EXHIBIT 13

LUCENT
TECHNOLOGIES FINANCIAL REVIEW 2004

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|Managements Discussion and Analysis of Financial Condition and Results of Operations | 
|Forward-Looking Statements                                                            | 
|Executive Summary                                                                     | 
|Application of Critical Accounting Estimates                                          | 
|Results of Operations                                                                 | 
|Results of Operations by Segment                                                      | 
|Liquidity and Capital Resources                                                       | 
|Quantitative and Qualitative Disclosures About Market Risk                            | 
|                                                                                      | 
|Five-Year Summary of Selected Financial Data                                          | 
|Report of Management                                                                  | 
|Report of Independent Registered Public Accounting Firm                               | 
|                                                                                      | 
|Consolidated Financial Statements                                                     | 
|Consolidated Statements of Operations                                                 | 
|Consolidated Balance Sheets                                                           | 
|Consolidated Statements of Changes in Shareowners (Deficit) Equity                   | 
|Consolidated Statements of Cash Flows                                                 | 
|                                                                                      | 
|Notes to Consolidated Financial Statements                                            | 
|1.  Summary of Significant Accounting Policies                                        | 
|2.  Business Restructuring                                                            | 
|3.  Business Acquisitions and Divestitures                                            | 
|4.  Supplementary Financial Information                                               | 
|5.  Earnings (Loss) Per Common Share                                                  | 
|6.  Accumulated Other Comprehensive Income                                            | 
|7.  Income Taxes                                                                      | 
|8.  Debt Obligations and Early Extinguishment of Debt                                 | 
|9.  Employee Benefit Plans                                                            | 
|10. Stock Compensation Plans                                                          | 
|11. Operating Segments                                                                | 
|12. Financial Instruments                                                             | 
|13. Commitments and Contingencies                                                     | 
|14. Quarterly Information (Unaudited)                                                 | 

F-1

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MANAGEMENTS
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

FORWARD-LOOKING
STATEMENTS

This
  Managements Discussion and Analysis of Financial Condition and Results
  of Operations (MD&A) contains forward-looking statements that
  are based on current expectations, estimates, forecasts and projections about
  us, our future performance, the industries in which we operate, our beliefs
  and our managements assumptions. In addition, other written or oral statements
  that constitute forward-looking statements may be made by us or on our behalf.
  Words such as expects, anticipates, targets,
  goals, projects, 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 that are difficult to assess. Therefore,
  actual outcomes and results may differ materially from what is expressed or
  forecasted in such forward-looking statements. These risks and uncertainties
  include: fluctuations in the telecommunications market; our ability to compete
  effectively; our product portfolio and ability to keep pace with technological
  advances in our industry; our reliance on a limited number of key customers;
  our exposure to the credit risk of our customers; the pricing, cost and other
  risks inherent in our long-term sales agreements; the costs and risks associated
  with our pension and postretirement benefit obligations; the social, political
  and economic risks of our foreign operations; our reliance on third parties
  to manufacture most of our products; our ability to generate positive cash flow;
  existing and future litigation; our ability to protect our intellectual property
  rights and the expenses we may incur in defending such rights; the complexity
  of our products; changes to existing regulations or technical standards; compliance
  with environmental health and safety laws; and our ability to retain and recruit
  key personnel. For a more complete list and description of such risks and uncertainties,
  see the reports filed by us with the Securities and Exchange Commission. Except
  as required under the federal securities laws and the rules and regulations
  of the SEC, we do not have any intention or obligation to update publicly any
  forward-looking statements after the distribution of this MD&A, whether
  as a result of new information, future events, changes in assumptions or otherwise.

EXECUTIVE
SUMMARY

We
  design and deliver the systems, software and services that drive next-generation
  communications networks. Backed by Bell Labs research and development, we use
  our strengths in mobility, optical, access, data and voice networking technologies,
  as well as services, to create new revenue-generating opportunities for our
  customers, while enabling them to quickly deploy and better manage their networks.
  Our customer base includes communications service providers, governments and
  enterprises worldwide.

We
  have three segments organized around the products and services we sell. The
  reportable segments are Integrated Network Solutions (INS), Mobility
  Solutions (Mobility) and Lucent Worldwide Services (Services). 
  INS provides a broad range of software and wireline equipment related to voice
  networking (primarily consisting of switching products, which we sometimes refer
  to as convergence solutions, and voice messaging products), data and network
  management (primarily consisting of access and related data networking equipment
  and operating support software) and optical networking. Mobility provides software
  and wireless equipment to support radio access and core networks. Services provides
  deployment, maintenance, professional and managed services in support of
  both our product offerings as well as multi-vendor networks.

Beginning
  in fiscal 2001, the global telecommunications market deteriorated, resulting
  from a decrease in the competitive local exchange carrier market and a significant
  reduction in capital spending by established service providers. This trend intensified
  during fiscal 2002 and continued into fiscal 2003. Reasons for the market deterioration
  included general economic slowdown, network overcapacity, customer bankruptcies,
  network build-out delays and limited availability of capital.

We
  believe that the market for telecommunications equipment has stabilized and
  is starting to grow in certain areas. The growing demands of enterprises and
  consumers for additional services tailored to their needs is creating the need
  for a new convergence of networks, technologies and applications.

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Service
  providers are looking for ways to bundle packages of voice, data and video services
  by deploying converged networks that will give users more seamless and simple
  access to communications across both wireline and mobile networks. At the same
  time, they are looking for help to streamline their network operations and to
  manage their operating expenses more effectively.

We
  have been seeing a significant increase in discussions with our customers about
  how they will make that transition. They are looking for partners who have the
  knowledge, skill and staying power to help smooth the transition. More and more
  major multi-year plans are being developed for next-generation networks that
  will deliver IP-based multimedia services.

This
  is a long-term technology transition, which creates opportunities for us and
  our customers in growth areas such as mobile high-speed data, broadband access,
  metro optical networking and Voice over Internet Protocol (or VoIP) solutions,
  as well as professional and managed services. We are working to turn these technologies
  and opportunities into cost-effective offers for our customers.

To
  effectively compete, we have to continue our work to expand our customer base,
  continue to improve overall productivity and efficiency and be innovative in
  delivering new solutions to customers.

Capital
  spending in our target markets can change rapidly and can vary over short periods
  of time. As a result of this uncertainty, it is difficult to make accurate forecasts
  of near- and long-term results and cash flow. In addition, because a limited
  number of customers account for a significant amount of our revenue, our results
  are subject to fluctuation from changes in spending by one or more of these
  customers. This exposure to fluctuation is most prevalent in our Mobility segment.

As
discussed in more detail throughout our MD&A:

| |  | Results of operations improved significantly during fiscal 2004. This
        improvement was driven by an increase in revenues, a higher gross margin
        rate and lower operating expenses as compared with fiscal 2003.
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| |  | Revenues increased by 7% during fiscal 2004, following three consecutive
        years of significant declines in annual revenues. The increase in fiscal
        2004 was driven by higher Mobility revenues, primarily due to higher CDMA
        sales in the U.S. as two of our large customers continued to upgrade their
        wireless networks and deploy additional capacity to support subscriber
        growth. Partially offsetting this increase were lower INS revenues, primarily
        driven by lower voice networking sales in the U.S., specifically with
        traditional circuit switching products, as carriers face weaker wireline
        demand and explore next generation networking technologies.  The
        sustained weakening of the telecommunications market and significant reduction
        in capital spending by service providers, among other factors, contributed
        to a 31% decline in revenues during fiscal 2003. The impact of product
        rationalizations and discontinuances under our restructuring program did
        not have a significant effect on the overall changes in our revenues during
        the past three fiscal years. However, certain product rationalization
        initiatives have reduced our total available market opportunities, such
        as our decision to discontinue our GSM offerings.
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| |  | Our gross margin rate was 42%, 31% and 13% during fiscal 2004, 2003 and
        2002, respectively. The improvement in fiscal 2004 and fiscal 2003 primarily
        resulted from the impact of cost reductions and product mix, as well as
        certain other items including lower inventory- and warranty-related charges.
        Product line discontinuances and the significant and rapid decline in revenues
        led to significant inventory charges and high-unabsorbed fixed costs during
        fiscal 2002.
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| |  | We continued to reflect lower operating expenses through the completion
        of restructuring actions taken during the past few years. These actions
        resulted in net charges of $2.3 billion during fiscal 2002. During fiscal
        2004 and 2003, net reversals of $20 million and $149 million were recognized
        due to changes in previously estimated costs for prior year plans. These
        revisions were mostly related to employee termination benefits and facility
        closing costs.
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| |  | We recognized net recoveries of bad debt and customer financings of $230
        million and $223 million in fiscal 2004 and 2003, respectively. These
        recoveries were primarily due to the favorable settlement of certain fully
        reserved notes and accounts receivable, and the expiration of certain
        customer financing guarantees. We recognized provisions for bad debts
        and customer financings of $1.3 billion during fiscal 2002 as a result
        of the significant weakening of the financial condition of certain customers.
|- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | We recognized charges of $56 million and $481 million during fiscal 2004
        and 2003, respectively, in connection with the settlement of purported
        class action securities lawsuits and other related lawsuits against us
        and certain of our current and former directors and officers for alleged
        violations of federal securities laws, ERISA and related claims. The charges
        in fiscal 2004 primarily resulted from changes in the estimated fair value
        of the warrants that we expect to issue in connection with the global
        shareowner settlement.
|- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | We maintained a valuation allowance on substantially all of our deferred
        tax assets that primarily originated during fiscal 2002. As a result,
        federal and certain state and non-U.S. income taxes attributable to pre-tax
        income were not provided during fiscal 2004, nor did we record income
        tax benefits attributable to pre-tax losses during fiscal 2003 and 2002.
        We recognized an income tax benefit of $939 million and $233 million during
        fiscal 2004 and 2003, respectively, primarily as a result of valuation
        allowance reversals due to the recognition of certain carryback claims,
        including an $816 million federal net operating loss carryback claim during
        fiscal 2004 and additional benefits from the favorable resolution of certain
        income tax audit matters. Fiscal 2002 results included a tax provision
        of $4.8 billion despite a pre-tax loss from continuing operations of $7.1
        billion due to the impact of establishing a full valuation allowance.
|- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Cash and cash equivalents and marketable securities increased by $366
        million to $4.9 billion during fiscal 2004, primarily from cash provided
        by operating activities.
|- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Looking
  ahead to fiscal 2005, we expect our market and our business to grow as customers
  invest in revenue-generating services and more efficient network operations.
  Mobility should remain a strong growth sector as service providers continue
  their transition to 3G networks for mobile high-speed data services. We will
  continue to invest in every key area of convergence, manage the product cycle
  of declining legacy business and focus on growth in next-generation areas like
  VoIP, broadband access and metro optical. We will continue to manage our cost
  and expense profile as we work on expanding our revenue base in each of our
  segments as well as government and emerging markets outside of the United States.
  We expect fiscal 2005 annual revenues to grow on a percentage basis in the mid-single
  digits, which we believe is at or above the market growth rate; we expect our
  annual gross margin rate on a percentage basis will be in the low 40s;
  and we expect annual operating expenses as a percentage of revenue to be about
  30%. Actual results could be different from these expectations.

APPLICATION
OF CRITICAL ACCOUNTING ESTIMATES

Our
  consolidated financial statements are based on the selection of accounting policies
  and the application of significant accounting estimates, some of which require
  management to make significant assumptions. Actual results could differ materially
  from the estimated amounts. We believe that some of the more critical estimates
  and related assumptions that affect our financial condition and results of operations
  are in the areas of revenue recognition, pension and postretirement benefits,
  income taxes, legal contingencies, receivables and customer financing, inventories,
  business restructuring and intangible assets. Our critical accounting estimates
  were discussed with our Audit and Finance Committee of the Board of Directors.

The
  impact of changes in the estimates and assumptions pertaining to revenue recognition,
  inventories and goodwill and other acquired intangibles arising in fiscal 2004
  is directly reflected in our segment results. The impact of changes in the estimates
  and assumptions related to goodwill and other acquired intangibles arising prior
  to fiscal 2004 and net deferred tax assets are not reflected in the segment
  results. However, the long-term forecasts supporting the realization and changes
  of those assets are significantly affected by the actual and expected results
  of each segment. Generally, the changes in estimates related

F-4

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to
  receivables, pension and postretirement benefits, restructuring program and
  litigation will not affect our segment results.

There
  were no accounting policies adopted during fiscal 2004 that had a material effect
  on our financial condition and results of operations. Refer to Note 1 to our
  consolidated financial statements for our significant accounting policies.

Revenue
recognition

Most
  of our sales are generated from complex contractual arrangements that require
  significant revenue recognition judgments, particularly in the areas of multiple-element
  arrangements, the application of software revenue recognition rules, contract
  accounting and collectibility.

Revenues
  from contracts with multiple-element arrangements, such as those including products
  with installation and integration services, are recognized as the revenue for
  each unit of accounting is earned based on the relative fair value of each unit
  of accountingas determined by internal or third party analyses of market-based
  prices. A delivered element is considered a separate unit of accounting if it
  has value to the customer on a standalone basis, there is objective and reliable
  evidence of the fair value of undelivered elements in the arrangement, and delivery
  or performance of undelivered elements is considered probable and substantially
  under our control.

Many
  of our products are integrated with software that is embedded in our hardware
  at delivery. In those cases where indications are that software is more than
  incidental and was a significant factor in the customers purchasing decision,
  such as where the transaction includes software upgrades or enhancements, we
  apply software revenue recognition rules which may affect the amount and timing
  of revenue recognition. In multiple element arrangements where software is considered
  more than incidental, fair value of an undelivered element is determined using
  vendor specific objective evidence.

The
  percentage of completion method of accounting is used for sales generated from
  certain contracts, primarily those related to customized network solutions and
  network build-outs with durations of at least six months. We make important
  judgments in estimating revenue and cost and in measuring progress toward completion.
  These judgments underlie our determinations regarding overall contract value,
  contract profitability and timing of revenue recognition. Revenue and cost estimates
  are revised periodically based on changes in circumstances. Revenues recognized
  under the percentage of completion method of accounting have increased during
  recent fiscal years and represented 24%, 18% and 13% of total revenues during
  fiscal 2004, 2003 and 2002, respectively.

The
  assessment of collectibility is critical in determining whether revenues should
  be recognized. As part of the revenue recognition process, we determine whether
  trade and notes receivable are reasonably assured of collection based on various
  factors, including our ability to sell the receivables and whether there has
  been deterioration in the credit quality of our customers that could result
  in our inability to collect or sell the receivables. In situations where we
  have the ability to sell the receivable, revenue is recognized up to the value
  we could reasonably expect to realize from the sale. Revenue and related costs
  are deferred if we are uncertain as to whether the receivable can be collected
  or sold. Revenue is deferred but costs are recognized when we determine that
  the collection or sale of the receivable is unlikely.

Deferred
revenues were $593 million and $536 million as of September 30, 2004 and 2003,
respectively.

Pension
and postretirement benefits

Our
  results of operations include the impact of significant pension and postretirement
  benefits that are measured using actuarial valuations. Inherent in these valuations
  are key assumptions, including assumptions about discount rates, expected return
  on plan assets and expected participation rates in retirement health care plans.
  These assumptions are updated on an annual basis at the beginning of each fiscal
  year or more frequently upon the occurrence of significant events. We are required
  to consider current market conditions, including changes in interest rates,
  in making these assumptions.

F-5

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Changes
  in the related pension and postretirement benefit costs or credits may occur
  in the future due to changes in the assumptions. Our net pension and postretirement
  credit (net pension credit) was $868 million, $669 million and $972
  million during fiscal 2004, 2003 and 2002, respectively, excluding the impact
  of restructuring actions and discontinued operations. Approximately two-thirds
  of these amounts are allocated to operating expenses, with the balance in costs
  used to determine gross margin. The allocation is based on a recent comparison
  of salaries that are related to costs and those that are related to operating
  expenses. Refer to our Results of Operations section of this MD&A for a
  further discussion of changes in the net pension credit and the related impact
  on our results.

The
  expected rate of return on pension plan assets used to develop our pension credit
  is 8.75%, 8.75% and 9.0% during fiscal 2004, 2003 and 2002, respectively, and
  is determined at the beginning of the period. We plan to use an expected rate
  of return of 8.5% during fiscal 2005. Changes in the rate were generally due
  to lower expectations of future returns based on studies performed by our external
  investment advisors. Similar changes were made to our expected rate of return
  on postretirement plan assets for these reasons as well as for changes in the
  mix of assets held. A lower expected rate of return will reduce our net pension
  credit and profitability. The discount rate used to determine our pension credit
  was 5.75%, 6.5% and 7.0% during fiscal 2004, 2003 and 2002, respectively, and
  is determined at the beginning of the period. We expect to use 5.5% during fiscal
  2005. Changes in the discount rate were due to declining interest rates. The
  discount rate is also volatile because it is determined based upon the prevailing
  rate as of the measurement date. Similar changes were made to the discount rate
  used to determine our postretirement benefit cost for these reasons. An additional
  0.25% reduction will also be reflected in fiscal 2005 due to a shorter expected
  duration of postretirement plan obligations as compared to pension plan obligations.
  A lower discount rate generally will increase our net pension credit and profitability.
  The expected rate of return on pension plan assets and discount rate were determined
  in accordance with consistent methodologies as described in Note 9 to our consolidated
  financial statements.

Holding
  all other assumptions constant, a 0.5% increase or decrease in the discount
  rate would have decreased or increased the fiscal 2004 net pension credit by
  approximately $60 million. Likewise, a 0.5% increase or decrease in the
  expected return on plan assets would have increased or decreased the fiscal
  2004 net pension credit by approximately $190 million.

There
  have also been several recent developments related to retiree health care benefits,
  including changes in benefits, cost sharing and legislation, such as Medicare
  Part D of the Medicare Prescription Drug Improvement and Modernization Act of
  2003. These legislative changes and recent experience with participation rates
  for management retiree plans have required us to assess the expected future
  participation rates of certain retirees in the existing plans. We now assume
  that approximately 3% of all retirees subject to cost sharing will opt out of
  our plans on an annual basis beginning July 1, 2004. The impact of these participation
  rates favorably impacts our annual net pension credit and profitability by approximately
  $60 million. The impact of differences between actual and assumed experience
  will affect our net pension credit and profitability in the future through the
  amortization of actuarial gains or losses.

We
have implemented various actions to reduce our share of retiree health care
costs during recent periods, including the shifting of certain costs to our
retirees. Our retiree health care obligations are determined using the terms of
the current plans and consider the existing communication to retirees. Health
care benefits for employees who retired prior to March 1, 1990 are not subject
to annual dollar caps on the Companys share of future benefit costs.
The benefit obligation associated with this retiree group approximated 60% of the total retiree health care obligation. Management employees who retired on or after March 1, 1990 have paid amounts
above their caps since 2001. The obligation related to plans covering formerly
represented retirees who retired on or after March 1, 1990 assumed that annual
dollar caps are effective and will be enforced beginning November 1, 2004. We
have either waived or increased these caps in two prior negotiations. Our
collective bargaining agreements expired on October 31, 2004 but were extended
through November 8, 2004.

F-6

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We
entered into a tentative agreement with the unions on November 9, 2004, that
will be submitted to union members for ratification by mid-December. The
agreement will be effective November 1, 2004 and will expire on May 26, 2012, if
ratified. The agreement addresses retiree health care benefits, among other
items. We agreed to continue to subsidize these benefits up to the established
cap level that is consistent with our current actuarial assumptions. Except for
costs attributable to an implementation period ending on or before March 1, 2005
(which we will absorb), costs that are in excess of this capped level will be
borne by the retirees in the form of premiums and plan design changes. We also agreed to establish a new $400 million trust that
will be funded by us over eight years and managed jointly by trustees appointed
by the Company and the unions. The trust will be used to mitigate the cost
impact of premiums or plan design changes on retirees. The agreement also
acknowledged that retiree health care benefits will no longer be a subject of
bargaining between the Company and the unions.

As
a result of these changes, our required obligation for retiree health care
benefits is expected to increase by the net present value of the $400 million of
committed contributions to the trust. This incremental cost will be amortized
over the contract period. We also considered the substantive plan requirements
of SFAS No. 106 and have determined that our obligation for retiree health care
benefits is appropriately stated based on our past practice of shifting certain
costs to retirees and the actions that are contemplated as a result of the new
agreement. The net present value of the required contributions to the new trust
is approximately one-third of the amount of the costs that are expected to be in
excess of the capped level during the contract period.

The
estimated accumulated benefit obligation related to the U.S. management
employees pension plan and several other smaller pension plans
exceeded the fair value of the plan assets as of September 30, 2004, 2003 and
2002.  This was due primarily to the decline in the discount rate used to
estimate the pension liability as a result of declining interest rates in the
United States and negative returns on the pension funds as a result of the
overall decline in the equity markets in 2002 and 2001. Changes in the minimum
pension liability reduced our shareowners deficit by $150 million during
fiscal 2004 and increased our shareowners deficit by $594 million and $2.9
billion during fiscal 2003 and 2002, respectively.

The
discount rate used to determine the minimum pension liability was 5.5%, 5.75%
and 6.5% as of September 30, 2004, 2003 and 2002, respectively. Changes in the
discount rates were due to the reasons described above.  Market conditions
and interest rates significantly affect the future assets and liabilities of our
pension plans, and similar changes might be required in the future. It is
difficult to predict these factors due to highly volatile market conditions.
Holding all other assumptions constant, a 0.5% decrease or increase in
the discount rate would have increased or decreased the minimum pension
liability by approximately $850 million as of September 30, 2004.

Income
taxes

Changes
in valuation allowances favorably impacted our results of operations by $1.2
billion during fiscal 2004 and unfavorably impacted our results of operations by
$129 million and $7.9 billion during fiscal 2003 and 2002, respectively. Our
valuation allowance on net deferred tax assets was $7.9 billion and $9.9 billion
as of September 30, 2004 and 2003, respectively.

We
have significant deferred tax assets, resulting from tax credit carryforwards,
net operating loss carryforwards and deductible temporary differences that may
reduce taxable income in future periods.  A valuation allowance is required
when it is more likely than not that all or a portion of a deferred tax asset
will not be realized. Forming a conclusion that a valuation allowance is not
needed is difficult when there is negative evidence such as cumulative losses in
recent years even if income is reported in the current or recent quarters.
Cumulative losses weigh heavily in the overall assessment. We determine
cumulative losses on a rolling twelve-quarter basis.

As
of September 30, 2001 and continuing through March 31, 2002, we provided
valuation allowances on future tax benefits with relatively short carryforward
periods, such as foreign tax credits, foreign net operating losses, capital
losses and most state net operating losses. We believed it was more likely
than

F-7

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not that the
remaining net deferred tax assets of $5.2 billion as of  September 30, 2001 and
March 31, 2002, would be realized, principally based upon  forecasted taxable income,
generally within the 20-year research and development  credit and net operating loss
carryforward periods, giving consideration to  substantial benefits realized to date
through our restructuring program.

Several
significant developments were considered in determining the need for a full
valuation allowance during the third quarter of fiscal 2002, including the
continuing and more severe market decline, increasing uncertainty and lack of
visibility in the telecommunications market as a whole, a significant decrease
in sequential quarterly revenue levels, a decrease in sequential earnings after
several quarters of sequential improvement and the possible need for further
restructuring and cost reduction actions to attain profitability.  As a
result of our assessment, we established a full valuation allowance for our
remaining net deferred tax assets as of June 30, 2002. Our net deferred tax
assets have essentially remained fully reserved since then. Accordingly, federal
and certain state and non-U.S. income taxes attributable to pre-tax income were
not provided for during fiscal 2004. Income tax benefits attributable to pre-tax
losses were also not provided for during fiscal 2003 and 2002. This has
significantly impacted our results in each of these years.

During
the fourth quarter of fiscal 2003, we filed a net operating loss carryback claim
related to the carryback of our fiscal year 2001 federal net operating loss to
1996, a year in which we filed our federal income tax return as part of the
AT&T consolidated group. We reached a tentative agreement with the Internal
Revenue Service (the IRS) on September 1, 2004 that allowed for a
tax refund of $816 million (plus statutory interest to the date of payment),
subject to approval by the Congressional Joint Committee on Taxation (the
Joint Committee). The tax benefit related to the claim was not
recognized at that time or prior to that time because it was related to a
complex matter and there was no assurance that the approval from the Joint
Committee would be obtained. On November 8, 2004, we received written
confirmation from the IRS that the Joint Committee approved our tentative
agreement with the IRS and that our agreement with the IRS was final. We were
required to reassess the realizability of our net operating loss carryforwards
as of September 30, 2004, because the Joint Committees final approval was
received prior to the issuance of our consolidated financial statements. As a
result, we recognized an $816 million income tax benefit from the reversal of
valuation allowances and interest income of $45 million during the fourth
quarter of fiscal 2004.

We
expect to receive the refund during fiscal 2005, following completion of the
IRSs audit of our 2001 federal income tax return. The refund will be paid
by the IRS to AT&T and the entire refund amount will become payable by
AT&T to us under our tax sharing agreements with AT&T. We do not believe
there are any other matters that would impact the refund claim.

We
reversed $17 million of valuation allowances related to three non-U.S. tax
jurisdictions during fiscal 2004. We determined that it was more likely than not
that these net deferred tax assets were realizable based upon the income
projections and certain other factors for those jurisdictions. We were not in a
cumulative loss position in these jurisdictions as of September 30, 2004.

We
expect to continue to maintain a full valuation allowance on our remaining net
deferred tax assets until an appropriate level of profitability is sustained, or
we are able to develop tax strategies that would enable us to conclude that it
is more likely than not that a portion of our deferred tax assets will be
realizable.

We
were profitable during all quarters of fiscal 2004 and the fourth quarter of
fiscal 2003. If we continue to generate comparable profits we will no longer be
in a U.S. cumulative loss position by the fourth quarter of fiscal 2005. If this
occurs, we will consider the extent to which we can rely on future income
forecasts to support the realization of our net U.S. deferred tax assets. These
income forecasts will be considered in conjunction with other positive and
negative evidence, including our forecasts of taxable income over the applicable
carryforward periods, our current financial performance, our market
environment, and other factors, in evaluating the need for a full or partial
valuation allowance. Similar analysis will continue to be performed in other
jurisdictions where we are no longer in a cumulative loss position.

F-8

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As
a result, we may determine in fiscal 2005 that it is more likely than not that a
portion of our net deferred tax assets is realizable and a portion of the
valuation allowance should be reversed. Although any reversal of valuation
allowances will favorably impact our results of operations in the period of the
reversal, federal and certain state and non-U.S. income taxes attributable to
pre-tax income will need to be provided for in subsequent periods, which will
reduce net income.

We
assess the likelihood of the ultimate determination of various contingent tax
liabilities that arise in many different tax jurisdictions. These tax matters
can be complex in nature and uncertain as to the ultimate outcome. We establish
reserves for tax contingencies when we believe an unfavorable outcome is likely
to occur and the liability can be reasonably estimated, similar to accounting
for other contingencies. Although we believe these positions are fully
supportable, we consider the likelihood of potential challenges and
sustainability of such challenges upon examination. Changes in our tax reserves
have occurred and are likely to continue to occur as our assessments change
based on current facts and circumstances such as further developments and
progress of tax examinations in various jurisdictions. The net impact of the
reassessments of such changes resulted in the recognition of income tax benefits
of $142 million, $77 million and $82 million during fiscal 2004, 2003 and 2002,
respectively.

Legal
contingencies

We
are subject to proceedings, lawsuits and other claims, including proceedings
under laws and government regulations related to securities, environmental,
labor, product and other matters. These contingencies are often resolved over
long periods of time. We assess the likelihood of any adverse judgments in or
outcomes to these contingencies, as well as potential ranges of possible losses.
Reserves are established when it is probable that a liability has been incurred
or an asset has been impaired and the amount of the loss can be reasonably
estimated based on a detailed analysis of each individual issue, often with the
assistance of outside legal counsel. We also determine whether disclosures are
required for each individual contingency based on this assessment. There are
several hundred contingencies that are currently being assessed. Most of these
contingencies are not currently reserved because we have determined that it is
not probable that a loss has been incurred. New developments, such as a change
in settlement strategy, may change our assessment as to the likely outcome or
potential range of possible losses. Our most significant reserves are related to
our global shareowners settlement and environmental matters that are
discussed in Note 13 to our consolidated financial statements along with our
other significant matters.

In
connection with our global shareowner settlement, we expect to issue warrants to
purchase 200 million shares of our common stock at $2.75 per share. The
estimated fair value of the warrants was $252 million and $161 million as of
September 30, 2004 and 2003, respectively. Key assumptions used to determine the
estimated fair value of the warrants using the Black-Scholes option pricing
model as of September 30, 2004 and 2003, respectively, included the closing
price of our common stock of $3.17 and $2.16, a risk-free interest rate of 3.36%
and 2.42% and volatility of 49.91% and 66.93%. Volatility was based on the
implied volatility (bid) of our publicly traded 2007 option with a $2.50 strike
price. Charges related to the warrants were $91 million and $161 million during
fiscal 2004 and 2003, respectively. Our future results of operations are likely
to be impacted by changes in the estimated fair value of the warrants until they
are issued.

Receivables
and customer financing

We are
required to estimate the collectibility of our trade receivables and notes
receivable. A considerable amount of judgment is required in assessing the
realization of these receivables, including the current creditworthiness of each
customer and the related aging of past due balances. Our reserves are
determined by using percentages applied to certain categories of aged
receivables. We also evaluate specific accounts when we become aware of
information indicating that a customer may not be able to meet its financial
obligations due to a deterioration of its financial condition, lower credit
ratings or bankruptcy. Reserve requirements are based on the best facts
available to us and are re-evaluated and adjusted as additional information is
received. Typically, reserves are reduced only when agings improve or
customer settlement proceeds are recovered. Recoveries are generally the
result of direct negotiations with the customer, resolutions in bankruptcy or
legal actions.

F-9

---

Our
provision for (recovery of) bad debts and customer financings were ($230)
million, ($223) million and $1.3 billion during fiscal 2004, 2003 and
2002, respectively. Receivables of $1.4 billion and $1.5
billion were net of reserves of $110 million and $246 million as of
September 30, 2004 and 2003, respectively. Drawn commitments of
$4 million and $27 million under our
customer-financing program were net of $135 million and
$415 million of reserves as of September 30, 2004 and 2003, respectively.
Additional provisions or recoveries may occur in the future due to
changes in the financial condition of our customers or as settlements of past
due balances are reached.

Inventories

In
assessing the ultimate realization of inventories, we make judgments as to
future demand requirements and compare these with the current or committed
inventory levels. Reserve requirements generally increase as our projected
demand requirements decrease due to market conditions, technological and product
life cycle changes and longer than previously expected usage periods.

We
incurred net inventory charges of $17 million, $56 million and $621 million
during fiscal 2004, 2003 and 2002, respectively. We experienced
significant charges related to changes in required reserves during fiscal
2002 due to changes in strategy, discontinuing
product lines, and rapid weakening of market conditions.
Inventories of $822 million and $632 million were net of reserves of
$720 million and $980 million as of September 30, 2004 and 2003,
respectively. It is possible that changes in inventory reserves may be required
in the future if there is a rapid change in the demand for our products due to
fluctuations in market conditions or to new technological developments.

Business
restructuring

Our
restructuring reserves reflect many estimates, including those pertaining to
employee separation costs, inventory, contractual obligations, facility exit
costs and proceeds from asset sales. We reassess the reserve requirements for
completing each individual plan under our restructuring program at the end of
each reporting period. Actual experience has been and may continue to be
different from these estimates. We have recognized significant reversals or
charges related to revisions of our estimates for certain restructuring plans
initiated in prior periods. Liabilities associated with our restructuring
program were $220 million and $467 million as of September 30, 2004 and 2003,
respectively. Most of the remaining reserve requirements are related to leases
on exited facilities as of September 30, 2004. Facility exit costs of $202
million are expected to be paid over the remaining lease terms, ranging from
several months to 11 years, and are reflected net of expected sublease rental
income of $137 million. Additional charges or reversals may be required if the
expected amount of sublease rental income changes in the future or if other
circumstances change. Refer to Note 2 to our consolidated financial statements
for more information including the impact of restructuring actions on our
results of operations.

Intangible
assets

Our
intangible assets include goodwill and other acquired intangibles of
$434 million, development costs for software to be sold, leased or otherwise
marketed of $284 million and internal use software development costs of $142
million as of September 30, 2004. As a result of the Telica
acquisition in fiscal 2004, we recorded $238 million of goodwill and
acquired intangible assets. Refer to Note 3 to our consolidated financial
statements for information related to the purchase price allocation.

Prior
to October 1, 2002, goodwill and identifiable intangible assets were amortized
on a straight-line basis over their estimated useful lives. With the adoption of
SFAS No. 142 on October 1, 2002, goodwill is no longer amortized but
is tested for impairment annually, or more often, if an event or circumstance
indicates that an impairment loss has been incurred. Other intangible
assets are reviewed for impairment whenever events such as product
discontinuances, plant closures, product dispositions or other changes in
circumstances indicate that the carrying amount may not be recoverable. We
recognized significant impairment charges during fiscal 2003 and 2002, and
similar charges may be required in the future.

---

The
initial goodwill impairment test under SFAS No. 142 was completed
during the first quarter of fiscal 2003 and resulted in no
transitional impairment loss. We assessed the realizability of goodwill related
to our multi-service switching reporting unit within INS during the third
quarter of fiscal 2003 as a result of business decisions to partner with other
suppliers to use their products in our sales offerings. The reporting
units fair value was determined using projected cash flows over a
seven-year period discounted at 15% after considering terminal value and related
cash flows associated with service revenues. The excess of the carrying
amount of the reporting units goodwill over its implied
fair value in the amount of $35 million was recognized as an impairment
charge in the third quarter of fiscal 2003. Annual goodwill impairment tests
completed during the fourth quarter of fiscal 2004 and 2003 did not result in an
impairment loss.

During
fiscal 2002, the continued decline in the telecommunications market prompted a
reassessment of all key assumptions underlying our goodwill valuation judgments,
including those relating to short- and long-term growth rates. As a result of
our analysis, we determined that an impairment charge of $975
million, including $826 million related to goodwill was
required because the forecasted cash flows were less than the
carrying values of certain businesses. The goodwill impairment related primarily
to goodwill recognized in connection with our September 2000 acquisition of
Spring Tide Networks. Fair values were determined on the basis of discounted
cash flows.

We
recognized approximately $200 million of impairment charges related
to capitalized software and $50 million of impairment charges
related to property, plant and equipment during fiscal 2002. These charges
were primarily related to delays and increasing uncertainties in the development
of the universal mobile telecommunications systems (UMTS) market. We
recognized an additional $50 million impairment charge related to
the remaining UMTS capitalized software during fiscal
2003. Software development costs related to UMTS technology were
expensed as incurred during fiscal 2004 and 2003.

RESULTS OF
OPERATIONS

Revenues

|                                                   | Years ended September 30, |  |   |       |  |  |     |   |   |       |  | 
|-------------------------------------------------- | ------------------------- |  | - | ----- |  |  | --- | - | - | ----- |  | 
|(in millions)                                     
|INS                                                |                           |  | $ | 2,984 |  |  | 33  | % | $ | 3,300 |  | 
|Mobility                                           |                           |  |   | 4,007 |  |  | 44  | % |   | 3,080 |  | 
|Services                                           |                           |  |   | 1,932 |  |  | 21  | % |   | 1,840 |  | 
|Optical fiber business                             |                           |  |   |      |  |  |    | % |   |      |  | 
|Other                                              |                           |  |   | 122   |  |  | 2   | % |   | 250   |  | 
|                                                   |                           |  |   |       |  |  |     |   |   |       | 
|Revenues                                           |                           |  | $ | 9,045 |  |  | 100 | % | $ | 8,470 |  | 
|                                                   |                           |  |   |       |  |  |     |   |   |       | 
|U.S.                                               |                           |  | $ | 5,517 |  |  | 61  | % | $ | 5,149 |  | 
|Other Americas (Canada, Caribbean & Latin America) |                           |  |   | 538   |  |  | 6   | % |   | 424   |  | 
|EMEA (Europe, Middle East & Africa)                |                           |  |   | 1,293 |  |  | 14  | % |   | 1,207 |  | 
|APAC (Asia Pacific & China)                        |                           |  |   | 1,697 |  |  | 19  | % |   | 1,690 |  | 
|                                                   |                           |  |   |       |  |  |     |   |   |       | 
|Revenues                                           |                           |  | $ | 9,045 |  |  | 100 | % | $ | 8,470 |  | 
|                                                   |                           |  |   |       |  |  |     |   |   |       | 
|                                                   |                           |  |   |       |  |  |     |   |   |       |  | 

F-11

---

Fiscal 2004
vs. 2003

Revenues
increased by 7% during fiscal 2004, primarily due to a $927 million increase in
Mobility and a $92 million increase in Services, partially offset by a $316
million decline in INS and a $128 million decline in other revenues. The
decrease in other revenues was due to decline in patent licensing revenue. The
segment discussion later in this MD&A contains information on changes in
revenues by segment and product.

The
increase in the United States was primarily due to higher
spending by Verizon Wireless and Sprint to upgrade their CDMA wireless networks
and deploy additional capacity to support subscriber growth. Sales to these two
customers increased by approximately $1.0 billion and accounted for
38% of our consolidated sales during fiscal 2004. The increase in Other Americas
was primarily driven by higher DSL and wireless revenue in Canada,
Mexico and Brazil. The increase in EMEA was primarily due to higher sales of
optical products and UMTS data cards in Europe and sales in Iraq. Revenues from
customers located in China represented 10% and 11% of consolidated revenues
during fiscal 2004 and 2003, respectively.

Our
revenues are subject to fluctuation as a result of changes in customer spending
patterns and short-term capital requirements, as well as the timing of customer
acceptances. The impact of changes in foreign currency rates did not
have a significant effect on our consolidated revenues in all periods presented.

Fiscal 2003
vs. 2002

Revenues
decreased by 31% during fiscal 2003. The significant reduction in capital
spending by large service providers was the primary reason for the decline. The
net decrease in revenues was primarily due to a $1.3 billion decrease in INS, a
$1.4 billion decrease in Mobility, and a $921 million decrease in Services.

The
decline in revenues affected all geographic areas. United States revenues
declined 37% in fiscal 2003, primarily as a result of spending reductions by
large service providers. Other Americas revenues declined in fiscal 2003 by 41%,
primarily due to the economic instability in Latin America. EMEA revenues
declined by 31% compared with the prior period, primarily due to lower spending
for optical networking products, resulting from service provider overcapacity
and to a lesser extent, lower revenues from a long-term project in Saudi Arabia.
Revenues in the APAC region were fairly consistent with the prior period, due to
sales related to a CDMA wireless network build-out in India and ongoing wireline
and wireless build-outs in China.

Gross Margin

|                  | Years ended September 30, |  |   |       |   |  
|----------------- | ------------------------- |  | - | ----- | - | -
|(in millions)    
|Gross margin      |                           |  | $ | 3,779 |   | $
|Gross margin rate |                           |  |   | 42    | % |  

The
most significant costs used in determining our gross margin are the cost of
materials, components and manufacturing that are sourced from third parties.
These costs are negotiated through supply agreements and fluctuate with
changes in sales volume. Employee-related costs,
such as salaries and related benefits associated with services, logistics
and warehousing and other direct supply chain functions, are also
included. Employee-related costs are more fixed in nature and will
not usually fluctuate based on changes in sales volume. However,
employee-related costs may change as a result of actions to align our
resources to market conditions, annual salary or wage increases or
changes in employee benefits, including those related to pension or health
care costs for active employees and retirees. A portion of
employee-related costs are subject to collective bargaining
agreements. To a lesser extent, amortization of software development costs,
certain other overhead items related to IT and facility related costs, as well
as charges associated with warranty and inventory values, are also
used in

F-12

---

determining
gross margin. Most of the costs used in determining gross  margin are included in our
reportable segments.

Our
gross margin rate is subject to fluctuation due to changes in volume, or mix,
the impact of significant inventory-related charges and revisions to estimates
related to long-term contracts. In addition, our gross margin rate may be
impacted by other factors, such as competitive pricing pressures, the initial
impact of sales of next generation products, our efforts in entering emerging
markets and our ability to continue to realize cost reductions.

Fiscal 2004
vs. 2003

The
gross margin rate increased by 11 percentage points in fiscal 2004 from fiscal
2003.

Certain
items accounted for four percentage points of the improvement in the gross
margin rate in fiscal 2004. These items favorably affected the gross margin rate
by approximately one percentage point during fiscal 2004, and negatively
affected the gross margin rate by approximately three percentage points during
fiscal 2003. The changes between periods reflected lower provisions for
slow-moving and obsolete inventories, including inventories associated with
customers experiencing financial difficulties; costs associated with supplier
and customer contract settlements; adjustments to long-term contracts; costs
associated with warranty; and certain customer obligations and product
performance issues.

Sales
volume favorably impacted the gross margin rate by approximately one percentage
point, because the fixed costs were spread over higher revenue
levels.

Lower
intellectual property licensing revenues and higher short- and long-term
employee incentive awards each unfavorably impacted the gross margin rate
by approximately one percentage point.

Cost
reductions and the impact of product and geographic mix accounted for eight
percentage points of improvement in the gross margin rate. Cost reductions were
realized primarily from supply chain rationalization and efficiency gains, as
well as product redesign. We also realized savings from employee workforce
reductions primarily in the Services segment in fiscal 2004. Increased
sales of certain U.S. Mobility products with higher gross margin
contributed to the gross margin rate improvement. Historically, our
Mobility gross margin rate was higher than the INS and
Services gross margin rates. Our gross margin rate was also
higher in the U.S. compared to non-U.S. regions. These trends are expected
to continue in fiscal 2005.

Fiscal 2003
vs. 2002

The
gross margin rate increased by approximately 18 percentage points in fiscal 2003
from fiscal 2002, despite a 31% decline in sales volume.

Inventory
and other charges negatively affected the gross margin rate by approximately
three percentage points during fiscal 2003 and 13 percentage points during
fiscal 2002, resulting in an improvement of 10 percentage points. The higher
charges during fiscal 2002 were primarily related to issues or events
associated with customers experiencing financial difficulties (in some cases,
declaring bankruptcy or becoming insolvent), costs associated with supplier and
customer contract settlements, higher provisions for slow-moving and obsolete
inventory, adjustments to long-term projects and higher than expected costs due
to certain customer obligations and product performance issues.

We
recognized $26 million in reversals and $64 million in charges during
fiscal 2003 and 2002, respectively, for inventory associated with product
line rationalizations and product line discontinuances under our restructuring
program. The inventory reversal had a negligible favorable impact on the gross
margin rate in fiscal 2003 and had a one-percentage point negative impact on the
gross margin rate in fiscal 2002.

F-13

---

The
remaining improvement in the gross margin rate was due to cost reductions
realized from supply chain rationalization and efficiency gains, which accounted
for six percentage points of improvement. We reduced costs across the supply
chain through internal restructuring and efficiencies, product redesign and
resourcing products to lower cost regions. To a lesser extent, the improvement
was due to favorable product mix, including a higher proportion of intellectual
property licensing revenues to total revenues.

Operating
Expenses

|                                                              | Years ended September 30, |  |   |       |   |  
|------------------------------------------------------------- | ------------------------- |  | - | ----- | - | -
|(in millions)                                                
|Selling, general and administrative (SG&A) expenses,        |                           |  |   |       |   |  
|excluding the following two items:                            |                           |  | $ | 1,523 |   | $
|Provision for (recovery of) bad debts and customer financings |                           |  |   | (230  | ) |  
|Amortization of goodwill and other acquired intangibles       |                           |  |   | 3     |   |  
|                                                              |                           |  |   |       |   |  
|SG&A                                                          |                           |  |   | 1,296 |   |  
|Research and development (R&D)                              |                           |  |   | 1,270 |   |  
|In-process research and development (IPR&D)                 |                           |  |   | 14    |   |  
|Goodwill impairment                                           |                           |  |   |      |   |  
|Business restructuring                                        |                           |  |   | (20   | ) |  
|                                                              |                           |  |   |       |   |  
|Operating expenses                                            |                           |  | $ | 2,560 |   | $
|                                                              |                           |  |   |       |   |  

The
most significant cost included in operating expenses is salaries and
related employee benefits associated with selling, general and
product development functions. These employee-related expenses are
usually more fixed in nature and do not fluctuate significantly with short-term
changes in revenue levels, unless there are changes in staffing levels to align
employee resources with market conditions. However, employee related
expenses may change as a result of salary increases or changes in related
benefits, including those related to pension or health
care for active employees and retirees. Salary increases are usually
provided to employees on an annual basis and historically have been between
3% and 4%. Changes in the funding levels of short- and long-term
employee incentive awards may also impact trends between various periods.
To a lesser extent, third party consulting fees and certain other overhead items
such as IT and facility related costs are also included in operating expenses.
Most of the SG&A expenses are included in our global sales organization
and shared services, such as general corporate functions. In
contrast, most of the R&D expenses are directly associated with research and
product development of our wireline and wireless products and included in our
reportable segments.

SG&A
expenses

Fiscal 2004
vs. 2003

Excluding
bad debts and customer financings and amortization of other acquired
intangibles, SG&Aexpenses decreased by $194 million or 11% during
fiscal 2004. The decrease was primarily a result of employee
workforce reductions under our restructuring program and other cost saving
initiatives that limited discretionary spending. Our restructuring program is
complete and is not expected to further reduce SG&A expense levels
during fiscal 2005.

SG&A
included approximately $100 million of higher accruals for short- and
long-term employee incentive awards during fiscal 2004. The comparability
of SG&A levels was also impacted by additional depreciation and
other related charges of $108 million recognized during fiscal 2003 due to the
shortening of the estimated useful lives of several properties that were in the
process of being sold at the time.

F-14

---

Fiscal 2003
vs. 2002

Excluding
provisions for bad debts and customer financings and amortization of goodwill
and other acquired intangibles, SG&Aexpenses decreased by $749
million or 30% during fiscal 2003. The decrease was primarily a result of
employee workforce reductions under our restructuring program and
other cost savings initiatives that limited discretionary spending. These
savings were partially offset by accelerated depreciation and other related
charges discussed above. Most of the SG&A reductions resulted
from lower spending in our global sales organization, shared services such as
general corporate functions and INS.

Provision
for (recovery of) bad debts and customer financings

In the
past, we provided substantial long-term financing to some of our customers as a
condition of obtaining or bidding on infrastructure projects. Such financing
took the form of both commitments to extend credit and third-party financial
guarantees. These commitments were extended to established companies,
as well as start-up companies, and ranged from modest amounts to more than a
billion dollars.  Our overall customer financing exposure, coupled
with the rapid and sustained decline in telecommunications market
conditions, negatively affected our results of operations and cash flows in
fiscal 2002. We may provide or commit to additional customer financings on a
limited basis. Significant recoveries were realized during fiscal 2004 and
2003. Further recoveries or charges may occur in the future.

Fiscal 2004
and 2003

We had
net recoveries of bad debts and customer financings of $230 million and $223
million, during fiscal 2004 and 2003, respectively. These recoveries
included charges for bad debts and customer financings of
$24 million and $100 million during fiscal 2004 and 2003,
respectively. Recoveries were realized from the favorable settlement of certain
fully reserved notes receivable and accounts receivable, significantly lower bad
debt and customer financing exposure and the expiration of certain customer
financing guarantees. Settlements generally occur through debt
workout procedures, including consummation of bankruptcy proceedings.

Fiscal 2002

The
significant provisions reflected in fiscal 2002 were net of recoveries of
$44 million. These provisions were realized due to the deterioration
in the creditworthiness of certain customers as a result of the decline in the
telecommunications market.

Amortization
of goodwill and other acquired intangibles

We
adopted FAS 142 during the first quarter of fiscal 2003. As a result, we no
longer amortize goodwill but test for impairment annually or more often if an
event or circumstance indicates that an impairment may have occurred. Our
goodwill was $373 million as of September 30, 2004.

Amortization
of other acquired intangibles was $3 million, $15 million and $42
million during fiscal 2004, 2003 and 2002, respectively. We expect the
annual amortization of other acquired intangible assets to increase by
approximately $13 million during fiscal 2005 as a result of higher amortization
for intangible assets acquired in the Telica acquisition in the fourth quarter
of fiscal 2004.

R&D

Our
continuing R&D investment is focused on enhancing and expanding our broad
portfolio of leading edge technologies. In Mobility, our R&D investment is
focused primarily on CDMA and UMTS next-generation technologies and includes
expenses associated with UMTS product trials with certain customers. This
investment continues to support our leadership position in spread-spectrum
technology and our development of high-speed mobile data solutions. Our INS
R&D investment supports a broad array of current and next-generation
technologies, including VoIP, metro optical and broadband

F-15

---

networking
solutions.  Together, Mobility and INS share R&D investment in a unified softswitch
platform to support both wireless and wireline applications. Our R&D  investment also
supports reshaping our product portfolio to capture convergence  opportunities and Bell
Labs long-term research programs in such areas as  computer science, materials science
and bioengineering. We believe our current  R&D spending levels and plans are aligned
with current and expected market  opportunities.

R&D
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. The
amortization of these costs was reflected as a cost component in determining our
gross margin. Unamortized software development costs determined to be in excess
of the net realizable value of the product are expensed immediately and
reflected in R&D if such determination is made prior to when the product is
available for general release to the customer.

Costs
capitalized for the development of computer software that will be sold, leased
or otherwise marketed were $258 million, $313 million and $485 million during
fiscal 2004, 2003 and 2002, respectively.  The amortization of these costs
was reflected as a cost component in determining gross margin and amounted to
$281 million, $291 million and $365 million during fiscal 2004, 2003 and 2002,
respectively.

Fiscal 2004
vs. 2003

R&D
expenses decreased by $218 million or 15% in fiscal 2004, primarily due to
employee workforce reductions and product rationalizations under our
restructuring program. Our restructuring program is complete and not expected to
further reduce R&D expenses during fiscal 2005. R&D expenses
included approximately $175 million of higher accruals for
short- and long-term employee incentive awards during fiscal
2004 and a $50 million UMTS impairment charge during fiscal 2003.

Fiscal 2003
vs. 2002

R&D
expenses decreased by $822 million or 36% in fiscal 2003 primarily due to
employee reductions and product rationalizations. Approximately 84% of the
reduction for fiscal 2003 was reflected in INS, due to the greater number of INS
product rationalizations. In addition, R&D expense included impairment
charges of $50 million and $250 million during fiscal 2003 and 2002,
respectively.

In-Process
Research and Development (IPR&D)

IPR&D
charges of $14 million resulted from the acquisition of Telica. Refer to Note 3
to our consolidated financial statements for information regarding the
purchase price allocation.

Goodwill
impairment

Fiscal
2003

Our
business decisions to partner with other suppliers to use their products in our
sales offerings prompted an assessment of the recoverability of certain goodwill
associated with the multi-service switching reporting unit within INS during the
third quarter of fiscal 2003. The excess of the carrying amount of the reporting
units goodwill over its implied fair value was recognized as a $35 million
impairment charge.

Fiscal
2002

The
continued, sharper decline in the telecommunications market prompted an
assessment of all key assumptions underlying goodwill valuation judgments,
including those related to short- and long-term growth rates. The excess of the
carrying amount over the estimated fair value of the goodwill previously
recognized in connection with the acquisition of Spring Tide was recognized as
an $826 million impairment charge.

F-16

---

Business
restructuring

|                                      | Years ended September 30, |  |      |      |      |  
|------------------------------------- | ------------------------- |  | ---- | ---- | ---- | -
|(in millions)                         | 2004                      |  | 2003 |      | 2002 |  
|Employee separations                  |                           |  | $    | (14  | )    | $
|Contract settlements                  |                           |  |      | (15  | )    |  
|Facility closings                     |                           |  |      | 12   |      |  
|Other                                 |                           |  |      | (3   | )    |  
|                                      |                           |  |      |      |      |  
|Restructuring costs (reversals)       |                           |  |      | (20  | )    |  
|Asset write-downs                     |                           |  |      | 1    |      |  
|Net gains on sales                    |                           |  |      | (1   | )    |  
|Impairment of goodwill                |                           |  |      |     |      |  
|Impairment of other intangible assets |                           |  |      |     |      |  
|                                      |                           |  |      |      |      |  
|Net charge (reversal)                 |                           |  | $    | (20  | )    | $
|                                      |                           |  |      |      |      |  
|Included in:                          |                           |  |      |      |      |  
|Costs                                 |                           |  | $    |     |      | $
|Operating expenses                    |                           |  |      | (20  | )    |  
|Goodwill impairment                   |                           |  |      |     |      |  
|                                      |                           |  |      |      |      |  
|Total                                 |                           |  | $    | (20) |      | $
|                                      |                           |  |      |      |      |  

During
the second quarter of fiscal 2001, we committed to and began implementing a
restructuring program to realign resources to market conditions and
focus on the large service providers. We assessed our product
portfolio and associated R&D, and then streamlined the rest of
our operations to support those reassessments. We eliminated some marginally
profitable or non-strategic product lines, merged certain technology platforms,
consolidated development activities, eliminated management positions and many
duplications in marketing functions and programs, centralized our sales support
functions and sold or leased certain of our manufacturing facilities and made
greater use of contract manufacturers. We sold or disposed of the assets related
to the eliminated product lines, closed facilities and reduced the employee
workforce on a global basis.

Since
the inception of the restructuring program, we reduced our employee
workforce by approximately 74,200 employees, to approximately 31,800
employees as of September 30, 2004 (including the impact of attrition and other
employee workforce reductions in the ordinary course of business). In
addition, the restructuring plans included the exit of a
significant number of owned and leased facilities, totaling approximately 15.9
million square feet. All of these sites were exited as of
September 30, 2003.

We
have completed the restructuring actions but continue to evaluate the remaining
restructuring reserves at the end of each reporting period. Additional
charges or reversals may be required if the expected amount of sublease rental
income changes in the future or if other circumstances change.

Refer
to Note 2 to our consolidated financial statements for additional details on our
business restructuring program.

Fiscal 2004

The
net reversals were primarily related to employee separations and net contract
settlements for amounts lower than originally estimated. Net facility-closing
charges were due to changes in estimated costs and
reductions in expected sublease rental income.

Fiscal 2003

The
net reversals were primarily related to actual termination benefits and
curtailment costs for employee separations that were lower than the estimated
amounts due to certain differences in actual versus assumed demographics,
including age, service lives and salaries of the separated employees. In
addition, net contract settlement reversals were related to the settlement of
certain contractual obligations and purchase commitments for amounts lower than
originally estimated. Facility closing charges were primarily due to lower
estimates for expected sublease rental income on certain properties, offset by
reversals resulting from negotiated settlements for lower amounts
than originally planned on certain

F-17

---

properties. The
adjustments to prior asset  write-downs included changes to original plans for certain
owned facility  closings and reversals of inventory reserves as we utilized more
discontinued  product inventory than anticipated.

Fiscal 2002

The
net charges primarily related to additional employee workforce
reductions; revisions to facility closings as a result of changes in estimates
for the amount and timing of expected sublease rental income; net asset
write-downs primarily related to property, plant and equipment, capitalized
software and inventory associated with additional product exits and the
disposition of a manufacturing facility. The net gains on sales were related to
business dispositions including the enterprise professional services business
and the billing and customer care business.

Pension,
Postretirement and Postemployment Benefits

|                                                              | Years ended September 30, |  |      |        |      |  
|------------------------------------------------------------- | ------------------------- |  | ---- | ------ | ---- | -
|(in millions)                                                 | 2004                      |  | 2003 |        | 2002 |  
|Pension benefit credit                                        |                           |  | $    | (1,111 | )    | $
|Postretirement benefit cost                                   |                           |  |      | 243    |      |  
|Postemployment benefit cost (credit)                          |                           |  |      | 40     |      |  
|                                                              |                           |  |      |        |      |  
|Net pension, postretirement and postemployment benefit credit |                           |  | $    | (828   | )    | $
|                                                              |                           |  |      |        |      |  
|Included in:                                                  |                           |  |      |        |      |  
|Business restructuring                                        |                           |  | $    |       |      | $
|Other costs and expenses                                      |                           |  |      | (828   | )    |  
|Discontinued operations                                       |                           |  |      |       |      |  
|                                                              |                           |  |      |        |      |  
|Net credit                                                    |                           |  | $    | (828   | )    | $
|                                                              |                           |  |      |        |      |  

We
maintain defined benefit pension plans covering the majority of employees and
retirees, as well as postretirement benefit plans for U.S. retirees that include
health care, dental benefits and life insurance coverage. Additionally, we offer
various postemployment benefits to certain employees after employment but before
retirement, including disability benefits, severance pay and workers
compensation. Refer to Note 9 to the consolidated financial statements for
further information.

Excluding
the amounts reflected in business restructuring and discontinued
operations, approximately two-thirds of the net credit is reflected in
operating expenses, with the balance in costs used to determine our gross
margin.

The
changes in the net credit during fiscal 2004 compared to fiscal 2003
were due to the net impact of the following items:

| |  | Revised estimates of termination benefits and curtailments during fiscal
2003 that related to restructuring actions.
|- |  | --------------------------------------------------------------------------------------------------------------------

| |  | Elimination
of certain pension death benefits and  reductions in certain retiree health
care benefits.
|- |  | ------------------------------------------------------------------------------------------------------

| |  | Reduction in the discount rate from 6.5% to 5.75%.
|- |  | --------------------------------------------------

| |  | Reduction in the market-related value of plan assets due to the impact of
actual losses incurred on plan assets during fiscal  2002 and
2001.
|- |  | ---------------------------------------------------------------------------------------------------------------------------------------------

| |  | Accelerated gain amortization related to postemployment benefits
during fiscal 2003.
|- |  | ------------------------------------------------------------------------------------

| |  | Initial
recognition of the  prescription  drug benefit under Medicare Part D of the Medicare
Prescription  Drug  Improvement and  Modernization  Act of 2003 (the Act) and
expected  reduction in plan  participation  rates as a result of recent  experience  and
the Act.
|- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F-18

---

The
changes in the net credit during fiscal 2003 compared to fiscal 2002
were due to the net impact of the following items:

| |  | Significant termination benefits and curtailments related to restructuring
actions during fiscal 2002.
|- |  | ------------------------------------------------------------------------------------------------------

| |  | Employee
workforce reductions associated with our restructuring actions.
|- |  | ------------------------------------------------------------------------

| |  | Reduction
in the discount rate from 7.0% to 6.5%.
|- |  | -------------------------------------------------

| |  | Reduction
in the market  related  value of plan assets and a reduction in the expected  rate of
return on plan assets from 9.0% to  8.75%.
|- |  | ------------------------------------------------------------------------------------------------------------------------------------------

| |  | Accelerated gain amortization related to postemployment benefits
during fiscal 2003.
|- |  | ------------------------------------------------------------------------------------

We
expect the net credit will decrease by approximately $200 million
during fiscal 2005, primarily due to negative asset returns during
fiscal 2001 and 2002 which continue to reduce
the market related value of plan assets, the reduction in
the expected rate of return on pension plan assets from 8.75% to
8.5%, and the impact of the tentative collective bargaining agreement, if
ratified.

Other Income
(Expense), Net and Interest Expense

|                                                      | Years ended September 30, |  |   |     |   |  
|----------------------------------------------------- | ------------------------- |  | - | --- | - | -
|(in millions)                                        
|Legal settlements                                     |                           |  | $ | (84 | ) | $
|SEC settlement                                        |                           |  |   | (25 | ) |  
|Debt conversion cost and gain on extinguishments, net |                           |  |   | (7  | ) |  
|Gain on sales of businesses, net                      |                           |  |   |    |   |  
|Gain (loss) on sale of investments                    |                           |  |   | 75  |   |  
|Interest income                                       |                           |  |   | 89  |   |  
|Interest income on tax settlements                    |                           |  |   | 135 |   |  
|Gain (loss) on foreign currency transactions          |                           |  |   | (10 | ) |  
|Other-than-temporary write-down of investments        |                           |  |   | (22 | ) |  
|Other, net                                            |                           |  |   | 89  |   |  
|                                                      |                           |  |   |     |   |  
|Other income (expense), net                           |                           |  | $ | 240 |   | $
|                                                      |                           |  |   |     |   |  
|Interest expense                                      |                           |  | $ | 396 |   | $
|                                                      |                           |  |   |     |   |  

Other income (expense)

Fiscal 2004

We
recognized charges of $56 million related to the shareowner lawsuit
settlement, including $91 million related to changes in the estimated
fair value of the warrants that are expected to be issued. These
changes are primarily caused by the market price of our common stock
and are likely to continue until the warrants are issued. We also
recovered $40 million from fiduciary insurance carriers and recognized a $5
million charge related to changes in the fair value of our common stock that
was deposited into escrow and subsequently sold. The remaining legal
settlement charges of $28 million were primarily related to Y2K
claims under our separation agreement with Avaya and the prior period sale of
our consumer products business. Refer to Note 13 to our consolidated
financial statements for more information on legal settlements.

We
reached an agreement with the SEC and paid a $25 million fine in
connection with the SECs investigation into our revenue recognition issues
previously identified in November and December of 2000. The final judgment and
consent decree to settle the investigation with the SEC was entered into
during May 2004.

F-19

---

The
gain on sale of an investment was primarily related to the maturity of a forward
contract for the sale of Corning common stock we owned. We obtained the shares
of Corning in connection with the sale of certain joint ventures associated with
OFS in fiscal 2002.

Interest
income on tax settlements was due primarily to the favorable resolution of
certain prior year federal income tax audits and the recognition of a federal
net operating loss carryback claim under tax sharing agreements with
AT&T, Avaya and Agere. Refer to Note 7 to our consolidated
financial statements for further information on these tax matters.

Fiscal 2003

Legal
settlements included a $481 million charge for the settlement of purported class
action lawsuits and other lawsuits against us and certain of our current and
former directors and officers for alleged violation of federal securities laws,
as well as for ERISA, and related claims. The charge included $315 million for
payment in cash, stock or a combination of both; warrants, originally valued at
$95 million, which increased to $161 million during fiscal 2003 as a result of a
change in their estimated fair value; and $5 million in administrative fees.
Partially offsetting the charge was an $80 million reserve reduction for a legal
settlement associated with our former consumer products leasing business, due to
lower than anticipated claims experience.

The
debt conversion cost and gain on extinguishments was a result of the exchange of
a portion of 7.75% trust preferred securities and certain other debt obligations
for shares of our common stock and cash. Refer to Note 8 to our
consolidated financial statements for more information on these exchanges,
including the number of securities exchanged.

The
other-than-temporary write-down of investments was due to
sustained weakness in the private equity markets. Refer to the section
Quantitative and Qualitative Disclosures About Market Risk for a
discussion of Equity Price Risk.

The
gain on sales of businesses included $41 million of business disposition reserve
reversals, primarily associated with the resolution of contingencies related to
the sale of OFS.

Fiscal 2002

Other
income (expense) included $725 million of gains from business dispositions, $664
million of which was from the sale of the OFS business and China joint ventures,
and interest income of $187 million, including $73
million related to the favorable resolution of federal income tax audits.
This was partially offset by a legal settlement of $162 million related to our
former consumer products leasing business, a $50 million purchase
price adjustment to settle a claim with VTech Holdings Limited and VTech
Electronics Netherlands B.V., and other-than-temporary investment write-downs of
$209 million, primarily related to an investment in Commscope.

Interest
Expense

Fiscal 2004
vs. 2003

Interest
expense increased by $43 million during fiscal 2004, primarily due to the
exchange of our 8.00% redeemable convertible preferred stock for 8.00%
subordinated debentures in November 2003. The impact of additional interest on
the 2.75% convertible securities that were issued in the third
quarter of fiscal 2003 was largely offset by our debt
recapitalization efforts.

Fiscal 2003
vs. 2002

Interest
expense decreased by $29 million due to lower borrowings and amortization of
fees related to a terminated credit facility, partially offset by higher average
outstanding balances related to our trust preferred securities.

F-20

---

Income Taxes

Fiscal
2004

The  tax
benefit of $939 million during  fiscal 2004 included the  impact of  maintaining
a valuation allowance on substantially  all of our net deferred tax assets. As
a result, federal and certain  state and non-U.S. income taxes attributable to
pre-tax income were  not provided. Refer to the Application
of Critical  Accounting  Estimates included in this MD&A and Note
7 to our consolidated financial statements for more detail regarding income  taxes.

The  tax
benefit also included current tax  expense related to certain non-U.S.  operations
and discrete items. The discrete  items included the
recognition of an $816  million net operating loss carryback claim
 and $142 million primarily related to the net
favorable  resolution of income tax  audits for years 1990 through
1998. We also recognized interest income of $135 million  related
to these items.

The
United States Congress passed the  American Jobs Creation Act of 2004  (the
 Jobs Creation Act), which the President  signed into
law on October 22, 2004. Key  provisions of the Jobs  Creation Act include
 a temporary incentive for United States  multinational
corporations to repatriate  foreign earnings, a  domestic manufacturing  deduction
and international tax reforms   designed to improve the global  competitiveness
of United  States  businesses. Our review of the Jobs Creation  Acts
provisions and our tax positions  indicates that it  will not have a material
 effect on our financial condition or  results  of operations
during fiscal 2005.

Fiscal
2003

The  tax
benefit of $233 million during  fiscal 2003 included the  impact of  maintaining
a full valuation allowance on our net  deferred tax assets and current tax expense,
primarily related to certain  non-U.S. operations, and several discrete items. Federal
and certain state  and  non-U.S. income tax benefits attributable to  pre-tax
losses were not provided. The discrete items included the realization of  $213
million in tax benefits from fully-reserved net operating losses as a  result of
carryback claims for taxes paid in prior years, principally by  previously merged
companies and our former foreign sales corporation. In  addition, a $77 million tax
benefit was recognized as a result of an expected  favorable resolution of certain tax
audit matters.

Fiscal
2002

The  provision
for income taxes of $4.8  billion during fiscal  2002 was primarily due to a charge for a
full valuation allowance on our net  deferred tax assets.  At that time, several
significant developments were  considered in determining the need for a full valuation
allowance, including the  continuing severe market decline, uncertainty and lack of
visibility in the  telecommunications market as a whole, a significant decrease in
sequential  quarterly revenue levels, a decrease in sequential earnings after several
quarters of sequential improvement, and the possible need for further  restructuring and
cost reduction actions to attain profitability. As a  result, federal and certain state
and  non-U.S. income tax benefits  attributable  to pre-tax losses were not provided.

F-21

---

RESULTS
OF OPERATIONS BY SEGMENT

INS

|                            | Years ended September 30, |  |   |       |   |   |       |   |   |      
|--------------------------- | ------------------------- |  | - | ----- | - | - | ----- | - | - | -----
|(in millions)              
|Voice networking            |                           |  | $ | 1,336 |   | $ | 1,560 |   |   | (14  
|Data and network management |                           |  |   | 933   |   |   | 1,034 |   |   | (10  
|Optical networking          |                           |  |   | 715   |   |   | 706   |   |   | 1    
|                            |                           |  |   |       |   |   |       |   |   |      
|Total revenues              |                           |  | $ | 2,984 |   | $ | 3,300 |   |   | (10  
|                            |                           |  |   |       |   |   |       |   |   |      
|U.S.                        |                           |  | $ | 1,490 |   | $ | 1,754 |   |   | (15  
|Non-U.S.                    |                           |  |   | 1,494 |   |   | 1,546 |   |   | (3   
|                            |                           |  |   |       |   |   |       |   |   |      
|Total revenues              |                           |  | $ | 2,984 |   | $ | 3,300 |   |   | (10  
|                            |                           |  |   |       |   |   |       |   |   |      
|Gross margin %              |                           |  |   | 35    | % |   | 27    | % |   | 8 pts
|                            |                           |  |   |       |   |   |       |   |   |      
|Segment income (loss)       |                           |  | $ | 345   |   | $ | 102   |   | $ | 243  
|                            |                           |  |   |       |   |   |       |   |   |      
|Return on sales             |                           |  |   | 12    | % |   | 3     | % |   | 9 pts
|                            |                           |  |   |       |   |   |       |   |   |      

Fiscal 2004
vs. 2003

INS
revenues declined by $316 million due primarily to a significant reduction in
sales to AT&T as it completed certain capital spending programs in prior
periods and reduced its annual spending during fiscal 2004. Five
customers accounted for approximately 39% and 40% of INS revenues during fiscal
2004 and 2003, respectively. Lower non-U.S. sales were primarily in APAC,
including China, as a result of competitive pricing pressures and the timing of
completing certain project deployments. The decreases in APAC sales
were primarily prevalent in the data and network management and optical
product lines.

Voice
networking revenues declined by $224 million due to lower circuit switching
product sales. Traditional circuit switching product sales
are currently declining at a faster rate than the growth in next generation
technologies. The decline is also more prevalent in the U.S., where
certain customers are shifting their spending to other areas, such as
broadband access (DSL). Circuit switching represented approximately
42% and 52% of voice networking revenues during fiscal 2004 and 2003,
respectively. Beginning in fiscal 2004, INS voice networking revenues
include an allocation of revenue earned from switching equipment common platform
sales to Mobility customers. This attribution is intended to better match
revenue from these common platforms with the underlying R&D investment. The
revenue impact to voice networking results for fiscal 2004 was $85 million.
Data and network management revenues declined $101 million due primarily
to lower revenues from multi-service switching products. Optical networking
revenues increased by $9 million as higher sales of
metro-optical products in the U.S. and EMEA, offset lower revenues from legacy
optical products. We believe that we have transitioned most of our optical
product contracts with key customers to next generation optical products.

Although
customer-spending levels for INS products are not expected to change
significantly in the aggregate, the mix of what they purchase is likely to
continue to change or fluctuate. Our future revenues will be impacted by our
success in offering a product portfolio that effectively addresses customer
needs. Quarterly revenues declined sequentially each quarter except
in the fourth quarter and ranged from $715 million to $790 million
during fiscal 2004. We expect that our quarterly revenue levels will remain
volatile as customers carefully consider alternatives in transitioning to next
generation networks.

F-22

---

Segment
income improved by $243 million. This improvement was driven by a $143 million
increase in gross margin and a $100 million decrease in operating expenses. The
higher gross margin was due to an eight-percentage point increase in
the gross margin rate, which more than offset the impact of lower
revenues. The increase in the gross margin rate primarily resulted from
certain items, including lower inventory- and warranty-related
charges that accounted for four percentage points of the improvement
and continued cost reductions. R&D and SG&A expenses declined
due to the impact of restructuring actions during fiscal 2003.
However, segment operating expenses included charges of $23 million
related to the Telica acquisition for IPR&D, employee compensation expense and
amortization of intangible assets during fiscal 2004.

Fiscal 2003
vs. 2002

INS
revenues declined by $1.3 billion. The $690 million decline in the U.S. was due
to reductions and delays in capital spending by large telecommunications service
providers. The $609 million decline in the non-U.S. regions was particularly
concentrated in EMEA and APAC. In EMEA, revenues decreased by $303 million as
certain European service providers responded to excess network capacity,
principally within the optical area. To a lesser extent, the decline was also
due to the timing of revenues associated with several projects in China.

Voice
networking revenues declined by $562 million due to lower circuit switching
product sales. Data and network management revenues declined by $98 million due
to a decrease in access networking revenues. Optical networking revenues
declined by $639 million, primarily related to lower sales of long-haul
products, as service providers in Europe and the U.S. responded to excess
network capacity.

Segment
income improved by $1.8 billion. This improvement was driven by a $961 million
increase in gross margin, despite lower sales volume, and an $834 million
decrease in operating expenses. The gross margin rate increased by 28 percentage
points primarily due to lower inventory-related charges, that
accounted for 12 percentage points of the improvement, and continued cost
reductions from supply chain rationalization and efficiency gains. The remaining
improvement in the gross margin rate was due to a more favorable product mix.
The lower operating expenses were due to the restructuring program and less
discretionary spending, of which over 80% was from lower R&D spending
resulting from product rationalizations.

Mobility

|                | Years ended September 30, |  |   |       |   |   |       |   |   |       
|--------------- | ------------------------- |  | - | ----- | - | - | ----- | - | - | ------
|(in millions)  
|U.S.            |                           |  | $ | 2,843 |   | $ | 2,116 |   |   | 34    
|Non-U.S.        |                           |  |   | 1,164 |   |   | 964   |   |   | 21    
|                |                           |  |   |       |   |   |       |   |   |       
|Total revenues  |                           |  | $ | 4,007 |   | $ | 3,080 |   |   | 30    
|                |                           |  |   |       |   |   |       |   |   |       
|Gross margin %  |                           |  |   | 51    | % |   | 40    | % |   | 11 pts
|                |                           |  |   |       |   |   |       |   |   |       
|Segment income  |                           |  | $ | 1,240 |   | $ | 173   |   | $ | 1,067 
|                |                           |  |   |       |   |   |       |   |   |       
|Return on sales |                           |  |   | 31    | % |   | 6     | % |   | 25 pts
|                |                           |  |   |       |   |   |       |   |   |       

Fiscal
2004 vs. 2003

Mobility
revenues increased $927 million. U.S. revenues increased $727 million due
primarily to higher CDMA sales to Verizon Wireless and Sprint as they
continued to upgrade their wireless networks and deploy additional capacity
to support subscriber growth. These two customers accounted for 61%
and 52% of total Mobility revenues during fiscal 2004 and fiscal 2003,
respectively. Including these two customers, five customers accounted for
approximately 80% and 74% of Mobility revenues during fiscal 2004 and 2003,
respectively. The $200 million increase in the non-U.S. regions was
primarily due to higher UMTS data card sales in EMEA and higher CDMA
sales in APAC and other Americas as certain customers
continued to expand their networks.

F-23

---

Quarterly
revenues ranged from $951 million to $1.1 billion during fiscal 2004. Although
the quarterly revenues during fiscal 2004 have been more stable than in prior
years, future quarterly revenue trends remain volatile as a result of the high
concentration of revenue among a limited number of customers and shifts in
their spending patterns, as well as the timing of revenue
recognition related to long-term contracts.

Approximately
91% of the fiscal 2004 wireless product revenue was derived from CDMA
technology. We continue to conduct third-generation UMTS/W-CDMA trials in
the U.S. and China. We expect certain customers to continue to
increase investments in mobile high-speed data equipment during fiscal 2005.

Segment
income improved by $1.1 billion. This
improvement was driven by an $820 million increase in gross margin
and a $247 million decrease in operating expenses. Gross margin increased due to
higher sales volume and an 11 percentage point increase in the gross margin
rate. The increase in the gross margin rate was driven by favorable product and
geographic mix, continued cost reductions, lower inventory and
warranty charges and better absorption of fixed costs due to the higher
revenues. R&D and SG&A expenses declined primarily due
to the impact of restructuring actions and relocating certain
activities to areas with lower cost structures. We also recognized a
$50 million impairment charge for UMTS capitalized software during
fiscal 2003. UMTS software development costs continued to be
expensed as incurred. Lower R&D expenses accounted for 85% of the decrease
in operating expenses.

Fiscal 2003
vs. 2002

Mobility
revenues decreased $1.4 billion.  The decrease resulted from reductions in
capital spending, primarily in the U.S., as large service providers
continued to preserve capital resources. The decline in U.S. revenues were also
attributable to two large service providers, AT&T Wireless and Cingular,
which selected alternatives to our TDMA technologies. Revenues from these two
customers represented 7% and 21% of Mobility sales during fiscal 2003 and 2002,
respectively, and the decline in revenues attributable to these two customers
represented 51% of the Mobility revenue decline in the U.S. during
fiscal 2003. Non-U.S. revenues increased by $98 million during fiscal 2003,
primarily as a result of large CDMA network build-outs in the APAC region,
primarily in China and India. Quarterly revenues ranged from $624 million to
nearly $1.1 billion during fiscal 2003. Approximately 85% of our wireless
product revenue was derived from CDMA technology.

Segment
income improved by $171 million. The improvement was due to a $177
million decrease in operating expenses, partially offset by a $6 million decline
in gross margin. Despite the decline in revenues, gross margin was consistent
with the fiscal 2002 level. The gross margin rate increased by 12 percentage
points in fiscal 2003. The higher gross margin rate was due to lower
inventory-related charges, that accounted for eight percentage points
of the improvement, supply chain rationalization and efficiency gains, and, to a
lesser extent, favorable product mix. The lower operating expenses reflected a
$160 million decline in R&D expenses. This decline included
a $100 million net impact of UMTS asset impairment charges
of $50 million and $250 million during fiscal 2003 and 2002, respectively,
as well as expensing UMTS development costs as incurred during fiscal
2003. The remainder of the operating expense decline was primarily due to cost
reductions realized from our restructuring program and lower discretionary
spending.

F-24

---

Services

|                | Years ended September 30, |  |   |       |   |   |       |   |   |      
|--------------- | ------------------------- |  | - | ----- | - | - | ----- | - | - | -----
|(in millions)  
|U.S.            |                           |  | $ | 1,063 |   | $ | 1,006 |   |   | 6    
|Non-U.S.        |                           |  |   | 869   |   |   | 834   |   |   | 4    
|                |                           |  |   |       |   |   |       |   |   |      
|Total revenues  |                           |  | $ | 1,932 |   | $ | 1,840 |   |   | 5    
|                |                           |  |   |       |   |   |       |   |   |      
|Gross margin %  |                           |  |   | 25    | % |   | 19    | % |   | 6 pts
|                |                           |  |   |       |   |   |       |   |   |      
|Segment income  |                           |  | $ | 282   |   | $ | 225   |   | $ | 57   
|                |                           |  |   |       |   |   |       |   |   |      
|Return on sales |                           |  |   | 15    | % |   | 12    | % |   | 3 pts
|                |                           |  |   |       |   |   |       |   |   |      

Fiscal 2004
vs. 2003

Services
revenues increased by $92 million. Revenues increased in the U.S. by $57 million
and in the non-U.S. regions by $35 million. Five customers accounted for
approximately 38% and 36% of Services revenues during fiscal 2004 and 2003,
respectively. Quarterly revenues ranged from $466 million to $514 million
during fiscal 2004.

The
increase in revenues was due to higher maintenance and professional services.
Professional services increased primarily due to new government contracts. Our
traditional installation services decreased as a result of competitive pricing
pressures, more customer self-installation, and lower wireline product sales.
Deployment services related to researching, selecting and preparing sites for
placement of our customers wireless equipment have partially offset the
decrease in traditional installation services.

Segment
income increased by $57 million. This improvement was due to a $139 million
increase in gross margin, partially offset by an $82 million increase in
operating expenses. The higher gross margin resulted from an increase in the
gross margin rate and to a lesser extent higher revenues. The gross margin rate
increased by six-percentage points as a result of employee workforce
reductions. Operating expenses increased due to higher sales and
marketing expenses in order to expand worldwide service offerings.

Fiscal 2003
vs. 2002

Services
revenues declined by $921 million.  Revenues declined in all regions except
APAC, due to a large project in China. The decline in U.S. revenues was
primarily due to lower deployment services for large service providers.

Deployment
services accounted for approximately 85% of the total Services decline. These
services declined primarily due to lower sales of wireline equipment requiring
installation. Competitive pricing pressures have also adversely affected
deployment services.

Segment
income decreased by $2 million. This decline was due to a $27 million decline in
gross margin, partially offset by a $25 million decrease in operating expenses.
The services gross margin rate increased by five-percentage points in fiscal
2003. The gross margin rate improvement was primarily due to a larger proportion
of services revenues being derived from maintenance services, which historically
have higher gross margin rates than engineering and installation services, and
significant cost reduction efforts aimed at aligning our cost structure with
market opportunities. The operating expense decrease was primarily due to
employee workforce reductions under our restructuring program and
lower discretionary spending.

F-25

---

LIQUIDITY
AND CAPITAL RESOURCES

Cash flow overview

Cash,
cash equivalents and marketable securities increased $366 million
during fiscal 2004 to $4.9 billion, primarily from $634 million of cash
provided by operating activities and $276 million of proceeds from
common stock issued for certain employee benefit plans, partially
offset by the repayment of certain debt obligations and convertible securities
of $500 million.

Operating
activities

Operating
activities provided $634 million of cash during fiscal 2004. This
primarily resulted from net income of $1.4 billion
(adjusted for non-cash items of $587 million) offset by changes in
other operating assets and liabilities of $799 million.
The changes in other operating assets and liabilities included an
increase in other current assets related to an $861 million income tax refund
that is expected to be received during fiscal 2005 and cash outlays for our
restructuring program of $227 million and capitalized software of $258 million
that were partially offset by the impact of certain insurance and customer
settlements and customer financing recoveries of approximately $600
million. Cash flow from operating activities also included
net proceeds from tax refunds of $118 million (including related
interest). Operating activities used approximately $1.0 billion of
cash during fiscal 2003. The improvement in cash flow from
operating activities during fiscal 2004 as compared with fiscal 2003
was primarily due to improved financial results driven by cost reductions,
higher settlements and recoveries, and lower cash outlays for
business restructuring.

Changes
in working capital requirements (receivables, inventories and contracts in
process, accounts payable and deferred revenue) provided $18 million of cash
during fiscal 2004. We periodically sell certain non-U.S.
receivables with extended payment terms where it is cost effective to do so. We
sold $468 million of receivables during fiscal 2004, of which
$263 million was due after September 30, 2004.
This impact is reflected in the change in
receivables. We also commit to extended billing terms on a limited basis, of
which $232 million was outstanding as of September 30, 2004. Our days
sales outstanding was 51 days and inventory turnover was
6.9 as of September 30, 2004.

Generally,
working capital requirements will increase or decrease with changes in quarterly
revenue levels. Our working capital requirements have also been reduced through
more favorable billing terms, collection efforts and streamlined supply chain
operations. In addition to changes in working capital, the timing of certain
payments will also impact our quarterly cash flow. For example, while employee
incentive awards are accrued throughout the fiscal year, they are usually paid
during the first quarter of the subsequent fiscal year. The fiscal 2004 annual
incentive awards of approximately $600 million are expected to be paid during
the first quarter of fiscal 2005.

Operating
activities used $948 million of cash during fiscal
2003. This primarily resulted from a net loss of $566
million (adjusted for non-cash items of $204 million) and changes in
other operating assets and liabilities of $931 million. This was
partially offset by a reduction in working capital requirements of
$549 million. The reduction in working capital was due to the
decrease in sales volume during the fourth quarter of fiscal 2003 compared with
the fourth quarter of fiscal 2002. The changes in other operating assets and
liabilities include cash outlays for our restructuring program of $629 million
and capitalized software of $313 million.

F-26

---

Operating
activities used $756 million of cash during fiscal
2002.  This primarily resulted from a loss from continuing operations
of $2.9 billion (adjusted for non-cash items of $8.9 billion) and changes
in other operating assets and liabilities of $1.6 billion, offset in
part by a reduction in working capital requirements of $3.7
billion.  The reduction in working capital primarily resulted from the
significant decrease in sales volume during fiscal 2002 compared with fiscal
2001. In addition to the effect of reduced sales volume, the decline in
inventory and contracts in process was also a result of our continued efforts to
streamline supply chain operations and accelerate billings for our long-term
contracts.  The changes in other operating assets and liabilities include
cash outlays under our restructuring program of $1.0 billion and a reduction in
other operating assets and liabilities due to the decrease in sales volume and
employee workforce. Federal and state income tax refunds amounted to
approximately $1.0 billion, including $616 million received in connection with
changes in tax legislation.

Investing
activities

Investing
activities used $869 million of cash during fiscal 2004. These activities
included net purchases of marketable securities of $821 million and capital
expenditures of $157 million, of which $54 million was for internal use
software. Partially offsetting these cash outflows were cash proceeds of $63
million from the sale of certain manufacturing and real estate
facilities in the United States and China. We do not expect to
receive any significant cash proceeds from business or asset dispositions in the
near future. We may continue to purchase marketable securities in an attempt to
improve our investment returns.

Investing
activities provided $758 million of cash during fiscal
2003. This was primarily due to net maturities of marketable
securities of $845 million, proceeds from the sale of facilities of $158
million and the sale of certain other investments of $78 million. Capital
expenditures were $291 million, which included $102 million for the repurchase
of certain real estate under a synthetic lease agreement that was previously
used to fund certain real estate construction costs. In addition, we purchased
the remaining 10% minority interest in AG Communication
Systems for $23 million.

Investing
activities provided $757 million of cash during fiscal
2002. This was primarily from the $2.6 billion of net cash proceeds
received from the disposition of businesses and the sale of certain
manufacturing operations, partially offset by $1.5 billion of purchases of
marketable securities and $449 million of capital expenditures. Cash proceeds
from dispositions primarily included the $2.1 billion received from the sale of
our OFS business, $60 million from the sale of our voice enhancement and echo
cancellation business, $93 million from the sale of New Venture Partners II LP,
$250 million from the sale of our billing and customer care business and $96
million from the sale of certain manufacturing operations.

Financing
activities

Financing
activities used $239 million of cash during fiscal 2004.  We used $500
million of cash to repay or repurchase certain debt obligations and convertible
securities, including $249 million under our recapitalization
program and $216 million of variable interest notes related to our Insured
Special Purpose Trust. We also received net proceeds of $276 million from
the issuance of 91 million common shares for certain employee
benefit plans.

Financing
activities provided $1.1 billion of cash during fiscal
2003. This was primarily from the issuance of 2.75% Series
A and Series B convertible senior debentures for a net amount of $1.6
billion.  A portion of these proceeds were used to repay or retire certain
debt obligations and convertible securities, all of which had higher interest or
dividend rates than the debentures issued (the remainder of the proceeds
were used for general corporate purposes). Specifically, we paid
approximately $500 million toward these obligations, including the prepayment of
$240 million of a mortgage loan for three of our primary facilities, retirement
of $176 million of certain other long-term debt obligations and $69 million for
the partial retirement of 8% redeemable convertible preferred stock. We also
received other proceeds of $113 million from prepaid forward sales agreements
for our investment in Corning common stock, which we received in connection
with the sale of our OFS business. These forward sales agreements were reflected
as secured borrowings as of September 30, 2003, and matured on October 1, 2003.
We also paid our 8% redeemable convertible preferred stock dividend requirement
of $91 million with 46 million shares of our common stock and $6 million of
cash.

F-27

---

Financing
activities provided $468 million of cash during fiscal
2002. This included $1.8 billion of proceeds from the sale of 7.75%
convertible trust preferred securities in March 2002. Fees paid in connection
with this transaction were approximately $46 million. Partially offsetting these
proceeds were repayments of $1.1 billion for amounts outstanding under credit
facilities and other short-term borrowings and $149 million for preferred stock
dividends.

Recapitalization
program

We are
currently authorized by our board of directors to issue shares of our common
stock or use cash in exchange for our convertible securities and certain other
debt obligations. Since the fourth quarter of fiscal 2002, we retired
approximately $2.5 billion of our convertible securities and certain other debt
obligations in exchange for approximately 643 million shares of our common stock
and $736 million in cash in separate, multiple and privately
negotiated transactions. Most of these transactions reduced future obligations
at a discount and reduced annual fixed charges such as interest and dividend
requirements. We may use cash or issue more of our common shares in
similar transactions in the future. If our common stock is issued, it would
result in additional dilution to our common shareowners. Subsequent to September
30, 2004, and through December 3, 2004, we retired $20 million of
our debt obligations for approximately $21 million of cash.

We
exchanged all of our outstanding 8% redeemable convertible preferred stock for
8% convertible subordinated debentures on November 24, 2003. This
action increased our flexibility to settle this obligation by eliminating
certain legal requirements related to available capital surplus as defined by
Delaware law.

Our
8% convertible subordinated debentures are redeemable at the option of the
holders on various dates. The next available redemption date at the option of
the holder is August 2, 2007. We have the right to redeem the
debentures beginning August 15, 2006. We have the option to satisfy the
redemption with cash, shares of our common stock or a combination of both. The
principal amount of these debentures was $817 million as of September 30, 2004.

Cash
management

Achieving
optimal returns on our cash balance involves concentrating domestic
cash in a primary account with our lead bank in order to make efficient
investment decisions in various instruments and maturities. Short-term domestic
cash is invested daily in money market funds and other short-term instruments
such as U.S. commercial paper and discount agency bills. Strategic long-term
domestic cash is outsourced to various fund managers and the portfolio consists
of investment grade quality debt securities such as treasury notes, corporate
bonds, high quality asset-backed securities and government agency bonds with
various maturities. International cash is invested in international money market
funds, time deposits and other bank accounts.
Approximately 80% of our cash and marketable securities was
held domestically as of September 30, 2004.

Future
capital requirements and funding sources

We
do not expect our operations will generate cash on a
sustainable basis until our pre-tax income exceeds the amount of net non-cash
income items, which have been driven primarily by our pension credit.
Our pension credit was $1.1 billion during fiscal 2004. Our cash
requirements during the next few years are primarily related to funding our
operations, capital expenditures, debt obligations and other matters discussed
below and in our contractual obligations table. We believe our cash
and cash equivalents of $3.4 billion and marketable securities of $1.5 billion
as of September 30, 2004, are sufficient to fund our cash requirements for
fiscal 2005 as well as the following few years. However, we cannot
provide assurance that our actual cash requirements will not be greater than we
currently expect. If sources of liquidity are not available or if we cannot
generate sufficient cash flow from operations, we might be required to obtain
additional sources of funds through additional operating improvements, capital

F-28

---

market
transactions, asset sales or financing from third parties, or a combination
thereof. We cannot provide assurance that these additional sources of funds will
be available or, if available, would have reasonable terms.

On
November 8, 2004, we received written confirmation from the IRS that the Joint
Committee approved our tentative agreement with the IRS that allowed for a tax
refund of approximately $816 million (plus statutory interest to the date of
payment). We expect to receive the refund during fiscal 2005, following
completion of the IRSs audit of our 2001 federal income tax return. The
refund will be paid by the IRS to AT&T and, under our tax sharing agreements
with AT&T, would then be payable by AT&T to us. We do not believe there
are any other matters that would impact the refund claim.

The
cash requirements of our restructuring program are $2.6 billion, of which $2.4
billion had been paid through September 30, 2004. The remaining cash requirement
is expected to be paid over the next 11 years, including approximately $100
million during fiscal 2005. This cash requirement is primarily for lease
obligations, which are net of expected sublease rental income of approximately
$137 million. Our cash requirements could increase in the future
years if we do not receive this expected income.

We do
not expect to make contributions to our qualified U.S. pension plans
in fiscal 2005 and fiscal 2006. Annual contributions to
our non-qualified and non-U.S. pension plans are expected to be
approximately $50 million over the next several years. Legislative and
regulatory changes were passed that alter the manner in which liabilities are
determined for the purpose of calculating required pension contributions.
The funding requirements for our pension plans are not expected to be
significantly affected through fiscal 2006 as a result of these changes. We
are unable to provide an estimate of future funding requirements beyond fiscal
2006 for U.S. pension plans. However, based on our actuarial projections, we
believe it is unlikely that any required contributions would have a material
effect on our liquidity during fiscal 2007 through fiscal 2009.

We
currently provide retiree health care benefits for our retirees in the United
States. These benefits are provided under a single plan covering 48,000
management retirees and 71,000 formerly represented retirees as well as an
additional 81,000 dependents of retirees. The plans for management and formerly
represented retirees are accounted for separately. Historically, retiree health
care benefits were funded through plan assets set aside in trusts and transfers
of excess pension assets. There are currently no plan assets available in these
trusts to fund the obligations of the management retirees. There are
approximately $600 million of assets in the trust that is available to fund the
obligations of the formerly represented retirees, and approximately $400 million
of plan assets in a welfare benefits trust that can be made available upon
authorization from our senior management.

We
are permitted to transfer pension plan assets that are in excess of 125% of
pension plan obligations under Section 420 of the Internal Revenue Code to fund
retiree health care benefits. The funding levels were below the required
thresholds that would allow for Section 420 transfers in either of our U.S.
pension plans as of the January 1, 2004 valuation date. The next valuation date
is January 1, 2005. Our cumulative Section 420 transfers during the past several
years were $1.9 billion, although no transfers were made within the management
retiree plan since fiscal 2002 or within the formerly represented retiree plan
since fiscal 2003. If a Section 420 transfer is made, we are required to
maintain a certain level of cost per participant for a period of five years
beginning with the year of transfer. As a result, although these excess pension
asset transfers can help fund retiree health care benefits, they limit the
ability to implement effective cost reductions in the future. We expect to seek
legislative changes to allow more flexibility regarding this aspect of cost
maintenance, together with our unions. If we are successful in obtaining the
legislative changes, we believe that a majority of the Companys funding
requirements for formerly represented retirees could be addressed through
Section 420 transfers based on current actuarial assumptions. However, no
assurances can be given that we will be successful in these efforts. If the
legislative changes are not obtained by September 1, 2006, the Companys
obligation to fund $400 million to a trust, as described below, terminates, and
the Company can change the level of its subsidy at its sole discretion beginning
January 1, 2007.

The
retiree health care benefit payments were approximately $500 million for  formerly
represented retirees and approximately $275 million for management  retirees during
fiscal 2004 after plan participant

F-29

---

contributions
of $80 million.  The benefits for formerly represented retirees were funded through the
assets  that were available in the trusts. The benefits for management retirees were
funded through Company contributions of $225 million and the remaining trust  assets. We
received $212 million from our welfare benefits trust in October 2004  as a reimbursement
for management retiree health care contributions that we made  during fiscal 2004. The
Companys expected funding requirements for retiree  health care benefits are
expected to be $201 million, $426 million, $534 million, $494 million and
$465 million during fiscal 2005 and the  next four consecutive fiscal years,
respectively. These amounts exclude  potential Section 420 transfers, $400 million that
we agreed to contribute to a  trust through September 30, 2012, in accordance with the
tentative agreement  with our unions, and approximately $400 million of plan assets in a
welfare  benefits trust that can be made available upon authorization from our senior
management. However, expected annual Medicare Part D subsidies of approximately  $60
million are included beginning in fiscal 2007. These expected funding  requirements are
subject to change.

As
discussed in more detail in Note 13 to our consolidated financial
statements, we may fund up to $315 million of our shareowner litigation
settlement with cash, common stock or a combination of both, at our option. On
December 24, 2003, we deposited 33 million shares of our common stock into
escrow, representing the initial $100 million payment of the settlement amount.
The appeals process has ended and the claims administration process is
almost complete. We expect the final distribution to occur during the first or
second quarter of fiscal 2005.

We expect  to
file a shelf  registration  statement  to  register  200  million  shares  of our
common stock that may be issued upon the exercise of
the warrants we will be issuing as part of the settlement  proceeds for our shareowner
litigation.

We
have effective shelf registration statements with the SEC for the issuance of up
to approximately $1.9 billion of securities, including shares of common stock
and preferred stock, debt securities, warrants, stock purchase contracts
and stock purchase units.

Contractual
obligations and other commercial commitments and contingencies

Our
contractual obligations as defined by the SECs rules and regulations are
presented in the table below. However, our expected cash flow cannot be entirely
assessed based on such obligations since they are subject to changes based on
future events. Many of our outsourced manufacturing agreements are linked to
future sales forecasts and will vary based on customer demands. Furthermore, we
have other cash requirements that are not included in the table. These
requirements are related to our normal operations that are not based on
commitments, such as purchases of services on an as
needed basis, employee compensation, and other items. The most significant
factor affecting our future cash flows is our ability to earn and collect cash
from our customers.

Contractual
obligations

|                                       | Payments due in periods |  |   |        |  |   |       |  |   |      
|-------------------------------------- | ----------------------- |  | - | ------ |  | - | ----- |  | - | -----
|(in millions)                         
|Long-term debt (a)                     |                         |  | $ | 6,003  |  | $ | 1     |  | $ | 1,267
|Interest on long-term debt             |                         |  |   | 4,338  |  |   | 345   |  |   | 656  
|Operating leases (b)                   |                         |  |   | 1,001  |  |   | 180   |  |   | 237  
|Unconditional purchase obligations (c) |                         |  |   | 856    |  |   | 783   |  |   | 65   
|                                       |                         |  |   |        |  |   |       |  |   |      
|Total (d) (e)                          |                         |  | $ | 12,198 |  | $ | 1,309 |  | $ | 2,225
|                                       |                         |  |   |        |  |   |       |  |   |      

|(a) |  | The
long-term debt principle amounts exclude $13 million of fair value basis  adjustments and
unamortized discounts. Refer  to Note 8 to our  consolidated financial
statements for additional information related to  long-term debt and convertible  securities,
including early  redemption features.
|--- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F-30

---

|(b) |  | The contractual obligations under operating leases exclude approximately
$275 million of potential lease obligations that  were assigned to
Avaya, Agere and other entities for which we remain secondarily liable. The operating lease obligations for facilities reserved under our
restructuring program of approximately $240 million are included in the table.
|--- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(c) |  | Unconditional purchase obligations include all commitments to purchase
goods or services that are noncancelable or would  impose a penalty
if the agreements were cancelled prior to expiration. In these situations, the
amount of the penalty was  included in the Less than 1
Year column in the table above. Amounts exclude obligations included in
accounts payable as  of September 30, 2004.
|--- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(d) |  | Certain other long-term liabilities of $1.0 billion are excluded in the
above table because they do not represent  contractual obligations as
defined by the SECs rules. These liabilities are contingencies related to
tax, litigation and  insurance matters, long-term employee
compensation and non-cash items, such as minority interests and deferred income.
 The estimated future cash payments for these items are expected to
be $409 million in 2006 through 2007, $179 million in  2008 through
2009, and $134 million thereafter. Other long-term liabilities related to facility reserves  in connection with our restructuring
plans are included in the operating leases caption.
|--- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(e) |  | Obligations related to pensions, postretirement health and welfare benefits
and post-employment benefit obligations are  excluded from the table.
Refer to Note 9 to our consolidated financial statements and the above
discussion for a summary of  our expected contributions to these
plans.
|--- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Other
commercial commitments

|                             | Amounts expiring in periods |  |   |     |  |   |     |  |   |   
|---------------------------- | --------------------------- |  | - | --- |  | - | --- |  | - | --
|(in millions)               
|Letters of credit            |                             |  | $ | 353 |  | $ | 317 |  | $ | 26
|Undrawn customer commitments |                             |  |   | 11  |  |   |    |  |   | 1 
|                             |                             |  |   |     |  |   |     |  |   |   
|Total                        |                             |  | $ | 364 |  | $ | 317 |  | $ | 27
|                             |                             |  |   |     |  |   |     |  |   |   

Letters of
credit

Letters
of credit are obtained to ensure the performance or payment to third parties in
accordance with specified terms and conditions. Secured and unsecured
outstanding letters of credit were $353 million and $588 million as of September
30, 2004 and 2003, respectively. The estimated fair value of these letters of
credit was $8 million and $14 million as of September 30, 2004 and 2003,
respectively. On October 1, 2004, we amended and restated our two primary
agreements. The first agreement provides for the issuance of up to $215 million
of new letters of credit until September 30, 2006. The second agreement permits
us to request renewal of $199 million of letters of credit until September 30,
2006. Under these revised agreements, we are no longer required to meet
specified levels of quarterly consolidated minimum operating income or to
provide cash collateral for letters of credit issued. However, we are required
to maintain a minimum amount of unrestricted cash and short-term investments in
the U.S. as defined in the agreements.

On
October 1, 2004, we also amended our Guarantee and Collateral Agreement and
Collateral Sharing Agreement. Under these agreements, certain of our U.S.
subsidiaries guaranteed certain of our obligations, and these subsidiaries
pledged significant portions of their assets as collateral. These agreements
secure certain obligations, including letters of credit, specified hedging
arrangements, guarantees to lenders for vendor financing, lines of credit, cash
management and other bank operating arrangements. These outstanding
obligations amounted to $261 million as of September 30, 2004.

F-31

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Customer
financing commitments

|                        | September 30, 2004 |  | September 30, 2003 |     |  |   |     |  |   |    |  |  
|----------------------- | ------------------ |  | ------------------ | --- |  | - | --- |  | - | -- |  | -
|(in millions)          
|Drawn commitments       |                    |  | $                  | 139 |  | $ | 125 |  | $ | 14 |  | $
|Available but not drawn |                    |  |                    | 11  |  |   | 3   |  |   | 8  |  |  
|Not available           |                    |  |                    |    |  |   |    |  |   |   |  |  
|                        |                    |  |                    |     |  |   |     |  |   |    |  |  
|Total commitments       |                    |  | $                  | 150 |  | $ | 128 |  | $ | 22 |  | $
|                        |                    |  |                    |     |  |   |     |  |   |    |  |  
|Reserves                |                    |  | $                  | 135 |  |   |     |  |   |    |  | $
|                        |                    |  |                    |     |  |   |     |  |  

We may
provide or commit to additional customer financings on a limited basis. We are
focusing on the larger service providers that typically have less demand for
such financing. We carefully review each individual request for
customer financing. Such review assesses the credit quality of the
individual borrowers, their respective business plans and market
conditions. We also assess our ability to sell or transfer the undrawn
commitments and drawn borrowings to unrelated third parties.

We
monitor drawn borrowings and undrawn commitments by assessing, among other
things, each customers short-term and long-term liquidity positions, the
customers current operating performance versus plan, the execution
challenges facing the customer, changes in the competitive landscape and the
customers management experience and depth. When potential problems
are evident, we undertake certain mitigating actions, including cancellation of
commitments. Although these actions can limit the extent of
our losses, we remain exposed to the extent of drawn
amounts. Our customer financing commitments were reduced during
fiscal 2004, as a result of the collections, settlement or write-off of certain
fully reserved notes and the expiration of several commitments.

Credit
ratings

Our
credit ratings are below investment grade. Any credit downgrade affects our
ability to enter into and maintain certain contracts on favorable terms and
increases our cost of borrowing. Our credit ratings as of December 3, 2004, are
as follows:

|                      |  |  |    | 
|--------------------- |  |  | -- | 
|
|Rating Agency         |  |  |    | 
|Standard & Poors (a) |  |  | B  | 
|Moodys (a)           |  |  | B2 | 
|Fitch (a)             |  |  | B  | 
|__________            |  |  |    | 

|(a) |  | Ratings
outlook is positive.
|--- |  | ----------------------------

F-32

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QUANTITATIVE
AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We are
exposed to market risk from changes in foreign currency exchange rates, interest
rates and equity prices. We manage our exposure to risk from changing
exchange rates and interest rates through the use of derivative financial
instruments, coupled with other strategies. Our risk management objective is to
minimize the effects of volatility on our cash flows by identifying the assets,
liabilities or forecasted transactions exposed to these risks and hedging them.
Hedges may be achieved either by forward or option contracts, swap derivatives,
or terms embedded into certain contracts that affect the ultimate
amount of cash flows under the contract. The gains and losses on
these exposures are generally offset by reciprocal changes in the
value of the hedging instruments when used because there is a high
correlation between the hedging instruments and the underlying exposures.
We use derivative financial instruments as risk management tools and not for
trading or speculative purposes. Generally, price risk on equity holdings
is not hedged.

Foreign
currency risk

As a
multinational company, we conduct our business in a wide variety of currencies
and are therefore subject to market risk for changes in foreign exchange rates.
We use foreign exchange forward and option contracts to minimize exposure to the
risk of the eventual net cash inflows and outflows resulting from foreign
currency denominated transactions with customers, suppliers and non-U.S.
subsidiaries. Our objective is to hedge all types of foreign currency risk to
preserve our cash flows, but we generally do not expect to designate these
derivative instruments as hedges under current accounting standards unless the
benefits of doing so are material. Cash inflows and outflows denominated in the
same foreign currency are netted on a legal entity basis or at the
corporate level. The corresponding net cash flow exposure is
appropriately hedged. To the extent that the forecasted cash flow
exposures are overstated or understated or if there is a shift in the timing of
the anticipated cash flows during periods of currency volatility, we may
experience unanticipated currency gains or losses. We do not hedge our net
investment in non-U.S. entities because we view those investments as long-term
in nature.

Our
primary net foreign currency exposures as of September 30, 2004 and 2003
included the euro, Chinese yuan, Japanese yen and British pound. The
fair value of foreign exchange contracts is subject to changes in foreign
currency exchange rates. For the purpose of assessing this risk, we use a
sensitivity analysis to determine the effects that market risk exposures
may have on the fair value of the foreign currency forwards and options and on
our results of operations. To perform the sensitivity analysis, we assess
the risk of loss in fair values from the effect of a hypothetical 10%
change in the value of foreign currencies, assuming no change in interest rates.
For contracts outstanding as of September 30, 2004 and 2003, a 10% adverse
movement in the value of foreign currencies against the U.S. dollar from the
prevailing market rates, including the primary foreign currency exposures noted
above, would have resulted in an incremental pre-tax net unrealized loss of
$32 million and $12 million, respectively. The model to determine
sensitivity assumes a parallel shift in all foreign currency exchange spot
rates, although exchange rates rarely move together in the same direction.

In
fiscal 2004 we began using a value-at-risk (VAR) model to estimate
and monitor our exposure to financial market risks because we believe it to be a
better statistical measure of risk. We use the Monte Carlo simulation
model to calculate VAR. This model estimates the potential loss in fair value of
foreign currency forwards and options over a defined period of time within a
certain confidence level by randomly generating different foreign currency
exchange rates repeatedly and then applying those exchange rates to our
outstanding forwards and options. As a result of our foreign currency VAR
calculations, we estimate with 95 percent confidence that the fair value of our
foreign currency derivatives would not decline by more than $12
million over a quarterly period. Consistent with the nature of the
economic hedge, any changes in the value of the forwards and options would be
offset by reciprocal changes in the underlying exposure.

F-33

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Interest
rate risk

We are
exposed to various forms of interest rate risk. The fair value of our fixed-rate
available-for-sale marketable securities and the interest income earned on our
cash and cash equivalents may fluctuate as interest rates change. In addition,
if interest rates remain low, we may forgo the opportunity to obtain
more favorable interest rates on borrowings due to our fixed rate debt
obligations. Our objective is to mitigate the variability of cash inflows and
outflows resulting from interest rate fluctuations by maintaining a balanced mix
of fixed and floating-rate debt and investments. We mitigate our interest rate
risk by entering into interest rate swaps on a portion of our debt obligations
to make them variable-rate debt instruments and by including fixed-rate assets
in our investment portfolio. We also expect that these transactions will reduce
our overall cost of borrowing and increase investment returns.

As
of September 30, 2004, we had interest rate swaps where we received fixed
interest rates (5.5% and 7.25%) and paid floating rates based upon the three and
six-month LIBOR rates plus agreed upon spreads (ranging from 1.72% to 2.89%) on
notional amounts aggregating $600 million. As of September 30, 2004, the three
and six-month LIBOR rates were 2.02% and 2.20%, respectively. We do not foresee
any significant changes in our interest rate risk management strategy or in our
exposure to interest rate fluctuations.

The
impacts of a sensitivity analysis we performed under a model that assumes a
hypothetical 75 basis point shift in interest rates are as follows:

|                                                                                      |  |  |   |      
|------------------------------------------------------------------------------------- |  |  | - | -----
|(in millions)                                                                        
|Assets:                                                                               |  |  |   |      
|Short-term marketable securities                                                      |  |  | $ | 858  
|Long-term marketable securities                                                       |  |  |   | 636  
|Interest rate swaps                                                                   |  |  |   | 17   
|Liabilities:                                                                          |  |  |   |      
|Long-term debt (including liability to subsidiary trust issuing preferred securities) |  |  |   | 6,325

Our
sensitivity analysis on long-term debt obligations excludes variable-rate debt
instruments because the changes in interest rates would not significantly affect
the fair values of such instruments. In addition, our variable-rate customer
finance notes have been excluded because a significant portion of the principal
balances and related receivables for accrued interest are fully-reserved. Refer
to Note 8 to our consolidated financial statements for information related to
long-term debt.

Equity price
risk

Our
investment portfolio includes equity investments in publicly held companies that
are classified as available-for-sale and other strategic equity holdings in
privately held companies and venture funds. These securities are exposed to
price fluctuations and are generally concentrated in high-technology industries.
The carrying values of our available-for-sale equity securities and privately
held securities were $2 million and $75 million as of September 30, 2004,
respectively. The carrying values of our available-for-sale equity securities
and privately held securities were $5 million and $131 million as of September
30, 2003, respectively.

We  generally
do not hedge our equity price risk due to hedging restrictions imposed  by the issuers,
illiquid capital markets or our inability to hedge  non-marketable equity securities in
privately held companies. An adverse  movement in equity prices on our available-for-sale equity securities  would not have a material

F-34

---

impact due to
their immaterial  carrying values as of September 30, 2004 and 2003. An adverse movement
in equity  prices on our holdings in privately held companies cannot be easily
quantified,  as our ability to realize returns on investments depends on the investees ability
to raise additional capital or derive cash inflows from continuing  operations or through
liquidity events such as initial public offerings, mergers  or private sales.

The
process of determining the fair values of our privately held equity investments
inherently requires certain assumptions and subjective judgments. These
valuation assumptions and judgments include consideration of: (1) the
investees earnings and cash flow position, cash flow projections, and rate
of cash consumption; (2) recent rounds of equity infusions by us and other
investors; (3) the strength of the investees management; and (4) valuation
data provided by the investee that may be compared with data for peers.
Investment impairment charges were $22 million, $63 million and $209
million during fiscal 2004, 2003 and 2002, respectively. Similar charges may be
required in the future if declines in the fair value of investments are
determined to be other-than-temporary.

We
entered into prepaid forward sales agreements for all of our Corning shares
during fiscal 2003. As a result, we received proceeds of $113
million and locked in $64 million of unrealized appreciation. This
gain was recognized during fiscal 2004.

F-35

---

FIVE-YEAR
SUMMARY OF SELECTED FINANCIAL DATA
(in millions, except per share amounts)

|                                                       |  |  | Years ended September 30, |       
|------------------------------------------------------ |  |  | ------------------------- | ------
|                                                       |  |  | 2004                      |       
|                                                       |  |  |                           |       
|RESULTS
      OF OPERATIONS                            |  |  |                           |       
|Revenues                                               |  |  | $                         | 9,045 
|Business
      restructuring                           |  |  |                           | (20   
|Goodwill
      impairment                              |  |  |                           |      
|Income
      taxes                                     |  |  |                           | (939  
|Income
      (loss) from continuing operations         |  |  |                           | 2,002 
|Earnings
      (loss) per common share from continuing |  | 
|operations:                                            |  | 
|Basic                                                  |  |  |                           | 0.47  
|Diluted                                                |  |  |                           | 0.42  
|Dividends
      per common share                       |  |  |                           |      
|                                                       |  | 
|FINANCIAL
      POSITION                               |  | 
|Cash,
      cash equivalents and marketable securities |  |  | $                         | 4,873 
|Assets                                                 |  |  |                           | 16,963
|Debt                                                   |  |  |                           | 5,990 
|8.00%
      redeemable convertible preferred stock     |  |  |                           |      
|Shareowners
      (deficit) equity                    |  |  |                           | (1,379

F-36

---

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
accounting  principles  generally  accepted in the United States of America and include
certain  amounts that 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
accountants and  the internal auditors.

The Audit and
Finance Committee of the Board of Directors,  which is  composed of independent
directors,  meets periodically with management,  the internal auditors and the
independent  auditors to review the manner  in which  these  groups 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.  Both  the internal  auditors and the independent  auditors  periodically  meet
privately  with the Audit and Finance  Committee  and have access to its  individual
members.

Lucent
  engaged PricewaterhouseCoopers LLP, independent registered public accounting
  firm, to audit the consolidated financial statements in accordance with the
  standards of the Public Company Accounting Oversight Board (United States),
  which includes consideration of our internal control structure for purposes
  of designing their audit procedures.

|Patricia
      F. Russo
      Chairman and Chief Executive Officer |  | Frank A. DAmelio
      Executive Vice President and Chief Financial Officer
|------------------------------------------------------------------ |  | ----------------------------------------------------------------------------

F-37

---

REPORT OF
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

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
operations, changes in shareowners (deficit) equity and cash flows present fairly,
in all material  respects, the financial position of Lucent Technologies Inc. and its
subsidiaries (the Company) as of September 30, 2004 and 2003, and the
results of their operations and their cash flows for each of the three  years in the
period ended September 30, 2004, in conformity with  accounting principles generally
accepted in the United States of  America.  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 the standards of the  Public Company Accounting
Oversight Board (United States).  Those  standards 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 our opinion.

As discussed in
Note 1 to the consolidated financial statements, in  2003 the Company changed its
accounting method for goodwill and other  intangible assets.

/s/
PRICEWATERHOUSECOOPERS LLP

Florham
  Park, New Jersey 
  October 20, 2004, 
  except for Note 7 and the second and eleventh paragraphs of Note 13, 
  as to which the date is November 9, 2004.

F-38

---

LUCENT
  TECHNOLOGIES INC. AND SUBSIDIARIES
  CONSOLIDATED STATEMENTS OF OPERATIONS
  (in millions, except per share amounts)

|                                                                   |  |  | Years
      ended September 30, |      
|------------------------------------------------------------------ |  |  | ------------------------------- | -----
|                                                                   |  |  | 2004                            |      
|                                                                   |  |  |                                 |      
|Revenues:                                                          |  |  |                                 |      
|Products                                                           |  |  | $                               | 7,113
|Services                                                           |  |  |                                 | 1,932
|                                                                   |  |  |                                 |      
|Total
      revenues                                               |  |  |                                 | 9,045
|                                                                   |  |  |                                 |      
|Costs:                                                             |  | 
|Products                                                           |  |  |                                 | 3,824
|Services                                                           |  |  |                                 | 1,442
|                                                                   |  |  |                                 |      
|Total
      costs                                                  |  |  |                                 | 5,266
|                                                                   |  |  |                                 |      
|Gross
      margin                                                 |  |  |                                 | 3,779
|Operating
      expenses:                                          |  | 
|Selling,
      general and administrative                          |  |  |                                 | 1,296
|Research
      and development                                     |  |  |                                 | 1,270
|In-process
      research and development                          |  |  |                                 | 14   
|Goodwill
      impairment                                          |  |  |                                 |     
|Business
      restructuring                                       |  |  |                                 | (20  
|                                                                   |  |  |                                 |      
|Total
      operating expenses                                     |  |  |                                 | 2,560
|                                                                   |  |  |                                 |      
|Operating
      income (loss)                                      |  |  |                                 | 1,219
|Other
      income (expense), net                                  |  |  |                                 | 240  
|Interest
      expense                                             |  |  |                                 | 396  
|                                                                   |  |  |                                 |      
|Income
      (loss) from continuing operations before income taxes |  |  |                                 | 1,063
|Income
      taxes                                                 |  |  |                                 | (939 
|                                                                   |  |  |                                 |      
|Income
      (loss) from continuing operations                     |  |  |                                 | 2,002
|Income
      from discontinued operations                          |  |  |                                 |     
|                                                                   |  |  |                                 |      
|Net income
      (loss)                                            |  |  |                                 | 2,002
|Conversion
      and redemption cost  8% preferred stock          |  |  |                                 | (1   
|Preferred
      stock dividends and accretion                      |  |  |                                 | 12   
|                                                                   |  |  |                                 |      
|Net income
      (loss) applicable to common shareowners           |  |  | $                               | 2,013
|                                                                   |  |  |                                 |      
|                                                                   |  | 
|Income
      (loss) from continuing operations:                    |  | 
|Basic                                                              |  |  | $                               | 0.47 
|Diluted                                                            |  |  | $                               | 0.42 
|Net income
      (loss) applicable to common shareowners:          |  | 
|Basic                                                              |  |  | $                               | 0.47 
|Diluted                                                            |  |  | $                               | 0.42 
|Weighted
      average number of common shares outstanding:        |  | 
|Basic                                                              |  |  |                                 | 4,258
|Diluted                                                            |  |  |                                 | 5,313

See Notes to
Consolidated Financial Statements.

F-39

---

LUCENT
TECHNOLOGIES INC. AND SUBSIDIARIESCONSOLIDATED BALANCE SHEETS(in millions, except per
share amounts)

|                                                                                                              |  |  | September
      30,
      2004 |         | September
      30,
      2003 |  
|------------------------------------------------------------------------------------------------------------- |  |  | ------------------------------ | ------- | ------------------------------ | -
|                                                                                                              |  |  |                                |         |                                |  
|ASSETS                                                                                                        |  |  |                                |         |                                |  
|Cash
      and cash equivalents                                                                               |  |  | $                              | 3,379   |                                | $
|Marketable
      securities                                                                                   |  |  |                                | 858     |                                |  
|Receivables                                                                                                   |  |  |                                | 1,359   |                                |  
|Inventories                                                                                                   |  |  |                                | 822     |                                |  
|Other
      current assets                                                                                    |  |  |                                | 1,813   |                                |  
|                                                                                                              |  |  |                                |         |                                |  
|Total
      current assets                                                                                    |  |  |                                | 8,231   |                                |  
|Marketable
      securities                                                                                   |  |  |                                | 636     |                                |  
|Property,
      plant and equipment, net                                                                      |  |  |                                | 1,376   |                                |  
|Prepaid
      pension costs                                                                                   |  |  |                                | 5,358   |                                |  
|Goodwill
      and other acquired intangibles, net                                                            |  |  |                                | 434     |                                |  
|Other
      assets                                                                                            |  |  |                                | 928     |                                |  
|                                                                                                              |  |  |                                |         |                                |  
|Total
      assets                                                                                            |  |  | $                              | 16,963  |                                | $
|                                                                                                              |  |  |                                |         |                                |  
|                                                                                                              |  | 
|LIABILITIES                                                                                                   |  | 
|Accounts
      payable                                                                                        |  |  | $                              | 872     |                                | $
|Payroll
      and benefit-related liabilities                                                                 |  |  |                                | 1,232   |                                |  
|Debt
      maturing within one year                                                                           |  |  |                                | 1       |                                |  
|Other
      current liabilities                                                                               |  |  |                                | 2,361   |                                |  
|                                                                                                              |  |  |                                |         |                                |  
|Total
      current liabilities                                                                               |  |  |                                | 4,466   |                                |  
|Postretirement
      and postemployment benefit liabilities                                                   |  |  |                                | 4,881   |                                |  
|Pension
      liabilities                                                                                     |  |  |                                | 1,874   |                                |  
|Long-term
      debt                                                                                          |  |  |                                | 4,837   |                                |  
|Liability
      to subsidiary trust issuing preferred securities                                              |  |  |                                | 1,152   |                                |  
|Other
      liabilities                                                                                       |  |  |                                | 1,132   |                                |  
|                                                                                                              |  |  |                                |         |                                |  
|Total
      liabilities                                                                                       |  |  |                                | 18,342  |                                |  
|                                                                                                              |  | 
|Commitments
      and contingencies                                                                           |  | 
|                                                                                                              |  |  |                                |         |                                |  
|8.00%
      redeemable convertible preferred stock                                                            |  |  |                                |        |                                |  
|                                                                                                             
|SHAREOWNERS
      DEFICIT                                                                                    |  | 
|Preferred
      stock  par value $1.00 per share; authorized shares: 250; issued and outstanding:
      none |  |  |                                |        |                                |  
|Common
      stock  par value $.01 per share;                                                                |  | 
|Authorized
      shares: 10,000; 4,396 issued and 4,395 outstanding shares as of September
      30,          |  | 
|2004,
      and 4,170 issued and 4,169 outstanding shares as of September 30, 2003                            |  |  |                                | 44      |                                |  
|Additional
      paid-in capital                                                                              |  |  |                                | 23,005  |                                |  
|Accumulated
      deficit                                                                                     |  |  |                                | (20,793 | )                              |  
|Accumulated
      other comprehensive loss                                                                    |  |  |                                | (3,635  | )                              |  
|                                                                                                              |  |  |                                |         |                                |  
|Total
      shareowners deficit                                                                              |  |  |                                | (1,379  | )                              |  
|                                                                                                              |  |  |                                |         |                                |  
|Total
      liabilities, redeemable convertible preferred stock and shareowners
      deficit                |  |  | $                              | 16,963  |                                | $
|                                                                                                              |  |  |                                |         |                                |  

See Notes to
Consolidated Financial Statements.

F-40

---

LUCENT
TECHNOLOGIES INC. AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF CHANGES IN SHAREOWNERS (DEFICIT)
EQUITY(in millions)

|                                                                                                                                    |  |  | Shares
      of 
      Common Stock |       | Common
      Stock |   | Additional
      
      Paid-In 
      Capital |  | Accumulated
      Deficit |        | Accumulated
      
      Other 
      Comprehensive
      Loss |   | Total
      Shareowners
      (Deficit) Equity |  
|----------------------------------------------------------------------------------------------------------------------------------- |  |  | ----------------------------------- | ----- | ------------------ | - | ---------------------------------------------- |  | ------------------------- | ------ | -------------------------------------------------------------- | - | ----------------------------------------------- | -
|                                                                                                                                    |  |  |                                     |       |                    |   |                                                |  |                           |        |                                                                |   |                                                 |  
|Balance
      as of September 30, 2001                                                                                              |  |  |                                     | 3,414 |                    | $ | 34                                             |  | $                         | 21,702 |                                                                | $ | (10,272                                         | )
|Net
      loss                                                                                                                      |  |  |                                     |       |                    |   |                                                |  |                           |        |                                                                |   | (11,753                                         | )
|Minimum
      pension liability adjustment                                                                                          |  |  |                                     |       |                    |   |                                                |  |                           |        |                                                                |   |                                                 |  
|Foreign
      currency translation adjustment                                                                                       |  |  |                                     |       |                    |   |                                                |  |                           |        |                                                                |   |                                                 |  
|Reclassification
      of foreign currency translation gain                                                                         |  | 
|realized
      upon the sale of foreign entities                                                                                    |  |  |                                     |       |                    |   |                                                |  |                           |        |                                                                |   |                                                 |  
|Unrealized
      holding losses on certain investments                                                                              |  |  |                                     |       |                    |   |                                                |  |                           |        |                                                                |   |                                                 |  
|Reclassification
      adjustment for realized holding losses and                                                                   |  | 
|impairment
      losses on certain investments                                                                                      |  |  |                                     |       |                    |   |                                                |  |                           |        |                                                                |   |                                                 |  
|Net
      unrealized holding losses on derivatives                                                                                  |  |  |                                     |       |                    |   |                                                |  |                           |        |                                                                |   |                                                 |  
|Amounts
      transferred to Agere                                                                                                  |  |  |                                     |       |                    |   |                                                |  |                           |        |                                                                |   |                                                 |  
|                                                                                                                                    |  |  |                                     |       |                    |   |                                                |  |                           |        |                                                                |   |                                                 |  
|Comprehensive
      loss                                                                                                            |  |  |                                     |       |                    |   |                                                |  |                           |        |                                                                |   |                                                 |  
|                                                                                                                                    |  |  |                                     |       |                    |   |                                                |  |                           |        |                                                                |   |                                                 |  
|Issuance
      of common stock in connection with exchange of 8%                                                                   
|convertible
      redeemable preferred stock                                                                                        |  |  |                                     | 58    |                    |   | 1                                              |  |                           | 174    |                                                                |   |                                                 |  
|Issuance
      of common stock related to employee benefit plans                                                                    |  |  |                                     | 18    |                    |   |                                                |  |                           | 55     |                                                                |   |                                                 |  
|Preferred
      stock dividends and accretion                                                                                       |  |  |                                     |       |                    |   |                                                |  |                           | (167   | )                                                              |   |                                                 |  
|Spin-off
      of Agere                                                                                                             |  |  |                                     |       |                    |   |                                                |  |                           | (1,191 | )                                                              |   |                                                 |  
|Other                                                                                                                               |  |  |                                     |       |                    |   |                                                |  |                           | 33     |                                                                |   |                                                 |  
|                                                                                                                                    |  |  |                                     |       |                    |   |                                                |  |                           |        |                                                                |   |                                                 |  
|Balance
      as of September 30, 2002                                                                                              |  |  |                                     | 3,490 |                    |   | 35                                             |  |                           | 20,606 |                                                                |   | (22,025                                         | )
|                                                                                                                                    |  |  |                                     |       |                    |   |                                                |  |                           |        |                                                                |   |                                                 |  
|Net
      loss                                                                                                                      |  |  |                                     |       |                    |   |                                                |  |                           |        |                                                                |   | (770                                            | )
|Minimum
      pension liability adjustment                                                                                          |  |  |                                     |       |                    |   |                                                |  |                           |        |                                                                |   |                                                 |  
|Foreign
      currency translation adjustment                                                                                       |  |  |                                     |       |                    |   |                                                |  |                           |        |                                                                |   |                                                 |  
|Unrealized
      holding gains on certain investments                                                                               |  |  |                                     |       |                    |   |                                                |  |                           |        |                                                                |   |                                                 |  
|                                                                                                                                    |  |  |                                     |       |                    |   |                                                |  |                           |        |                                                                |   |                                                 |  
|Comprehensive
      loss                                                                                                            |  |  |                                     |       |                    |   |                                                |  |                           |        |                                                                |   |                                                 |  
|                                                                                                                                    |  |  |                                     |       |                    |   |                                                |  |                           |        |                                                                |   |                                                 |  
|Issuance
      of common stock in connection with the exchange of   convertible
      securities and certain other debt obligations |  |  |                                     | 563   |                    |   | 6                                              |  |                           | 1,430  |                                                                |   |                                                 |  
|Conversion
      costs in connection with the exchange of 7.75%                                                                     |  | 
|trust
      preferred securities                                                                                                    |  |  |                                     |       |                    |   |                                                |  |                           | 129    |                                                                |   |                                                 |  
|Issuance
      of common stock in connection with the payment of                                                                    |  | 
|preferred
      stock dividend                                                                                                      |  |  |                                     | 46    |                    |   | 1                                              |  |                           | 85     |                                                                |   |                                                 |  
|Issuance
      of common stock in connection with contribution to                                                                   |  | 
|Lucent
      Technologies Inc. Represented Employees                                                                                |  | 
|Post-retirement
      Health Benefits Trust                                                                                         |  |  |                                     | 46    |                    |   |                                                |  |                           | 76     |                                                                |   |                                                 |  
|Issuance
      of common stock related to employee benefit plans                                                                    |  |  |                                     | 24    |                    |   |                                                |  |                           | 51     |                                                                |   |                                                 |  
|Preferred
      stock dividends and accretion                                                                                       |  |  |                                     |       |                    |   |                                                |  |                           | (103   | )                                                              |   |                                                 |  
|Other                                                                                                                               |  |  |                                     |       |                    |   |                                                |  |                           | (22    | )                                                              |   |                                                 |  
|                                                                                                                                    |  |  |                                     |       |                    |   |                                                |  |                           |        |                                                                |   |                                                 |  
|Balance
      as of September 30, 2003                                                                                              |  |  |                                     | 4,169 |                    |   | 42                                             |  |                           | 22,252 |                                                                |   | (22,795                                         | )
|                                                                                                                                    |  |  |                                     |       |                    |   |                                                |  |                           |        |                                                                |   |                                                 |  
|Net
      income                                                                                                                    |  |  |                                     |       |                    |   |                                                |  |                           |        |                                                                |   | 2,002                                           |  
|Minimum
      pension liability adjustment                                                                                          |  |  |                                     |       |                    |   |                                                |  |                           |        |                                                                |   |                                                 |  
|Reclassification
      adjustment for realized gains on investments                                                                 |  |  |                                     |       |                    |   |                                                |  |                           |        |                                                                |   |                                                 |  
|Foreign
      currency translation adjustments                                                                                      |  |  |                                     |       |                    |   |                                                |  |                           |        |                                                                |   |                                                 |  
|Unrealized
      holding losses on investments                                                                                      |  |  |                                     |       |                    |   |                                                |  |                           |        |                                                                |   |                                                 |  
|                                                                                                                                    |  |  |                                     |       |                    |   |                                                |  |                           |        |                                                                |   |                                                 |  
|Comprehensive
      income                                                                                                          |  |  |                                     |       |                    |   |                                                |  |                           |        |                                                                |   |                                                 |  
|                                                                                                                                    |  |  |                                     |       |                    |   |                                                |  |                           |        |                                                                |   |                                                 |  
|Issuance
      of common stock in connection with the exchange of   certain
      debt obligations                                  |  |  |                                     | 22    |                    |   |                                                |  |                           | 92     |                                                                |   |                                                 |  
|Issuance
      of common stock related to employee benefit plans                                                                    |  |  |                                     | 93    |                    |   | 1                                              |  |                           | 291    |                                                                |   |                                                 |  
|Issuance
      of common stock in connection with settlement of                                                                     |  | 
|shareowner
      lawsuit                                                                                                            |  |  |                                     | 33    |                    |   |                                                |  |                           | 105    |                                                                |   |                                                 |  
|Issuance
      of common stock related to Telica acquisition                                                                        |  |  |                                     | 78    |                    |   | 1                                              |  |                           | 253    |                                                                |   |                                                 |  
|Preferred
      stock dividends and accretion                                                                                       |  |  |                                     |       |                    |   |                                                |  |                           | 12     |                                                                |   |                                                 |  
|                                                                                                                                    |  |  |                                     |       |                    |   |                                                |  |                           |        |                                                                |   |                                                 |  
|Balance
      as of September 30, 2004                                                                                              |  |  |                                     | 4,395 |                    | $ | 44                                             |  | $                         | 23,005 |                                                                | $ | (20,793                                         | )
|                                                                                                                                    |  |  |                                     |       |                    |   |                                                |  |                           |        |                                                                |   |                                                 |  

See Notes to
Consolidated Financial Statements.

F-41

---

LUCENT
TECHNOLOGIES INC. AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF CASH FLOWS(in millions)

|                                                                                           |  |  | Years
      ended September 30, |       
|------------------------------------------------------------------------------------------ |  |  | ------------------------------- | ------
|                                                                                           |  |  | 2004                            |       
|                                                                                           |  |  |                                 |       
|Operating
      activities:                                                                |  |  |                                 |       
|Net income
      (loss)                                                                    |  |  | $                               | 2,002 
|Less:
      Income from discontinued operations                                            |  |  |                                 |      
|                                                                                           |  |  |                                 |       
|Income
      (loss) from continuing operations                                             |  |  |                                 | 2,002 
|                                                                                           |  | 
|Adjustments
      to reconcile net income (loss) from continuing operations to net cash    |  | 
|provided
      by (used
      in) operating activities, net of effects of acquisitions and |  | 
|dispositions
      of businesses
      and manufacturing operations:                       |  | 
|Non-cash
      portion of business restructuring                                           |  |  |                                 | 1     
|Impairment
      of goodwill                                                               |  |  |                                 |      
|Depreciation
      and amortization                                                        |  |  |                                 | 693   
|Provision
      for (recovery of) bad debts and customer financings                        |  |  |                                 | (230  
|Deferred
      income taxes                                                                |  |  |                                 | (19   
|Pension
      credit                                                                       |  |  |                                 | (1,111
|Gains
      on sales of businesses                                                         |  |  |                                 |      
|Other
      adjustments for non-cash items                                                 |  |  |                                 | 79    
|Changes
      in operating assets and liabilities:                                         |  | 
|Decrease
      in receivables                                                              |  |  |                                 | 200   
|(Increase)
      decrease in inventories and contracts in process                          |  |  |                                 | (59   
|Decrease
      in accounts payable                                                         |  |  |                                 | (203  
|Increase
      (decrease) in deferred revenue                                              |  |  |                                 | 80    
|Changes
      in other operating assets and liabilities                                    |  |  |                                 | (799  
|                                                                                           |  |  |                                 |       
|Net cash
      provided by (used in) operating activities                                  |  |  |                                 | 634   
|                                                                                           |  |  |                                 |       
|                                                                                           |  | 
|Investing
      activities:                                                                |  | 
|Capital
      expenditures                                                                 |  |  |                                 | (157  
|Dispositions
      of businesses and manufacturing operations                              |  |  |                                 |      
|Purchases
      of marketable securities                                                   |  |  |                                 | (2,091
|Maturities
      of marketable securities                                                  |  |  |                                 | 918   
|Sales
      of marketable securities                                                       |  |  |                                 | 352   
|Proceeds
      from the sale or disposal of property, plant and equipment                  |  |  |                                 | 63    
|Other
      investing activities                                                           |  |  |                                 | 46    
|                                                                                           |  |  |                                 |       
|Net cash
      (used in) provided by investing activities                                  |  |  |                                 | (869  
|                                                                                           |  |  |                                 |       
|                                                                                           |  | 
|Financing
      activities:                                                                |  | 
|Issuance
      of convertible senior debt                                                  |  |  |                                 |      
|Issuance
      of 7.75% trust preferred securities                                         |  |  |                                 |      
|Repayments
      of credit facilities                                                      |  |  |                                 |      
|Net
      proceeds (repayments) of other short-term borrowings                             |  |  |                                 | 2     
|Repayments
      of long-term debt                                                         |  |  |                                 | (479  
|Issuance
      of common stock                                                             |  |  |                                 | 276   
|Repayments
      of preferred stock                                                        |  |  |                                 | (21   
|Dividends
      paid on preferred stock                                                    |  |  |                                 |      
|Other
      financing activities                                                           |  |  |                                 | (17   
|                                                                                           |  |  |                                 |       
|Net cash
      (used in) provided by financing activities                                  |  |  |                                 | (239  
|Effect
      of exchange rate changes on cash and cash equivalents                         |  |  |                                 | 32    
|                                                                                           |  |  |                                 |       
|Net (decrease)
      increase in cash and cash equivalents                                 |  |  |                                 | (442  
|Cash
      and cash equivalents at beginning of year                                       |  |  |                                 | 3,821 
|                                                                                           |  |  |                                 |       
|Cash
      and cash equivalents at end of year                                             |  |  | $                               | 3,379 
|                                                                                           |  |  |                                 |       
|                                                                                          
|Income
      tax refunds, net                                                              |  |  | $                               | 52    
|                                                                                           |  |  |                                 |       
|Interest
      payments                                                                    |  |  | $                               | 371   
|                                                                                           |  |  |                                 |       

See Notes to
Consolidated Financial Statements.

F-42

---

1.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of
Consolidation

The
consolidated  financial  statements  include  all  majority-owned  subsidiaries  over
which  we  exercise  control.  Investments  where we  exercise  significant  influence
but do not control  (generally a 20% to  50%  ownership  interest),  are accounted for
under the equity method of  accounting.  All material  intercompany  transactions  and
balances have  been  eliminated.  Except  as  otherwise  noted,  all  amounts  and
disclosures only include continuing operations.

Use of Estimates

We are required
to make  estimates and  assumptions  that affect amounts  reported in the  financial
statements  and  footnotes.  Actual  results  could be  different  from  estimated
amounts.  We believe  that some of  the more  critical  estimates  and related
assumptions  that affect our  financial  condition  and  results  of  operations  are in
the  areas of  revenue recognition,  pension and postretirement benefits, income taxes,
legal  contingencies,  receivables and customer financing,  inventories,  business
restructuring  and  intangible  assets.  Estimates  and  assumptions are periodically
reviewed,  and the effects of any material  revisions are reflected in the period that they are determined to be necessary.

Foreign
Currency Translation and Transactions

Results of
operations and cash flows are translated at average  exchange  rates  and  assets  and
liabilities  are  translated  at  end-of-period  exchange  rates for  operations  outside
the United  States that prepare  financial  statements  in  currencies  other  than  the
U.S.  dollar.  Translation  adjustments  are  included  as  a  separate  component  of
accumulated other comprehensive  income (loss) in shareowners deficit.  Gains and
losses from foreign  currency  transactions  are  reflected in  other income (expense),
net.

Revenue
Recognition

Revenue is
recognized when persuasive  evidence of an agreement  exists,  delivery  has  occurred,
the  amount  is  fixed  or  determinable,  and  collection  of  the  resulting
receivable,  including  receivables  of  customers to which we have provided customer
financing, is probable.

Most of our
sales are generated  from complex  contractual  arrangements  that require significant
revenue recognition judgments,  particularly in  the areas of multiple-element
arrangements, the application of software  revenue recognition rules, contract accounting
and collectibility.

Revenues from
contracts  with  multiple-element  arrangements,  such as  those including  products with
installation  and integration  services,  are  recognized  as the  revenue for each unit
of  accounting  is earned  based  on the  relative  fair  value  of  each  unit  of
accounting  as  determined by internal or third party analyses of  market-based  prices.
A delivered  element is  considered a separate  unit of accounting if it  has value to
the customer on a standalone basis,  there is objective and  reliable  evidence  of the
fair  value of  undelivered  elements  in the  arrangement,  and delivery or  performance
of  undelivered  elements is  considered  probable and  substantially  under our
control.  Revenue is  generally  recognized  when title passes to the customer,  which
usually  is  upon  delivery  of  the  equipment,  provided  our  installation
requirements  are expected to be completed within 90 days from equipment  delivery and
all other revenue  recognition  criteria is met. Revenue is  generally  recognized  for
products sold through  multiple  distribution  channels when the reseller or  distributor
sells the product to the end  user.  Services  revenue  is  generally  recognized  at
the  time  of  performance.

We apply
software revenue  recognition  rules when we sell software on a  standalone  basis,  or
when  software is embedded with our hardware and  the software is  considered  more than
incidental.  We  determine  that  software  is  more  than  incidental  when it is
apparent  that it is a  significant factor in the customers  purchasing decision
such as when a  transaction  also  includes  software  upgrades  or  enhancements.  In
multiple  element  arrangements  where software is considered  more than  incidental, fair

F-43

---

value of an
undelivered  element is  determined  using vendor  specific  objective  evidence  (VSOE).
If  VSOE  cannot  be  determined  or  any  undelivered  element is essential to the
functionality of the delivered  element,  revenue is deferred  until such  criteria are
met or until the  last element is delivered.

The  percentage
of  completion  method of  accounting is used for sales  generated from certain
contracts,  primarily those related to customized  network solutions and network
build-outs with durations of at least six  months. The units-of-delivery  method or
units-of-work  performed method  is  used  to  measure  progress  on  each  contract.
Revenue  and  cost  estimates are revised  periodically  based on changes in
circumstances.  Any  expected  losses  on  contracts  are  recognized  immediately  upon
contract signing or as soon thereafter as identified.

The  assessment
of  collectibility  is critical in  determining  whether  revenue  should  be
recognized.  As  part  of the  revenue  recognition  process,  we  determine  whether
trade  and  notes  receivables  are  reasonably  assured of collection based on various
factors.  Revenue and  related  costs  are  deferred  if we are  uncertain  as to
whether  the  receivable  can be collected or sold.  Revenue is deferred but costs are
recognized  when  we  determine  that  the  collection  or  sale  of the  receivable is
unlikely.

Research and
Development and Software Development Costs

Research  and
development  costs are  charged to  expense as  incurred.  However,  the direct labor and
related  overhead  costs incurred for the  development  of  computer  software  that
will  be  sold  (marketed  software)  are  capitalized  when  technological
feasibility  is  established.  Technological  feasibility is established  upon completion
of all of the planning,  designing,  coding and testing  activities that  are necessary
in order to establish  that the product can be produced to  meet  its  design
specifications,  including  functions,  features  and  technical performance
requirements.  These capitalized costs are subject  to an ongoing  assessment of
recoverability  based on anticipated future  revenues and changes in hardware and
software technologies.

Capitalization
ceases and amortization of marketed software development  costs  begins  when the
product is  available  for  general  release to  customers.  Amortization  is  recognized
as costs included in our  gross  margin  on  a  product-by-product  basis,
generally  using  the  straight-line  method  over  a  12  to  18-month  period.
Unamortized  marketed  software  development  costs determined to be in excess of the
net  realizable  value  of the  product  are  charged  to  Research  and  Development
expense prior to the general release to the customer,  or to  Costs thereafter.

Internal Use
Software

Direct labor
and related  overhead costs incurred during the application  development  stage  and  the
implementation  stage  for  developing,  purchasing  or  otherwise  acquiring  software
for  internal  use  are  capitalized.  These costs are amortized over the estimated
useful lives  of the  software,  generally  three  years.  Costs  incurred  during the
preliminary project stage are expensed as incurred.

Stock-Based
Compensation

We follow
Accounting  Principles Board Opinion No. 25,  Accounting for  Stock Issued to
Employees, for our stock-based  compensation  plans and  do not recognize  expense
for stock option grants if the exercise  price  is at least  equal to the market  value
of the common  stock at the date  of  grant.  Stock-based  compensation  expense
reflected  in  the  as  reported net income (loss)  includes  expense for restricted
stock unit  awards  and  option  modifications  and  the  amortization  of  certain
acquisition-related deferred compensation expense.

In accordance
with Statement of Financial  Accounting Standards (SFAS)  123, Accounting
for Stock-Based Compensation,  as amended by SFAS 148,  the  following  table
summarizes  the pro forma  effect of  stock-based  compensation  as if the  fair  value
method  of  accounting  for  stock  options  had  been  applied  in  measuring
compensation  cost.  No  tax  benefits  were  attributed  to  the  stock-based  employee
compensation  expense  during  fiscal 2004 and 2003 because we  maintained a valuation
allowance on substantially all of our net deferred tax assets.

F-44

---

|                                                                |  |  | Years
      ended September 30, |      
|--------------------------------------------------------------- |  |  | ------------------------------- | -----
|                                                                |  |  | 2004                            |      
|(in
      millions, except per share amounts)                   |  |  |                                 |      
|Net income
      (loss), as reported                            |  |  | $                               | 2,002
|Add:
      Stock-based employee compensation expense            | 
|included
      in as reported net income (loss), including tax  |  | 
|expense of $13
      during fiscal 2002                         |  |  |                                 | 16   
|Deduct:
      Total stock-based employee compensation           |  |  |                                 |      
|expense
      determined under the fair value based method,     |  |  |                                 |      
|including tax expense
      of $1,408 during fiscal 2002        |  |  |                                 | (338 
|                                                                |  |  |                                 |      
|Pro forma
      net income (loss)                               |  |  | $                               | 1,680
|                                                                |  |  |                                 |      
|Income
      (loss) per share applicable to common shareowners: |  | 
|Basic
       as reported                                       |  |  | $                               | 0.47 
|Diluted
       as reported                                     |  |  |                                 | 0.42 
|Basic
       pro forma                                         |  |  |                                 | 0.40 
|Diluted
       pro forma                                       |  |  |                                 | 0.36 

The
  fair value of stock options used to compute the pro forma disclosures is estimated
  using the Black-Scholes option-pricing model. This model requires the input
  of subjective assumptions, including the expected price volatility of the underlying
  stock. Projected data related to the expected volatility and expected life of
  stock options is based upon historical and other information. Changes in these
  subjective assumptions can materially affect the fair value estimates. The following
  table summarizes the assumptions used to compute the weighted average fair value
  of stock option grants.

|                                                     |  |  | 2004 |      | 2003 |   | 2002 |  
|---------------------------------------------------- |  |  | ---- | ---- | ---- | - | ---- | -
|                                                     |  |  |     
|Dividend
      yield                                 |  |  |      | 0.0  | %    |   | 0.0  | %
|Expected
      volatility                            |  |  |      | 90.2 | %    |   | 95.1 | %
|Risk-free
      interest rate                        |  |  |      | 2.6  | %    |   | 2.2  | %
|Expected
      holding period (in years)             |  |  |      | 3.2  |      |   | 3.0  |  
|Weighted
      average fair value of options granted |  |  | $    | 1.83 |      | $ | 0.87 |  

Refer  to Note
10 for  further  information  regarding  our  stock-based  compensation plans.

Cash and Cash
Equivalents

All highly
liquid  investments with original  maturities of three months  or less are considered
cash  equivalents.  These  primarily  consist of  money market funds and to a lesser
extent,  certificates  of deposit and  commercial  paper.  Cash held as collateral  or
escrowed for  contingent  liabilities  is included in other current and  non-current
assets based  on the expected release of the underlying obligation.

Marketable
Securities

Our  marketable
securities  consist  of  debt  securities  that  are  designated  as  available-for-sale
and  recorded  at  fair  value.  Unrealized  holding  gains or losses  are  reported  as
a  component  of  accumulated  other  comprehensive  income  (loss).  Realized  gains  or
losses  resulting from the sale of these securities are determined based  on the
specific  identification  of  the  securities  sold.  Marketable  securities with
maturities  greater than three months and less than one  year are  classified as
short-term,  otherwise  they are  classified as  long-term.

An impairment
charge is  recognized  when the decline in the fair value  of a  security  below  the
amortized  cost  basis is  determined  to be  other-than-temporary.  We  consider
various  factors  in  determining  whether to recognize an  impairment  charge,
including  the duration of  time and the  severity  to which  the fair  value has been
less than our  amortized cost basis,  any adverse  changes in the investees financial
condition  and our  intent  and  ability  to hold the  investment  for a  period of time
sufficient  to allow  for any  anticipated  recovery  in  market value.

F-45

---

Inventories

Inventories
are  stated  at  the  lower  of  standard  cost  (which  approximates cost determined on
a first-in,  first-out basis) or market.  Excess and obsolete  inventory  reserves  are
generally  determined  by  future demand  forecasts.  Inventories  associated with
deferred revenue  and where title and risk of loss was  transferred  to the customer
were  $166  million  and $158  million  as of  September  30,  2004  and  2003,
respectively.

Property, Plant
and Equipment

Property,
plant and  equipment  are  stated  at cost  less  accumulated  depreciation.
Depreciation  is  determined  using  accelerated  and  straight-line  methods  over the
estimated  useful lives of the various  asset  classes.  Useful lives for buildings  and
building  improvements,  furniture and fixtures,  and machinery and equipment
principally  range  from  five to  fifty  years,  five to ten  years  and two to ten
years,  respectively.

Acquisition
costs and substantial  improvements to property,  plant and  equipment are  capitalized.
The cost of normal  maintenance and repairs  are expensed as incurred.

Goodwill and
Other Intangible Assets

We adopted
  SFAS 142, Goodwill and Other Intangible Assets, in the first quarter
  of fiscal 2003. As a result, goodwill is no longer amortized but is tested for
  impairment in the fourth quarter of each fiscal year or more often if an event
  or circumstance indicates that an impairment loss has been incurred. An impairment
  charge is recognized if a reporting units goodwill carrying amount exceeds
  its implied fair value. We experienced no transitional impairment loss upon
  adoption of SFAS 142. Prior to adoption, goodwill and identifiable intangible
  assets were amortized on a straight-line basis over their estimated useful lives.
  Other acquired intangible assets continue to be amortized on a straight-line
  basis over the periods benefited, primarily over four years. The following table
  summarizes the changes in the carrying value of goodwill and other acquired
  intangible assets.

|                               |  |  | Goodwill | Other 
      Acquired 
      Intangible
      Assets |         
|------------------------------ |  |  | -------- | ---------------------------------------------------- | --------
|                               |  |  |          |                                                     
|                               |  |  | INS      |                                                      | Mobility
|(in millions)                  |  |  |          |                                                      |         
|As
      of September 30, 2002 |  |  | $        | 151                                                  |         
|Acquisition/contingencies      |  |  |          | 5                                                    |         
|Impairment/amortization        |  |  |          | (35                                                  | )       
|Other                          |  |  |          | 10                                                   |         
|                               |  |  |          |                                                      |         
|As of
      September 30, 2003 |  |  |          | 131                                                  |         
|Acquisition/contingencies      |  |  |          | 127                                                  |         
|Impairment/amortization        |  |  |          |                                                     |         
|Other                          |  |  |          | (1                                                   | )       
|                               |  |  |          |                                                      |         
|As of
      September 30, 2004 |  |  | $        | 257                                                  |         
|                               |  |  |          |                                                      |         

F-46

---

Other
acquired  intangible  assets were net of accumulated  amortization  of $48  million  and
$45  million  as of  September  30,  2004 and 2003,  respectively.  The  following  table
presents  the net loss for  fiscal  2002, adjusted to exclude goodwill amortization of
$208 million.

|                                              |  |  | Year endedSeptember 30, 2002 |        
|--------------------------------------------- |  |  | ---------------------------- | -------
|(in millions,
      except per share amounts) |  |  |                              |        
|Net loss:                                     |  |  |                              |        
|As
      reported                             |  |  | $                            | (11,753
|Adjusted                                      |  |  |                              | (11,545
|Basic
      and diluted loss per share:       |  | 
|As
      reported                             |  |  | $                            | (3.49  
|Adjusted                                      |  |  |                              | (3.43  

The
  following table summarizes the estimated future amortization expense of other
  acquired intangible assets.

|(in
      millions)
      Fiscal Year: |  |  | Amount |   
|-------------------------------------- |  |  | ------ | --
|                                       |  |  |       
|2005                                   |  |  | $      | 16
|2006                                   |  |  |        | 16
|2007                                   |  |  |        | 15
|2008                                   |  |  |        | 14
|                                       |  |  |        |   
|Total                                  |  |  | $      | 61
|                                       |  |  |        |   

Impairment of
Other Long-Lived Assets

Other
long-lived  assets,  including  property,  plant  and  equipment,  capitalized  software
and other acquired  intangible assets are reviewed  for impairment  whenever events such
as product  discontinuances,  plant  closures,  product  dispositions  or  other  changes
in  circumstances  indicate  that  the  carrying  amount  may  not  be  recoverable.  An
impairment  loss is recognized  when the carrying amount of a long-lived  asset exceeds
the sum of the undiscounted  cash flows expected to result  from the assets use and
eventual  disposition.  An  impairment  loss is  measured  as the amount by which the
carrying  amount  exceeds its fair  value,  which is typically  calculated using
discounted  expected future  cash flows.  The  discount  rate applied to these cash flows
is based on  our  weighted  average  cost of capital,  which  represents  the blended
after-tax costs of debt and equity.

Reclassifications

Certain amounts
have been  reclassified to conform to our current period  presentation.

2. BUSINESS
RESTRUCTURING

During the
second  quarter of fiscal  2001,  we  committed  to and began  implementing a
restructuring  program to realign  resources to focus on  the large  telecommunications
service provider market.  We assessed our  product  portfolio and associated R&D, and
then  streamlined the rest of  our  operations  to support  those  reassessments.  We
eliminated  some  marginally  profitable or  non-strategic  product lines,  merged
certain  technology platforms,  consolidated  development activities,  eliminated
management  positions and many  duplications in marketing  functions and  programs,
centralized  our sales  support  functions and sold or leased  certain  of  our
manufacturing  facilities  and  made  greater  use  of  contract  manufacturers.  We sold
or disposed  of the assets  related to  the  eliminated  product  lines,  closed
facilities  and  reduced  the  employee workforce on a global basis.

All  reportable
segments,  sales and marketing,  and general  corporate  functions  participated  in
these  actions,  however  the  charges  or  subsequent  reversals to the reserves  were
excluded from their results  and were reported  separately.  The following  table
summarizes the net  charges or reversals under our restructuring program.

F-47

---

|                                                |  |  | Years
      ended September 30, |    
|----------------------------------------------- |  |  | ------------------------------- | ---
|                                                |  |  | 2004                            |    
|                                                |  |  |                                 |    
|(in
      millions)                             |  |  |                                 |    
|Restructuring
      costs                       |  |  | $                               | (20
|Asset
      write-downs                         |  |  |                                 | 1  
|Business
      dispositions                     |  |  |                                 | (1 
|Impairment
      of goodwill and other acquired |  | 
|intangible
      assets                         |  |  |                                 |   
|                                                |  |  |                                 |    
|Net charges
      (reversals)                   |  |  | $                               | (20
|                                                |  |  |                                 |    
|                                                |  | 
|Reflected
      in:                             |  | 
|Costs                                           |  |  | $                               |   
|Operating
      expenses                        |  |  |                                 | (20
|Impairment
      of goodwill                    |  |  |                                 |   
|                                                |  |  |                                 |    
|Net charges
      (reversals)                   |  |  | $                               | (20
|                                                |  |  |                                 |    

Restructuring
Costs

Restructuring
  costs consisted of employee separations of $3.4 billion, contract settlements
  of $944 million, facility closings of $304 million, and other charges of $79
  million during fiscal 2001. The following table summarizes the components of
  restructuring costs and related reserve activity.

|                                                     |  |  | Employee 
      Separations |        | Contract 
      Settlements |   | Facility
      Closings |   | Other |      | Total |  
|---------------------------------------------------- |  |  | --------------------------- | ------ | --------------------------- | - | ----------------------- | - | ----- | ---- | ----- | -
|                                                     |  |  |                             |       
|(in millions)                                        |  |  |                             |        |                             |   |                         |   |       |      |       |  
|Restructuring
      reserve as of September 30, 2001 |  |  | $                           | 588    |                             | $ | 610                     |   | $     | 296  |       | $
|                                                     |  |  |                             |       
|Charges
      related to current year plans          |  |  |                             | 944    |                             |   | 90                      |   |       | 210  |       |  
|Charges
      related to prior year plans            |  |  |                             | 5      |                             |   | 18                      |   |       | 116  |       |  
|Reversals
      related to prior year plans          |  |  |                             | (150   | )                           |   | (201                    | ) |       | (25  | )     |  
|                                                     |  |  |                             |       
|Total
      restructuring costs for fiscal 2002      |  |  |                             | 799    |                             |   | (93                     | ) |       | 301  |       |  
|Utilization
      of reserves                        |  |  |                             | (1,020 | )                           |   | (367                    | ) |       | (114 | )     |  
|                                                     |  |  |                             |       
|Restructuring
      reserve as of September 30, 2002 |  |  |                             | 367    |                             |   | 150                     |   |       | 483  |       |  
|                                                     |  |  |                             |       
|Charges
      related to current year plans          |  |  |                             | 18     |                             |   | 17                      |   |       |     |       |  
|Charges
      related to prior year plans            |  |  |                             | 163    |                             |   | 27                      |   |       | 54   |       |  
|Reversals
      related to prior year plans          |  |  |                             | (228   | )                           |   | (60                     | ) |       | (37  | )     |  
|                                                     |  |  |                             |       
|Total
      restructuring costs for fiscal 2003      |  |  |                             | (47    | )                           |   | (16                     | ) |       | 17   |       |  
|Utilization
      of reserves                        |  |  |                             | (258   | )                           |   | (100                    | ) |       | (133 | )     |  
|                                                     |  |  |                             |       
|Restructuring
      reserve as of September 30, 2003 |  |  |                             | 62     |                             |   | 34                      |   |       | 367  |       |  
|                                                     |  |  |                             |       
|Charges
      related to prior year plans            |  |  |                             |       |                             |   |                        |   |       | 44   |       |  
|Reversals
      related to prior year plans          |  |  |                             | (14    | )                           |   | (15                     | ) |       | (32  | )     |  
|                                                     |  |  |                             |       
|Total
      restructuring costs for fiscal 2004      |  |  |                             | (14    | )                           |   | (15                     | ) |       | 12   |       |  
|Utilization
      of reserves                        |  |  |                             | (38    | )                           |   | (11                     | ) |       | (177 | )     |  
|                                                     |  |  |                             |       
|Restructuring
      reserve as of September 30, 2004 |  |  | $                           | 10     |                             | $ | 8                       |   | $     | 202  |       | $
|                                                     |  |  |                             |       

F-48

---

Employee
Separations

There were
approximately  53,600  voluntary  and  involuntary  employee  separations  associated
with  employee  separation  charges from fiscal  2001  through  fiscal  2003.
Substantially  all  of  the  employee  separations  were  completed  as of  September
30,  2003.  The employee  separations  affected  all  business  groups  and  geographic
regions.  Management  represented  approximately  70%  of  the  total  employee
separations.  In  addition,  involuntary  separations  represented  approximately 70% of
the total employee separations.

The  fiscal
2003  charges  for new  plans  were for  approximately  200  employee  separations
associated  with  the  discontinuance  of the TMX  Multi-Service  Switching  and  Spring
Tide  product  lines  in the  INS  segment.  The fiscal 2002  charges for new plans were
for  approximately  17,300  employee  separations  and  included  charges  for  pension
termination  benefits for certain former U.S.  employees  funded through  our pension
assets,  pension and postretirement  curtailment charges and  postemployment benefit
curtailment credits.

The  fiscal
2004 and 2003  revisions  to prior  year  plans were due to  actual  termination
benefits and curtailment costs being lower than the  estimated  amounts  as  a  result
of  certain  differences  in  assumed  demographics,  including  the age,  service  lives
and  salaries  of the  separated  employees.  Fiscal  2003  also  included  a  reversal
of  approximately  900  employee  separations  due to higher  than  expected  attrition
rates.  Components  of the fiscal 2003 net reversal  included  non-cash reversals for
pension and postretirement  termination  benefits  to certain former U.S.  employees
funded through our pension assets, and  pension,  postretirement and postemployment
benefit  curtailments.  The  fiscal  2002  revisions  to prior  year  plans  were due to
higher  than  expected  attrition rates that resulted in a reduction of 2,200 expected
employee  terminations.  Also, the  actual severance cost per person was  lower than
the original  estimates  after execution of the various plans  in many countries.

Contract
Settlements

Contract
settlement  charges were primarily incurred for settlements of  purchase  commitments
with  suppliers  and contract  renegotiations  or  cancellations  of contracts with
customers,  all of which resulted from  the  discontinuance  of various  product lines.
Revisions to prior year  plans were due primarily to the  negotiated  settlement  of
obligations  and commitments for amounts lower than originally estimated.

Facility
Closings

The planned
exit of certain  owned and leased  facilities  consisting of  approximately  15.9
million  square  feet  were  included  in  the  restructuring  program.  All of these
sites were exited as of  September  30, 2003.  Charges were  recognized  for the expected
remaining  future  cash  outlays  associated  with  trailing  lease  liabilities,  lease
termination  payments and expected  restoration costs in connection with  the plans.  The
trailing  lease  liabilities  were  reduced by expected  sublease rental income.

Revisions  to
prior  year  plans  were due to the  impact of  changes in  estimated  facility  closing
costs,  including  additional  space  consolidation,  expected  sublease  rental income
on certain  properties  resulting  from changes in the  commercial  real estate market
and early  termination of certain lease obligations.

The  facility
closings  charges  were net of expected  sublease  rental  income of $136  million and
$241  million  during  fiscal 2002 and 2001,  respectively.  This expected  sublease
rental  income was  subsequently  reduced by $105  million,  $55  million and $63
million  during  fiscal  2004,  2003  and  2002,  respectively.  The  remaining  reserve
as  of  September  30,  2004 of $202  million  is  expected  to be paid over the
remaining  lease terms  ranging from  several  months to 11 years and is  reflected  net
of  expected  sublease  income of $137  million.  We have  received  commitments  for
approximately  $30 million of this  expected  sublease  rental  income as of September
30, 2004.  Additional  charges  may be required  in the future if the  expected  sublease
income is not  realized.

F-49

---

Utilization
  of business restructuring reserves

|                                                                            |  |  | Years ended September 30, |     
|--------------------------------------------------------------------------- |  |  | ------------------------- | ----
|                                                                            |  |  | 2004                      |     
|(in millions)                                                               |  |  |                           |     
|Cash
      payments                                                         |  |  | $                         | (227
|Net pension
      and postretirement termination benefits to certain former |  | 
|U.S.
      employees to be funded through our pension assets                |  |  |                           |    
|Net pension
      and postretirement benefit curtailments                   |  |  |                           |    
|Net postemployment
      benefit curtailments                               |  |  |                           |    
|Other                                                                       |  |  |                           |    
|                                                                            |  |  |                           |     
|Utilization
      of reserves                                               |  |  | $                         | (227
|                                                                            |  |  |                           |     

Asset
write-downs

The following
table summarizes the components of asset write-downs.

|                                            |  |  | Inventory |       | Property,
      plant
      and equipment |   | Capitalized
      software |   | Other |     | Total |  
|------------------------------------------- |  |  | --------- | ----- | ----------------------------------------- | - | -------------------------- | - | ----- | --- | ----- | -
|(in millions)                               |  |  |           |       |                                           |   |                            |   |       |     |       |  
|Fiscal
      2001 asset write-downs         |  |  | $         | 1,259 |                                           | $ | 425                        |   | $     | 362 |       | $
|                                            |  |  |           |       |                                           |   |                            |   |       |     |       |  
|                                           
|Charges
      related to current year plans |  |  | $         | 129   |                                           | $ | 304                        |   | $     | 72  |       | $
|Charges
      related to prior year plans   |  |  |           | 97    |                                           |   | 51                         |   |       |    |       |  
|Reversals
      related to prior year plans |  |  |           | (162  | )                                         |   | (35                        | ) |       |    |       |  
|                                            |  |  |           |       |                                           |   |                            |   |       |     |       |  
|Fiscal
      2002 asset write-downs         |  |  | $         | 64    |                                           | $ | 320                        |   | $     | 72  |       | $
|                                            |  |  |           |       |                                           |   |                            |   |       |     |       |  
|Charges
      related to current year plans |  |  | $         | 3     |                                           | $ | 2                          |   | $     |    |       | $
|Charges
      related to prior year plans   |  |  |           | 26    |                                           |   | 24                         |   |       |    |       |  
|Reversals
      related to prior year plans |  |  |           | (55   | )                                         |   | (113                       | ) |       |    |       |  
|                                            |  |  |           |       |                                           |   |                            |   |       |     |       |  
|Fiscal
      2003 asset write-downs         |  |  | $         | (26   | )                                         | $ | (87                        | ) | $     |    |       | $
|                                            |  |  |           |       |                                           |   |                            |   |       |     |       |  
|                                           
|Fiscal
      2004 asset write-downs         |  |  | $         |      |                                           | $ |                           |   | $     |    |       | $
|                                            |  |  |           |       |                                           |   |                            |   |       |     |       |  

Significant
asset  write-downs  were  required  as  a  result  of  our  restructuring  actions,
including the elimination of product lines, the  sale or lease of certain manufacturing
operations,  the exit of certain  facilities and the  elimination  of certain  management
positions.  The  realizability  of each asset affected by the  restructuring  actions was
assessed  and  written  down to a new cost basis if  required,  based on  estimated
future cash flows.

Inventory
charges  included an estimate of amounts  related to products  rationalized or
discontinued  that were not required to fulfill existing  customer  obligations.
Additional  inventory  charges  or  reserve  reductions  were  recognized  if  the
fulfillment  of  those  customer  obligations  were  different  from  amounts  estimated.
In  addition,  reversals  related to property,  plant and equipment were recognized due
to changes in the original plans for certain owned facility closings.

Business
dispositions

The  fiscal
2002  net  gain  of  $140  million  related  to  business  dispositions  contemplated as
part of our overall restructuring program,  including  a $188  million  gain  related to
the sale of the billing and  customer  care  business  and a $38 million  loss related to
the sale of  the enterprise professional services business.

Impairment of
goodwill and other acquired intangible assets

Business
decisions  during fiscal 2003 to partner with other  suppliers  to use their products in
our sales  offerings  prompted an assessment of  the  recoverability  of  certain
goodwill  associated  with  the  multi-service  switching  reporting  unit  within the
INS  segment.  The  reporting  units fair value was determined  using  projected
cash flows  over a seven-year period,  discounted at 15% after considering  terminal
value and related  cash flows  associated  with  service  revenues.  The  excess of the
goodwills  carrying value over its implied fair value was  recognized as an
impairment charge in the amount of $35 million.

F-50

---

The  continued
and  sharper  decline in the  telecommunications  market  prompted  an  assessment
during  fiscal  2002  of all  key  assumptions  underlying  goodwill  valuation
judgments,  including those relating to  short- and long-term  growth rates.  It was
determined that the carrying  amounts of goodwill and other intangible  assets,
primarily  related to  the September  2000  acquisition  of Spring Tide,  were greater
than the  forecasted  undiscounted cash flows. As a result,  impairment charges of  $826
million  for  goodwill  and  $149  million  for  other  acquired  intangibles  were
recognized  based  on  the  difference  between  the  estimated fair values and
corresponding  carrying  amounts.  Fair values  were determined on the basis of
discounted cash flows.

3. BUSINESS
ACQUISITIONS AND DIVESTITURES

Acquisitions

On August 20,
2004,  we acquired 100 percent of the  outstanding  equity  of Telica.  Telica  provides
VoIP  communications  switching  equipment  that  enables  service  providers to deliver
enhanced  and  traditional  voice  services  over  Internet  Protocol  and  legacy
networks.  The  operating  results of Telica were included in our  consolidated  results
since the date of  acquisition.  Pro forma  results  were not  presented  because the
effect of the acquisition was not material.

The aggregate
purchase price of $262 million included  approximately 80  million  shares of our common
stock  valued at $258 million and options  to purchase  shares of our common stock.  The
value of the common shares  was  determined  based on the average  market price of our
common shares  over the 2-day  period  before  and  after  the date of the  acquisition
agreement.  The purchase  price  includes $9 million that was recognized  as a current
liability because certain Telica shares were not presented  for  exchange as of
September  30,  2004.  An  additional  nine million  shares of our common stock,  valued
at $29 million, is held in an escrow  account for potential general  indemnification
matters through February  2006.  Goodwill will be increased if these common shares are
released.

In addition to
the  consideration  referenced  above,  a $7 million cash  bonus was paid to Telicas
employees.  An  additional  $7 million  cash  bonus will be  provided  to  employees  if
certain  product  development  milestones  are  achieved  during the next two  years.  We
have begun to  accrue this cost over the milestone  period  because we expect that they
will be achieved.

The  purchase
price in excess of the  estimated  fair value of tangible  assets acquired was allocated
to goodwill ($178  million),  identifiable  intangible assets ($60 million) and
in-process  research and development  (IPR&D)  ($14  million).  The  identifiable
intangible  assets  were  attributed to developed  technology  that is amortized over its
expected  useful  life of four years.  IPR&D  represents  technology  that has not
reached  technological  feasibility and has no alternate future use. The  value
allocated to IPR&D was determined  using an income  approach that  included an excess
earnings analysis  reflecting the appropriate cost of  capital for each project.  These
estimated  future cash flows considered  estimates of revenue, gross margin,  operating
expenses and income taxes  and were  consistent with  historical  pricing,  cost and
expense levels  for similar  products.  A 33% discount rate was utilized to discount the
cash  flows  based on  consideration  of our  weighted  average  cost of  capital,  as
well as other factors  including the estimated  useful life  of each project,  the
anticipated  profitability  of each project,  the  uncertainty  of technology  advances
that were known at the time and the  stage of completion of each project.

On February 3,
2003, we purchased  the  remaining 10% minority  interest  in  AG  Communications
Systems  Corporation  for  $23  million.  This  transaction  resulted in $3 million of
goodwill  and $3 million of other  acquired intangible assets that related to developed
technology.

F-51

---

Dispositions

On September
30, 2002, we sold two of our China-based  joint ventures to  Corning  Incorporated.
These  joint  ventures  were part of the optical  fiber  solutions  business  (OFS).
The total  purchase  price of $200  million  included  a cash  payment  of $123  million,
shares of Corning  common  stock  valued  at  $50  million  and a  note  receivable  of
$27  million.  The note receivable was collected  during fiscal 2003.  A gain  of
$100  million was  recognized  and  included in other  income  during  fiscal 2002.

On May 31,
2002, we sold certain  manufacturing  equipment and inventory  for $96  million  and
commenced  a  three-year  supply  agreement  with  Solectron  Corporation for certain
optical networking  products.  Due to  continuing  market  uncertainties,  we  terminated
the  agreements,  purchased  certain  assets back from  Solectron  and paid $50
million to  Solectron  in November  2002.  The contract  manufacturing  work for the
optical  networking  products was transitioned to other suppliers during  the first  half
of fiscal  2003.  These  events  did not  significantly  impact our results of
operations.

On February 28,
2002,  we sold our billing and customer care business to  CSG Systems  International,
Inc. for $250 million. After the settlement  of  certain  post-closing  purchase  price
adjustments,  a gain of $188  million was  recognized  and included in business
restructuring  during  fiscal 2002.

On November 16,
2001,  we sold OFS to The Furukawa  Electric  Co.,  Ltd.  for approximately  $2.3
billion,  including shares of CommScope,  Inc.s  common  stock  valued  at  $173
million.  A gain of  $564  million  was  recognized  and  included  in  other  income
during  fiscal  2002.  The  favorable resolution of certain contingencies  resulted in an
additional  gain of $41 million during fiscal 2003.

Discontinued
Operations

On June 1,
2002,  we  completed  the  spin-off  of Agere  Systems  Inc.  (Agere),  our
former  microelectronics  business,  by distributing our  57.8% interest in Agere common
stock,  consisting of 37.0 million shares  of Agere Class A common stock and 908.1
million  shares of Agere Class B  common stock,  to our common  shareowners of record on
May 3, 2002. Each  of our shareowners  received one share of Agere Class A common stock
for  every  92.768991  shares of our common stock held and one share of Agere  Class B
common  stock for every  3.779818  shares  of our  common  stock  held. The historical
carrying  amount of the net assets  transferred to  Agere of approximately $1.2 billion
was charged to shareowners deficit  during fiscal 2002.  Our results of  operations
included $73 million of  income on  disposal  of Agere,  including  tax  expense  of $34
million  during  fiscal 2002.  This income  included  subsequent  adjustments  to  the
related  loss  reserve for our share of Ageres net losses from the  initial
measurement date through the spin-off date,  including  pension  termination  benefit
charges  of  $102  million  related  to  business  restructuring actions taken by Agere
prior to the spin-off.

During fiscal
2002 and through the spin-off date,  Ageres net cash used  by  operating
activities  was  $521  million,  net  cash  provided  by  investing  activities  was $279
million and net cash used by  financing  activities was $1.7 billion.

F-52

---

4.
SUPPLEMENTARY FINANCIAL INFORMATION

|                                                            |  |  | Years
      ended September 30, |    
|----------------------------------------------------------- |  |  | ------------------------------- | ---
|                                                            |  |  | 2004                            |    
|(in millions)                                               |  |  |                                 |    
|Supplementary
      Statement of Operations Information:    |  |  |                                 |    
|Depreciation
      of property, plant and equipment         |  |  | $                               | 284
|Amortization
      of software development costs            |  |  |                                 | 376
|Amortization
      of other acquired intangible assets      |  |  |                                 | 3  
|Amortization
      of goodwill                              |  |  |                                 |   
|Other
      amortization                                    |  |  |                                 | 30 
|                                                            |  |  |                                 |    
|Depreciation
      and amortization                         |  |  | $                               | 693
|                                                            |  |  |                                 |    
|                                                           
|Legal
      settlements                                     |  |  | $                               | (84
|SEC settlement                                              |  |  |                                 | (25
|Debt
      conversion cost and gain on extinguishments, net |  |  |                                 | (7 
|Gain
      on sale of businesses, net                       |  |  |                                 |   
|Gain
      (loss) on sale of investments                    |  |  |                                 | 75 
|Interest
      income                                       |  |  |                                 | 89 
|Interest
      income on tax settlements                    |  |  |                                 | 135
|Gain
      (loss) on foreign currency transactions          |  |  |                                 | (10
|Other-than-temporary
      write-down of investments        |  |  |                                 | (22
|Other,
      net                                            |  |  |                                 | 89 
|                                                            |  |  |                                 |    
|Other
      income (expense), net                           |  |  | $                               | 240
|                                                            |  |  |                                 |    

|                                                         |  |  | September
      30, |      
|-------------------------------------------------------- |  |  | ------------------- | -----
|                                                         |  |  | 2004                |      
|(in millions)                                            |  |  |                     |      
|Supplementary
      Balance Sheet Information:           |  |  |                     |      
|Completed
      goods                                    |  |  | $                   | 604  
|Work
      in process                                    |  |  |                     | 49   
|Raw materials                                            |  |  |                     | 169  
|                                                         |  |  |                     |      
|Inventories                                              |  |  | $                   | 822  
|                                                         |  |  |                     |      
|Contracts
      in process, gross                        |  |  | $                   | 3,696
|Less:
      progress billings                            |  |  |                     | 3,798
|                                                         |  |  |                     |      
|Contracts
      in process                               |  |  | $                   | (102 
|                                                         |  |  |                     |      
|Costs
      and recognized income not yet billed         |  |  | $                   | 106  
|Billings
      in excess of costs and recognized income  |  |  |                     | (208 
|                                                         |  |  |                     |      
|Contracts
      in process                               |  |  | $                   | (102 
|                                                         |  |  |                     |      
|Retainage
      receivables (included in other assets)   |  |  | $                   | 16   
|                                                         |  |  |                     |      
|Land
      and improvements                              |  |  | $                   | 76   
|Buildings
      and improvements                         |  |  |                     | 1,505
|Machinery,
      electronic and other equipment          |  |  |                     | 2,223
|                                                         |  |  |                     |      
|Property,
      plant and equipment, gross               |  |  |                     | 3,804
|Less:
      accumulated depreciation                     |  |  |                     | 2,428
|                                                         |  |  |                     |      
|Property,
      plant and equipment, net                 |  |  | $                   | 1,376
|                                                         |  |  |                     |      
|Income
      tax receivables, including related interest |  |  | $                   | 868  
|Non-trade
      receivables                              |  |  |                     | 360  
|Deferred
      income taxes                              |  |  |                     | 197  
|Prepaid
      expenses                                   |  |  |                     | 187  
|Restricted
      cash                                    |  |  |                     | 148  
|Forward
      contracts receivable                       |  |  |                     | 24   
|Contracts
      in process                               |  |  |                     |     
|Other                                                    |  |  |                     | 29   
|                                                         |  |  |                     |      
|Other
      current assets                               |  |  | $                   | 1,813
|                                                         |  |  |                     |      

F-53

---

|                                     |  |  | September
      30, |      
|------------------------------------ |  |  | ------------------- | -----
|                                     |  |  | 2004                |      
|                                     |  |  |                     |      
|Marketed
      software              |  |  | $                   | 284  
|Internal
      use software          |  |  |                     | 142  
|Restricted
      cash                |  |  |                     | 125  
|Non-trade
      receivables          |  |  |                     | 78   
|Investments                          |  |  |                     | 77   
|Other                                |  |  |                     | 222  
|                                     |  |  |                     |      
|Other
      assets                   |  |  | $                   | 928  
|                                     |  |  |                     |      
|                                     |  |  |                     |      
|Deferred
      revenue               |  |  | $                   | 593  
|Shareholder
      lawsuit settlement |  |  |                     | 572  
|Warranty
      reserve               |  |  |                     | 221  
|Contracts
      in process           |  |  |                     | 102  
|Restructuring                        |  |  |                     | 88   
|Other                                |  |  |                     | 785  
|                                     |  |  |                     |      
|Other
      current liabilities      |  |  | $                   | 2,361
|                                     |  |  |                     |      
|                                     |  |  |                     |      
|Deferred
      income taxes          |  |  | $                   | 178  
|Deferred
      compensation          |  |  |                     | 155  
|Restructuring                        |  |  |                     | 122  
|Environmental                        |  |  |                     | 83   
|Warranty                             |  |  |                     | 76   
|Minority
      interests             |  |  |                     | 35   
|Other,
      including contingencies |  |  |                     | 483  
|                                     |  |  |                     |      
|Other
      liabilities              |  |  | $                   | 1,132
|                                     |  |  |                     |      

|                                                       |  |  | Years
      ended September 30, |     
|------------------------------------------------------ |  |  | ------------------------------- | ----
|                                                       |  |  | 2004                            |     
|(in millions)                                          |  |  |                                 |     
|Valuation
      and Qualifying Accounts                |  |  |                                 |     
|Allowance
      for uncollectible accounts receivable: |  | 
|Allowance at beginning of year                         |  |  | $                               | 246 
|Provision
      for (recovery of) bad debts            |  |  |                                 | (42 
|Transfers
      to (from) other accounts               |  |  |                                 | 7   
|Write-offs                                             |  |  |                                 | (101
|                                                       |  |  |                                 |     
|Allowance at end of year                               |  |  | $                               | 110 
|                                                       |  |  |                                 |     
|                                                       |  | 
|Inventory
      valuation reserves:                    |  | 
|Reserve at beginning of year                           |  |  | $                               | 980 
|Charged
      to costs                                 |  |  |                                 | 17  
|Transfers
      to (from) other accounts               |  |  |                                 | (26 
|Write-offs                                             |  |  |                                 | (251
|                                                       |  |  |                                 |     
|Reserve at end of year                                 |  |  | $                               | 720 
|                                                       |  |  |                                 |     

5. EARNINGS
(LOSS) PER COMMON SHARE

Basic EPS is
calculated by dividing the net income (loss)  applicable to  common  shareowners  by the
weighted  average  number of common  shares  outstanding  during the period.  Diluted EPS
is  calculated  by dividing  net income (loss) applicable to common shareowners,
adjusted to exclude  preferred  dividends and accretion,  conversion costs,  redemption
costs  and interest expense related to the potentially dilutive securities,  by  the
weighted  average  number of common  shares  outstanding  during the  period,  plus  any
additional  common  shares  that  would  have  been  outstanding  if  potentially
dilutive  common  shares  had been  issued  during the period.

The following
table  summarizes  the  computation  of basic and diluted  EPS. Due to the net loss
incurred in fiscal 2003 and 2002,  the diluted  loss per share was the same as basic
because any  potentially  dilutive  securities would have reduced the loss per share.

F-54

---

|                                                                    |  |  | Years
      ended September 30, |      
|------------------------------------------------------------------- |  |  | ------------------------------- | -----
|                                                                    |  |  | 2004                            |      
|(in millions, except
      per share amounts)                       |  |  |                                 |      
|Net
      income (loss)                                             |  |  | $                               | 2,002
|Conversion
      and redemption cost  8.00% convertible securities |  |  |                                 | (1   
|Preferred
      stock dividends and accretion                       |  |  |                                 | 12   
|                                                                    |  |  |                                 |      
|Net income
      (loss) applicable to common shareowners  basic    |  |  |                                 | 2,013
|Adjustment
      for dilutive securities on net income (loss):      |  | 
|Interest
      expense related to convertible securities            |  |  |                                 | 200  
|                                                                    |  |  |                                 |      
|Net income
      (loss) applicable to common shareowners  diluted  |  |  | $                               | 2,213
|                                                                    |  |  |                                 |      
|Weighted
      average shares outstanding  basic                   |  |  |                                 | 4,258
|Effect
      of dilutive securities:                                |  | 
|Stock
      options                                                 |  |  |                                 | 72   
|2.75%
      convertible securities                                  |  |  |                                 | 496  
|8.00%
      convertible securities                                  |  |  |                                 | 249  
|7.75%
      convertible securities                                  |  |  |                                 | 238  
|                                                                    |  |  |                                 |      
|Weighted
      average shares outstanding  diluted                 |  |  |                                 | 5,313
|                                                                    |  |  |                                 |      
|                                                                    |  | 
|EPS:                                                                |  | 
|Basic                                                               |  |  | $                               | 0.47 
|Diluted                                                             |  |  |                                 | 0.42 

The loss from
continuing  operations  applicable to common  shareowners  was  approximately  $12.0
billion or $3.51 per share during fiscal 2002.  Income from  discontinued  operations was
$73 million or $0.02 per share  during fiscal 2002.

The following
table  summarizes  the  potential  shares of common stock  that were excluded from the
diluted per share  calculation,  because the  effect of including these potential shares
was antidilutive.

|                                                                                                     |  |  | Years
      ended September 30, |    
|---------------------------------------------------------------------------------------------------- |  |  | ------------------------------- | ---
|                                                                                                     |  |  | 2004                            |    
|(in millions)                                                                                        |  |  |                                 |    
|8% convertible
      securities                                                                      |  |  |                                 | 3  
|7.75%
      convertible securities                                                                   |  |  |                                 |   
|2.75%
      convertible securities                                                                   |  |  |                                 |   
|Stock
      options                                                                                  |  |  |                                 |   
|Other                                                                                                |  |  |                                 |   
|                                                                                                     |  |  |                                 |    
|Potentially
      dilutive shares                                                                    |  |  |                                 | 3  
|                                                                                                     |  |  |                                 |    
|                                                                                                    
|Stock
      options excluded from the diluted per share calculation because the exercise
      price |  | 
|was
      greater than the average market price of the common shares                                 |  |  |                                 | 252
|                                                                                                     |  |  |                                 |    

The
calculation  of  dilutive or  potentially  dilutive  common  shares  related to our
convertible  securities considers the conversion features  or  redemption  features,
whichever  is  more  dilutive.  Redemption  features are only considered if  we have
the right to settle  redemption  requests  through the issuance of our common stock
as in the case of our  2.75%  and  8.00%  convertible  securities.  In  this  case,
the  if  redeemed  calculations are based upon the 12-month average price of
our  common  stock  and  the  weighted  average  number  of  the  respective  securities
outstanding  during the periods  presented.  The conversion  features  related  to
our  2.75%  convertible  securities  are  only  considered if certain  conditions  are
met,  otherwise the if redeemed calculations are  used. The
dilutive  effect  of  our  convertible  securities  may  fluctuate  from  period to
period as a result of the as  reported  net income  levels and the average  market price
of our common  stock.

In  September
2004,  the  FASBs  Emerging  Issues  Task  Force  (EITF)  finalized EITF Issue No.
04-8, The Effect of  Contingently  Convertible  Instruments on Diluted  Earnings
per Share.  As a result,  beginning in  the first quarter of fiscal 2005,  the
conversion  features  related to  our  2.75%  convertible  securities  will

F-55

---

always be
considered  in the  diluted  EPS  calculation  and  will be used  unless  the if
redeemed calculation  is more  dilutive.  The impact of EITF 04-8 is not expected
to materially  effect our future diluted EPS  calculations and would not  have changed
our quarterly and annual fiscal 2004 diluted EPS.

6. ACCUMULATED
OTHER COMPREHENSIVE LOSS

The components
of accumulated other comprehensive loss are summarized  below. Foreign currency
translation adjustments are generally not  adjusted for income taxes as they relate to
indefinite investments in  non-U.S. subsidiaries.

|                                       |  |  | Foreign
      currency
      translation
      adjustment |      | Change in net
      unrealized holding
      gains/losses on
      investments |   | Minimum
      pension
      liability
      adjustment |   | Total
      accumulated
      other
      comprehensive
      loss |       
|-------------------------------------- |  |  | --------------------------------------------------------- | ---- | ------------------------------------------------------------------------------ | - | ------------------------------------------------------ | - | ------------------------------------------------------------------ | ------
|(in millions)                          |  |  |                                                           |      |                                                                                |   |                                                        |   |                                                                    |       
|Balance
      as of October 1, 2001    |  |  | $                                                         | (467 | )                                                                              | $ | 40                                                     |   | $                                                                  | (14   
|Current-period
      change            |  |  |                                                           | 60   |                                                                                |   | (36                                                    | ) |                                                                    | (2,927
|Amounts
      transferred to Agere     |  |  |                                                           | (6   | )                                                                              |   |                                                       |   |                                                                    |      
|                                       |  |  |                                                           |      |                                                                                |   |                                                        |   |                                                                    |       
|Balance
      as of September 30, 2002 |  |  |                                                           | (413 | )                                                                              |   | 4                                                      |   |                                                                    | (2,941
|Current-period
      change            |  |  |                                                           | 135  |                                                                                |   | 71                                                     |   |                                                                    | (594  
|                                       |  |  |                                                           |      |                                                                                |   |                                                        |   |                                                                    |       
|Balance
      as of September 30, 2003 |  |  |                                                           | (278 | )                                                                              |   | 75                                                     |   |                                                                    | (3,535
|Current-period
      change            |  |  |                                                           | 34   |                                                                                |   | (81                                                    | ) |                                                                    | 150   
|                                       |  |  |                                                           |      |                                                                                |   |                                                        |   |                                                                    |       
|Balance
      as of September 30, 2004 |  |  | $                                                         | (244 | )                                                                              | $ | (6                                                     | ) | $                                                                  | (3,385
|                                       |  |  |                                                           |      |                                                                                |   |                                                        |   |                                                                    |       

7. INCOME TAXES

The  following
table  summarizes  the U.S. and non-U.S.  components  of  income  (loss) from  continuing
operations  before income taxes and the  provision (benefit) for income taxes.

|                                                                    |  |  | Years
      ended September 30, |      
|------------------------------------------------------------------- |  |  | ------------------------------- | -----
|                                                                    |  |  | 2004                            |      
|(in millions)                                                       |  |  |                                 |      
|Income
      (loss) from continuing operations before income taxes: |  |  |                                 |      
|U.S.                                                                |  |  | $                               | 985  
|Non-U.S.                                                            |  |  |                                 | 78   
|                                                                    |  |  |                                 |      
|Income
      (loss) from continuing operations before income taxes  |  |  | $                               | 1,063
|                                                                    |  |  |                                 |      
|Provision
      (benefit) for income taxes:                         |  | 
|Current:                                                            |  | 
|Federal                                                             |  |  | $                               | (967 
|State
      and local                                               |  |  |                                 | (10  
|Non-U.S.                                                            |  |  |                                 | 57   
|                                                                    |  |  |                                 |      
|Subtotal                                                            |  |  |                                 | (920 
|                                                                    |  |  |                                 |      
|Deferred:                                                           |  | 
|Federal                                                             |  |  |                                 |     
|State
      and local                                               |  |  |                                 |     
|Non-U.S.                                                            |  |  |                                 | (19  
|                                                                    |  |  |                                 |      
|Subtotal                                                            |  |  |                                 | (19  
|                                                                    |  |  |                                 |      
|Provision
      (benefit) for income taxes                          |  |  | $                               | (939 
|                                                                    |  |  |                                 |      

F-56

---

The following
table summarizes the principal  reasons for the difference  between the effective tax
(benefit)  rate on continuing  operations  and  the U.S. federal statutory income tax
(benefit) rate.

|                                                                                  |  |  | Years
      ended September 30, |       
|--------------------------------------------------------------------------------- |  |  | ------------------------------- | ------
|                                                                                  |  |  | 2004                            |       
|                                                                                  |  |  |                                 |       
|U.S.
      federal statutory income tax (benefit) rate                            |  |  |                                 | 35.0  
|State
      and local income tax (benefit) rate, net of federal income tax effect |  |  |                                 | 3.1   
|Foreign
      earnings taxed at different rates                                   |  |  |                                 | (2.3  
|Research
      credits                                                            |  |  |                                 |      
|IPR&D,
      goodwill amortization and impairments                                |  |  |                                 | 0.5   
|Disposition
      of OFS business                                                 |  |  |                                 |      
|Conversions
      of 7.75% trust preferred securities                             |  |  |                                 |      
|Tax audit-related
      adjustments                                               |  |  |                                 | (13.4 
|Other
      differences, net                                                      |  |  |                                 | 0.5   
|Change
      in valuation allowance                                               |  |  |                                 | (111.8
|                                                                                  |  |  |                                 |       
|Effective
      income tax (benefit) rate                                         |  |  |                                 | (88.4 
|                                                                                  |  |  |                                 |       

The following
table summarizes the change in the valuation allowance.

|                                                     |  |  | September
      30, |       
|---------------------------------------------------- |  |  | ------------------- | ------
|                                                     |  |  | 2004                |       
|(in millions)                                        |  |  |                     |       
|Valuation
      allowance at beginning of year       |  |  | $                   | 9,934 
|Charged
      (credited) to expense                  |  |  |                     | (1,188
|Charged
      (credited) to other comprehensive loss |  |  |                     | (29   
|Write-off
      of carryforwards                     |  |  |                     | (756  
|Acquisitions
      and other                         |  |  |                     | (21   
|                                                     |  |  |                     |       
|Valuation
      allowance at end of year             |  |  | $                   | 7,940 
|                                                     |  |  |                     |       

The
  following table summarizes the components of deferred income tax assets and
  liabilities.

|                                               |  |  | September
      30, |       
|---------------------------------------------- |  |  | ------------------- | ------
|                                               |  |  | 2004                |       
|(in millions)                                  |  |  |                     |       
|Bad
      debt and customer financing reserves |  |  | $                   | 98    
|Inventory
      reserves                       |  |  |                     | 216   
|Business
      restructuring reserves          |  |  |                     | 86    
|Other
      operating reserves                 |  |  |                     | 479   
|Postretirement
      and other benefits        |  |  |                     | 2,358 
|Net operating
      loss/credit carryforwards  |  |  |                     | 6,053 
|Other                                          |  |  |                     | 223   
|Valuation
      allowance                      |  |  |                     | (7,940
|                                               |  |  |                     |       
|Deferred
      tax assets                      |  |  | $                   | 1,573 
|                                               |  |  |                     |       
|Pension                                        |  |  | $                   | 1,367 
|Other                                          |  |  |                     | 187   
|                                               |  |  |                     |       
|Deferred
      tax liabilities                 |  |  | $                   | 1,554 
|                                               |  |  |                     |       
|Net deferred
      tax assets                  |  |  | $                   | 19    
|                                               |  |  |                     |       
|Included
      in:                             |  | 
|Other
      current assets                     |  |  | $                   | 197   
|Other
      liabilities                        |  |  |                     | 178   
|                                               |  |  |                     |       
|Total                                          |  |  | $                   | 19    
|                                               |  |  |                     |       

F-57

---

The
  following table summarizes carryforwards of losses (tax-effected) and tax credits.

|                                           |  |  |        |       |           
|------------------------------------------ |  |  | ------ | ----- | ----------
|                                           |  |  | Amount |       | Expiration
|(in millions)                              |  |  |        |       |           
|Federal
      net operating losses         |  |  | $      | 2,881 |           
|State
      net operating losses           |  |  |        | 792   |           
|Capital
      losses                       |  |  |        | 430   |           
|Foreign
      net operating losses/credits |  |  |        | 495   |           
|Foreign
      tax credits                  |  |  |        | 252   |           
|Research
      credits                     |  |  |        | 958   |           
|State
      credits (various)              |  |  |        | 245   |           
|                                           |  |  |        |       |           
|Total
as of September 30, 2004             |  |  | $      | 6,053 |           
|                                           |  |  |        |       |           

The write-off
of carryforwards  includes the impact of the expiration of  certain  net  operating  loss
and  tax  credit  carryforwards,  the  repatriation  of non-U.S.  earnings to the U.S.
and  audit-related  and  other  adjustments  that reduced the net  operating  loss
carryforwards  during the respective periods.

A valuation
allowance is required  when it is more likely than not that  all or a  portion  of a
deferred  tax  asset  will not be  realized.  A  review of all  available  positive  and
negative  evidence  needs to be  considered,  including a companys  current  and
past  performance,  the  market  environment in which the company  operates,  the
utilization of  past tax  credits,  length of  carryback  and  carryforward  periods and
existing contracts or sales backlog that will result in future profits.

Forming  a
conclusion  that a  valuation  allowance  is not  needed  is  difficult when there is
negative  objective  evidence such as cumulative  losses in recent years.  Cumulative
losses weigh heavily in the overall  assessment.  We determine cumulative losses on a
rolling  twelve-quarter  basis.  Accordingly,  as of June  30,  2002,  we  concluded
that it was  appropriate  to  establish  a  full  valuation  allowance  for  our  net
deferred tax assets.  Subsequent to June 30, 2002, we have  maintained a  valuation
allowance  on  substantially  all of  our  net  deferred  tax  assets.  We expect to
continue to  maintain a full  valuation  allowance  until an appropriate  level of
profitability is sustained or we are able  to develop tax  strategies  that would enable
us to conclude  that it is  more likely than not that a portion of our  deferred tax
assets would be  realizable.

During the
fourth  quarter of fiscal 2003, we filed a net operating loss  carryback  claim  related
to the  carryback  of our  fiscal  year  2001  federal  net  operating  loss to 1996,  a
year in  which  we  filed  our  federal  income tax return as part of the AT&T
consolidated  group.  We  reached a tentative  agreement  with the Internal  Revenue
Service (the  IRS)  on  September  1,  2004  that  allowed  for  a  tax
refund  of  $816  million  (plus  statutory  interest  to the date of
payment),  subject to approval by the  Congressional  Joint Committee on  Taxation (the
Joint  Committee).  The tax benefit related to the claim  was not  recognized
at that time or prior to that time  because  it was  related  to a  complex  matter  and
there  was no  assurance  that  the  approval  from the Joint  Committee  would be
obtained.  On November 8,  2004,  we  received  written  confirmation  from the IRS that
the  Joint  Committee  approved our  tentative  agreement  with the IRS and that our
agreement  with the IRS was final.  We were  required  to  reassess  the  realizability
of our net operating loss  carryforwards  as of September  30,  2004,  because the Joint
Committees  final  approval was received  prior to the issuance of our
consolidated  financial  statements.  As a  result,  we  recognized  an $816  million
income tax  benefit  from the  reversal of valuation  allowances due to the realization
of deferred tax  assets and interest  income of $45 million  during the fourth quarter of
fiscal 2004.

We  expect  to
receive  the  refund  during  fiscal  2005,  following  completion  of the IRSs
audit of our 2001  federal  income tax return.  The refund will be paid by the IRS to AT&T
and the entire  refund amount  will become payable by AT&T to us under our tax
sharing  agreements with  AT&T.  We do not believe  there are any other  matters that
would impact  the refund claim.

During  fiscal
year 2004,  $908  million  of  undistributed  earnings of various non-U.S.  subsidiaries
were repatriated  to the U.S.  The  income  taxes on these  distributions  are  not
expected to be  significant  as a result of our U.S. net  operating  loss  carryforwards
and  valuation  allowance.  These  tax  efficient  one time  distributions  were made to
reset  the  operating  cash  needs  in  certain  foreign  jurisdictions  and reflect
recent  changes in our  business  and  business  model as well as various  other
contributing  factors.  We

F-58

---

have  not  provided  for U.S.  deferred  income  taxes  or
foreign  withholding  taxes  on  the  remaining  undistributed  earnings  of  $1.9
billion  of our  non-U.S.  subsidiaries  since  these  earnings  are  intended  to  be
reinvested  indefinitely.  As  a  result  of  our  U.S.  net  operating loss
carryforwards and valuation  allowance,  the  amount of  additional  taxes  that  might
be payable on such  undistributed  earnings is not  expected to be  significant.
However,  if  significant  changes to our net operating loss  carryforwards  and
valuation  allowance occur in the future,  the amount of  additional  taxes on
undistributed  earnings  could be  significant.  As a result,  it is not practical to
estimate  the  amount  of  additional  taxes  that  might be  payable on such
undistributed earnings.

We are subject
to ongoing tax  examinations  and assessments  in  various  jurisdictions.  Accordingly,
we  may  record  incremental tax expense based upon the probable  outcomes of  such
matters.  In  addition,  we  adjust  the  previously  reported  tax  expense to reflect
the  expected  results of  these  examinations.  The net income tax benefit  recognized
as a result of the expected favorable  resolution of certain  tax audit  matters  were
$142  million,  $77 million and $82  million during fiscal 2004, 2003 and 2002,
respectively.

8. DEBT
OBLIGATIONS AND EARLY EXTINGUISHMENT OF DEBT

The following
table summarizes components of long-term debt  obligations.

|                                                                          |  |  | September
      30, |      
|------------------------------------------------------------------------- |  |  | ------------------- | -----
|                                                                          |  |  | 2004                |      
|(in millions)                                                             |  |  |                     |      
|Variable
      interest notes due November 21, 2007 (5.75% as of          |  |  |                     |      
|September
      30, 2003)                                                 |  |  | $                   |     
|7.25%
      notes due July 15, 2006                                       |  |  |                     | 450  
|11.755%
      notes due July 1, 2006                                      |  |  |                     |     
|8% convertible
      securities redeemable on August 2, 2007              |  |  |                     | 817  
|5.50%
      notes due November 15, 2008                                   |  |  |                     | 291  
|2.75%
      Series A debentures due June 15, 2023                         |  |  |                     | 750  
|2.75%
      Series B debentures due June 15, 2025                         |  |  |                     | 881  
|6.50%
      debentures due January 15, 2028                               |  |  |                     | 300  
|6.45%
      debentures due March 15, 2029                                 |  |  |                     | 1,360
|Unamortized
      discount                                                |  |  |                     | (30  
|Fair
      value basis adjustment attributable to hedged debt obligations |  |  |                     | 17   
|Other                                                                     |  |  |                     | 2    
|                                                                          |  |  |                     |      
|Subtotal
      long-term debt                                             |  |  |                     | 4,838
|Amounts
      maturing within one year                                    |  |  |                     | (1   
|                                                                          |  |  |                     |      
|                                                                          |  |  |                     |      
|Long-term
      debt                                                      |  |  | $                   | 4,837
|                                                                          |  |  |                     |      
|Liability
      to subsidiary trust issuing preferred securities          |  |  | $                   | 1,152
|                                                                          |  |  |                     |      

Variable
interest  notes were repaid  during fiscal 2004 as a result of  settling a dispute with
an unaffiliated  insurer relating to our Insured  Special Purpose Trust.

Debt  maturing
within one year  included  $275 million  classified as a  secured borrowing  attributed
to a prepaid forward sales agreement as of  September 20, 2003. The agreement matured
during fiscal 2004.

The 8%
convertible  securities  were  classified as preferred  stock on  September  30, 2003.
On November  24,  2003,  we exchanged  all of our  outstanding  8%  redeemable
convertible  preferred  stock  for  8%  convertible subordinated debentures.

The  weighted
average  interest  rate on  long-term  debt  outstanding,  including  the  liability  to
subsidiary  trust  issuing  preferred  securities,  was 5.9%  and  5.8% as of  September
30,  2004  and  2003,  respectively.

The  maturities
of long-term  debt and  liability to  subsidiary  trust  issuing  preferred  securities
as of  September  30,  2004 for the next  successive  five fiscal  years and  thereafter
were $1 million in 2005,  $450 million in 2006,  $817 million in 2007, $0 in 2008, $291
million in  2009, and $4.4 billion thereafter.

F-59

---

2.75% series A
and B debentures

During  the
third  quarter  of  fiscal  2003,  we sold  2.75%  Series A  Convertible  Senior
Debentures  and 2.75% Series B  Convertible  Senior  Debentures  for  an  aggregate
amount  of  $1.6  billion,  net  of  the  underwriters  discount and related  fees and
expenses of $46  million.  The  debentures  were issued at a price of $1,000 per
debenture and were  issued  under  our  universal  shelf  registration  statement.  The debentures
rank  equal in  priority  with all of the  existing  and  future unsecured and
unsubordinated  indebtedness and senior in right of  payment to all of the  existing and
future  subordinated  indebtedness.  The terms  governing the debentures  limit our
ability to create liens,  secure certain  indebtedness and merge with or
sell substantially all of  our assets to another entity.

The debentures
are  convertible  into shares of common stock only if (1)  the sale price of our common
stock for  at least  twenty  trading  days  during the period of thirty consecutive
trading days ending on the last  trading day of the  previous  calendar  quarter is
greater than or equal  to 120% of  the applicable  conversion  price,  (2) the
trading price of  the debentures is  less than 97% of the product of the sale price
of our  common  stock  and the  conversion  rate  during  any  five  consecutive
trading-day  period,  (3) the debentures have been called for redemption  by us or (4)
certain specified corporate actions occur.

At our  option, the
debentures  are  redeemable  for cash after certain  dates  (optional  redemption
periods) at 100% of the principal amount  plus any accrued and unpaid interest.  In
addition,  at our option,  the  debentures are redeemable earlier
(provisional redemption periods) if  the sale  price  of the  common  stock
exceeds  130% of the  applicable  conversion  price.  Under  these
circumstances,  the  redemption  price  would also include a make-whole  payment  equal
to the present  value of  all remaining  scheduled  interest payments through the
beginning of the  optional redemption periods.

At the option
of the holder,  the  debentures  are redeemable on certain  dates at 100% of the
principal  amount  plus  any  accrued  and  unpaid  interest. In these
circumstances,  we may pay the purchase  price with  cash,  common stock (with the common
stock to be valued at a 5% discount  from the then current market price) or a combination
of both.

The
  following table summarizes the specific terms of these securities.

|                                                     |  |  |  | Series
      A                         |  |  | Series
      B                         | 
|---------------------------------------------------- |  |  |  | -------------------------------------- |  |  | -------------------------------------- | 
|Amount                                               |  |  |  | $750,000,000                           |  |  | $881,000,000                           | 
|Conversion
      ratio of common share per debenture |  |  |  | 299.4012                               |  |  | 320.5128                               | 
|Initial
      conversion price                       |  |  |  | $             3.34                     |  |  | $             3.12                     | 
|Redemption
      periods at our option:              |  |  |  |                                        |  |  |                                        | 
|Provisional
      redemption periods                 |  |  |  | June
      20, 2008 thru June 19, 2010 |  |  | June
      20, 2009 thru June 19, 2013 | 
|Optional
      redemption periods                    |  |  |  | After
      June 19, 2010              |  |  | After
      June 19, 2013              | 
|Redemption
      dates at the option of the holder   |  |  |  | June
      15, 2010, 2015 and 2020     |  |  | June
      15, 2013 and 2019           | 
|Maturity
      dates                                 |  |  |  | June
      15, 2023                    |  |  | June
      15, 2025                    | 

Liability to
subsidiary trust issuing preferred securities (7.75% convertible securities)

During fiscal
2002,  Lucent  Technologies  Capital Trust I (the Trust)  sold 7.75%
cumulative  convertible  trust  preferred  securities for an  aggregate amount of $1.75
billion.  We own all of the common  securities  of the Trust and as a result  had
previously  consolidated  the  Trust.  The  Trust  used  the  proceeds  to  purchase  our
7.75%  convertible  subordinated  debentures due March 15, 2017,  which represent all of
the  Trusts  assets.  The  terms  of  the  trust  preferred  securities  are
substantially the same as the terms of the debentures.

In  December
2003,  the  FASB  issued  a  revision  to  FIN  No. 46,  Consolidation  of
Variable  Interest  Entities (FIN  46(R)).  The  revision  clarified
certain  provisions of what  constitutes a variable  interest  and  addressed
substantive  ownership  provisions  related to  consolidation.  We  adopted  FIN 46(R)
during  the  second  quarter  of  fiscal 2004.

F-60

---

We
determined  that the holders of the trust  preferred  securities were  the primary
beneficiaries of the Trust upon review of the provisions of  FIN 46(R). As a result, we
de-consolidated  the Trust and reflected our  obligation  to the Trust  under the
caption  liability  to  subsidiary  trust issuing  preferred  securities. We
renamed the related balance as  of September 30, 2003 to conform with the current  period
presentation.  The effect of this change had no effect on our reported  liabilities  or
results  of  operations.  We  continue  to be  obligated  to  repay  the  debentures
held by the Trust and  guarantee  repayment of the preferred  securities issued by the
Trust.

We may redeem
the debentures,  in whole or in part, for cash at premiums  ranging from 103.88%
beginning  March 20, 2007, to 100.00% on March 20,  2012, and thereafter.  To the extent
we redeem debentures,  the Trust is  required  to  redeem  a  corresponding  amount  of
trust  preferred  securities.  We have irrevocably and  unconditionally  guaranteed,  on
a  subordinated  basis, the payments due on the trust preferred  securities  to the
extent we make payments on the debentures to the Trust.

The  ability of
the Trust to pay  dividends  depends  on the  receipt of  interest  payments  on the
debentures.  We  have  the  right  to  defer  payments  of  interest  on  the  debentures
for  up to  20  consecutive  quarters.  If payment of interest on the  debentures  is
deferred,  the  Trust  will defer the  quarterly  distributions  on the trust  preferred
securities for a corresponding  period.  Deferred interest accrues at an  annual  rate
of  9.25%.  At  the  option  of  the  holder,  each  trust  preferred  security  is
convertible  into  shares of our common  stock,  subject to an additional  adjustment
under certain  circumstances.  The  following table summarizes the terms of this security.

|Conversion ratio of
      common shares per security |  | 206.6116                  
|---------------------------------------------------- |  | --------------------------
|Conversion price                                     |  | $ 4.84                    
|Redemption period
      at our option                |  | After
      March 19, 2007
|Maturity date                                        |  | March
      15, 2017      

8% convertible
securities

The
  following table summarizes the terms of this security.

|Conversion ratio of
      common shares per security |  | 168.3502                                   
|---------------------------------------------------- |  | -------------------------------------------
|Conversion price                                     |  | $ 5.94                                     
|Liquidation preference
      per share               |  | $1,000
      plus accreted unpaid dividends
|                                                    
|Redemption period
      at our option                |  | After
      August 15, 2006                
|Redemption dates at
      the option of the holder   |  | On August
      2, 2007, 2010 and 2016     
|Mandatory redemption
      date                      |  | August
      1, 2031                       

On November 24,
2003, we exchanged all of our  outstanding 8% redeemable  convertible  preferred  stock
for  8%  convertible  subordinated  debentures.  This  exchange was made pursuant to
rights we had under the  terms of the preferred  stock to exchange the stock for the
convertible  subordinated  debentures.  These debentures have an interest rate of 8%,
the same as the dividend rate on the preferred  stock, and have the same  payment  and
record  dates as the  preferred  stock  dividends,  but the  interest  on the  debentures
must  be paid in  cash.  The  subordinated  debentures  have terms  substantially  the
same as the  preferred  stock  with  respect to put  rights,  redemptions  and
conversion  into common  stock.  Securities  tendered  to  us  pursuant  to  the  August
2004  redemption feature were less than $1 million.

F-61

---

Early
extinguishment of convertible securities and debt obligations

The
  following table summarizes the impact of convertible securities and certain
  debt obligations retired through exchanges of our common stock and cash.

|                                                                   |  |  | Years
      ended September 30, |    
|------------------------------------------------------------------ |  |  | ------------------------------- | ---
|                                                                   |  |  | 2004                            |    
|(in millions)                                                      |  |  |                                 |    
|8% convertible
      securities                                    |  |  | $                               | 58 
|7.75%
      convertible securities                                 |  |  |                                 |   
|                                                                   |  |  |                                 |    
|Total
      convertible securities                                 |  |  |                                 | 58 
|Other
      debt obligations                                       |  |  |                                 | 274
|                                                                   |  |  |                                 |    
|Total
      convertible securities and debt extinguished           |  |  | $                               | 332
|                                                                   |  |  |                                 |    
|Shares
      of our common stock exchanged                         |  |  |                                 | 22 
|                                                                   |  |  |                                 |    
|Cash
      used for early extinguishments                          |  |  | $                               | 249
|                                                                   |  |  |                                 |    
|8% convertible
      securities  conversion/ redemption costs     |  |  | $                               | (4 
|7.75%
      convertible securities  conversion costs              |  |  |                                 |   
|Debt
      obligations  gains (losses)                            |  |  |                                 | (4 
|                                                                   |  |  |                                 |    
|Impact
      on net income (loss) applicable to common shareowners |  |  | $                               | (8 
|                                                                   |  |  |                                 |    

Conversion
costs were  recognized in amounts equal to the fair value of  the  additional  common
shares issued to the holders of each  respective  preferred  security to prompt the
exchange  over the number of shares of  common stock obligated to be issued pursuant to
the original  conversion  terms of the respective security.

9. EMPLOYEE
BENEFIT PLANS

We maintain
defined  benefit  pension  plans  covering  the majority of  employees  and  retirees,
and  postretirement  benefit  plans  for U.S.  retirees that include  health care,
dental  benefits and life insurance  coverage.  The  pension  plans  feature  a
traditional  service-based  program as well as a cash balance program.  The cash balance
program was  added to our defined benefit pension plan for U.S. management  employees
hired after December 31, 1998. No employees were  transitioned  from our  traditional
program  to  our  cash  balance  program.  Additionally,  employees  covered  by the cash
balance  program  are not  eligible  to  receive company-paid  postretirement  health and
group life coverage. We  are not obligated to pay for  postretirement  group life and
health care  benefits  for  U.S.  management  employees  with  less  than 15 years of
service as of June 30, 2001.

F-62

---

The following
tables summarize  changes in the benefit  obligation,  the  plan  assets and the funded
status of our  pension  and  postretirement  benefit plans as well as the  components of
net periodic  benefit costs,  including key  assumptions.  The  measurement  dates for
plan assets and  obligations were September 30, 2004 and 2003.

|                                                                                |  |  | Pension
      benefits 
      September 30, |        | Postretirement
      benefits 
      September 30, |  
|------------------------------------------------------------------------------- |  |  | ------------------------------------------- | ------ | -------------------------------------------------- | -
|                                                                                |  |  | 2004                                        |        | 2003                                               |  
|(in millions)                                                                   |  |  |                                             |        |                                                    |  
|Change
      in benefit obligation:                                             |  |  |                                             |        |                                                    |  
|Benefit
      obligation at beginning of year                                   |  |  | $                                           | 31,235 |                                                    | $
|Service
      cost                                                              |  |  |                                             | 150    |                                                    |  
|Interest
      cost                                                             |  |  |                                             | 1,716  |                                                    |  
|Actuarial
      (gains) losses                                                  |  |  |                                             | 832    |                                                    |  
|Amendments                                                                      |  |  |                                             | (11    | )                                                  |  
|Benefits
      paid                                                             |  |  |                                             | (2,671 | )                                                  |  
|Plan
      participant contributions                                            |  |  |                                             | 3      |                                                    |  
|Settlements                                                                     |  |  |                                             | (5     | )                                                  |  
|Termination
      benefits                                                      |  |  |                                             |       |                                                    |  
|Curtailments                                                                    |  |  |                                             | (1     | )                                                  |  
|Exchange
      rate changes                                                     |  |  |                                             | 53     |                                                    |  
|Benefit
      obligation assumed by Agere and OFS                               |  |  |                                             |       |                                                    |  
|                                                                                |  |  |                                             |        |                                                    |  
|Benefit
      obligation at end of year                                         |  |  | $                                           | 31,301 |                                                    | $
|                                                                                |  |  |                                             |        |                                                    |  
|                                                                               
|Change
      in plan assets:                                                    |  | 
|Fair
      value of plan assets at beginning of year                            |  |  | $                                           | 30,148 |                                                    | $
|Actual
      return on plan assets                                              |  |  |                                             | 4,507  |                                                    |  
|Benefits
      paid                                                             |  |  |                                             | (2,671 | )                                                  |  
|Plan
      participant contributions                                            |  |  |                                             | 3      |                                                    |  
|Company
      contributions                                                     |  |  |                                             | 57     |                                                    |  
|Exchange
      rate changes                                                     |  |  |                                             | 48     |                                                    |  
|Other
      (including transfer of assets from pension to postretirement plans) |  |  |                                             | (19    | )                                                  |  
|                                                                                |  |  |                                             |        |                                                    |  
|Fair
      value of plan assets at end of year                                  |  |  | $                                           | 32,073 |                                                    | $
|                                                                                |  |  |                                             |        |                                                    |  
|                                                                                |  |  |                                             |        |                                                    |  
|Funded
      status of the plan                                                 |  |  | $                                           | 772    |                                                    | $
|Unrecognized
      prior service cost (credit)                                  |  |  |                                             | 85     |                                                    |  
|Unrecognized
      transition obligation                                        |  |  |                                             | 1      |                                                    |  
|Unrecognized
      net loss                                                     |  |  |                                             | 6,017  |                                                    |  
|                                                                                |  |  |                                             |        |                                                    |  
|Net asset
      (liability) recognized                                          |  |  | $                                           | 6,875  |                                                    | $
|                                                                                |  |  |                                             |        |                                                    |  
|                                                                                |  | 
|Amounts
      recognized in the consolidated balance sheets:                    |  | 
|Prepaid
      pension costs                                                     |  |  | $                                           | 5,358  |                                                    | $
|Other
      assets                                                              |  |  |                                             | 11     |                                                    |  
|Payroll
      and benefit-related liabilities                                   |  |  |                                             | (5     | )                                                  |  
|Postretirement
      and postemployment benefit liabilities                     |  |  |                                             |       |                                                    |  
|Pension
      liabilities                                                       |  |  |                                             | (1,874 | )                                                  |  
|Accumulated
      other comprehensive loss                                      |  |  |                                             | 3,385  |                                                    |  
|                                                                                |  |  |                                             |        |                                                    |  
|Net asset
      (liability) recognized                                          |  |  | $                                           | 6,875  |                                                    | $
|                                                                                |  |  |                                             |        |                                                    |  

F-63

---

|                                                                            |  |  | Pension
      benefits 
      September 30, |        | Postretirement
      benefits 
      September 30, |  
|--------------------------------------------------------------------------- |  |  | ------------------------------------------- | ------ | -------------------------------------------------- | -
|Additional Information:                                                     |  |  | 2004                                        |        | 2003                                               |  
|(in millions)                                                               |  |  |                                             |        |                                                    |  
|Benefit
      obligation by major plans:                                    |  |  |                                             |        |                                                    |  
|U.S.
      management                                                       |  |  | $                                           | 17,684 |                                                    | $
|U.S.
      occupational                                                     |  |  |                                             | 12,459 |                                                    |  
|Non-U.S.
      and supplemental                                             |  |  |                                             | 1,158  |                                                    |  
|Non-represented
      health                                                |  |  |                                             |       |                                                    |  
|Formerly
      represented health                                           |  |  |                                             |       |                                                    |  
|Group
      Life and other                                                  |  |  |                                             |       |                                                    |  
|                                                                            |  |  |                                             |        |                                                    |  
|Benefit
      obligation at end of year                                     |  |  | $                                           | 31,301 |                                                    | $
|                                                                            |  |  |                                             |        |                                                    |  
|                                                                            |  | 
|Plan
      assets by major plans:                                           |  | 
|U.S.
      management                                                       |  |  | $                                           | 15,974 |                                                    | $
|U.S.
      occupational                                                     |  |  |                                             | 15,354 |                                                    |  
|Non-U.S.
      and supplemental                                             |  |  |                                             | 745    |                                                    |  
|Non-represented
      health                                                |  |  |                                             |       |                                                    |  
|Formerly
      represented health                                           |  |  |                                             |       |                                                    |  
|Group
      Life and other                                                  |  |  |                                             |       |                                                    |  
|                                                                            |  |  |                                             |        |                                                    |  
|Fair
      value of plan assets at end of year                              |  |  | $                                           | 32,073 |                                                    | $
|                                                                            |  |  |                                             |        |                                                    |  
|                                                                            |  |  |                                             |        |                                                    |  
|Accumulated
      benefit obligation                                        |  |  | $                                           | 30,953 |                                                    | $
|                                                                            |  | 
|Plans
      with under-funded or non-funded benefit obligation:             |  | 
|Aggregate
      benefit obligation                                          |  |  |                                             | 18,287 |                                                    |  
|Aggregate
      fair value of plan assets                                   |  |  |                                             | 16,090 |                                                    |  
|Plans
      with under-funded or non-funded accumulated benefit obligation: |  | 
|Aggregate
      accumulated benefit obligation                              |  |  |                                             | 17,957 |                                                    |  
|Aggregate
      fair value of plan assets                                   |  |  |                                             | 16,086 |                                                    |  

Components of
Net Periodic Benefit Cost:

|                                                       |  |  | Years
      ended September 30, |       
|------------------------------------------------------ |  |  | ------------------------------- | ------
|                                                       |  |  | 2004                            |       
|(in millions)                                          |  |  |                                 |       
|Pension
      credit:                                  |  |  |                                 |       
|Service
      cost                                     |  |  | $                               | 150   
|Interest
      cost on benefit obligation              |  |  |                                 | 1,716 
|Expected
      return on plan assets                   |  |  |                                 | (3,059
|Amortization
      of unrecognized prior service costs |  |  |                                 | 70    
|Amortization
      of transition asset                 |  |  |                                 |      
|Amortization
      of net loss (gain)                  |  |  |                                 | 6     
|                                                       |  |  |                                 |       
|Subtotal                                               |  |  |                                 | (1,117
|Termination
      benefits                             |  |  |                                 |      
|Curtailments                                           |  |  |                                 | 1     
|Settlements                                            |  |  |                                 | 5     
|                                                       |  |  |                                 |       
|Pension
      credit                                   |  |  | $                               | (1,111
|                                                       |  |  |                                 |       
|Distribution
      of pension credit:                  |  | 
|Continuing
      operations:                           |  | 
|Business
      restructuring                           |  |  | $                               |      
|Other
      costs and expenses                         |  |  |                                 | (1,111
|                                                       |  |  |                                 |       
|Subtotal                                               |  |  |                                 | (1,111
|Discontinued
      operations                          |  |  |                                 |      
|                                                       |  |  |                                 |       
|Pension
      credit                                   |  |  | $                               | (1,111
|                                                       |  |  |                                 |       

F-64

---

|                                                       |  |  | Years
      ended September 30, |     
|------------------------------------------------------ |  |  | ------------------------------- | ----
|                                                       |  |  | 2004                            |     
|(in millions)                                          |  |  |                                 |     
|Postretirement
      benefit cost:                     |  |  |                                 |     
|Service
      cost                                     |  |  | $                               | 8   
|Interest
      cost on benefit obligation              |  |  |                                 | 434 
|Expected
      return on plan assets                   |  |  |                                 | (161
|Amortization
      of unrecognized prior service costs |  |  |                                 | (97 
|Amortization
      of net loss (gain)                  |  |  |                                 | 59  
|                                                       |  |  |                                 |     
|Subtotal                                               |  |  |                                 | 243 
|Termination
      benefits                             |  |  |                                 |    
|Curtailments                                           |  |  |                                 |    
|                                                       |  |  |                                 |     
|Postretirement
      benefit cost                      |  |  | $                               | 243 
|                                                       |  |  |                                 |     
|                                                       |  | 
|Distribution
      of net postretirement benefit cost: |  | 
|Continuing
      operations:                           |  | 
|Business
      restructuring                           |  |  | $                               |    
|Other
      costs and expenses                         |  |  |                                 | 243 
|                                                       |  |  |                                 |     
|Subtotal                                               |  |  |                                 | 243 
|Discontinued
      operations                          |  |  |                                 |    
|                                                       |  |  |                                 |     
|Postretirement
      benefit cost                      |  |  | $                               | 243 
|                                                       |  |  |                                 |     

|Key
      assumptions:                                |  |  |  |      |   |  |      |   |  |      |  
|----------------------------------------------------- |  |  |  | ---- | - |  | ---- | - |  | ---- | -
|                                                      |  | 
|Weighted-average
      assumptions used to determine: |  | 
|Benefit
      obligations:                            |  | 
|Discount
      rate  pension                         |  |  |  | 5.50 | % |  | 5.75 | % |  | 6.50 | %
|Discount
      rate  postretirement                  |  |  |  | 5.25 | % |  | 5.75 | % |  | 6.50 | %
|Rate
      of compensation increase                   |  |  |  | 4.00 | % |  | 3.50 | % |  | 3.50 | %
|Net
      cost or credit:                             |  | 
|Discount
      rate                                   |  |  |  | 5.75 | % |  | 6.50 | % |  | 7.00 | %
|Expected
      return on plan assets  pension        |  |  |  | 8.75 | % |  | 8.75 | % |  | 9.00 | %
|Expected
      return on plan assets  postretirement |  |  |  | 5.53 | % |  | 7.93 | % |  | 9.00 | %
|Rate
      of compensation increase                   |  |  |  | 3.50 | % |  | 3.50 | % |  | 4.50 | %

The weighted
average  expected  rate of return on plan assets that will  be used to determine the
fiscal 2005 net periodic  benefit cost is 8.50%  for pension and 5.72% for postretirement
benefits.

|                                                                                  |  |  | September
      30, |     
|--------------------------------------------------------------------------------- |  |  | ------------------- | ----
|                                                                                  |  |  | 2004                |     
|                                                                                  |  |  |                     |     
|Assumed
      health care cost trend rates:                                       |  |  |                     |     
|Health
      care cost trend rate assumed for next year                           |  |  |                     | 11.1
|Health
      care cost trend rate assumed for next year (excluding postretirement |  |  |                     |     
|dental
      benefits)                                                            |  |  |                     | 11.4
|Rate
      that the cost trend rate gradually declines to                         |  |  |                     | 5.0 
|Year
      that the rate reaches the rate it is assumed to remain at              |  |  |                     | 2010

The
  assumed health care cost trend rate has a significant effect on the amounts
  reported. A one-percentage-point change in the assumed health care cost trend
  rate would have the following effects:

|                                                              |  |  | 1
      percentage point |    
|------------------------------------------------------------- |  |  | ------------------------ | ---
|                                                              |  |  | Increase                 |    
|(in millions)                                                 |  |  |                          |    
|Effect
      on total of service and interest cost components |  |  | $                        | 13 
|Effect
      on postretirement benefit obligation             |  |  |                          | 255

We  considered
the  available  yields  on  high-quality  fixed-income  investments with maturities
corresponding to our benefit obligations to  determine  our  discount  rates at each
measurement  date.  Although we  considered  yields and changes in yields of several
funds,  the primary  fund we  considered  is the Moodys Aa long-term  corporate
yield fund.  The  average  duration  of  our  primary  pension  obligations  and
postretirement  health  care  obligations  were 11  years  and 7  years,  respectively as
of September 30, 2004.

F-65

---

We considered
several factors in developing our expected rate of return  on plan assets  based on input
from our  external  advisors.  Individual  asset class return  forecasts were  developed
based upon current market  conditions, for example,  price-earnings levels and yields and
long-term  growth  expectations.  Historical  returns  were  used  to  test  for
reasonableness.  The expected  long-term  rate of return is the weighted  average of the
target asset  allocation of each individual  asset class.  Our  long-term  expected  rate
of  return  on  plan  assets  included  approximately  0.5% for an anticipated  premium
over market returns from  our active  investment  managers.  Our  actual  10-year  annual
rate of  return on pension  plan assets were 11.0%,  9.9% and 9.5% during  fiscal  2004,
2003 and 2002, respectively.

The  expected
return on plan assets was  determined  using the expected  rate of  return  and a
calculated  value of assets  referred  to as the  market-related  value. The
aggregate  market-related  value of pension  and  postretirement  plan assets was $37.7
billion and $39.6 billion as  of September 30, 2004 and 2003,  respectively,  which
exceeded the fair  value of plan  assets  by $4.0  billion  and $7.1  billion.
Differences  between  the  assumed  and  actual  returns  are  amortized  to  the
market-related  value on a straight-line  basis over a five-year period.  The
amortization of these  differences,  including those resulting from  the actual losses
incurred  during fiscal 2002 and 2001,  will continue  to reduce both the market-related
value and our pension credit.

Gains and
losses  resulting  from changes in actuarial  assumptions  and  from  differences
between assumed and actual  experience  (except those  differences being amortized to the
market-related  value) are amortized  over the expected  remaining service periods of
active plan participants  for the  management  pension  plan and over the average
remaining  life  expectancy  of the  inactive  participants  for all  other  plans to the
extent they exceed 10% of the higher of the market-related  value or the  projected
benefit obligation of each respective plan.

On December  8,
2003,  the  President  of the United  States  signed the  Medicare  Prescription  Drug
Improvement and  Modernization Act of 2003.  This  Act  introduced  a  prescription  drug
benefit  under  Medicare  (Medicare  Part D) as well as a federal  subsidy to  sponsors
of retiree  health  care  benefits  plans  that  provide a benefit  that is at least
actuarially  equivalent  to  Medicare  Part  D.  We  currently  sponsor  retiree  health
care plans that provide  prescription  drug  benefits to  our U.S. retirees.

We elected to
prospectively  recognize the effects of the Act during the  fourth  quarter of fiscal
2004,  which reduced the  accumulated  benefit  obligation  by  approximately  $600
million.  The  impact of the Act is  expected  to reduce the annual  expense of
providing  the  prescription  drug  benefit  by  approximately  $90  million,  including
lower  participation  rates.  Approximately  25% of this impact was  recognized  during
the fourth  quarter of fiscal  2004.  This  included an estimated  impact for retirees
who may  determine  the addition of Part D makes the  complete  reliance  on  Medicare
more  financially  attractive  than  remaining  a  participant  in  our  retiree  medical
plans.  While  the  accounting  treatment has been  addressed,  other  detailed
regulations  necessary  to  implement  the Act have not yet been  promulgated.  These
regulations  will need to  specify  how  actuarial  equivalency  must be  determined  and
demonstrated  to the  Secretary  of  Health  and  Human  Services  and  specify  the
reimbursement  mechanism  for the  subsidy.  These final regulations may change the
estimated impact of the Act.

Plan Assets

The following
table  summarizes the target asset  allocation  ranges of  our pension and postretirement
trusts by asset category.

|                               |      | Pension target
      allocation range as of
      September 30, 2004 |      | Percentage
      of pension
      plan assets as of
      September 30, |      | Postretirement
      target
      allocation as of
      September 30, 2004 |      | Percentage of
      postretirement plan assets
      as of September 30, |  
|------------------------------ | ---- | -------------------------------------------------------------------- | ---- | ----------------------------------------------------------------------- | ---- | --------------------------------------------------------------------------- | ---- | ------------------------------------------------------------------------ | -
|                               | 2004 |                                                                      | 2003 |                                                                         | 2004 |                                                                             | 2003
|Asset category:                |      |                                                                      |      |                                                                         |      |                                                                             |      |                                                                          |  
|Equity
      securities        |      | 52%
       70%                                                      |      |                                                                         | 62   | %                                                                           |      | 63                                                                       | %
|Fixed
      income securities  |      | 20%
       28%                                                      |      |                                                                         | 24   |                                                                             |      | 24                                                                       |  
|Real
      estate              |      | 5%
       9%                                                        |      |                                                                         | 6    |                                                                             |      | 5                                                                        |  
|Private
      equity and other |      | 6%
       10%                                                       |      |                                                                         | 8    |                                                                             |      | 8                                                                        |  
|                               |      |                                                                      |      |                                                                         |      |                                                                             |      |                                                                          |  
|Total                          |      |                                                                      |      |                                                                         | 100  | %                                                                           |      | 100                                                                      | %
|                               |      |                                                                      |      |                                                                         |      |                                                                             |      |                                                                          |  

F-66

---

The  majority
of the pension  plan assets are held in a master  pension  trust.  Postretirement  plan
assets are held in three  separate  trusts.  Plan  assets are managed by  independent
investment  advisors  with the  objective  of  maximizing  returns  with a  prudent
level of  risk.  We  periodically  complete  asset-liability  studies  to  assure  that
the  optimal asset  allocation is maintained in order to meet future  benefit
obligations.  The pension  target  allocation  ranges  summarized  above  were  approved
by our  Board of  Directors  during  fiscal  2003,  upon  completion  of a study by our
external  advisors.  There were no changes  from our  previous  target  allocations.
Investment  advisors  managing  plan assets may use derivative financial  instruments
including futures  contracts,  forward contracts, options and interest rate swaps to
manage  market exposure and foreign currency and interest-rate risk.

Pension  plan
assets  included  $12 million and $7 million of our common  stock as of September  30,
2004 and 2003,  respectively.  Postretirement  plan assets  included $40 million and $47
million of our common stock as  of September 30, 2004 and 2003, respectively.

Contributions

We  contribute
to our pension and  postretirement  benefit plans to make  benefit  payments to plan
participants and to pre-fund some benefits by  means of trust funds.  For our U.S.
pension  plans,  the funding policy  is to  contribute  amounts  to the  trusts
sufficient  to meet  minimum  funding  requirements as set forth in employee benefit and
tax laws plus  such  additional  amounts  as  we  may  determine  to  be  appropriate.
Contributions  are made to  benefit  plans for the sole  benefit of plan  participants.

In addition,
we received $212 million from our welfare  benefits  trust  during  October  2004  as
reimbursement  for  retiree  health  care  contributions  that  were  made  during
fiscal  2004.  The  Companys  contributions for  postretirement  benefits of $27
million are reflected  net of this amount during fiscal 2004.

The following
table  summarizes  expected  contributions  to our various  pension and  postretirement
plans through fiscal 2014. We do not expect  to make  contributions to our qualified U.S.
pension plans during fiscal  2005 or 2006.  We are unable to estimate the expected
contributions  to  our  qualified  U.S.  pension  plans  beyond  fiscal  2006.  Actual
contributions may differ from expected contributions.

|              |  |  | Pension                                               |     | Postretirement                                                |  
|------------- |  |  | ----------------------------------------------------- | --- | ------------------------------------------------------------- | -
|              |  |  |                                                       |     |                                                               |  
|              |  |  | Non-qualified
      and non-U.S. 
      pension plans |     | Formerly 
      represented 
      retiree health
      plans |  
|(in millions) |  |  |                                                       |     |                                                               |  
|2005          |  |  | $                                                     | 53  |                                                               | $
|2006          |  |  |                                                       | 51  |                                                               |  
|2007          |  |  |                                                       | 52  |                                                               |  
|2008          |  |  |                                                       | 54  |                                                               |  
|2009          |  |  |                                                       | 53  |                                                               |  
|201014       |  |  |                                                       | 270 |                                                               |  

Benefit Payments

The  following
table  summarizes  expected  benefit  payments  from our  various  pension and
postretirement  plans through fiscal 2014.  Actual  benefit  payments  may differ  from
expected  benefit  payments.  These  amounts are  reflected net of expected  plan
participant  contributions  and the annual  Medicare  Part D subsidy of  approximately
$60  million  beginning in fiscal 2007.

|              |  |  | Pension                            |        | Postretirement                                             |  
|------------- |  |  | ---------------------------------- | ------ | ---------------------------------------------------------- | -
|              |  |  |                                    |        |                                                            |  
|              |  |  | Qualified U.S.
      pension plans |        | Non-qualified
      and
      non-U.S. pension
      plans |  
|(in millions) |  |  |                                    |        |                                                            |  
|2005          |  |  | $                                  | 2,453  |                                                            | $
|2006          |  |  |                                    | 2,421  |                                                            |  
|2007          |  |  |                                    | 2,385  |                                                            |  
|2008          |  |  |                                    | 2,351  |                                                            |  
|2009          |  |  |                                    | 2,312  |                                                            |  
|201014       |  |  |                                    | 10,974 |                                                            |  

F-67

---

Savings Plans

Our  savings
plans allow  employees  to  contribute  a portion of their  compensation  on a pre-tax
and/or  after-tax  basis in accordance  with  specified  guidelines.  We  match  a
percentage  of  the  employee  contributions  up  to  certain  limits,  in  cash,  in
accordance  with  participants investment  elections.  Savings plan  expense
charged to  continuing  operations was $97 million,  $75 million and $71 million for
fiscal 2004, 2003 and 2002, respectively.

Postemployment
Benefits

We offer
various  postemployment  benefits to certain  employees  after  employment  but  before
retirement.  These  benefits  are  paid  in  accordance with our  established
postemployment  benefit  practices and  policies.  Postemployment  benefits  include
disability  benefits,  severance pay and workers  compensation  benefits.  We accrue for
these  future  postemployment  benefits,  which are  funded on a  pay-as-you-go  basis.
The expense  (credit)  under these plans was $40 million,  $(93)  million  and  $(17)
million  during  fiscal  2004,  2003  and  2002,  respectively,  including $41 million
and $34 million of credits  related  to our restructuring actions. The accrued
postemployment  liability was  $310  million  and $417  million  as of  September  30,
2004 and  2003,  respectively.  These  amounts  include  $47  million  and $88 million in
payroll and benefit  related  liabilities  as of September  30, 2004 and  2003,
respectively.

10. STOCK
COMPENSATION PLANS

We have
stock-based  compensation plans under which directors,  officers  and  other  eligible
employees  receive  stock  options  and  other  equity-based  awards.  The plans provide
for the grant of stock options,  stock appreciation rights,  performance awards,
restricted stock awards  and other stock unit awards.

Stock  options
generally  are granted  with an exercise  price equal to  100% of the  market  value  of
a share  of  common  stock on the date of  grant,  have terms of five to 10 years and
vest  within  four years from  the date of grant.  Subject to customary  antidilution
adjustments  and  certain  exceptions,  the  total  number  of  shares  of  common  stock
authorized  for option and other  equity  grants under the plans was 563  million shares
as of September 30, 2004.

On April 22,
2002, we commenced a voluntary offer to eligible  employees  to exchange  certain
outstanding  stock  options to purchase  shares of  common stock,  including  all stock
options  issued during the six-month  period  ended  April  22,  2002,  for our  promise
to grant a new stock  option  on or about  November  25,  2002.  In  response  to this
offer,  employees  tendered  stock  options  to  purchase  an  aggregate  of 214  million
shares of our common  stock in exchange  for  promises to grant  new stock  options to
purchase up to an aggregate of 123 million  shares  of our common  stock.  On  November
25,  2002,  111  million  new stock  options were granted in  connection  with the
exchange  with an exercise  price of $1.78 per share,  which was the fair market value of
our common  stock on the date of the grant.  The 214 million stock options  tendered  by
employees in the exchange were cancelled.

Under the terms
of the  Employee  Stock  Purchase  Plan  (2001  ESPP),  eligible employees
may have up to 10% of eligible  compensation deducted  from  their pay to  purchase
shares of common  stock,  subject  to plan  limits,  at a discount of 15% of the market
value at either the purchase  date or at certain  earlier  dates  defined in the plan.
During  fiscal  2004,  2003 and 2002,  18 million,  12 million and 10 million  shares of
common stock were  purchased,  respectively.  As of September  30, 2004,  210 million
shares were available for issuance under the 2001 ESPP.

During fiscal
2002, four million  restricted  stock units were awarded at a  weighted average market value
of $6.74.

F-68

---

The
following table summarizes stock option activity.

|                                                     |  |  | Shares 
      (in millions) |      | Weighted
      average
      exercise price 
      per share |  
|---------------------------------------------------- |  |  | --------------------------- | ---- | ------------------------------------------------------------ | -
|                                                     |  |  |                             |      |                                                              |  
|Outstanding
      as of September 30, 2001           |  |  |                             | 683  |                                                              | $
|Granted                                              |  |  |                             | 13   |                                                              |  
|Exercised                                            |  |  |                             | (7   | )                                                            |  
|Forfeited/expired                                    |  |  |                             | (101 | )                                                            |  
|Cancelled
      due to exchange offer                |  |  |                             | (213 | )                                                            |  
|                                                     |  |  |                             |      |                                                              |  
|Outstanding
      as of May 31, 2002                 |  |  |                             | 375  |                                                              |  
|                                                     |  |  |                             |      |                                                              |  
|Outstanding
      as of June 1, 2002, after spin-off |  |  |                             | 363  |                                                              |  
|adjustments
      (a)                                |  | 
|Granted                                              |  |  |                             | 1    |                                                              |  
|Exercised                                            |  |  |                             |     |                                                              |  
|Forfeited/expired                                    |  |  |                             | (77  | )                                                            |  
|                                                     |  |  |                             |      |                                                              |  
|Outstanding
      as of September 30, 2002           |  |  |                             | 287  |                                                              |  
|                                                     |  |  |                             |      |                                                              |  
|Granted                                              |  |  |                             | 162  |                                                              |  
|Exercised                                            |  |  |                             | (1   | )                                                            |  
|Forfeited/expired                                    |  |  |                             | (60  | )                                                            |  
|                                                     |  |  |                             |      |                                                              |  
|Outstanding
      as of September 30, 2003           |  |  |                             | 388  |                                                              |  
|                                                     |  |  |                             |      |                                                              |  
|Granted/assumed                                      |  |  |                             | 55   |                                                              |  
|Exercised                                            |  |  |                             | (9   | )                                                            |  
|Forfeited/expired                                    |  |  |                             | (31  | )                                                            |  
|                                                     |  |  |                             |      |                                                              |  
|Outstanding
      as of September 30, 2004           |  |  |                             | 403  |                                                              |  
|                                                     |  |  |                             |      |                                                              |  

---

(a) Effective
with the spin-off of Agere on June 1, 2002,  Lucent stock  options held by Agere
employees  were converted to Agere stock options.  For the  remaining  unexercised  stock
options,  the  number  of  stock  options and the exercise  price were  adjusted to
preserve the intrinsic  value of the stock options that existed prior to the spin-off.

The
  following table summarizes information about stock options.

|                                         |  |  | Stock
      options outstanding |     | Stock
      options exercisable                                                       | 
|---------------------------------------- |  |  | ------------------------------- | --- | ------------------------------------------------------------------------------------- | 
|                                         |  |  |                                 |     |                                                                                       | 
|Range
      of exercise prices per share |  |  | Shares
      (in millions)      |     | Weighted 
      average 
      remaining 
      contractual
      life 
      (years) | 
|                                         |  |  |                                 |     |                                                                                       | 
|$ 0.02
      to $ 2.25                   |  |  |                                 | 124 |                                                                                       | 
|$ 2.26
      to $ 3.50                   |  |  |                                 | 48  |                                                                                       | 
|$ 3.51
      to $ 6.26                   |  |  |                                 | 61  |                                                                                       | 
|$ 6.27
      to $ 9.99                   |  |  |                                 | 35  |                                                                                       | 
|$10.00
      to $ 16.03                  |  |  |                                 | 79  |                                                                                       | 
|$16.04
      to $ 77.10                  |  |  |                                 | 56  |                                                                                       | 
|                                         |  |  |                                 |     |                                                                                       | 
|Amounts
      as of September 30, 2004   |  |  |                                 | 403 |                                                                                       | 
|                                         |  |  |                                 |     |                                                                                       | 
|Amounts
      as of September 30, 2003   |  |  |                                 | 388 |                                                                                       | 
|                                         |  |  |                                 |     |                                                                                       | 
|Amounts
      as of September 30, 2002   |  |  |                                 | 287 |                                                                                       | 
|                                         |  |  |                                 |     |                                                                                       | 

F-69

---

11.
OPERATING SEGMENTS

We design and
deliver  networks for the worlds  largest  communications  service providers.  The
accounting  policies of the reportable  segments  are  the  same  as  those  applied  in
the  consolidated  financial  statements.  The reportable  segments are Integrated
Network  Solutions  (INS),  Mobility Solutions  (Mobility) and
Lucent Worldwide Services  (Services).  INS  provides a broad  range of
software  and  wireline  equipment  related  to  voice  networking  (primarily
consisting  of  switching  products,  which  we  sometimes  refer  to  as  convergence
solutions,  and voice messaging  products),  data and network management  (primarily
consisting of access and related data  networking  equipment  and  operating  support
software)  and  optical  networking.  Mobility  provides  software  and wireless
equipment to support  radio access and  core  networks.  Services  is a  worldwide
organization  that  provides  deployment,  maintenance,  professional  and  managed
services  in support of  both  our  product  offerings  as  well  as
multivendor  networks.  Performance  measurement  and  resource  allocation  for  the
reportable  segments  are  based  on  many  factors.  Total  assets  by  reportable
segment  are not  included in the  measures of each  segment  reviewed by the chief
operating  decision maker.  The primary  financial  measures include the revenues,  costs
and expenses  directly  controlled  by each reportable segment and excludes the following:

- Business
    restructuring.
- Global
    sales organization expenses.
- Bad
    debt and customer financing expenses and recoveries.
- Certain
    personnel costs and benefits, including most of the impacts related to pension,
    postretirement and postemployment benefits, differences between the actual
    and budgeted benefit rates and differences between actual and budgeted employee
    incentive awards.
- Certain
    costs related to shared services, such as general corporate functions, which
    are managed on a common basis in order to realize economies of scale and efficient
    use of resources.
- Revenues
    and expenses associated with licensing and protecting intellectual property
    rights.
- Results
    of the optical fiber business.
- Certain
    other general and miscellaneous costs and expenses not directly used in assessing
    the performance of the operating segments, including impairment or amortization
    of goodwill and other acquired intangible assets related to acquisitions completed
    prior to fiscal 2004.

F-70

---

|                                                                |  |  | Years
      ended September 30, |       
|--------------------------------------------------------------- |  |  | ------------------------------- | ------
|                                                                |  |  | 2004                            |       
|(in millions)                                                   |  |  |                                 |       
|Revenues                                                        |  |  |                                 |       
|INS                                                             |  |  | $                               | 2,984 
|Mobility                                                        |  |  |                                 | 4,007 
|Services                                                        |  |  |                                 | 1,932 
|                                                                |  |  |                                 |       
|Reportable
      segments                                       |  |  |                                 | 8,923 
|Optical
      fiber business                                    |  |  |                                 |      
|Other (a)                                                       |  |  |                                 | 122   
|                                                                |  |  |                                 |       
|Revenues                                                        |  |  | $                               | 9,045 
|                                                                |  |  |                                 |       
|Operating
      income (loss)                                   |  | 
|INS                                                             |  |  | $                               | 345   
|Mobility                                                        |  |  |                                 | 1,240 
|Services                                                        |  |  |                                 | 282   
|                                                                |  |  |                                 |       
|Reportable
      segments                                       |  |  |                                 | 1,867 
|Business
      restructuring                                    |  |  |                                 | 20    
|Global
      sales organization                                 |  |  |                                 | (515  
|Bad
      debts and customer financings                         |  |  |                                 | 230   
|Goodwill
      and other acquired intangible asset amortization |  |  |                                 | (1    
|Goodwill
      impairment                                       |  |  |                                 |      
|Optical
      fiber business                                    |  |  |                                 |      
|Unallocated
      personnel costs and benefits                  |  |  |                                 | 859   
|Shared
      services such as general corporate functions       |  |  |                                 | (1,162
|Other                                                           |  |  |                                 | (79   
|                                                                |  |  |                                 |       
|Operating
      income (loss)                                   |  |  | $                               | 1,219 
|                                                                |  |  |                                 |       
|Supplemental
      Segment Information                          |  |  |                                 |       
|                                                                |  |  | Years
      ended September 30, |       
|                                                                |  |  | 2004                            |       
|(in millions)                                                   |  |  |                                 |       
|Depreciation
      and amortization                             |  |  |                                 |       
|INS                                                             |  |  | $                               | 171   
|Mobility                                                        |  |  |                                 | 181   
|Services                                                        |  |  |                                 | 26    
|                                                                |  |  |                                 |       
|Reportable
      segments                                       |  |  |                                 | 378   
|Non-segment                                                     |  |  |                                 | 315   
|                                                                |  |  |                                 |       
|Depreciation
      and amortization                             |  |  | $                               | 693   
|                                                                |  |  |                                 |       
|Products
      and Services Revenues                            |  |  |                                 |       
|                                                                |  |  | Years
      ended September 30, |       
|                                                                |  |  | 2004                            |       
|(in millions)                                                   |  |  |                                 |       
|Wireless                                                        |  |  | $                               | 4,007 
|Voice
      networking                                          |  |  |                                 | 1,336 
|Data
      and network management                               |  |  |                                 | 933   
|Optical
      networking                                        |  |  |                                 | 715   
|Services                                                        |  |  |                                 | 1,932 
|Optical
      fiber                                             |  |  |                                 |      
|Other
      (a)                                                 |  |  |                                 | 122   
|                                                                |  |  |                                 |       
|Totals                                                          |  |  | $                               | 9,045 
|                                                                |  |  |                                 |       

---

(a)  Includes
intellectual property licensing revenues.

F-71

---

Geographic
Information

|              |  |  | Revenues (a) 
      Years ended September 30, |       | Long-
      lived assets (b)
      September 30, |  
|------------- |  |  | --------------------------------------------- | ----- | ------------------------------------------------ | -
|              |  |  | 2004                                          |       | 2003                                             |  
|(in millions) |  |  |                                               |       |                                                  |  
|U.S.          |  |  | $                                             | 5,517 |                                                  | $
|Non-U.S.      |  |  |                                               | 3,528 |                                                  |  
|              |  |  |                                               |       |                                                  |  
|Totals        |  |  | $                                             | 9,045 |                                                  | $
|              |  |  |                                               |       |                                                  |  

---

(a)
  Revenues are attributed to geographic areas based on the location of customers.(b)
  Includes property, plant and equipment and goodwill and other acquired intangible
  assets.

Concentrations

Historically,
we have  relied on a limited  number of  customers  for a  substantial  portion  of our
total  revenues.  Revenues  from  Verizon,  including  Verizon  Wireless,  accounted  for
27%,  22%  and  19%  of  consolidated  revenues  in fiscal  2004,  2003 and  2002,
respectively.  Revenues  from  Sprint  accounted  for 11% in  consolidated  revenue  in
fiscal 2004.  Revenues from customers located in China accounted for 10%  and  11%  of
consolidated  revenues  in  fiscal  2004  and  2003,  respectively.  We expect a
significant  amount of our  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  adversely  affect  our
operating  results.  Refer  to  Note  13  for  a  discussion  of  our  contract
manufacturing concentration.

12. FINANCIAL
INSTRUMENTS

Fair Values

The following
table  summarizes the carrying  values and estimated fair  values of financial
instruments,  based on quoted  market  prices.  The  carrying values of cash and cash
equivalents,  receivables, payables and  debt maturing within one year approximate fair
value.

|                                                                 |  |  | Years
      ended September 30, |      
|---------------------------------------------------------------- |  |  | ------------------------------- | -----
|                                                                 |  |  | 2004                            |      
|                                                                 |  |  |                                 |      
|                                                                 |  |  | Carrying
      value            |      
|(in millions)                                                    |  |  |                                 |      
|Long-term
      debt                                             |  |  | $                               | 4,837
|Liability
      to subsidiary trust issuing preferred securities |  |  |                                 | 1,152
|8% redeemable
      convertible preferred stock                  |  |  |                                 |     

F-72

---

The following
table summarizes our available-for-sale debt securities.

|                                                                                                         |  |   |           |      
|-------------------------------------------------------------------------------------------------------- |  | - | --------- | -----
|                                                                                                         |  |   |           |      
|                                                                                                         |  |   | Amortized |      
|                                                                                                         |  |   | cost      |      
|(in millions)                                                                                            |  |   |           |      
|U.S. Treasury and government agency debt securities                                                      |  |   | $         | 979  
|Corporate bonds                                                                                          |  |   |           | 340  
|Asset-backed securities                                                                                  |  |   |           | 179  
|                                                                                                         |  |   |           |      
|Total as of September 30, 2004                                                                           |  |   | $         | 1,498
|                                                                                                         |  |   |           |      
|Classified as:                                                                                           |  |  
|Current                                                                                                  |  |   | $         | 859  
|Non-current                                                                                              |  |   |           | 639  
|                                                                                                         |  |   |           |      
|Total                                                                                                    |  |   | $         | 1,498
|                                                                                                         |  |   |           |      
|                                                                                                         |  |   |          
|U.S. Treasury and government agency debt securities  classified as current     as of September 30, 2003 |  | $ | 686       |      
|                                                                                                         |  |   |           |      

Gross
unrealized  losses of $5 million were primarily related to U.S. Treasury and government
agency debt securities that were  in a continuous loss position for less than one year.
These  unrealized  losses were primarily  caused by increases in interest  rates. We do
not consider these  investments to be  other-than-temporarily  impaired because we have
the ability and intent to  hold these investments until maturity or until the fair value
is recovered.

Proceeds from
the sale of marketable  debt  securities  were $352 million during fiscal 2004. The
realized gains and losses on  these sales were $1 million and $2 million for fiscal 2004,
respectively.  There were no sales of marketable  debt securities  during fiscal 2003 and
2002.

The following
table summarizes the contractual maturities of our available-for-sale debt securities.

|                    |  |               
|------------------- |  | --------------
|                    |  | Amortized cost
|(in millions)       |  |               
|2005                |  | $             
|2006  2010         |  |               
|2011  2015         |  |               
|2016 and thereafter |  |               

The following
table summarizes the carrying value of our non-consolidated equity investments.

|                                    |  | 
|----------------------------------- |  | 
|                                    |  | 
|                                    |  | 
|(in millions)                       |  | 
|Available-for-sale                  |  | 
|Cost-method                         |  | 
|Equity-method                       |  | 
|                                    |  | 
|Non-consolidated equity investments |  | 
|                                    |  | 

Proceeds from
the sale of  available-for-sale  equity  securities were $178 million during fiscal 2003.
During fiscal 2003, we  entered into prepaid forward sales  agreements for all of our
Corning shares,  under which we received proceeds of $113 million and locked  in $64  million  of
unrealized  appreciation.  This  gain  was  recognized  during  fiscal  2004.  Proceeds
from the sale of  available-for-sale  equity  securities  were  not  material  during
fiscal  2004  and  2002.  Gross  unrealized  losses  on  available-for-sale equity
securities were not material during fiscal 2004 and 2003 and were $150 million during
fiscal 2002.

All investments
are  periodically  reviewed to determine if declines in fair value below cost basis are
other-than-temporary.  This review  considers  among other  factors,  significant  and
sustained  decreases  in quoted  market  prices,  a series of  historical  and projected
operating  losses,  changes in the market demand for  technology  and our intent to
provide  future  funding. If the decline in fair value has been

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determined to
be other-than-temporary,  an impairment loss is recognized,  and a new cost basis is
established.  We recognized  $22 million, $63 million and $209 million of
other-than-temporary  impairment losses related to our  non-consolidated  equity
investments during fiscal 2004, 2003 and 2002, respectively.

Credit Risk

All financial
instruments  involve credit risk for  non-performance  by  counterparties.  The contract
or notional amounts of  these instruments reflect the extent of involvement we have in
particular classes of financial instruments.

Our maximum
exposure to credit loss in the event of  non-performance  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.  Exposure to credit
risk is controlled through credit approvals,  credit limits and continuous monitoring
procedures.  Reserves  for losses are established based upon collectibility assessments.

Derivative
Financial Instruments and Market Risk

All financial
instruments  inherently expose the holders to market risk, including changes in currency
and interest rates and  equity  prices.  We manage our  exposure to these  market  risks
through  our regular  operating  and  financing  activities,  including the use of
derivative financial instruments.

Foreign
currency risk

Our business is
conducted using different  foreign  currencies.  The objective of our foreign currency
risk management  policy  is to  preserve  the value of cash  flows in  non-functional
currencies.  Our policy is to hedge all  significant  booked and  firmly  committed cash
flows identified as creating  foreign  currency  exposure on a rolling 12-month basis. In
addition,  we  typically  hedge a portion of our exposure  resulting from  identified
anticipated  cash flows,  providing the flexibility to  mitigate the variability of
longer-term forecasts as well as changing market conditions.

Foreign
exchange  forward and option  contracts are used to manage our foreign currency risk. We
have hedged foreign exchange  risk in certain  sales and purchase  contracts by embedding
terms in the  contracts  that affect the ultimate  amount of cash  flows under the
contract.  Our primary net foreign  currency  exposures  included the euro,  Chinese
yuan,  Japanese yen, and  British pound as of September 30, 2004 and 2003.

The following table provides a summary of the total net notional amounts of foreign exchange forward and option contracts.

|                   |  | 
|------------------ |  | 
|                   |  | 
|                   |  | 
|(in millions)      |  | 
|Purchase contracts |  | 
|Sale contracts     |  | 

The fair value
of our hedged contracts and the notional  amounts and fair values of embedded
derivatives were not material as  of September 30, 2004 and 2003.

We hedge all
types of foreign  currency risk to preserve our cash flows in accordance with corporate
risk management  policies  but  generally  do not  designate  related  derivative
instruments  as hedges  under  SFAS  133,  for  cost/benefit  reasons.  Accordingly,  the
changes in fair value of these  undesignated  freestanding  foreign  currency  derivative
instruments  are  recorded  in other  income  (expense)  in the  period of change  and have not been  material  because of the short  maturities of these instruments.

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Our foreign
currency  embedded  derivatives  consist of sales and purchase  contracts with cash flows
indexed to changes in or  denominated  in a currency that neither party to the contract
uses as its  functional  currency.  Changes in the fair value of  these embedded
derivatives were not significant during fiscal 2004 and 2003.

Interest rate
risk

We are  exposed
to various  forms of  interest  rate risk.  The fair  value of our  fixed-rate
available-for-sale  marketable  securities  and the interest  income  earned on our cash
and cash  equivalents  may  fluctuate as interest  rates  change.  In  addition,  if
interest rates remain low we may forgo the opportunity to obtain more favorable interest
rates on borrowings due  to our fixed rate debt obligations.  Our objective is to
mitigate the variability of cash inflows and outflows  resulting from  interest rate
fluctuations by maintaining a balanced mix of fixed and  floating-rate  debt and
investments.  We mitigate our  interest rate risk by entering into interest rate swaps on
a portion of our debt obligations to make them  variable-rate  debt  instruments  and by
including  fixed-rate  assets in our investment  portfolio.  We also expect that these
transactions  will  reduce our overall cost of borrowing and increase investment returns.

As of
September  30,  2004,  we had  interest  rate swaps where we received  fixed  interest
rates (5.5% and 7.25%) and paid  floating  rates based upon the three and  six-month
LIBOR rates plus agreed  upon  spreads  (ranging  from 1.72% to 2.89%) on  notional
amounts  aggregating  $600  million.  As of September 30, 2004,  the three and six-month
LIBOR rates were 2.02% and  2.20%,  respectively.  We do not foresee any  significant
changes in our  interest  rate risk  management  strategy or in our  exposure to interest
rate fluctuations.

Equity price
risk

We hold equity
investments in publicly held companies that are classified as  available-for-sale  and
other strategic  equity  holdings in privately held companies and venture funds.  These
equity  investments are exposed to price  fluctuations  and are  generally  concentrated
in the  high-technology  industries.  We  generally do not hedge our equity price risk
due to hedging  restrictions imposed by the issuers,  illiquid capital markets or our
inability to hedge  non-marketable  equity securities in  privately held companies.  We
had no outstanding hedging instruments for our equity price risk as of September 30, 2004.

Customer
Financing Commitments

Requests for
providing  commitments  to extend credit and financial  guarantees are reviewed and
subject to approval by senior  management.  We  regularly  review all  outstanding
commitments,  letters of credit and  financial  guarantees  to assess the  adequacy of
our reserves for possible credit and guarantee losses.

The  following
table  summarizes  our customer  financing  commitments  for amounts  drawn,  available
but not drawn and not  available to be drawn.  These  commitments  may expire  without
being drawn upon. The amounts drawn on these  commitments  are  generally collateralized
by substantially all of the assets of the respective creditors.

|                        |  |  |                                 |     |                    |  
|----------------------- |  |  | ------------------------------- | --- | ------------------ | -
|                        |  |  | September 30, 2004              |     | September 30, 2003 |  
|                        |  |  | Total loans
  and
   guarantees |     | Loans              |  
|(in millions)           |  |  |                                 |     |                    |  
|Drawn commitments       |  |  | $                               | 139 |                    | $
|                        |  |  |                                 |     |                    |  
|Available but not drawn |  |  |                                 | 11  |                    |  
|Not available           |  |  |                                 |    |                    |  
|                        |  |  |                                 |     |                    |  
|Total                   |  |  | $                               | 150 |                    | $
|                        |  |  |                                 |     |                    |  

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The following
table summarizes the change in the customer financing reserves.

|                                               |  |  |  
|---------------------------------------------- |  |  | -
|                                               |  |  |  
|                                               |  |  |  
|(in millions)                                  |  |  |  
|Reserve at beginning of year                   |  |  | $
|Provision for (recovery of) customer financing |  |  |  
|Transfers from (to) other accounts, net        |  |  |  
|Write offs                                     |  |  |  
|                                               |  |  |  
|Reserve at end of year                         |  |  | $
|                                               |  |  |  

Commitments
to Extend Credit

Commitments to
extend credit to third parties are conditional  agreements  generally having fixed
expiration or termination  dates and specific  interest rates  and purposes.  In certain
situations, credit may not be available for drawdown until certain conditions are met.

Letters of
Credit

Letters of
credit are obtained to ensure the performance or payment to third parties in accordance
with specified terms and conditions.  Secured and unsecured  outstanding  letters of
credit were $353 million and $588 million as of September 30, 2004 and 2003,
respectively.  The estimated  fair value of these letters  of credit  were $8 million
and $14 million as of  September  30, 2004 and 2003,  respectively.  On October 1, 2004,
we amended and  restated  our two primary  agreements.  The first  agreement  provides
for the issuance of up to $215 million of new letters of credit until  September  30,
2006.  The second  agreement  permits us to request  renewal of $199 million of letters
of credit until  September 30, 2006.  Under these revised  agreements,  we are no longer
required to  meet  specified  levels of quarterly  consolidated  minimum  operating
income or to provide cash  collateral  for letters of credit  issued.  However,  we are
required to maintain a minimum amount of unrestricted cash and short-term investments in
the U.S. as defined in the agreements.

Transfers of
Financial Instruments

We have
agreements that allow us to sell accounts  receivable from selected customers at a
discount to various financial  institutions on a non-recourse basis.  We sold
approximately  $468  million and $339  million of accounts  receivable  under  these
agreements  during  fiscal 2004 and 2003,  respectively.  These  transactions  were
accounted for as a sale.  Discounting  fees were $5 million and $3 million during 2004
and 2003,  respectively.  Sales and transfers that do  not meet the criteria for
surrender of control are accounted for as secured borrowings.  There were no secured
borrowings as of September 30, 2004.

13.
COMMITMENTS AND CONTINGENCIES

Legal
Proceedings

We are subject
to legal  proceedings,  lawsuits,  and other  claims,  including  proceedings  by
government  authorities.  In  addition,  we may be subject to  liabilities of some of our
former  affiliates  under  separation  agreements with them. Legal  proceedings are
subject to  uncertainties,  and the outcomes are  difficult to predict.  Consequently,
unless otherwise  indicated,  we are unable to estimate the ultimate aggregate amounts of
monetary liability or financial  impact with  respect to these  matters as of September
30, 2004.  As  described  below,  we have  received  final court  approval  for the
settlement  of our  securities and related  litigation.  The impact of other pending
litigation matters that we agreed to settle during the year were not material
individually or  in the aggregate to our results of  operations or financial  condition.
We believe that the remainder of the cases will not have a material  financial  impact
on our results of operations or financial  condition after final  disposition.  However,
because of the  uncertainties  of legal  proceedings,  one or more of  these proceedings
could ultimately result in a material obligation.

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Securities and
Related Cases

On March 27,
2003, we announced  that we reached an agreement to settle  assorted  securities,  ERISA
and  derivative  class action and other related  lawsuits  against us and certain of our
current and former  directors,  officers and employees.  The settlement  covers all
claims generally  relating to the purchase of  Lucent  securities  during  different
class  periods.  The primary  class period is October 26, 1999 through  December 20,
2000. We did not admit nor deny any  wrongdoing as part of the  settlement.  We received
final  approval of the  settlement  from the U.S.  District  Court in Newark,  New
Jersey,  on December 12,  2003.  All appeals of this order are  resolved,  and on
November 9, 2004,  the court  approved  the  plaintiffs plan of  distribution.  The
distribution  is  scheduled to occur during the first or second quarter of fiscal 2005.

The agreement
is a global  settlement of 53 separate  lawsuits,  including a consolidated  shareowner
class action  lawsuit in the U.S.  District Court of New  Jersey,  and related ERISA,
bondholder,  derivative,  and other state securities  cases.  Under the settlement
agreement,  we will pay $315 million in common  stock,  cash or a combination of both, at
our option.  On December 24, 2003, we deposited 33 million shares of our common stock
into escrow,  representing  the  initial $100 million  payment of the  settlement
amount.  These shares were  subsequently  sold in the market by the escrow agent for $105
million  during the  second quarter of fiscal 2004 and the net proceeds remain in escrow.

We will also
issue  warrants to purchase 200 million  shares of our common stock at an exercise  price
of $2.75 per share with an  expiration  date three years  from the date of issuance.  The
estimated  fair value of these warrants was $252 million,  based upon the  Black-Scholes
option-pricing  model as of September  30,  2004.  We also paid $5  million  for the cost
of  settlement  administration.  We will also pay for  certain  other  costs  involved
in the  issuance  of  securities.

In addition to
our  contributions,  certain of our insurance  carriers agreed to pay their
available  policy limits of $148 million into the  settlement  fund. Our former
affiliate,  Avaya Inc.,  contributed  shares of its common stock valued at $24 million to
the settlement  during  September 2004. We continue  to pursue a partial  recovery of the
settlement from our fiduciary  insurance  carriers under certain  insurance  policies.
We filed a lawsuit against them to  recover  these  amounts.  We settled with two of the
carriers for $40 million and are  continuing  to pursue our claim  against a third
carrier that  provided  additional coverage up to $20 million.

The charge for
the global settlement will be revised in future quarters to reflect any additional
recoveries,  as well as to reflect additional changes in the  fair value of the warrants
until the warrants are issued.  The estimated fair value of the warrants may continue to
change as a result of  fluctuations  in the  share price of our common stock.

We will defend
any lawsuits that may be brought by parties that have opted out of the settlement.
We and certain of our current and former officers and directors are defendants in two
such actions in the U.S. District Court in New Jersey, Staro Asset Management, LLC v.
Lucent Technologies Inc. et al., and Florida State Board of Administration v. Lucent
Technologies Inc. et al., alleging violations of federal securities laws. These cases
were originally part of the global settlement referred to above. However, the
plaintiffs opted out of the settlement and are pursuing their claims separately against
Lucent and the other defendants. Other cases have been and may continue to be brought
by individual investors opting out of the settlement.

Government
Investigations

During
November and December 2000, we identified  certain  revenue  recognition  issues that we
publicly  disclosed and brought to the attention of the SEC. A  final  judgment and
consent  decree with the SEC was entered for this matter in May 2004.  Under the terms of
the consent  decree,  we paid a $25 million civil  penalty in the third  quarter of
fiscal 2004 and were not  required to restate our  financial  statements.  Without
admitting  or denying any  wrongdoing,  we  consented to the settlement enjoining us from
future violations of specific provisions of the federal securities laws.

During August
2003, the U.S.  Department of Justice (the DOJ) and the SEC informed us that
they had each commenced an investigation into possible  violations  of the Foreign
Corrupt  Practices Act (FCPA).  These  investigations  followed  allegations
made by National  Group for  Communications  and Computers

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Ltd.  (NGC) in an
action filed against us on August 8, 2003,  which is described  below.  In April 2004, we
reported to the DOJ and the SEC that a FCPA  compliance  audit and an outside  counsel
investigation  found  incidents and internal  control  deficiencies  in our  operations
in China that  potentially  involve FCPA  violations.  We are cooperating  with those
agencies.  We believe these incidents and deficiencies did not have a material effect on
our results of operations.  However, we cannot determine whether this matter will affect
our future business operations in China.

As disclosed in an 8-K filing on November 8, 2004, our former
Chairman and Chief Executive  Officer,  Richard McGinn, the former head of our Saudi
Arabia  operations,  John Heindel,  and a third former employee  received  Wells notices
from the SEC.  These Wells notices state that the staff of the SEC is considering
recommending  that civil actions be taken against  these three former employees for FCPA
violations.  The allegations  against these  individuals  include  violations of the
anti-bribery  provisions of the FCPA  and aiding and abetting the Companys alleged
violations of requirements  under the FCPA to keep accurate books and records and to
maintain a proper system of  internal accounting controls.  We have not received a Wells
notice at this time, but the investigation is continuing.

Other Matters

We are involved in commercial disputes with customers,  suppliers,
subcontractors and other parties. These matters generally  involve claims for monetary
damages for breach of contract or breach of warranty or similar claims in the normal course of business.  While many of
these disputes are settled amicably without  litigation,  some of these matters have
resulted in lawsuits  being filed  against us. The condition of the  telecommunications
market in the past three years  and the insolvency or failure of numerous service
providers has led to more claims and disputes  resulting in litigation.  In addition,
our restructuring has  resulted in the  termination of tens of thousands of employees and
changes in benefits for current and former  employees.  These actions have led to
additional  claims against us. The following is a description of significant pending
litigation.

A lawsuit
involving investors in Actel Integrated Communications was filed against us for
unspecified damages, claiming we misled them as to certain technology, which
influenced their decision to invest in Actel. This case, Sandler Capital Partners IV,
L.P. et al. v. Lucent Technologies, filed in New York State Court, is in its early
stages. During fiscal 2004, we settled cases filed against us by Actel. In addition,
two other cases were filed against us alleging that we failed to deliver working
products related to this technology. Those cases, Maxcess, Inc. v. Lucent
Technologies Inc. et al., filed in the U.S. District Court for the Middle District of
Florida, and Official Plan Committee of Omniflex, Inc. v. Lucent Technologies Inc.,
filed in Missouri State Court, are in the early stages of the litigation process.

We are a
defendant  in an  adversary  proceeding  filed in U.S.  Bankruptcy  Court in Delaware by
Winstar and Winstar  Wireless,  Inc. in  connection  with the  bankruptcy of Winstar and
various  related  entities.  The complaint  asserts claims for breach of contract and
other claims against us and seeks  compensatory  damages,  as well as costs and expenses
associated with  litigation.  Many of these claims against us have been  dismissed.  The
complaint also seeks recovery  of a payment to us of approximately $190 million in
December 2000.

On August 8,
2003,  NGC filed an action in the U.S.  District  Court for the  Southern  District of
New York  against us, our  subsidiary  Lucent  Technologies  International  Inc. and an
unaffiliated  company,  alleging  violations of the Racketeer  Influenced  Corrupt
Organizations  Act (RICO) and other  improper  activities.  These allegations
relate to activities in Saudi Arabia in connection with certain  telecommunications
contracts between us, the Kingdom of Saudi  Arabia and other entities.  The complaint
seeks damages in excess of $63 million,  which could be tripled under RICO. The
allegations in this complaint  appear  to arise out of certain  contractual  disputes
between NGC and Lucent,  that are the subject of a separate case that NGC  previously
filed against us in U.S.  District Court in New Jersey. This case is in its early stages.

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In the case of Pf.Net Supply Corp. v. Lucent Technologies, pending in the U.S. District Court in New
Jersey, the plaintiff claims that we breached an alleged $100 million purchase
commitment and seeks to compel us to meet this purchase commitment or pay damages.
Both parties have filed motions for summary judgement, which are currently pending.

A purported
class action lawsuit, Foss v. Lucent Technologies, was filed against us in U.S.
District Court in New Jersey during October 2003 in connection with the elimination of
the death benefit from our U.S. management pension plan in early 2003. The elimination
of these benefits reduced the future pension obligations by approximately $450 million.
The benefit was paid out of the pension plan assets to certain qualified surviving
dependents, such as spouses or dependent children of management retirees who retired
before 1998. The case alleges that we wrongfully terminated this death benefit and
requests that it be reinstated, along with other remedies. This case is in the early
stages. Three other cases of a similar nature have recently been filed: Berendt, et al.
v. Lucent Technologies Inc., et al. and Lucas, et al. v. Lucent Technologies, et al.,
both filed in the U.S. District Court in New Jersey; and Chastain, et al. v. AT&T, filed
in the U.S. District Court in the Western District of Oklahoma.

The Equal
Employment Opportunity Commission (EEOC) filed a purported class action lawsuit against
us, EEOC v. Lucent Technologies Inc., in the U.S District Court in California. The
case alleges gender discrimination in connection with the provision of service
credit to a class of present and former Lucent employees who were out of work because
of maternity prior to 1980 and seeks the restoration of lost service credit prior to
April 29, 1979, together with retroactive pension payment adjustments; corrections of
service records; back pay, other damages and attorneys fees and costs.

Separation
Agreements

We are party to
various  agreements that were entered into in connection with the separation of Lucent
and former  affiliates,  including  AT&T, Avaya,  Agere  Systems and NCR Corporation.
Pursuant to these agreements,  we and the former affiliates have agreed to allocate
certain  liabilities  related to each others  business,  and have agreed to share
liabilities  based on certain  allocations and thresholds.  For example,  AT&T, Avaya and
NCR each assumed a portion of the  settlement  liability related to our former consumer
products leasing  business,  which settled in August 2002. The plaintiffs  counsel in
this case has filed  a motion to  reconsider  the  disposition  of certain  settlement
proceeds,  so this matter may not be completely  resolved.  We are not aware of any
material  liabilities  to our former  affiliates as a result of the  separation
agreements  that are not otherwise  reflected in our  unaudited  consolidated  financial
statements.  Nevertheless,  it is possible that potential liabilities for which the
former affiliates bear primary  responsibility may lead to contributions by  us.

Avaya has
informed us that they settled three separate  purported class action  lawsuits that are
based on claims that we, as predecessor to Avayas  business,  sold products that
were not Year 2000  compliant.  In addition,  NCR has disclosed that it is  responsible
for  remediation  costs related to the discharge of  contaminants  into the Fox River in
Wisconsin.  NCR has informed us that these costs are expected to exceed  threshold
limits under the  separation  agreement  among NCR,  AT&T and us. We have reserves for
the amounts we currently  expect to pay Avaya and NCR under the  separation  agreements
for these  matters.  The  impact of these matters was not material to our results of
operations or financial condition.

Other
Commitments

We agreed to
purchase 90% of our  requirements  for products we currently  purchase from Agere and 60%
of our  requirements  for other  products that Agere can  supply through September 30,
2006,  provided Agere is competitive with other potential  suppliers as to price, lead
time and technological  merit. We have also  agreed to proceed first with Agere on all
joint product development projects where Agere meets our criteria.

We exited most
of our  manufacturing  operations and increased our use of contract  manufacturers.  A
sole-source  supplier is currently used for a majority of  the switching and wireless
product lines.  Purchases  from this supplier were  approximately  $750 million,  $695
million and $1.5 billion during fiscal 2004,  2003 and 2002,  respectively.  Four other
contract  manufacturers  supplied the majority of our other product  lines.
Purchases  from these  suppliers  were  approximately  $880 million,  $825 million and
$1.0 billion during fiscal 2004, 2003 and 2002,  respectively.  We are generally not
committed to  unconditional

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purchase obligations in these  contract-manufacturing
relationships.  However, there is exposure to short-term purchase commitments when they
occur within the  contract  manufacturers lead-time for specific  products or raw
materials.  These  commitments  were $691 million as of September 30, 2004. As a result,
any  sudden and significant  changes in forecasted  demand  requirements  within the
lead-time of those products or raw materials could adversely affect our results  of
operations and cash flows.

Guarantees and
Indemnification Agreements

We divested
certain  businesses  and assets  through sales to  third-party  purchasers  and
spin-offs to our common  shareowners.  In  connection  with these  transactions,  certain
direct or indirect  indemnifications are provided to the buyers or other third parties
doing business with the divested entities.  These  indemnifications  include  secondary
liability  for certain  leases of real  property  and  equipment  assigned to the
divested  entity and certain  specific  indemnifications for certain legal and
environmental  contingencies,  as well as vendor supply commitments.  The time durations
of such  indemnifications  vary  but are standard for transactions of this nature.

We remain
secondarily  liable for approximately  $275 million of lease obligations as of September
30, 2004, that were assigned to Avaya, Agere and purchasers  of other  businesses.  The
remaining  terms of these assigned leases and our  corresponding  guarantees  range from
one month to 15 years.  The primary obligor  under assigned leases may terminate or
restructure the lease  obligation  before its original  maturity and thereby relieve us
of our secondary  liability.  We  generally have the right to receive indemnity or
reimbursement from the assignees and have not reserved for losses on this form of
guarantee.

We are party to
a tax-sharing  agreement to indemnify AT&T and are liable for tax  adjustments  that are
attributable  to our lines of business,  as well as a  portion of certain  other  shared
tax  adjustments  during the years  prior to our  separation  from AT&T. We have  similar
agreements  with Avaya and Agere.  In addition to the fiscal year 2001 federal net operating loss carryback claim discussed in Note 7, certain tax adjustments  have been proposed or
assessed  subject to these  tax-sharing  agreements.  Certain tax issues,  including
potential  adjustments and  refunds  related to the years 1990 through 1998 were recently
resolved with the Internal  Revenue Service and our former  affiliates.  The resolution
of these  matters  resulted in a benefit of $234  million,  including  interest of $90
million,  to our results of  operations  during  fiscal  2004.  The outcome of all
remaining matters is not expected to have a material adverse effect on our consolidated
results of operations,  consolidated  financial  position or near-term  liquidity.

We license to
our customers  software and rights to use intellectual  property that might provide the
licensees with an  indemnification  against any liability  arising from  third-party
claims of patent,  copyright or trademark  infringement.  We cannot determine the maximum
amount of losses that we could incur under  this type of  indemnification,  because  we
often may not have  enough  information  about the  nature  and scope of an  infringement
claim  until it has been  submitted to us.

We indemnify
our directors and certain of our current and former  officers for  third-party  claims
alleging  certain  breaches of their  fiduciary  duties as  directors or officers.
Certain costs incurred for providing such indemnification may be recovered under various
insurance policies.

We are unable
to reasonably  estimate the maximum amount that could be payable under certain of our
arrangements  since these exposures are not capped and due  to the conditional  nature of
our  obligations  and the unique facts and  circumstances  involved in each  agreement.
Historically,  payments made under these  agreements have not had a material effect on
our business, financial condition or results of operations.

Warranty
reserves are  established  for costs that are  expected to be incurred  after the sale
and  delivery of a product or service for  deficiencies  under  specific  product or
service  warranty  provisions.  These reserves are  established  when it is probable that
customers will make claims and when a reasonable  estimate of costs can be made. The
reserves are determined as a percentage of revenues  based on the actual trend of
historical  charges  incurred over various  periods,  excluding any significant or
infrequent issues that are
specifically  identified and reserved.  The following table summarizes the activity
related  to warranty reserves:

F-80

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|                                  |  | 
|--------------------------------- |  | 
|                                  |  | 
|                                  |  | 
|(in millions)                     |  | 
|Reserve at beginning of year      |  | 
|Accruals for warranties, net      |  | 
|Payments                          |  | 
|Optical Fiber business adjustment |  | 
|                                  |  | 
|Reserve at end of year            |  | 
|                                  |  | 

Environmental
Matters

Our current and
historical  operations  are subject to a wide range of  environmental  laws. In the
United  States,  these laws often require  parties to fund  remedial action regardless of
fault.  We have remedial and investigatory activities underway at numerous current and
former facilities.

Environmental
reserves of $118 million have been established for  environmental  liabilities that can
be reasonably  estimated as of September 30, 2004. These  reserves are not discounted to
present value. We have receivables of $31 million with respect to environmental  matters
due from third-party  indemnitors as of  September 30, 2004.  Receivables are recorded
only if the indemnitors  have agreed to pay the claims and management  believes
collection of the receivables is  reasonably assured.  Environmental  matters did not
have a significant impact on our consolidated  financial  condition,  results of
operations,  or cash flows  during the year ended  September 30, 2004.  Charges  related
to  environmental  matters were $15 million,  $25 million and $26 million during fiscal
2004, 2003  and 2002, respectively and were included in costs.

Reserves for
estimated losses from environmental remediation are, depending on the site, based on
analyses of many interrelated factors, including:

- The extent and degree of
contamination and the nature of required remedial actions.
- The timing and various types of
environmental expenditures, such as investigatory, remedial, capital and operations, and
maintenance costs.
- Applicable legal requirements
defining remedial goals and methods.
- Progress and stage of existing
remedial programs in achieving remedial goals.
- Innovations in remedial
technology and expected trends in environmental costs and legal requirements.
- The number, participation level
and financial viability of other potentially responsible parties.
- The timing and likelihood of
potential recoveries or contributions from other third parties.
- Historical experience.
- The degree of certainty and
reliability of all the factors considered.

It is often
difficult to estimate the future impact of environmental matters,  including potential
liabilities,  due to the above factors and the lengthy time  periods  involved in
resolving  them (which may be up to 30 years or longer).  Although we believe that our
reserves are  currently  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 reserves or will not have a material  adverse  effect on our  consolidated
financial  condition,  results of  operations or cash flows.  Any possible  loss or range
of possible loss that may be incurred in excess of amounts  provided for as of September
30,  2004 cannot be reasonably estimated.

Lease
Commitments

We lease land,
buildings and equipment  under  agreements that expire in various years through 2020.
Rental expense under operating  leases was $230 million,  $267 million and $325  million,
net of sublease  rental  income of $38 million,  $53 million and $96 million,  for fiscal
2004,  2003 and 2002,  respectively.  Future minimum lease payments due under
non-cancelable  operating leases  (including  leases that are part of our  restructuring
actions) as of September 30,  2004 were $180  million in 2005,  $136 million in 2006,
$101 million in 2007,  $86 million in 2008,  $75 million in 2009 and $423  million
thereafter.  These future  minimum
lease payments do not include  future  sublease  rental income of $27 million in 2005,
$18 million in 2006, $16 million in 2007, $14 million in  2008, $12 million in 2009 and
$125 million thereafter.

F-81

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14.
QUARTERLY INFORMATION (UNAUDITED)

|                                                                                           |  |  |       |       |       
|------------------------------------------------------------------------------------------ |  |  | ----- | ----- | ------
|                                                                                           |  |  | First |       | Second
|(in millions, except per share amounts)                                                    |  |  |       |       |       
|Year ended September 30, 2004                                                              |  |  |       |       |       
|Revenues                                                                                   |  |  | $     | 2,259 |       
|Gross margin                                                                               |  |  |       | 919   |       
|Recovery of bad debts and customer financings                                              |  |  |       | (14   | )     
|Business restructuring charges (reversals), net                                            |  |  |       | 29    |       
|Other income (expense), net                                                                |  |  |       | 79    |       
|Income taxes                                                                               |  |  |       | (101  | )     
|Net income                                                                                 |  |  |       | 338   |       
|Conversion  / redemption cost  8% preferred stock                                         |  |  |       | (1    | )     
|Preferred stock dividends and accretion                                                    |  |  |       | 12    |       
|Net income applicable to common shareholders                                               |  |  |       | 349   |       
|                                                                                           |  | 
|Income per common share:                                                                   |  | 
|Net income applicable to common shareowners  basic                                        |  |  |       | 0.08  |       
|Net income applicable to common shareowners  diluted                                      |  |  |       | 0.07  |       
|                                                                                           |  | 
|Year ended September 30, 2003                                                              |  | 
|Revenues                                                                                   |  |  | $     | 2,075 |       
|Gross margin                                                                               |  |  |       | 454   |       
|Provision for (recovery of) bad debts and customer financings                              |  |  |       | (91   | )     
|Goodwill impairment                                                                        |  |  |       |      |       
|Business restructuring charges (reversals), net (including amounts affecting gross margin) |  |  |       | (14   | )     
|Other income (expense), net                                                                |  |  |       | 22    |       
|Income taxes                                                                               |  |  |       | (120  | )     
|Net (loss) income                                                                          |  |  |       | (264  | )     
|Conversion/redemption cost  8% preferred stock                                            |  |  |       | (100  | )     
|Preferred stock dividends and accretion                                                    |  |  |       | (25   | )     
|Net income (loss) applicable to common shareholders                                        |  |  |       | (389  | )     
|                                                                                           |  | 
|(Loss) income per common share  basic and diluted:                                        |  | 
|Net income (loss) applicable to common shareowners                                         |  |  |       | (0.11 | )     

As reflected
above,  our  quarterly  results were  impacted by charges,  recoveries or reversals
related to bad debts and customer  financing,  restructuring  actions and  retirements of
convertible  securities and certain debt  obligations  among other items.  There were no
dividends per common share for any of the  periods  presented.  The impact of
significant  items  incurred  during the first three  interim  periods of each fiscal
year are discussed in more detail and  disclosed in our quarterly reports on Form 10-Q.
Additional items affecting our quarterly results were as follows:

- During the second  quarter of
fiscal 2003, we recognized a $415 million charge in other income  (expense)  related to
the settlement of our shareowner  class action  lawsuits for alleged  securities
violations.  Additional  charges  (benefits),  primarily to adjust the fair value of the
warrants that are  expected to be issued in connection with the legal settlement,  were
$54 million,  $212 million,  ($72) million and ($98) million for the four quarters of
fiscal 2004 and $33 million in both the third and fourth quarters of fiscal 2003.
- The results for the four
quarters of fiscal 2004 included the impact of certain  discrete tax items  related to
the reversal of valuation  allowances  and the favorable  settlement of certain prior
year federal and state tax audit matters.  Tax related benefits  recognized for the four
quarters of fiscal  2004 were $123 million,  $37 million,  $15 million and $828 million,
including the recognition of an $816 million net operating loss carryback  claim. We
also recognized $68 million,  $18 million,  $4 million and $45 million of interest income
related to these settlements  during the four quarters of fiscal  2004.  During each of
the first three  quarters of fiscal 2003,  the income  tax benefit  reflected the
expected  utilization  of a portion of the current  periods  operating  losses as a
result of certain  equity  transactions,  including  a $135  million  tax benefit
from  exchanges  of 7.75%  convertible  securities  for shares of our common  stock,  and
a $30 million tax benefit from  unrealized  investment  holding  gains.  These income tax
benefits  were  reversed  during the fourth  quarter of fiscal 2003 as a result of
changes in the minimum  pension  liability  that was  reflected in other  comprehensive
income.

F-82

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