<PAGE>   1
                                                                      Exhibit 13

                    MANAGEMENT'S DISCUSSION AND ANALYSIS OF
                 RESULTS OF OPERATIONS AND FINANCIAL CONDITION
 
HIGHLIGHTS
 
     For the year ended September 30, Lucent Technologies Inc. ("Lucent" or the
"Company") reported the following:
 
                                      1998
 
- Net income of $970 million, $0.73 per share (diluted)
 
  EXCLUDING CERTAIN ONE-TIME EVENTS:
 
- Net income of $2,287 million, $1.72 per share (diluted)
 
                                      1997
 
- Net income of $541 million, $0.42 per share (diluted)
 
  EXCLUDING CERTAIN ONE-TIME EVENTS:
 
- Net income of $1,507 million, $1.17 per share (diluted)
 
     ONE-TIME EVENTS in 1998 include $1,416 million ($1,412 million after tax)
of purchased in-process research and development charges related to the
acquisitions of Livingston Enterprises Inc., Prominet Corporation, Yurie
Systems, Inc., Optimay GmBH, SDX Business Systems plc, MassMedia Communications
Inc., LANNET and JNA Telecommunications Limited, as well as a $95 million after
tax gain on the sale of Lucent's Advanced Technology Systems ("ATS") unit.
 
     ONE-TIME EVENTS in 1997 include a purchased in-process research and
development charge and other charges of $979 million ($966 million after tax)
related to the acquisition of Octel Communications Corporation.
 
                               NET INCOME GROWTH
 
                       EXCLUDING CERTAIN ONE-TIME EVENTS
 
                           [NET INCOME GROWTH CHART]
---------------
(a) Excludes impact of $2,801 million ($1,847 million after tax) of business
    restructuring and other charges incurred in December 1995.
 
(b) Excludes one-time charges of $979 million ($966 million after tax) related
    to the acquisition of Octel.
 
(c) Excludes one-time charges of $1,416 million ($1,412 million after tax)
    related to the acquisitions of Livingston, Prominet, Yurie, Optimay, SDX,
    MassMedia, LANNET, and JNA and a gain of $95 million (after tax) on the sale
    of ATS.
                                        1
<PAGE>   2
 
     The earnings per share data discussed above have been adjusted to reflect
the two-for-one split of Lucent's common stock which became effective April 1,
1998.
 
COMMUNICATIONS REVOLUTION
 
     The communications industry is going through a revolution, centered on
rapidly growing demand by commercial and residential users for voice, data,
Internet and wireless services. As a result, the industry has undergone a global
consolidation of key players, including traditional telecommunications network
manufacturers and data networking companies, which compete in the same markets
as Lucent. This consolidation -- driven by the need for key technologies, new
distribution channels in untapped markets, economies of scale and global
expansion -- is expected to continue into the near future.
 
     Lucent continues to evaluate its presence and product offerings in the
marketplace and may use acquisitions to enhance those offerings where that makes
good business sense. These acquisitions may occur through the use of cash, or
the issuance of debt or common stock, or any combination of the three.
 
ACQUISITIONS AND DIVESTITURES
 
     As part of Lucent's efforts to focus on the fastest growing markets in the
communications industry, the Company has acquired a number of businesses,
complementing its existing product lines and its internal product development
efforts.
 
     - In September 1998, Lucent acquired JNA, an Australian telecom equipment
       manufacturer, reseller and system integrator.
 
     - In August 1998, Lucent acquired LANNET, an Israeli-based supplier of
       Ethernet and asynchronous transfer mode ("ATM") switching solutions.
 
     - In July 1998, Lucent acquired both SDX, a United Kingdom-based provider
       of business communications systems, and MassMedia, a developer of
       next-generation network interoperability software.
 
     - In May 1998, Lucent acquired Yurie, a provider of ATM access technology
       and equipment for data, voice and video networking.
 
     - In April 1998, Lucent acquired Optimay, a developer of software products
       and services for chip sets to be used for Global System for Mobile
       Communications ("GSM") cellular phones.
 
     - In January 1998, Lucent acquired Prominet, a participant in the emerging
       Gigabit Ethernet networking industry.
 
     - In December 1997, Lucent acquired Livingston, a global provider of
       equipment used by Internet service providers to connect their subscribers
       to the Internet.
 
     - In September 1997, Lucent acquired Octel, a provider of voice, fax and
       electronic messaging technologies that complement those offered by
       Lucent.
 
     Lucent has also sought to divest itself of non-core businesses.
 
     - On October 1, 1997, Lucent contributed its Consumer Products business to
       a new venture formed by Lucent and Philips Electronics N.V. ("Philips")
       in exchange for 40% ownership of the venture. The venture, Philips
       Consumer Communications ("PCC"), was formed to create a worldwide
       provider of personal communications products. On October 22, 1998, Lucent
       and Philips announced their intention to end the venture in PCC. It is
       expected that Lucent and Philips will each regain control of the original
       businesses they contributed to the venture. Lucent plans to close down
       the wireless handset business it previously contributed to PCC and to
       sell the consumer product and leasing businesses.
 
     - In October 1997, Lucent completed the sale of its ATS unit.
 
     - In December 1996, Lucent sold its interconnect products and Custom
       Manufacturing Services ("CMS") businesses.
 
     - In July 1996, Lucent completed the sale of its Paradyne subsidiary.
 
                                        2
<PAGE>   3
 
LUCENT'S FORMATION
 
     Lucent was formed from the systems and technology units that were formerly
part of AT&T Corp., including the research and development capabilities of Bell
Laboratories. Prior to February 1, 1996, AT&T conducted Lucent's original
business through various divisions and subsidiaries. On February 1, 1996, AT&T
began executing its decision to separate Lucent into a stand-alone company (the
"Separation") by transferring to Lucent the assets and liabilities related to
its business. In April 1996, Lucent completed the initial public offering of its
common stock ("IPO") and on September 30, 1996, became independent of AT&T when
AT&T distributed to its shareowners all of its Lucent shares.
 
     Lucent's consolidated financial statements for periods prior to February 1,
1996 reflect the financial position, results of operations and cash flows of the
operations transferred to Lucent from AT&T in the Separation and were carved out
from the financial statements of AT&T using the historical results of operations
and historical basis of the assets and liabilities of the business. Management
believes the assumptions underlying these financial statements are reasonable,
although these financial statements may not necessarily reflect the results of
operations or financial position had Lucent been a separate, stand-alone entity.
 
     In 1996, Lucent changed its fiscal year to begin October 1 and end
September 30. Due to this change, Lucent reported 1996 audited consolidated
financial results for a short fiscal period beginning on January 1, 1996 and
ending on September 30, 1996. For comparability to the audited consolidated
financial statements, Lucent has provided unaudited consolidated statements of
income and cash flows for the twelve months ended September 30, 1996.
 
KEY BUSINESS CHALLENGES
 
     Lucent continues to face significant competition and expects that the level
of competition on pricing and product offerings will intensify. Lucent expects
that new competitors will enter its markets as a result of the trend toward
global expansion by foreign and domestic competitors as well as continued
changes in technology and public policy. These competitors may include entrants
from the telecommunications, software, data networking and semiconductor
industries. Existing competitors have, and new competitors may have, strong
financial capability, technological expertise, well-recognized brand names and a
global presence. Such competitors may include Cisco Systems, Inc., Nortel
Networks, Ericsson, Alcatel Alsthom and Siemens AG. As a result, Lucent's
management periodically assesses market conditions and redirects the Company's
resources to meet the challenges of competition. Steps Lucent may take include
acquiring or investing in new businesses and ventures, partnering with existing
businesses, delivering new technologies, closing and consolidating facilities,
disposing of assets, reducing work force levels or withdrawing from markets.
 
     Lucent has taken measures to manage the seasonality of its business by
changing the date on which its fiscal year ends and its compensation programs
for employees. As a result, Lucent has achieved a more uniform distribution of
revenues -- accompanied by a related redistribution of earnings -- throughout
the year. Revenues and earnings still remain higher in the first fiscal quarter
primarily because many of Lucent's large customers historically delay a
disproportionate percentage of their capital expenditures until the fourth
quarter of the calendar year (Lucent's first fiscal quarter).
 
     The purchasing behavior of Lucent's largest customers has increasingly been
characterized by the use of fewer, larger contracts. These contracts typically
involve longer negotiating cycles, require the dedication of substantial amounts
of working capital and other resources, and in general require costs that may
substantially precede recognition of associated revenues. Moreover, in return
for larger, longer-term purchase commitments, customers often demand more
stringent acceptance criteria, which can also cause revenue recognition delays.
Lucent has increasingly provided or arranged long-term financing for customers
as a condition to obtain or bid on infrastructure projects. Certain multi-year
contracts involve new technologies that may not have been previously deployed on
a large-scale commercial basis. On its multi-year contracts, Lucent may incur
significant initial cost overruns and losses that are recognized in the quarter
in which they become ascertainable. Further, profit estimates on such contracts
are revised periodically over the lives of the contracts, and such revisions can
have a significant impact on reported earnings in any one quarter.
 
                                        3
<PAGE>   4
 
     Lucent has been successful in diversifying its customer base and seeking
out new types of customers globally. These new types of customers include
competitive access providers, competitive local exchange carriers, wireless
service providers, cable television network operators and computer
manufacturers.
 
     Historically, a limited number of customers have provided a substantial
portion of Lucent's total revenues. These customers include AT&T, which
continues to be a significant customer, as well as other large carriers such as
Sprint Spectrum Holding LP ("Sprint PCS"), and the Regional Bell Operating
Companies ("RBOCs"). The loss of any of these customers, or any substantial
reduction in orders by any of these customers, could materially adversely affect
the Company's operating results.
 
                                        4
<PAGE>   5
 
                   LUCENT TECHNOLOGIES INC. AND SUBSIDIARIES
 
                               FIVE-YEAR SUMMARY
 
<TABLE>
<CAPTION>
                                              YEAR ENDED                                         YEAR ENDED
                                             SEPTEMBER 30,             NINE MONTHS ENDED        DECEMBER 31,
                                            (TWELVE MONTHS)              SEPTEMBER 30,        (TWELVE MONTHS)
                                     -----------------------------     ------------------    ------------------
                                      1998       1997       1996       1996(1)     1995       1995       1994
                                     -------    -------    -------     -------    -------    -------    -------
                                                  (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
                                                                    (UNAUDITED)
<S>                                  <C>        <C>        <C>         <C>        <C>        <C>        <C>
RESULTS OF OPERATIONS
Revenues...........................  $30,147    $26,360    $23,286     $15,859    $13,986    $21,413    $19,765
Gross margin.......................   13,991     11,462      8,894       6,569      6,143      8,468      8,428
Depreciation and amortization
  expense..........................    1,334      1,450      1,326         937      1,104      1,493      1,311
Operating income (loss)............    2,461      1,631       (947)        487        434     (1,000)       971
Net income (loss)..................      970        541       (793)        224        150       (867)       482
Earnings (loss) per common share --
  basic(2)(3)......................     0.74       0.42      (0.69)       0.19       0.14      (0.83)       n/a
Earnings (loss) per common share --
  diluted(2)(3)....................     0.73       0.42      (0.69)       0.19       0.14      (0.83)       n/a
Earnings (loss) per common share --
  pro forma(3)(4)..................      n/a        n/a      (0.62)       0.18       0.12      (0.68)       n/a
Dividends per common share(3)......    0.155     0.1125      0.075       0.075         --         --        n/a
FINANCIAL POSITION
Total assets.......................  $26,720    $23,811    $22,626     $22,626    $18,219    $19,722    $17,340
Working capital....................    3,650(8)   1,763      2,068       2,068        188       (384)       246
Total debt.........................    4,640      4,203      3,997       3,997      4,192      4,014      3,164
Shareowners' equity................    5,534      3,387      2,686       2,686      2,783      1,434      2,476
OTHER INFORMATION
Selling, general and administrative
  expenses as a percentage of
  revenues.........................     21.3%      21.9%      31.3%       26.8%      28.9%      33.1%      27.1%
Research and development expenses
  as a percentage of revenues......     12.2       11.5       11.0        11.6       12.0       11.1       10.6
Gross margin percentage............     46.4       43.5       38.2        41.4       43.9       39.5       42.6
Return on assets...................      9.3(5)     6.5(6)     5.3(7)      n/a        n/a        n/a        n/a
Ratio of total debt to total
  capital (debt plus equity).......     45.6       55.4       59.8        59.8       60.1       73.7       56.1
Capital expenditures...............  $ 1,626    $ 1,635    $ 1,432     $   939    $   784    $ 1,277    $   878
EXCLUDING CERTAIN ONE-TIME EVENTS
Net income.........................  $ 2,287(5) $ 1,507(6) $ 1,054(7)  $   224    $   150    $   980(7) $   482
Earnings per common share --
  diluted(2)(3)....................     1.72(5)    1.17(6)    0.83(4,7)    0.19      0.14       0.93(7)     n/a
</TABLE>
 
---------------
(1) Beginning September 30, 1996, Lucent changed its fiscal year end from
    December 31 to September 30, and reported results for the nine-month
    transition period ended September 30, 1996.
 
(2) The calculation of earnings per share on a historical basis includes the
    retroactive recognition to January 1, 1995 of the 1,049,249,788 shares
    (524,624,894 shares on a pre-split basis) owned by AT&T on April 10, 1996.
 
(3) All per share data has been restated to reflect the two-for-one split of
    Lucent's common stock which became effective on April 1, 1998.
 
(4) The calculation of earnings (loss) per share on a pro forma basis assumes
    that all 1,273,323,862 shares (636,661,931 shares on a pre-split basis)
    outstanding on April 10, 1996 were outstanding since January 1, 1995 and
    gives no effect to the use of proceeds from the IPO.
 
(5) Excludes one-time charges of $1,412 (after tax) of purchased in-process
    research and development costs from acquisitions of Livingston, Prominet,
    Optimay, Yurie, SDX, MassMedia, LANNET and JNA, as well as a $95 (after tax)
    gain on the sale of ATS.
 
(6) Excludes one-time acquisition charges of $966 (after tax), including $945 of
    purchased in-process research and development costs, from the acquisition of
    Octel.
 
                                        5
<PAGE>   6
 
(7) Excludes pre-tax restructuring and other charges of $2,801 ($1,847 after
    tax) recorded as $892 of costs, $1,645 of selling, general and
    administrative expenses and $264 of research and development expenses.
 
(8) Reflects the reclassification from debt maturing within one year to
    long-term debt as a result of the November 19, 1998 sale of $500 ($495 net
    of unamortized costs) of ten-year notes.
 
n/a Not applicable
 
TWELVE MONTHS ENDED SEPTEMBER 30, 1998 VERSUS TWELVE MONTHS ENDED SEPTEMBER 30,
1997
 
  Revenues
 
     Total revenues increased to $30,147 million, or 14.4% compared with the
same period in 1997, primarily due to increases in sales from Systems for
Network Operators, Business Communications Systems and Microelectronic Products.
The overall revenue growth was impacted by the elimination of the Consumer
Products sales as a component of total revenue as well as lower revenues from
Other Systems and Products. The decline in Other Systems and Products was due
primarily to the sale of Lucent's ATS and CMS businesses in October 1997 and in
December 1996, respectively. Excluding revenues from Lucent's Consumer Products,
ATS and CMS businesses, total revenues increased 20.3% compared with the same
period in 1997. Revenue growth was driven by sales increases globally. For
fiscal year 1998, sales within the United States grew 11.9% compared with the
same period in 1997. Sales outside the United States increased 22.2% compared
with the same period in 1997. These sales represented 25.7% of total revenues
compared with 24.1% in 1997. Excluding revenues from Lucent's Consumer Products,
ATS and CMS businesses, sales within the United States increased 19.6% compared
with the same period in 1997.
 
                             GLOBAL REVENUE GROWTH
 
                               PERFORMANCE CHART
---------------
* Excluding the revenues from Lucent's Consumer Products, ATS and CMS
  businesses, total revenues increased 20.3% compared with the same period in
  1997.
 
                                        6
<PAGE>   7
 
     The following table presents Lucent's revenues by product line, and the
approximate percentage of total revenues for the twelve months ended September
30, 1998 and 1997:
 
<TABLE>
<CAPTION>
                                                             TWELVE MONTHS ENDED SEPTEMBER 30,
                                                   -----------------------------------------------------
                                                   AS A PERCENTAGE                      AS A PERCENTAGE
                                         1998      OF TOTAL REVENUE        1997         OF TOTAL REVENUE
                                        -------    ----------------    -------------    ----------------
                                                             (DOLLARS IN MILLIONS)
<S>                                     <C>        <C>                 <C>              <C>
Systems for Network Operators.........  $18,752           62%             $15,614              59%
Business Communications Systems.......    8,093           27                6,411              24
Microelectronic Products..............    3,027           10                2,755              11
Consumer Products.....................       --           --                1,013               4
Other Systems and Products............      275            1                  567               2
          Total.......................  $30,147          100%             $26,360             100%
</TABLE>
 
     Revenues from SYSTEMS FOR NETWORK OPERATORS increased $3,138 million, or
20.1% compared with the same period in 1997. The increase resulted from higher
sales of switching and wireless systems with associated software, optical
networking systems, communications software, and data networking systems for
service providers -- including those provided by recently acquired Livingston.
Demand for those products was driven in part by second line subscriber growth in
businesses and residences for Internet services and data traffic.
 
     Revenues from Systems for Network Operators in the United States increased
by 20.4% over the year-ago period. The revenue increase in the United States was
led by sales to RBOCs, competitive local exchange carriers, wireless service
providers and long distance carriers. Revenues generated outside the United
States for 1998 increased 19.3% compared with the same period in 1997 due to
revenue growth in the Europe/ Middle East/Africa, Canada, China and
Caribbean/Latin America regions. Revenues generated outside the United States
represented 24.9% of revenues for 1998 compared with 25.1% in the same period of
1997.
 
     For 1998, sales of wireless infrastructure increased significantly compared
with 1997 as customers accepted networks for commercial service in 1998 using
various digital technologies. These technologies include Code Division Multiple
Access ("CDMA"), GSM and Time Division Multiple Access ("TDMA"). The Lucent
digital technologies continue to show acceptance in markets both within and
outside the United States.
 
     Revenues from BUSINESS COMMUNICATIONS SYSTEMS increased $1,682 million, or
26.2% compared with the same period in 1997. This increase was led by sales of
messaging systems, including systems provided by recently acquired Octel,
SYSTIMAX(R) structured cabling, enterprise data networking systems and services.
Revenues generated outside the United States increased by 53.9% due to growth in
all international regions, led by the Europe/Middle East/Africa region. Revenues
generated outside the United States represented 19.2% of the revenues for 1998
compared with 15.8% in the same period in 1997. For 1998, sales within the
United States increased 21.1% compared with the same period in 1997.
 
     Revenues from MICROELECTRONIC PRODUCTS increased $272 million, or 9.9% for
1998 compared with the same period in 1997 due to higher sales of chips for
computing and communications, including components for broadband and narrowband
networks, data networking, wireless telephones and infrastructure, high-end
workstations, optoelectronic components, power systems and the licensing of
intellectual property. Sales within the United States increased 11.9% compared
with the same period in 1997. Revenues generated outside the United States
increased 8.0% compared with the same period in 1997. The increase in revenues
generated outside the United States was driven by sales in all international
regions, led by the Caribbean/Latin America region. Revenues generated outside
the United States represented 50.5% of sales compared with 51.3% for the same
period in 1997.
 
---------------
(R) Registered trademark of Lucent
                                        7
<PAGE>   8
 
     Despite a nearly 8.0%(a) decline in the world semiconductor market,
Microelectronic Products achieved revenue growth of 9.9% for 1998.
 
     On October 1, 1997, Lucent contributed its CONSUMER PRODUCTS unit to PCC in
exchange for 40% ownership of PCC. On October 22, 1998, Lucent and Philips
announced they would end their PCC venture. Lucent plans to close down the
wireless handset business it previously contributed to PCC and to sell the
remaining businesses. Lucent expects that these activities will be completed
during the first calendar quarter of 1999.
 
     Revenues from sales of OTHER SYSTEMS AND PRODUCTS decreased $292 million,
or 51.5% compared with the same period in 1997. The reduction in revenues was
primarily due to the sale of Lucent's ATS and CMS businesses. ATS designed and
manufactured custom defense systems for the United States government.
 
  Costs and Gross Margin
 
     Total costs increased $1,258 million, or 8.4% compared with the same period
in 1997 due to the increase in sales volume. Gross margin percentage increased
to 46.4% from 43.5% in the year-ago period. The increase in gross margin
percentage for the current period was due to an overall favorable mix of higher
margin products and services sales.
 
  Operating Expenses
 
     Selling, general and administrative expenses as a percentage of revenues
were 21.3% for 1998, a decrease of 0.6 percentage points from the same period in
1997. Excluding the amortization expense associated with goodwill and existing
technology for both years, selling, general and administrative expenses as a
percentage of revenues was 20.9%, a decrease of 0.9 percentage points from the
same period in 1997.
 
     Selling, general and administrative expenses increased $652 million, or
11.3% compared with the same period in 1997. This increase is attributed to the
higher sales volume, investment in growth initiatives, amortization expense
associated with goodwill and existing technology as well as the implementation
of SAP, an integrated software platform. Amortization expense associated with
goodwill and existing technology was $147 million for the year ended September
30, 1998, an increase of $115 million from the same year-ago period. These
increases were offset by the reversal of $66 million of 1995 business
restructuring charges. In addition, the 1997 period included a $174 million
reversal of 1995 business restructuring charges.
 
     Research and development expenses represented 12.2% of revenues for the
period as compared with 11.5% of revenues from the same period in 1997.
 
     Research and development expenses increased $655 million compared with the
same period in 1997. This was primarily due to increased expenditures in support
of wireless, data networking, optical networking and software as well as
switching and access systems and microelectronic products.
 
     The purchased in-process research and development expenses for 1998 were
$1,416 million, reflecting the charges associated with the acquisitions of
Livingston, Prominet, Yurie, Optimay, SDX, MassMedia, LANNET and JNA compared
with $1,024 million related to the acquisitions of Octel and Agile Networks,
Inc. for the same period in 1997.
 
  Other Income, Interest Expense and Provision for Income Taxes
 
     Other income -- net increased $22 million for 1998 compared with the same
period in 1997. This increase was primarily due to gains recorded on the sale of
certain business operations, including $149 million associated with the sale of
Lucent's ATS business. These gains were offset by higher net losses associated
with Lucent's equity investments, primarily from the PCC investment. Also,
included in Other income -- net for 1998 is a charge of $110 million related to
a write-down associated with Lucent's investment in the PCC
 
---------------
(a) Source: World Semiconductor Trade Statistics, Inc.
                                        8
<PAGE>   9
 
venture. This charge was offset by one-time gains of $103 million primarily
related to the sale of an investment and the sale of certain business operations
including Bell Labs Design Automation Group.
 
     Interest expense was $318 million for the 1998 fiscal year, an increase of
$13 million compared with the same period in 1997. The increase in interest
expense is due to higher debt levels in 1998 as compared with the prior year.
 
     The effective income tax rate of 57.9% for 1998 decreased from the
effective income tax rate of 63.1% in the same year-ago period. Excluding the
impact of the purchased in-process research and development expenses associated
with Livingston, Prominet, Yurie, Optimay, SDX, LANNET and JNA acquisitions, as
well as the similar impact of the Octel and Agile acquisitions in 1997, the
effective income tax rate was 36.0% for 1998, a decrease from the year-ago rate
of 37.2%. This decrease was primarily due to a reduced state effective tax rate
and increased research tax credits.
 
  Cash Flows
 
     Cash provided by operating activities was $1,366 million in 1998, a
decrease of $580 million compared with the same period in 1997. This decrease in
cash was largely due to the increase in accounts receivable, partially offset by
the increase in payroll and benefit-related liabilities.
 
     Cash payments of $176 million were charged against the December 1995
business restructuring reserves in 1998 compared with $483 million in 1997. Of
the 23,000 positions that Lucent announced it would eliminate in connection with
the 1995 restructuring charges, approximately 19,900 positions had been
eliminated through September 30, 1998. Actual experience in employee
separations, combined with redeploying employees into other areas of the
business, resulted in lower separation costs than originally anticipated. Lucent
expects employee reductions in positions to be substantially complete by
September 1999.
 
     Comparing 1998 and 1997, cash used in investing activities decreased to
$2,808 million from $3,121 million primarily due to a decrease in cash used for
acquisitions as well as an increase in cash received from dispositions. In 1998,
cash was used in the acquisitions of Yurie, Optimay, SDX, LANNET and JNA. The
acquisitions of Livingston and Prominet in 1998 were completed through the
issuance of stock and options and did not require the use of cash. The use of
cash in 1998 was partially offset by proceeds from the sale of ATS. In 1997,
Lucent acquired Octel and Agile and disposed of its interconnect products and
CMS businesses.
 
     Capital expenditures were $1,626 million and $1,635 million for 1998 and
1997, respectively. Capital expenditures include expenditures for equipment and
facilities used in manufacturing and research and development, including
expansion of manufacturing capacity and international growth.
 
     Cash provided by financing activities for 1998 was $838 million compared
with $295 million in 1997. The increase in cash provided by financing activities
was due to higher debt levels and increased issuances of common stock when
compared with the prior period.
 
TWELVE MONTHS ENDED SEPTEMBER 30, 1997 VERSUS TWELVE MONTHS ENDED SEPTEMBER 30,
1996
 
  Revenues
 
     Total revenues increased $3,074 million or 13.2% for 1997 compared with
1996, primarily due to gains in sales from Systems for Network Operators,
Business Communications Systems and Microelectronic Products. The overall
revenue growth was partially offset by the expected decline in revenue from
Consumer Products and Other Systems and Products. Revenues for Lucent's three
core businesses increased 17.9% for 1997 compared with 1996. Revenue growth
continued to be generated from sales both within and outside the United States.
Sales outside the United States increased 11.9% compared with 1996 and
represented 24.1% of total revenues in 1997. The increased sales outside of the
United States reflected Lucent's targeted approach toward revenue expansion
outside the United States for increased profitability. The following table
presents
 
                                        9
<PAGE>   10
 
Lucent's revenues by product line, and the related percentage of total revenues
for the twelve months ended September 30, 1997 and 1996:
 
<TABLE>
<CAPTION>
                                                                    TWELVE MONTHS ENDED
                                                                       SEPTEMBER 30,
                                                    ----------------------------------------------------
                                                    AS A PERCENTAGE
                                                       OF TOTAL                         AS A PERCENTAGE
                                          1997          REVENUE            1996         OF TOTAL REVENUE
                                         -------    ---------------    -------------    ----------------
                                                                   (DOLLARS IN MILLIONS)
<S>                                      <C>        <C>                <C>              <C>
Systems for Network Operators..........  $15,614           59%            $13,192              57%
Business Communications Systems........    6,411           24               5,509              24
Microelectronic Products...............    2,755           11               2,315              10
Consumer Products......................    1,013            4               1,431               6
Other Systems and Products.............      567            2                 839               3
                                         -------          ---             -------             ---
          Total........................  $26,360          100%            $23,286             100%
                                         =======          ===             =======             ===
</TABLE>
 
     Revenues from SYSTEMS FOR NETWORK OPERATORS increased $2,422 million or
18.4% compared with 1996. The increase resulted from higher sales of both
switching and wireless systems with associated software, fiber-optic cable and
professional services. Demand for second lines in businesses and residences for
Internet services and data connectivity contributed to the revenue growth for
1997.
 
     Sales from Systems for Network Operators in the United States increased
22.2%. The revenue increase in the United States was led by sales to traditional
service providers and non-traditional customers such as personal communications
services ("PCS") wireless providers, competitive access providers and cable
television companies. Sales outside the United States increased 8.2% compared
with 1996, resulting from increased sales in the Europe/Middle East/Africa,
Asia/Pacific and Caribbean/Latin America regions. Sales outside the United
States represented 25.1% of Systems for Network Operators revenues for 1997.
 
     For 1997, sales of wireless infrastructure increased significantly compared
with the same period in 1996 primarily due to PCS contracts as customers
accepted networks for commercial service in 1997 using various digital
technologies. These technologies include CDMA, GSM and TDMA. The Lucent digital
technologies continue to show acceptance in markets both within and outside the
United States.
 
     Revenues from BUSINESS COMMUNICATIONS SYSTEMS increased $902 million or
16.4% compared with the same period in 1996. This increase was led by sales of
DEFINITY(R) products, SYSTIMAX structured cabling, messaging systems, integrated
offers such as call centers and higher revenues from service contracts. This
increase was partially offset by the continued erosion of the rental base.
Revenues in the United States increased 17.0% compared with 1996. Revenues
outside the United States increased by 13.2%, reflecting growth in all
international regions. The increases both within and outside the United States
were primarily due to sales of DEFINITY products, call centers and messaging
systems. In addition, higher sales of SYSTIMAX structured cabling contributed to
the revenue growth in the United States. Sales outside the United States
represented 15.8% of revenue for 1997.
 
     Sales of MICROELECTRONIC PRODUCTS increased $440 million or 19.0% compared
with 1996, due to higher sales of customized chips for computing and
communications, including components for local area networks, data networking,
high-end computer workstations and wireless telephones. Higher sales of power
systems and optoelectronic components also contributed to the increase for 1997.
Sales within the United States increased 12.5% compared with 1996, led by sales
to original equipment manufacturers ("OEMs"). The 25.9% growth in revenues
outside the United States was driven by application specific integrated circuits
("ASICs") sales in the Asia/Pacific region as well as the growth of wireless and
multimedia integrated circuits and power products sold to customers in Europe
for cellular applications. Sales outside the United States represented 51.3% of
the Microelectronic Products sales for 1997. Microelectronic
 
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Products continued to bring to market new technologies, such as the introduction
of the K56flex(TM) modem technology.
 
     Revenues from CONSUMER PRODUCTS decreased $418 million or 29.2% compared
with 1996. The decline in revenues was primarily due to decreased product sales
related to the closing of the Phone Center Stores, the discontinuation of
unprofitable product lines and the continued decrease in phone rental revenues.
Lucent's Consumer Products unit was contributed to the venture between Lucent
and Philips on October 1, 1997.
 
     Revenues from OTHER SYSTEMS AND PRODUCTS decreased $272 million or 32.4%
compared with 1996. The decrease is largely due to the sale of Lucent's CMS
business in fiscal year 1997 and its Paradyne subsidiary in fiscal year 1996.
 
  Gross Margin
 
     Gross margin percentage increased to 43.5% from 38.2% in 1996 primarily due
to the restructuring charges recorded in the quarter ended December 31, 1995.
Excluding restructuring charges, gross margin for 1996 was 42.0%. The increase
in gross margin percentage for 1997 was due to an overall favorable mix of
higher margin product revenues and the benefits associated with Lucent's
business productivity improvement initiatives.
 
  Operating Expenses
 
     Selling, general and administrative expenses decreased $1,506 million or
20.7% compared with 1996. Excluding the $1,645 million of restructuring charges
recorded in December 1995, selling, general and administrative expenses
increased $139 million compared with 1996. This increase was due to expenditures
associated with higher sales levels, investment in growth initiatives, and the
implementation of SAP, an integrated software platform. These increases were
partially offset by the reversal of $174 million of business restructuring
liabilities in 1997, the lower start-up costs incurred in 1997, and business
productivity improvement initiatives, including lower expenses since some
businesses were exited in fiscal 1997 and 1996. Selling, general and
administrative expenses as a percentage of revenue declined 2.3 percentage
points to 21.9% of revenues compared with 24.2% of revenues, excluding
restructuring charges in 1996.
 
     Research and development expenses increased $472 million or 18.5% compared
with 1996. Excluding the impact of restructuring charges recorded in the quarter
ended December 31, 1995, research and development expenses increased by $736
million, primarily due to expenditures in support of wireless infrastructure,
microelectronic products and advanced multimedia communications systems as well
as a $127 million write-down of special-purpose Bell Labs assets no longer being
used. Research and development expenses represented 11.5% of revenues as
compared with 11.0% of revenues in 1996. Research and development expenses as a
percentage of revenues increased 1.7 percentage points from 9.8%, excluding
restructuring charges in 1996.
 
     Purchased in-process research and development for 1997 reflects one-time
write-offs totaling $1,024 million of in-process research and development in
connection with the acquisitions of Octel and Agile. Agile is a provider of
advanced intelligent data switching products acquired by Lucent in October 1996.
 
  Other Income, Interest Expense and Provision for Income Taxes
 
     Other income-net decreased $77 million compared with 1996. This decrease
was largely due to gains recognized on the sale of certain investments and
insurance recoveries in 1996, offset in part by increased interest income in
1997.
 
     Interest expense increased $12 million compared with 1996 due primarily to
replacing a portion of commercial paper with long-term debt in July 1996.
 
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     The effective tax rate of 63.1% for 1997 increased from the effective tax
rate of 22.4% for the same period of 1996 due to the 1997 write-offs of
purchased in-process research and development costs and the tax impact of
restructuring charges incurred in 1996. Excluding charges related to the
acquisitions of Agile and Octel, the effective tax rate for 1997 was 37.2%, a
decrease of 3.6 percentage points from the 1996 effective tax rate of 40.8%
before considering the effects of restructuring charges incurred in 1996. This
decrease is primarily attributable to the tax impact of foreign earnings.
 
  Cash Flows
 
     Cash provided by operating activities was $1,946 million in 1997, an
increase of $967 million compared with the same period in 1996. This increase in
cash was largely due to the retention of $2,000 million of customer accounts
receivable by AT&T in 1996 as well as the increase in cash collections
associated with higher sales. This was offset by changes in accounts payable due
to the end of payments to AT&T related to the Separation and the change in other
operating assets and liabilities over 1996. The change in other operating assets
and liabilities was primarily due to the receipt of a $500 million cash advance
made to Lucent in April 1996 by AT&T and the utilization by AT&T of that advance
in 1997.
 
     Cash payments of $483 million were charged against the December 1995
business restructuring reserves in 1997. As of September 30, 1997, the workforce
had been reduced by approximately 17,900 positions in connection with business
restructuring. In addition, approximately 1,000 employees left Lucent's
workforce as part of the sale of Paradyne in 1996. Actual experience in employee
separations, combined with redeploying employees into other areas of the
business, has resulted in lower separation costs than originally anticipated.
 
     Comparing 1997 and 1996, cash used in investing activities increased to
$3,121 million from $1,638 million primarily due to the acquisition of Octel.
 
     Capital expenditures were $1,635 million and $1,432 million for 1997 and
1996, respectively. Capital expenditures include expenditures for equipment and
facilities used in manufacturing and research and development, including
expansion of manufacturing capacity and international growth.
 
     Cash provided by financing activities for 1997 was $295 million compared
with $2,503 million in 1996. This decrease was primarily due to the proceeds
received from the IPO in the year-ago period.
 
     In 1995, Lucent relied on AT&T to provide financing for its operations. The
cash flows from financing activities for the year ended September 30, 1996
reflect changes in the Company's assumed capital structure. These cash flows are
not necessarily indicative of the cash flows that would have resulted if Lucent
had been a stand-alone entity.
 
  Financial Condition, Liquidity and Capital Resources
 
     Total assets as of September 30, 1998 increased $2,909 million, or 12.2%,
from September 30, 1997. This increase was primarily due to increases in
accounts receivable and other assets of $1,566 million and $1,001 million,
respectively. The increase in accounts receivable was primarily due to higher
sales. The increase in other assets was largely due to the increase in goodwill
and existing technology associated with the Livingston, Prominet, Yurie,
Optimay, SDX, LANNET and JNA acquisitions, and an increase in equity investments
as a result of Lucent's contribution of its Consumer Products business to PCC.
 
     Total liabilities increased $762 million, or 3.7%, from September 30, 1997.
This increase was largely due to the increases in payroll and benefit-related
liabilities and postretirement and postemployment benefit liabilities. These
increases are primarily related to the increase in employee headcount as a
result of Lucent's recent acquisitions as well as year end payroll and benefit
accruals.
 
     Working capital, defined as current assets less current liabilities,
increased $1,887 million from fiscal year end 1997 primarily resulting from the
increase in accounts receivable, and the following reclassification of $500
million ($495 million net of unamortized costs) from short-term debt to
long-term debt. On November 19, 1998, Lucent sold $500 million of ten-year notes
and reclassified the amount from debt
 
                                       12
<PAGE>   13
 
maturing within one year to long-term debt. The proceeds were used to pay down a
portion of Lucent's commercial paper during the first quarter of fiscal 1999.
 
     For the year ended September 30, 1998, Lucent's inventory turnover ratio
was 4.6 times compared with 4.0 times for the year ended September 30, 1997. The
increase was primarily due to improved inventory management at the factories and
in the distribution channels. Inventory turnover is defined as cost of sales
(excluding costs related to long-term contracts) divided by average inventory
during the year.
 
     Accounts receivable were outstanding an average of 64 days for the years
ended September 30, 1998 and 1997, respectively.
 
     The fair value of Lucent's pension plan assets is greater than the
projected pension obligations. Lucent records pension income when the expected
return on plan assets plus amortization of the transition asset is greater than
the interest cost on the projected benefit obligation plus service cost for the
year. Consequently, Lucent continued to have a net pension credit that added to
prepaid pension costs in 1998 and which is expected to continue in the near
term.
 
     Lucent expects that, from time to time, outstanding commercial paper
balances may be replaced with short- or long-term borrowings as market
conditions permit. At September 30, 1998, Lucent maintained approximately $5,200
million in credit facilities, of which a portion is used to support Lucent's
commercial paper program. At September 30, 1998, approximately $4,850 million
was unused. Future financings will be arranged to meet Lucent's requirements,
with the timing, amount and form of issue depending on the prevailing market and
general economic conditions. Lucent anticipates that borrowings under its bank
credit facilities, the issuance of additional commercial paper, cash generated
from operations, and short- and long-term debt financings will be adequate to
satisfy its future cash requirements, although there can be no assurance that
this will be the case.
 
     Network operators, inside and outside the United States, increasingly have
required their suppliers to arrange or provide long-term financing for them as a
condition to obtaining or bidding on infrastructure projects. These projects may
require financing in amounts ranging from modest sums to over a billion dollars.
Lucent has increasingly provided or arranged long-term financing for customers.
As market conditions permit, Lucent's intention is to lay off these long-term
financing arrangements, which may include both commitments and drawn down
borrowings, to other financial institutions and investors. This enables Lucent
to reduce the amount of its commitments and free up additional financing
capacity.
 
     As of September 30, 1998, Lucent had made commitments or entered into an
agreement to extend credit to certain customers, including Sprint PCS, up to an
aggregate of approximately $2,300 million. As of September 30, 1998,
approximately $400 million had been advanced and was outstanding. Included in
the $2,300 million is approximately $1,230 million to six other PCS or wireless
network operators (including fixed wireless) for possible future sales. As of
September 30, 1998, approximately $130 million had been advanced under four of
these arrangements. In addition, Lucent had made commitments or entered into
agreements to extend credit up to an aggregate of approximately $370 million for
two network operators other than PCS or wireless network operators. As of
September 30, 1998, no amount was advanced under either of these agreements. In
November 1998, a commitment for $110 million, included in the $370 million, was
terminated.
 
     In October 1996, Lucent entered into a credit agreement to provide Sprint
PCS long-term financing of $1,800 million for purchasing Lucent's equipment and
services for its PCS network. In May 1997, under the $1,800 million credit
facility provided by Lucent to Sprint PCS, Lucent closed transactions to lay off
$500 million of loans and undrawn commitments and $300 million of undrawn
commitments to a group of institutional investors and Sprint Corporation (a
partner in Sprint PCS), respectively. As of September 30, 1998, all of these
commitments were drawn down by Sprint PCS. On June 8, 1998, Lucent sold $645
million of loans in a private sale. As of September 30, 1998, Lucent has $253
million of undrawn commitments and $226 million of drawn loans outstanding.
 
     As part of the revenue recognition process, Lucent has assessed the
collectibility of the accounts receivable relating to the Sprint PCS purchase
contract in light of its financing commitment to Sprint PCS. Lucent has
determined that the receivables under the contract are reasonably assured of
collection based on
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<PAGE>   14
 
various factors among which was the ability of Lucent to sell the loans and
commitments without recourse. Lucent intends to continue pursuing opportunities
for the sale of the $226 million of loans outstanding, and the future loans and
commitments to Sprint PCS.
 
     On October 22, 1998, Lucent announced that it had entered into a five-year
agreement with WinStar Communications, Inc. to provide WinStar with a fixed
wireless broadband telecommunications network in major domestic and
international markets. In connection with this agreement, Lucent entered into a
credit agreement with WinStar to provide up to $2,000 million in equipment
financing to fund the buildout of this network. The maximum amount of credit
that Lucent is obligated to extend to WinStar at any one time is $500 million.
 
     In addition to the above arrangements, Lucent will continue to provide or
commit to financing where appropriate for its business. The ability of Lucent to
arrange or provide financing for its customers will depend on a number of
factors, including Lucent's capital structure and level of available credit, and
its continued ability to lay off commitments and drawn down borrowings on
acceptable terms.
 
     Lucent believes that it will be able to access the capital markets on terms
and in amounts that will be satisfactory to Lucent and that it will be able to
obtain bid and performance bonds, to arrange or provide customer financing as
necessary, and to engage in hedging transactions on commercially acceptable
terms, although there can be no assurance that this will be the case.
 
     The ratio of total debt to total capital (debt plus equity) was 45.6% at
September 30, 1998 compared with 55.4% at September 30, 1997. The decrease in
the ratio was primarily due to the increase in shareowners' equity, which
resulted from net income and the issuance of common stock, partially offset by
the increase in debt.
 
     Excluding the one-time charges related to the acquisitions of Livingston,
Prominet, Optimay, Yurie, SDX, MassMedia, LANNET and JNA as well as the gain on
the sale of ATS in 1998, the return on assets was 9.3%. This represents a 2.8
percentage point increase over the prior year return on assets of 6.5%,
excluding the Octel acquisition charges in 1997.
 
  Risk Management
 
     Lucent is exposed to market risk from changes in foreign currency exchange
rates and interest rates, which could impact its results of operations and
financial condition. Lucent manages its exposure to these market risks through
its regular operating and financing activities and, when deemed appropriate,
through the use of derivative financial instruments. Lucent uses derivative
financial instruments as risk management tools and not for speculative or
trading purposes. In addition, derivative financial instruments are entered into
with a diversified group of major financial institutions in order to manage
Lucent's exposure to nonperformance on such instruments.
 
     Lucent uses foreign currency exchange contracts, and to a lesser extent,
foreign currency purchased options to reduce its exposure to the risk that the
eventual net cash inflows and outflows resulting from the sale of products to
foreign customers and purchases from foreign suppliers will be adversely
affected by changes in exchange rates. Foreign currency exchange contracts are
designated for firmly committed or forecasted purchases and sales. The use of
these derivative financial instruments allows Lucent to reduce its overall
exposure to exchange rate movements, since the gains and losses on these
contracts substantially offset losses and gains on the assets, liabilities and
transactions being hedged. As of September 30, 1998, Lucent's primary net
foreign currency market exposures include Deutsche marks and British pounds. As
of September 30, 1997, Lucent's primary net foreign currency market exposures
included Deutsche marks, Japanese yen and Dutch guilders. Lucent has not changed
its policy regarding how such exposures are managed since the year ended
September 30, 1997. Management does not foresee or expect any significant
changes in foreign currency exposure in the near future.
 
     The fair value of foreign currency exchange contracts is sensitive to
changes in foreign currency exchange rates. As of September 30, 1998 and 1997, a
10% appreciation in foreign currency exchange rates from the prevailing market
rates would increase the related net unrealized gain by $11 million and $27
million,
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<PAGE>   15
 
respectively. Conversely, a 10% depreciation in these currencies from the
prevailing market rates would decrease the related net unrealized gain by $18
million and $35 million, as of September 30, 1998 and 1997 respectively.
Unrealized gains/losses in foreign currency exchange contracts are defined as
the difference between the contract rate at the inception date of the foreign
currency exchange contract and the current market exchange rates. Consistent
with the nature of the economic hedge of such foreign currency exchange
contracts, such unrealized gains or losses would be offset by corresponding
decreases or increases, respectively, of the underlying instrument or
transaction being hedged.
 
     While Lucent hedges actual and anticipated transactions with customers, the
decline in value of the Asia/Pacific currencies or currencies in other regions
may, if not reversed, adversely affect future product sales because Lucent
products may become more expensive for customers to purchase in their local
currency.
 
     Lucent manages its ratio of fixed to floating rate debt with the objective
of achieving a mix that management believes is appropriate. To manage this mix
in a cost-effective manner, Lucent, from time to time, enters into interest rate
swap agreements, in which it agrees to exchange various combinations of fixed
and/or variable interest rates based on agreed upon notional amounts. Lucent had
no material interest rate swap agreements in effect as of September 30, 1998 and
1997. The strategy employed by Lucent to manage its exposure to interest rate
fluctuations is unchanged from September 30, 1997. Management does not foresee
or expect any significant changes in its exposure to interest rate fluctuations
or in how such exposure is managed in the near future.
 
     The fair value of Lucent's fixed rate long-term debt is sensitive to
changes in interest rates. Interest rate changes would result in gains/losses in
the market value of this debt due to differences between the market interest
rates and rates at the inception of the debt obligation. Based upon a
hypothetical immediate 150 basis point increase in interest rates at September
30, 1998 and 1997, the market value of Lucent's fixed rate long-term debt would
be impacted by a net decrease of $209 million and $113 million, respectively.
Conversely, a 150 basis point decrease in interest rates would result in a net
increase in the market value of Lucent's fixed rate long-term debt outstanding
at September 30, 1998 and 1997 of $247 million and $121 million, respectively.
As a result of the change in market conditions in 1998, Lucent used a
hypothetical 150 basis point change, versus 100 basis points used in the fiscal
year 1997 presentation, to determine the change in market value of this debt.
 
  Other
 
     Lucent's current and historical operations are subject to a wide range of
environmental protection laws. In the United States, these laws often require
parties to fund remedial action regardless of fault. Lucent has remedial and
investigatory activities underway at numerous current and former facilities. In
addition, Lucent was named a successor to AT&T as a potentially responsible
party ("PRP") at numerous "Superfund" sites pursuant to the Comprehensive
Environmental Response, Compensation and Liability Act of 1980 ("CERCLA") or
comparable state statutes. Under the Separation and Distribution Agreement,
among AT&T, Lucent and NCR Corporation dated as of February 1, 1996, as amended
and restated, Lucent is responsible for all liabilities primarily resulting from
or related to the operation of Lucent's business as conducted at any time prior
to or after the Separation including related businesses discontinued or disposed
of prior to the Separation, and Lucent's assets including, without limitation,
those associated with these sites. In addition, under the Separation and
Distribution Agreement, Lucent is required to pay a portion of contingent
liabilities paid out in excess of certain amounts by AT&T and NCR, including
environmental liabilities.
 
     It is often difficult to estimate the future impact of environmental
matters, including potential liabilities. Lucent records an environmental
reserve when it is probable that a liability has been incurred and the amount of
the liability is reasonably estimable. This practice is followed whether the
claims are asserted or unasserted. Management expects that the amounts reserved
will be paid out over the period of remediation for the applicable site which
ranges from 5 to 30 years. Reserves for estimated losses from environmental
remediation are, depending on the site, based primarily upon internal or third
party environmental studies, and estimates as to the number, participation level
and financial viability of any other PRPs, the extent of the contamination and
the nature of required remedial actions. Accruals are adjusted as further
information develops or
 
                                       15
<PAGE>   16
 
circumstances change. The amounts provided for in Lucent's consolidated
financial statements in respect to environmental reserves are the gross
undiscounted amount of such reserves, without deductions for insurance or third
party indemnity claims. In those cases where insurance carriers or third party
indemnitors have agreed to pay any amounts and management believes that
collectibility of such amounts is probable, the amounts are reflected as
receivables in the financial statements. Although Lucent believes that its
reserves are adequate, there can be no assurance that the amount of capital and
other expenditures that will be required relating to remedial actions and
compliance with applicable environmental laws will not exceed the amounts
reflected in Lucent's reserves or will not have a material adverse effect on
Lucent's financial condition, results of operations or cash flows. Any amounts
of environmental costs that may be incurred in excess of those provided for at
September 30, 1998 cannot be determined.
 
  Forward-Looking Statements
 
     This Management's Discussion and Analysis of Results of Operations and
Financial Condition and other sections of this report contain forward-looking
statements that are based on current expectations, estimates, forecasts and
projections about the industries in which Lucent operates, management's beliefs
and assumptions made by management. In addition, other written or oral
statements which constitute forward-looking statements may be made by or on
behalf of the Company. Words such as "expects," "anticipates," "intends,"
"plans," "believes," "seeks," "estimates," variations of such words and similar
expressions are intended to identify such forward-looking statements. These
statements are not guarantees of future performance and involve certain risks,
uncertainties and assumptions ("Future Factors") which are difficult to predict.
Therefore, actual outcomes and results may differ materially from what is
expressed or forecasted in such forward-looking statements. The Company
undertakes no ob ligation to update publicly any forward-looking statements,
whether as a result of new information, future events or otherwise.
 
     Future Factors include increasing price and product/services competition by
foreign and domestic competitors, including new entrants; rapid technological
developments and changes and the Company's ability to continue to introduce
competitive new products and services on a timely, cost-effective basis; the mix
of products/services; the achievement of lower costs and expenses; the outcome
and impact of Year 2000; domestic and foreign governmental and public policy
changes which may affect the level of new investments and purchases made by
customers; changes in environmental and other domestic and foreign governmental
regulations; protection and validity of patent and other intellectual property
rights; reliance on large customers; technological, implementation and
cost/financial risks in the increasing use of large, multi-year contracts; the
cyclical nature of the Company's business; the outcome of pending and future
litigation and governmental proceedings and continued availability of financing,
financial instruments and financial resources in the amounts, at the times and
on the terms required to support the Company's future business. These are
representative of the Future Factors that could affect the outcome of the
forward-looking statements. In addition, such statements could be affected by
general industry and market conditions and growth rates, general domestic and
international economic conditions including interest rate and currency exchange
rate fluctuations and other Future Factors.
 
     Competition:
 
     See discussion above under KEY BUSINESS CHALLENGES.
 
     Dependence On New Product Development:
 
     The markets for the Company's principal products are characterized by
rapidly changing technology, evolving industry standards, frequent new product
introductions and evolving methods of building and operating communications
systems for network operators and business customers. The Company's operating
results will depend to a significant extent on its ability to continue to
introduce new systems, products, software and services successfully on a timely
basis and to reduce costs of existing systems, products, software and services.
The success of these and other new offerings is dependent on several factors,
including proper identification of customer needs, cost, timely completion and
introduction, differentiation from offerings of the Company's competitors and
market acceptance. In addition, new technological innovations generally require
a
                                       16
<PAGE>   17
 
substantial investment before any assurance is available as to their commercial
viability, including, in some cases, certification by international and domestic
standards-setting bodies.
 
     Reliance on Major Customers:
 
     See discussion above under KEY BUSINESS CHALLENGES.
 
     Readiness for Year 2000:
 
     Lucent is engaged in a major effort to minimize the impact of the Year 2000
date change on Lucent's products, information technology systems, facilities and
production infrastructure. Lucent has targeted June 30, 1999 for completion of
these efforts.
 
     The Year 2000 challenge is a priority within Lucent at every level of the
Company. Primary Year 2000 preparedness responsibility rests with program
offices which have been established within each of Lucent's product groups and
corporate centers. A corporate-wide Lucent Year 2000 Program Office ("LYPO")
monitors and reports on the progress of these offices. Each program office has a
core of full-time individuals augmented by a much larger group who have been
assigned specific Year 2000 responsibilities in addition to their regular
assignments. Further, Lucent has engaged third parties to assist in its
readiness efforts in certain cases. LYPO has established a methodology to
measure, track and report Year 2000 readiness status consisting of five steps:
inventory; assessment; remediation; testing and deployment.
 
     Lucent is completing programs to make its new commercially available
products Year 2000 ready and has developed evolution strategies for customers
who own non-Year 2000 ready Lucent products. The majority of the upgrades and
new products needed to support customer migration are already generally
available. By the end of 1998, all but a few of these products are targeted for
general availability.
 
     Lucent has launched extensive efforts to alert customers who have non-Year
2000 ready products, including direct mailings, phone contacts and participation
in user and industry groups. Recently, Lucent has set up a Year 2000 website
www.lucent.com/y2k that provides Year 2000 product information. Lucent continues
to cooperate in the Year 2000 information sharing efforts of the Federal
Communications Commission and other governmental bodies.
 
     Lucent believes it has sufficient resources to provide timely support to
its customers that require product migrations or upgrades. However, because this
effort is heavily dependent on customer cooperation, Lucent continues to monitor
customer response and will take steps to improve customer responsiveness, as
necessary. Also, Lucent has begun contingency planning to address potential
spikes in demand for customer support resulting from the Year 2000 date change.
These plans are targeted for completion by April 30, 1999.
 
     Lucent has largely completed the inventory and assessment phases of the
program with respect to its factories, information systems, and facilities.
Approximately, two-thirds of the production elements included in the factory
inventory were found to be Year 2000 ready. The factories have commenced the
remediation phase of their effort through a combination of product upgrades and
replacement. Plans have been developed to facilitate the completion of this
work, as well as the related testing and deployment, by June 30, 1999.
 
     Currently, approximately 60% of Lucent's information technology
infrastructure has been determined to be Year 2000 ready and is deployed for
use. Approximately, 45% of the applications requiring Year 2000 remediation that
are supported by Lucent's information technology group are now Year 2000 ready
and have been deployed or are awaiting deployment. LYPO is monitoring the
progress of readiness efforts across the Company, with a special emphasis on the
early identification of any areas where progress to-date could indicate
difficulty in meeting the Company's June 1999 internal readiness target date.
Lucent is developing specific contingency plans, as appropriate.
 
     Lucent is also assessing the Year 2000 readiness of the large number of
facilities that it owns or leases world-wide. Priority is being placed on
Lucent-owned facilities, leased facilities that Lucent manages and other
critical facilities that house large numbers of employees or significant
operations. Based on the results of
 
                                       17
<PAGE>   18
 
these assessment activities, Lucent plans to complete remediation efforts by
March 31, 1999 and complete development of applicable contingency plans by May
31, 1999.
 
     To ensure the continued delivery of third party products and services,
Lucent's procurement organization has analyzed Lucent's supplier base and has
sent surveys to approximately 5,000 suppliers. Follow-up efforts have commenced
to obtain feedback from critical suppliers. To supplement this effort, Lucent
plans to conduct readiness reviews of the Year 2000 status of the suppliers
ranked as most critical based on the nature of their relationship with Lucent,
the product/service provided and/or the content of their survey responses.
Almost all of Lucent's suppliers are still deeply engaged in executing their
Year 2000 readiness efforts and, as a result, Lucent cannot, at this time, fully
evaluate the Year 2000 risks to its supply chain. Lucent will continue to
monitor the Year 2000 status of its suppliers to minimize this risk and will
develop appropriate contingent responses as the risks become clearer.
 
     The risk to Lucent resulting from the failure of third parties in the
public and private sector to attain Year 2000 readiness is the same as other
firms in Lucent's industry or other business enterprises generally. The
following are representative of the types of risks that could result in the
event of one or more major failures of Lucent's information systems, factories
or facilities to be Year 2000 ready, or similar major failures by one or more
major third party suppliers to Lucent: (1) information systems -- could include
interruptions or disruptions of business and transaction processing such as
customer billing, payroll, accounts payable and other operating and information
processes, until systems can be remedied or replaced; (2) factories and
facilities -- could include interruptions or disruptions of manufacturing
processes and facilities with delays in delivery of products, until
non-compliant conditions or components can be remedied or replaced; and (3)
major suppliers to Lucent -- could include interruptions or disruptions of the
supply of raw materials, supplies and Year 2000 ready components which could
cause interruptions or disruptions of manufacturing and delays in delivery of
products, until the third party supplier remedied the problem or contingency
measures were implemented. Risks of major failures of Lucent's principal
products could include adverse functional impacts experienced by customers, the
costs and resources for Lucent to remedy problems or replace products where
Lucent is obligated or undertakes to take such action, and delays in delivery of
new products.
 
     Lucent believes it is taking the necessary steps to resolve Year 2000
issues; however, given the possible consequences of failure to resolve
significant Year 2000 issues, there can be no assurance that any one or more
such failures would not have a material adverse effect on Lucent. Lucent
estimates that the costs of efforts to prepare for Year 2000 from calendar year
1997 through 2000 is about $535 million, of which an estimated $210 million has
been spent as of September 30, 1998. Lucent has been able to reprioritize work
projects to largely address Year 2000 readiness needs within its existing
organizations. As a result, most of these costs represent costs that would have
been incurred in any event. These amounts cover costs of the Year 2000 readiness
work for inventory, assessment, remediation, testing and deployment including
fees and charges of contractors for outsourced work and consultant fees. Costs
for previously contemplated updates and replacements of Lucent's internal
systems and information systems infrastructure have been excluded without
attempting to establish whether the timing of non-Year 2000 replacement or
upgrading was accelerated.
 
     While the Year 2000 cost estimates above include additional costs, Lucent
believes, based on available information, that it will be able to manage its
total Year 2000 transition without any material adverse effect on its business
operations, products or financial prospects.
 
     The actual outcomes and results could be affected by Future Factors
including, but not limited to, the continued availability of skilled personnel,
cost control, the ability to locate and remediate software code problems,
critical suppliers and subcontractors meeting their commitments to be Year 2000
ready and provide Year 2000 ready products, and timely actions by customers.
 
     European Monetary Union -- Euro:
 
     On January 1, 1999, several member countries of the European Union will
establish fixed conversion rates between their existing sovereign currencies,
and adopt the Euro as their new common legal currency. As
 
                                       18
<PAGE>   19
 
of that date, the Euro will trade on currency exchanges and the legacy
currencies will remain legal tender in the participating countries for a
transition period between January 1, 1999 and January 1, 2002.
 
     During the transition period, cash-less payments can be made in the Euro,
and parties can elect to pay for goods and services and transact business using
either the Euro or a legacy currency. Between January 1, 2002 and July 1, 2002,
the participating countries will introduce Euro notes and coins and withdraw all
legacy currencies so that they will no longer be available.
 
     Lucent has begun planning for the Euro's introduction. For this purpose,
Lucent has in place a joint European-United States team representing affected
functions within the Company.
 
     The Euro conversion may affect cross-border competition by creating
cross-border price transparency. Lucent is assessing its pricing/marketing
strategy in order to insure that it remains competitive in a broader European
market. Lucent is also assessing its information technology systems to allow for
transactions to take place in both the legacy currencies and the Euro and the
eventual elimination of the legacy currencies, and reviewing whether certain
existing contracts will need to be modified. Lucent's currency risk and risk
management for operations in participating countries may be reduced as the
legacy currencies are converted to the Euro. Final accounting, tax and
governmental legal and regulatory guidance generally has not been provided in
final form. Lucent will continue to evaluate issues involving introduction of
the Euro. Based on current information and Lucent's current assessment, Lucent
does not expect that the Euro conversion will have a material adverse effect on
its business, results of operations, cash flows or financial condition.
 
     Employee Relations:
 
     On September 30, 1998, Lucent employed approximately 141,600 persons,
including 78.9% located in the United States. Of these domestic employees, about
40% are represented by unions, primarily the Communications Workers of America
("CWA") and the International Brotherhood of Electrical Workers ("IBEW"). Lucent
signed new five-year agreements with the CWA and IBEW expiring May 31, 2003.
 
     Multi-Year Contracts:
 
     Lucent has significant contracts for the sale of infrastructure systems to
network operators which extend over a multi-year period, and expects to enter
into similar contracts in the future, with uncertainties affecting recognition
of revenues, stringent acceptance criteria, implementation of new technologies
and possible significant initial cost overruns and losses. See also discussion
above under FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES, and KEY
BUSINESS CHALLENGES.
 
     Seasonality:
 
     See discussion above under KEY BUSINESS CHALLENGES.
 
     Future Capital Requirements:
 
     See discussion above under FINANCIAL CONDITION, LIQUIDITY AND CAPITAL
RESOURCES.
 
     Growth Outside the United States, Foreign Exchange and Interest Rates:
 
     Lucent intends to continue to pursue growth opportunities in markets
outside the United States. In many markets outside the United States,
long-standing relationships between potential customers of Lucent and their
local providers, and protective regulations, including local content
requirements and type approvals, create barriers to entry. In addition, pursuit
of such growth opportunities outside the United States may require significant
investments for an extended period before returns on such investments, if any,
are realized. Such projects and investments could be adversely affected by
reversals or delays in the opening of foreign markets to new competitors,
exchange controls, currency fluctuations, investment policies, repatriation of
cash, nationalization, social and political risks, taxation, and other factors,
depending on the country in which such opportunity arises. Difficulties in
foreign financial markets and economies, and of foreign financial institutions,
could adversely affect demand from customers in the affected countries.
                                       19
<PAGE>   20
 
     See discussion above under RISK MANAGEMENT with respect to foreign exchange
and interest rates. A significant change in the value of the dollar against the
currency of one or more countries where Lucent sells products to local customers
or makes purchases from local suppliers may materially adversely affect Lucent's
results. Lucent attempts to mitigate any such effects through the use of foreign
currency contracts, although there can be no assurances that such attempts will
be successful.
 
     Legal Proceedings and Environmental:
 
     See discussion above under OTHER.
 
                                       20
<PAGE>   21
 
                              REPORT OF MANAGEMENT
 
     Management is responsible for the preparation of Lucent Technologies Inc.'s
consolidated financial statements and all related information appearing in this
Annual Report. The consolidated financial statements and notes have been
prepared in conformity with generally accepted accounting principles and include
certain amounts which are estimates based upon currently available information
and management's judgment of current conditions and circumstances.
 
     To provide reasonable assurance that assets are safeguarded against loss
from unauthorized use or disposition and that accounting records are reliable
for preparing financial statements, management maintains a system of accounting
and other controls, including an internal audit function. Even an effective
internal control system, no matter how well designed, has inherent
limitations -- including the possibility of circumvention or overriding of
controls -- and therefore can provide only reasonable assurance with respect to
financial statement presentation. The system of accounting and other controls is
improved and modified in response to changes in business conditions and
operations and recommendations made by the independent public accountants and
the internal auditors.
 
     The Audit and Finance Committee of the Board of Directors, which is
composed of directors who are not employees, meets periodically with management,
the internal auditors and the independent auditors to review the manner in which
these groups of individuals are performing their responsibilities and to carry
out the Audit and Finance Committee's oversight role with respect to auditing,
internal controls and financial reporting matters. Periodically, both the
internal auditors and the independent auditors meet privately with the Audit and
Finance Committee and have access to its individual members.
 
     Lucent engaged PricewaterhouseCoopers LLP, independent public accountants,
to audit the consolidated financial statements in accordance with generally
accepted auditing standards, which include consideration of the internal control
structure. Their report appears on this page.
 
<TABLE>
<S>                                                   <C>
              /s/ RICHARD A. MCGINN                                 /s/ DONALD K. PETERSON
--------------------------------------------------    --------------------------------------------------
                   Chairman and                                  Executive Vice President and
             Chief Executive Officer                               Chief Financial Officer
</TABLE>
 
                                       21
<PAGE>   22
 
                       REPORT OF INDEPENDENT ACCOUNTANTS
 
To the Board of Directors and Shareowners
of Lucent Technologies Inc.:
 
     In our opinion, the accompanying consolidated balance sheets and the
related consolidated statements of income and changes in shareowners' equity and
of cash flows present fairly, in all material respects, the financial position
of Lucent Technologies Inc. and its subsidiaries at September 30, 1998 and 1997,
and the results of their operations and their cash flows for each of the two
years in the period ended September 30, 1998, and for the nine-month period
ended September 30, 1996, in conformity with generally accepted accounting
principles. These financial statements are the responsibility of the Company's
management; our responsibility is to express an opinion on these financial
statements based on our audits. We conducted our audits of these statements in
accordance with generally accepted auditing standards, which require that we
plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements, assessing the accounting principles used and
significant estimates made by management, and evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for the opinion expressed above.
 
                                          PricewaterhouseCoopers LLP
 
New York, New York
October 21, 1998
 
                                       22
<PAGE>   23
 
                   LUCENT TECHNOLOGIES INC. AND SUBSIDIARIES
 
                       CONSOLIDATED STATEMENTS OF INCOME
 
<TABLE>
<CAPTION>
                                                       YEAR ENDED
                                                      SEPTEMBER 30,            NINE MONTHS ENDED
                                                     (TWELVE MONTHS)             SEPTEMBER 30,
                                              -----------------------------    -----------------
                                               1998       1997       1996            1996
                                              -------    -------    -------    -----------------
                                               (DOLLARS IN MILLIONS, EXCEPT PER-SHARE AMOUNTS)
                                                                 (UNAUDITED)
<S>                                           <C>        <C>        <C>        <C>
Revenues....................................  $30,147    $26,360    $23,286         $15,859
Costs.......................................   16,156     14,898     14,392           9,290
Gross margin................................   13,991     11,462      8,894           6,569
Operating expenses
Selling, general and administrative.........    6,436      5,784      7,290           4,244
Research and development....................    3,678      3,023      2,551           1,838
Purchased in-process research and
  development...............................    1,416      1,024         --              --
Total operating expenses....................   11,530      9,831      9,841           6,082
Operating income (loss).....................    2,461      1,631       (947)            487
Other income -- net.........................      163        141        218              96
Interest expense............................      318        305        293             216
Income (loss) before income taxes...........    2,306      1,467     (1,022)            367
Provision (benefit) for income taxes........    1,336        926       (229)            143
Net income (loss)...........................  $   970    $   541    $  (793)        $   224
Earnings (loss) per common share -- basic...  $  0.74    $  0.42    $ (0.69)        $  0.19
Earnings (loss) per common
  share -- diluted..........................  $  0.73    $  0.42    $ (0.69)        $  0.19
Dividends per common share..................  $ 0.155    $0.1125    $ 0.075         $ 0.075
</TABLE>
 
                See Notes to Consolidated Financial Statements.
                                       23
<PAGE>   24
 
                   LUCENT TECHNOLOGIES INC. AND SUBSIDIARIES
 
                          CONSOLIDATED BALANCE SHEETS
 
<TABLE>
<CAPTION>
                                                              SEPTEMBER 30,    SEPTEMBER 30,
                                                                  1998             1997
                                                              -------------    -------------
                                                                  (DOLLARS IN MILLIONS,
                                                                EXCEPT PER SHARE AMOUNTS)
<S>                                                           <C>              <C>
ASSETS
Cash and cash equivalents...................................     $   685          $ 1,350
Accounts receivable less allowances of $390 in 1998 and $352
  in 1997...................................................       6,939            5,373
Inventories.................................................       3,081            2,926
Contracts in process (net of progress billings of $3,036 in
  1998 and $2,003
  in 1997)..................................................       1,259            1,046
Deferred income taxes -- net................................       1,623            1,333
Other current assets........................................         491              473
Total current assets........................................      14,078           12,501
Property, plant and equipment -- net........................       5,403            5,147
Prepaid pension costs.......................................       3,754            3,172
Deferred income taxes -- net................................         750            1,262
Capitalized software development costs......................         298              293
Other assets................................................       2,437            1,436
Total assets................................................     $26,720          $23,811
LIABILITIES
Accounts payable............................................     $ 2,040          $ 1,931
Payroll and benefit-related liabilities.....................       2,511            2,178
Postretirement and postemployment benefit liabilities.......         187              239
Debt maturing within one year...............................       2,231            2,538
Other current liabilities...................................       3,459            3,852
Total current liabilities...................................      10,428           10,738
Postretirement and postemployment benefit liabilities.......       6,380            6,073
Long-term debt..............................................       2,409            1,665
Other liabilities...........................................       1,969            1,948
Total liabilities...........................................     $21,186          $20,424
Commitments and contingencies...............................
 
SHAREOWNERS' EQUITY
Preferred stock -- par value $1 per share
  Authorized 250,000,000 shares.............................     $    --          $    --
  Issued and outstanding shares: none
Common stock -- par value $.01 per share
Authorized shares: 3,000,000,000
  Issued and outstanding shares:
  1,316,394,169 at September 30, 1998; 1,284,125,312 at
     September 30, 1997.....................................          13               13
Additional paid-in capital..................................       4,485            3,047
Guaranteed ESOP obligation..................................         (49)             (77)
Foreign currency translation................................        (279)            (191)
Retained earnings...........................................       1,364              595
Total shareowners' equity...................................     $ 5,534          $ 3,387
Total liabilities and shareowners' equity...................     $26,720          $23,811
</TABLE>
 
                See Notes to Consolidated Financial Statements.
                                       24
<PAGE>   25
 
                   LUCENT TECHNOLOGIES INC. AND SUBSIDIARIES
 
                           CONSOLIDATED STATEMENTS OF
                         CHANGES IN SHAREOWNERS' EQUITY
 
<TABLE>
<CAPTION>
                                               YEAR ENDED            YEAR ENDED
                                           SEPTEMBER 30, 1998    SEPTEMBER 30, 1997    NINE MONTHS ENDED
                                            (TWELVE MONTHS)       (TWELVE MONTHS)      SEPTEMBER 30, 1996
                                           ------------------    ------------------    ------------------
                                                               (DOLLARS IN MILLIONS)
<S>                                        <C>                   <C>                   <C>
PREFERRED STOCK..........................            --                    --                    --
COMMON STOCK
  Balance at beginning of period.........        $   13                $   13               $    --
  Issuance of common stock...............            --                    --                     6
  Two-for-one common stock split.........            --                    --                     7
Balance at end of period.................            13                    13                    13
ADDITIONAL PAID-IN CAPITAL
  Balance at beginning of period.........         3,047                 2,595                 1,406
  Issuance of common stock...............           608                   260                 2,881
  Issuance of common stock for
     acquisitions........................           689                    --                    --
  Conversion of stock options related to
     acquisitions........................           186                   116                    --
  Net loss from 1/1/96 through 1/31/96...            --                    --                   (72)
  Dividends declared.....................            --                    --                    (7)
  Accounts receivable holdback by AT&T...            --                    --                (2,000)
  Unrealized (loss) gain on
     investments.........................           (37)                   40                    15
  Acceptance of ESOP.....................            --                    --                   120
  Other contributions from AT&T..........            --                    --                   252
  Other..................................            (8)                   36                    --
  Balance at end of period...............         4,485                 3,047                 2,595
GUARANTEED ESOP OBLIGATION
  Balance at beginning of period.........           (77)                 (106)                   --
  Acceptance of ESOP.....................            --                    --                  (120)
  Amortization of ESOP obligation........            28                    29                    14
  Balance at end of period...............           (49)                  (77)                 (106)
FOREIGN CURRENCY TRANSLATION
  Balance at beginning of period.........          (191)                  (16)                   28
  Translation adjustments................           (88)                 (175)                  (44)
  Balance at end of period...............          (279)                 (191)                  (16)
RETAINED EARNINGS
  Balance at beginning of period.........           595                   200                    --
  Net income.............................           970                   541                    --
  Net income from 2/1/96 through
     9/30/96.............................            --                    --                   296
  Two-for-one common stock split.........            --                    --                    (7)
  Dividends declared.....................          (201)                 (146)                  (89)
  Balance at end of period...............         1,364                   595                   200
Total Shareowners' Equity................        $5,534                $3,387               $ 2,686
</TABLE>
 
                See Notes to Consolidated Financial Statements.
                                       25
<PAGE>   26
 
                   LUCENT TECHNOLOGIES INC. AND SUBSIDIARIES
 
                     CONSOLIDATED STATEMENTS OF CASH FLOWS
 
<TABLE>
<CAPTION>
                                                  YEAR ENDED SEPTEMBER 30,     NINE MONTHS ENDED
                                                       (TWELVE MONTHS)           SEPTEMBER 30,
                                                 ---------------------------   -----------------
                                                  1998      1997      1996           1996
                                                 -------   -------   -------   -----------------
                                                              (DOLLARS IN MILLIONS)
                                                                   (UNAUDITED)
<S>                                              <C>       <C>       <C>       <C>
OPERATING ACTIVITIES:
Net income (loss)..............................  $   970   $   541   $  (793)       $   224
Adjustments to reconcile net income (loss) to
  net cash provided by (used in) operating
  activities, net of effects from acquisitions
  of businesses:
  Business restructuring (reversal) charge.....     (100)     (201)    2,515            (98)
  Asset impairment and other charges...........       --        81       293            105
  Depreciation and amortization................    1,334     1,450     1,326            937
  Provision for uncollectibles.................      130       127        73             54
  Deferred income taxes........................      113         9      (996)          (251)
  Purchased in-process research and
     development...............................    1,416     1,024        --             --
  Increase in accounts receivable -- net.......   (1,987)     (389)   (3,114)        (1,506)
  Increase in inventories and contracts in
     process...................................     (365)     (273)     (309)          (524)
  Increase (decrease) in accounts payable......      170       (16)    1,021            629
  Changes in other operating assets and
     liabilities...............................      133      (315)    1,040            537
  Other adjustments for noncash items -- net...     (448)      (92)      (77)          (111)
Net cash provided by (used in) operating
  activities...................................    1,366     1,946       979             (4)
INVESTING ACTIVITIES:
Capital expenditures...........................   (1,626)   (1,635)   (1,432)          (939)
Proceeds from the sale or disposal of property,
  plant and equipment..........................       57       108       119             15
Purchases of equity investments................     (212)     (149)      (96)           (46)
Sales of equity investments....................       71        12       102            102
Dispositions of businesses.....................      329       181        58             58
Acquisitions of businesses -- net of cash
  acquired.....................................   (1,347)   (1,568)     (234)          (234)
Other investing activities -- net..............      (80)      (70)     (155)           (22)
Net cash used in investing activities..........   (2,808)   (3,121)   (1,638)        (1,066)
FINANCING ACTIVITIES:
Repayments of long-term debt...................      (93)      (16)      (53)           (39)
Issuance of long-term debt.....................      375        52     1,499          1,499
Proceeds from issuance of common stock.........      608       260     2,887          2,887
Dividends paid.................................     (201)     (192)      (48)           (48)
Increase (decrease) in short-term
  borrowings -- net............................      149       191    (1,525)        (1,436)
Repayments of debt sharing agreement -- net....       --        --       (67)            --
Transfers (to) from AT&T.......................       --        --      (190)            13
Net cash provided by financing activities......      838       295     2,503          2,876
Effect of exchange rate changes on cash and
  cash equivalents.............................      (61)      (11)      (16)           (13)
Net (decrease) increase in cash and cash
  equivalents..................................     (665)     (891)    1,828          1,793
Cash and cash equivalents at beginning of
  period.......................................    1,350     2,241       413            448
Cash and cash equivalents at end of period.....  $   685   $ 1,350   $ 2,241        $ 2,241
</TABLE>
 
                See Notes to Consolidated Financial Statements.
                                       26
<PAGE>   27
 
                   LUCENT TECHNOLOGIES INC. AND SUBSIDIARIES
 
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
 
1.  BACKGROUND AND BASIS OF PRESENTATION
 
  Background
 
     Lucent Technologies Inc. ("Lucent" or the "Company") was formed from the
systems and technology units of AT&T Corp. and the associated assets and
liabilities of those units, including Bell Laboratories (the "Separation").
Lucent was incorporated on November 29, 1995 with 1,000 shares of common stock
("Common Stock"), authorized and outstanding, all of which were owned by AT&T.
On April 2, 1996, AT&T obtained an additional 524,623,894 shares (pre-split
basis) of Common Stock and on April 10, 1996, Lucent issued 112,037,037 shares
(pre-split basis) in an Initial Public Offering. On September 30, 1996, AT&T
distributed to its shareowners all of its remaining interest in Lucent (the
"Distribution").
 
  Basis of Presentation
 
     The consolidated financial statements as of and for the nine months ended
September 30, 1996, reflect the results of operations, changes in shareowners'
equity and cash flows, and the financial position of the business that was
transferred to Lucent from AT&T as if Lucent were a separate entity. The
consolidated financial statements have been prepared using the historical basis
of the assets and liabilities and historical results of operations of these
businesses. Additionally, the aforementioned financial statements include an
allocation of certain AT&T corporate headquarters assets, liabilities and
expenses related to the businesses that were transferred to Lucent from AT&T.
Management believes the allocations reflected in the consolidated financial
statements are reasonable. The aforementioned financial statements may not
necessarily reflect Lucent's consolidated results of rations, financial
position, changes in shareowners' equity or cash flows in the future or what
they would have been had Lucent been a separate, stand-alone company during such
period.
 
     On April 1, 1998, a two-for-one split of Lucent's common stock became
effective. Shareowners' equity has been restated to give retroactive recognition
to the stock split for all periods presented by reclassifying from retained
earnings to common stock the par value of the additional shares arising from the
split. In addition, all references in the financial statements and notes to
number of shares, per share amounts, stock option data and market prices have
been restated to reflect this stock split.
 
     On November 19, 1998, Lucent sold $500 ($495 net of unamortized costs) of
10-year notes and reclassified the amount from debt maturing within one year to
long-term debt. The proceeds were used to pay down a portion of Lucent's
commercial paper during the first quarter of fiscal 1999.
 
                                       27
<PAGE>   28
                   LUCENT TECHNOLOGIES INC. AND SUBSIDIARIES
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
  Acquisitions
 
     The following table presents information about certain acquisitions by
Lucent in the fiscal years ended September 30, 1998 and 1997. All charges were
recorded in the quarter in which the transaction was completed.
 
<TABLE>
<CAPTION>
                                 JNA    LANNET   MASSMEDIA   SDX     YURIE    OPTIMAY   PROMINET   LIVINGSTON    OCTEL
                                 (1)     (2)        (3)      (4)      (5)       (6)       (7)         (8)         (9)
                                 ----   ------   ---------   ----   -------   -------   --------   ----------   -------
<S>                              <C>    <C>      <C>         <C>    <C>       <C>       <C>        <C>          <C>
Acquisition Date...............  9/98    8/98      7/98      7/98      5/98    4/98        1/98       12/97        9/97
Purchase Price.................   $67    $115       N/S      $207    $1,056     $64        $199         $610     $1,819
                                 cash    cash                cash    cash &    cash     stock &     stock &      cash &
                                                                    options             options     options     options
Goodwill.......................    37       2         1        96       292       1          35         114         181
Existing technology............    18      15         0        16        40      18          23          69         186
Purchased in-process research &
  development costs (after
  tax).........................     3      67         8        82       620      48         157         427         945
Amortization period -- goodwill
  (years)......................    10       7         5        10         7       5           5           5           7
Amortization period -- existing
  technology (years)...........    10       5       N/A         5         5       5           6           8           5
</TABLE>
 
---------------
(1)  JNA Telecommunications Limited was an Australian telecom manufacturer,
     reseller and system integrator.
 
(2)  LANNET, a subsidiary of Madge Networks N.V., was an Israeli-based supplier
     of Ethernet and asynchronous transfer mode ("ATM") switching solutions for
     local area networks.
 
(3)  MassMedia Communications, Inc., was a privately held start-up developer of
     highly-reliable, next-generation network interoperability software.
 
(4)  SDX Business Systems plc was a United Kingdom-based provider of business
     communications systems.
 
(5)  Yurie Systems, Inc. was a provider of ATM access technology and equipment
     for data, voice and video networking.
 
(6)  Optimay GmbH specialized in the development of software products and
     services for chip sets to be used for Global System for Mobile
     Communications cellular phones.
 
(7)  Prominet Corporation was a participant in the emerging Gigabit Ethernet
     networking industry. The merger involved $164 of Lucent stock and options.
     In addition, under the terms of the agreement, Lucent had contingent
     obligations to pay former Prominet shareowners $35 in stock. The $35 of
     stock was paid by Lucent, in July 1998 and recorded primarily as goodwill.
 
(8)  Livingston Enterprises, Inc. was a global provider of equipment used by
     Internet service providers to connect their subscribers to the Internet.
 
(9)  Octel Communications Corporation was a provider of voice, fax and
     electronic messaging technologies.
 
N/A Not applicable
 
N/S Not significant
 
     All the above acquisitions were accounted for under the purchase method of
accounting. The fair market value of the assets and liabilities acquired were
independently determined and included in the balance sheet as of the quarter in
which the acquisition was completed.
 
     For all the above acquisitions, the acquired technology valuation included
both existing technology and purchased in-process research and development. The
valuation of these technologies was made by applying the income forecast method,
which considers the present value of cash flows by product lines.
 
                                       28
<PAGE>   29
                   LUCENT TECHNOLOGIES INC. AND SUBSIDIARIES
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
     Included in the purchase price for the above acquisitions, was purchased
in-process research and development, which was a noncash charge to earnings as
this technology had not reached technological feasibility and had no future
alternative use. This technology will require varying additional development,
coding and testing efforts over the next year before technological feasibility
can be determined. The remaining purchase price was allocated to tangible assets
and intangible assets, including goodwill and existing technology, less
liabilities assumed.
 
2.  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
 
  Basis of Consolidation
 
     The consolidated financial statements include all majority-owned
subsidiaries in which Lucent exercises control. Investments in which Lucent
exercises significant influence, but which it does not control (generally a
20% -- 50% ownership interest), are accounted for under the equity method of
accounting. All material intercompany transactions and balances have been
eliminated.
 
  Use of Estimates
 
     The preparation of financial statements and related disclosures in
conformity with generally accepted accounting principles requires management to
make estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and revenue and expenses during the period reported.
Actual results could differ from those estimates. Estimates are used when
accounting for long-term contracts, allowance for uncollectible accounts
receivable, inventory obsolescence, product warranty, depreciation, employee
benefits, taxes, restructuring reserves and contingencies, among others.
 
  Foreign Currency Translation
 
     For operations outside the United States that prepare financial statements
in currencies other than the United States dollar, results of operations and
cash flows are translated at average exchange rates during the period, and
assets and liabilities are translated at end of period exchange rates.
Translation adjustments are included as a separate component of shareowners'
equity.
 
  Revenue Recognition
 
     Revenue is generally recognized when all significant contractual
obligations have been satisfied and collection of the resulting receivable is
reasonably assured. Revenue from product sales of hardware and software is
recognized at time of delivery and acceptance, and after consideration of all
the terms and conditions of the customer contract. Sales of services are
recognized at time of performance and rental revenue is recognized
proportionately over the contract term. Revenues and estimated profits on
long-term contracts are generally recognized under the percentage of completion
method of accounting using either a units-of-delivery or a cost-to-cost
methodology. Profit estimates are revised periodically based on changes in
facts. Any losses on contracts are recognized immediately.
 
  Research and Development Costs
 
     Research and development costs are charged to expense as incurred. However,
the costs incurred for the development of computer software that will be sold,
leased or otherwise marketed are capitalized when technological feasibility has
been established. These capitalized costs are subject to an ongoing assessment
of recoverability based on anticipated future revenues and changes in hardware
and software technologies. Costs that are capitalized include direct labor and
related overhead.
 
                                       29
<PAGE>   30
                   LUCENT TECHNOLOGIES INC. AND SUBSIDIARIES
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
     Amortization of capitalized software development costs begins when the
product is available for general release. Amortization is provided on a
product-by-product basis on either the straight-line method over periods not
exceeding two years or the sales ratio method. Unamortized capitalized software
development costs determined to be in excess of net realizable value of the
product are expensed immediately.
 
  Cash and Cash Equivalents
 
     All highly liquid investments with original maturities of three months or
less are considered to be cash equivalents.
 
  Inventories
 
     Inventories are stated at the lower of cost (determined principally on a
first-in, first-out basis) or market.
 
  Contracts in Process
 
     Contracts in process are valued at cost plus accrued profits less progress
billings.
 
  Property, Plant and Equipment
 
     Property, plant and equipment are stated at cost less accumulated
depreciation. Depreciation is determined using primarily the unit and group
methods. The unit method is used for manufacturing and laboratory equipment and
large computer systems. The group method is used for other depreciable assets.
When assets that were depreciated using the unit method are sold or retired, the
gains or losses are included in operating results. When assets that were
depreciated using the group method are sold or retired, the original cost is
deducted from the appropriate account and accumulated depreciation. Any gains or
losses are applied against accumulated depreciation.
 
     The accelerated depreciation method is used for certain high technology
computer processing equipment. All other facilities and equipment are
depreciated on a straight-line basis over their estimated useful lives.
 
     Long-lived assets are reviewed for impairment whenever events or changes in
circumstances indicate that the carrying amount may not be recoverable. If the
fair value is less than the carrying amount of the asset, a loss is recognized
for the difference.
 
  Financial Instruments
 
     Lucent uses various financial instruments, including foreign currency
exchange contracts and interest rate swap agreements to manage and reduce risk
to Lucent by generating cash flows, which offset the cash flows of certain
transactions in foreign currencies or underlying financial instruments in
relation to their amount and timing. Lucent's derivative financial instruments
are for purposes other than trading and are not entered into for speculative
purposes. Lucent's nonderivative financial instruments include letters of
credit, commitments to extend credit and guarantees of debt. Lucent generally
does not require collateral to support its financial instruments.
 
  Goodwill
 
     Goodwill is the excess of the purchase price over the fair value of
identifiable net assets acquired in business combinations accounted for as
purchases. Goodwill is amortized on a straight-line basis over the periods
benefited, principally in the range of 5 to 15 years. Goodwill is reviewed for
impairment whenever events or changes in circumstances indicate that the
carrying amount may not be recoverable.
 
                                       30
<PAGE>   31
                   LUCENT TECHNOLOGIES INC. AND SUBSIDIARIES
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
  Reclassifications
 
     Certain prior year amounts have been reclassified to conform to the 1998
presentation.
 
3.  RECENT PRONOUNCEMENTS
 
     In June 1998, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for
Derivative Instruments and Hedging Activities" ("SFAS 133"). SFAS 133
establishes new accounting and reporting standards for derivative financial
instruments and for hedging activities. SFAS 133 requires an entity to measure
all derivatives at fair value and to recognize them in the balance sheet as an
asset or liability, depending on the entity's rights or obligations under the
applicable derivative contract. Lucent will designate each derivative as
belonging to one of several possible categories, based on the intended use of
the derivative. The recognition of changes in fair value of a derivative that
affect the income statement will depend on the intended use of the derivative.
If the derivative does not qualify as a hedging instrument, the gain or loss on
the derivative will be recognized currently in earnings. If the derivative
qualifies for special hedge accounting, the gain or loss on the derivative will
either (1) be recognized in income along with an offsetting adjustment to the
basis of the item being hedged or (2) be deferred in other comprehensive income
and reclassified to earnings in the same period or periods during which the
hedged transaction affects earnings. SFAS 133 will be effective for Lucent no
later than the quarter ending December 31, 1999. SFAS 133 may not be applied
retroactively to financial statements of prior periods. SFAS 133 is not expected
to have a material impact on Lucent's consolidated results of operations,
financial position or cash flows.
 
     In February 1998, FASB issued SFAS No. 132, "Employers' Disclosures about
Pensions and Other Postretirement Benefits" ("SFAS 132"). SFAS 132 revises
employers' disclosures about pension and other postretirement benefit plans.
SFAS 132 is effective for fiscal years beginning after December 15, 1997.
Restatement of disclosures for earlier periods provided for comparative purposes
is required unless the information is not readily available. Lucent is in the
process of evaluating the disclosure requirements. The adoption of SFAS 132 will
have no impact on Lucent's consolidated results of operations, financial
position or cash flows.
 
     In June 1997, FASB issued SFAS No. 131, "Disclosures about Segments of an
Enterprise and Related Information" ("SFAS 131"). SFAS 131 establishes standards
for the way that public business enterprises report information about operating
segments in annual financial statements and requires that those enterprises
report selected information about operating segments in interim financial
reports issued to shareholders. It also establishes standards for related
disclosures about products and services, geographic areas, and major customers.
SFAS 131 is effective for financial statements for fiscal years beginning after
December 15, 1997. Financial statement disclosures for prior periods are
required to be restated. Lucent is in the process of evaluating the disclosure
requirements. The adoption of SFAS 131 will have no impact on Lucent's
consolidated results of operations, financial position or cash flows.
 
     In June 1997, FASB issued SFAS No. 130, "Reporting Comprehensive Income"
("SFAS 130"). SFAS 130 establishes standards for reporting and display of
comprehensive income and its components in the financial statements. SFAS 130 is
effective for fiscal years beginning after December 15, 1997. Reclassification
of financial statements for earlier periods provided for comparative purposes is
required. Lucent is in the process of determining its preferred format. The
adoption of SFAS 130 will have no impact on Lucent's consolidated results of
operations, financial position or cash flows.
 
     In March 1998, the American Institute of Certified Public Accountants (the
"AICPA") issued Statement of Position 98-1, "Accounting for the Costs of
Computer Software Developed or Obtained for Internal Use" ("SOP 98-1"). SOP 98-1
provides guidance on accounting for the costs of computer software developed or
obtained for internal use. This pronouncement identifies the characteristics of
internal use
 
                                       31
<PAGE>   32
                   LUCENT TECHNOLOGIES INC. AND SUBSIDIARIES
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
software and provides guidance on new cost recognition principles. SOP 98-1 is
effective for financial statements for fiscal years beginning after December 15,
1998. Lucent currently expenses its costs of computer software developed or
obtained for internal use and is evaluating the impacts of adopting SOP 98-1.
 
     In October 1997, the AICPA issued Statement of Position 97-2, "Software
Revenue Recognition" ("SOP 97-2"). SOP 97-2 provides guidance on when revenue
should be recognized and in what amounts for licensing, selling, leasing or
otherwise marketing computer software. SOP 97-2 is effective for financial
statements for fiscal years beginning after December 15, 1997. During March
1998, the AICPA issued Statement of Position 98-4, "Deferral of the Effective
Date of a Provision of SOP 97-2, Software Revenue Recognition",("SOP 98-4"). SOP
98-4 defers for one year the limitation of what is considered vendor-specific
objective evidence of the fair value of the various elements in a
multiple-element arrangement, a requirement to recognize revenue for elements
delivered early in the arrangement. Effective October 1, 1998, Lucent has
adopted SOP 97-2 and the adoption is not expected to have a material impact on
Lucent's consolidated results of operations, financial position or cash flows.
 
4.  SUPPLEMENTARY FINANCIAL INFORMATION
 
  Supplementary Income Statement Information
 
<TABLE>
<CAPTION>
                                                                                         NINE MONTHS
                                                    YEAR ENDED         YEAR ENDED           ENDED
                                                   SEPTEMBER 30,      SEPTEMBER 30,     SEPTEMBER 30,
                                                       1998               1997              1996
                                                  ---------------    ---------------    -------------
                                                  (TWELVE MONTHS)    (TWELVE MONTHS)
<S>                                               <C>                <C>                <C>
INCLUDED IN COSTS
Amortization of software development costs......       $ 234             $  380             $218
INCLUDED IN SELLING, GENERAL AND ADMINISTRATIVE
  EXPENSES
Amortization of goodwill and existing
  technology....................................       $ 147             $   32             $ 25
INCLUDED IN COSTS AND OPERATING EXPENSES
Depreciation and amortization of property, plant
  and equipment.................................       $ 919             $1,008             $674
OTHER INCOME -- NET
Interest income.................................       $  83             $  132             $ 71
Minority interests in earnings of
  subsidiaries..................................         (24)               (35)             (21)
Net equity losses from investments..............        (209)               (64)             (26)
Increase in cash surrender value of life
  insurance.....................................          52                 54               35
Loss on foreign currency transactions...........         (44)               (12)              (4)
Gains on businesses sold........................         208                 --               --
Miscellaneous -- net............................          97                 66               41
                                                       -----             ------             ----
Total other income -- net.......................       $ 163             $  141             $ 96
DEDUCTED FROM INTEREST EXPENSE
Capitalized interest............................       $  17             $   14             $ 14
</TABLE>
 
                                       32
<PAGE>   33
                   LUCENT TECHNOLOGIES INC. AND SUBSIDIARIES
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
  Supplementary Balance Sheet Information
 
<TABLE>
<CAPTION>
                                                              SEPTEMBER 30,    SEPTEMBER 30,
                                                                  1998             1997
                                                              -------------    -------------
<S>                                                           <C>              <C>
INVENTORIES
Completed goods.............................................     $ 1,578          $ 1,611
Work in process and raw materials...........................       1,503            1,315
                                                                 -------          -------
Inventories.................................................     $ 3,081          $ 2,926
PROPERTY, PLANT AND EQUIPMENT -- NET
Land and improvements.......................................     $   301          $   299
Buildings and improvements..................................       3,130            2,852
Machinery, electronic and other equipment...................       8,354            8,403
                                                                 -------          -------
Total property, plant and equipment.........................      11,785           11,554
Less: Accumulated depreciation and amortization.............      (6,382)          (6,407)
                                                                 -------          -------
Property, plant and equipment -- net........................     $ 5,403          $ 5,147
OTHER CURRENT LIABILITIES
Advance billings and customer deposits......................     $   515          $   844
</TABLE>
 
  Supplementary Cash Flow Information
 
<TABLE>
<CAPTION>
                                                                                          NINE MONTHS
                                                     YEAR ENDED         YEAR ENDED           ENDED
                                                    SEPTEMBER 30,      SEPTEMBER 30,     SEPTEMBER 30,
                                                        1998               1997              1996
                                                   ---------------    ---------------    -------------
                                                   (TWELVE MONTHS)    (TWELVE MONTHS)
<S>                                                <C>                <C>                <C>
Interest payments, net of amounts capitalized....      $  319             $  307             $209
Income tax payments..............................      $  714             $  781             $142
Acquisitions of businesses:
Fair value of assets acquired....................      $2,341             $1,812             $527
Less: Fair value of liabilities assumed..........      $  994             $  244             $293
                                                       ------             ------             ----
Acquisitions of businesses.......................      $1,347             $1,568             $234
</TABLE>
 
     On October 1, 1997, Lucent contributed its Consumer Products business to a
new venture formed by Lucent and Philips Electronics N.V. in exchange for 40%
ownership of Philips Consumer Communications ("PCC"). For the year ended
September 30, 1998, the statement of cash flows excludes Lucent's contribution
of its Consumer Products business.
 
     For the year ended September 30, 1998, Other income -- net includes a
charge of $110 related to a write-down associated with Lucent's investment in
the PCC venture. This charge was offset by gains of $103, primarily related to
the sale of an investment and the sale of certain business operations, including
Bell Labs Design Automation Group.
 
     For the year ended September 30, 1998, the statement of cash flows excludes
the issuance of common stock related to the acquisitions of Livingston and
Prominet and the conversion of stock options related to the acquisitions of
Livingston, Prominet, Yurie and Optimay.
 
     For the year ended September 30, 1997, the statement of cash flows excludes
the conversion of stock options related to the acquisition of Octel. For
information on the 1998 and 1997 acquisitions, see Note 1.
 
     For the year ended September 30, 1997, research and development costs
include a $127 write-down of special purpose Bell Labs assets no longer being
used.
 
                                       33
<PAGE>   34
                   LUCENT TECHNOLOGIES INC. AND SUBSIDIARIES
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
     The statement of cash flows for the nine-month period ended September 30,
1996 excludes $2,000 of customer accounts receivable retained by AT&T as well as
net asset transfers of $239 received from AT&T. These transactions have not been
reflected on the consolidated statement of cash flows because they were noncash
events accounted for as changes in paid-in capital.
 
5.  EARNINGS PER COMMON SHARE
 
     Basic earnings per common share was calculated by dividing net income by
the weighted average number of common shares outstanding during the period.
Diluted earnings per share was calculated by dividing net income by the sum of
the weighted average number of common shares outstanding plus all additional
common shares that would have been outstanding if potentially dilutive common
shares had been issued.
 
     Included in the calculation of the weighted-average shares is the
retroactive recognition to January 1, 1996 of the 1,049.2 million shares (524.6
million shares on a pre-split basis) owned by AT&T. The following table
reconciles the number of shares utilized in the earnings per share calculations:
 
<TABLE>
<CAPTION>
                                                     YEAR ENDED
                                                   SEPTEMBER 30,        NINE MONTHS ENDED
                                                --------------------      SEPTEMBER 30,
                                                  1998        1997            1996
                                                --------    --------    -----------------
                                                  (TWELVE MONTHS)
<S>                                             <C>         <C>         <C>
Net income....................................  $    970    $    541        $    224
Earnings per common share -- basic............  $   0.74    $   0.42        $   0.19
Earnings per common share -- diluted..........  $   0.73    $   0.42        $   0.19
NUMBER OF SHARES (IN MILLIONS)
Common shares -- basic........................   1,304.6     1,278.4         1,191.5
Effect of dilutive securities:
  Stock options...............................      26.8         9.9             0.0
  Other.......................................       2.0         0.1             0.2
Common shares -- diluted......................   1,333.4     1,288.4         1,191.7
</TABLE>
 
6.  BUSINESS RESTRUCTURING AND OTHER CHARGES
 
     In the fourth quarter of calendar year 1995, a pre-tax charge of $2,801 was
recorded to cover restructuring costs of $2,613 and asset impairment and other
charges of $188. The restructuring plans included restructuring Lucent's
Consumer Products business, including closing all of the Company-owned retail
Phone Center Stores; consolidating and re-engineering numerous corporate and
business unit operations; and selling the Microelectronics' interconnect and
Paradyne businesses.
 
     The 1995 business restructuring charge of $2,613 included restructuring
liabilities of $1,774, asset impairments of $497 and $342 of benefit plan
losses. Benefit plan losses were related to pension and other employee benefit
plans and primarily represented losses in 1995 from the actuarial changes that
otherwise might have been amortized over future periods.
 
     The pre-tax total charge for restructuring, impairments and other charges
of $2,801 for 1995 was recorded as $892 of costs, $1,645 of selling, general and
administrative expenses, and $264 of research and development expenses. The
charges included $1,509 for employee separations; $627 for asset write-downs;
$202 for closing, selling and consolidating facilities; and $463 for other
items. The total charges reduced net income by $1,847.
 
     The restructuring charge of $2,613 incorporated the separation costs, both
voluntary and involuntary, for nearly 22,000 employees. As of September 30,
1998, the work force had been reduced by approximately 19,900 positions due to
business restructuring. In addition, approximately 1,000 employees left Lucent's
work force as part of the sale of Paradyne in 1996. Actual experience in
employee separations, combined with
 
                                       34
<PAGE>   35
                   LUCENT TECHNOLOGIES INC. AND SUBSIDIARIES
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
redeploying employees into other areas of the business, has resulted in lower
separation costs than originally anticipated. Lucent expects employee reductions
in positions to be substantially complete by September 1999.
 
     The following table displays a rollforward of the liabilities for business
restructuring from September 30, 1996 to September 30, 1998:
 
<TABLE>
<CAPTION>
                               SEPTEMBER 30,      1997      SEPTEMBER 30,      1998      SEPTEMBER 30,
        TYPE OF COST           1996 BALANCE    DEDUCTIONS   1997 BALANCE    DEDUCTIONS   1998 BALANCE
        ------------           -------------   ----------   -------------   ----------   -------------
<S>                            <C>             <C>          <C>             <C>          <C>
Employee Separation..........     $  766         $(418)         $348          $(235)         $113
Facility Closing.............        175          (109)           66            (23)           43
Other........................        348          (193)          155            (60)           95
Total........................     $1,289         $(720)         $569          $(318)         $251
</TABLE>
 
     Management believes that the remaining reserves for business restructuring
are adequate to complete its plan.
 
     Total deductions to Lucent's business restructuring reserves were $318 and
$720 for the years ended September 30, 1998 and 1997, respectively. Included in
these deductions were cash payments of $176 and $483 and noncash related charges
of $42 and $36 for the years ended September 30, 1998 and 1997, respectively.
The noncash related charges were primarily associated with asset write-offs that
were charged against the business restructuring reserves. In addition, Lucent
reversed $100 and $201 of business restructuring reserves primarily related to
favorable experience in employee separations for the years ended September 30,
1998 and 1997, respectively.
 
7.  INCOME TAXES
 
     The following table presents the principal reasons for the difference
between the effective tax rate and the United States federal statutory income
tax rate:
 
<TABLE>
<CAPTION>
                                                                                     NINE
                                             YEAR ENDED         YEAR ENDED       MONTHS ENDED
                                            SEPTEMBER 30,      SEPTEMBER 30,     SEPTEMBER 30,
                                                1998               1997              1996
                                           ---------------    ---------------    -------------
                                           (TWELVE MONTHS)    (TWELVE MONTHS)
<S>                                        <C>                <C>                <C>
United States federal statutory income
  tax rate...............................       35.0%              35.0%             35.0%
                                                ----               ----              ----
State and local income taxes, net of
  federal income tax effect..............        3.2                5.4               1.4
Foreign earnings and dividends taxed at
  different rates........................        1.1                0.9               4.1
Research credits.........................       (2.8)              (2.6)             (5.0)
Other differences -- net.................       (0.5)              (1.5)              3.5
                                                ----               ----              ----
Effective income tax rate before
  purchased in-process research and
  development costs......................       36.0%              37.2%             39.0%
Purchased in-process research and
  development costs......................       21.9               25.9               0.0
                                                ----               ----              ----
Effective income tax rate................       57.9%              63.1%             39.0%
                                                ====               ====              ====
</TABLE>
 
                                       35
<PAGE>   36
                   LUCENT TECHNOLOGIES INC. AND SUBSIDIARIES
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
     The following table presents the United States and foreign components of
income before income taxes and the provision for income taxes:
 
<TABLE>
<CAPTION>
                                                                                     NINE
                                             YEAR ENDED         YEAR ENDED       MONTHS ENDED
                                            SEPTEMBER 30,      SEPTEMBER 30,     SEPTEMBER 30,
                                                1998               1997              1996
                                           ---------------    ---------------    -------------
                                           (TWELVE MONTHS)    (TWELVE MONTHS)
<S>                                        <C>                <C>                <C>
INCOME BEFORE INCOME TAXES
United States............................      $1,942             $  873             $ 101
Foreign..................................         364                594               266
                                               ------             ------             -----
Income before income taxes...............      $2,306             $1,467             $ 367
                                               ======             ======             =====
PROVISION FOR INCOME TAXES
CURRENT
Federal..................................      $  823             $  464             $ 242
State and local..........................         141                129                53
Foreign..................................         205                226                98
                                               ------             ------             -----
Sub-Total................................       1,169                819               393
                                               ------             ------             -----
DEFERRED
Federal..................................         113                 35              (198)
State and local..........................          43                 77               (45)
Foreign and other........................          11                 (5)               (7)
                                               ------             ------             -----
Sub-Total................................         167                107              (250)
                                               ------             ------             -----
Provision for income taxes...............      $1,336             $  926             $ 143
                                               ======             ======             =====
</TABLE>
 
     As of September 30, 1998, Lucent had tax credit carryforwards of $32 and
federal, state and local, and foreign net operating loss carryforwards (tax
effected) of $179, all of which expire primarily after the year 2000.
 
     The components of deferred tax assets and liabilities at September 30, 1998
and 1997 are as follows:
 
<TABLE>
<CAPTION>
                                                            SEPTEMBER 30,    SEPTEMBER 30,
                                                                1998             1997
                                                            -------------    -------------
<S>                                                         <C>              <C>
DEFERRED INCOME TAX ASSETS
  Employee pensions and other benefits -- net.............     $1,510           $1,777
  Business restructuring..................................        165              112
  Reserves and allowances.................................      1,063              887
  Net operating loss/credit carryforwards.................        211              107
  Valuation allowance.....................................       (261)            (234)
  Other...................................................        462              664
                                                               ------           ------
Total deferred income tax assets..........................     $3,150           $3,313
                                                               ======           ======
DEFERRED INCOME TAX LIABILITIES
  Property, plant and equipment...........................     $  397           $  478
  Other...................................................        380              240
                                                               ------           ------
Total deferred income tax liabilities.....................     $  777           $  718
                                                               ======           ======
</TABLE>
 
                                       36
<PAGE>   37
                   LUCENT TECHNOLOGIES INC. AND SUBSIDIARIES
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
     Lucent has not provided for United States deferred income taxes or foreign
withholding taxes on $2,432 of undistributed earnings of its non-United States
subsidiaries as of September 30, 1998, since these earnings are intended to be
reinvested indefinitely.
 
8.  DEBT OBLIGATIONS
 
<TABLE>
<CAPTION>
                                                            SEPTEMBER 30,    SEPTEMBER 30,
                                                                1998             1997
                                                            -------------    -------------
<S>                                                         <C>              <C>
DEBT MATURING WITHIN ONE YEAR
Commercial paper (net of $495* expected to be
  refinanced).............................................     $2,106           $2,364
Long-term debt............................................         39               25
Other.....................................................         86              149
                                                               ------           ------
Total debt maturing within one year.......................     $2,231           $2,538
                                                               ======           ======
WEIGHTED AVERAGE INTEREST RATES
  Commercial paper........................................        5.6%             5.5%
  Long-term debt and other................................        7.9%             6.3%
</TABLE>
 
     Lucent had revolving credit facilities at September 30, 1998 aggregating
$5,211 (a portion of which is used to support Lucent's commercial paper
program), $4,000 with domestic lenders and $1,211 with foreign lenders. At
September 30, 1998, $4,000 with domestic lenders and $855 with foreign lenders
were available.
 
<TABLE>
<CAPTION>
                                                            SEPTEMBER 30,    SEPTEMBER 30,
                                                                1998             1997
                                                            -------------    -------------
<S>                                                         <C>              <C>
LONG-TERM DEBT
6.90% notes due July 15, 2001.............................     $  750           $  750
7.25% notes due July 15, 2006.............................        750              750
6.50% debentures due January 15, 2028.....................        300               --
Commercial paper expected to be refinanced................        495*              --
Long-term lease obligations...............................          1                2
Other.....................................................        164              198
Less: Unamortized discount................................         12               10
                                                               ------           ------
Total long-term debt......................................      2,448            1,690
Less: Amounts maturing within one year....................         39               25
                                                               ------           ------
Net long-term debt........................................     $2,409           $1,665
                                                               ======           ======
</TABLE>
 
     Lucent has an effective shelf registration statement for the issuance of
debt securities up to $3,500, of which $1,160* remains available at September
30, 1998.
 
     This table shows the maturities, by year, of the $2,448 in total long-term
debt obligations:
 
<TABLE>
<CAPTION>
                SEPTEMBER 30,
----------------------------------------------
1999   2000   2001   2002   2003   LATER YEARS
----   ----   ----   ----   ----   -----------
<S>    <C>    <C>    <C>    <C>    <C>
$39    $71    $773   $14    $14      $1,537*
</TABLE>
 
---------------
* On November 19, 1998, Lucent sold $500 ($495 net of unamortized costs) of
  10-year 5.5% notes due November 15, 2008 and reclassified the amount from debt
  maturing within one year to long-term debt. The proceeds were used to pay down
  a portion of Lucent's commercial paper during the first quarter of fiscal
  1999.
 
                                       37
<PAGE>   38
                   LUCENT TECHNOLOGIES INC. AND SUBSIDIARIES
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
9.  EMPLOYEE BENEFIT PLANS
 
  Pension and Postretirement Benefits
 
     Lucent maintains noncontributory defined benefit pension plans covering the
majority of its employees and retirees, and postretirement benefit plans for the
majority of its retirees that include health care benefits and life insurance
coverage. Prior to October 1, 1996, Lucent's financial statements reflect
estimates of the costs experienced for its employees and retirees while they
were included in AT&T pension and postretirement plans.
 
     Pension-related benefits for management employees are based principally on
career-average pay while benefits for nonmanagement employees are not directly
pay-related. Pension contributions are determined principally using the
aggregate cost method and are made primarily to trust funds held for the sole
benefit of plan participants.
 
     The following table shows the Lucent plans' funded status reconciled with
amounts reported in Lucent's consolidated balance sheets, and the assumptions
used in determining the actuarial present value of the benefit obligation:
 
<TABLE>
<CAPTION>
                                                           PENSION            POSTRETIREMENT
                                                         SEPTEMBER 30          SEPTEMBER 30
                                                      ------------------    ------------------
                                                       1998       1997       1998       1997
                                                      -------    -------    -------    -------
<S>                                                   <C>        <C>        <C>        <C>
Plan assets at fair value...........................  $36,191    $36,204    $ 3,959    $ 4,152
Less: benefit obligation............................   27,846     23,187      9,193      7,939
                                                      -------    -------    -------    -------
Funded (Unfunded) status of the plan................    8,345     13,017     (5,234)    (3,787)
Unrecognized prior service costs....................    1,509      1,048        533        261
Unrecognized transition asset.......................     (944)    (1,244)        --         --
Unrecognized net gain...............................   (5,175)    (9,669)      (408)    (1,256)
Net minimum liability of nonqualified plans.........      (27)       (23)        --         --
                                                      -------    -------    -------    -------
Prepaid (Accrued) benefit cost......................  $ 3,708    $ 3,129    $(5,109)   $(4,782)
                                                      =======    =======    =======    =======
Accumulated pension benefit obligation..............  $26,799    $22,669        n/a        n/a
Vested pension benefit obligation...................  $25,112    $21,246        n/a        n/a
                                                      -------    -------    -------    -------
Accumulated postretirement benefit obligation:
  Retirees..........................................      n/a        n/a    $ 6,662    $ 5,902
  Fully eligible active plan participants...........      n/a        n/a      1,131        777
  Other active plan participants....................      n/a        n/a      1,400      1,260
                                                      -------    -------    -------    -------
Accumulated postretirement benefit obligation.......      n/a        n/a    $ 9,193    $ 7,939
                                                      =======    =======    =======    =======
Assumptions:
  Weighted average discount rate....................     6.00%      7.25%      6.00%      7.25%
  Rate of increase in future compensation levels....     4.50%      4.50%       n/a        n/a
                                                      =======    =======    =======    =======
</TABLE>
 
     Pension plan assets consist primarily of listed stocks (of which $126 and
$73 represent Lucent common stock at September 30, 1998 and 1997, respectively).
Postretirement plan assets include listed stocks (of which $11 and $2 represent
Lucent common stock at September 30, 1998 and 1997, respectively). Assets in
both plans also include corporate and governmental debt, and cash and cash
equivalents. Pension plan assets also include real estate investments, and
postretirement plan assets also include life insurance contracts.
 
     The prepaid pension benefit costs shown above are net of pension
liabilities for plans where accumulated plan benefits exceed assets. Such
liabilities are included in other liabilities in the consolidated balance
sheets.
 
                                       38
<PAGE>   39
                   LUCENT TECHNOLOGIES INC. AND SUBSIDIARIES
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
     The following table shows the components of pension and postretirement
costs for the periods indicated:
 
<TABLE>
<CAPTION>
                                                                                  NINE MONTHS
                                             YEAR ENDED         YEAR ENDED           ENDED
                                            SEPTEMBER 30,      SEPTEMBER 30,     SEPTEMBER 30,
                                                1998               1997              1996
                                           ---------------    ---------------    -------------
                                           (TWELVE MONTHS)    (TWELVE MONTHS)
<S>                                        <C>                <C>                <C>
PENSION COST
Service cost-benefits earned during the
  period.................................      $   331            $   312           $   277
Interest cost on projected benefit
  obligation.............................        1,631              1,604             1,172
Expected return on plan assets(1)........       (2,384)            (2,150)           (1,589)
Amortization of unrecognized prior
  service costs..........................          164                149               113
Amortization of transition asset.........         (300)              (300)             (222)
Charges (credits) for plan
  curtailments(2)........................           --                 56               (16)
                                               -------            -------           -------
Net pension credit.......................      $  (558)           $  (329)          $  (265)
                                               =======            =======           =======
POSTRETIREMENT COST
Service cost-benefits earned during the
  period.................................      $    63            $    57           $    51
Interest cost on accumulated
  postretirement benefit obligation......          540                554               408
Expected return on plan assets(3)........         (263)              (264)             (189)
Amortization of unrecognized prior
  service costs..........................           53                 35                53
Amortization of net loss (gain)..........            3                (15)                8
Charges (credits) for plan
  curtailments(2)........................           --                 26                (2)
                                               -------            -------           -------
Net postretirement benefit cost..........      $   396            $   393           $   329
                                               =======            =======           =======
</TABLE>
 
---------------
(1) A 9.0% long-term rate of return on pension plan assets was assumed for 1998,
    1997 and 1996. The actual return on plan assets was $1,914 and $8,523 for
    the years ended September 30, 1998 and 1997, respectively, and $2,204 for
    the nine-month period ended September 30, 1996.
 
(2) The 1997 pension and postretirement charges for plan curtailments of $56 and
    $26, respectively, reflect the final determination of 1996 curtailment
    effects.
 
(3) A 9.0% long-term rate of return on postretirement plan assets was assumed
    for 1998, 1997 and 1996. The actual return on plan assets was $349 and
    $1,040 for the years ended September 30, 1998 and 1997, respectively, and
    $219 for the nine-month period ended September 30, 1996.
 
     Pension cost was computed using the projected unit credit method. Lucent is
amortizing over approximately 16 years the unrecognized pension transition asset
related to the adoption of SFAS No. 87, "Employers' Accounting for Pensions," in
1986. Prior service pension costs are amortized primarily on a straight-line
basis over the average remaining service period of active employees.
 
     For postretirement benefit plans, Lucent assumed a 5.5% annual rate of
increase in the per capita cost of covered health care benefits (the health care
cost trend rate) for 1999, gradually declining to 4.9% by the year 2005, after
which the costs would remain level. This assumption has a significant effect on
the amounts reported. Increasing the assumed trend rate by 1% in each year would
increase Lucent's accumulated postretirement benefit obligation as of September
30, 1998 by $358 and the interest and service cost by $30 for the year then
ended.
 
                                       39
<PAGE>   40
                   LUCENT TECHNOLOGIES INC. AND SUBSIDIARIES
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
  Savings Plans
 
     Lucent's savings plans allow employees to contribute a portion of their
pre-tax and/or after tax income in accordance with specified guidelines. Lucent
matches a percentage of employee contributions up to certain limits. Beginning
in 1998, Lucent changed its savings plan for management employees to provide for
both a fixed and a variable matching contribution. The fixed match is 50% of
qualified management employee contributions and the variable match is based on
Company performance. For 1998, Lucent's total match of qualified management
employee contributions is 109%, as compared with 66 2/3% in prior years.
Qualified nonmanagement employee contributions continued to be matched at a
66 2/3% rate. Savings plan expense amounted to $311 and $180 for the years ended
September 30, 1998 and 1997, respectively, and $131 for the nine-month period
ended September 30, 1996.
 
  Employee Stock Ownership Plan
 
     Lucent's leveraged Employee Stock Ownership Plan ("ESOP") funds the
employer's contributions to the Long Term Savings and Security Plan ("LTSSP")
for nonmanagement employees. The ESOP obligation is reported as debt and as a
reduction in shareowners' equity. Cash contributions to the ESOP are determined
based on the ESOP's total debt service less dividends paid on ESOP shares. As of
September 30, 1998, the ESOP contained 10.4 million shares of Lucent's common
stock. Of the 10.4 million shares, 8.2 million have been allocated to the LTSSP
and 2.2 million were unallocated. As of September 30, 1998, the unallocated
shares had a fair value of $154.
 
10.  STOCK COMPENSATION PLANS
 
     Lucent has stock-based compensation plans under which certain employees
receive stock options and other equity-based awards. Effective October 1, 1996,
any AT&T awards held by Lucent employees were replaced by substitute awards
under the Lucent Technologies Inc. 1996 Long Term Incentive Program ("1996
LTIP").
 
     The 1996 LTIP provides for the grant of stock options, stock appreciation
rights, performance awards, restricted stock awards and other stock unit awards.
Awards under the 1996 LTIP are generally made to executives. Lucent also awards
stock options to selected employees below executive levels under the Lucent
Technologies Inc. 1997 Long-Term Incentive Plan ("1997 LTIP"). In addition, the
Company has made special, broad-based grants under the Lucent Technologies Inc.
Founders Grant Stock Option Plan ("FGP")(1996 world-wide option grants) and the
Lucent Technologies Inc. 1998 Global Stock Option Plan ("GSOP")(1998 world-wide
option grants to management employees).
 
     Stock options are granted with an exercise price equal to or greater than
100% of market value at the date of grant, generally have a ten-year term and
vest within four years from the date of grant. Subject to customary
anti-dilution adjustments and certain exceptions, the total number of shares of
Common Stock authorized for option grants under the 1996 LTIP is 64 million
shares between February 1998 and February 2003. Under the 1997 LTIP, the number
of shares authorized for option grants in each calendar year is 1.3% of the
total number of outstanding shares of Common Stock as of the first day of the
calendar year. The total number of shares of Common Stock originally authorized
for grant under the FGP and GSOP are 30 million and 18 million, respectively.
 
     In connection with several of Lucent's acquisitions (see Note 1),
outstanding stock options held by employees of acquired companies will become
exercisable, according to their terms, for Lucent common stock effective at the
acquisition date. The fair value of these options was included as part of the
purchase price related to the acquisition. These options did not reduce the
shares available for grant under any of Lucent's other option plans.
 
                                       40
<PAGE>   41
                   LUCENT TECHNOLOGIES INC. AND SUBSIDIARIES
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
     Lucent established an Employee Stock Purchase Plan (the "ESPP") effective
October 1, 1996. Under the terms of the ESPP, eligible employees may have up to
10% of eligible compensation deducted from their pay to purchase Common Stock
through June 30, 2001. On the date of exercise, which is the last trading day of
each month, the per share purchase price is 85% of the average high and low per
share trading price of Common Stock on the New York Stock Exchange on that date.
The amount that may be offered pursuant to this plan is 100 million shares. In
1998 and 1997, 4.2 million and 6.2 million shares, respectively, were purchased
under the ESPP at a weighted average price of $49.02 and $25.15, respectively.
 
     Lucent has adopted the disclosure requirements of SFAS No. 123, "Accounting
for Stock-Based Compensation" and, as permitted under SFAS No. 123, applies
Accounting Principles Board Opinion ("APB") No. 25 and related interpretations
in accounting for its plans. Compensation expense recorded under APB No. 25 was
$73 and $36 for the years ended September 30, 1998 and 1997, respectively, and
$11 for the nine months ended September 30, 1996. If Lucent had elected to adopt
the optional re cognition provisions of SFAS No. 123 for its stock option plans
and the ESPP, net income and earnings per share would have been changed to the
pro forma amounts indicated below:
 
<TABLE>
<CAPTION>
                                                                                     NINE
                                             YEAR ENDED         YEAR ENDED       MONTHS ENDED
                                            SEPTEMBER 30,      SEPTEMBER 30,     SEPTEMBER 30,
                                                1998               1997              1996
                                           ---------------    ---------------    -------------
                                           (TWELVE MONTHS)    (TWELVE MONTHS)
<S>                                        <C>                <C>                <C>
Net income
  As reported............................       $ 970              $ 541             $ 224
  Pro forma..............................       $ 799              $ 444             $ 202
                                                -----              -----             -----
Earnings per share -- basic
  As reported............................       $0.74              $0.42             $0.19
  Pro forma..............................       $0.61              $0.35             $0.17
Earnings per share -- diluted
  As reported............................       $0.73              $0.42             $0.19
  Pro forma..............................       $0.58              $0.34             $0.17
                                                -----              -----             -----
</TABLE>
 
---------------
NOTE: The pro forma disclosures shown include the incremental fair value of the
      Lucent stock options that were substituted for AT&T stock options at the
      time of the Distribution and may not be representative of the effects on
      net income and earnings per share in other years.
 
     The fair value of stock options used to compute pro forma net income and
earnings per share disclosures is the estimated fair value at grant date using
the Black-Scholes option-pricing model with the following assumptions:
 
<TABLE>
<CAPTION>
                                                                LUCENT           AT&T
WEIGHTED AVERAGE ASSUMPTIONS                             --------------------    ----
----------------------------                             (1)     (2)     (3)     (4)
<S>                                                      <C>     <C>     <C>     <C>
Dividend yield.........................................  0.26%   0.65%   0.75%    2.4%
Expected volatility....................................  28.2%   22.4%   22.4%   19.4%
Risk-free interest rate................................   5.5%    6.4%    6.1%    6.4%
Expected holding period (in years).....................   4.7     5.1     4.5     5.0
</TABLE>
 
---------------
(1) Assumptions for Lucent options awarded during 1998.
 
(2) Assumptions for Lucent options awarded during 1997.
 
(3) Assumptions for Lucent options substituted for AT&T options effective
    October 1, 1996.
 
(4) Assumptions for AT&T options awarded in 1996.
 
                                       41
<PAGE>   42
                   LUCENT TECHNOLOGIES INC. AND SUBSIDIARIES
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
     Presented below is a summary of the status of Lucent stock options and the
related transactions for the years ended September 30, 1998 and 1997. Also shown
is a summary of the status of the AT&T stock options held by Lucent's employees
and the related transactions for the nine months ended September 30, 1996.
 
<TABLE>
<CAPTION>
                                                                         WEIGHTED
                                                                         AVERAGE
                                                              SHARES     EXERCISE
                                                              (000'S)     PRICE
                                                              -------    --------
<S>                                                           <C>        <C>
AT&T options outstanding at December 31, 1995...............   12,784     $23.72
                                                              -------     ------
Granted.....................................................    3,380      32.91
Exercised...................................................     (366)     19.14
Forfeited/Expired...........................................       (6)     31.59
                                                              -------     ------
AT&T options outstanding at September 30, 1996..............   15,792      25.68
                                                              -------     ------
Lucent options substituted for AT&T options, and outstanding
  at October 1, 1996........................................   19,572      20.72
                                                              -------     ------
Granted(1)(2)...............................................   51,245      23.19
Exercised...................................................   (4,044)     16.78
Forfeited/Expired...........................................   (1,960)     23.80
                                                              -------     ------
Lucent options outstanding at September 30, 1997............   64,813      22.83
                                                              -------     ------
Granted(2)(3)...............................................   41,613      58.07
Exercised...................................................  (10,781)     17.63
Forfeited/Expired...........................................   (2,045)     24.12
                                                              -------     ------
Lucent options outstanding at September 30, 1998............   93,600     $39.06
</TABLE>
 
---------------
(1) Includes options covering 25,506 shares of Common Stock granted under the
    FGP in 1996 (at a weighted average exercise price of $22.31). No additional
    options will be granted under the FGP.
 
(2) Includes options covering 5,192 and 4,942 shares of Common Stock, which
    resulted from the conversion of options of acquired companies for the years
    ended September 30, 1998 and 1997, respectively (at a weighted average
    exercise price of $10.09 and $20.00, respectively). No additional options
    will be granted under the converted plans of acquired companies.
 
(3) Includes options covering 16,178 shares of Common Stock granted under the
    GSOP on September 1, 1998 (at a weighted average exercise price of $74.69).
 
     The weighted average fair value of Lucent stock options, calculated using
the Black-Scholes option-pricing model, granted during the years ended September
30, 1998 and 1997 is $24.53 and $7.30 per share, respectively. The weighted
average fair value of AT&T stock options, calculated using the Black-Scholes
option-pricing model, granted during the nine months ended September 30, 1996 is
$7.07 per share.
 
                                       42
<PAGE>   43
                   LUCENT TECHNOLOGIES INC. AND SUBSIDIARIES
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
     The following table summarizes the status of Lucent's stock options
outstanding and exercisable at September 30, 1998:
 
<TABLE>
<CAPTION>
                      STOCK OPTIONS OUTSTANDING         STOCK OPTIONS
                  ---------------------------------      EXERCISABLE
                              WEIGHTED                ------------------
                              AVERAGE      WEIGHTED             WEIGHTED
                             REMAINING     AVERAGE              AVERAGE
RANGE OF          SHARES    CONTRACTUAL    EXERCISE   SHARES    EXERCISE
EXERCISE PRICES   (000'S)   LIFE (YEARS)    PRICE     (000'S)    PRICE
---------------   -------   ------------   --------   -------   --------
<S>               <C>       <C>            <C>        <C>       <C>
$ 0.04 to $21.30   9,561        5.2         $15.42     6,531     $16.61
$21.31 to $22.28  32,218(1)     8.0          22.28       721      22.20
$22.29 to $26.28  10,587        7.9          25.01     1,200      24.73
$26.29 to $43.33  15,414        8.5          38.68     2,845      31.64
$43.34 to $91.66  25,820        9.9          74.75        79      61.62
                  ------                    ------    ------     ------
Total...........  93,600                    $39.06    11,376     $21.89
                  ======                    ======    ======     ======
</TABLE>
 
---------------
(1) NOTE: One-half of the options granted to nonmanagement employees under the
          FGP, covering approximately 3,890 shares, became exercisable on
          October 1, 1998.
 
     Other stock unit awards are granted under the 1996 LTIP. Presented below is
the total number of shares of Common Stock represented by awards granted to
Lucent employees for the years ended September 30, 1998 and 1997, and the total
number of AT&T shares represented by awards granted to Lucent employees for the
nine-month period ended September 30, 1996:
 
<TABLE>
<CAPTION>
                                                                                    NINE MONTHS
                                                 YEAR ENDED        YEAR ENDED          ENDED
                                                SEPTEMBER 30,     SEPTEMBER 30,    SEPTEMBER 30,
                                                    1998              1997             1996
                                               ---------------   ---------------   -------------
                                               (TWELVE MONTHS)   (TWELVE MONTHS)
<S>                                            <C>               <C>               <C>
Lucent shares granted (000's)................         795             4,282              n/a
AT&T shares granted (000's)..................         n/a               n/a              524
Weighted average market value of shares
  granted during the period..................      $44.15            $23.19           $33.12
</TABLE>
 
11.  SEGMENT INFORMATION
 
  Industry Segment
 
     Lucent operates in the global communications networking industry segment.
This segment includes wire-line and wireless systems, software and products used
for voice, data and video communications.
 
  Geographic Segments
 
     Transfers between geographic areas are on terms and conditions comparable
with sales to external customers. The methods followed in developing the
geographic segment data require the use of estimates and do not take into
account the extent to which product development, manufacturing and marketing
depend on each other. Thus, the information may not be indicative of results if
the geographic areas were independent organizations.
 
     Corporate assets are principally cash and temporary cash investments. Data
on other geographic areas pertain to operations that are located outside the
United States. Revenues from all international activities (other geographic
areas revenues plus export revenues) provided 25.7% and 24.1% of consolidated
revenues for the years ended September 30, 1998 and 1997, respectively, and
23.1% for the nine-month period ended September 30, 1996.
 
                                       43
<PAGE>   44
                   LUCENT TECHNOLOGIES INC. AND SUBSIDIARIES
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
<TABLE>
<CAPTION>
                                                                                             NINE
                                                     YEAR ENDED         YEAR ENDED       MONTHS ENDED
                                                    SEPTEMBER 30,      SEPTEMBER 30,     SEPTEMBER 30,
                                                        1998               1997              1996
                                                   ---------------    ---------------    -------------
                                                   (TWELVE MONTHS)    (TWELVE MONTHS)
<S>                                                <C>                <C>                <C>
REVENUES
United States....................................      $24,416            $21,807           $13,334
Other geographic areas...........................        5,731              4,553             2,525
                                                       -------            -------           -------
                                                       $30,147            $26,360           $15,859
                                                       =======            =======           =======
TRANSFERS BETWEEN GEOGRAPHIC AREAS
  (ELIMINATED IN CONSOLIDATION)
United States....................................      $ 2,371            $ 1,927           $ 1,353
Other geographic areas...........................        1,544              1,267               648
                                                       -------            -------           -------
                                                       $ 3,915            $ 3,194           $ 2,001
                                                       =======            =======           =======
OPERATING INCOME (LOSS)
United States....................................      $ 2,328(1)         $ 1,514(2)        $   940
Other geographic areas...........................          525                410              (108)
Corporate, eliminations and nonoperating.........         (547)              (457)             (465)
                                                       -------            -------           -------
Income before income taxes.......................      $ 2,306            $ 1,467           $   367
                                                       =======            =======           =======
ASSETS (END OF PERIOD)
United States....................................      $19,665            $17,054           $16,492
Other geographic areas...........................        6,755              5,600             3,912
Corporate assets.................................        1,282              1,778             2,744
Eliminations.....................................         (982)              (621)             (522)
                                                       -------            -------           -------
                                                       $26,720            $23,811           $22,626
                                                       =======            =======           =======
</TABLE>
 
---------------
(1) Includes charges of $1,416 of purchased in-process research and development
    costs associated with the acquisitions of Livingston, Prominet, Optimay,
    Yurie, SDX, LANNET, MassMedia and JNA.
 
(2) Includes charges of $1,024 of purchased in-process research and development
    costs associated with the acquisitions of Octel and Agile.
 
  Concentrations
 
     Historically, Lucent has relied on a limited number of customers for a
substantial portion of its total revenues. In terms of total revenues, Lucent's
largest customer has been AT&T, although other customers may purchase more of
any particular system or product line. Revenues from AT&T were $3,775 and $3,731
for the years ended September 30, 1998 and 1997, respectively, and $1,970 for
the nine-month period ended September 30, 1996. Lucent expects that a
significant portion of its future revenues will continue to be generated by a
limited number of customers. The loss of any of these customers or any
substantial reduction in orders by any of these customers could materially
adversely affect Lucent's operating results. Lucent does not have a
concentration of available sources of supply materials, labor, services or other
rights that, if suddenly eliminated, could severely impact its operations.
 
                                       44
<PAGE>   45
                   LUCENT TECHNOLOGIES INC. AND SUBSIDIARIES
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
12.  FINANCIAL INSTRUMENTS
 
     The carrying values and estimated fair values of financial instruments,
including derivative financial instruments were as follows:
 
<TABLE>
<CAPTION>
                                                         SEPTEMBER 30, 1998    SEPTEMBER 30, 1997
                                                         ------------------    ------------------
                                                         CARRYING     FAIR     CARRYING     FAIR
                                                          AMOUNT     VALUE      AMOUNT     VALUE
                                                         --------    ------    --------    ------
<S>                                                      <C>         <C>       <C>         <C>
ASSETS
Derivative and Off Balance Sheet Instruments:
  Foreign currency forward exchange contracts/purchased
     options...........................................   $   26     $    4     $   28     $   54
  Letters of credit....................................       --          2         --          2
LIABILITIES
Long-term debt(1)(2)...................................   $2,408     $2,559     $1,663     $1,748
Derivative and Off Balance Sheet Instruments:
  Foreign currency forward exchange contracts/purchased
     options...........................................       25         (4)        31         36
</TABLE>
 
---------------
(1) Excluding long-term lease obligations of $1 at September 30, 1998 and $2 at
    September 30, 1997.
 
(2) Reflects the reclassification from debt maturing within one year to
    long-term debt as a result of the November 19, 1998, sale of $500 ($495 net
    of unamortized costs) of 10-year notes.
 
     The following methods were used to estimate the fair value of each class of
financial instruments:
 
<TABLE>
<CAPTION>
FINANCIAL INSTRUMENT                                  VALUATION METHOD
--------------------                                  ----------------
<S>                                  <C>
Long-term debt                       Market quotes for instruments with similar terms
                                       and maturities
Foreign currency forward exchange    Market quotes
  contracts/purchased options
Letters of credit                    Fees paid to obtain the obligations
</TABLE>
 
     The carrying values of cash and cash equivalents, accounts receivable and
debt maturing within one year contained in the consolidated balance sheets
approximate fair value.
 
  Credit Risk and Market Risk
 
     By their nature, all financial instruments involve risk, including credit
risk for nonperformance by counterparties. The contract or notional amounts of
these instruments reflect the extent of involvement Lucent has in particular
classes of financial instruments. The maximum potential loss may exceed any
amounts recognized in the consolidated balance sheets. However, Lucent's maximum
exposure to credit loss in the event of nonperformance by the other party to the
financial instruments for commitments to extend credit and financial guarantees
is limited to the amount drawn and outstanding on those instruments.
 
     Lucent seeks to reduce credit risk on financial instruments by dealing only
with financially secure counterparties. Exposure to credit risk is controlled
through credit approvals, credit limits and monitoring procedures. Lucent seeks
to limit its exposure to credit risks in any single country or region.
 
     All financial instruments inherently expose the holders to market risk,
including changes in currency and interest rates. Lucent manages its exposure to
these market risks through its regular operating and financing activities and
when appropriate, through the use of derivative financial instruments.
 
                                       45
<PAGE>   46
                   LUCENT TECHNOLOGIES INC. AND SUBSIDIARIES
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
  Derivative Financial Instruments
 
     Lucent conducts its business on a multi-national basis in a wide variety of
foreign currencies. Consequently, Lucent enters into various foreign exchange
forward and purchased option contracts to manage its exposure against adverse
changes in those foreign exchange rates. The notional amounts for foreign
exchange forward and purchased option contracts represent the U.S. dollar
equivalent of an amount exchanged. Generally, foreign currency forward exchange
contracts are designated for firmly committed or forecasted sales and purchases
that are expected to occur in less than one year. Gains and losses on firmly
committed transactions are deferred in other current assets and liabilities and
are not material to the consolidated financial statements at September 30, 1998
and 1997. Gains and losses on foreign currency exchange contracts that are
designated for forecasted transactions are recognized in other income as the
exchange rates change. The following table presents the gross notional amounts
of these derivative financial instruments in U.S. dollars:
 
<TABLE>
<CAPTION>
                                                           GROSS NOTIONAL AMOUNT
                                                                SEPTEMBER 30
                                                           ----------------------
                                                             1998          1997
                                                           --------      --------
<S>                                                        <C>           <C>
Foreign exchange forward contracts:
  Singapore dollars......................................   $  247        $   59
  Deutsche marks.........................................      189           558
  British pounds.........................................      185           136
  Australian dollars.....................................      142             1
  Japanese yen...........................................      120           249
  Spanish pesetas........................................      113           109
  Dutch guilders.........................................      110           186
  Brazilian reals........................................       82            58
  French francs..........................................       81           116
  Other..................................................      186           270
Total....................................................   $1,455        $1,742
Foreign exchange purchased option contracts:
  Canadian dollars.......................................   $   66        $   --
  Singapore dollars......................................       60            --
  Other..................................................        4            --
Total....................................................   $  130        $   --
</TABLE>
 
     Lucent enters into certain interest rate swap agreements to manage its risk
between long-term fixed rate and short-term variable rate instruments. Interest
rate swap agreements were not material during 1998 and 1997.
 
  Nonderivative and Off Balance Sheet Instruments
 
     Requests for providing commitments to extend credit and financial
guarantees are reviewed and approved by senior management. Management regularly
reviews all outstanding commitments, letters of credit and financial guarantees,
and the results of these reviews are considered in assessing the adequacy of
Lucent's reserve for possible credit and guarantee losses. At September 30, 1998
and 1997, in management's opinion, there was no significant risk of loss in the
event of nonperformance of the counterparties to these financial instruments.
 
                                       46
<PAGE>   47
                   LUCENT TECHNOLOGIES INC. AND SUBSIDIARIES
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
     The following table presents the contract amount of Lucent's nonderivative
and off balance sheet instruments and the amounts drawn down on such
instruments. These instruments may exist or expire without being drawn upon.
Therefore, the total contract amount does not necessarily represent future cash
flows.
 
<TABLE>
<CAPTION>
                                                                         AMOUNTS DRAWN
                                                                            DOWN AND
                                                     CONTRACT AMOUNT      OUTSTANDING
                                                       SEPTEMBER 30       SEPTEMBER 30
                                                     ----------------    --------------
                                                      1998      1997     1998     1997
                                                     ------    ------    -----    -----
<S>                                                  <C>       <C>       <C>      <C>
Letters of credit..................................  $  804    $  832    $ --     $ --
Commitments to extend credit.......................   2,312     1,898     399       25
Guarantees of debt.................................     292       309     205      118
</TABLE>
 
  Letters of Credit
 
     Letters of credit are purchased guarantees that ensure Lucent's performance
or payment to third parties in accordance with specified terms and conditions.
 
  Commitments to Extend Credit
 
     Commitments to extend credit to third parties are legally binding,
conditional agreements generally having fixed expiration or termination dates
and specific interest rates and purposes.
 
     Lucent may enter into credit agreements to provide long-term financing for
customers. In October 1996, Lucent entered into an agreement to extend $1,800 of
long-term financing to Sprint Spectrum Holdings LP ("Sprint PCS") for its
purchase of Lucent's equipment and services for its nationwide personal
communication services ("PCS") network. In 1997, Lucent closed transactions
under this facility to lay off $500 of loans and undrawn commitments and $300 of
undrawn commitments to a group of institutional investors and Sprint Corporation
(a partner in Sprint PCS), respectively. In 1998, Lucent sold $645 of loans in a
private sale. As of September 30, 1998 and 1997, the balance of these
commitments not yet drawn down by Sprint PCS were $253 and $146, respectively,
and the total drawn loans due were $226 and $17, respectively.
 
     As part of the revenue recognition process, Lucent has assessed the
collectibility of the accounts receivable relating to the Sprint PCS purchase
contract in light of its financing commitment to Sprint PCS. Lucent has
determined that the receivables under the contract are reasonably assured of
collection based on various factors among which was the ability of Lucent to
sell the loans and commitments without recourse. Lucent intends to continue
pursuing opportunities for the sale of future loans and commitments.
 
     In addition, Lucent also entered into agreements with others to extend
credit up to an aggregate of approximately $1,371 in 1998 and $850 in 1997 for
possible future sales.
 
  Guarantees of Debt
 
     From time to time, Lucent guarantees the financing for product purchases by
customers and the debt of certain unconsolidated joint ventures. Requests for
providing such guarantees are reviewed and approved by senior management.
Certain financial guarantees are backed by amounts held in trust for Lucent or
assigned to a third party reinsurer.
 
13.  COMMITMENTS AND CONTINGENCIES
 
     In the normal course of business, Lucent is subject to proceedings,
lawsuits and other claims, including proceedings under government laws and
regulations related to environmental and other matters. Such matters are subject
to many uncertainties, and outcomes are not predictable with assurance.
Consequently, the ultimate aggregate amount of monetary liability or financial
impact with respect to these matters at
 
                                       47
<PAGE>   48
                   LUCENT TECHNOLOGIES INC. AND SUBSIDIARIES
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
September 30, 1998 cannot be ascertained. While these matters could affect the
operating results of any one quarter when resolved in future periods and while
there can be no assurance with respect thereto, management believes that after
final disposition, any monetary liability or financial impact to Lucent beyond
that provided for at September 30, 1998 would not be material to the annual
consolidated financial statements.
 
     In connection with the Separation and Distribution, Lucent, AT&T and NCR
Corporation executed and delivered the Separation and Distribution Agreement,
dated as of February 1, 1996, as amended and restated (the "Separation and
Distribution Agreement"), and certain related agreements. The Separation and
Distribution Agreement, among other things, provides that Lucent will indemnify
AT&T and NCR for all liabilities relating to Lucent's business and operations
and for all contingent liabilities relating to Lucent's business and operations
or otherwise assigned to Lucent. In addition to contingent liabilities relating
to the present or former business of Lucent, any contingent liabilities relating
to AT&T's discontinued computer operations (other than those of NCR) were
assigned to Lucent. The Separation and Distribution Agreement provides for the
sharing of contingent liabilities not allocated to one of the parties, in the
following proportions: AT&T: 75%, Lucent: 22%, and NCR: 3%. The Separation and
Distribution Agreement also provides that each party will share specified
portions of contingent liabilities related to the business of any of the other
parties that exceed specified levels.
 
  Environmental Matters
 
     Lucent's current and historical operations are subject to a wide range of
environmental protection laws. In the United States, these laws often require
parties to fund remedial action regardless of fault. Lucent has remedial and
investigatory activities underway at numerous current and former facilities. In
addition, Lucent was named a successor to AT&T as a potentially responsible
party ("PRP") at numerous "Superfund" sites pursuant to the Comprehensive
Environmental Response, Compensation and Liability Act of 1980 ("CERCLA") or
comparable state statutes. Under the Separation and Distribution Agreement,
Lucent is responsible for all liabilities primarily resulting from or relating
to the operation of Lucent's business as conducted at any time prior to or after
the Separation including related businesses discontinued or disposed of prior to
the Separation, and Lucent's assets including, without limitation, those
associated with these sites. In addition, under such Separation and Distribution
Agreement, Lucent is required to pay a portion of contingent liabilities paid
out in excess of certain amounts by AT&T and NCR, including environmental
liabilities.
 
     It is often difficult to estimate the future impact of environmental
matters, including potential liabilities. Lucent records an environmental
reserve when it is probable that a liability has been incurred and the amount of
the liability is reasonably estimable. This practice is followed whether the
claims are asserted or unasserted. Management expects that the amounts reserved
will be paid out over the periods of remediation for the applicable sites which
range from 5 to 30 years. Reserves for estimated losses from environmental
remediation are, depending on the site, based primarily upon internal or
third-party environmental studies, and estimates as to the number, participation
level and financial viability of any other PRPs, the extent of the contamination
and the nature of required remedial actions. Accruals are adjusted as further
information develops or circumstances change. The amounts provided for in
Lucent's consolidated financial statements for environmental reserves are the
gross undiscounted amount of such reserves, without deductions for insurance or
third-party indemnity claims. In those cases where insurance carriers or
third-party indemnitors have agreed to pay any amounts and management believes
that collectibility of such amounts is probable, the amounts are reflected as
receivables in the financial statements. Although Lucent believes that its
reserves are adequate, there can be no assurance that the amount of capital
expenditures and other expenses which will be required relating to remedial
actions and compliance with applicable environmental laws will not exceed the
amounts reflected in Lucent's reserves or will not have a material adverse
effect on Lucent's financial condition, results of operations or cash flows. Any
amounts of environmental costs that may be incurred in excess of those provided
for at September 30, 1998 cannot be determined.
 
                                       48
<PAGE>   49
                   LUCENT TECHNOLOGIES INC. AND SUBSIDIARIES
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
  Lease Commitments
 
     Lucent leases land, buildings and equipment under agreements that expire in
various years through 2016. Rental expense under operating leases was $408 and
$324 for the years ended September 30, 1998 and 1997, respectively, and $182 for
the nine-month period ended September 30, 1996. The table below shows the future
minimum lease payments due under noncancelable operating leases at September 30,
1998. Such payments total $876.
 
<TABLE>
<CAPTION>
                                                    YEAR ENDED SEPTEMBER 30
                                         ---------------------------------------------
                                                                                 LATER
                                         1999    2000    2001    2002    2003    YEARS
                                         ----    ----    ----    ----    ----    -----
<S>                                      <C>     <C>     <C>     <C>     <C>     <C>
Operating leases.......................  $250    $188    $113    $74     $55     $196
</TABLE>
 
14. QUARTERLY INFORMATION (UNAUDITED)
 
<TABLE>
<CAPTION>
                                                 FISCAL YEAR QUARTERS
                                  ---------------------------------------------------
                                   FIRST          SECOND      THIRD           FOURTH            TOTAL
                                  -------         ------     -------          -------          -------
<S>                               <C>             <C>        <C>              <C>              <C>
Year Ended September 30, 1998
Revenues........................  $ 8,724         $6,157     $ 7,228          $ 8,038          $30,147
Gross margin....................    4,205          2,724       3,279            3,783           13,991
Net income (loss)...............      792(a)          23(b)     (233)(c)          388(d)           970(a,b,c,d)
Earnings(loss) per common
  share -- basic................  $  0.62(a)      $ 0.02(b)  $ (0.18)(c)      $  0.30(d)       $  0.74(a,b,c,d)
Earnings (loss) per common
  share -- diluted..............  $  0.61(a)      $ 0.02(b)  $ (0.18)(c)      $  0.29(d)       $  0.73(a,b,c,d)
Dividends per share.............  $ 0.075         $ 0.00     $  0.04          $  0.04          $ 0.155
Stock price: (f)
       High.....................       45 3/32        64 1/8      83 11/16        108 1/2          108 1/2
       Low......................       36 3/16        36 23/32      64             68 3/8           36 3/16
       Quarter-end close........       39 15/16       63 15/16      83 3/16        69 1/4           69 1/4
Year Ended September 30, 1997
Revenues........................  $ 7,938         $5,149     $ 6,340          $ 6,933          $26,360
Gross margin....................    3,642          2,168       2,600            3,052           11,462
Net income (loss)...............      859             66         213             (597)(e)          541(e)
Earnings (loss) per common
  share -- basic................  $  0.67         $ 0.05     $  0.17          $ (0.47)(e)      $  0.42(e)
Earnings (loss) per common
  share -- diluted..............  $  0.67         $ 0.05     $  0.17          $ (0.47)(e)      $  0.42(e)
Dividends per share.............  $0.0375         $0.000     $0.0375          $0.0375          $0.1125
Stock price:(f)
       High.....................       26 9/16        30 5/16      37 3/32         45 3/8           45 3/8
       Low......................       21 1/16        22 3/8      24 15/16         36 3/32          21 1/16
       Quarter-end close........       23 1/8         26 1/4      36 1/32          40 11/16         40 11/16
</TABLE>
 
---------------
(a) As a result of the 1998 acquisition of Livingston, Lucent recorded a non-tax
    charge of $427 in the first quarter for purchased in-process research and
    development.
 
(b) As a result of the 1998 acquisition of Prominet, Lucent recorded a non-tax
    charge of $157 in the second quarter for purchased in-process research and
    development.
 
                                       49
<PAGE>   50
                   LUCENT TECHNOLOGIES INC. AND SUBSIDIARIES
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
(c) As a result of the 1998 acquisitions of Yurie and Optimay, Lucent recorded a
    non-tax charge of $668 in the third quarter for purchased in-process
    research and development.
 
(d) As a result of the 1998 acquisitions of SDX, MassMedia, LANNET and JNA,
    Lucent recorded a charge of $164 ($160 after tax) in the fourth quarter for
    purchased in-process research and development.
 
(e) As a result of the 1997 acquisition of Octel, Lucent recorded a charge of
    $979 ($966 after tax) in the fourth quarter for purchased in-process
    research and development and other charges.
 
(f) Obtained from the Composite Tape. Stock prices have been restated to reflect
    the two-for-one split of the Company's common stock effective April 1, 1998.
 
15. SUBSEQUENT EVENTS
 
  Quadritek Systems, Inc.
 
     On October 1, 1998, Lucent acquired Quadritek Systems, Inc. for
approximately $50 in cash. Quadritek is a privately held start-up company which
develops next-generation Internet Protocol ("IP") network administration
software solutions. The acquisition will be accounted for using the purchase
method of accounting.
 
     Included in the purchase price was approximately $21 ($13 after tax) of
in-process research and development which will result in a noncash charge to
earnings in the quarter ending December 31, 1998. The remaining purchase price
will be allocated to tangible assets and intangible assets, including goodwill
and existing technology, less liabilities assumed.
 
  Philips Consumer Communications
 
     On October 22, 1998, Lucent and Philips announced their intention to end
the PCC venture. On October 1, 1997, Lucent contributed its Consumer Products
business in exchange for 40% ownership of the PCC venture. It is expected Lucent
and Philips will each regain control of their original businesses by November
30, 1998. Lucent plans to close down the wireless handset business it previously
contributed to PCC and to sell the remaining businesses. Lucent expects that
these activities will be completed during the first calendar quarter of 1999.
 
  WinStar Communications, Inc.
 
     On October 22, 1998, Lucent announced that it had entered into a five-year
agreement with WinStar Communications, Inc. to provide WinStar with a fixed
wireless broadband telecommunications network in major domestic and
international markets. In connection with this agreement, Lucent entered into a
credit agreement with WinStar to provide up to $2,000 in equipment financing to
fund the buildout of this network. The maximum amount of credit that Lucent is
obligated to extend to WinStar at any one time is $500.
 
                                       50