##### Table of Contents



---

---

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 September 30, 2001

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 number000-30758

Nortel Networks Limited(Exact name of registrant as specified in its charter)

|                                                                       |  |                                                    
|---------------------------------------------------------------------- |  | ---------------------------------------------------
|Canada
(State or other jurisdiction of 
incorporation or organization) |  | Not Applicable
(I.R.S. Employer Identification No.)

|                                                                                              |  |                   
|--------------------------------------------------------------------------------------------- |  | ------------------
|8200 Dixie Road, Suite 100
Brampton, Ontario, Canada
(Address of principal executive offices) |  | L6T 5P6
(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
[(CHECKMARK)]           No [   ]

Indicate the number of shares outstanding of each of the issuers classes of
common stock, as at September 30, 2001

1,460,978,634 without nominal or par value



---

---





---

TABLE OF CONTENTS



|                             |                                                                                                   |  |  |  |  |  |  | 
|---------------------------- | ------------------------------------------------------------------------------------------------- |  |  |  |  |  |  | 
|PART I FINANCIAL INFORMATION
|                             | ITEM 2.     MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
|                             | ITEM 3. Quantitative and Qualitative Disclosures About Market Risk                               
|PART II OTHER INFORMATION   
|                             | ITEM 1. Legal Proceedings                                                                        
|                             | ITEM 2. Changes in Securities and Use of Proceeds                                                
|                             | ITEM 6. Exhibits and Reports on Form 8-K                                                         



---



##### Table of Contents



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 |  |  | 23 |     
|
|
|
|
| | ITEM 3. |  | Quantitative and
Qualitative Disclosures About Market Risk                            |  |  | 50 |     

PART II
OTHER INFORMATION

| |            |  |                                           |  |  |    |  |    | 
| | ---------- |  | ----------------------------------------- |  |  | -- |  | -- | 
| | ITEM 1.    |  | Legal Proceedings                         |  |  | 51 | 
|
|
|
|
| | ITEM 2.    |  | Changes in Securities and Use of Proceeds |  |  | 51 | 
|
|
|
|
| | ITEM 6.    |  | Exhibits and Reports on Form 8-K          |  |  | 52 | 
|
|
|
|
| | Signatures |  |                                           |  |  |    |  | 54 | 

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

Clarify, DMS, Nortel Networks, and Universal Edge are trademarks of Nortel
Networks.

JungleMUX is a trademark of GE Industrial Systems Technology Management Inc.

2



---



##### Table of Contents






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



---



##### Table of Contents



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

|                                                               |                            |   |                    |       |                   |   |       |       |      |   |         |       |   |   |        |       |  
|-------------------------------------------------------------- | -------------------------- | - | ------------------ | ----- | ----------------- | - | ----- | ----- | ---- | - | ------- | ----- | - | - | ------ | ----- | -
|                                                              
|                                                               |                            |   | Three months ended |       | Nine months ended
|                                                               |                            |   | September 30,      |       | September 30,    
|                                                               |                            |   | 2001               |       | 2000              |   | 2001  |       | 2000
|                                                              
|Revenues                                                       |                            | $ | 3,673              |       |                   | $ | 6,715 |       |      | $ | 13,933  |       |   | $ | 19,739 |      
|                                                              
|                                                              
|                                                              
|                                                              
|Cost of revenues                                               |                            |   | 3,683              |       |                   |   | 3,606 |       |      |   | 11,764  |       |   |   | 10,887 |      
|                                                              
|Gross profit (loss)                                            |                            |   | (10                | )     |                   |   | 3,109 |       |      |   | 2,169   |       |   |   | 8,852  |      
|                                                              
|                                                              
|                                                              
|                                                              
|Selling, general and administrative expense (excluding         |                            |   |                    |       |                   |   |       |       |      |   |         |       |   |   |        |      
|                                                               | stock option compensation) |   |                    | 1,897 |                   |   |       | 1,301 |      |   |         | 4,808 |   |   |        | 3,839 |  
|                                                              
|                                                              
|                                                              
|                                                              
|Research and development expense                               |                            |   | 771                |       |                   |   | 897   |       |      |   | 2,547   |       |   |   | 2,594  |      
|                                                              
|                                                              
|                                                              
|                                                              
|In-process research and development expense                    |                            |   |                   |       |                   |   |      |       |      |   |        |       |   |   | 623    |      
|                                                              
|                                                              
|                                                              
|                                                              
|Amortization of intangibles                                    |                            |   |                    |       |                   |   |       |       |      |   |         |       |   |   |        |      
|                                                              
|                                                              
|                                                              
|                                                              
|                                                               | Acquired technology        |   |                    | 145   |                   |   |       | 202   |      |   |         | 551   |   |   |        | 586   |  
|                                                              
|                                                              
|                                                              
|                                                              
|                                                               | Goodwill                   |   |                    | 357   |                   |   |       | 678   |      |   |         | 1,718 |   |   |        | 1,805 |  
|                                                              
|                                                              
|                                                              
|                                                              
|Stock option compensation                                      |                            |   |                   |       |                   |   | 29    |       |      |   |        |       |   |   | 96     |      
|                                                              
|                                                              
|                                                              
|                                                              
|Special charges                                                |                            |   | 1,000              |       |                   |   |      |       |      |   | 4,630   |       |   |   | 195    |      
|                                                              
|                                                              
|                                                              
|                                                              
|Gain on sale of businesses                                     |                            |   | (45                | )     |                   |   |      |       |      |   | (45     | )     |   |   | (174   | )    
|                                                              
|                                                               |                            |   | (4,135             | )     |                   |   | 2     |       |      |   | (12,040 | )     |   |   | (712   | )    
|                                                              
|                                                              
|                                                              
|                                                              
|                                                              
|Equity in net loss of associated companies                     |                            |   | (6                 | )     |                   |   | (16   | )     |      |   | (138    | )     |   |   | (22    | )    
|                                                              
|                                                              
|                                                              
|                                                              
|Other income (expense)  net                                   |                            |   | (313               | )     |                   |   | 206   |       |      |   | (252    | )     |   |   | 797    |      
|                                                              
|                                                              
|                                                              
|                                                              
|Interest expense                                               |                            |   |                    |       |                   |   |       |       |      |   |         |       |   |   |        |      
|                                                              
|                                                              
|                                                              
|                                                              
|Long-term debt                                                 |                            |   | (43                | )     |                   |   | (22   | )     |      |   | (127    | )     |   |   | (69    | )    
|                                                              
|                                                              
|                                                              
|                                                              
|                                                               | Other                      |   |                    | (28   | )                 |   |       | (16   | )    |   |         | (90   | ) |   |        | (48   | )
|                                                              
|Earnings (loss) from continuing operations before income taxes |                            |   | (4,525             | )     |                   |   | 154   |       |      |   | (12,647 | )     |   |   | (54    | )    
|                                                              
|                                                              
|                                                              
|                                                              
|                                                              
|Income tax recovery (provision)                                |                            |   | 1,255              |       |                   |   | (250  | )     |      |   | 2,645   |       |   |   | (867   | )    
|                                                              
|Net loss from continuing operations                            |                            |   | (3,270             | )     |                   |   | (96   | )     |      |   | (10,002 | )     |   |   | (921   | )    
|                                                              
|                                                              
|                                                              
|                                                              
|                                                              
|Net loss from discontinued operations (net of taxes)           |                            |   |                   |       |                   |   | (79   | )     |      |   | (2,538  | )     |   |   | (255   | )    
|                                                              
|Net loss before cumulative effect of accounting change         |                            |   | (3,270             | )     |                   |   | (175  | )     |      |   | (12,540 | )     |   |   | (1,176 | )    
|                                                              
|                                                              
|                                                              
|                                                              
|                                                              
|Cumulative effect of accounting change (net of tax of $9)      |                            |   |                   |       |                   |   |      |       |      |   | 15      |       |   |   |       |      
|                                                              
|Net loss                                                       |                            |   | (3,270             | )     |                   |   | (175  | )     |      |   | (12,525 | )     |   |   | (1,176 | )    
|                                                              
|                                                              
|                                                              
|                                                              
|                                                              
|Dividends on preferred shares                                  |                            |   | (6                 | )     |                   |   | (7    | )     |      |   | (21     | )     |   |   | (23    | )    
|                                                              
|Net loss applicable to common shares                           |                            | $ | (3,276             | )     |                   | $ | (182  | )     |      | $ | (12,546 | )     |   | $ | (1,199 | )    
|                                                              

See notes to unaudited consolidated financial statements.

4



---



##### Table of Contents



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

|                                                                                                                                                                           |                                                                                                  |   |               |       |              |   |        |       | 
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ------------------------------------------------------------------------------------------------ | - | ------------- | ----- | ------------ | - | ------ | ----- | 
|                                                                                                                                                                          
|                                                                                                                                                                           |                                                                                                  |   | September 30, |       | December 31,
|                                                                                                                                                                           |                                                                                                  |   | 2001          |       | 2000        
|                                                                                                                                                                          
|ASSETS                                                                                                                                                                     |                                                                                                  |   |               |       |              |   |        |      
|                                                                                                                                                                          
|                                                                                                                                                                          
|                                                                                                                                                                          
|                                                                                                                                                                          
|Current assets                                                                                                                                                             |                                                                                                  |   |               |       |              |   |        |      
|                                                                                                                                                                          
|                                                                                                                                                                          
|                                                                                                                                                                          
|                                                                                                                                                                          
|                                                                                                                                                                           | Cash and cash equivalents                                                                        |   | $             | 3,299 |              |   | $      | 1,567 | 
|                                                                                                                                                                          
|                                                                                                                                                                          
|                                                                                                                                                                          
|                                                                                                                                                                          
|                                                                                                                                                                           | Accounts
receivable (less provisions of  $684 at September 30, 2001;
$363 at December 31, 2000) |   |               | 3,839 |              |   |        | 7,234 | 
|                                                                                                                                                                          
|                                                                                                                                                                          
|                                                                                                                                                                          
|                                                                                                                                                                          
|                                                                                                                                                                           | Inventories                                                                                      |   |               | 1,950 |              |   |        | 3,811 | 
|                                                                                                                                                                          
|                                                                                                                                                                          
|                                                                                                                                                                          
|                                                                                                                                                                          
|                                                                                                                                                                           | Income taxes recoverable                                                                         |   |               | 662   |              |   |        |      | 
|                                                                                                                                                                          
|                                                                                                                                                                          
|                                                                                                                                                                          
|                                                                                                                                                                          
|                                                                                                                                                                           | Deferred income taxes  net                                                                      |   |               | 1,294 |              |   |        | 653   | 
|                                                                                                                                                                          
|                                                                                                                                                                          
|                                                                                                                                                                          
|                                                                                                                                                                          
|                                                                                                                                                                           | Other current assets                                                                             |   |               | 979   |              |   |        | 1,588 | 
|                                                                                                                                                                          
|                                                                                                                                                                          
|                                                                                                                                                                          
|                                                                                                                                                                          
|                                                                                                                                                                           | Current assets of discontinued operations                                                        |   |               | 1,288 |              |   |        | 1,511 | 
|                                                                                                                                                                          
|Total current assets                                                                                                                                                       |                                                                                                  |   | 13,311        |       |              |   | 16,364 |      
|                                                                                                                                                                          
|Long-term
receivables (less provisions of  $968 at September 30,
2001;
$383 at December 31, 2000)                                                                         |                                                                                                  |   | 548           |       |              |   | 1,116  |      
|                                                                                                                                                                          
|                                                                                                                                                                          
|                                                                                                                                                                          
|                                                                                                                                                                          
|Investments at cost and associated companies at equity                                                                                                                     |                                                                                                  |   | 245           |       |              |   | 767    |      
|                                                                                                                                                                          
|                                                                                                                                                                          
|                                                                                                                                                                          
|                                                                                                                                                                          
|Plant and equipment  net                                                                                                                                                  |                                                                                                  |   | 2,677         |       |              |   | 3,292  |      
|                                                                                                                                                                          
|                                                                                                                                                                          
|                                                                                                                                                                          
|                                                                                                                                                                          
|Intangible assets  net                                                                                                                                                    |                                                                                                  |   | 2,854         |       |              |   | 7,347  |      
|                                                                                                                                                                          
|                                                                                                                                                                          
|                                                                                                                                                                          
|                                                                                                                                                                          
|Deferred income taxes  net                                                                                                                                                |                                                                                                  |   | 1,454         |       |              |   | 280    |      
|                                                                                                                                                                          
|                                                                                                                                                                          
|                                                                                                                                                                          
|                                                                                                                                                                          
|Other assets                                                                                                                                                               |                                                                                                  |   | 712           |       |              |   | 556    |      
|                                                                                                                                                                          
|                                                                                                                                                                          
|                                                                                                                                                                          
|                                                                                                                                                                          
|Long-term assets of discontinued operations                                                                                                                                |                                                                                                  |   | 412           |       |              |   | 1,190  |      
|                                                                                                                                                                          
|Total assets                                                                                                                                                               |                                                                                                  | $ | 22,213        |       |              | $ | 30,912 |      
|                                                                                                                                                                          
|LIABILITIES AND SHAREHOLDERS EQUITY                                                                                                                                       |                                                                                                  |   |               |       |              |   |        |      
|                                                                                                                                                                          
|                                                                                                                                                                          
|                                                                                                                                                                          
|                                                                                                                                                                          
|Current liabilities                                                                                                                                                        |                                                                                                  |   |               |       |              |   |        |      
|                                                                                                                                                                          
|                                                                                                                                                                          
|                                                                                                                                                                          
|                                                                                                                                                                          
|                                                                                                                                                                           | Notes payable                                                                                    |   | $             | 647   |              |   | $      | 315   | 
|                                                                                                                                                                          
|                                                                                                                                                                          
|                                                                                                                                                                          
|                                                                                                                                                                          
|                                                                                                                                                                           | Trade and other accounts payable                                                                 |   |               | 1,997 |              |   |        | 3,389 | 
|                                                                                                                                                                          
|                                                                                                                                                                          
|                                                                                                                                                                          
|                                                                                                                                                                          
|                                                                                                                                                                           | Payroll and benefit-related liabilities                                                          |   |               | 792   |              |   |        | 911   | 
|                                                                                                                                                                          
|                                                                                                                                                                          
|                                                                                                                                                                          
|                                                                                                                                                                          
|                                                                                                                                                                           | Other accrued liabilities                                                                        |   |               | 5,482 |              |   |        | 3,588 | 
|                                                                                                                                                                          
|                                                                                                                                                                          
|                                                                                                                                                                          
|                                                                                                                                                                          
|                                                                                                                                                                           | Income taxes payable                                                                             |   |               |      |              |   |        | 306   | 
|                                                                                                                                                                          
|                                                                                                                                                                          
|                                                                                                                                                                          
|                                                                                                                                                                          
|                                                                                                                                                                           | Long-term debt due within one year                                                               |   |               | 38    |              |   |        | 445   | 
|                                                                                                                                                                          
|                                                                                                                                                                          
|                                                                                                                                                                          
|                                                                                                                                                                          
|                                                                                                                                                                           | Current liabilities of discontinued operations                                                   |   |               | 1,221 |              |   |        | 181   | 
|                                                                                                                                                                          
|Total current liabilities                                                                                                                                                  |                                                                                                  |   | 10,177        |       |              |   | 9,135  |      
|                                                                                                                                                                          
|Deferred income                                                                                                                                                            |                                                                                                  |   | 120           |       |              |   | 93     |      
|                                                                                                                                                                          
|                                                                                                                                                                          
|                                                                                                                                                                          
|                                                                                                                                                                          
|Long-term debt                                                                                                                                                             |                                                                                                  |   | 2,635         |       |              |   | 1,177  |      
|                                                                                                                                                                          
|                                                                                                                                                                          
|                                                                                                                                                                          
|                                                                                                                                                                          
|Deferred income taxes  net                                                                                                                                                |                                                                                                  |   | 519           |       |              |   | 680    |      
|                                                                                                                                                                          
|                                                                                                                                                                          
|                                                                                                                                                                          
|                                                                                                                                                                          
|Other liabilities                                                                                                                                                          |                                                                                                  |   | 1,096         |       |              |   | 1,024  |      
|                                                                                                                                                                          
|                                                                                                                                                                          
|                                                                                                                                                                          
|                                                                                                                                                                          
|Minority interest in subsidiary companies                                                                                                                                  |                                                                                                  |   | 73            |       |              |   | 161    |      
|                                                                                                                                                                          
|                                                                                                                                                                          
|                                                                                                                                                                          
|                                                                                                                                                                          
|Long-term liabilities of discontinued operations                                                                                                                           |                                                                                                  |   | 12            |       |              |   | 74     |      
|                                                                                                                                                                          
|                                                                                                                                                                           |                                                                                                  |   | 14,632        |       |              |   | 12,344 |      
|                                                                                                                                                                          
|Contingencies (note 18)                                                                                                                                                    |                                                                                                  |   |               |       |              |   |        |      
|                                                                                                                                                                          
|SHAREHOLDERS EQUITY                                                                                                                                                       |                                                                                                  |   |               |       |              |   |        |      
|                                                                                                                                                                          
|                                                                                                                                                                          
|                                                                                                                                                                          
|                                                                                                                                                                          
|Preferred
shares, without par value  Authorized shares: unlimited; Issued
and outstanding
shares: 30,000,000 at September 30, 2001 and 30,000,200 at December 31, 2000    |                                                                                                  |   | 536           |       |              |   | 609    |      
|                                                                                                                                                                          
|                                                                                                                                                                          
|                                                                                                                                                                          
|                                                                                                                                                                          
|Common shares, without par value  Authorized shares: unlimited; Issued and outstanding
shares: 1,460,978,634 at September 30, 2001 and 1,453,437,535 at December 31, 2000 |                                                                                                  |   | 2,111         |       |              |   | 17,024 |      
|                                                                                                                                                                          
|                                                                                                                                                                          
|                                                                                                                                                                          
|                                                                                                                                                                          
|Additional paid-in capital                                                                                                                                                 |                                                                                                  |   | 18,796        |       |              |   | 1,878  |      
|                                                                                                                                                                          
|                                                                                                                                                                          
|                                                                                                                                                                          
|                                                                                                                                                                          
|Deficit                                                                                                                                                                    |                                                                                                  |   | (12,948       | )     |              |   | (402   | )    
|                                                                                                                                                                          
|                                                                                                                                                                          
|                                                                                                                                                                          
|                                                                                                                                                                          
|Accumulated other comprehensive loss                                                                                                                                       |                                                                                                  |   | (914          | )     |              |   | (541   | )    
|                                                                                                                                                                          
|Total shareholders equity                                                                                                                                                 |                                                                                                  |   | 7,581         |       |              |   | 18,568 |      
|                                                                                                                                                                          
|Total liabilities and shareholders equity                                                                                                                                 |                                                                                                  | $ | 22,213        |       |              | $ | 30,912 |      
|                                                                                                                                                                          

See notes to unaudited consolidated financial statements.

5



---



##### Table of Contents



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

|                                                       |                                                                                                                                                                                |                                                                   |                                          |         |                   |       |       |        |       |      |  
|------------------------------------------------------ | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ | ----------------------------------------------------------------- | ---------------------------------------- | ------- | ----------------- | ----- | ----- | ------ | ----- | ---- | -
|                                                      
|                                                       |                                                                                                                                                                                |                                                                   |                                          |         | Nine months ended
|                                                       |                                                                                                                                                                                |                                                                   |                                          |         | September 30,    
|                                                       |                                                                                                                                                                                |                                                                   |                                          |         | 2001              |       | 2000 
|                                                      
|Cash flows from (used in) operating activities         |                                                                                                                                                                                |                                                                   |                                          |         |                   |       |       |       
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       | Net loss from continuing operations                                                                                                                                            |                                                                   | $                                        | (10,002 | )                 |       | $     | (921   | )    
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       | 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                                     |                                          |         | 2,796             |       |       |        | 2,867 |     
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       |                                                                                                                                                                                | In-process research and development expense                       |                                          |         |                  |       |       |        | 623   |     
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       |                                                                                                                                                                                | Non-cash portion of special charges and related asset write downs |                                          |         | 3,021             |       |       |        | 133   |     
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       |                                                                                                                                                                                | Equity in net loss of associated companies                        |                                          |         | 138               |       |       |        | 22    |     
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       |                                                                                                                                                                                | Stock option compensation                                         |                                          |         |                  |       |       |        | 96    |     
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       |                                                                                                                                                                                | Tax benefit from stock options                                    |                                          |         | 105               |       |       |        | 408   |     
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       |                                                                                                                                                                                | Deferred income taxes                                             |                                          |         | (1,949            | )     |       |        | 16    |     
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       |                                                                                                                                                                                | Other liabilities                                                 |                                          |         | 62                |       |       |        | 71    |     
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       |                                                                                                                                                                                | Gain on sale of investments and businesses                        |                                          |         | (71               | )     |       |        | (791  | )   
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       |                                                                                                                                                                                | Other  net                                                       |                                          |         | 306               |       |       |        | (263  | )   
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       |                                                                                                                                                                                | Change in operating assets and liabilities:                       |                                          |         |                   |       |       |        |       |     
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       |                                                                                                                                                                                |                                                                   | Accounts receivable                      |         |                   | 4,404 |       |        |       | (180 | )
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       |                                                                                                                                                                                |                                                                   | Inventories                              |         |                   | 1,753 |       |        |       | (948 | )
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       |                                                                                                                                                                                |                                                                   | Income taxes                             |         |                   | (968  | )     |        |       | (187 | )
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       |                                                                                                                                                                                |                                                                   | Accounts payable and accrued liabilities |         |                   | 434   |       |        |       | (547 | )
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       |                                                                                                                                                                                |                                                                   | Other operating assets and liabilities   |         |                   | 359   |       |        |       | (800 | )
|                                                      
|                                                       | Net cash from (used in) operating activities of continuing operations                                                                                                          |                                                                   |                                          | 388     |                   |       |       | (401   | )    
|                                                      
|Cash flows from (used in) investing activities         |                                                                                                                                                                                |                                                                   |                                          |         |                   |       |       |       
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       | Expenditures for plant and equipment                                                                                                                                           |                                                                   |                                          | (1,074  | )                 |       |       | (1,140 | )    
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       | Proceeds on disposals of plant and equipment                                                                                                                                   |                                                                   |                                          | 151     |                   |       |       | 33     |      
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       | Increase in long-term receivables                                                                                                                                              |                                                                   |                                          | (677    | )                 |       |       | (588   | )    
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       | Decrease in long-term receivables                                                                                                                                              |                                                                   |                                          | 192     |                   |       |       | 908    |      
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       | Acquisitions of investments and businesses  net of cash acquired                                                                                                              |                                                                   |                                          | (88     | )                 |       |       | (270   | )    
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       | Proceeds on sale of investments and businesses                                                                                                                                 |                                                                   |                                          | 232     |                   |       |       | 1,692  |      
|                                                      
|                                                       | Net cash from (used in) investing activities of continuing operations                                                                                                          |                                                                   |                                          | (1,264  | )                 |       |       | 635    |      
|                                                      
|Cash flows from (used in) financing activities         |                                                                                                                                                                                |                                                                   |                                          |         |                   |       |       |       
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       | Dividends on common and preferred shares                                                                                                                                       |                                                                   |                                          | (21     | )                 |       |       | (76    | )    
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       | Increase in notes payable  net                                                                                                                                                |                                                                   |                                          | 355     |                   |       |       | 58     |      
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       | Proceeds from long-term debt                                                                                                                                                   |                                                                   |                                          | 1,522   |                   |       |       | 50     |      
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       | Repayments of long-term debt                                                                                                                                                   |                                                                   |                                          | (463    | )                 |       |       | (62    | )    
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       | Proceeds from parent                                                                                                                                                           |                                                                   |                                          | 1,800   |                   |       |       |       |      
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       | Increase (decrease) in capital leases payable                                                                                                                                  |                                                                   |                                          | (21     | )                 |       |       | 8      |      
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       | Issuance of common shares                                                                                                                                                      |                                                                   |                                          |        |                   |       |       | 207    |      
|                                                      
|                                                       | Net cash from financing activities of continuing operations                                                                                                                    |                                                                   |                                          | 3,172   |                   |       |       | 185    |      
|                                                      
|                                                       | Effect of foreign exchange rate changes on cash and cash equivalents                                                                                                           |                                                                   |                                          | (5      | )                 |       |       | (35    | )    
|                                                      
|                                                       | Net cash from continuing operations                                                                                                                                            |                                                                   |                                          | 2,291   |                   |       |       | 384    |      
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       | Net cash used in discontinued operations                                                                                                                                       |                                                                   |                                          | (559    | )                 |       |       | (829   | )    
|                                                      
|Net increase (decrease) in cash and cash equivalents   |                                                                                                                                                                                |                                                                   | 1,732                                    |         |                   |       | (445  | )     
|                                                      
|Cash and cash equivalents at beginning of period  net |                                                                                                                                                                                |                                                                   | 1,567                                    |         |                   |       | 2,153 |       
|                                                      
|Cash and cash equivalents at end of period  net       |                                                                                                                                                                                | $                                                                 | 3,299                                    |         |                   | $     | 1,708 |       
|                                                      

See notes to unaudited consolidated financial statements.

6



---



##### Table of Contents



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 (the Company; also
referred to herein as Old Nortel) and a newly formed Canadian corporation
(New Nortel) participated in a Canadian court-approved plan of
arrangement (the Arrangement) with BCE Inc. (BCE). 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 the Company 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.
|  
|   | The accompanying unaudited Consolidated Financial Statements and notes
thereto relate to the operations of the Company and its subsidiary
companies (collectively, Nortel Networks).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|  
|2. | Basis of presentation                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|  
|   | The accompanying unaudited Consolidated Financial Statements of the Company
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 as those described in the Companys audited Consolidated Financial
Statements and notes thereto prepared in accordance with GAAP for the three
years ended December 31, 2000, restated for discontinued operations, and
included in the Companys Current Report on Form 8-K, filed with the SEC on
August 8, 2001 (the 2001 Form 8-K), except as described in note 3.
Although the Company is headquartered in Canada, the accompanying unaudited
Consolidated Financial Statements are expressed in United States dollars as
the greater part of the Companys 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 nine months ended September 30, 2001, are not
necessarily indicative of financial results for the full year. The
accompanying unaudited Consolidated Financial Statements should be read in
conjunction with the Companys Annual Report on Form 10-K for the year
ended December 31, 2000, the 2001 Form 8-K, and the Companys Current
Report on Form 8-K, filed with the SEC on November 6, 2001, which includes
Managements Discussion and Analysis of Financial Condition and Results of
Operations for the year ended December 31, 2000, restated for discontinued
operations.                                                                                                                                                                                                                                                                                                                                                                                                          
|  
|   | The preparation of the Companys 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, inventory obsolescence, product
warranty, amortization, asset valuations, employee benefits, taxes,
restructuring and other provisions, in-process research and development,
and contingencies.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            

7



---



##### Table of Contents





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



| | (a) | Impairment of intangible assets and other long-lived assets                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
| | --- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |     | When events and circumstances warrant a review, the Company evaluates
the carrying values of long-lived assets, certain identifiable
intangibles, and goodwill related to those assets to be held and used in
accordance with Statement of Financial Accounting Standards (SFAS) No.
121, Accounting for the Impairment of Long-lived Assets and for
Long-lived Assets to be Disposed Of (SFAS 121) and evaluates the
carrying value of enterprise level intangible assets in accordance with
the provisions of Accounting Principles Board (APB) Opinion No. 17,
Intangible Assets (APB 17). An impairment review is performed
whenever events or circumstances indicate that the carrying value may
not be recoverable. Certain factors that the Company considers
important which could trigger an impairment review include, but are not
limited to, significant underperformance relative to historical or
projected future operating results, significant changes in the manner of
use of the acquired assets or the strategy for the Companys overall
business, significant negative industry or economic trends, a
significant decline in the Companys stock price for a sustained period,
and the Companys market capitalization relative to net book value.                                    
|
| |     | The carrying values of long-lived assets, certain identifiable
intangibles, and goodwill related to those assets are considered
impaired when the anticipated undiscounted cash flow from such assets is
less than their carrying values. In that event, a loss is recognized
based on the amount by which the carrying value exceeds the fair value.
Fair value is determined using the anticipated cash flows discounted at
a rate commensurate with the risk involved. Losses on long-lived assets
to be disposed of are determined in a similar manner, except that fair
values are reduced by the cost to dispose of such assets.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|
| |     | During the three months ended June 30, 2001, the Company changed its
method of evaluating impairment of enterprise level goodwill in
accordance with APB 17. The Company changed from the undiscounted cash
flows method to the market value method. Under the market value method
the Companys net book value is compared to the value of the Companys
equity securities. As the Company and its subsidiaries comprise
substantially all of the operations of Nortel Networks Corporation, the
value of the Companys equity securities is determined based on Nortel
Networks Corporations market capitalization attributable to the
Company. If net book value exceeds this value, the excess carrying
amount of goodwill is written off. The Company believes that the market
value method is preferable since it provides a more realistic valuation
than the undiscounted cash flow method. This change has had no effect
on the business, results of operations, and financial condition of
Nortel Networks.                                                                                                                                                                                                                                                                                                  
|
| | (b) | Derivative financial instruments                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|
| |     | Effective January 1, 2001, the Company adopted SFAS No. 133, Accounting
for Derivative Instruments and Hedging Activities (SFAS 133), and the
corresponding amendments under SFAS No. 138, Accounting for Certain
Derivative Instruments and Certain Hedging Activities  an amendment of
SFAS No. 133 (SFAS 138). SFAS 133 requires that all derivative
financial instruments be recognized in the financial statements and
measured at fair value regardless of the purpose or intent for holding
them. If the derivative is designated as a fair value hedge, changes in
the fair value of the derivative and of the hedged item attributable to
the hedged risk are recognized in net earnings (loss). If the
derivative is designated as a cash flow hedge, the effective portions of
changes in the fair value of the derivative are recorded in other
comprehensive income (loss) (OCI) and are recognized in net earnings
(loss) when the hedged item affects net earnings (loss). Ineffective
portions of changes in the fair value of cash flow hedges are recognized
in net earnings (loss). If the derivative used in an economic hedging
relationship is not designated in an accounting hedging relationship,
changes in the fair value of the derivative are recognized in net
earnings (loss).



| |                                                                                                                                                                                                                                                                                                                                                                                                            
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | The adoption of SFAS 133 resulted in a cumulative decrease to net loss
of $15 (pre-tax $24) and a charge to OCI of $7 (pre-tax $11). The
decrease in net loss is primarily attributable to embedded derivatives.
The charge to OCI is primarily attributable to the effective portion of
option and forward contracts related to the Canadian dollar hedge
program that are designated as cash flow hedges.

8



---



##### Table of Contents





| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Nortel Networks net earnings (loss) and cash flows may be negatively
impacted by fluctuating interest rates, foreign exchange rates, and
equity prices. To effectively manage these market risks, Nortel
Networks enters into foreign currency forwards, foreign currency swaps,
foreign currency option contracts, interest rate swaps, and equity
forward contracts.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|
| | Foreign Currency Risk                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|
| | Nortel Networks enters into option contracts to limit its exposure to
exchange fluctuations on future revenue or expenditure streams, and
forward contracts, which are denominated in various currencies, to limit
its exposure to exchange fluctuations on existing assets and liabilities
and on future revenue or expenditure streams. Principal currencies
hedged include the Canadian dollar, British pound, and Euro. Option and
forward contracts used to hedge future revenue or expenditure streams
are designated as cash flow hedges and hedge these exposures out to a
maximum of 24 months. Forward contracts used to hedge foreign exchange
exposure on existing assets and liabilities are designated as fair value
hedges. Option and forward contracts not designated as hedging
instruments under SFAS 133 are also used to economically hedge the
impact of fluctuations in exchange rates on existing assets and
liabilities and on future revenue and expenditure streams.
|
| | Interest Rate Risk                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|
| | Nortel Networks enters into interest rate swap contracts to minimize
financing costs on long-term debt and to manage interest rate risk on
existing liabilities and receivables due to interest rate fluctuations.
The contracts swap floating interest rate payments to fixed interest
rate payments or vice versa. Contracts that are used to swap fixed
interest rates to floating interest rates are designated as fair value
hedges. Nortel Networks also enters into United States to Canadian
dollar cross currency swap contracts, which are not designated as
hedging instruments, to limit its exposure to foreign currency
fluctuations on the non-cumulative preferential cash dividends with
respect to the outstanding Non-cumulative Redeemable Class A Preferred
Shares Series 7 of the Company.                                                                                                                                                                               
|
| | Other Derivatives                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|
| | Nortel Networks may invest in warrants to purchase securities of other
companies as a strategic investment. Warrants that relate to publicly
traded companies or that can be net share settled are deemed derivative
financial instruments under SFAS 133. Such warrants are generally not
eligible to be designated as hedging instruments as there is no
corresponding underlying exposure. In addition, Nortel Networks may
enter into certain commercial contracts containing derivative financial
instruments.                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|
| | For option contracts designated as fair value hedges, changes in the
time value are excluded from the assessment of hedge effectiveness.
Hedge ineffectiveness, determined in accordance with SFAS 133, had no
material impact on the net loss for the three months and nine months
ended September 30, 2001. No material fair value hedges or cash flow
hedges were derecognized or discontinued for the three months and nine
months ended September 30, 2001.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|
| | Selling, general and administrative expenses for the three months and
nine months ended September 30, 2001 included net losses of $70 and $24,
respectively. Revenues for the three months and nine months ended
September 30, 2001, included net losses of $37 and $20, respectively.
The net losses included in selling, general and administrative expenses
and revenues are primarily related to changes in the fair value of
derivative instruments not designated as hedging instruments.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|
| | Derivative gains and losses included in OCI are reclassified into
earnings (loss) at the time the underlying transaction is recognized.
During the three months and nine months ended September 30, 2001, $6 and
$11, respectively, of net derivative losses were reclassified to
selling, general and administrative expense. Nortel Networks estimates
that $19 of net derivative losses included in OCI will be reclassified
into earnings (loss) within the next twelve months.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            

9



---



##### Table of Contents





|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|-- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|4. | Discontinued operations                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|  
|   | On June 14, 2001, the Companys 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. Also affected by the
decision were Nortel Networks prior acquisitions of Promatory
Communications, Inc. (Promatory), Aptis Communications, Inc., and
Broadband Networks Inc. Nortel Networks is currently working to dispose of
or transition the ownership of certain operations. Any operations not
disposed of or so transitioned are expected to be closed. Nortel Networks
expects to complete this plan by June 2002.
|  
|   | Pursuant to APB Opinion 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) the accompanying unaudited Consolidated Financial Statements and
notes thereto of the Company have been restated to reflect the decision to
discontinue Nortel Networks access solutions operations for all comparative
periods presented. Accordingly, 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, Consolidated Balance Sheets, and Consolidated
Statements of Cash Flows, and are reported as discontinued operations.                      
|  
|   | The results of discontinued operations, presented in the accompanying
unaudited Consolidated Statements of Operations, were as follows:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               

|                                                     |  |                    |     |                   |  |      |     |      |  |   |        |   |  |   |       |  
|---------------------------------------------------- |  | ------------------ | --- | ----------------- |  | ---- | --- | ---- |  | - | ------ | - |  | - | ----- | -
|                                                    
|                                                     |  | Three months ended |     | Nine months ended
|                                                     |  | September 30,      |     | September 30,    
|                                                     |  | 2001               |     | 2000              |  | 2001 |     | 2000
|                                                    
|                                                    
|Revenues                                             |  | $                  | 151 |                   |  | $    | 588 |      |  | $ | 862    |   |  | $ | 1,707 |  
|                                                    
|                                                    
|Loss from discontinued operations (net of taxes) (a) |  | $                  |    |                   |  | $    | (79 | )    |  | $ | (354   | ) |  | $ | (255  | )
|                                                    
|                                                    
|                                                    
|                                                    
|Loss on disposal of operations (net of tax) (b)      |  |                    |    |                   |  |      |    |      |  |   | (2,184 | ) |  |   |      |  
|                                                    
|Net loss from discontinued operations                |  | $                  |    |                   |  | $    | (79 | )    |  | $ | (2,538 | ) |  | $ | (255  | )
|                                                    



| | (a) | Loss from discontinued operations was net of an applicable income
tax recovery of $12 for the three months ended September 30, 2000, and
income tax recoveries of $122 and $46 for the nine months ended
September 30, 2001 and 2000, respectively.
| | --- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| | (b) | Loss on disposal of operations was net of an applicable income
tax recovery of $596 for the nine months ended September 30, 2001.                                                                                                                  



| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | The pre-tax loss on disposal of the access solutions operations of $2,780
reflects the estimated costs directly associated with Nortel Networks plan
of disposition. The loss reflects 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 totalling $151; future
contractual obligations and estimated liabilities of $1,059; and estimated
operating losses during the planned period of disposition of $172.
|
| | At September 30, 2001, the remaining accruals of $1,125 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 drawn down by cash payments over the planned
period of disposition.                                                                                                                                                                                    
|
| | On August 24, 2001, Nortel Networks completed a transaction with Zhone
Technologies, Inc. to sell Nortel Networks Access Node ABM and CDS product
shelves and the Universal Edge 9000 digital loop carrier shelf and remote
access shelf products.                                                                                                                                                                                                                                                                                                                                     

10



---



##### Table of Contents





| |                                                                                                                                                                                                                                                                                                                                                                                                                                    
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | On August 3, 2001, Nortel Networks Corporation announced the completion of
the previously announced transfer of Nortel Networks ownership interest in
Arris to Arris Group, Inc. (Arris Group), ANTEC Corporations new parent
company and as a result at September 30, 2001, Nortel Networks owned a 49.2
percent non-controlling interest in Arris Group, compared to the previous
81.25 percent controlling interest in Arris.
|
| | On July 25, 2001, Nortel Networks completed a transaction with GE
Industrial Systems Technology Management Inc., a division of the General
Electric Company, to sell Nortel Networks Lentronics JungleMUX SONET
multiplexer and TN-1U SDH multiplexer products.                                                                                                                                                                    
|
| | The assets and liabilities of discontinued operations, presented in the
accompanying unaudited Consolidated Balance Sheets, were as follows as at:                                                                                                                                                                                                                                                                                 

|                                                |  |               |       |              |  |   |       | 
|----------------------------------------------- |  | ------------- | ----- | ------------ |  | - | ----- | 
|                                               
|                                                |  | September 30, |       | December 31,
|                                                |  | 2001          |       | 2000        
|                                               
|
|                                               
|                                               
|                                               
|                                               
|                                               
|Inventories                                     |  |               | 192   |              |  |   | 499   | 
|                                               
|                                               
|                                               
|                                               
|Other current assets                            |  |               | 934   |              |  |   | 90    | 
|                                               
|Total current assets of discontinued operations |  |               | 1,288 |              |  |   | 1,511 | 
|                                               
|                                               
|                                               
|                                               
|
|                                               
|                                               
|                                               
|                                               
|                                               
|Other long-term assets                          |  |               | 392   |              |  |   | 590   | 
|                                               
|Total assets of discontinued operations         |  | $             | 1,700 |              |  | $ | 2,701 | 
|                                               
|
|                                               
|                                               
|                                               
|                                               
|                                               
|Long-term liabilities                           |  |               | 12    |              |  |   | 74    | 
|                                               
|Total liabilities of discontinued operations    |  | $             | 1,233 |              |  | $ | 255   | 
|                                               



| |                                                                                                                                                                                                   
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | The net cash used in discontinued operations for the nine months ended
September 30, 2001 and 2000, presented in the accompanying unaudited
Consolidated Statements of Cash Flows, was as follows:

|                                                  |                      |   |      |      |      |   |      |      |  
|------------------------------------------------- | -------------------- | - | ---- | ---- | ---- | - | ---- | ---- | -
|                                                 
|                                                  |                      |   | 2001 |      | 2000
|                                                 
|Cash flows from (used in) discontinued operations
|                                                  | Operating activities |   | $    | (577 | )    |   | $    | (559 | )
|                                                 
|                                                 
|                                                 
|                                                 
|                                                  | Investing activities |   |      | 18   |      |   |      | (270 | )
|                                                 
|Net cash used in discontinued operations          |                      | $ | (559 | )    |      | $ | (829 | )   
|                                                 



|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|-- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|5. | Segmented information                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|  
|   | General description                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|  
|   | Nortel Networks customers, markets, and solutions continue to evolve. As a
result, the specific customer groups identified within our previous Service
Provider and Carrier segment and Enterprise segment have now merged or
become uniform. In response to this change, Nortel Networks changed the
way it manages its business to reflect a focus on providing seamless
networking solutions and service capabilities to its customers.
Consequently, financial information by segment and customer solution has
been restated and reported on a new basis commencing in the three month
period ended March 31, 2001.
|  
|   | Nortel Networks operations include two reportable operating segments: the
Network Infrastructure segment (Network Infrastructure); and the
Photonics Components segment (Photonics Components). Network
Infrastructure consists of all networking solutions and includes optical
inter-city transmission products, metropolitan optical transmission
products, core Internet Protocol networking solutions (including packet and
circuit switching), eBusiness and service                                                                                                                                          

11



---



##### Table of Contents





| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | solutions, and applications solutions and services for wireless networks.
These networking solutions are used by service provider, carrier, and
enterprise customers, including incumbent and competitive local exchange
carriers, interexchange carriers, global carriers, wireless network
providers, Internet service providers, application service providers,
resellers, public utilities, cable television companies, large enterprises
and their branch offices, small businesses, and home offices, as well as
government, education, and utility organizations. Photonics Components
consists of the optical and electronic component design and manufacturing
operations for incorporation into Nortel Networks own products and for sale
to other networking systems manufacturers and includes active and passive
optical components, lasers and filters, transmitters and receivers, modules
and subsystems, and microelectronics devices.                                                                                                                                                                  
|
| | Other represents operating segments and business activities which include
certain customer premises-based voice and data networking solutions, global
professional services, and civil works and original equipment manufacturer
offerings. None of these operating segments or business activities meet
the criteria to be disclosed as reportable segments.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|
| | As described in note 4, Nortel Networks has reclassified the results of
operations of its access solutions operations as discontinued operations.
These operations were previously included as a separate operating segment
within Other. The segment data included below excludes amounts related to
the operations of the access solutions operating segment.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|
| | The Companys 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. The CEO relies on the information derived directly from Nortel
Networks management reporting system which provides revenue and gross
profit information by segment. The CEO reviews selling, general and
administrative expense, research and development expense, and the costs
associated with acquisitions on a total Nortel Networks basis. Therefore,
Nortel Networks does not allocate these costs to the segments as the CEO
does not use this information to either assess the performance of or
allocate resources to the segments. In addition, the CEO does not review
asset information on a segmented basis. Intersegment sales are based on
fair market values. All intersegment profit, including any unrealized
profit on ending inventories, is eliminated on consolidation. The
accounting policies of the segments are the same as those described in
note 2 of the 2001 Form 8-K.

12



---



##### Table of Contents





| |                                                        
| | -------------------------------------------------------
| | Segments                                               
|
| | The following tables set forth information by segments:

|                                                           |  |                    |        |                   |  |      |       |      |  |   |        |    |  |   |        |  
|---------------------------------------------------------- |  | ------------------ | ------ | ----------------- |  | ---- | ----- | ---- |  | - | ------ | -- |  | - | ------ | -
|                                                          
|                                                           |  | Three months ended |        | Nine months ended
|                                                           |  | September 30,      |        | September 30,    
|                                                           |  | 2001               |        | 2000              |  | 2001 |       | 2000
|                                                          
|
|                                                          
|                                                          
|                                                          
|                                                          
|                                                          
|Network Infrastructure                                     |  | $                  | 2,786  |                   |  | $    | 5,349 |      |  | $ | 10,827 |    |  | $ | 15,838 |  
|                                                          
|                                                          
|                                                          
|                                                          
|Photonics Components                                       |  |                    | 40     |                   |  |      | 674   |      |  |   | 445    |    |  |   | 1,611  |  
|                                                          
|                                                          
|                                                          
|                                                          
|Other                                                      |  |                    | 864    |                   |  |      | 1,224 |      |  |   | 2,951  |    |  |   | 3,575  |  
|                                                          
|                                                          
|                                                          
|                                                          
|Intersegment sales elimination                             |  |                    | (17    | )                 |  |      | (532  | )    |  |   | (290   | )  |  |   | (1,285 | )
|                                                          
|Total                                                      |  | $                  | 3,673  |                   |  | $    | 6,715 |      |  | $ | 13,933 |    |  | $ | 19,739 |  
|                                                          
|
|                                                          
|                                                          
|                                                          
|                                                          
|                                                          
|Network Infrastructure                                     |  | $                  | (104   | )                 |  | $    | 2,571 |      |  | $ | 1,764  |    |  | $ | 7,232  |  
|                                                          
|                                                          
|                                                          
|                                                          
|Photonics Components                                       |  |                    | (87    | )                 |  |      | 285   |      |  |   | (202   | )  |  |   | 617    |  
|                                                          
|                                                          
|                                                          
|                                                          
|Other                                                      |  |                    | 184    |                   |  |      | 281   |      |  |   | 620    |    |  |   | 1,041  |  
|                                                          
|                                                          
|                                                          
|                                                          
|Intersegment inventory unrealized profit elimination  net |  |                    | (3     | )                 |  |      | (28   | )    |  |   | (13    | )  |  |   | (38    | )
|                                                          
|Total                                                      |  | $                  | (10    | )                 |  | $    | 3,109 |      |  | $ | 2,169  |    |  | $ | 8,852  |  
|                                                          
|
|                                                          
|                                                          
|                                                          
|                                                          
|                                                          
|Network Infrastructure                                     |  |                    | (3.7   | )%                |  |      | 48.1  | %    |  |   | 16.3   | %  |  |   | 45.7   | %
|                                                          
|                                                          
|                                                          
|                                                          
|Photonics Components                                       |  |                    | (217.5 | )%                |  |      | 42.3  | %    |  |   | (45.4  | )% |  |   | 38.3   | %
|                                                          
|                                                          
|                                                          
|                                                          
|Other                                                      |  |                    | 21.3   | %                 |  |      | 23.0  | %    |  |   | 21.0   | %  |  |   | 29.1   | %
|                                                          
|                                                          
|                                                          
|                                                          
|Nortel Networks                                            |  |                    | (0.3   | )%                |  |      | 46.3  | %    |  |   | 15.6   | %  |  |   | 44.8   | %



| |                                                                        
| | -----------------------------------------------------------------------
| | Customer solutions revenues                                            
|
| | The following table sets forth external revenues by customer solutions:

|                  |  |                    |       |                   |  |      |       |      |  |   |        |  |  |   |        | 
|----------------- |  | ------------------ | ----- | ----------------- |  | ---- | ----- | ---- |  | - | ------ |  |  | - | ------ | 
|                 
|                  |  | Three months ended |       | Nine months ended
|                  |  | September 30,      |       | September 30,    
|                  |  | 2001               |       | 2000              |  | 2001 |       | 2000
|                 
|
|                 
|                 
|                 
|                 
|                 
|Local internet    |  |                    | 1,181 |                   |  |      | 2,402 |      |  |   | 4,951  |  |  |   | 7,338  | 
|                 
|                 
|                 
|                 
|Wireless internet |  |                    | 1,254 |                   |  |      | 1,370 |      |  |   | 4,241  |  |  |   | 3,700  | 
|                 
|                 
|                 
|                 
|Other (a)         |  |                    | 887   |                   |  |      | 1,366 |      |  |   | 3,106  |  |  |   | 3,901  | 
|                 
|Total             |  | $                  | 3,673 |                   |  | $    | 6,715 |      |  | $ | 13,933 |  |  | $ | 19,739 | 
|                 



| | (a) | Other includes the external customer solutions revenues of the
Photonics Components segment of $23 and $142 for the three months
ended September 30, 2001 and 2000, respectively, and $155 and $326 for
the nine months ended September 30, 2001 and 2000, respectively.
| | --- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

13



---



##### Table of Contents





| |                                                                        
| | -----------------------------------------------------------------------
| | Geographic information                                                 
|
| | The following table sets forth external revenues by geographic regions:

|                |  |                    |       |                   |  |      |       |      |  |   |        |  |  |   |        | 
|--------------- |  | ------------------ | ----- | ----------------- |  | ---- | ----- | ---- |  | - | ------ |  |  | - | ------ | 
|               
|                |  | Three months ended |       | Nine months ended
|                |  | September 30,      |       | September 30,    
|                |  | 2001               |       | 2000              |  | 2001 |       | 2000
|               
|
|               
|               
|               
|               
|               
|United States   |  | $                  | 1,755 |                   |  | $    | 3,815 |      |  | $ | 6,794  |  |  | $ | 11,983 | 
|               
|               
|               
|               
|Canada          |  |                    | 183   |                   |  |      | 389   |      |  |   | 695    |  |  |   | 1,030  | 
|               
|               
|               
|               
|Other countries |  |                    | 1,735 |                   |  |      | 2,511 |      |  |   | 6,444  |  |  |   | 6,726  | 
|               
|Total           |  | $                  | 3,673 |                   |  | $    | 6,715 |      |  | $ | 13,933 |  |  | $ | 19,739 | 
|               



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



| |                                                                              
| | -----------------------------------------------------------------------------
| | The following table sets forth long-lived assets by geographic regions as
at:

|                |  |               |       |              |  |   |        | 
|--------------- |  | ------------- | ----- | ------------ |  | - | ------ | 
|               
|                |  | September 30, |       | December 31,
|                |  | 2001          |       | 2000        
|               
|
|               
|               
|               
|               
|               
|United States   |  | $             | 3,567 |              |  | $ | 8,029  | 
|               
|               
|               
|               
|Canada          |  |               | 1,123 |              |  |   | 1,257  | 
|               
|               
|               
|               
|Other countries |  |               | 841   |              |  |   | 1,353  | 
|               
|Total           |  | $             | 5,531 |              |  | $ | 10,639 | 
|               



| | (a) | Represents plant and equipment  net and intangible assets  net
that are identified with each geographic region.
| | --- | -----------------------------------------------------------------------------------------------------------------



|   |                                                                                                                                                                                                                                                                                                                                      
|-- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|6. | Acquisitions                                                                                                                                                                                                                                                                                                                         
|  
|   | In certain acquisition transactions, Nortel Networks has agreed to
additional purchase consideration to be paid upon the achievement of
specific objectives by the acquired business. The maximum contingent
consideration was fixed as at the date of acquisition.                                                                  
|  
|   | The business performance objectives relating to the remaining $200 of
contingent consideration available to the former shareholders, option
holders and warrant holders of Qtera Corporation (Qtera) were not
achieved in the six months ended June 30, 2001, and as a result such
remaining contingent consideration was not paid.

14



---



##### Table of Contents





|   |                                 
|-- | --------------------------------
|7. | Special charges                 
|  
|   | Special charges were as follows:

|                             |                                     |   |                    |     |          |   |               |     |       |   |       |               |                      |   |               |     |  |   |     |     |  |   |       |     |   |   |           |     | 
|---------------------------- | ----------------------------------- | - | ------------------ | --- | -------- | - | ------------- | --- | ----- | - | ----- | ------------- | -------------------- | - | ------------- | --- |  | - | --- | --- |  | - | ----- | --- | - | - | --------- | --- | 
|                            
|                             |                                     |   |                    |     |          |   |               |     |       |   |       |               |                      |   |               |     |  |   |     |     |  |   |       |     |   |   | Provision
|                             |                                     |   | Three months ended |     |          |   |               |     |       |   |       | balance as at
|                             |                                     |   | March 31,          |     | June 30, |   | September 30, |     |       |   |       |               | Cumulative
drawdowns |   | September 30,
|                             |                                     |   | 2001               |     | 2001     |   | 2001          |     | Total |   | Cash  |               | Non-cash             |   | 2001         
|                            
|                            
|Restructuring activities:    |                                     |   |                    |     |          |   |               |     |       |   |       |               |                      |   |               |     |  |   |     |     |  |   |       |     |   |   |           |    
|                            
|                            
|                            
|                            
|                             | Workforce reduction                 |   | $                  | 247 |          |   | $             | 426 |       |   | $     | 286           |                      |   | $             | 959 |  |   | $   | 630 |  |   | $     | (14 | ) |   | $         | 343 | 
|                            
|                            
|                            
|                            
|                             | Contract settlement
and lease costs |   |                    | 20  |          |   |               | 302 |       |   |       | 278           |                      |   |               | 600 |  |   |     | 45  |  |   |       |    |   |   |           | 555 | 
|                            
|                            
|                            
|                            
|                             | Plant and equipment write downs     |   |                    |    |          |   |               | 410 |       |   |       | 428           |                      |   |               | 838 |  |   |     |    |  |   |       | 838 |   |   |           |    | 
|                            
|                            
|                            
|                            
|                             | Intangible asset write-off          |   |                    | 64  |          |   |               |    |       |   |       |              |                      |   |               | 64  |  |   |     |    |  |   |       | 64  |   |   |           |    | 
|                            
|                            
|                            
|                            
|                             | Other                               |   |                    | 24  |          |   |               | 4   |       |   |       | 8             |                      |   |               | 36  |  |   |     | 1   |  |   |       |    |   |   |           | 35  | 
|                            
|                             |                                     |   | 355                |     |          |   | 1,142         |     |       |   | 1,000 |               |                      |   | 2,497         |     |  |   | 676 |     |  |   | 888   |     |   |   | 933       |    
|                            
|Intangible assets write down |                                     |   |                   |     |          |   | 2,133         |     |       |   |      |               |                      |   | 2,133         |     |  |   |    |     |  |   | 2,133 |     |   |   |          |    
|                            
|Special charges              |                                     | $ | 355                |     |          | $ | 3,275         |     |       | $ | 1,000 |               |                      | $ | 4,630         |     |  | $ | 676 |     |  | $ | 3,021 |     |   | $ | 933       |    
|                            



| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | In light of the continued significant downturn in both the industry and
economic environment, and capital market trends impacting both Nortel
Networks current operations and expected future growth rates, Nortel
Networks has continually augmented its work plan during 2001 to optimize
results and drive efficiencies in its business by further streamlining
operations and activities that are not aligned with its core markets and
leadership strategies.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|
| | In addition, as part of its review of financial results during both the
three months ended June 30, 2001 and the three months ended September 30,
2001, Nortel Networks performed separate assessments of the carrying values
of its intangible assets based on the respective intangible asset balances
outstanding in each period. The carrying value of the intangible assets
used for the assessment during the three months ended September 30, 2001
reflected the $2,133 write down recorded for the three months ended June
30, 2001 as well as the ongoing amortization expense incurred on the
remaining intangible assets during the three months ended September 30,
2001. The conclusion of the assessment performed during the three months
ended September 30, 2001 was that no additional write down of intangible
assets was required. A significant portion of the remaining carrying value
of the goodwill represents enterprise level goodwill. There has been no
impairment in enterprise level goodwill during either the three months
ended June 30, 2001 or the three months ended September 30, 2001.                                                                                                                                                                                                                 
|
| | Restructuring activities                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|
| | For the three months and nine months ended September 30, 2001, Nortel
Networks recorded restructuring charges of $1,000 and $2,497, respectively.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|
| | Workforce reduction charges of $286 and $959 for the three months and nine
months ended September 30, 2001, respectively, were related to the cost of
severance and benefits associated with approximately 7,400 and 27,600
employees notified of termination, respectively. Of the 27,600 employees
notified by September 30, 2001, approximately 10,700 were direct employees
performing manufacturing, assembly, test and inspection activities
associated with the production of Nortel Networks solutions, and
approximately 16,900 were indirect sales, marketing, and administrative
employees, and manufacturing managers. Included in the current period
charge of $286 is approximately $27 related to the approximately 20,200
employees notified during the six months ended June 30, 2001. The
workforce reduction was primarily in North America and the United Kingdom
and extended across all of Nortel Networks operating segments. As at
September 30, 2001, the workforce reduction provision balance has been
drawn down by cash payments of $630, offset by $14 of non-cash curtailment
income related to both pension and other post-retirement benefits,
resulting in an ending provision balance of $343. The remaining provision
is expected to be substantially drawn down by the end of the second quarter of 2002.

15



---



##### Table of Contents





| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | In conjunction with the above noted workforce reduction, Nortel Networks
identified a number of leased facilities comprised of office and 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 $254 and $510 for the three months and nine months
ended September 30, 2001, respectively. The costs primarily related to
Nortel Networks future contractual obligations under operating leases.
Partially offsetting the total lease charge is approximately $561 in
expected sublease revenue on leases that Nortel Networks cannot terminate.
Contract settlement costs included negotiated settlements of approximately
$24 and $90 for the three months and nine months ended September 30, 2001,
respectively, to either cancel contracts or renegotiate existing contracts
within Network Infrastructure and Other. As at September 30, 2001, the
provision balance has been drawn down by cash payments of $45 resulting in
an ending provision balance of $555. The remaining provision is expected
to be substantially drawn down by the end of the fourth quarter of 2002.
|
| | Plant and equipment write downs of $244 and $429 for the three months and
nine months ended September 30, 2001, respectively, consisted of the write
down of leasehold improvements and certain information technology equipment
associated with the exiting of the above noted leased facilities.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|
| | As a result of the significant negative industry and economic trends
impacting both Nortel Networks current 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 both
the three months ended June 30, 2001 and September 30, 2001. The
conclusion of these assessments resulted in a write down of certain plant
and equipment within global operations, a function that supports all of
Nortel Networks segments, and Photonics Components for the three months and
nine months ended September 30, 2001, of $184 and $409 respectively.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|
| | 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 current industry and economic environment. As a result,
Nortel Networks recorded a charge of approximately $24 and $82 for the
three months and nine months ended September 30, 2001, respectively, 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 the first
quarter of 2002.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|
| | Within Photonics Components, it was determined that there was excess
manufacturing equipment at a number of facilities that would no longer be
required as a result of the current industry and economic environment. As
a result, Nortel Networks recorded a charge of approximately $160 and $236
for the three months and nine months ended September 30, 2001,
respectively, 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 by the end of the first quarter of 2002. Also, during the nine
months ended September 30, 2001, Nortel Networks wrote down the net
carrying value of a specialized manufacturing facility within Photonics
Components 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.                                                                                                                                                                                                 
|
| | The intangible asset write-off of $64 for the nine months ended September
30, 2001, is related to the remaining net book value of goodwill recorded
on the prior acquisition of MICOM Communications Corp (MICOM). As part
of Nortel Networks current initiative to strategically realign resources,
Nortel Networks has made the decision to exit the technologies associated
with the MICOM acquisition completely. The results of this prior
acquisition were not material to the business, results of operations, and
financial condition of Nortel Networks.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|
| | Intangible assets write down                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|
| | For the nine months ended September 30, 2001, Nortel Networks recorded an
intangible assets write down of $2,133.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|
| | Nortel Networks, as part of its review of financial results during the
three months ended June 30, 2001, performed an assessment of the carrying
values of intangible assets recorded in connection with its various
acquisitions. The assessment during that period was performed in light of
the significant negative industry and economic trends impacting both Nortel
Networks current operations and expected future growth rates, and the
adjustment of technology valuations. The conclusion of that assessment was
that the decline in market conditions within Nortel Networks industry was
significant and other than temporary. As a result, Nortel Networks
recorded a $2,133 write down of                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          

16



---



##### Table of Contents





|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|    | intangible assets in the three months ended June 30, 2001, based on the
amount by which the carrying amount of these assets exceeded the fair
value. The write down was primarily related to the goodwill associated
with the acquisitions of Qtera and Clarify Inc. within Network
Infrastructure.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|   
|    | Fair value was determined based on discounted future cash flows for the
businesses that had separately distinguishable intangible asset balances
and whose operations had not yet been fully integrated into Nortel
Networks. The cash flow periods used were five years, the discount rate
used was 20 percent, and the terminal values were estimated based upon
terminal growth rates ranging from 5 to 11 percent. The assumptions
supporting the estimated future cash flows, including the discount rate and
estimated terminal values, reflect managements best estimates. The
discount rate was based upon Nortel Networks weighted average cost of
capital as adjusted for the risks associated with the operations.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|   
|    | Nortel Networks has determined that the remaining intangible asset balances
will continue to be amortized on a straight-line basis over the remaining
useful lives established at the time of the related acquisition as the
remaining useful life of these intangible assets has not changed.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|   
|8.  | Gain on sale of businesses                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|   
|    | Gain on sale of businesses was $45 for the three months and nine months
ended September 30, 2001, respectively, and nil and $174 for the three
months and nine months ended September 30, 2000, respectively. The gain
for the three months and nine months ended September 30, 2001 related to
both the outsourcing of certain activities as part of Nortel Networks
continued supply chain transformation strategy that began in 1999 and the
divestiture of certain non-core businesses in connection with Nortel
Networks work plan to streamline its business around core markets. The
gain for the nine months ended September 30, 2000 related to the
divestiture of certain manufacturing operations and tangible and intangible
assets in connection with Nortel Networks then current operations strategy.                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|   
|9.  | Other income (expense)  net                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|   
|    | Other expense  net for the three months and nine months ended September
30, 2001 was $313 and $252, respectively, and other income  net was $206
and $797 for the three months and nine months ended September 30, 2000,
respectively. Other expense  net for both the three months and nine
months ended September 30, 2001 primarily related to a $296 write down in
the value of minority investments due to a change in Nortel Networks
strategic focus as well as an other than temporary decline in carrying
values caused by a continued significant downturn in both the industry and
economic environment. Other income  net for the three months ended
September 30, 2000 primarily related to a $169 gain due to a reduction in
Nortel Networks investment in Entrust, Inc. (formerly known as Entrust
Technologies, Inc.) (Entrust) from 33.5 percent to 27.0 percent primarily
as a result of Entrusts issuance of common shares in connection with its
acquisition of enCommerce, Inc. (the Entrust Transaction). Other income
- net for the nine months ended September 30, 2000 primarily related to the
Entrust Transaction and a $513 gain from the sale by Nortel Networks of a
portion of its share ownership in Entrust in the three months ended March
31, 2000.
|   
|10. | Long-term debt                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|   
|    | On February 8, 2001, the Company completed an offering of $1,500 of 6.125
percent notes due on February 15, 2006 (the Notes). The Notes pay
interest on a semi-annual basis on February 15 and August 15, which began
on August 15, 2001. The Notes are redeemable, at any time at the Companys
option, at a redemption price equal to the principal amount thereof plus
accrued and unpaid interest and a make-whole premium.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|   
|11. | Income taxes                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|   
|    | Nortel Networks effective tax rate from continuing operations, excluding
the impact of Acquisition Related Costs (IPR&D expense and the amortization
of acquired technology and goodwill from all acquisitions subsequent to
July 1998), stock option compensation, and where applicable certain of the
one-time gains and charges, for the three months and nine months ended
September 30, 2001 was an income tax recovery rate of 30.0 percent and 30.9
percent, respectively, and for the three months and nine months ended
September 30, 2000 was an income tax provision rate of 30.4 percent and
32.0 percent, respectively.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           

17



---



##### Table of Contents





|    |                                                                                                                                                                                                                                                                           
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|    | Global investment tax credits of $63 and $47 for the three months ended
September 30, 2001 and 2000, respectively, and $109 and $121 for the nine
months ended September 30, 2001 and 2000, respectively, have been
incorporated into the income tax recovery (provision).
|   
|12. | Inventories                                                                                                                                                                                                                                                               
|   
|    | The following table sets forth inventories as at:                                                                                                                                                                                                                         

|                |  |               |       |              |  |   |       | 
|--------------- |  | ------------- | ----- | ------------ |  | - | ----- | 
|               
|                |  | September 30, |       | December 31,
|                |  | 2001          |       | 2000        
|               
|               
|Raw materials   |  | $             | 658   |              |  | $ | 677   | 
|               
|               
|               
|               
|Work in process |  |               | 640   |              |  |   | 852   | 
|               
|               
|               
|               
|Finished goods  |  |               | 652   |              |  |   | 2,282 | 
|               
|Inventories     |  | $             | 1,950 |              |  | $ | 3,811 | 
|               



|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|    | As a result of the significant downturn in both the industry and economic
environment, and capital market trends impacting both Nortel Networks
current operations and expected future growth rates, Nortel Networks has
increased the total inventory provision by $485 as at September 30, 2001,
compared to December 31, 2000.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|   
|13. | Related party transactions                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|   
|    | The Company engages in certain transactions with both its parent
company, Nortel Networks Corporation, and with a directly owned
subsidiary of its parent. These transactions include cash borrowings
between the parties in addition to funding activities pursuant to
reciprocal credit agreements. As at September 30, 2001 and December
31, 2000, the balance included in trade and other accounts payable
owing to the Companys parent was $203 and $101, respectively, and to
a directly owned subsidiary of the Companys parent was $183 and $252,
respectively.                                                                                                                                                                                                                                               
|   
|    | On August 15, 2001, Nortel Networks Corporation completed a private
offering of $1,800 of 4.25 percent convertible senior notes (the Senior
Notes), due on September 1, 2008. The Company, as the guarantor of the
Senior Notes, will make payment for the principal, or interest, or premium,
if any, or other amounts, if any, should Nortel Networks Corporation not
make such payments as they are due. The guarantee of the Senior Notes is a
direct, unconditional, unsecured, and unsubordinated obligation of the
Company. Nortel Networks Corporation lent the full proceeds from the
offering to the Company for its general corporate purposes and those of its
subsidiaries. On September 30, 2001, Nortel Networks Corporation converted
the entire loan into one additional common share of the Company.
|   
|14. | Preferred shares                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|   
|    | During the three months ended September 30, 2001, the registered holders of
all 200 Cumulative Redeemable Class A Preferred Shares Series 4 (Series 4
Preferred Shares) of the Company, exercised their right to exchange their
Series 4 Preferred Shares for common shares of Nortel Networks Corporation.
Nortel Networks Corporation issued in aggregate approximately 9,035,000
common shares to the former holders of Series 4 Preferred Shares. In
return the Company issued approximately 4,090,000 common shares to Nortel
Networks Corporation.                                                                                                                                                                                                                                                              
|   
|15. | Common shares                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|   
|    | On September 30, 2001 and June 14, 2001, Nortel Networks Corporation, as
the holder of all of the Companys issued and outstanding common shares,
approved a reduction in the Companys legal stated capital for its common
shares in the amount of $1,800 and $15,000, respectively.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   

18



---



##### Table of Contents





|    |                                                                          
|--- | -------------------------------------------------------------------------
|16. | Consolidated statements of cash flows                                    
|   
|    | The following table sets forth interest paid and income taxes paid  net:

|                        |  |                   |     |      |  |   |     | 
|----------------------- |  | ----------------- | --- | ---- |  | - | --- | 
|                       
|                        |  | Nine months ended
|                        |  | September 30,    
|                        |  | 2001              |     | 2000
|                       
|                       
|Interest paid           |  | $                 | 195 |      |  | $ | 99  | 
|                       
|                       
|                       
|                       
|Income taxes paid  net |  | $                 | 195 |      |  | $ | 732 | 



|    |                                                                   
|--- | ------------------------------------------------------------------
|17. | Comprehensive loss                                                
|   
|    | The components of comprehensive loss, net of tax, were as follows:

|                                   |                                                            |   |                    |     |                   |   |      |     |      |   |         |      |   |   |        |      |  
|---------------------------------- | ---------------------------------------------------------- | - | ------------------ | --- | ----------------- | - | ---- | --- | ---- | - | ------- | ---- | - | - | ------ | ---- | -
|                                  
|                                   |                                                            |   | Three months ended |     | Nine months ended
|                                   |                                                            |   | September 30,      |     | September 30,    
|                                   |                                                            |   | 2001               |     | 2000              |   | 2001 |     | 2000
|                                  
|                                  
|Net loss                           |                                                            | $ | (3,270             | )   |                   | $ | (175 | )   |      | $ | (12,525 | )    |   | $ | (1,176 | )   
|                                  
|                                  
|                                  
|                                  
|Other comprehensive income (loss): |                                                            |   |                    |     |                   |   |      |     |      |   |         |      |   |   |        |     
|                                  
|                                  
|                                  
|                                  
|                                   | Change
in foreign currency translation adjustment (a)      |   |                    | (92 | )                 |   |      | (26 | )    |   |         | (310 | ) |   |        | (145 | )
|                                  
|                                  
|                                  
|                                  
|                                   | Unrealized gain (loss) on investments  net (b)            |   |                    | 30  |                   |   |      | (25 | )    |   |         | (43  | ) |   |        | 14   |  
|                                  
|                                  
|                                  
|                                  
|                                   | Unrealized derivative losses on cash flow hedges  net (c) |   |                    | (14 | )                 |   |      |    |      |   |         | (20  | ) |   |        |     |  
|                                  
|Comprehensive loss                 |                                                            | $ | (3,346             | )   |                   | $ | (226 | )   |      | $ | (12,898 | )    |   | $ | (1,307 | )   
|                                  



| | (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. The change
during the three months ended September 30, 2001 represents the write
down of the value of minority investments due to a change in Nortel
Networks strategic focus as well as an other than temporary decline in
carrying values caused by a continued significant downturn in both the
industry and economic environment, resulting in a charge to other
income (expense)  net.
|
| | (c) | Includes $7 (pre-tax $11) of net derivative losses related to the
adoption of SFAS 133. During the three months and nine months ended
September 30, 2001, $6 and $11, respectively, of net derivative losses
were reclassified to selling, general and administrative expense.                                                                                                                                                                                                                                                                                                                                                                     



|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|18. | Contingencies                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|   
|    | In connection with the January 28, 2000 acquisition of Qtera, currently an
indirect subsidiary of the Company, Qtera and two of its employees were
named as defendants in a lawsuit filed by Siemens ICN in the 15th Judicial
Circuit for Palm Beach County, Florida. The lawsuit alleged various
claims, including purported misappropriation of trade secrets. This
dispute has been resolved to the satisfaction of the parties and without
material adverse effect to Nortel Networks.                                                                                                                                                                                                                 
|   
|    | 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 have been named as
defendants in more than twenty-five purported class action lawsuits. These
lawsuits, which have been served through September 24, 2001, 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

19



---



##### Table of Contents





| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | 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. In addition, a class action lawsuit was
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 other
lawsuits. On May 11, 2001, Nortel Networks Corporation filed motions to
dismiss and/or stay in connection with the 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. 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 order requires that the
plaintiffs file a consolidated amended complaint within 30 days of the
order and that the defendants respond 30 days thereafter. To date, no
consolidated amended complaint has been filed by the plaintiffs.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|
| | On February 12, 2001, Nortel Networks Inc., a subsidiary of the Company,
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 and two of
its then current officers in the United States District Court of Texas,
Marshall Division (the District Court). The First 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 (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
by the Company 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 and on September 8, 2000, a notice
of appeal of that order and judgment was filed by the plaintiffs. In
January 2001, the plaintiffs filed their opening brief in the United States
Court of Appeals for the Ninth Circuit and the defendants filed their
responsive brief in April 2001. The oral arguments for the appeal were
heard on July 11, 2001 and on August 1, 2001, the Ninth Circuit denied the
plaintiffs appeal. 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 June 18, 2001, the
defendants removed the consolidated state court actions to the Federal
Court, on the grounds that the class claims asserted by the complaint are
barred by the Securities Litigation Uniform Standards Act. The defendants
have filed a motion to dismiss that complaint, while the various plaintiffs
have sought to have the case remanded to the California Court. On
September 19, 2001, the defendants motion to dismiss was rejected and the
plaintiffs motion to remand was granted. The defendants will appeal in the
United States Court of Appeals for the Ninth Circuit with respect to the
decisions in such motions.
|
| | Nortel Networks is also a defendant in various other suits, claims,
proceedings and investigations which arise in the normal course of
business.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              

20



---



##### Table of Contents





|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|    | 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. Unless otherwise noted, Nortel Networks and any named
directors and officers of Nortel Networks intend to vigorously defend these
actions, suits, claims, proceedings and investigations.                                                                                                                                                                                                                                                                                                                                              
|   
|19. | Recent pronouncements                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|   
|    | In October 2001, the Financial Accounting Standards Board (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. This
Statement supersedes SFAS 121, and the accounting and reporting provisions
of APB 30, for the disposal of a segment of a business. The provisions of
SFAS 144 are required to be adopted by Nortel Networks effective January 1,
2002. The Company has not yet determined the effect that the adoption of
SFAS 144 will have on the business, results of operations, and financial
condition of Nortel Networks.                                                                                                                                                                                                                                                                                       
|   
|    | In July 2001, the FASB issued SFAS No. 141, Business Combinations (SFAS
141), effective for business combinations initiated after June 30, 2001,
and SFAS No. 142, Goodwill and Other Intangible Assets (SFAS 142)
effective for fiscal years beginning after December 15, 2001. SFAS 141
transitional rules require that the purchase method of accounting be used
for all business combinations initiated after June 30, 2001. As a result,
the pooling-of-interests method is now prohibited. SFAS 142 changes 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 intangibles with an indefinite life, will
cease upon adoption of this Statement, which for Nortel Networks will be
January 1, 2002. However, for any acquisitions completed after June 30,
2001, goodwill and intangible assets with an indefinite life will not be
amortized.
|   
|    | The adoption of SFAS 141 will not have an impact on the business, results
of operations, and financial condition of Nortel Networks. The Company
will be performing the first of the required SFAS 142 impairment tests
during 2002 and has not yet determined the effect that the adoption of SFAS
142 will have on the business, results of operations, and financial
condition of Nortel Networks.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|   
|20. | Subsequent events                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              



| |     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
| | --- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | i)  | 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, which have been served 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, into a single case,
appointing class plaintiffs and counsel for such plaintiffs. The
order requires that the plaintiffs file a consolidated amended
complaint within 30 days of the order and that the defendants respond
30 days thereafter. To date, no consolidated amended complaint has
been filed by the plaintiffs (see note 18).
|
| | ii) | On October 2, 2001, as part of Nortel Networks work plan to
further reduce its cost structure and streamline operations, Nortel
Networks Corporation announced that it expects Nortel Networks overall
workforce will be approximately 45,000 following additional workforce
reductions and the additional divestiture of non-core businesses expected to be completed during
the next several quarters. As a result, Nortel Networks expects a workforce
reduction and related charge in the
fourth quarter of 2001.                                                                                                                                                                                                       

21



---



##### Table of Contents





| |      |                                                                                                                         
| | ---- | ------------------------------------------------------------------------------------------------------------------------
| | iii) | In addition, Nortel Networks Corporation announced the following
transactions associated with Nortel Networks work plan.



| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | On October 3, 2001, Nortel Networks Corporation announced that Nortel
Networks has entered into an agreement with C-MAC Industries Inc.
(C-MAC) to divest the majority of Nortel Networks manufacturing
activities related to the systems integration, configuration, and
testing of Nortel Networks DMS circuit-switching products, currently
performed in Nortel Networks System House in Research Triangle Park,
North Carolina. Nortel Networks also proposes to divest to C-MAC
similar manufacturing activities performed in its System House in
Monkstown, Northern Ireland. C-MAC will also supply back to Nortel
Networks systems integration, configuration, and testing services for
DMS products, and will assume most of the management functions
related to the associated supply chain. The transactions include the
sale of associated equipment and inventory. These proposed
transactions are subject to conditions, approvals, and consultation
processes in certain jurisdictions and are both expected to close in
the fourth quarter of 2001.
|
| | On October 2, 2001, Nortel Networks Corporation announced an
agreement with Amdocs Limited (Amdocs) whereby Nortel Networks will
sell substantially all assets used in its Clarify portfolio,
including patents, intellectual property, and trademarks, for
approximately $200 in cash. Under the agreement, Amdocs will also
assume existing customer contracts, as well as certain leased office
space. As a condition of the sale in Europe, all necessary employee
consultation requirements must also be met. The completion of the
transaction is subject to customary regulatory approvals and is
expected to close in the fourth quarter of 2001.                                                                                                                                                                                                                                                                                                                                                                                                          



|    |                                                                                                                                                                      
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------
|21. | Comparative figures                                                                                                                                                  
|   
|    | Certain comparative figures in the accompanying unaudited Consolidated
Financial Statements have been reclassified to conform with the current
periods presentation.

22



---



##### Table of Contents






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

You should read this section in conjunction with our unaudited
consolidated financial statements and notes. This section adds 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 the Company, we mean Nortel Networks Limited without its
subsidiaries. Where we say we, us, our, or Nortel Networks, we mean
the Company and its subsidiaries.

Overview

Nortel Networks Corporations common shares are publicly-traded on the New
York and Toronto stock exchanges under the symbol NT. The Company is the
principal direct operating subsidiary of Nortel Networks Corporation. Nortel
Networks Corporation owns all of the Companys outstanding common shares and
none of the Companys preferred shares. Acquisitions involving any share
consideration are completed by Nortel Networks Corporation and acquisitions
involving only cash consideration are generally completed by the Company or one
of its direct subsidiaries.

Developments in 2001

Discontinued operations

On June 15, 2001, as a result of initiatives to streamline our businesses,
we announced plans to discontinue our access solutions operations, consisting
of all of our narrowband and broadband solutions, including copper, cable, and
fixed wireless solutions, as well as our then current consolidated membership
interest in Arris Interactive LLC and equity investment in Elastic Networks
Inc. Also affected by the decision were our prior acquisitions of Promatory
Communications, Inc., Aptis Communications, Inc., and
Broadband Networks Inc. The access solutions operations were previously
included as a separate operating segment within other, in addition to the
global professional services operating segment and customer premises-based
solutions operating segment. We are currently working to dispose of or
transition the ownership of certain operations and expect to complete this plan
by June 2002. Any operations not disposed of or so transitioned are expected
to be closed.

In conjunction with this decision, we have restated certain historical
financial statements and we refer you to the Companys audited consolidated
financial statements and notes thereto for the three years ended December 31,
2000 and unaudited consolidated financial statements and notes thereto for the
three months ended March 31, 2001, restated for discontinued operations, and
included in the Companys Current Report on Form 8-K, filed with the United
States Securities and Exchange Commission on August 8, 2001. We also refer you
to the Companys Current Report on Form 8-K, filed with the United States
Securities and Exchange Commission on November 6, 2001, which includes
Managements Discussion and Analysis of Financial Condition and Results of
Operations for the year ended December 31, 2000, restated for discontinued
operations.

We recorded a net loss of $2,538 from discontinued operations, comprised
of a $354 net loss from operations and a $2,184 net loss on disposal. The
estimated loss on disposal of the access solutions operations reflects the
costs directly associated with discontinuing operations and the net loss of the
access solutions operations during the phase-out period. Major components of
the loss included future contractual obligations and estimated liabilities of
$1,059 (pre-tax); provisions for both short-term and long-term receivables of
$600 (pre-tax); the write-off of goodwill associated with the acquisition of
Promatory Communications, Inc. of $417 (pre-tax); and a provision for
inventories of $381 (pre-tax). We have not revised our estimate of the net
loss on disposal, recorded in the three months ended June 30, 2001, during the
three months ended September 30, 2001.

23



---



##### Table of Contents



At September 30, 2001, the remaining accruals totalled $1,125 and were
primarily related to future contractual obligations and estimated liabilities
related to the planned period of disposition. The remaining accruals are
expected to be drawn down by cash payments, the impact of which is expected to
be partially offset by cash inflows generated from the sale of certain assets
over the planned period of disposition.

On August 24, 2001, we completed a transaction with Zhone Technologies,
Inc. to sell our Access Node ABM and CDS product shelves and the Universal Edge
9000 digital loop carrier shelf and remote access shelf products.

On August 3, 2001, we completed the previously announced transfer of our
ownership interest in Arris Interactive LLC to Arris Group, Inc., ANTEC
Corporations new parent company, and as a result, at September 30, 2001, we
owned a 49.2 percent non-controlling interest in Arris Group, compared to the
previous 81.25 percent controlling interest in Arris Interactive.

On July 25, 2001, we completed a transaction with GE Industrial Systems
Technology Management Inc., a division of the General Electric Company, to sell
our Lentronics JungleMUX SONET multiplexer and TN-1U SDH multiplexer products.

For additional information related to discontinued operations, see
Discontinued operations in note 4.

The following discussion focuses on our results from continuing operations.

Divestitures/outsourcing

As part of the continuing transformation of our supply chain from a
vertically integrated manufacturing model to a virtually integrated model, and
in conjunction with our current work plan to streamline the business around
core markets in order to align our cost structure to current market conditions
and strengthen our financial position, Nortel Networks Corporation announced
the following transactions:



| |  |  | On October 3, 2001, Nortel Networks Corporation announced that Nortel
Networks has entered into an agreement with C-MAC Industries Inc. to
divest the majority of Nortel Networks manufacturing activities related
to the systems integration, configuration, and testing of Nortel
Networks DMS circuit-switching products, currently performed in Nortel
Networks system house in Research Triangle Park, North Carolina. We
also propose to divest to C-MAC similar manufacturing activities
performed in our system house in Monkstown, Northern Ireland. C-MAC
will also supply back to Nortel Networks systems integration,
configuration, and testing services for DMS products, and will assume
most of the management functions related to the associated supply chain.
The transactions include the sale of associated equipment and
inventory. These proposed transactions are both expected to close in
the fourth quarter of 2001.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | On October 2, 2001, Nortel Networks Corporation announced an
agreement with Amdocs Limited whereby Nortel Networks will sell
substantially all assets used in Nortel Networks Clarify portfolio,
including patents, intellectual property, and trademarks, for
approximately $200 in cash. Under the terms of the agreement, Amdocs
will also assume existing customer contracts, as well as certain leased
office space. The transaction is expected to close in the fourth
quarter of 2001.                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|
| |  |  | On September 20, 2001, Nortel Networks Corporation announced an
agreement with SCI Systems, Inc. to outsource Nortel Networks remaining
printed circuit board assembly activities performed in Nortel Networks
system houses in St. Laurent, Quebec and Monkstown, Northern Ireland,
including the sale of associated equipment and inventory. In addition,
Nortel Networks will extend the master supply agreement with SCI, which
covers existing printed circuit board assembly manufacturing services
performed for Nortel Networks. The North American portion of the
transaction closed on September 28, 2001, and the European portion is
expected to close in the fourth quarter of 2001.                                                                                                                                                                                                                                              

During the third quarter, Nortel Networks also completed additional
divestitures of various non-core, non-strategic business activities.

24



---



##### Table of Contents



The divestiture of non-core businesses completed or entered into
subsequent to the second quarter of 2001, or planned, is expected to ultimately
approach a reduction of approximately 10,000 positions and is expected to be
completed during the next several quarters.

Restructuring activities

In light of the continued significant downturn in both the industry and
economic environment, and capital market trends impacting both Nortel Networks
current operations and expected future growth rates, we have continually
augmented our work plan during 2001 to optimize results and drive efficiencies
in our business by further streamlining operations and activities that are not
aligned with our core markets and leadership strategies. As part of this work
plan to further reduce our cost structure and streamline operations, we have
notified for termination and provisioned for approximately 27,600 employees for
the nine months ended September 30, 2001. Special charges with respect to the
notification of employees, contract settlement and lease costs, the write down
of plant and equipment, and the write-off of goodwill in the first nine months
of 2001 were $2,497 (pre-tax). See Special charges for additional details
related to restructuring activities undertaken up to September 30, 2001.

On October 2, 2001, the Company provided an update on our work plan and
announced that we now expect our overall workforce to be approximately 45,000
following additional workforce reductions and the divestiture of non-core
businesses. As a result, we expect a workforce reduction and related charge in the fourth quarter of 2001. In
addition, the divestiture of non-core businesses completed or entered into
subsequent to the second quarter of 2001, or planned, is expected to ultimately
approach a reduction of approximately 10,000 positions and is expected to be
completed during the next several quarters. As of October 31, 2001,
we have substantially completed the notification of employees
impacted by the work plan's overall workforce reductions announced to
date.

Write down of intangible assets

As part of our review of financial results during the three months ended
June 30, 2001, we performed an assessment of the carrying values of intangible
assets recorded in connection with our various acquisitions. The assessment
was performed, during that period, in light of the significant negative
industry and economic trends impacting both our current operations and expected
future growth rates, and the adjustment of technology valuations. The
conclusion of that assessment was that the decline in market conditions within
our industry was significant and other than temporary. As a result, we
recorded a $2,133 (pre-tax) write down of intangible assets in the three months
ended June 30, 2001, based on the amount by which the carrying amount of these
assets exceeded their fair value. The write down was primarily related to the
goodwill associated with the acquisitions of Qtera Corporation and Clarify Inc.
within the network infrastructure segment. See Special charges for
additional details.

Legal matters

Subsequent to Nortel Networks Corporations February 15, 2001 announcement
in which it provided revised guidance for financial performance for the fiscal
year and first quarter 2001, Nortel Networks Corporation and certain of its
then current officers and directors have been named as defendants in more than
twenty-five purported class action lawsuits. These lawsuits, which have been
served through September 24, 2001 in the United States, and in Ontario, Quebec,
and British Columbia, 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.
In addition, a class action lawsuit was 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 violation of the same United States federal
securities laws as the other lawsuits. This case arose after the acquisition
on February 13, 2001 by the Company of JDS Uniphase Corporations Zurich,
Switzerland-based subsidiary, a designer and manufacturer of strategic 980
nanometer pump-laser chips, and related assets in Poughkeepsie, New York in
exchange for common shares of Nortel Networks Corporation. 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. See Legal
proceedings for additional details.

25



---



##### Table of Contents



Debt issuances

On August 15, 2001, Nortel Networks Corporation completed a private
offering of $1,800 of 4.25 percent convertible senior notes, due on September
1, 2008. These notes pay interest on a semi-annual basis on March 1 and
September 1, beginning on March 1, 2002. Nortel Networks Corporation lent all
of the proceeds from its private debt offering to the Company, which is the
guarantor of the notes, for its general corporate purposes and those of its
subsidiaries. On September 30, 2001, Nortel Networks Corporation converted the entire loan into one additional common share of the Company.

On February 8, 2001, the Company completed an offering of $1,500 of 6.125
percent notes due on February 15, 2006. These notes pay interest on a
semi-annual basis on February 15 and August 15, which began on August 15, 2001.
These notes are redeemable, at any time at the Companys option, at a
redemption price equal to the principal amount thereof plus accrued and unpaid
interest and a make-whole premium.

See Liquidity and capital resources for additional details.

Conversion of preferred shares

During the three months ended September 30, 2001, Nortel Networks
Corporation issued in aggregate approximately 9,035,000 common shares to the
registered holders of the 200 Cumulative Redeemable Class A Preferred Shares
Series 4 of the Company, each of whom had exercised their right to exchange
their Series 4 preferred shares for common shares of Nortel Networks
Corporation. See Preferred shares in note 14 for additional details.

Financial results

Revenues for the three months and nine months ended September 30, 2001
decreased substantially compared to the same periods in 2000, due to the
significant adjustment in the global telecom industry, particularly in the
United States, and the impact of continuing economic concerns. Gross margins
for the three months and nine months ended September 30, 2001 were (0.3)
percent and 15.6 percent, respectively, compared to 46.3 percent and 44.8
percent, respectively, for the same periods in 2000. We reported net losses
from continuing operations for the three months and nine months ended September
30, 2001, of $3,270 and $10,002, respectively.

Results of operations  Three months and nine months ended September 30, 2001
versus three months and nine months ended September 30, 2000

Our customers, markets, and solutions continue to evolve. As a result,
the specific customer groups identified within our previous service provider
and carrier segment and enterprise segment have merged or become uniform. In
response to this change, we changed the way we manage our business to reflect a
focus on providing seamless networking solutions and service capabilities to
our customers. Financial information by segment and customer solution has been
restated and reported on a new basis commencing in the three month period ended
March 31, 2001.

Network infrastructure  This operating segment consists of all networking
solutions and includes optical inter-city transmission products, metropolitan
optical transmission products, core Internet Protocol networking solutions
(including packet and circuit switching), eBusiness and service solutions, and
applications solutions and services for wireless networks. These networking
solutions are used by service provider, carrier, and enterprise customers,
including incumbent and competitive local exchange carriers, interexchange
carriers, global carriers, wireless network providers, Internet service
providers, application service providers, resellers, public utilities, cable
television companies, large enterprises and their branch offices, small
businesses, and home offices, as well as government, education, and utility
organizations.

Photonics components  This operating segment consists of the optical and
electronic component design and manufacturing operations for incorporation into
Nortel Networks own products and for sale to other networking systems
manufacturers and includes active and passive optical components, lasers and
filters, transmitters and receivers, modules and subsystems, and
microelectronics devices.

26



---



##### Table of Contents



Other  Other represents operating segments and business activities which
include certain customer premises-based voice and data networking solutions,
global professional services, and civil works and original equipment
manufacturer offerings. None of these operating segments or business
activities meet the criteria to be disclosed as reportable segments.

Commensurate with Nortel Networks Corporations announcement on October 2,
2001 regarding the alignment of its resources around three core businesses
(Metro Networks, Wireless Networks, and Optical Long Haul Networks), Nortel
Networks will change its financial reporting to reflect the new organization
beginning in the fourth quarter of 2001.

Revenues

Segment revenues

The following table sets forth information by segment for the three months and
nine months ended September 30, 2001 and 2000:

|                               |  |                                  |       |                                 |  |          |       |          |  |      |        |      |  |          |       |          |  |   |        |   |  |   |        |   |  |   |        |   |  |  |       |  
|------------------------------ |  | -------------------------------- | ----- | ------------------------------- |  | -------- | ----- | -------- |  | ---- | ------ | ---- |  | -------- | ----- | -------- |  | - | ------ | - |  | - | ------ | - |  | - | ------ | - |  |  | ----- | -
|                              
|                               |  | Three months ended September 30, |       | Nine months ended September 30,
|                               |  | 2001                             |       | 2000                            |  | $ Change |       | % Change |  | 2001 |        | 2000 |  | $ Change |       | % Change
|                              
|Network infrastructure         |  | $                                | 2,786 |                                 |  | $        | 5,349 |          |  | $    | (2,563 | )    |  |          | (47.9 | )        |  | $ | 10,827 |   |  | $ | 15,838 |   |  | $ | (5,011 | ) |  |  | (31.6 | )
|                              
|                              
|                              
|                              
|Photonics components           |  |                                  | 40    |                                 |  |          | 674   |          |  |      | (634   | )    |  |          | (94.1 | )        |  |   | 445    |   |  |   | 1,611  |   |  |   | (1,166 | ) |  |  | (72.4 | )
|                              
|                              
|                              
|                              
|Other                          |  |                                  | 864   |                                 |  |          | 1,224 |          |  |      | (360   | )    |  |          | (29.4 | )        |  |   | 2,951  |   |  |   | 3,575  |   |  |   | (624   | ) |  |  | (17.5 | )
|                              
|                              
|                              
|                              
|Intersegment sales
elimination |  |                                  | (17   | )                               |  |          | (532  | )        |  |      | 515    |      |  |          | N/A   |          |  |   | (290   | ) |  |   | (1,285 | ) |  |   | 995    |   |  |  | N/A   |  
|                              
|Consolidated                   |  | $                                | 3,673 |                                 |  | $        | 6,715 |          |  | $    | (3,042 | )    |  |          | (45.3 | )        |  | $ | 13,933 |   |  | $ | 19,739 |   |  | $ | (5,806 | ) |  |  | (29.4 | )
|                              

Customer solutions revenues

The following table sets forth external revenues by customer solutions for the
three months and nine months ended September 30, 2001 and 2000:

|                   |  |                                  |       |                                 |  |          |       |          |  |      |        |      |  |          |       |          |  |   |        |  |  |   |        |  |  |   |        |   |  |  |       |  
|------------------ |  | -------------------------------- | ----- | ------------------------------- |  | -------- | ----- | -------- |  | ---- | ------ | ---- |  | -------- | ----- | -------- |  | - | ------ |  |  | - | ------ |  |  | - | ------ | - |  |  | ----- | -
|                  
|                   |  | Three months ended September 30, |       | Nine months ended September 30,
|                   |  | 2001                             |       | 2000                            |  | $ Change |       | % Change |  | 2001 |        | 2000 |  | $ Change |       | % Change
|                  
|Optical inter-city |  | $                                | 351   |                                 |  | $        | 1,577 |          |  | $    | (1,226 | )    |  |          | (77.7 | )        |  | $ | 1,635  |  |  | $ | 4,800  |  |  | $ | (3,165 | ) |  |  | (65.9 | )
|                  
|                  
|                  
|                  
|Local internet     |  |                                  | 1,181 |                                 |  |          | 2,402 |          |  |      | (1,221 | )    |  |          | (50.8 | )        |  |   | 4,951  |  |  |   | 7,338  |  |  |   | (2,387 | ) |  |  | (32.5 | )
|                  
|                  
|                  
|                  
|Wireless internet  |  |                                  | 1,254 |                                 |  |          | 1,370 |          |  |      | (116   | )    |  |          | (8.5  | )        |  |   | 4,241  |  |  |   | 3,700  |  |  |   | 541    |   |  |  | 14.6  |  
|                  
|                  
|                  
|                  
|Other (a)          |  |                                  | 887   |                                 |  |          | 1,366 |          |  |      | (479   | )    |  |          | (35.1 | )        |  |   | 3,106  |  |  |   | 3,901  |  |  |   | (795   | ) |  |  | (20.4 | )
|                  
|Consolidated       |  | $                                | 3,673 |                                 |  | $        | 6,715 |          |  | $    | (3,042 | )    |  |          | (45.3 | )        |  | $ | 13,933 |  |  | $ | 19,739 |  |  | $ | (5,806 | ) |  |  | (29.4 | )
|                  



|(a) |  | Other includes the external customer solutions revenues of the photonics
components segment of $23 and $142 for the three months ended September
30, 2001 and 2000, respectively, and $155 and $326 for the nine months
ended September 30, 2001 and 2000, respectively.
|--- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Consolidated

The substantial decline in revenues for the three months ended September
30, 2001, compared to the same period in 2000, was due to substantial declines
across all segments. The substantial decline in revenues for the nine months
ended September 30, 2001, compared to the same period in 2000, was due to a
substantial decline in network infrastructure segment revenues, a significant
decline in other revenues, and a substantial decline in photonics components
external revenues. Consolidated revenues declined substantially as a result of
reduced and/or deferred capital spending by our customers, particularly in the
United States, as they changed their focus from building new networks, in
anticipation of previously expected levels of demand, to increasing the
capacity utilization rates and the efficiency of existing networks, and
conserving their capital.

27



---



##### Table of Contents



The global telecom industry is undergoing a significant adjustment,
particularly in the United States. Following a period of rapid infrastructure
build-out and strong economic conditions in 1999 and 2000, we have seen
continued tightened capital markets and a continued slowdown in the telecom
industry through the first three quarters of 2001. This has resulted in lower
capital spending by industry participants and less demand for our products and
services as service providers focused on driving return on invested capital.
We expect that the severe lack of available funding from capital markets, high
debt levels of many service providers, excess and shared bandwidth capacity,
reduced service provider competition due to the reduced presence of competitive
local exchange carriers, and the compounding impact of economic concerns will
continue to constrain capital spending by service providers. While there can
be no certainty as to the duration or severity of this industry adjustment,
meaningful growth in spending is not expected to occur before the fourth
quarter of 2002 after economic concerns subside and the anticipated
rationalization of the telecom industry is well underway. Also, we cannot
predict the potential impact on economies and businesses around the world of
events occurring in the wake of September 11, 2001. As a result, it is not
currently possible to provide specific guidance for the Companys financial
performance for the fourth quarter of 2001 or the full year 2002 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 significant adjustment in the telecom industry, which was initially
felt and continues to be most severe in the United States, has also impacted
Europe and the Caribbean and Latin America region. Overall revenues declined
substantially in the United States, significantly in Europe, and substantially
in Canada and the Caribbean and Latin America region for the first nine months ended
September 30, 2001, compared to the same periods in 2000. This has been
partially offset by considerable growth in the Asia Pacific region during the
same period. The declines in Europe and the Caribbean and Latin America region
during the first nine months of 2001 reflect sequential declines in the second
and third quarters of 2001. Overall, we experienced sequential declines in the third quarter of 2001
across all major regions in which we conduct business. We cannot predict
whether or to what extent this significant adjustment will impact the Asia
Pacific region, particularly the Peoples Republic of China. A comparable
impact on the telecom industry in this region could result in further
reductions in our overall revenues.

We expect to continue to focus on potentially higher-growth areas,
including wireless internet and optical inter-city customer solutions and the
metro and core Internet Protocol networks portions of our local internet
customer solutions, and to continue to reduce our investment in lower margin,
lower growth, and/or non-strategic businesses, which may include disposing of
or otherwise exiting certain businesses.

Network infrastructure

The substantial decline in revenues for the three months ended September
30, 2001, compared to the same period in 2000, was due to substantial declines
in sales of optical inter-city and local internet customer solutions, and a
decline in sales of wireless internet customer solutions.

The substantial decline in revenues for the nine months ended September
30, 2001, compared to the same period in 2000, was due to substantial declines
in sales of optical inter-city and local internet customer solutions, partially
offset by significant growth in sales of wireless internet customer solutions.

Optical inter-city

The substantial decline in revenues for the three months ended September
30, 2001, compared to the same period in 2000, was primarily the result of
substantial declines in the United States, Europe, and the Caribbean and Latin
America region. The substantial decline in revenues for the nine months ended
September 30, 2001, compared to the same period in 2000, was primarily the
result of substantial declines in the United States and Canada, partially
offset by a substantial increase in the Asia Pacific region. The substantial
decline in sales was primarily the result of reductions and/or continuing
deferrals in capital spending, primarily by our major United States customers.
Our major customers continue to focus on driving 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 and
profitability in the near term.

28



---



##### Table of Contents



Local internet

The substantial decline in revenues for the three months ended September
30, 2001, compared to the same period in 2000, was primarily the result of
substantial declines in sales of the circuit switching portion of our local
internet customer solutions, certain optical products having a metro
application, and the core Internet Protocol networks portion of our local
internet customer solutions. The substantial decrease in sales of the circuit
switching portion of our local internet customer solutions was primarily the
result of reduced demand in the exchange carrier market due to the significant
adjustment in the telecom industry and the tightened capital markets. The
substantial decrease in sales of optical products having a metro application
was due to declines in the sales volumes of mature products in this category.
The substantial decline in sales of the core Internet Protocol networks portion
of our local internet customer solutions was primarily the result of a decline
in demand for multi-service wide area network, or WAN, switch products due to
the continuing industry adjustment. The substantial decline in overall sales
of local internet customer solutions was primarily due to substantial declines
in the United States and Europe.

The substantial decline in revenues for the nine months ended September
30, 2001, compared to the same period in 2000, was primarily the result of
substantial declines in sales of the circuit switching portion of our local
internet customer solutions and certain optical products having a metro
application, partially offset by considerable growth in sales of the next
generation metro portion of our local internet customer solutions. The
substantial decrease in sales of the circuit switching portion of our local
internet customer solutions was primarily the result of reduced demand in the
exchange carrier market due to the significant adjustment in the telecom
industry and the tightened capital markets. The substantial decrease in sales
of optical products having a metro application was due to declines in the sales
volumes of mature products in this category. The considerable growth in sales
of the next generation metro portion of our local internet customer solutions
was driven by strong sales in the first half of 2001 as our major customers
continued the build-out of metro networks in order to interconnect the previous
build-out of inter-city networks and reduce capacity bottlenecks. The
substantial decline in overall sales of local internet customer solutions was
primarily due to a substantial decline in the United States and a significant
decline in Europe.

Wireless internet

The decline in revenues for the three months ended September 30, 2001,
compared to the same period in 2000, was primarily the result of a substantial
decline in the Caribbean and Latin America region, due, in part, to our
providing limited, incremental customer financing as a result of the current
market conditions.

The significant growth in revenues for the nine months ended September 30,
2001, compared to the same period in 2000, was primarily the result of
considerable growth in the United States and the Asia Pacific region, partially
offset by a substantial decline in the Caribbean and Latin America region. The
growth was primarily the result of continuing network expansions by major
United States and Asia Pacific region customers during the first half of 2001,
partially offset by lower sales in the Caribbean and Latin America region for
the reasons described above.

Photonics components

Revenues declined substantially for the three months and nine months ended
September 30, 2001, compared to the same periods in 2000. The decline in
revenues were primarily the result of substantial declines in internal sales to
the network infrastructure segment due to the reductions and/or continuing
deferrals in capital spending by our major United States customers and
considerable declines in sales to external customers. The decrease in sales of
photonics components to external customers for the three months and nine months
ended September 30, 2001 was primarily the result of substantial declines in
Europe, the United States, and Canada.

Other

Other revenues declined substantially for the three months ended September
30, 2001 and declined significantly for the nine months ended September 30,
2001, compared to the same periods in 2000, primarily due to substantial
declines in sales of customer premises-based solutions and civil works and
original equipment manufacturer offerings, which more than offset considerable
increases in global professional services revenues. The substantial declines
in sales of customer premises-based solutions were primarily due to lower sales
of mature voice products as a result of the industry and economic environment,
primarily in the United States, and as a result of the shift in the market from
legacy voice products to next

29



---



##### Table of Contents



generation products. Customer premises-based solutions sales declined by
$231, to $534, for the three months ended September 30, 2001 and by $514, to
$1,832, for the nine months ended September 30, 2001. The substantial
increases in global professional services revenues were due to increasing
professional services opportunities in the market as a result of customers
focus on improving capacity utilization rates and the efficiency of existing
networks due to tightened capital markets and accelerating industry
rationalization. The declines overall in other revenues were primarily due to
substantial declines in the United States and Europe for the three months ended
September 30, 2001, and substantial declines in the United States, Canada, and
the Caribbean and Latin America region, and a decline in Europe for the
nine months ended September 30, 2001.

Gross profit (loss) and gross margin

The following tables set forth information by segment for the three months and
nine months ended September 30, 2001 and 2000:

|                                                           |  |                                  |      |                                 |  |          |       |          |  |      |        |      |  |          |        |          |  |   |       |   |  |   |       |   |  |   |        |   |  |  |        |  
|---------------------------------------------------------- |  | -------------------------------- | ---- | ------------------------------- |  | -------- | ----- | -------- |  | ---- | ------ | ---- |  | -------- | ------ | -------- |  | - | ----- | - |  | - | ----- | - |  | - | ------ | - |  |  | ------ | -
|                                                          
|                                                           |  | Three months ended September 30, |      | Nine months ended September 30,
|                                                           |  | 2001                             |      | 2000                            |  | $ Change |       | % Change |  | 2001 |        | 2000 |  | $ Change |        | % Change
|                                                          
|Gross profit (loss)                                        |  |                                  |      |                                 |  |          |       |          |  |      |        |      |  |          |        |          |  |   |       |   |  |   |       |   |  |   |        |   |  |  |        |  
|                                                          
|                                                          
|                                                          
|                                                          
|Network infrastructure                                     |  | $                                | (104 | )                               |  | $        | 2,571 |          |  | $    | (2,675 | )    |  |          | (104.0 | )        |  | $ | 1,764 |   |  | $ | 7,232 |   |  | $ | (5,468 | ) |  |  | (75.6  | )
|                                                          
|                                                          
|                                                          
|                                                          
|Photonics components                                       |  |                                  | (87  | )                               |  |          | 285   |          |  |      | (372   | )    |  |          | (130.5 | )        |  |   | (202  | ) |  |   | 617   |   |  |   | (819   | ) |  |  | (132.7 | )
|                                                          
|                                                          
|                                                          
|                                                          
|Other                                                      |  |                                  | 184  |                                 |  |          | 281   |          |  |      | (97    | )    |  |          | (34.5  | )        |  |   | 620   |   |  |   | 1,041 |   |  |   | (421   | ) |  |  | (40.4  | )
|                                                          
|                                                          
|                                                          
|                                                          
|Intersegment inventory
unrealized profit
elimination  net |  |                                  | (3   | )                               |  |          | (28   | )        |  |      | 25     |      |  |          | N/A    |          |  |   | (13   | ) |  |   | (38   | ) |  |   | 25     |   |  |  | N/A    |  
|                                                          
|Consolidated                                               |  | $                                | (10  | )                               |  | $        | 3,109 |          |  | $    | (3,119 | )    |  |          | (100.3 | )        |  | $ | 2,169 |   |  | $ | 8,852 |   |  | $ | (6,683 | ) |  |  | (75.5  | )
|                                                          

|                       |  |                                  |        |                                 |  |        |      |          |  |      |        |      |  |        |        |          |  |  |       |    |  |  |      |   |  |  |       |    |  |  |        |  
|---------------------- |  | -------------------------------- | ------ | ------------------------------- |  | ------ | ---- | -------- |  | ---- | ------ | ---- |  | ------ | ------ | -------- |  |  | ----- | -- |  |  | ---- | - |  |  | ----- | -- |  |  | ------ | -
|                      
|                       |  | Three months ended September 30, |        | Nine months ended September 30,
|                       |  | 2001                             |        | 2000                            |  | Change |      | % Change |  | 2001 |        | 2000 |  | Change |        | % Change
|                      
|Gross Margin           |  |                                  |        |                                 |  |        |      |          |  |      |        |      |  |        |        |          |  |  |       |    |  |  |      |   |  |  |       |    |  |  |        |  
|                      
|                      
|                      
|                      
|Network infrastructure |  |                                  | (3.7   | )%                              |  |        | 48.1 | %        |  |      | (51.8  | )%   |  |        | (107.7 | )        |  |  | 16.3  | %  |  |  | 45.7 | % |  |  | (29.4 | )% |  |  | (64.3  | )
|                      
|                      
|                      
|                      
|Photonics components   |  |                                  | (217.5 | )%                              |  |        | 42.3 | %        |  |      | (259.8 | )%   |  |        | (614.2 | )        |  |  | (45.4 | )% |  |  | 38.3 | % |  |  | (83.7 | )% |  |  | (218.5 | )
|                      
|                      
|                      
|                      
|Other                  |  |                                  | 21.3   | %                               |  |        | 23.0 | %        |  |      | (1.7   | )%   |  |        | (7.4   | )        |  |  | 21.0  | %  |  |  | 29.1 | % |  |  | (8.1  | )% |  |  | (27.8  | )
|                      
|                      
|                      
|                      
|Consolidated           |  |                                  | (0.3   | )%                              |  |        | 46.3 | %        |  |      | (46.6  | )%   |  |        | (100.6 | )        |  |  | 15.6  | %  |  |  | 44.8 | % |  |  | (29.2 | )% |  |  | (65.2  | )
|                      

Consolidated

Gross profit decreased substantially for the three months and nine months
ended September 30, 2001, compared to the same periods in 2000, due to
substantial declines in revenues and gross margin. The decreases in gross
margin were due to substantial decreases in gross margins in the network
infrastructure and photonics components segments for the three months ended
September 30, 2001 and substantial decreases in gross margins in the network
infrastructure and photonics components segments, and other for the nine months
ended September 30, 2001. The overall decreases in gross margin were primarily
due to approximately $728 of increased inventory provisions, related to the
entire supply chain, for the three months ended September 30, 2001 and
approximately $1,478 of increased inventory provisions, related to the entire
supply chain, and contract and customer settlements for the nine months ended
September 30, 2001, as a result of the significant adjustment in the telecom
industry, fixed infrastructure costs that were not reflective of the lower
sales volumes during the first three quarters of 2001, and shifts in the
geographical mix of sales from the United States to Europe and the Asia Pacific
region, where we generally earn lower gross margins. Sales in the United
States accounted for approximately 49% of overall sales through the first three
quarters of 2001, compared to approximately 61% through the first three
quarters of 2000. We review the levels of our inventory provisions on a
regular basis, and as a result of our reviews during the second and third
quarters of 2001, we increased our inventory provisions based on our standard
policies to reflect both current and anticipated future market demand.

30



---



##### Table of Contents



Network infrastructure

The substantial declines in gross margins for the three months and nine
months ended September 30, 2001, compared to the same periods in 2000, were
primarily the result of the increased inventory provisions and contract and
customer settlements recorded during the second and third quarters of 2001, as
applicable and as outlined above, fixed infrastructure costs that were not
reflective of the lower sales volumes during the first three quarters of 2001,
and shifts in the geographical mix of sales, as outlined above. We are
currently undertaking the initiatives related to the most recent update on our
work plan, and have continued with our initiatives that began during the first
and second quarters of 2001, to streamline our businesses and reduce our cost
structure to reflect the current business environment. Any inability to
proportionately reduce our fixed infrastructure costs to reflect the expected
business level could result in further reductions in gross margin. The
significant adjustment in the global telecom industry, particularly in the
United States, has led to increasing shifts in the geographic mix of sales from
the United States to Europe and the Asia Pacific region during the first three
quarters of 2001. Further shifts in the geographic mix could result in further
reductions in gross margin.

Photonics components

The substantial declines in gross margins for the three months and nine
months ended September 30, 2001, compared to the same periods in 2000, were
primarily due to fixed infrastructure costs, which, in part, related to
significant capital expenditures incurred in 2000 to meet the then expected
future increase in demand for photonics components, and the increased inventory
provisions and contract and customer settlements recorded during the second
quarter of 2001, as outlined above. During the second and third quarters, we
recorded charges to write down certain fixed assets within this segment and
will continue to review the recoverability of fixed assets and capacity
requirements in relation to the current business environment and outlook for
the industry.

Other

Gross margin declined slightly for the three months ended September 30,
2001, compared to the same period in 2000, primarily due to a decline in gross
margin, by 6.3 percentage points to 32.8 percent, for customer premises-based
solutions and a significant decline in gross margins for global professional
services, partially offset by a significant increase in gross margins for civil
works and original equipment manufacturer offerings. Gross margin decreased
substantially for the nine months ended September 30, 2001, compared to the
same period in 2000, primarily due to a decrease in gross margin, by 3.5
percentage points to 36.0 percent, for customer premises-based solutions and a
decline in gross margin for global professional services. The decreases in
gross margin for global professional services were primarily due to erosions of
gross margins for certain service offerings. The decreases in gross margin for
customer premises-based solutions were primarily due to increased inventory
provisions recorded in the second and third quarters of 2001 to reflect the
current business outlook and fixed infrastructure costs that did not reflect
current sales volumes.

Selling, general and administrative expense

The following table sets forth selling, general and administrative, or SG&A,
expense for the three months and nine months ended September 30, 2001 and 2000:

|                            |  |                                  |       |                                 |  |          |       |          |  |      |     |      |  |          |      |          |  |   |       |   |  |   |       |   |  |   |     |  |  |  |      | 
|--------------------------- |  | -------------------------------- | ----- | ------------------------------- |  | -------- | ----- | -------- |  | ---- | --- | ---- |  | -------- | ---- | -------- |  | - | ----- | - |  | - | ----- | - |  | - | --- |  |  |  | ---- | 
|                           
|                            |  | Three months ended September 30, |       | Nine months ended September 30,
|                            |  | 2001                             |       | 2000                            |  | $ Change |       | % Change |  | 2001 |     | 2000 |  | $ Change |      | % Change
|                           
|SG&A expense                |  | $                                | 1,897 |                                 |  | $        | 1,301 |          |  | $    | 596 |      |  |          | 45.8 |          |  | $ | 4,808 |   |  | $ | 3,839 |   |  | $ | 969 |  |  |  | 25.2 | 
|                           
|                           
|                           
|                           
|As a percentage of
revenues |  |                                  | 51.6  | %                               |  |          | 19.4  | %        |  |      | N/A |      |  |          | N/A  |          |  |   | 34.5  | % |  |   | 19.4  | % |  |   | N/A |  |  |  | N/A  | 
|                           

31



---



##### Table of Contents



SG&A expense increased substantially for the three months ended September
30, 2001, compared to the same period in 2000, due to increased provisions of
approximately $767 related to various customer receivables and financings.
SG&A expense has increased significantly for the three months ended September
30, 2001 compared to the three months ended June 30, 2001, however, has
declined by approximately $167, excluding the impact of the increased
provisions in each of these periods.

SG&A expense increased substantially for the nine months ended September
30, 2001, compared to the same period in 2000, reflecting costs incurred during
the first half of 2001 resulting from the increased investment in North
American and international markets across the network infrastructure and
photonics components segments during the second half of 2000 to support our
revenue growth during that period, and also as a result of increased provisions
of approximately $1,067 related to various customer receivables and financings.

SG&A expense is expected to continue to decline as the full impact of
initiatives undertaken by us to streamline our business and reduce our cost
structure are realized. The considerable increase in SG&A expense as a
percentage of revenue for the three months and nine months ended September 30,
2001, compared to the same periods in 2000, was primarily due to the
substantial decrease in revenues.

Research and development expense

The following table sets forth research and development, or R&D, expense for
the three months and nine months ended September 30, 2001 and 2000:

|                            |  |                                  |      |                                 |  |          |      |          |  |      |      |      |  |          |       |          |  |   |       |   |  |   |       |   |  |   |     |   |  |  |      |  
|--------------------------- |  | -------------------------------- | ---- | ------------------------------- |  | -------- | ---- | -------- |  | ---- | ---- | ---- |  | -------- | ----- | -------- |  | - | ----- | - |  | - | ----- | - |  | - | --- | - |  |  | ---- | -
|                           
|                            |  | Three months ended September 30, |      | Nine months ended September 30,
|                            |  | 2001                             |      | 2000                            |  | $ Change |      | % Change |  | 2001 |      | 2000 |  | $ Change |       | % Change
|                           
|R&D expense                 |  | $                                | 771  |                                 |  | $        | 897  |          |  | $    | (126 | )    |  |          | (14.0 | )        |  | $ | 2,547 |   |  | $ | 2,594 |   |  | $ | (47 | ) |  |  | (1.8 | )
|                           
|                           
|                           
|                           
|As a percentage of
revenues |  |                                  | 21.0 | %                               |  |          | 13.4 | %        |  |      | N/A  |      |  |          | N/A   |          |  |   | 18.3  | % |  |   | 13.1  | % |  |   | N/A |   |  |  | N/A  |  
|                           

R&D expense decreased significantly for the three months ended September
30, 2001, compared to the same period in 2000, reflecting the impact of
initiatives undertaken by us to focus our spending on key potential growth
areas. R&D expense was flat for the nine months ended September 30, 2001,
compared to the same period in 2000, reflecting the impact of the initiatives
undertaken during 2001 to focus R&D spending. R&D expense represented our
planned investment in the network infrastructure segment, including wireless
internet, optical inter-city customer solutions, and the core Internet Protocol
networks and metro optical portions of our local internet customer solutions.
The considerable increase in R&D expense as a percentage of revenues for the
three months and nine months ended September 30, 2001, compared to the same
periods in 2000, was due to the substantial decline in revenues during the same
periods. R&D expense in absolute dollars has declined for the three months
ended September 30, 2001, compared to the three months ended June 30, 2001, as a result of the initiatives undertaken to focus our
spending on key potential growth areas. As a result, R&D expense in absolute
dollars will decline in full year 2001, compared to full year 2000.

32



---



##### Table of Contents



In-process research and development expense and amortization of intangibles

The following table sets forth in-process research and development, or IPR&D,
expense and amortization of intangibles for the three months and nine months
ended September 30, 2001 and 2000:

|                            |                     |   |                                  |     |                                 |   |          |     |          |   |      |      |      |  |          |       |          |   |   |       |  |   |     |       |  |   |      |     |   |  |        |      |  
|--------------------------- | ------------------- | - | -------------------------------- | --- | ------------------------------- | - | -------- | --- | -------- | - | ---- | ---- | ---- |  | -------- | ----- | -------- | - | - | ----- |  | - | --- | ----- |  | - | ---- | --- | - |  | ------ | ---- | -
|                           
|                            |                     |   | Three months ended September 30, |     | Nine months ended September 30,
|                            |                     |   | 2001                             |     | 2000                            |   | $ Change |     | % Change |   | 2001 |      | 2000 |  | $ Change |       | % Change
|                           
|IPR&D expense               |                     | $ |                                 |     |                                 | $ |         |     |          | $ |     |      |      |  | N/A      |       |          | $ |  |       |  | $ | 623 |       |  | $ | (623 | )   |   |  | (100.0 | )   
|                           
|                           
|                           
|                           
|Amortization
of intangibles
|                           
|                           
|                           
|                           
|                            | Acquired technology |   | $                                | 145 |                                 |   | $        | 202 |          |   | $    | (57  | )    |  |          | (28.2 | )        |   | $ | 551   |  |   | $   | 586   |  |   | $    | (35 | ) |  |        | (6.0 | )
|                           
|                           
|                           
|                           
|                            | Goodwill            |   | $                                | 357 |                                 |   | $        | 678 |          |   | $    | (321 | )    |  |          | (47.3 | )        |   | $ | 1,718 |  |   | $   | 1,805 |  |   | $    | (87 | ) |  |        | (4.8 | )
|                           

IPR&D expense

For the nine months ended September 30, 2000, IPR&D expense primarily
related to the acquisition of Qtera Corporation.

Amortization of intangibles

Acquired technology

The amortization of acquired technology for the three months and nine
months ended September 30, 2001 and 2000 primarily reflected the charges
related to the acquisition of Bay Networks, Inc. As at September 30, 2001 and
December 31, 2000, the capitalized amount of acquired technology  net was $74
and $623, respectively.

Goodwill

The amortization of goodwill for the three months ended September 30, 2001
primarily reflected the charges related to the acquisition of Bay Networks, and
for the three months ended September 30, 2000 and the nine months ended
September 30, 2001 and 2000 primarily reflected the charges related to the
acquisitions of Bay Networks, Qtera, and Clarify Inc. The substantial
reduction in the amortization of goodwill for the three months ended September
30, 2001, compared to the same period in 2000, reflects the impact of the write
down of goodwill in the second quarter of 2001. See Special charges for
additional details. As at September 30, 2001 and December 31, 2000, the
capitalized amount of goodwill  net was $2,780 and $6,724, respectively.

The above impacts to our results of operations for the three months and
nine months ended September 30, 2001 were primarily a result of the large
number and value of acquisitions completed from 1998 to 2000.

The Company has determined that the remaining intangible asset balances,
following our write down in the second quarter of 2001, will continue to be
amortized on a straight-line basis over the remaining useful lives established
at the time of the related acquisition as the remaining useful life of these
intangible assets has not changed. As a result, the ongoing amortization of
intangibles for the fourth quarter of 2001, based on balances as at September
30, 2001, is expected to be approximately $400. The adoption of Statement of
Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets,
or SFAS 142, changes the accounting for goodwill from an amortization method to
an impairment-only approach and, as a result, the amortization of goodwill will
cease upon adoption of this Statement on January 1, 2002. As a result,
quarterly amortization expense of approximately $250 will no longer be incurred
beginning with the first quarter of 2002. The Company will be performing the
first of the required impairment tests under SFAS 142 during 2002 and has not
yet determined the effect of adoption on our business, results of operations,
or financial condition.

33



---



##### Table of Contents



Special charges

2001

For the three months ended September 30, 2001, Nortel Networks recorded
special charges of $1,000 related to restructuring activities. For the nine
months ended September 30, 2001, Nortel Networks recorded special charges of
$4,630 related to both restructuring activities and an intangible assets write
down.

Restructuring activities

In light of the continued significant downturn in both the industry and
economic environment, and capital market trends impacting both Nortel Networks
current operations and expected future growth rates, we have continually
augmented our work plan during 2001 to optimize results and drive efficiencies
in our business by further streamlining operations and activities that are not
aligned with our core markets and leadership strategies.

Workforce reduction charges of $286 and $959 for the three months and nine
months ended September 30, 2001, respectively, were related to the cost of
severance and benefits associated with approximately 7,400 and 27,600 employees
notified of termination, respectively. Of the 27,600 employees notified by
September 30, 2001, approximately 10,700 were direct employees performing
manufacturing, assembly, test and inspection activities associated with the
production of Nortel Networks solutions, and approximately 16,900 were indirect
sales, marketing, and administrative employees, and manufacturing managers.
Included in the current period charge of $286 is approximately $27 related to
the approximately 20,200 employees notified during the six months ended June
30, 2001. The workforce reduction was primarily in North America and the
United Kingdom and extended across all of our operating segments. As at
September 30, 2001, the workforce reduction provision balance has been drawn
down by a net $616 resulting in an ending provision balance of $343. The
remaining provision is expected to be substantially drawn down by cash payments
by the end of the second quarter of 2002.

In conjunction with the above noted workforce reduction, we identified a
number of leased facilities comprised of office and 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 $254 and $510 for
the three months and nine months ended September 30, 2001, respectively. The
costs primarily related to our future contractual obligations under operating
leases. Partially offsetting the total lease charge is approximately $561 in
expected sublease revenue on leases that Nortel Networks cannot terminate.
Contract settlement costs included negotiated settlements of approximately $24
and $90 for the three months and nine months ended September 30, 2001,
respectively, to either cancel contracts or renegotiate existing contracts
within the network infrastructure segment and other. As at September 30, 2001,
the provision balance has been drawn down by cash payments of $45 resulting in
an ending provision balance of $555. The remaining provision is expected to be
substantially drawn down by cash payments by the end of the fourth quarter of
2002.

Plant and equipment write downs of $244 and $429 for the three months and
nine months ended September 30, 2001, respectively, consisted of the write down
of leasehold improvements and certain information technology equipment
associated with the exiting of the above noted leased facilities.

As a result of the significant negative industry and economic trends
impacting both Nortel Networks current operations and expected future growth
rates, we performed assessments of certain plant and equipment assets as part
of our review of financial results during both the three months ended June 30,
2001 and September 30, 2001. The conclusion of these assessments resulted in a
write down of certain plant and equipment within global operations, a function
that supports all of our segments, and the photonics components segment for the
three months and nine months ended September 30, 2001, of $184 and $409
respectively.

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 current industry and economic environment. As a result, we
recorded a charge of approximately $24 and $82 for the three months and nine
months ended September 30, 2001, respectively, 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 the first quarter of 2002.

34



---



##### Table of Contents



Within the photonics components segment, it was determined that there was
excess manufacturing equipment at a number of facilities that would no longer
be required as a result of the current industry and economic environment. As a
result, we recorded a charge of approximately $160 and $236 for the three
months and nine months ended September 30, 2001, respectively, 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 by the end of the first quarter of 2002. Also, during the
nine months ended September 30, 2001, we wrote down the net carrying value of a
specialized manufacturing facility within the photonics components 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.

The intangible asset write-off of $64 for the nine months ended September
30, 2001, is related to the remaining net book value of goodwill recorded on
the prior acquisition of MICOM Communications Corp (MICOM). As part of our
current initiative to strategically realign resources, we made the decision to
completely exit the technologies associated with the MICOM acquisition. The
results of this prior acquisition were not material to our business, results of
operations, and financial condition.

Write down of intangible assets

As part of our review of financial results during the three months ended
June 30, 2001, we performed an assessment of the carrying values of intangible
assets recorded in connection with our various acquisitions. The assessment
was performed in light of the significant negative industry and economic trends
impacting both our current operations and expected future growth rates, and the
adjustment of technology valuations. The conclusion of that assessment was
that the decline in market conditions within our industry was significant and
other than temporary. As a result, we recorded a $2,133 write down of
intangible assets in the three months ended June 30, 2001, based on the amount
by which the carrying amount of these assets exceeded their fair value. The
write down was primarily related to the goodwill associated with the
acquisitions of Qtera and Clarify within the network infrastructure segment.
This charge was in addition to the ongoing amortization of intangibles of $882
in the second quarter of 2001, as previously discussed above.

We performed a further assessment for the three months ended September 30,
2001, of the carrying values of intangible assets based on the intangible asset
balances outstanding in the period. The carrying value of the intangible
assets used for the assessment during the three months ended September 30, 2001
reflected the $2,133 write down recorded for the three months ended June 30,
2001, as well as the ongoing amortization expense incurred on the remaining
intangible assets during the three months ended September 30, 2001. The
conclusion of the assessment performed during the three months ended September
30, 2001 was that no additional write down of intangible assets was required.
In addition, a significant portion of the remaining carrying value of the
intangible assets represented enterprise level goodwill. There has been no
impairment in enterprise level goodwill during either the three months ended
June 30, 2001 or the three months ended September 30, 2001.

Fair value was determined based on discounted future cash flows for the
businesses that had separately distinguishable intangible asset balances and
whose operations had not yet been fully integrated into Nortel Networks. The
cash flow periods used were five years, the discount rate used was 20 percent,
and the terminal values were estimated based upon terminal growth rates ranging
from 5 to 11 percent. The assumptions supporting the estimated future cash
flows, including the discount rate and estimated terminal values, reflect
managements best estimates. The discount rate was based upon Nortel Networks
weighted average cost of capital, as adjusted for the risks associated with the
operations.

For additional information related to these restructuring activities see
Special charges in note 7.

Other income (expense)  net

For the three months ended September 30, 2001, other expense  net was
$313 compared to other income  net of $206 for the same period in 2000. Other
expense  net for the three months ended September 30, 2001 primarily related
to the write down of certain minority investments due to a change in our
strategic focus, as well as an other than temporary decline in carrying values
caused by a continued significant downturn in both the industry and economic
environment. For the three months ended September 30, 2000, other income  net
primarily related to a $169 ($116 after-tax) gain due to a reduction in Nortel
Networks investment in Entrust, Inc. (formerly Entrust Technologies, Inc.) from
33.5 percent to 27.0 percent primarily as a result of Entrusts issuance of
common shares in connection with its acquisition of enCommerce, Inc.

35



---



##### Table of Contents



For the nine months ended September 30, 2001, other expense  net was $252
compared to other income  net of $797 for the same period in 2000. Other
expense  net for the nine months ended September 30, 2001 primarily related to
the write down of certain minority investments due to a change in our strategic
focus, as well as an other than temporary decline in carrying values caused by
a continued significant downturn in both the industry and economic environment.
For the nine months ended September 30, 2000, other income  net primarily
related to a $169 ($116 after-tax) gain due to a reduction in Nortel Networks
investment in Entrust from 33.5 percent to 27.0 percent primarily as a result
of Entrusts issuance of common shares in connection with its acquisition of
enCommerce, Inc. and a pre-tax gain of $513 (after-tax $344), due to a sale, in
the first quarter of 2000, of a portion of our share ownership in Entrust.

Income tax recovery (provision)

Our effective tax rates from continuing operations for the three months
and nine months ended September 30, 2001 were 30.0 percent and 30.9 percent,
respectively, compared to 30.4 percent and 32.0 percent, respectively, for the
same periods in 2000, excluding the impact of after-tax charges of Acquisition
Related Costs (in-process research and development expense and the amortization
of acquired technology and goodwill from all acquisitions subsequent to July
1998), stock option compensation and, where applicable, certain of the one-time
gains and one-time charges. The lower effective tax rate for the three months
and nine months ended September 30, 2001, compared to the same periods in 2000,
primarily reflected changes in geographic earnings (loss) mix.

Liquidity and capital resources

Cash flows

Cash and cash equivalents, or cash, were $3,299 at September 30, 2001, an
increase of $1,732 (including net cash used by the access solutions operations
of $559) from December 31, 2000.

Cash flows from operating activities were $388 for the nine months ended
September 30, 2001. Cash flows from operating activities resulted from cash
from changes in operating assets and liabilities, partially offset by a net
loss of $5,594, adjusted for non-cash items. Cash from operating assets and
liabilities was primarily the result of a decrease in accounts receivable and
inventories.

Cash flows used in investing activities were $1,264 for the nine months
ended September 30, 2001. The use of cash was primarily due to expenditures
for plant and equipment and a net increase in long-term receivables during the
period, partially offset by proceeds on sale of businesses and investments.
The expenditures of $1,074 for plant and equipment largely reflect purchases
related to general infrastructure. We are currently focusing expenditures for
plant and equipment on our core businesses. The previously announced
investment plan to expand optical components and systems production capacity
and capability was discontinued during the second quarter of 2001 as a result
of the then current business environment. The net increase in long-term
receivables during the period was approximately $485, primarily attributable to
increased funding of customer financings in the first half of 2001. Proceeds
on sale of businesses and investments of $232 resulted primarily from the
outsourcing of manufacturing activities.

Cash flows generated from financing activities were $3,172 for the nine
months ended September 30, 2001. Cash flows from financing activities
primarily resulted from Nortel Networks Corporations loan of $1,800 to the
Company, and the Companys debt offering of $1,500 of 6.125 percent notes
completed on February 8, 2001.

On August 15, 2001, Nortel Networks Corporation completed a private
offering of $1,800 of 4.25 percent convertible senior notes, due on September
1, 2008. These notes pay interest on a semi-annual basis on March 1 and
September 1, beginning on March 1, 2002. Nortel Networks Corporation lent all
of the proceeds from its private debt offering to the Company, which is the
guarantor of the notes, for its general corporate purposes and those of its
subsidiaries. On September 30, 2001, Nortel Networks Corporation
converted the entire loan into one additional common share of the Company.

36



---



##### Table of Contents



On February 8, 2001, the Company completed an offering of $1,500 of 6.125
percent notes due on February 15, 2006. These notes pay interest on a
semi-annual basis on February 15 and August 15, which began on August 15, 2001.
These notes are redeemable, at any time at the Companys option, at a
redemption price equal to the principal amount thereof plus accrued and unpaid
interest and a make-whole premium.

Uses of liquidity

Discontinued operations

The remaining accruals totalling $1,125 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, and are expected to be drawn down by cash payments, the impact
of which is expected to be partially offset by cash inflows generated from the
sale of certain assets over the planned period of disposition. See
Discontinued operations for additional details.

Special charges

The remaining cash outlays of $933 related to workforce reduction
initiatives and contract settlement and lease costs are expected to be
substantially completed by the end of the fourth quarter of 2002. An
additional cash charge will be recorded in the fourth quarter of 2001, related
to our announcement on October 2, 2001, of further workforce reductions. See
Special charges for additional details.

Customer financing and related credit risk

The competitive environment in which we operate has required in the past,
and we expect may continue to require in the future, that we, and many of our
principal competitors, 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, 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. At September 30, 2001, we had entered into
certain financing agreements for which the remaining commitment to provide
future customer financing was up to approximately $1,900, not all of which is
expected to be drawn upon.

We expect to continue to hold certain current 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, current capital market conditions, adverse changes in the credit
ratings of our customers or ourselves, and reduced demand for
telecommunications financings in capital and bank markets. In addition,
specific risks 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. There can
be no assurance that we will be able to place any of our current, or future,
customer financing obligations with third-party lenders on acceptable terms.

As well, recently certain of our customers, including competitive local
exchange carriers, have filed for bankruptcy or have been experiencing
financial difficulties. Should customers fail to meet their customer financing
obligations to us, we could experience reduced cash flows and losses in excess
of provisions. We review the levels of our customer financing provisions on a
regular basis, and as a result of our reviews during the second and third
quarters of 2001, we increased our customer financing provisions to reflect the
fact that customers may be unable to meet their repayment obligations to us in
the future as a result of the current market conditions. In addition to being
increasingly selective in providing customer financing, we have various
programs in place to monitor and mitigate customer credit risk, including
performance milestones, other conditions of funding, and active customer
financing portfolio reviews. Management is focused on the strategic use of our
limited customer financing capacity, on revolving that capacity as quickly and
efficiently as possible, and on managing the absolute dollar amount of our
customer financing obligations. However, there can be no assurance that such
measures will reduce our exposure to customers credit risk.

37



---



##### Table of Contents



As part of the selective use of our customer financing capacity, we may
provide customer financing in the future for such customer requirements as
turnkey construction of new networks, particularly third generation, or 3G,
wireless operators. We anticipate that, due to current capital market
conditions, if we provide such customer financing in the future we will be required to directly support a significantly greater
amount of such financings compared to our past experience, in which we have
traditionally been able to place a large amount of our customer financing
obligations with third-party lenders. We will continue to seek to arrange for
third-party lenders to assume our customer financing obligations and to fund
other customer financings from working capital and conventional sources of
external financing in the normal course.

Any unexpected developments in our customer financing arrangements could
have a material adverse effect on our business, results of operations, and
financial condition.

Supply contracts, network outsourcing contracts, and turnkey arrangements

We have 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. These
supply and network outsourcing contracts may 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. Any
unexpected developments in these supply and outsourcing contracts could have a
material adverse effect on our business, results of operations, and financial
condition.

Sources of liquidity

Subsequent to the February 8, 2001 offering of $1,500 of 6.125 percent
notes by the Company, we have remaining capacity to issue from time to time up
to an aggregate of $1,000 of debt securities and warrants to purchase debt
securities, pursuant to a shelf registration statement filed with the United
States Securities and Exchange Commission. Refer to the discussion below
regarding our debt ratings and also see Forward-looking statements for
factors that may affect this program.

Additionally, the Company has also filed in each of the provinces of
Canada a short form prospectus under the Canadian shelf prospectus program
qualifying it to issue up to $500 (Canadian) of debt securities and warrants to
purchase debt securities. This program will expire on February 23, 2002. In
order to issue securities under this program, the securities to be issued must
have received minimum specified approved ratings from approved ratings
organizations. Refer to the discussion below regarding our debt ratings and
also see Forward-looking statements for factors that may affect this program.

On April 12, 2000, the Company and Nortel Networks Inc. entered into
five-year and 364-day syndicated credit agreements, which permit borrowings in
an aggregate amount of up to $2,000. On April 11, 2001, the Company and Nortel
Networks Inc. extended and increased the April 12, 2000, 364-day syndicated
credit agreements to permit borrowings in an aggregate amount of up to $1,750
from $1,250, with a one-year term out option to convert outstanding amounts
under the 364-day syndicated credit agreements into term loans on the
termination date of the credit agreements. As a result, total borrowings
permitted under these syndicated five-year and 364-day credit agreements are
$2,500. The Company and Nortel Networks Inc. had not drawn on these syndicated
credit agreements as at September 30, 2001. These agreements have been used to
support borrowings under our commercial paper program. Borrowings related to
the commercial paper program have been substantially reduced from levels at
June 30, 2001, due to limited access to the commercial paper market as a result
of our recent debt ratings downgrades. Refer to the discussion below regarding
our debt ratings and also see Forward-looking statements for factors that may
affect our commercial paper program. On June 14, 2001, the Company and Nortel
Networks Inc. entered into new 364-day credit agreements with certain banks to
permit additional borrowings in an aggregate amount up to $2,000, 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.
The Company and Nortel Networks Inc. had not drawn on these credit agreements
as at September 30, 2001. The credit agreements contain customary covenants,
events of default and conditions to drawdown, including satisfaction of a
minimum level of consolidated tangible net worth of the Company. We are in
ongoing discussions with our banks on Nortel Networks liquidity needs. As
of September 30, 2001, the Company and Nortel Networks Inc. were in compliance
with the covenants and conditions under the credit agreements. See
Forward-looking statements for factors that may affect our ability to comply
with such covenants and conditions.

38



---



##### Table of Contents



Subsequent to the second quarter of 2001, Nortel Networks has completed or
announced several transactions to divest portions of our business, primarily
related to the continuing transformation of its supply chain from a vertically
integrated manufacturing model to a virtually integrated model, and in
conjunction with our current work plan to divest non-core businesses. Net cash
proceeds from these transactions are expected to be approximately $700, of
which approximately $150 has been received and $550 is expected to be realized
during the next several quarters. See Forward-looking statements for factors
that may affect our ability to consummate these transactions.

The total debt to total capitalization ratio of the Company was 30 percent
at September 30, 2001, compared to nine percent at December 31, 2000 and nine
percent at September 30, 2000. The increase in the total debt to total
capitalization ratio at September 30, 2001, compared to December 31, 2000, was
due to the reduction in retained earnings as a result of the net losses for the
nine months ended September 30, 2001, and the increase in total debt due to the
issuance of $1,500 of 6.125 percent notes on February 8, 2001.

On October 3, 2001, Moodys Investors Service lowered the credit ratings
on long term, unsecured debt issued or guaranteed by the Company to Baa2 from
Baa1 and on preferred shares issued by the Company from Baa3 to Ba1. Moodys
also placed both the long term ratings and the Prime-2 short term ratings on
review for possible future downgrade. This downgrade follows previous
downgrades on August 2, 2001 and July 3, 2001. On October 3, 2001, Standard &
Poors lowered the credit ratings on long term unsecured debt issued or
guaranteed by the Company from BBB to BBB- and on commercial paper issued or
guaranteed by the Company from A-2 to A-3. Standard & Poors also assigned a
global scale rating of BB and a Canadian scale rating of P-3 on preferred
shares issued by the Company. Standard & Poors outlook was negative. This
downgrade follows the previous downgrade on July 18, 2001. In their respective
press releases since July 3, 2001, Moodys and Standard & Poors stated that
the lowered ratings over the past several months reflect the considerable
decline in purchasing of our products by service providers, uncertainties as to
the duration and severity of the industry adjustment, and the challenge of
maintaining appropriate capacity and employee morale. Despite the lowered
ratings, our ratings remain within investment grade levels. 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 and reduced access to the capital markets.

We believe that our current cash and cash equivalents, potential proceeds
from the sale of non-core businesses or businesses that do not provide us with
competitive differentiation, and/or investments and additional unused sources
of cash available to us as outlined above, and potential proceeds from other
conventional sources of external financing (which may include a variety of debt
and/or convertible debt financings) will satisfy our expected working capital,
capital expenditure, and investment requirements through at least the next 12
months. However, there can be no assurance that our net cash requirements will
be as we currently expect, or that we will continue to have access to our
credit facilities when and as needed. See Forward-looking statements for
factors that may affect our cash flows and debt levels.

Legal proceedings

In connection with the January 28, 2000 acquisition of Qtera Corporation,
currently an indirect subsidiary of the Company, Qtera and two of its employees
were named as defendants in a lawsuit filed by Siemens ICN in the 15th Judicial
Circuit for Palm Beach County, Florida. The lawsuit alleged various claims,
including purported misappropriation of trade secrets. This dispute has been
resolved to the satisfaction of the parties and without material adverse effect
to Nortel Networks.

Subsequent to Nortel Networks Corporations February 15, 2001 announcement
in which Nortel Networks Corporation provided revised guidance for financial
performance for the fiscal year and first quarter 2001, Nortel Networks
Corporation and certain of its then current officers and directors have been
named as defendants in more than twenty-five purported class action lawsuits.
These lawsuits, which have been served through September 24, 2001 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. In addition, a class action lawsuit was filed in the United

39



---



##### Table of Contents



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 violation of the same United
States federal securities laws as the other lawsuits. This case arose after
the acquisition on February 13, 2001 by Nortel Networks Corporation of JDS
Uniphase Corporations Zurich, Switzerland-based subsidiary, a designer and
manufacturer of strategic 980 nanometer pump-laser chips, and related assets in
Poughkeepsie, New York in exchange for common shares of Nortel Networks
Corporation. On May 11, 2001, Nortel Networks Corporation filed motions to
dismiss and/or stay in connection with the 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. 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 order requires that the plaintiffs file a consolidated
amended complaint within 30 days of the order and that the defendants respond
30 days thereafter. To date, no consolidated amended complaint has been filed
by the plaintiffs.

On February 12, 2001, Nortel Networks Inc., a subsidiary of the Company,
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 of Texas, Marshall
Division. This first 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 this first
complaint against it. On July 31, 2001, the complaint was dismissed without
prejudice. On August 31, 2001, two plaintiffs filed a second amended class
action complaint against the same defendants asserting claims substantially
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 by the Company on
August 31, 1998, announced that some of its shareholders had filed two separate
lawsuits against Bay Networks and ten of Bay Networks current and former
officers and directors. Both lawsuits sought damages on behalf of a class of
shareholders who purchased Bay Networks common shares during the period of May
1, 1995 through October 14, 1996. Shareholders filed one lawsuit in the United
States District Court for the Northern District of California and alleged
violations of the federal securities laws. In September 1998, the California
District Court dismissed the plaintiffs complaint, granting leave for the
plaintiffs to amend the complaint. In November 1998, the California District
Court ordered a stay of the proceedings until the United States Court of
Appeals for the Ninth Circuit rendered a decision regarding pleading standards
in securities litigation in an unrelated case involving Silicon Graphics, Inc.
After this decision was rendered on July 2, 1999 favourably to the defense, the
plaintiffs filed a third amended complaint in December 1999, and the defendants
filed a motion to dismiss on January 31, 2000. On August 17, 2000, the
defendants motion to dismiss the federal complaint was granted and judgment in
favour of defendants was entered August 18, 2000. On September 8, 2000, the
plaintiffs filed a notice of appeal of that order and judgment. Briefing in
the Ninth Circuit has been completed and oral arguments were held on July 11,
2001. On August 1, 2001, the Ninth Circuit denied the plaintiffs appeal.
Plaintiffs filed the other lawsuit announced on March 4, 1997 in the California
Superior Court, County of Santa Clara, alleging violations of the California
Corporations Code. On April 18, 1997, a shareholder (represented by some of
the same plaintiffs law firms as in the cases discussed above) filed a second
lawsuit in the California Superior Court, alleging violations of the federal
securities laws and California Corporations Code by Bay Networks and nine of
its current and former officers and directors. The second action before the
California Superior Court sought damages 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. In April 1998, the
California Superior Court granted the defendants motion to consolidate the two
state court actions and denied the plaintiffs motion for class certification.
The plaintiffs in the consolidated California actions appealed the order
denying class certification. On January 19, 2000, the California Court of
Appeals affirmed the order denying the class certification. The plaintiffs
filed a petition for review with the California Supreme Court which 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
consolidated California Superior Court actions; they seek to become the
representatives of a class of shareholders alleged in their complaint in
intervention. The motion for intervention 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 June 18, 2001, defendants
removed the consolidated state court actions to the California District Court
on the grounds

40



---



##### Table of Contents



that the class claims asserted by the complaint in intervention are barred
by Securities Litigation Uniform Standards Act. The defendants have filed a
motion to dismiss that complaint while the various plaintiffs have sought to
have the case remanded to the California Superior Court. On September 19,
2001, the defendants motion to dismiss was rejected and the plaintiffs motion
to remand was granted. The defendants will appeal in the United States Court
of Appeals for the Ninth Circuit with respect to the decisions in such motions.

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

We cannot determine our total aggregate amount of monetary liability or
the financial impact of the above matters. We do not therefore know whether
these actions, suits, claims, proceedings and investigations, which seek
damages of material or indeterminate amounts, will, individually or
collectively, have a material adverse effect on our business, results of
operations, and financial condition. Unless we have otherwise noted, we and
any of our named directors and officers and those of any of our subsidiaries
intend to vigorously defend these actions, suits, claims, proceedings, and
investigations.

Environmental matters

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

Nortel Networks has remedial activities under way at six of its facilities
and seven previously occupied sites. An estimate of Nortel Networks
anticipated remediation costs associated with all such facilities and sites, to
the extent probable and reasonably estimable, is included in the Companys
environmental accruals in an approximate amount of $24.

For a discussion of Environmental matters, see Environmental matters in
note 20 to the Companys audited Consolidated Financial Statements and notes
thereto for the year ended December 31, 2000, restated for discontinued
operations, and included in the Companys Current Report on Form 8-K, filed
with the United States Securities and Exchange Commission on August 8, 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.

41



---



##### Table of Contents



Restructuring and our work plan.In response to changes in industry and
market conditions, we have restructured, we are further restructuring, and we
may continue to restructure our activities to more strategically realign our
resources. Our work plan is based on certain assumptions regarding the cost
structure of our business and the nature and severity of the current industry
adjustment which may not prove to be accurate. Our work plan has involved the
implementation of a number of initiatives to streamline our business and focus
our investments on delivering key next-generation solutions, including
discontinuing our access solutions operations, writing off tangible and
intangible assets, and otherwise exiting businesses. There can be no assurance
that our work plan will be sufficient in light of current or future capital
markets and telecommunications and networking industry conditions. As well,
there can be no assurance that we will not be required to refine, expand or
extend our work plan, or that we will return to profitability as a result of
our work plan. In addition, there can be no assurance that the reductions in
employee positions and disposition of assets associated with our work plan have
not impaired our ability to realize our current or future business objectives.

There can be no assurance that the costs actually incurred in connection
with restructuring actions will not be higher than the estimated costs of such
actions. Additional restructuring actions may include assessing whether we
should consider disposing of or otherwise exiting additional businesses and
reviewing the recoverability of remaining tangible and intangible assets. Any
decision to further limit investment or to dispose of or otherwise exit
additional businesses may result in the recording of additional accrued
liabilities for one-time or other charges such as workforce reduction costs,
facilities reduction costs, asset write downs, and contractual settlements.
Current and additional restructuring actions may result in further cash and/or
non-cash charges, which could have a material adverse effect on our business,
results of operations, and financial condition.

Fluctuations in operating results, general industry, economic, and market
conditions, and volatility.Our results of operations for any quarter or year
are not necessarily indicative of results to be expected in future periods.
Our future operating results may be affected by various trends and factors that
must be managed in order to achieve favourable operating results. The
inability to accurately forecast and manage these trends and factors could have
a material adverse effect on our business, results of operations, and financial
condition. 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:



| |  |  | fixed costs and our ability to successfully complete programs on a
timely basis to reduce our cost structure and streamline our operations;                                                                                                                                       
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | our ability to focus our business on what we believe to be
potentially higher growth, higher margin businesses, and to dispose of
or exit other non-core businesses;                                                                                                              
|
| |  |  | inherent uncertainties underlying the estimates and assumptions used
in calculating asset valuations, changes in accounting estimates with
respect to the useful life and ultimate recoverability of our carrying
basis of assets, including goodwill and other intangible assets;
|
| |  |  | our ability to implement our work plan without negatively impacting our relationships with our customers;                                                                                                                                                                         
|
| |  |  | fluctuations in our current cash flows and our estimates of future cash requirements;                                                                                                                                                                                             
|
| |  |  | the impact of acquired businesses and technologies;                                                                                                                                                                                                                               
|
| |  |  | increased price and product competition in the networking industry;                                                                                                                                                                                                               
|
| |  |  | 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;                                                                                                                                                                                                                             
|
| |  |  | correctly sizing inventory levels; and                                                                                                                                                                                                                                            

42



---



##### Table of Contents





| |  |  | product development schedules, manufacturing capacity and lead times.
| | - |  | ---------------------------------------------------------------------

In addition, there are trends and factors beyond our control which may
affect our businesses. Such potential 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 the credit ratings of our customers, suppliers, and ourselves;                                                                                                                                 
|
| |  |  | adverse changes in the conditions in our industry and the specific markets for our products;                                                                                                                      
|
| |  |  | the trend towards sales of integrated network solutions;                                                                                                                                                          
|
| |  |  | visibility to, and the actual size and timing of, capital expenditures by our customers;                                                                                                                          
|
| |  |  | inventory practices, including the timing of deployment, of our customers;                                                                                                                                        
|
| |  |  | the amount of network capacity, sharing and/or acquisition of new
and/or existing network capacity, and network capacity utilization
rates, of our customers, and 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 customers, competitors and suppliers;                                                                                                   
|
| |  |  | conditions in the broader market for communications, including data
networking, computerized information access equipment and services, and
the domestic or global economy generally;                             
|
| |  |  | geographic mix of revenues, and the associated impact on gross margins;                                                                                                                                           
|
| |  |  | governmental regulation or intervention affecting communications or data networking;                                                                                                                              
|
| |  |  | the effects of war and acts of terrorism; and                                                                                                                                                                     
|
| |  |  | other factors.                                                                                                                                                                                                    

We cannot assure you that the slowdown in capital spending by service
providers will not 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 consequence of these and the
above factors, 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. Any of the above
factors could have a material adverse effect on our business, results of
operations, and financial condition.

General economic conditions, and specifically market conditions in the
telecommunications and networking industry, in the United States and globally
affect our business. Reduced capital spending and/or negative economic
conditions in the United States, Europe, Asia, Latin America and/or other areas
of the world could have a material adverse effect on our business, results of
operations, and financial condition.

Gross margins may be adversely affected by 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, increased levels of customer
services, changes in distribution channels, and changes in product and
geographic mix. Lower than expected gross margins could have a material
adverse effect on our business, results of operations, and financial condition.

43



---



##### Table of Contents



Senior management and employees.Competition for key positions and
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 to attracting and retaining qualified
employees is our ability to provide employees with the opportunity to
participate in the potential growth of our business through such programs as
stock option plans and employee investment plans, the value of which may be
adversely affected by stock price volatility or negative stock price
performance. We may also find it more difficult to attract or retain qualified
employees due to our recent significant reductions in employee positions. 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. There can be no assurance that we will be successful in
attracting, retaining or recruiting qualified employees, including members of
senior management, in the future and a failure to do so could have a material
adverse effect on our business, results of operations, and financial condition.

Cash flows, liquidity, debt levels, and debt ratings.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 levels of sales, timing and size of capital expenditures, timing of
deliveries and collection of receivables, inventory levels, customer payment
terms, customer financing obligations, and supplier terms and conditions. The
inability to manage cash flow fluctuations resulting from such factors could
have a material adverse effect on our business, results of operations, and
financial condition.

In order to finance our business we have incurred, or have entered into
credit facilities allowing for drawdowns of, significant levels of debt
compared to historical levels, and we may need to secure additional sources of
funding, including debt or convertible debt financing, in the future. A high
level of debt, arduous or restrictive terms and conditions relating
to certain sources
of funding, including credit facilities, or lower than expected cash inflows
could have adverse consequences on the operation of our business, including the
following:



| |  |  | we may have difficulty borrowing money in the future, or accessing
sources of funding, including credit facilities;                                                                                                                                                                                                                                                                                                                           
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | we may need to use a larger 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 inflows 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.

Certain of our debt instruments are publicly rated by independent rating
agencies. Our public debt ratings also affect our ability to raise debt,
including our access to the commercial paper market, and to perform asset-based
financings, as well as the cost and terms and conditions of debt and
asset-based financings. Any negative developments regarding our cash flows,
public debt ratings and/or our incurring significant levels of debt could have
a material adverse effect on our business, results of operations, and financial
condition.

Voice and data convergence.We expect that data communications traffic
will grow at a faster rate than the growth expected for voice traffic. We also
expect that use of the Internet will continue to increase. We expect the
growth of data traffic and the use of the Internet to have a significant impact
on traditional voice networks, both wireline and wireless, and we believe that
this will create market discontinuities, which will drive the convergence of
data and telephony and give rise to the demand for Internet Protocol (or
IP)-optimized networking solutions and third generation, or 3G, wireless
networks. Many of our traditional customers have already begun to invest in
data networking and/or in transitioning from voice to include data traffic.
However, as a result of the recent changes in industry and market conditions,
many of our customers have reduced their capital spending on telecommunications
infrastructure. As well, we cannot be sure what the rate of such convergence
will be due to the dynamic and rapidly evolving nature of the communications
business, and the technology involved. Consequently, there is no assurance
that the market discontinuities and the resulting demand for IP-optimized

44



---



##### Table of Contents



networking solutions or 3G wireless networks will continue to develop or
any assurance as to the pace of that development. Certain events (including
the availability of required new technologies and products or the evolution of
other technologies) may occur which would affect the extent or timing of
anticipated market demand or increase the demand for products based on other
technologies and reduce the demand for IP-optimized networking solutions or 3G
wireless networks. Continued reductions in capital spending on
telecommunications infrastructure by our customers, or a lack of growth in the
rate of data traffic, in the use of the Internet, or in demand for IP-optimized
networking solutions or 3G wireless networks in the future, could have a
material adverse effect on our business, results of operations, and financial
condition.

Costs of the business, and related factors.We must implement our work
plan in a timely manner to adjust the costs of our business to reflect current
and expected future economic conditions, market demands and revenues, and to
achieve future profitability. We must also manage what we believe to be the
potentially higher growth areas of our business and the non-core areas of our
business effectively in light of current and future market demands and trends.
In addition, in order for us to take advantage of the anticipated growth in
demand for IP-optimized networking solutions, we have made, and may continue to
make, strategic acquisitions, involving 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 needed to be successful in the industry;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | the risk that future valuations of acquired businesses may vary
materially from the market price we paid for such businesses;                                                          
|
| |  |  | the generation of insufficient revenues by acquired businesses to
offset increased operating expenses associated with such businesses;                                                 
|
| |  |  | the potential difficulties in completing in-process research and development projects;                                                                                                 
|
| |  |  | the 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 may divert the attention of 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 implement and/or refine our work plan on a
timely basis, to operate and integrate significant acquired businesses, to
manage the business effectively, or size our business appropriately could have
a material adverse effect on our business, results of operations, and financial
condition.

Rapid technological change.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 new products and upgrades and cost reductions of current
products to address the operational speed, bandwidth, efficiency, and cost
requirements of our customers, to provide our customers with new
revenue-generation opportunities, to comply with emerging industry standards
and to operate with products of other suppliers, and to address emerging market
trends as well as competing 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.
There can be no assurance that we will successfully target new market
opportunities, develop and commercialize new products in a timely manner, or
achieve market acceptance for our new products. The success of new or enhanced
products, including IP-optimized networking solutions and 3G wireless networks,

45



---



##### Table of Contents



depends on a number of other factors including the timely introduction of
such products, market acceptance of new technologies and industry standards,
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. An
unanticipated change in one or more of the technologies affecting
telecommunications and data networking, or 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
metropolitan optical 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 in a timely and effective manner to such
changes.

Competition.We participate 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 both from start-up companies and established competitors, and from
well-capitalized computer systems and communications companies, which, in turn,
could have a material adverse effect on our business, results of operations,
and financial condition.

Our principal competitors are large telecommunications equipment
suppliers, such as Alcatel, Lucent Technologies Inc., Siemens
Aktiengesellschaft, and Telefonaktiebolagat LM Ericsson, and data networking
companies, such as Cisco Systems, Inc. and Avaya Inc. Other principal
competitors include providers of wireless networking equipment, such as Nokia
Corporation and Motorola, Inc., and providers of optical networking equipment,
including Fujitsu Limited, Marconi plc, CIENA Corporation, and ONI Systems
Corp. 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 niche market companies and start-up
ventures are now and may become principal competitors in the future. We may
also face competition from resales of used telecommunications equipment,
including our own on occasion, by failed, downsized or consolidated
high-technology enterprises and telecommunications service providers.

One way to maximize market growth, enhance existing products and introduce
new products is through acquisitions of companies, where advisable. These
acquisitions or general market conditions 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 financial (which includes the ability to provide customer
financing in connection with the sale of its products), marketing and technical
resources. Many of our current and potential competitors have also
established, or may in the future establish, relationships with our current and
potential customers. Increased competition could result in price reductions,
reduced profit margins and loss of market share, each of which could have a
material adverse effect on our business, results of operations, and financial
condition.

International and emerging markets.We intend to continue to pursue
international and emerging market growth opportunities. In many international
markets, long-standing relationships between our potential customers and their
local providers and protective regulations, including local content
requirements and type approvals, create barriers to entry. In addition,
pursuing international and emerging growth opportunities may require
significant investments for an extended period before we realize returns on
such investments, if any. Investments in international and emerging markets
may result in expenses growing at a faster rate than revenues. 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;                                                       
|
| |  |  | currency fluctuations;                                                   
|
| |  |  | investment policies;                                                     

46



---



##### Table of Contents





| |  |  | 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 difficulties
experienced by 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.

Foreign exchange.We continue to pursue business opportunities globally.
Accordingly, an increasing proportion of our business may be denominated in
currencies other than United States dollars. As a result, 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 the Peoples Republic of China renminbi. These currencies
may be affected by internal factors, and external developments in other
countries, which can have an adverse impact on a countrys currency. We will
continue to monitor our exposure and we may hedge against these or any other
emerging market currencies as we consider necessary.

We try to minimize the impact of currency fluctuations through our ongoing
commercial practices and by attempting to hedge our exposures to major
currencies. In attempting to manage our foreign exchange risk, we identify
operations and transactions that may have foreign exchange exposure based upon,
among other factors, the excess or deficiency of foreign currency receipts over
foreign currency expenditures in each of our significant foreign currencies.
We continuously monitor all of our foreign currency exposures and, given our
exposure to emerging markets, monitor the volatility in the foreign exchange
markets. 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 business, results of operations, and financial condition.

Industry standards and intellectual property.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 patents, copyrights, trademarks 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. There can be
no assurance that any of our issued patents will not be challenged,
invalidated, or circumvented, or that any of our rights under issued patents
will provide us with competitive advantages. There can be no assurance that
patents will be issued from pending applications, or that claims in patents
issued in the future will be sufficiently broad to protect our proprietary
technology. As well, we or our subsidiaries may be subject to claims of
intellectual property infringement or trade secret misappropriation, and there
can be no assurance as to the outcome of any such claims or similar claims that
may be asserted against our customers in connection with their use of our
products. A failure by us to react to changing industry standards, lack of
broadly-accepted industry standards, successful claims of intellectual property
infringement or trade secret misappropriation 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.

Rationalization and consolidation in the telecommunications industry.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 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

47



---



##### Table of Contents



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, various
telecommunications equipment suppliers may enter into business combinations, or
may be acquired by or sell a substantial portion of their assets to another
competitor, 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
suppliers. The business failure of operators, competitors or suppliers may
cause uncertainty among investors and the telecommunications market generally.
Industry consolidation and rationalization could have a material adverse effect
on our business, results of operations, and financial condition.

Uncertainties of the Internet.There are currently few laws or
regulations that apply directly to access or commerce on the Internet. We
could be materially 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, as well as the continuing deregulation of the telecommunications
industry. If a jurisdiction adopts such measures then 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.

Customer financing and customer credit risk.The competitive environment
in which we operate has required in the past, and we expect may continue to
require in the future, that we, and many of our principal competitors, 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, 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 expect to continue to hold certain current 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, current capital market conditions, adverse changes in the credit
ratings of our customers or ourselves, and reduced demand for
telecommunications financings in capital and bank markets. In addition,
specific risks 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. There can
be no assurance that we will be able to place any of our current, or future,
customer financing obligations with third-party lenders on acceptable terms.

As well, recently certain of our customers, including competitive local
exchange carriers, have filed for bankruptcy or have been experiencing
financial difficulties. Should customers fail to meet their customer financing
obligations to us, we could experience reduced cash flows and losses in excess
of provisions. We review the levels of our customer financing provisions on a
regular basis. In addition to being increasingly selective in providing
customer financing, we have various programs in place to monitor and mitigate
customer credit risk, including performance milestones, other conditions of
funding, and active customer financing portfolio reviews. Management is
focused on the strategic use of our limited customer financing capacity, on
revolving that capacity as quickly and efficiently as possible, and on managing
the absolute dollar amount of our customer financing obligations. However,
there can be no assurance that such measures will reduce our exposure to
customers credit risk.

As part of the selective use of our customer financing capacity, we may
provide customer financing in the future for such customer requirements as
turnkey construction of new networks, particularly 3G wireless operators. We
anticipate that, due to current capital market conditions, if we
provide such customer financing in the future we will be required
to directly support a significantly greater amount of such financings compared
to our past experience, in which we have traditionally been able to place a
large amount of our customer financing obligations with third-party lenders.
We will continue to seek to arrange for third-party lenders to assume our
customer financing obligations and to fund other customer financings from
working capital and conventional sources of external financing in the normal
course.

Any unexpected developments in our customer financing arrangements could
have a material adverse effect on our business, results of operations, and
financial condition.

48



---



##### Table of Contents



Supply contracts, network outsourcing contracts, and turnkey arrangements.
We have 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. These
supply and network outsourcing contracts may 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. Any
unexpected developments in these supply and outsourcing contracts could have a
material adverse effect on our business, results of operations, and financial
condition.

Component supply, manufacturing capacity, and inventories.Our ability to
meet customer demand is, in part, dependent on us obtaining timely and adequate
component parts from suppliers and internal manufacturing capacity. We work
closely with our suppliers to meet increases in customer demand, when needed,
and also manage our internal manufacturing capacity and inventory levels as
required. However, there can be no assurance that we will not encounter
component shortages in the future. In addition, our component and
manufacturing services suppliers have experienced, and may continue to
experience, a consolidation in the industry, which may result in fewer sources
of components and greater exposure to the financial stability of our suppliers.
Also, inventory purchases and commitments are based upon future sales
forecasts. If inventory levels are higher than required to meet actual sales
levels, obsolescence charges and loss of cost savings on future inventory
purchases may result, adversely affecting gross margins. If product demand is
less than our commitments to suppliers, we may need to renegotiate our
commitment levels. A reduction or interruption in component supply or external
manufacturing capacity, a significant increase in the price of one or more
components, our inability to renegotiate supplier commitment levels, if
necessary, or excessive inventory levels could have a material adverse effect
on our business, results of operations, and financial condition or our
relationships with our customers.

Strategic alliances.We have entered into a number of strategic alliances
with suppliers, developers, and members of 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, we compete in business areas with companies with which we also have
strategic alliances. If a member of a strategic alliance fails to perform its
obligations, or if the relationship fails to develop as expected, we could
experience delays in product availability or impairment of our relationships
with our customers. Negative developments with respect to, or terminations of,
strategic alliances could have a material adverse effect on our business,
results of operations, and financial condition.

Litigation.We are currently a defendant in over twenty-five class
actions and other lawsuits as well as lawsuits 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 may be 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 October 2001, the Financial Accounting Standards Board, or FASB, issued
Statement of Financial Accounting Standards, or SFAS, No. 144, Accounting for
the Impairment or Disposal of Long-Lived Assets, or SFAS 144, which addresses
financial accounting and reporting for the impairment or disposal of long-lived
assets. 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 No.
30, for the disposal of a segment of a business. We are required to adopt the
provisions of SFAS 144 effective January 1, 2002. The Company has not yet
determined the effect of the adoption of SFAS 144 on our business, results of
operations or financial condition.

In July 2001, the FASB issued SFAS No. 141, Business Combinations, or
SFAS 141, and SFAS No. 142, Goodwill and Other Intangible Assets, or SFAS
142, effective for fiscal years beginning after December 15, 2001. SFAS 141
transitional rules require that the purchase method of accounting be used for
all business combinations initiated after June 30, 2001. As a result, the
pooling-of-interests method is now prohibited. SFAS 142 changes the accounting
for goodwill from an amortization method to an impairment-only approach and, as
a result, the amortization of goodwill will cease upon adoption of this
Statement on January 1, 2002. However, goodwill and intangible assets with an
indefinite life will not be amortized for any acquisitions completed after June
30, 2001.

49



---



##### Table of Contents



The adoption of SFAS 141 will not have an impact on our business, results
of operations, or financial condition. The Company will be performing the first of the required impairment tests
under SFAS 142 during 2002 and has not yet determined the effect of adoption on
our business, results of operations, or financial condition.

For a discussion of recent pronouncements, see Recent pronouncements in note 19.




ITEM 3. Quantitative and Qualitative Disclosures About Market Risk

Market risk represents the risk of loss that may impact the Consolidated
Financial Statements of the Company due to adverse changes in financial market
prices and rates. The Companys market risk exposure is primarily a result of
fluctuations in interest rates and foreign exchange rates. Disclosure of
market risk is contained in the Companys Annual Report on Form 10-K for the
year ended December 31, 2000.

50



---



##### Table of Contents






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

Effective March 5, 2001, Nortel Networks organized its High Performance
Optical Component Solutions business into a number of wholly-owned
subsidiaries, including Nortel Networks Optical Components Inc. (the
Reorganization). In connection with the Reorganization, the Company issued
two common shares to Nortel Networks Corporation, its parent company, in
consideration for the purchase of Class A common stock of Nortel Networks
Optical Components Inc., having a then estimated value of U.S.$680,000,
pursuant to a purchase agreement made as of June 6, 2001. This transaction
was exempt from registration pursuant to Regulation S under the United States
Securities Act of 1933, as amended (the Securities Act), on the basis that it
occurred outside the United States.

The former registered holders of Cumulative Redeemable Class A Preferred
Shares Series 4 (the Series 4 Preferred Shares) of the Company had the right
to exchange such shares into common shares of Nortel Networks Corporation upon
the occurrence of at least two consecutive unsuccessful auctions in respect of
the monthly dividend rate for the Series 4 Preferred Shares (the Exchange
Rights). Under the Exchange Rights, holders of Series 4 Preferred Shares who
gave notice of exercise within three business days after the date of the second
(or subsequent) consecutive unsuccessful auction were entitled to exchange, on
the next scheduled auction date, each of their Series 4 Preferred Shares into
that number of Nortel Networks Corporations common shares determined by
dividing $500,000 (Canadian) by the greater of $2.50 (Canadian) and 95% of the
weighted average trading price of Nortel Networks Corporations common shares
on The Toronto Stock Exchange for the ten trading days immediately prior to the
exchange date.

The Exchange Rights were exercised as a result of a second consecutive
unsuccessful auction on July 10, 2001 and a third consecutive unsuccessful
auction on August 14, 2001. As a result, effective August 14, 2001, registered
holders of 173 of the 200 then issued and outstanding Series 4 Preferred Shares
exchanged their Series 4 Preferred Shares for an aggregate of 7,544,828 common
shares of Nortel Networks Corporation using $11.4648 (Canadian) as the
denominator in the conversion formula described above, and effective September
11, 2001, registered holders of the remaining 27 then issued and outstanding
Series 4 Preferred Shares exchanged their Series 4 Preferred Shares for an
aggregate of 1,490,608 common shares of Nortel Networks Corporation, using
$9.0567 (Canadian) as the denominator in the conversion formula described
above. An inter-company agreement dated as of May 1, 2000 and amended as of
July 26, 2001 (the Inter-company Agreement) between the Company and Nortel
Networks Corporation provided for the issuance by Nortel Networks Corporation
of its common shares to the registered holders of Series 4 Preferred Shares who
exercised their Exchange Rights, and specified the formula for calculating the
number of common shares of the Company that were issued to Nortel Networks
Corporation in consideration for the Nortel Networks Corporation common shares
that were issued upon the exchange. Pursuant to the Inter-company Agreement,
the Company issued 3,415,191 common shares on August 14, 2001 and 674,378
common shares on September 11, 2001 to Nortel Networks Corporation in
consideration for the 7,544,828 and 1,490,608 common shares issued by Nortel
Networks Corporation on those respective dates upon the effective exercise of
the Exchange Rights. The issuance of common shares of the Company to Nortel
Networks Corporation on each exchange date 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.

On September 30, 2001, Nortel Networks Corporation elected, pursuant to
the August 15, 2001 loan agreement between Nortel Networks Corporation and the
Company, as amended, whereby Nortel Networks Corporation lent a total of U.S.$1.8
billion to the Company, to convert the full amount of the loan outstanding
under the loan agreement into one common share of the Company. Pursuant to the
election to convert, the Company issued one common share to Nortel Networks
Corporation on September 30, 2001 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.

51



---



##### Table of Contents






ITEM 6. Exhibits and Reports on Form 8-K



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



| |      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
| | ---- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | 4    | Indenture dated as of August 15, 2001 between Nortel Networks
Corporation, the Company, as guarantor, and Bankers Trust Company, as
trustee, related to convertible debt securities and guarantees
authenticated and delivered thereunder, which to date comprise the
4.25% Convertible Senior Notes due 2008 (filed as Exhibit 4 to Nortel
Networks Corporations Quarterly Report on Form 10-Q for the quarter
ended September 30, 2001).                                                                                       
|
| | 10.1 | Amendment effective as of July 26, 2001 between the Company and
Nortel Networks Corporation, amending the Agreement dated May 1, 2001
between the Company (formerly known as Nortel Networks Corporation)
and Nortel Networks Corporation (formerly known as New Networks Inc.)
with respect to exchange rights attached to the Companys Cumulative
Redeemable Class A Preferred Shares Series 4 (filed as Exhibit 10.1
to Nortel Networks Corporations Quarterly Report on Form 10-Q for
the quarter ended September 30, 2001).
|
| | 10.2 | Nortel Networks Corporation Executive Retention and Termination
Plan, as amended and restated, effective from July 26, 2001 (filed as
Exhibit 10.2 to Nortel Networks Corporations Quarterly Report on
Form 10-Q for the quarter ended September 30, 2001).                                                                                                                                                                                                                                                                      
|
| | 10.3 | Nortel Networks Corporation Special Retention Plan effective
August 1, 2001 (filed as Exhibit 10.3 to Nortel Networks
Corporations Quarterly Report on Form 10-Q for the quarter ended
September 30, 2001).                                                                                                                                                                                                                                                                                                                      
|
| | 10.4 | Loan Agreement dated as of August 15, 2001 made between the
Company, as borrower, and Nortel Networks Corporation, as lender, as
amended by Amendment No. 1 dated as of September 30, 2001 between the
Company, as borrower, and Nortel Networks Corporation, as lender
(filed as Exhibit 10.4 to Nortel Networks Corporations Quarterly
Report on Form 10-Q for the quarter ended September 30, 2001).                                                                                                                          



|b) |  | Reports on Form 8-K:
|-- |  | --------------------



| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | The Company filed a Report on Form 8-K dated July 23, 2001 related to the
financial results for the second quarter of 2001 of Nortel Networks
Corporation, its parent corporation.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|
| | The Company filed a Report on Form 8-K dated August 8, 2001 related to the
audited consolidated financial statements for the three years ended
December 31, 2000 and unaudited consolidated financial statements for the
three month period ended March 31, 2001, each restated to reflect the
previously announced discontinued operations. In addition, the Form 8-K
also related to the announcement of the proposed offering on a private
basis of U.S.$1.0 billion of convertible senior notes by Nortel Networks
Corporation, and guaranteed by the Company.                                                                                                                          
|
| | The Company filed a Report on Form 8-K dated August 10, 2001 related to
the announcement of certain details of the U.S.$1.5 billion convertible
senior notes offering by Nortel Networks Corporation, and guaranteed by
the Company, reflecting an increase in the size of the offering from
U.S.$1.0 billion as previously announced on August 8, 2001.                                                                                                                                                                                                                                                                                                                                    
|
| | The Company filed a Report on Form 8-K dated August 14, 2001 related to
the announcement of the increase in the size of the offering of
convertible senior notes by Nortel Networks Corporation, and guaranteed by
the Company, from U.S.$1.5 billion, as previously announced on August 10,
2001, to U.S.$1.8 billion.                                                                                                                                                                                                                                                                                                                                                                     
|
| | The Company filed a Report on Form 8-K dated October 4, 2001 related to
the financial outlook for the third quarter of 2001 of Nortel Networks
Corporation, including certain restructuring charges and facility closures
related to workforce reductions and business streamlining activities, an
update on Nortel Networks Corporations work plan, including expected
additional workforce reductions and business streamlining activities and
the expected impact of the divestiture of non-core businesses, and the
announcement of Nortel Networks Corporation and the Companys new senior
management team, including Frank A. Dunn as the new President and Chief
Executive Officer.

52



---



##### Table of Contents





| |                                                                                                                                                                                     
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | The Company filed a Report on Form 8-K dated October 22, 2001 related to
the financial results for the third quarter of 2001 of Nortel Networks
Corporation, its parent corporation.

53



---



##### Table of Contents



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           
|                                                        
|                                                        
|                                                        
|"TERRY G. HUNGLETERRY G. HUNGLE
Chief Financial Officer |  | "D.C. BEATTYD.C. BEATTY
Controller

Date: November 6, 2001

54