------
|
| |  |  | excess capacity;                                                                        
|
| |  |  | higher material or labour costs;                                                        
|
| |  |  | warranty costs;                                                                         
|
| |  |  | obsolescence charges;                                                                   
|
| |  |  | loss of cost savings on future inventory purchases as a result of high inventory levels;
|
| |  |  | introductions of new products and costs of entering new markets;                        
|
| |  |  | increased levels of customer services;                                                  
|
| |  |  | changes in distribution channels; and                                                   
|
| |  |  | changes in product and geographic mix.                                                  

Lower than expected gross margins would negatively affect our operating
results and could contribute to volatility in the market price of Nortel
Networks Corporations common shares.

We may not be able to attract or retain the specialized technical and
managerial personnel necessary to achieve our business objectives.

Competition for certain key positions and specialized technical personnel
in the high-technology industry is intense, despite current economic
conditions. We believe that our future success depends in part on our
continued ability to hire, assimilate, and retain qualified personnel in a
timely manner, particularly key members of senior management and in our key
areas of potential growth. A key factor in attracting and retaining qualified
employees is our ability to provide employees with the opportunity to
participate in the potential growth of our business through programs such as
stock option plans and employee investment plans. The value of these
opportunities may be adversely affected by the volatility or negative
performance of the market price for Nortel Networks Corporations common
shares. We may also find it more difficult to attract or retain qualified
employees because of our recent significant workforce reductions and business
performance. In addition, if we have not properly sized our workforce and
retained those employees with the appropriate skills, our ability to compete
effectively may be adversely affected. We are also more dependent on those
employees we have retained, as many have taken on increased responsibilities
due to the workforce reductions. If we are not successful in attracting,
retaining or recruiting qualified employees, including members of senior
management, in the future, we may not have the necessary personnel to
effectively compete in the highly dynamic, specialized and volatile industry in
which we operate or to achieve our business objectives.

Future cash flow fluctuations may affect our ability to fund our working
capital requirements or achieve our business objectives in a timely manner.

Our working capital requirements and cash flows historically have been,
and are expected to continue to be, subject to quarterly and yearly
fluctuations, depending on such factors as timing and size of capital
expenditures, levels of sales, timing of deliveries and collection of
receivables, inventory levels, customer payment terms, customer financing
obligations, and supplier terms and conditions. Our inability to manage cash
flow fluctuations resulting from such factors could have a

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material adverse
effect on our ability to fund our working capital requirements from operating
cash flows and other sources of liquidity or to achieve our business objectives
in a timely manner.

Our business may be materially and adversely affected by our increased levels
of debt.

In order to finance our business we have incurred, have entered into
credit facilities allowing for drawdowns of, and filed a shelf registration
statement and base shelf prospectus for potential offerings of, significant
levels of debt compared to historical levels, and we may need to secure
additional sources of funding, which may include debt or convertible debt
financing, in the future. A high level of debt, arduous or restrictive terms
and conditions relating to accessing certain sources of funding, failure to
meet certain covenants under our credit agreements, poor business performance
or lower than expected cash inflows could have adverse consequences on our
ability to fund our business and the operation of our business.

In particular, certain of such credit agreements contain financial
covenants that require the maintenance of a minimum consolidated tangible net
worth and the achievement of certain minimum consolidated earnings before
interest, taxes, depreciation and amortization (EBITDA) thresholds. The
consolidated tangible net worth of Nortel Networks Limited may not be less than
$1,888 at any time. The consolidated EBITDA covenant requires that we achieve
a cumulative EBITDA of negative $700 or better for the nine months ended
September 30, 2002 and negative $350 or better for the full year ended December
31, 2002. In addition, there are minimum EBITDA covenants in place for the
first three quarters of 2003, tested in quarterly increments during the period.
Compliance with this covenant will require EBITDA improvements during the
third and fourth quarters of 2002, and further improvements in the year
thereafter. Certain business restructuring charges and other incremental
charges and gains as publicly disclosed are excluded from the calculation of
EBITDA. In addition, these credit agreements contain covenants restricting
additional debt, the payment of dividends, corporate events, liens, sale and
leasebacks, and investments, among others. Payments of dividends on the
outstanding preferred shares of Nortel Networks Limited is permitted provided
that compliance with certain covenants of the credit agreements is maintained.
If we continue to incur net losses, we may be unable to comply with certain of
our covenants under the credit agreements, which could adversely affect the
liquidity available to us. Our principal credit facilities are scheduled to
expire in December 2002 and April 2003. If we are unable to renew, extend,
and/or replace such facilities, or to do so on terms or at commitment levels
equivalent to our current facilities, the liquidity available to us could be
reduced.

Other effects of a high level of debt include the following:



| |  |  | we may have difficulty borrowing money in the future, or accessing
sources of funding, including our credit facilities;                                                                                                                                                                                                                                                                                                                        
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | 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, research and development projects, or product
design enhancements.

Changes in respect of our public debt ratings may materially and adversely
affect the availability, the cost, and the terms and conditions of our debt and
asset-based financings.

Certain of our outstanding debt instruments are publicly rated by
independent rating agencies, which ratings are now below investment grade.
These public debt ratings affect our ability to raise debt, our access to the
commercial paper market (which is currently closed to us), our ability to
engage in asset-based financing, and our ability to obtain performance bonds.
These public debt ratings also may negatively affect the cost to us and terms
and conditions of debt and asset-based financings. Additionally, any negative
developments regarding our cash flow, public debt ratings and/or our incurring
significant levels of debt, or our failure to meet certain covenants under our
credit agreements, could cause us to lose access

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to, and/or cause a default
under certain of our credit facilities and adversely affect further the cost
and terms and conditions of our debt and asset-based financings.

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

We expect that data communications traffic will grow at a faster rate than
the growth expected for voice traffic, and that the use of the Internet will
continue to increase. We expect the growth of data traffic and the use of the
Internet will significantly impact traditional voice networks, both wireline
and wireless. We believe that this will create market discontinuities. By
market discontinuities, we mean opportunities for new technologies,
applications, products and services that enable the secure, rapid, and
efficient transport of large volumes of data traffic over networks and allow
service providers and carriers to increase revenues and improve operating
results. Market discontinuities will also make traditional voice network
products and services less effective as they were not designed for data
traffic. We believe that these market discontinuities in turn will lead to the
convergence of data and voice through upgrades of traditional voice networks to
transport large volumes of data traffic or through the construction of new
networks designed to transport both voice and data traffic. Either approach
would require significant capital expenditures by service providers and
carriers. We also believe that such developments will give rise to the demand
for Internet Protocol-, or IP-, optimized networking solutions, and third
generation, or 3G, wireless networks. Internet Protocol is the predominant
method by which data is sent from one computer to another on the Internet  a
data message is divided into smaller packets which contain both the senders
unique IP address and the receivers unique IP address, and each packet is
sent, potentially by different routes and as independent units, across the
Internet. There is no continuing connection between the end points which are
communicating versus traditional telephone communications which involve
establishing a fixed circuit that is maintained for the duration of the voice
or data communications call. 3G wireless networks are an evolution of
communications networks from second generation wireless networks for voice and
low speed data communications that are based on circuit switching  when a call
is dialed, a circuit is established between the mobile handset and the third
party, and the connection lasts for the duration of the call. By comparison,
3G networks allow devices to be always on because the networks are
packet-based. We expect 3G networks to include such features as voice, high
speed data communications and high bandwidth multimedia capabilities, and
usability on a variety of different communications devices, such as cellular
telephones and pagers, with the user having accessibility anywhere and at any
time to these features.

We cannot be sure what the rate of such convergence of voice and data
networks will be, due to the dynamic and rapidly evolving nature of the
communications business, the technology involved and the availability of
capital. Consequently, market discontinuities and the resulting demand for
IP-optimized networking solutions or 3G wireless networks may not materialize.
Alternatively, the pace of that development may be slower than currently
anticipated. It may also be the case that the market may develop in an
unforeseen direction. Certain events, including the commercial availability
and actual implementation of new technologies, including 3G networks, or the
evolution of other technologies, may occur which would affect the extent or
timing of anticipated market demand, or increase demand for products based on
other technologies, or reduce the demand for IP-optimized networking solutions
or 3G wireless networks, which in turn may reduce purchases of our networking
solutions by our customers, require increased expenditures to develop and
market different technologies, or provide market opportunities for our
competitors. Our performance may also be materially and adversely affected by
a lack of growth in the rate of data traffic, a reduction in the use of the
Internet or a reduction in the demand for IP-optimized networking solutions or
3G wireless networks in the future.

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

In the past, we acquired companies to enhance the expansion of our
business and products. We may consider selective opportunistic acquisitions of
companies or businesses with resources and product or service offerings capable
of providing us with additional strengths to help fulfill our vision of
building the new, high-performance Internet. Acquisitions involve significant
risks and uncertainties. These risks and uncertainties include:



| |  |  | the risk that the industry may develop in a different direction than
anticipated and that the technologies we acquire do not prove to be
those we need to be successful in the industry;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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| |  |  | the risk that future valuations of acquired businesses may decrease
from the market price we paid for these acquisitions;                                                       
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | the generation of insufficient revenues by acquired businesses to
offset increased operating expenses associated with these acquisitions;                                       
|
| |  |  | the potential difficulties in completing in-process research and
development projects and delivering high quality robust products to our
customers;                             
|
| |  |  | the potential difficulties in integrating new products, businesses
and operations in an efficient and effective manner;                                                         
|
| |  |  | the risk that 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;
|
| |  |  | the potential loss of key employees of the acquired businesses;                                                                                                                 
|
| |  |  | the risk that acquired businesses will divert the attention of our
senior management from the operation of our business; and                                                    
|
| |  |  | the risks of entering new markets in which we have limited experience
and where competitors may have a stronger market presence.                                                

Our inability to successfully operate and integrate newly-acquired
businesses appropriately, effectively and in a timely manner could have a
material adverse effect on our ability to take advantage of further growth in
demand for IP-optimized network solutions and other advances in technology, as
well as on our revenues, gross margins, and expenses.

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.

The markets for our products are characterized by rapidly changing
technologies, evolving industry standards, frequent new product introductions
and short product life cycles. We expect our success to depend, in substantial
part, on the timely and successful introduction of high quality, new products
and upgrades, as well as cost reductions on current products to address the
operational speed, bandwidth, efficiency, and cost requirements of our
customers. Our success will also depend on our ability to comply with emerging
industry standards, to operate with products of other suppliers, to address
emerging market trends, to provide our customers with new revenue-generating
opportunities and to compete with technological and product developments
carried out by others. The development of new, technologically advanced
products, including IP-optimized networking solutions and 3G wireless networks,
is a complex and uncertain process requiring high levels of innovation, as well
as the accurate anticipation of technological and market trends. Investments
in such development may result in expenses growing at a faster rate than
revenues, particularly since the initial investment to bring a product to
market may be high. We may not be successful in targeting new market
opportunities, in developing and commercializing new products in a timely
manner, or in achieving market acceptance for our new products.

The success of new or enhanced products, including IP-optimized networking
solutions and 3G wireless networks, depends on a number of other factors,
including the timely introduction of such products, market acceptance of new
technologies and industry standards, the quality and robustness of new or
enhanced products, competing product offerings, the pricing and marketing of
such products, and the availability of funding for such networks. Products and
technologies developed by our competitors may render our products obsolete.
Hackers may attempt to disrupt or exploit our customers use of our
technologies. If we fail to respond in a timely and effective manner to
unanticipated changes in one or more of the technologies affecting
telecommunications and data networking or our new products or product
enhancements fail to achieve market acceptance, our ability to compete
effectively in our industry, and our sales, market share, and customer
relationships could be materially and adversely affected.

In addition, unanticipated changes in market demand for products based on
a specific technology, particularly lower than anticipated, or delays in,
demand for IP-optimized networking solutions, particularly long-haul and metro
optical

55



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networking solutions, or 3G wireless networks, could have a material
adverse effect on our business, results of operations, and financial condition
if we fail to respond to such changes in a timely and effective manner.

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

We operate in a highly volatile industry that is characterized by vigorous
competition for market share and rapid technological development. Competition
is heightened in periods of slow overall market growth. These factors could
result in aggressive pricing practices and growing competition from smaller
niche companies, established competitors, as well as well-capitalized computer
systems and communications companies, which, in turn, could have a material
adverse effect on our gross margins.

Our principal competitors in the sale of our Metro and Enterprise Networks
products to service providers are large communications companies such as
Alcatel S.A., Fujitsu Limited, Telefonaktiebolagat LM Ericsson, Lucent
Technologies Inc., and Siemens Aktiengesellschaft. In addition, we compete
with smaller companies that address specific niches within this market, such as
Ciena Corporation (who recently combined with ONI Systems Corp), Sonus Systems
Limited, and Redback Networks Inc. Our principal competitors in the sale of
our Metro and Enterprise Networks solutions to enterprises are Alcatel, Avaya
Inc., Cisco Systems, Inc., Ericsson, and Siemens. We also compete with smaller
companies that address specific niches, such as Foundry Networks, Inc., Extreme
Networks, Inc., Enterasys Networks, Inc., 3Com Corporation, and Genesys
Telecommunications Laboratories, Inc. Our major competitors in the global
wireless infrastructure business have traditionally included Ericsson, Lucent,
Motorola, Inc., and Nokia Corporation. More recently, Siemens and Samsung
Electronics Co., Ltd. have emerged as competitors. Our major competitors in
the sale of long-distance optical networking equipment include Alcatel, Ciena,
Fujitsu, Lucent, and Marconi plc. Since some of the markets in which we
compete are characterized by the potential for rapid growth and, in certain
cases, low barriers to entry and rapid technological changes, smaller,
specialized companies and start-up ventures are now or may become principal
competitors in the future. We may also face competition from the resale of
used telecommunications equipment, including our own on occasion, by failed,
downsized or consolidated high technology enterprises and telecommunications
service providers. In addition, one way to maximize market growth, enhance
existing products and introduce new products is through acquisitions of
companies, where advisable. Our acquisitions of other companies may cause
certain of our competitors to enter into additional business combinations, to
accelerate product development, or to engage in aggressive price reductions or
other competitive practices, creating even more powerful or aggressive
competitors.

We expect that we will face additional competition from existing
competitors and from a number of companies that have entered or may enter our
existing and future markets. Some of our current and potential competitors
have greater marketing, technical and financial resources, including access to
capital markets and/or the ability to provide customer financing in connection
with the sale of products. Many of our current and potential competitors have
also established, or may in the future establish, relationships with our
current and potential customers. Other competitive factors include the ability
to provide new technologies and products, end-to-end networking solutions, and
new product features, as well as conformance to industry standards. Increased
competition could result in price reductions, negatively affecting our
operating results, reducing profit margins and potentially leading to a loss of
market share.

We face certain barriers in our efforts to expand internationally.

We intend to continue to pursue international and emerging market growth
opportunities. In many international markets, long-standing relationships
between potential customers and their local suppliers and protective
regulations, including local content requirements and type approvals, create
barriers to entry. In addition, pursuing international opportunities may
require significant investments for an extended period before we realize
returns on such investments, if any, and such investments may result in
expenses growing at a faster rate than revenues. Furthermore, such projects
and investments could be adversely affected by:



| |  |  | reversals or delays in the opening of foreign markets to new competitors;
| | - |  | -------------------------------------------------------------------------
|
| |  |  | trade protection measures;                                               
|
| |  |  | exchange controls;                                                       

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| |  |  | currency fluctuations;                           
| | - |  | -------------------------------------------------
|
| |  |  | investment policies;                             
|
| |  |  | restrictions on repatriation of cash;            
|
| |  |  | nationalization of local industry;               
|
| |  |  | economic, social and political risks;            
|
| |  |  | taxation;                                        
|
| |  |  | interest rates; and                              
|
| |  |  | other factors, depending on the country involved.

Difficulties in foreign financial markets and economies and of foreign
financial institutions, particularly in emerging markets, could adversely
affect demand from customers in the affected countries. An inability to
maintain or expand our business in international and emerging markets could
have a material adverse effect on our business, results of operations, and
financial condition.

Fluctuating foreign currencies may negatively impact our business, results of
operations, and financial condition.

As an increasing proportion of our business may be denominated in
currencies other than United States dollars, fluctuations in foreign currencies
may have an impact on our business, results of operations, and financial
condition. Our primary currency exposures are to Canadian dollars, United
Kingdom pounds, and the Euro. These exposures may change over time as we
change the geographic mix of our global business and as our business practices
evolve. For instance, if we increase our presence in emerging markets, we may
see an increase in our exposure to such emerging market currencies, such as,
for example, the Chinese renminbi. These currencies may be affected by
internal factors, and external developments in other countries, all of which
can have an adverse impact on a countrys currency. We cannot predict whether
foreign exchange losses will be incurred in the future, and significant foreign
exchange fluctuations may have a material adverse effect on our results of
operations.

We may become involved in disputes regarding intellectual property rights that
could materially and adversely affect our business if we do not prevail.

Our industry is subject to uncertainty over adoption of industry standards
and protection of intellectual property rights. Our success is dependent on our
proprietary technology, which we rely on patent, copyright, trademark and trade
secret laws to protect. While our business is global in nature, the level of
protection of our proprietary technology provided by such laws varies by
country. Our issued patents may be challenged, invalidated, or circumvented,
and our rights under issued patents may not provide us with competitive
advantages. Patents may not be issued from pending applications, and claims in
patents issued in the future may not be sufficiently broad to protect our
proprietary technology. In addition, claims of intellectual property
infringement or trade secret misappropriation may be asserted against us or our
customers in connection with their use of our products, and the outcome of any
such claims are uncertain. A failure by us to react to changing industry
standards, the lack of broadly-accepted industry standards, successful claims
of intellectual property infringement or other intellectual property claims
against us or our customers, or a failure by us to protect our proprietary
technology, could have a material adverse effect on our business, results of
operations, and financial condition. In addition, if others infringe on our
intellectual property rights, we may not be able to successfully contest such
challenges.

Rationalization and consolidation in the telecommunications industry may cause
us to experience a loss of customers.

The telecommunications industry has experienced the consolidation and
rationalization of industry participants and we expect this trend to continue.
There have been adverse changes in the public and private equity and debt
markets for telecommunications industry participants which have affected their
ability to obtain financing or to fund capital expenditures. Some operators
have experienced financial difficulty and have, or may, file for bankruptcy
protection or be acquired by other

57



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operators. Other operators may merge and we
and one or more of our competitors may each supply products to the companies
that have merged or will merge. This rationalization/consolidation could
result in our dependence on a smaller number of customers, purchasing decision
delays by the merged companies and/or our playing a lesser role, or no longer
playing a role, in the supply of communications products to the merged
companies. In addition, telecommunications
equipment suppliers may enter into business combinations, or may be
acquired by or sell a substantial portion of their assets to other competitors,
resulting in accelerated product development, increased financial strength, or
a broader base of customers, creating even more powerful or aggressive
competitors. We may also see rationalization among equipment/component
suppliers. The business failures of operators, competitors or suppliers may
cause uncertainty among investors and in the telecommunications market
generally.

Changes in regulation of the Internet may affect the manner in which we conduct
our business and may materially and adversely affect our business, results of
operations, and financial condition.

There are currently few domestic or international laws or regulations that
apply directly to access to or commerce on the Internet. We could be
materially and adversely affected by regulation of the Internet in any country
where we operate in respect of such technologies as voice over the Internet,
encryption technology and access charges for Internet service providers. We
could also be materially and adversely affected by increased competition as a
result of the continuing deregulation of the telecommunications industry. If a
jurisdiction in which we operate adopts measures which affect the regulation of
the Internet or the deregulation of the telecommunications industry, we could
experience both decreased demand for our products and increased costs of
selling such products. Changes in laws or regulations governing the Internet
and Internet commerce could have a material adverse effect on our business,
results of operations, and financial condition.

We have provided and may continue to provide significant financing to our
customers. The current downturn in the economy increases our exposure to our
customers credit risk and the risk that our customers will not be able to
fulfill their payment obligations.

The competitive environment in which we operate has required us in the
past, and we expect may continue to require us in the future, to provide
significant amounts of medium-term and long-term customer financing. Customer
financing arrangements may include financing in connection with the sale of our
products and services, funding for certain non-product and service costs
associated with network installation and integration of our products and
services, financing for working capital and equity financing. We may provide
customer financing in the future for such customer requirements as turnkey
construction of new networks, particularly for 3G wireless operators. If we
do, we may be required to directly hold a significantly greater amount of such
financings than in the past, when we were able to place a large amount of our
customer financing obligations with third party lenders.

We expect to continue to hold certain current and future customer
financing obligations for longer periods prior to any possible placement with
third-party lenders, due to, among other factors, recent economic uncertainty
in various countries, adverse capital market conditions, adverse changes in the
credit ratings of our customers or ourselves, and reduced demand for
telecommunications financing in capital and bank markets. In addition, risks
generally associated with customer financing, including the risks associated
with new technologies, new network construction, market demand and competition,
customer business plan viability and funding risks, may require us to hold
certain customer financing obligations over a longer term. We may not be able
to place any of our current or future customer financing obligations with
third-party lenders on acceptable terms.

Recently, certain of our customers, including a number of competitive
local exchange carriers, have been experiencing financial difficulties, and
during the third and fourth quarters of 2001, we noted the amount of customer
financing with respect to which customers that have failed to meet their
financing obligations had increased. If there is further increase in the
failure of our customers to meet their customer financing obligations to us, we
could incur losses in excess of our provisions, which could have a material
adverse effect on our cash flow and operating results.

Negative developments associated with our supply and outsourcing contracts,
turnkey arrangements and contract manufacturing agreements may materially and
adversely affect our business, results of operations, financial condition, and
supply relationships.

We have entered into supply contracts with customers to provide products
and services, which in some cases involve new technologies currently being
developed, or which we have not yet commercially deployed, or which require us
to build

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and operate networks on a turnkey basis. We have also entered into
network outsourcing contracts with customers to operate their networks. Some
of these supply and network outsourcing contracts contain delivery and
installation timetables, performance criteria and other contractual obligations
which, if not met, could result in our having to pay substantial penalties or
liquidated damages, the termination of the related supply or network
outsourcing contract, and/or the reduction of
shared revenues under a turnkey arrangement, in certain circumstances.
Unexpected developments in these supply and outsourcing contracts could have a
material adverse effect on our revenues, cash flows, and relationships with our
customers.

Our ability to meet customer demand is, in part, dependent on us obtaining
timely and adequate component parts and products from suppliers, contract
manufacturers, and internal manufacturing capacity. As part of the
transformation of our supply chain from a vertically integrated manufacturing
model to a virtually integrated model, we have outsourced a substantial portion
of our manufacturing capacity to contract manufacturers. We work closely with
our suppliers and contract manufacturers to address quality issues and to meet
increases in customer demand, when needed, and we also manage our internal
manufacturing capacity, quality, and inventory levels as required. However, we
may encounter shortages of quality components and/or products in the future.
In addition, our component suppliers and contract manufacturers have
experienced, and may continue to experience, a consolidation in the industry,
which may result in fewer sources of components or products and greater
exposure to the financial stability of our suppliers. A reduction or
interruption in component supply or external manufacturing capacity, a
significant increase in the price of one or more components, or excessive
inventory levels could materially and negatively affect our gross margins and
our operating results and could materially damage customer relationships.

Further, certain of our supply arrangements with our contract
manufacturers were negotiated prior to the current industry and economic
downturn and, depending upon the extent and duration of this downturn, the
terms of these arrangements may not be achievable. To the extent that we fail
to meet any of these arrangements, and if we are unable to successfully
renegotiate the applicable arrangement, we may be obligated to indemnify the
contract manufacturer for certain direct costs attributable to our failure to
so perform. The actual amount of any such indemnification, which could be
substantial, would be based on a variety of complex,
inter-related factors. The
failure to reach a satisfactory resolution of any such matter could have a
material adverse effect on our business, results of operations, financial
condition, and supply relationships.

Our business may suffer if strategic alliances which we have entered into are
not successful.

We have entered into a number of strategic alliances with suppliers,
developers, and members in our industry to facilitate product compatibility,
encourage adoption of industry standards, or to offer complementary product or
service offerings to meet customer needs. In some cases, the companies with
which we have strategic alliances also compete against us in some of our
business areas. If a member of a strategic alliance fails to perform its
obligations, if the relationship fails to develop as expected, or if the
relationship is terminated, we could experience delays in product availability
or impairment of our relationships with our customers.

The adverse resolution of litigation against us could negatively impact our
business.

We are currently a defendant in numerous class actions and other lawsuits,
including lawsuits initiated on behalf of holders of Nortel Networks
Corporations common shares, which seek damages of material and indeterminate
amounts, as well as lawsuits in the normal course of business. We are and may
in the future be subject to other litigation arising in the normal course of
our business. Litigation may be time consuming, expensive, and distracting
from the conduct of our business, and the outcome of litigation is difficult to
predict. The adverse resolution of any specific lawsuit could have a material
adverse effect on our business, results of operations, and financial condition.

Recent pronouncements

In July 2002, the Financial Accounting Standards Board, or FASB, issued
Statement of Financial Accounting Standards, or SFAS, No. 146, Accounting for
Costs Associated with Exit or Disposal Activities, or SFAS 146, which is
effective for exit or disposal activities initiated after December 31, 2002.
SFAS 146 nullifies Emerging Issues Task Force Issue No. 94-3, Liability
Recognition for Certain Employee Termination Benefits and Other Costs to Exit
an Activity (including Certain Costs Incurred in
Restructuring)or EITF 94-3.
SFAS 146 requires that costs associated with an exit or disposal activity be
recognized when the liability is incurred, whereas EITF 94-3 required
recognition of a liability when an

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entity committed to an exit plan. We have
not yet determined the effect that the adoption of SFAS 146 will have on our
business, results of operations, and financial condition.

In August 2001, the FASB issued SFAS No. 143, Accounting for Asset
Retirement Obligations, or SFAS 143, which is effective for financial
statements issued for fiscal years beginning after June 15, 2002. SFAS 143
addresses the
recognition and remeasurement of obligations associated with the
retirement of a tangible long-lived asset. We have not yet determined the
effect that the adoption of SFAS 143 will have on our business, results of
operations, and financial condition.

ITEM 3.   QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Market risk represents the risk of loss that may impact the consolidated
financial statements of Nortel Networks due to adverse changes in financial
market prices and rates. Nortel Networks market risk exposure is primarily a
result of fluctuations in interest rates and foreign exchange rates.
Disclosure of market risk is contained in our Annual Report on Form 10-K for
the year ended December 31, 2001.

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PART II
OTHER INFORMATION

ITEM 1.   Legal Proceedings

For a discussion of our material legal proceedings, see Legal
proceedings in Managements Discussion and Analysis of Financial Condition and
Results of Operations.

ITEM 2.   Changes in Securities and Use of Proceeds

On June 28, 2002, Nortel Networks Corporation subscribed for one common
share of Nortel Networks Limited for cash consideration of $800 million.
Nortel Networks Limited issued one common share to Nortel Networks Corporation
on June 28, 2002 and such issuance was exempt from registration under the
Securities Act on the basis that it occurred outside the United States within
the meaning of Regulation S under the Securities Act.

ITEM 4.   Submissions of Matters to a Vote of Security Holders

Pursuant to a unanimous written resolution dated April 25, 2002 by Nortel
Networks Corporation, the sole holder of the common shares of Nortel Networks
Limited, the following items of business were passed:

Election of Directors

The following individuals were elected as directors of Nortel Networks
Limited to hold office in accordance with By-law No. 1 of Nortel Networks
Limited:

| |                           | 
| | ------------------------- | 
| | Directors                 | 
| |                           | 
| | Honourable J.J. Blanchard | 
| | R.E. Brown                | 
| | J.E. Cleghorn             | 
| | F.A. Dunn                 | 
| | L.Y. Fortier              | 
| | R.A. Ingram               | 
| | W.A. Owens                | 
| | G. Saucier                | 
| | S.H. Smith, Jr.           | 
| | L.R. Wilson               | 

Appointment of Auditors

The appointment of Deloitte & Touche LLP as independent auditors was
approved.

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ITEM   6.      Exhibits and Reports on Form 8-K



|   |          
|-- | ---------
|a) | Exhibits:



|     |                                                                                                                                                                                                                                                                                                                                                                                                                  | 
|---- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | 
|10.1 | Resolution of the Board of Directors of Nortel Networks Limited dated
January 24, 2002, related to the payment of directors fees.                                                                                                                                                                                                                                                                              
|    
|10.2 | Pledge Agreement Supplement dated as of May 20, 2002 between Nortel
Networks Mauritius Ltd and JPMorgan Chase Bank, as Collateral Agent
supplementing the Foreign Pledge Agreement dated as of April 4, 2002 among
Nortel Networks International Finance & Holding B.V., Nortel
Communications Holdings (1997) Limited, Nortel Networks AB and JPMorgan
Chase Bank, as Collateral Agent.                        
|    
|10.3 | Pledge Agreement Supplement dated as of May 15, 2002 between Nortel
Networks International Finance & Holding B.V. and JPMorgan Chase Bank, as
Collateral Agent, supplementing the Foreign Pledge Agreement dated as of
April 4, 2002 among Nortel Networks International Finance & Holding
B.V., Nortel Communications Holdings (1997) Limited, Nortel Networks AB
and JPMorgan Chase Bank, as Collateral Agent.
|    
|10.4 | Pledge Agreement Supplement dated as of June 4, 2002 between Nortel
Networks Singapore Pte Ltd, and JPMorgan Chase Bank, as Collateral Agent,
supplementing the Foreign Pledge Agreement dated as of April 4, 2002 among
Nortel Networks International Finance & Holding B.V., Nortel
Communications Holdings (1997) Limited, Nortel Networks AB and JPMorgan
Chase Bank, as Collateral Agent.                  
|    
|10.5 | Pledge Agreement Supplement dated as of May 15, 2002 between Nortel
Networks Limited and JPMorgan Chase Bank, as Collateral Agent,
supplementing the Foreign Pledge Agreement dated as of April 4, 2002 among
Nortel Networks Limited, the Subsidiary Guarantors party thereto and
JPMorgan Chase Bank, as Collateral Agent.                                                                                    



|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|-- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|  
|b) | Reports on Form 8-K:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|  
|   | Nortel Networks Limited filed a Current Report on Form 8-K dated April 4,
2002 related to a press release Nortel Networks Corporation issued in
response to an announcement that Moodys Investors Service, Inc. lowered
ratings on securities issued or guaranteed by it and its principal
operating subsidiaries to below investment grade.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|  
|   | Nortel Networks Limited filed a Current
Report on Form 8-K dated April 10,
2002 related to: (i) the announcement by Nortel Networks Corporation of
the amendment and extension of the $1.75 billion April 2001 credit
facilities, and the reduction of the facilities to $1.175, of its
principal operating subsidiaries, Nortel Networks Limited and Nortel
Networks Inc.; and (ii) an update by Nortel Networks Corporation on its
first quarter of 2002 performance.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|  
|   | Nortel Networks Limited filed a Current Report on Form 8-K dated April 22,
2002 related to Nortel Networks Corporations financial results for the
first quarter of 2002.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|  
|   | Nortel Networks Limited filed a Current Report on Form 8-K dated May 13,
2002 related to: (i) the filing of audited consolidated financial
statements for the three years ended December 31, 2001 of Nortel Networks
Limited and audited financial statements for the three years ended
December 31, 2001 of Nortel Networks S.A. in accordance with Rule 3-10 and
3-16, respectively, of Regulation S-X under the Securities Act of 1933;
(ii) the intended filing of a shelf registration statement on Form S-3
with the United States Securities and Exchange Commission and a
preliminary base shelf prospectus with the Canadian securities regulatory
authorities for the purpose of qualifying the potential sale by Nortel
Networks Corporation or Nortel Networks Limited from time to time in the
United States and/or Canada of up to an aggregate of $2.5 billion of
various types of securities; (iii) the intended withdrawal by Nortel
Networks Limited and Nortel Networks Capital Corporation, a wholly owned
indirect finance subsidiary of Nortel Networks Limited, of their existing
U.S. shelf registration statement currently pertaining to an aggregate of
up to US$1.0 billion of debt securities and warrants to purchase debt
securities; and (iv) the filing of certain information incorporated by
reference into the Canadian preliminary base shelf prospectus, including
historical consolidated financial statements of Nortel Networks Limited
prepared in accordance with Canadian generally accepted accounting
principles.

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##### 





| | Nortel Networks Limited filed a Current Report on Form 8-K dated May 28,
2002 related to the filing of unaudited interim Consolidated Financial
Statements of Nortel Networks Limited, prepared in accordance with
Canadian generally accepted accounting principles, for the three month
period ended March 31, 2002.                                                                                                                                                                                                               
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| | Nortel Networks Limited filed a Current Report on Form 8-K dated May 29,
2002 related to the announcement by Nortel Networks Corporation that (i)
Nortel Networks Corporation expects revenues in the second quarter of 2002
to be flat to down 5 percent compared to the first quarter of 2002; (ii)
Nortel Networks Corporation plans to further realign its Optical Long Haul
business, including optical components; and (iii) Nortel Networks
Corporations actions are aimed at reducing its overall break even cost
structure.
|
| | Nortel Networks Limited filed a Current Report on Form 8-K dated June 3,
2002 related to the announcement by Nortel Networks Corporation of the
commencement pursuant to separate preliminary prospectus supplements and
accompanying prospectuses of two concurrent offerings in the United States
and Canada of common shares of Nortel Networks Corporation and equity
units.                                                                                                                                                     
|
| | Nortel Networks Limited filed a Current Report on Form 8-K dated June 7,
2002 related to the announcement by Nortel Networks Corporation of two
concurrent offerings in the United States and Canada of common shares of
Nortel Networks Corporation and equity units pursuant to separate
prospectus supplements and accompanying prospectuses.                                                                                                                                                                                     
|
| | Nortel Networks Limited filed a Current Report on Form 8-K dated June 11,
2002 related to exercise by the underwriters of the two concurrent public
offerings of common shares of Nortel Networks Corporation and equity units
of their respective
over-allotment options to purchase
additional prepaid forward purchase contracts of Nortel Networks
Corporation and common shares of Nortel Networks Corporation.                                                                                                                 
|
| | Nortel Networks Limited filed a Current
Report on Form 8-K dated July 22,
2002 related to (i) the appointment of the new Chief Financial Officer of
Nortel Networks Limited, and (ii) Nortel Networks Corporations financial
results for the second quarter of 2002.                                                                                                                                                                                                                                                                

63



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##### 



SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.



NORTEL NETWORKS LIMITED

(Registrant)




|                        |  |                         
|----------------------- |  | ------------------------
|Chief Financial Officer |  | Chief Accounting Officer
|                       
|                        |  |                         
|                       
|                       
|D.C. BEATTY           |  | M.J. GOLLOGLY         
|                        |  |                         
|D.C. BEATTY             |  | M.J. GOLLOGLY           
|                       
|                       
|                       
|                       
|Chief Financial Officer |  | Controller              
|                       
|                       
|                       
|                       
|                        |  |                         

Date: August 13, 2002

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