<PAGE>   1
                                                                      EXHIBIT 13


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

HIGHLIGHTS

Lucent Technologies Inc. (the "Company") reported net income of $4,766 million,
or $1.52 per share (diluted), for the year ended September 30, 1999, compared
with year-ago net income of $1,035 million, or $0.34 per share (diluted). In
1999, Lucent changed its method for determining annual net pension and
postretirement benefit costs. As a result, included in 1999 net income is a
$1,308 million, or $0.42 per share (diluted), cumulative effect of accounting
change. See Note 10 to the Consolidated Financial Statements for further detail
of the accounting change. Lucent's income before the cumulative effect of the
accounting change was $3,458 million for the year ended September 30, 1999.

In 1999, Lucent recorded a $141 million ($93 million after-tax) reversal of
business restructuring charges, a $101 million non-tax deductible charge to
operating expenses for merger-related costs and a $236 million charge ($169
million after-tax) primarily associated with asset impairments and
integration-related charges associated with the Ascend Communications, Inc. and
Nexabit Networks, Inc. mergers, a $274 million gain ($167 million after-tax) on
the sale of an equity investment in Juniper Networks, and $282 million ($272
million after-tax) purchased in-process research and development expenses
related to the acquisitions of Stratus Computer, Inc., Quadritek Systems, Inc.,
Sybarus Technologies, WaveAccess Ltd. and the Ethernet local area network
("LAN") component business of Enable Semiconductor ("Enable").

In 1998, Lucent recorded a $118 million ($76 million after-tax) reversal of
business restructuring charges (including an $18 million pre-tax reversal of
merger-related costs by Ascend), a $149 million ($95 million after-tax) gain on
the sale of Lucent's Advanced Technology Systems ("ATS") business, and $1,683
million ($1,679 million after-tax) purchased in-process research and development
expenses related to the acquisitions of Stratus, JNA Telecommunications Limited,
LANNET, MassMedia Communications Inc., SDX Business Systems plc, Yurie Systems,
Inc., Optimay GmBH, Prominet Corporation and Livingston Enterprises, Inc.

All per share amounts have been adjusted to reflect the two-for-one stock splits
of Lucent common stock that became effective April 1, 1999 and April 1, 1998.

All financial information has been restated to reflect the Ascend and Kenan
Systems Corporation mergers.

CONVERGENCE

The communications industry is experiencing rapid changes in the technologies
used to service customers' needs. Traditional circuit-based switching and data
packet transmission are converging. This convergence of technologies is driven
by the growing demands for the transmission of information using data, voice,
video and fax, or any combination of these. The demand is driven by the
expansion of Internet traffic over existing networks - both wireline and
wireless - as well as the buildout of new and improved networks.

Lucent's strategy is to meet its customers' needs by offering an end-to-end
solutions platform. This strategy brings together the core products of
switching, transmission, software, messaging and optoelectronics (including
microelectronic componentry) with the new portfolio offerings obtained through
strategic acquisitions as well as the research and development of Bell
Laboratories. These new offerings are in the areas of data packet switching,
access products, software and services. With these new offerings, Lucent will
enhance its spectrum of communications products and services - data, voice,
optical, wireless, software, services and support - and is able to offer a
full-service package for the next generation of networks.

In June 1999, Lucent merged with Ascend. The Ascend merger enhances Lucent's
data switching and remote access products. The February 1999 merger with Kenan
refines Lucent's expertise in the field of billing software and customer care.
Subsequent to the close of fiscal 1999, Lucent continued to broaden its
portfolio by merging with International Network Services ("INS"), a global
provider of network consulting and software solutions, and Excel Switching
Corporation, a provider of open switching solutions for telecom carriers.


<PAGE>   2

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

Lucent will continue to review its portfolio of offerings and may use
acquisitions to enhance those offerings where it makes good business sense.
These acquisitions may occur through the use of cash, the issuance of debt or
common stock, or any combination of the three.

ACQUISITIONS AND DISPOSITIONS

As part of Lucent's continued efforts to provide its customers with end-to-end
communications solutions, the Company completed the following acquisitions and
dispositions during the three years ended September 30, 1999:

August 1999       Acquisition of 61% interest in SpecTran Corporation, a
                  designer and manufacturer of specialty optical fiber and
                  fiber-optic products. Lucent expects to acquire the remaining
                  shares of SpecTran by the end of the first quarter of fiscal
                  year 2000

July 1999         Merger with Nexabit, a developer of high-speed switching
                  equipment and software that directs traffic along
                  telecommunications networks

                  Merger with Mosaix Inc., a provider of software that links
                  companies' front and back offices and helps them deliver more
                  responsive and efficient customer service

June 1999         Merger with Ascend, a developer, manufacturer and seller of
                  wide area networking solutions

March 1999        Acquisition of the Ethernet LAN component business of Enable
                  Semiconductor

February 1999     Merger with Kenan, a developer of third-party billing and
                  customer care software

                  Acquisition of Sybarus, a semiconductor design company

January 1999      Acquisition of the remaining 80% interest in WaveAccess, a
                  developer of high-speed systems for wireless data
                  communications

October 1998      Acquisition of Quadritek, a start-up developer of
                  next-generation Internet protocol ("IP") network
                  administration software solutions

                  Ascend acquisition of Stratus, a manufacturer of
                  fault-tolerant computer systems

September 1998    Acquisition of JNA, an Australian telecom equipment
                  manufacturer, reseller and system integrator

August 1998       Acquisition of LANNET, an Israeli-based supplier of Ethernet
                  and asynchronous transfer mode ("ATM") switching solutions

July 1998         Acquisition of SDX, a United Kingdom-based provider of
                  business communications systems

                  Acquisition of MassMedia, a developer of next-generation
                  network interoperability software

May 1998          Acquisition of Yurie, a provider of ATM access technology and
                  equipment for data, voice and video networking

April 1998        Acquisition of Optimay, a Germany-based developer of software
                  products and services for chip sets to be used for Global
                  System for Mobile Communications cellular phones

January 1998      Acquisition of Prominet, a participant in the emerging Gigabit
                  Ethernet networking industry

December 1997     Acquisition of Livingston, a global provider of equipment
                  used by Internet service providers to connect their
                  subscribers to the Internet

September 1997    Acquisition of Octel Communications Corporation, a provider of
                  voice, fax and electronic messaging technologies


<PAGE>   3

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

June 1997         Ascend merger with Cascade Communications Corp., a developer
                  and manufacturer of wide area network switches

April 1997        Ascend merger with Whitetree, Inc., a developer and
                  manufacturer of high-speed ATM switching products

February 1997     Ascend acquisition of InterCon Systems Corporation, a
                  developer of remote access client software products

January 1997      Ascend acquisition of Sahara Networks, Inc., a developer of
                  scalable high-speed broadband access products

Lucent has also sought to divest itself of non-core businesses:

October 1, 1997   Lucent contributed its Consumer Products business to a new
                  venture formed by Lucent and Philips Electronics N.V.
                  ("Philips") in exchange for 40% ownership of the venture. The
                  venture, Philips Consumer Communications ("PCC"), was formed
                  to create a worldwide provider of personal communications
                  products. On October 22, 1998, Lucent and Philips announced
                  their intention to end the venture in PCC. The venture was
                  terminated in late 1998. In December 1998, Lucent sold certain
                  assets of its wireless handset business to Motorola. Lucent is
                  continuing to look for opportunities to sell the remaining
                  consumer products business.

October 1997      Sale of ATS unit

December 1996     Sale of interconnect products and Custom Manufacturing
                  Services ("CMS") businesses

In addition, subsequent to the 1999 fiscal year-end, Lucent merged with the
following:

On October 15, 1999, Lucent merged with INS, a global provider of network
consulting and software solutions

On November 3, 1999, Lucent merged with Excel, a provider of open switching
solutions for telecom carriers

On November 12, 1999, Lucent merged with Xedia Corporation, a developer of
high-performance Internet access routers for wide area networks

LUCENT'S FORMATION

Lucent was formed from the systems and technology units that were formerly part
of AT&T Corp., including the research and development capabilities of Bell
Laboratories. Prior to February 1, 1996, AT&T conducted Lucent's original
business through various divisions and subsidiaries. On February 1, 1996, AT&T
began executing its decision to separate Lucent into a stand-alone company by
transferring to Lucent the assets and liabilities related to its business. In
April 1996, Lucent completed the initial public offering of its common stock
("IPO") and on September 30, 1996, became independent of AT&T when AT&T
distributed to its shareowners all of its Lucent shares.

OPERATING SEGMENTS

Lucent operates in the global telecommunications networking industry and has
three reportable segments: Service Provider Networks ("SPN"), Enterprise
Networks ("Enterprise"), and Microelectronics and Communications Technologies
("MCT"). SPN provides public networking systems and software to
telecommunications service providers and public network operators around the
world. Enterprise develops, manufactures, markets and services advanced
communications products and data networking systems for business customers. MCT
designs and manufactures high-performance integrated circuits, power systems and
optoelectronic components for applications in the communications and computing
industries. In addition, MCT includes network products, new ventures and
intellectual property. The results of other smaller units and corporate
operations are reported in Other and Corporate.

The three reportable operating segments are strategic market units that offer
distinct products and services. These segments were determined based on the
customers and the markets that Lucent serves. Each market unit is managed
separately as each operation requires different technologies and marketing
strategies.


<PAGE>   4

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

SEGMENT REVENUES-for the year ended September 30, 1997, 1998 and 1999
(Dollars in Billions)

<TABLE>
<CAPTION>
                                           1997        1998        1999
<S>                                       <C>         <C>         <C>
Other                                     $   1.4     $   0.1     $   0.7
Microelectronics and Communications
  Technologies                                4.2         4.6         5.4
Enterprise Networks                           6.3         8.0         8.6
Service Provider Networks                    15.7        19.1        23.6
</TABLE>

Lucent's Service Provider Networks segment represents about 62% of the total
external sales for 1999. Lucent offers a wide range of products and services
that represent a full-service package for the next generation of networks.

PRODUCT AND SERVICE REVENUES-for the year ended September 30, 1999

Core Networking Systems            46%
Business Communications Systems    18%
Wireless Products                  15%
Microelectronics                    7%
NetCare Professional Services       2%
Other                              12%

Lucent's segments include products and services businesses focused on developing
and delivering systems and technologies to our customers.

KEY BUSINESS CHALLENGES

Lucent continues to face significant competition and expects that the level of
competition on pricing and product offerings will intensify. Lucent expects that
new competitors will enter its markets as a result of the trend toward global
expansion by U.S. and non-U.S. competitors as well as continued changes in
technology and public policy. These competitors may include entrants from the
telecommunications, software, data networking, cable television and
semiconductor industries. Existing competitors have, and new competitors may
have, strong financial capabilities, technological expertise, well-recognized
brand names and a global presence. Such competitors may include Alcatel Alsthom,
Cisco Systems, Inc., Ericsson, Nortel Networks, and Siemens AG. Lucent's
management periodically assesses market conditions and redirects the Company's
resources to meet new challenges. Steps Lucent may take include acquiring or
investing in new businesses and ventures, partnering with other companies,
delivering new technologies, closing and consolidating facilities, disposing of
assets, reducing work force levels and withdrawing from markets.

Historically, revenues and earnings were higher in the first fiscal quarter
primarily because many of Lucent's large customers delay a disproportionate
percentage of their capital expenditures until the fourth quarter of the
calendar year (Lucent's first fiscal quarter). Lucent has taken measures to
manage the seasonality of its business by changing the date on which its fiscal
year ends to September 30 and its compensation programs for employees, resulting
in a more uniform distribution of revenues and earnings throughout the year.

The purchasing behavior of Lucent's largest customers has increasingly been
characterized by the use of fewer, larger contracts. These contracts typically
involve longer negotiating cycles, require the dedication of substantial amounts
of working capital and other resources, and in general require costs that may
substantially precede the recognition of associated revenues. Moreover, in
return for larger, longer-term purchase commitments, customers often demand more
stringent acceptance criteria, which can also cause revenue recognition delays.
Lucent has increasingly provided or arranged long-term financing for customers
as a condition to obtain or bid on infrastructure projects. Certain multiyear
contracts involve new technologies that may not have been previously deployed on
a large-scale commercial basis. On its multiyear contracts, Lucent may incur
significant initial cost overruns and losses that are recognized in the quarter
in which they become ascertainable. Further, profit estimates on such contracts
are revised periodically over the lives of the contracts, and such revisions can
have a significant impact on reported earnings in any one quarter.

Historically, a limited number of customers have provided a substantial portion
of Lucent's total revenues. These customers include AT&T, which continues to be
a significant customer, and the Regional Bell Operating Companies ("RBOCs"). The
communications industry is experiencing a consolidation of both U.S. and
non-U.S. companies. The loss of any of these customers, or any


<PAGE>   5

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

substantial reduction in orders by any of these customers, could materially
adversely affect the Company's operating results.

Lucent is diversifying its customer base and seeking out new types of customers
globally. These new types of customers include competitive access providers and
local exchange carriers, wireless service providers, cable television network
operators and computer manufacturers.

RESULTS OF OPERATIONS

REVENUES

Total revenues for 1999 increased 20.4% to $38,303 million compared with 1998,
due to increases in sales from all reportable operating segments, as well as
Other and Corporate. Revenue growth was driven by sales increases globally. For
1999, sales within the United States grew 11.1% compared with 1998. Non-U.S.
revenues increased 47.0% compared with 1998. These non-U.S. sales represented
31.8% of total revenues compared with 26.1% in 1998.

REVENUES BY NON-U.S. REGIONS-for the year ended September 30, 1997, 1998 and
1999
(Dollars in Billions)

<TABLE>
<CAPTION>
                                      1997      1998      1999
<S>                                   <C>       <C>       <C>
Canada                                $0.1      $0.5      $0.4
Caribbean/Latin America                0.7       0.9       1.5
Asia/Pacific                           2.8       3.0       3.5
Europe/Middle East/Africa              3.0       3.9       6.8
</TABLE>

Lucent continues to expand its business outside of the United States, with
growth led by the Europe/Middle East/ Africa region for the past three years.

Total revenues for 1998 increased 15.2% to $31,806 million compared with 1997,
due to increases in sales from all reportable operating segments. Revenue growth
was driven by sales increases globally. For 1998, U.S. sales grew 12.7% compared
with 1997 and non-U.S. sales increased 22.8% compared with 1997. These sales
represented 26.1% of total revenues compared with 24.5% in 1997.

The following table presents Lucent's revenues by segment and the approximate
percentage of total revenues for the years ended September 30, 1999, 1998, and
1997:

<TABLE>
<CAPTION>
                                                             1999                   1998                     1997
---------------------------------------------------------------------------------------------------------------------------
                                                                    % of                    % of                    % of
---------------------------------------------------------------------------------------------------------------------------
                                                                    Total                   Total                   Total
---------------------------------------------------------------------------------------------------------------------------
<S>                                                  <C>            <C>      <C>            <C>      <C>            <C>
Service Provider Networks                            $23,562          62     $19,108          60     $15,675          57
---------------------------------------------------------------------------------------------------------------------------
Enterprise Networks                                    8,559          22       7,954          25       6,257          23
---------------------------------------------------------------------------------------------------------------------------
Microelectronics and Communications Technologies       5,424          14       4,628          15       4,238          15
---------------------------------------------------------------------------------------------------------------------------
Other and Corporate                                      758           2         116           -       1,441           5
---------------------------------------------------------------------------------------------------------------------------
Total Lucent                                         $38,303         100     $31,806         100     $27,611         100
---------------------------------------------------------------------------------------------------------------------------
</TABLE>

Revenues in 1999 from the SERVICE PROVIDER NETWORKS segment increased by 23.3%,
or $4,454 million compared with 1998, and increased 21.9%, or $3,433 million for
1998 compared with 1997. These increases resulted primarily from higher sales of
switching and wireless systems products with associated software, optical
networking and data networking systems and communications software. Continued
demand for voice, data and wireless services, as well as the need for increased
network capacity contributed to the group's revenues.


<PAGE>   6

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

U.S. revenues in 1999 from the Service Provider Networks segment increased by
9.0% over 1998, and by 22.3% comparing 1998 with 1997. The 1999 U.S. revenue
increase was led by sales to local exchange carriers, wireless service providers
and long distance carriers. The 1998 U.S. revenue increase was led by sales to
RBOCs, local exchange carriers, wireless service providers and long distance
carriers. Non-U.S. revenues for 1999 increased 64.8% compared with 1998 due to
revenue growth in the Europe/Middle East/Africa, Caribbean/Latin America and
Asia/Pacific regions and represented 34.2% of revenues for 1999 compared with
25.6% in 1998. Non-U.S. revenues for 1998 increased 20.8% compared with 1997 due
to growth in all non-U.S. regions, led by the Europe/Middle East/Africa region.
Non-U.S. revenues represented 25.8% of revenues in 1997.

Revenues in 1999 from the ENTERPRISE NETWORKS segment increased by 7.6%, or $605
million compared with 1998. This increase was led by sales of DEFINITY
enterprise communication servers, including those with call center applications
and messaging systems. Revenue gains were partially offset by decreased sales of
SYSTIMAX(R) structured cabling systems. Revenues in 1998 increased 27.1%, or
$1,697 million compared with 1997. This increase was led by sales of messaging
systems, including systems provided by Octel, SYSTIMAX structured cabling and
services. Non-U.S. revenues increased by 16.3% in 1999 compared with 1998 and
52.0% in 1998 compared with 1997 due to growth in all non-U.S. regions, led by
the Europe/Middle East/Africa region. Non-U.S. revenues represented 20.6% of the
revenues for 1999 compared with 19.0% for 1998 and 15.9% for 1997. For 1999,
U.S. sales increased 5.6% compared with 1998 and 22.4% for 1998 compared with
1997.

Revenues in 1999 from the MICROELECTRONICS AND COMMUNICATIONS TECHNOLOGIES
segment increased 17.2%, or $796 million compared with 1998, due to higher sales
of optoelectronic components and integrated circuits for high-speed
communications, data networking, wireless, and computing systems. Increased
sales of power systems also contributed to the increase. Revenues increased
9.2%, or $390 million for 1998 compared with 1997, due to higher sales of chips
for computing and communications, including semiconductor components for
broadband and narrowband networks, data networking, wireless telephones and
infrastructure, high-end workstations, optoelectronic transmission systems,
power systems and the licensing of intellectual property. U.S. sales in 1999
increased 11.8% compared with 1998 and 8.2% in 1998 compared with 1997. Non-U.S.
revenues increased 25.0% compared with 1998 driven by sales in the Asia/Pacific
and the Europe/Middle East/Africa regions. Non-U.S. revenues increased 10.7% in
1998 compared with 1997 due to growth in all non-U.S. regions, led by the
Europe/Middle East/Africa region. Non-U.S. revenues represented 43.6% of sales
compared with 40.8% in 1998 and 40.3% in 1997.

Revenues in 1999 from sales of OTHER AND CORPORATE increased $642 million
compared with 1998, primarily due to the consolidation of the businesses
regained from the PCC venture. On October 22, 1998, Lucent and Philips announced
they would end their PCC venture. The venture was terminated in late 1998. The
results of operations and net assets of the remaining businesses Lucent
previously contributed to PCC had been consolidated as of October 1, 1998. The
revenues are included in Other and Corporate. In December 1998, Lucent sold
certain assets of the wireless handset portion of the remaining businesses to
Motorola, Inc. Lucent is continuing to look for opportunities to sell the
remaining consumer products businesses. Revenues for 1998 decreased 92.0%, or
$1,325 million, compared with 1997. The reduction in revenues was primarily due
to Lucent's contribution of its Consumer Products business in exchange for 40%
ownership of PCC in October 1997. In addition, the sale of Lucent's ATS and CMS
businesses contributed to the decrease in Other and Corporate.

(R) Registered trademark of Lucent


<PAGE>   7

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

COSTS AND GROSS MARGIN

<TABLE>
<CAPTION>
                           1999         1998         1997
                          -------      -------      -------
                               (Dollars in Millions)
<S>                       <C>          <C>          <C>
Costs                     $19,688      $16,715      $15,318
Gross margin              $18,615      $15,091      $12,293
Gross margin %               48.6%        47.4%        44.5%
</TABLE>

Total costs in 1999 increased $2,973 million, or 17.8%, compared with 1998, and
$1,397 million, or 9.1%, in 1998 compared with 1997 due to the increase in sales
volume. Gross margin percentage increased 1.2 percentage points from 1998. The
increase in gross margin percentage for the year was due to a more favorable mix
of products. Gross margin percentage increased 2.9 percentage points in 1998
from 1997 due to an overall favorable mix of higher margin products and services
sales.

OPERATING EXPENSES - SG&A

<TABLE>
<CAPTION>
                                                         1999          1998          1997
                                                       --------      --------      --------
                                                                (Dollars in Millions)
<S>                                                    <C>           <C>           <C>
Selling, general and administrative ("SG&A")           $  8,417      $  6,867      $  6,254
As a percentage of revenues                                22.0%         21.6%         22.7%
As a percentage of revenues excluding amortization
 of goodwill and existing technology                       20.9%         21.1%         22.5%
</TABLE>

SG&A expenses increased $1,550 million, or 22.6%, and increased 0.4 percentage
points as a percentage of revenues comparing 1999 with 1998 and increased $613
million, or 9.8%, and decreased 1.1 percentage points as a percentage of
revenues comparing 1998 with 1997. The dollar increases are attributable to
higher sales volume, investment in growth initiatives, and increased
amortization of goodwill and existing technology. In addition, the 1998 increase
reflects the implementation of SAP, an integrated software platform.

Amortization expense associated with goodwill and existing technology was $394
million, $149 million and $32 million for the years ended September 30, 1999,
1998, and 1997, respectively. The 1999 increase largely relates to the write-off
of Livingston goodwill and existing technology. For further detail see
IN-PROCESS RESEARCH AND DEVELOPMENT below. The 1998 increase relates to
increased business acquisition activity in 1998.

In addition, 1999 includes a $118 million reversal of 1995 business
restructuring charges compared with $66 million in 1998 and $174 million in
1997. The 1998 period also includes an $18 million reversal of merger-related
costs associated with the acquisition of Cascade.

OPERATING EXPENSES - R&D

<TABLE>
<CAPTION>
                                       1999        1998        1997
                                      ------      ------      ------
                                          (Dollars in Millions)
<S>                                   <C>         <C>         <C>
Research and development ("R&D")      $4,510      $3,903      $3,185
As a percentage of revenues             11.8%       12.3%       11.5%

Purchased in-process research and
  development                         $  282      $1,683      $1,255
</TABLE>

R&D expenses in 1999 increased $607 million, or 15.6%, and decreased 0.5
percentage points as a percentage of revenues compared with 1998, and increased
$718 million, or 22.5%, and increased 0.8 percentage points in 1998 as a
percentage of revenues compared with 1997. The dollar increases were primarily
due to increased expenditures in support of wireless, data networking, optical
networking, switching and microelectronic products. The 1998 increase also
reflected increased expenditures in support of software development and sales.
The 1999 decrease in R&D as a percentage of revenues includes more custom
contract work that is recorded in Costs as opposed to R&D.


<PAGE>   8

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

Purchased in-process research and development expenses for 1999 reflect charges
associated with the acquisitions of Stratus, Quadritek, Sybarus, WaveAccess and
Enable, compared with 1998 expenses associated with the acquisitions of Stratus,
JNA, LANNET, MassMedia, SDX, Optimay, Yurie, Prominet and Livingston and with
1997 expenses associated with the acquisitions of Octel, InterCon, Sahara and
Agile Networks, Inc.

In 1999, $24 million of in-process research and development charges related to
the acquisition of Stratus by Ascend were reversed. Since the proceeds received
by Ascend in the divestiture of the non-telecommunications business units of
Stratus exceeded the carrying value of the assets held for sale, a portion of
the original charge for purchased in-process research and development was
reversed, reducing the amount of the purchase price allocated to non-current
assets on a pro-rata basis. The Stratus acquisition is reported in the 1999 and
1998 fiscal years as a result of the merger with Ascend, which had a different
year-end than Lucent.

OTHER INCOME-NET, INTEREST EXPENSE AND PROVISION FOR INCOME TAXES

<TABLE>
<CAPTION>
                                1999        1998        1997
                               ------      ------      ------
                                   (Dollars in Millions)
<S>                            <C>         <C>         <C>
Other income-net               $  443      $  128      $   97
Interest expense               $  406      $  254      $  238
Provision for income taxes     $1,985      $1,477      $1,009
Effective income tax rate        36.5%       58.8%       69.2%
Adjusted income tax rate *       33.9%       35.3%       36.8%
</TABLE>

* excludes non-tax deductible purchased in-process research and development
expenses and merger-related costs

Other income - net in 1999 increased $315 million compared with 1998. This
increase was primarily due to the $274 million gain on the sale of an equity
investment in Juniper Networks and lower net equity losses in 1999, partially
offset by the $149 million gain on the sale of the Company's ATS business in
1998. For 1998, the increase was $31 million compared with 1997. This increase
was primarily due to gains recorded on the sale of certain business operations,
including the gain on ATS. The 1998 gain was partially offset by higher net
losses associated with Lucent's equity investments, primarily from the PCC
investment. Also included in Other income - net for 1998 is a charge of $110
million related to a write-down associated with Lucent's investment in the PCC
venture. This charge was offset by one-time gains of $103 million primarily
related to the sale of an investment and the sale of certain business operations
including Bell Labs Design Automation Group.

Interest expense for 1999 increased $152 million compared with 1998 and $16
million for 1998 compared with 1997. The increases in interest expense are due
to higher debt levels in each comparable period.

The effective income tax rates for 1998 and 1997 exceed the U.S. federal
statutory income tax rates primarily due to the write-offs of purchased
in-process research and development costs and merger-related expenses that are
not deductible for tax purposes. Excluding the impact of non-tax deductible
purchased in-process research and development expenses and certain
merger-related costs, the effective income tax rate decreased 1.4 percentage
points in 1999 compared with 1998. This decrease was primarily due to a reduced
state effective tax rate and the tax impact of foreign activity. Excluding the
impact of the purchased in-process research and development expenses associated
with acquisitions, the effective income tax rate decreased 1.5 percentage points
in 1998 compared with 1997. This decrease was primarily due to a reduced state
effective tax rate and increased research tax credits.

The 1998 and 1997 effective income tax rates do not include a federal income tax
provision for Kenan since Kenan was an S-Corporation during those years.


<PAGE>   9

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

CASH FLOWS

<TABLE>
<CAPTION>
                                    1999         1998         1997
                                  -------      -------      -------
                                        (Dollars in Millions)
<S>                               <C>          <C>          <C>
Net cash (used in) provided by:
  Operating activities            $ ( 276)     $ 1,860      $ 2,129
  Investing activities            $(1,787)     $(3,100)     $(3,371)
  Financing activities            $ 2,685      $   849      $   297
</TABLE>


Cash from operating activities decreased $2,136 million in 1999 compared with
1998. This decrease was primarily due to increases in receivables and
inventories as well as a decrease in payroll and benefit-related liabilities.
Cash payments of $77 million were charged against the 1995 business
restructuring reserves in 1999, compared with $176 million in 1998. As of
September 30, 1999, $18 million of reserves remained, and substantially all of
the 23,000 positions that Lucent announced it would eliminate in connection with
the 1995 restructuring charges have been eliminated.

Cash provided by operating activities decreased $269 million in 1998 compared
with 1997. This decrease in cash was largely due to the increase in receivables,
partially offset by the increase in payroll and benefit-related liabilities.
Cash payments of $176 million were charged against the December 1995 business
restructuring reserves in 1998 compared with $483 million in 1997.

The restructuring reserves were established in December 1995 after AT&T decided
to spinoff Lucent, but before the formal transfer of assets and personnel. The
restructuring plans included the exit of certain businesses as well as
consolidating and re-engineering numerous corporate and business unit
operations. The reserves were in support of Lucent's intention to focus on the
technologies and markets it viewed as critical to its long-term success as a
stand-alone entity.

Many of the 1995 restructuring projects were significant and complex
initiatives, some of which could not be completed until new enterprisewide
information technology systems, centralized back office support hubs and
provisioning centers were in place. At the time the restructuring plans were
adopted, the estimated time lines and project plans indicated that substantially
all projects would be complete within two years. Some of the restructuring
projects have taken longer than anticipated to complete due to their complicated
nature and size, and the complicated nature and size of other projects that
needed to be completed first. All projects have been substantially completed as
of September 30, 1999.

Cash used in investing activities decreased $1,313 million in 1999 compared with
1998, primarily due to increased sales of investment securities and a reduction
in cash used for acquisitions, partially offset by increased capital
expenditures.

Cash used in investing activities decreased $271 million in 1998 compared with
1997, primarily due to a decrease in cash used for acquisitions as well as an
increase in proceeds from sales of investment securities, partially offset by an
increase in cash used to purchase investment securities. In 1998, cash was used
in the acquisitions of Yurie, Optimay, SDX, LANNET and JNA. The acquisitions of
Livingston, Stratus and Prominet in 1998 were completed through the issuance of
stock and options and did not require the use of cash. The use of cash in 1998
was partially offset by proceeds from the sale of ATS and $269 million of cash
acquired as part of the acquisition of Stratus. In 1997, Lucent acquired Octel,
InterCon, Sahara and Agile and disposed of its interconnect products and CMS
businesses. The 1997 acquisition of Sahara was completed through the issuance of
stock and options and did not require the use of cash.

Capital expenditures were $2,215 million, $1,791 million and $1,744 million for
1999, 1998, and 1997, respectively. Capital expenditures relate to expenditures
for equipment and facilities used in manufacturing and research and development,
including expansion of manufacturing capacity, and expenditures for cost
reduction efforts and non-U.S. growth.

Cash provided by financing activities increased $1,836 million in 1999 compared
with 1998. This increase was primarily due to increased issuances of long-term
debt. Cash provided by financing activities increased $552 million in 1998
compared with 1997. The increase was due to increased issuances of long-term
debt and common stock when compared with the prior year.


<PAGE>   10


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

FINANCIAL CONDITION

<TABLE>
<CAPTION>
                                               1999         1998
                                             -------      -------
                                             (Dollars in Millions)
<S>                                          <C>          <C>
Total assets                                 $38,775      $29,363
Total liabilities                            $25,191      $21,654
Working capital                              $10,153      $ 4,899
Debt to total capital (debt plus equity)        34.1%        37.6%
Inventory turnover ratio                         4.5x         5.6x
Average days outstanding - receivables          85 days      71 days
</TABLE>

Total assets as of September 30, 1999, increased $9,412 million, or 32.1%, from
September 30, 1998. This increase was largely due to increases in cash and cash
equivalents, receivables, prepaid pension costs, inventories and other current
assets of $662 million, $3,033 million, $2,421 million, $1,769 million and
$1,031 respectively. Cash increased primarily due to the securitization of
certain customer receivables. The increase in receivables reflects higher sales
volume and a higher percentage of sales from outside the United States. Prepaid
pension costs increased due to the change in accounting for pensions. The
increase in inventories resulted from the need to meet current and anticipated
sales commitments to customers. The increase in other current assets is largely
due to increases in notes receivable and prepaid expenses.

Total liabilities increased $3,537 million, or 16.3%, from September 30, 1998.
This increase was due primarily to higher short- and long-term debt levels,
including debt recorded in connection with the sale of certain customer
receivables with recourse.

Working capital, defined as current assets less current liabilities, increased
$5,254 million from September 30, 1998, primarily resulting from the increase in
receivables and inventories, partially offset by higher short-term debt and
accounts payable.

Debt to total capital decreased 350 basis points due to the increase in
shareowners' equity, partially offset by the increase in total debt.

For the year ended September 30, 1999, Lucent's inventory turnover ratio
decreased 1.1 times compared with the year ended September 30, 1998. The
decrease includes the build-up of inventory to meet current and anticipated
sales to customers. Inventory turnover ratio is calculated by dividing cost of
sales for the three months ended September 30 by the fourth quarter average
ending inventory balance, using a two-point average.

Average days outstanding - receivables were up 14 days in 1999 compared with
1998 reflecting the growth in Lucent's sales outside the United States, which
typically carry longer payment terms. Average days outstanding is calculated by
dividing the fourth quarter average ending receivables balance, using a
two-point average, by total revenues for the three months ended September 30.

The fair value of Lucent's pension plan assets is greater than the projected
pension obligations. Lucent records pension income when the expected return on
plan assets plus amortization of the transition asset is greater than the
interest cost on the projected benefit obligation plus service cost for the
year. Consequently, Lucent continued to have a net pension credit that added to
prepaid pension costs in 1999 and which is expected to continue in the near
term.

LIQUIDITY AND CAPITAL RESOURCES

Lucent expects that, from time to time, outstanding commercial paper balances
may be replaced with short- or long-term borrowings as market conditions permit.
At September 30, 1999, Lucent maintained approximately $4.7 billion in credit
facilities, of which a portion is used to support Lucent's commercial paper
program. At September 30, 1999, approximately $4.4 billion was unused.

Future financings will be arranged to meet Lucent's requirements with the
timing, amount and form of issue depending on the prevailing market and general
economic conditions. Lucent anticipates that borrowings under its bank credit
facilities, the issuance of additional commercial paper, cash generated from
operations, short- and long-term debt financings and receivable securitizations
will be adequate to satisfy its future cash requirements, although there can be
no assurance that this will be the case.


<PAGE>   11

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

Network operators worldwide are requiring their suppliers to arrange or provide
long-term financing for them as a condition of obtaining or bidding on
infrastructure projects. These projects may require financing in amounts ranging
from modest sums to more than a billion dollars. Lucent has increasingly
provided or arranged long-term financing for customers. As market conditions
permit, Lucent's intention is to lay off these long-term financing arrangements,
which may include both commitments and drawn-down borrowings, to financial
institutions and other investors. This enables Lucent to reduce the amount of
its commitments and free up additional financing capacity.

As of September 30, 1999, Lucent had made commitments or entered into agreements
to extend credit to certain network operators, including personal communications
service and wireless operators, for an aggregate of approximately $7.1 billion.
As of September 30, 1999, approximately $1.6 billion had been advanced and was
outstanding under these agreements.

In September 1999, a subsidiary of Lucent sold approximately $625 million of
accounts receivable to a non-consolidated qualified special purpose entity
("QSPE") which, in turn, sold an undivided ownership interest in these
receivables to entities managed by an unaffiliated financial institution.
Additionally, Lucent transferred a designated pool of qualified accounts
receivable of approximately $700 million to the QSPE as collateral for the
initial sale. Lucent's retained interest in the QSPE's designated pool of
qualified accounts receivable has been included in Receivables. Lucent will
continue to service, administer and collect the receivables on behalf of the
purchaser. The impact of the above transaction reduced Receivables and increased
cash flows from operating activities in the Consolidated Statements of Cash
Flows by $600 million.

As part of the revenue recognition process, Lucent assesses the collectibility
of its receivables relating to contracts with customers for which Lucent
provides financing.

In addition to the above arrangements, Lucent will continue to provide or commit
to financing where appropriate for its business. The ability of Lucent to
arrange or provide financing for its customers will depend on a number of
factors, including Lucent's capital structure and level of available credit, and
its continued ability to lay off commitments and drawn-down borrowings on
acceptable terms. Lucent believes that it will be able to access the capital
markets on terms and in amounts that will be satisfactory to Lucent and that it
will be able to obtain bid and performance bonds, to arrange or provide customer
financing as necessary, and to engage in hedging transactions on commercially
acceptable terms, although there can be no assurance that this will be the case.

IN-PROCESS RESEARCH AND DEVELOPMENT

In connection with the acquisitions of Octel, Livingston and Yurie, Lucent
allocated a significant portion of the purchase price to purchased in-process
research and development. In addition, in connection with the purchase of
Stratus, Lucent allocated $267 million to purchased in-process research and
development. As part of the process of analyzing each of these acquisitions,
Lucent made a decision to buy technology that had not yet been commercialized
rather than develop the technology internally. Lucent based this decision on
factors such as the amount of time it would take to bring the technology to
market. Lucent also considered Bell Labs' resource allocation and its progress
on comparable technology, if any. Lucent management expects to use the same
decision process in the future.

Lucent estimated the fair value of in-process research and development for each
of the above acquisitions using an income approach. This involved estimating the
fair value of the in-process research and development using the present value of
the estimated after-tax cash flows expected to be generated by the purchased
in-process research and development, using risk-adjusted discount rates and
revenue forecasts as appropriate. The selection of the discount rate was based
on consideration of Lucent's weighted average cost of capital, as well as other
factors, including the useful life of each technology, profitability levels of
each technology, the uncertainty of technology advances that were known at the
time, and the stage of completion of each technology. Lucent believes that the
estimated in-process research and development amounts so determined represent
fair value and do not exceed the amount a third party would pay for the
projects.


<PAGE>   12

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

Where appropriate, Lucent deducted an amount reflecting the contribution of the
core technology from the anticipated cash flows from an in-process research and
development project. At the date of acquisition, the in-process research and
development projects had not yet reached technological feasibility and had no
alternative future uses. Accordingly, the value allocated to these projects was
capitalized and immediately expensed at acquisition. If the projects are not
successful or completed in a timely manner, management's product pricing and
growth rates may not be achieved and Lucent may not realize the financial
benefits expected from the projects.

Set forth below are descriptions of certain acquired in-process research and
development projects, including their status at the end of fiscal 1999.

Octel

On September 29, 1997, Lucent completed the purchase of Octel for $1,819
million. Octel was a public company involved in the development of voice, fax
and electronic messaging technologies. The allocation of $945 million to
in-process research and development represented its estimated fair value using
the methodology described above. The $945 million was allocated to the following
projects: Unified Messenger ($245 million), Phoenix/Intelligent Messaging
Architecture ("IMA") ($540 million), Octel Network Services ("ONS") Projects
($111 million) and three other projects ($49 million in total).

Unified Messenger - Revenues attributable to Unified Messenger were estimated to
be $5 million in 1998 and $46 million in 1999. Revenue was expected to peak in
2004 and decline thereafter through the end of the product's life (2008) as new
product technologies were expected to be introduced by Lucent. Revenue growth
was expected to decrease from 179% in 2000 to 20% in 2004, and be negative for
the remainder of the projection period. At the acquisition date, costs to
complete the research and development efforts related to the initial release of
the project were expected to be $3 million.

Phoenix/IMA - Revenues attributable to Phoenix/IMA were estimated to be $94
million in 1998 and $508 million in 1999. Revenue was expected to peak in 2004
and decline thereafter through the end of the product's life (2010) as new
product technologies were expected to be introduced by Lucent. Revenue growth
was expected to decrease from 59% in 2000 to 10% in 2004, and be negative for
the remainder of the projection period. At the acquisition date, costs to
complete the research and development efforts related to the Phoenix/IMA project
were expected to be $49 million.

ONS Projects - Revenues attributable to the ONS Projects were estimated to be
$18 million in 1998 and $93 million in 1999. Revenue was expected to peak in
2003 and decline thereafter through the end of the product's life (2006) as new
product technologies were expected to be introduced by Lucent. Revenue growth
was expected to decrease from 52% in 2000 to 10% in 2003, and be negative for
the remainder of the projection period. At the acquisition date, costs to
complete the research and development efforts related to the ONS projects were
expected to be less than $1 million.

An average risk-adjusted discount rate of 20% was utilized to discount projected
cash flows.

There have not been any significant departures from the planned efforts for
Unified Messenger. The Phoenix and ONS efforts have been completed. The IMA
research and development effort has been delayed twice as a result of the
inclusion of new capability specifications, first, in January 1998 to include
unified messaging capabilities and, second, in September 1998 to include
significant new hardware platform capabilities and incorporate Internet software
capabilities. This enhanced version reached technological feasibility, a beta
stage, in August 1999, and is scheduled for shipment in December 1999. Since
intermediate milestones for IMA have been met on schedule and Phoenix will
continue to earn revenues through completion of IMA development, the completion
and exploitation of this project and current market conditions make it
reasonable that estimated revenue and cash flow levels will be achieved,
although on a delayed basis. The IMA version enhancements and the rescheduled
market introduction are not expected to impact the originally forecasted market
penetration rates.


<PAGE>   13

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

Livingston

On December 15, 1997, Lucent completed the purchase of Livingston for $610
million. Livingston was involved in the development of equipment used by
Internet service providers to connect subscribers to the Internet. The
allocation to in-process research and development of $427 million represented
its estimated fair value using the methodology described above. Approximately
$421 million was allocated to the PortMaster4, a remote access concentrator
targeted at large independent telecommunication companies, cable television
companies, and Internet service providers, and the remaining $6 million was
allocated to another project.

Revenues attributable to the PortMaster4 were estimated to be $48 million in
1998 and $261 million in 1999. Revenue was expected to peak in 2002 and decline
thereafter through the end of the product's life (2007) as new product
technologies were expected to be introduced by Lucent. Revenue growth was
expected to decrease from 69% in 2000 to 11% in 2002, and be negative for the
remainder of the projection period. At the acquisition date, costs to complete
the research and development efforts related to the PortMaster4 were expected to
be $5 million.

A risk adjusted discount rate of 20% was utilized to discount projected cash
flows.

Livingston's Portmaster4 was commercially released in July 1998 and started
generating revenues immediately after commercial launch. As a result of the
merger between Lucent and Ascend, the decision was made to discontinue future
development and sales of the PortMaster4 platform in order to maximize research
and development efficiency by concentrating on the MAX TNT platform. Instead of
having two platforms to address the full spectrum of access switching products,
Lucent will be able to have one platform that can address a broad spectrum of
applications while minimizing duplicative research and development.

Yurie

On May 29, 1998, Lucent completed the purchase of Yurie for $1,056 million.
Yurie was involved in the development of ATM access solutions. The allocation to
in-process research and development of $620 million represented its estimated
fair value using the methodology described above. The $620 million was allocated
to the following projects: (i) LDR 50/200/250 ($609 million) and (ii) LDR 4 ($11
million).

Revenues attributable to the LDR 50/200/250 were estimated to be $132 million in
1999. Revenue was expected to peak in 2000 and decline thereafter through the
end of the product's life (2009) as new product technologies were expected to be
introduced by Lucent. Revenue growth was expected to decrease from 84% in 2000
to 9% in 2007, and be negative for the remainder of the projection period. Costs
to complete the research and development efforts related to the LDR 50/200/250
were expected to be $29 million at the acquisition date.

A risk-adjusted discount rate of 20% was utilized to discount projected cash
flows.

The LDR 50, LDR 200 and LDR 250 were all completed on time or have met all of
their scheduled milestones. Some of the product releases have been renamed.

Stratus

On October 20, 1998, Ascend completed the purchase of Stratus for $917 million.
Stratus was a manufacturer of fault-tolerant computer systems. The allocation to
in-process research and development of $267 million represented its estimated
fair value using the methodology described above. The primary projects that made
up the in-process research and development were as follows: HP-UX, Continuum
1248, Continuum 448, M708, SPHINX, HARMONY, LNP, CORE IN, Personal Number
Portability (PN), Signaling System 7 (SS7) Gateway and Internet Gateway.

Revenues attributable to the projects were estimated to be $84 million in 1999
and $345 million in 2000. Revenue was expected to peak in 2002 and decline
thereafter through the end of the product's life (2009) as new product
technologies were expected to be introduced by Lucent. Revenue growth was
expected to decrease from 310% in 2000 to 6% in 2002, and be negative for the
remainder of the projection period. At the acquisition date, costs to complete
the research and development efforts related to the projects were expected to be
$48 million.

A risk-adjusted discount rate of 35% was utilized to discount projected cash
flows.

<PAGE>   14

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

The actual results to date have been consistent, in all material respects, with
our assumptions at the time of the acquisition, except as noted below. During
fiscal 1999 the product development relating to the HARMONY, SPHINX, and
Continuum 448 projects were discontinued due to management's reprioritization of
product direction. In addition, it was decided that the development relating to
the Continuum 1248 will cease by the quarter ending December 31, 1999.
Consequently, Lucent will not realize the forecasted revenues from these
projects.

RISK MANAGEMENT

Lucent is exposed to market risk from changes in foreign currency exchange rates
and interest rates that could impact its results of operations and financial
condition. Lucent manages its exposure to these market risks through its regular
operating and financing activities and, when deemed appropriate, through the use
of derivative financial instruments. Lucent uses derivative financial
instruments as risk management tools and not for speculative or trading
purposes. In addition, derivative financial instruments are entered into with a
diversified group of major financial institutions in order to manage Lucent's
exposure to nonperformance on such instruments.

Lucent uses foreign currency exchange contracts, and to a lesser extent foreign
currency options, to reduce significant exposure to the risk that the eventual
net cash inflows and outflows resulting from the sale of products to non-U.S.
customers and purchases from non-U.S. suppliers will be adversely affected by
changes in exchange rates. Foreign currency exchange contracts are designated
for recorded, firmly committed or anticipated purchases and sales. The use of
these derivative financial instruments allows Lucent to reduce its overall
exposure to exchange rate movements, since the gains and losses on these
contracts substantially offset losses and gains on the assets, liabilities and
transactions being hedged. As of September 30, 1999, Lucent's primary net
foreign currency market exposures included Canadian dollars and Brazilian reals.
As of September 30, 1998, Lucent's primary net foreign currency market exposures
included German marks and British pounds. In 1999, Lucent revised its hedging
policy regarding anticipated purchase and sales transaction exposures. Prior to
the revision, the Company hedged 100% of all recorded, firmly committed and
anticipated transactions with amounts over $1 million. Beginning on August 31,
1999, Lucent's policy is to hedge 50% of the first six months of a 12-month
anticipated exposure forecast, with the hedging of the remainder of the forecast
to be evaluated on an ongoing basis. This applies to all transactions with value
equal to the lesser of $5 million or 10% of the relevant subsidiary's 12-month
trailing net revenues. These revisions provide greater risk management
flexibility in cases where hedging costs may be excessive relative to the actual
risk and when there is greater cash flow uncertainty. Management does not expect
that this revised policy will have any material impact on the results of
operations or financial condition of the Company. In addition, management does
not foresee or expect any significant changes in foreign currency exposure in
the near future.

The fair value of foreign currency exchange contracts is sensitive to changes in
foreign currency exchange rates. As of September 30, 1999 and 1998, a 10%
appreciation in foreign currency exchange rates from the prevailing market rates
would increase the related net unrealized gain by approximately $41 million and
$11 million, respectively. Conversely, a 10% depreciation in these currencies
from the prevailing market rates would decrease the related net unrealized gain
by approximately $55 million and $18 million, as of September 30, 1999 and 1998,
respectively. Consistent with the nature of the economic hedge of such foreign
currency exchange contracts, such unrealized gains or losses would be offset by
corresponding decreases or increases, respectively, of the underlying instrument
or transaction being hedged.

While Lucent hedges certain foreign currency transactions, the decline in value
of non-U.S. dollar currencies, may, if not reversed, adversely affect Lucent's
ability to contract for product sales in U.S. dollars because Lucent's products
may become more expensive to purchase in U.S. dollars for local customers doing
business in the countries of the affected currencies.


<PAGE>   15

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

The fair value of Lucent's fixed rate long-term debt is sensitive to changes in
interest rates. Interest rate changes would result in gains/losses in the market
value of this debt due to differences between the market interest rates and
rates at the inception of the debt obligation. Based on a hypothetical immediate
150 basis point increase in interest rates at September 30, 1999 and 1998, the
market value of Lucent's fixed rate long-term debt would be impacted by a net
decrease of approximately $360 million and $209 million, respectively.
Conversely, a 150 basis point decrease in interest rates would result in a net
increase in the market value of Lucent's fixed rate long-term debt outstanding
at September 30, 1999 and 1998 of approximately $456 million and $247 million,
respectively.

FORWARD-LOOKING STATEMENTS

This Management's Discussion and Analysis of Results of Operations and Financial
Condition and other sections of this report contain forward-looking statements
that are based on current expectations, estimates, forecasts and projections
about the industries in which Lucent operates, management's beliefs and
assumptions made by management. In addition, other written or oral statements
that constitute forward-looking statements may be made by or on behalf of the
Company. Words such as "expects," "anticipates," "intends," "plans," "believes,"
"seeks," "estimates," variations of such words and similar expressions are
intended to identify such forward-looking statements. These statements are not
guarantees of future performance and involve certain risks, uncertainties and
assumptions ("Future Factors") that are difficult to predict. Therefore, actual
outcomes and results may differ materially from what is expressed or forecasted
in such forward-looking statements. The Company undertakes no obligation to
update publicly any forward-looking statements, whether as a result of new
information, future events or otherwise.

Future Factors include increasing price and products and services competition by
non-U.S. and U.S. competitors, including new entrants; rapid technological
developments and changes and the Company's ability to continue to introduce
competitive new products and services on a timely, cost-effective basis; the mix
of products and services; the achievement of lower costs and expenses; customer
demand for the Company's products and services; the ability to successfully
integrate the operations and business of acquired companies; readiness for Year
2000; the impact of Year 2000 on customer spending habits; U.S. and non-U.S.
governmental and public policy changes that may affect the level of new
investments and purchases made by customers; changes in environmental and other
U.S. and non-U.S. governmental regulations; protection and validity of patent
and other intellectual property rights; reliance on large customers;
technological, implementation and cost/financial risks in the increasing use of
large, multiyear contracts; the cyclical nature of the Company's business; the
outcome of pending and future litigation and governmental proceedings and
continued availability of financing, financial instruments and financial
resources in the amounts, at the times and on the terms required to support the
Company's future business. These are representative of the Future Factors that
could affect the outcome of the forward-looking statements. In addition, such
statements could be affected by general industry and market conditions and
growth rates, general U.S. and non-U.S. economic conditions, including interest
rate and currency exchange rate fluctuations and other Future Factors.

Competition

See discussion above under KEY BUSINESS CHALLENGES.

Dependence on New Product Development
The markets for the Company's principal products are characterized by rapidly
changing technology, evolving industry standards, frequent new product
introductions and evolving methods of building and operating communications
systems for network operators and business customers. The Company's operating
results will depend to a significant extent on its ability to continue to
introduce new systems, products, software and services successfully on a timely
basis and to reduce costs of existing systems, products, software and services.
The success of these and other new offerings is dependent on several factors,
including proper identification of customer needs, cost, timely completion and
introduction, differentiation from offerings of the Company's competitors and
market acceptance. In addition, new technological innovations generally require
a substantial investment before any assurance is available as to their
commercial viability, including, in some cases, certification by non-U.S. and
U.S. standard-setting bodies.

Reliance on Major Customers
See discussion above under KEY BUSINESS CHALLENGES.

<PAGE>   16

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

Readiness for Year 2000
Lucent is in the final phase of a major effort to minimize the impact of the
Year 2000 date change on Lucent's products, information technology systems,
facilities and production infrastructure.

The Year 2000 challenge is a priority within Lucent at every level of the
Company. Primary Year 2000 preparedness responsibility rests with program
offices which have been established within each of Lucent's product groups and
corporate centers. A corporatewide Lucent Year 2000 Program Office ("LYPO")
monitors and reports on the progress of these offices. Each program office has a
core of full-time individuals augmented by a much larger group who have been
assigned specific Year 2000 responsibilities in addition to their regular
assignments. Further, Lucent has engaged third parties to assist in its
readiness efforts in certain cases. LYPO has established a methodology to
measure, track and report Year 2000 readiness status consisting of five steps:
inventory; assessment; remediation; testing; and deployment. In addition, LYPO
tracks and reports on the development and deployment of Year 2000 contingency
plans.

Lucent has completed programs to make its commercially available products Year
2000 ready and has developed evolution strategies for customers who own non-Year
2000 ready Lucent products. All of the upgrades and products needed to support
customer migration are generally available.

Lucent is completing its extensive efforts to alert customers who have non-Year
2000 ready products, including direct mailings, phone contacts and participation
in user and industry groups. Lucent also has a Year 2000 Web site
www.lucent.com/y2k, which provides Year 2000 product information. Lucent
continues to cooperate in the Year 2000 information sharing efforts of the
Federal Communications Commission and other governmental bodies.

Lucent believes it has sufficient resources to provide timely support to its
customers who require product migrations or upgrades. However, because this
effort is heavily dependent on customer cooperation, Lucent monitors customer
response and takes steps to encourage customer responsiveness, as necessary.

With very few exceptions, Lucent has completed the five steps of its Year 2000
readiness program with respect to its factories, information systems and
facilities. LYPO has developed a formal "exceptions" tracking process to approve
and track a small number of cases in which factors such as third-party
dependencies prevented project completion by Lucent's internal readiness target
date of June 30, 1999. Virtually all of the exceptions identified have since
been closed. In addition, Lucent has implemented various change management
mechanisms to allow the Company to maintain Year 2000 readiness even as systems
are modified or replaced to address non-Year 2000 business needs.

To ensure the continued delivery of third-party products and services, Lucent's
procurement organization has analyzed Lucent's supplier base and has sent
surveys to approximately 5,000 suppliers. To supplement this effort, Lucent has
conducted more detailed readiness reviews of the Year 2000 status of the
suppliers ranked as most critical based on the nature of their relationship with
Lucent, the product/service provided and/or the content of their survey
responses. Over 90% of Lucent's critical suppliers have reported completion of
their Year 2000 readiness efforts. However, Lucent continues to monitor the Year
2000 status of all of its critical suppliers to minimize its Year 2000 supply
chain risk and is developing appropriate contingency responses as the risks
become clearer.

Lucent has committed considerable resources to Year 2000 contingency planning
throughout the enterprise. These plans focus on risks posed by the Year 2000
date change, as well as other sensitive dates such as February 29, 2000.
Lucent's plans are designed to mitigate the impact of Year 2000 failures, as
well as providing emergency response mechanisms and supporting the prompt
resumption of regular operations. Lucent is currently in the process of
completing the preparations necessary to support the implementation of its
contingency plans. In addition, the plans are updated as new information is
obtained, the risks posed by external dependencies become clearer and customer
support needs become more focused.

A network of corporate center and business group communications centers, staffed
on a continuous basis during the period before and after the Year 2000 date
transition, will support Lucent's contingency planning efforts. These
communications centers will facilitate the handling of Year 2000 issues that may
arise. An initial test of the Lucent communications center network was conducted
in connection with the September 9, 1999, date change. The September 9, 1999,
date change passed with no reported impacts on Lucent's business.

<PAGE>   17

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

The risk to Lucent resulting from the failure of third parties in the public and
private sectors to attain Year 2000 readiness is the same as other firms in
Lucent's industry and other business enterprises generally. The following are
representative of the types of risks that could result in the event of one or
more major failures of Lucent's information systems, factories or facilities to
be Year 2000 ready, or similar major failures by one or more major third-party
suppliers to Lucent: (1) information systems--could include interruptions or
disruptions of business and transaction processing such as customer billing,
payroll, accounts payable and other operating and information processes, until
systems can be remedied or replaced; (2) factories and facilities--could include
interruptions or disruptions of manufacturing processes and facilities with
delays in delivery of products, until non-compliant conditions or components can
be remedied or replaced; and (3) major suppliers to Lucent--could include
interruptions or disruptions of the supply of raw materials, supplies and Year
2000 ready components, that could cause interruptions or disruptions of
manufacturing and delays in delivery of products, until the third-party supplier
remedied the problem or contingency measures were implemented. Risks of major
failures of Lucent's principal products could include adverse functional impacts
experienced by customers, the costs and resources for Lucent to remedy problems
or replace products where Lucent is obligated or undertakes to take such action,
and delays in delivery of new products.

Lucent believes it is taking the necessary steps to resolve Year 2000 issues;
however, given the possible consequences of failure to resolve significant Year
2000 issues, there can be no assurance that any one or more such failures would
not have a material adverse effect on Lucent. Lucent estimates that the costs of
efforts to prepare for Year 2000 from calendar year 1997 through 2000 is about
$560 million, of which an estimated $515 million has been spent as of September
30, 1999. Lucent has been able to reprioritize work projects to largely address
Year 2000 readiness needs within its existing organizations. As a result, most
of these costs represent costs that would have been incurred in any event. These
amounts cover costs of the Year 2000 readiness work for inventory, assessment,
remediation, testing, deployment and contingency planning, including fees and
charges of contractors for outsourced work and consultant fees. Costs for
previously contemplated updates and replacements of Lucent's internal systems
and information systems infrastructure have been excluded without attempting to
establish whether the timing of non-Year 2000 replacement or upgrading was
accelerated.

While the Year 2000 cost estimates above include additional costs, Lucent
believes, based on available information, that it will be able to manage its
total Year 2000 transition without any material adverse effect on its business
operations, products or financial prospects.

The actual outcomes and results could be affected by Future Factors including,
but not limited to, the continued availability of skilled personnel, cost
control, the ability to locate and remediate software code problems, critical
suppliers and subcontractors meeting their commitments to be Year 2000 ready and
provide Year 2000 ready products, and timely actions by customers.

European Monetary Union - Euro
On January 1, 1999, 11 member countries of the European Union established fixed
conversion rates between their existing sovereign currencies, and adopted the
Euro as their new common legal currency. The Euro is currently trading on
currency exchanges and the legacy currencies will remain legal tender in the
participating countries for a transition period between January 1, 1999, and
January 1, 2002. During the transition period, cash-less payments can be made in
the Euro, and parties can elect to pay for goods and services and transact
business using either the Euro or a legacy currency. Between January 1, 2002,
and July 1, 2002, the participating countries will introduce Euro notes and
coins and withdraw all legacy currencies so that they will no longer be
available.

Lucent has in place a joint European-United States team representing affected
functions within the Company. This team is evaluating Euro related issues
affecting the Company that include its pricing/marketing strategy, conversion of
information technology systems, existing contracts and currency risk and risk
management in the participating countries. The Euro conversion may affect
cross-border competition by creating cross-border price transparency.

Lucent will continue to evaluate issues involving introduction of the Euro as
further accounting, tax and governmental legal and regulatory guidance is
available. Based on current information and Lucent's current assessment, Lucent
does not expect that the Euro conversion will have a material adverse effect on
its business or financial condition.

<PAGE>   18

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

Employee Relations
On September 30, 1999, Lucent employed approximately 153,000 persons, including
76.5% located in the United States. Of these domestic employees, approximately
40% are represented by unions, primarily the Communications Workers of America
("CWA") and the International Brotherhood of Electrical Workers ("IBEW"). Lucent
entered into new five-year agreements with the CWA and IBEW expiring May 31,
2003.

Multiyear Contracts
Lucent has significant contracts for the sale of infrastructure systems to
network operators that extend over multiyear periods, and expects to enter into
similar contracts in the future, with uncertainties affecting recognition of
revenues, stringent acceptance criteria, implementation of new technologies and
possible significant initial cost overruns and losses. See also discussion above
under LIQUIDITY AND CAPITAL RESOURCES and KEY BUSINESS CHALLENGES.

Seasonality
See discussion above under KEY BUSINESS CHALLENGES.

Future Capital Requirements
See discussion above under LIQUIDITY AND CAPITAL RESOURCES.

Non-U.S. Growth, Foreign Exchange and Interest Rates
Lucent intends to continue to pursue growth opportunities in non-U.S. markets.
In many non-U.S. markets, long-standing relationships between potential
customers of Lucent and their local providers, and protective regulations,
including local content requirements and type approvals, create barriers to
entry. In addition, pursuit of such non-U.S. growth opportunities may require
significant investments for an extended period before returns on such
investments, if any, are realized. Such projects and investments could be
adversely affected by reversals or delays in the opening of non-U.S. markets to
new competitors, exchange controls, currency fluctuations, investment policies,
repatriation of cash, nationalization, social and political risks, taxation, and
other factors, depending on the country in which such opportunity arises.
Difficulties in non-U.S. financial markets and economies, and of non-U.S.
financial institutions, could adversely affect demand from customers in the
affected countries.

See discussion above under RISK MANAGEMENT with respect to foreign exchange and
interest rates. A significant change in the value of the U.S. dollar against the
currency of one or more countries where Lucent sells products to local customers
or makes purchases from local suppliers may materially adversely affect Lucent's
results. Lucent attempts to mitigate any such effects through the use of foreign
currency contracts, although there can be no assurances that such attempts will
be successful.

Legal Proceedings and Environmental Matters
See discussion in Note 14 to the Consolidated Financial Statements.


<PAGE>   19

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

            Five-Year Summary of Selected Financial Data (Unaudited)

                    Lucent Technologies Inc. and Subsidiaries
                 (Dollars in millions, except per share amounts)

<TABLE>
<CAPTION>
                                                                                                                     Year Ended
                                                       Year Ended                               Nine Months           December
                                                      September 30,                                Ended                 31,
                                                     (Twelve Months)                           September 30,          (Twelve
                                                                                                                       Months)
                                      ----------------------------------------------       ---------------------     ---------
                                         1999        1998         1997          1996          1996        1995          1995
<S>                                   <C>          <C>          <C>          <C>           <C>          <C>          <C>
RESULTS OF OPERATIONS                                                                          (1)
Revenues                              $ 38,303     $ 31,806     $ 27,611     $ 24,215      $ 16,639     $ 14,247     $ 21,718
Gross margin                            18,615       15,091       12,293        9,506         7,085        6,315        8,669
Depreciation and
 amortization expense                    1,806        1,411        1,499        1,350           957        1,112        1,504
Operating income(loss)                   5,406        2,638        1,599         (656)          734          503         (921)

Income(loss) before
  cumulative effect of
  accounting change                      3,458        1,035          449         (604)          382          197         (813)
Cumulative effect of
  accounting change                      1,308            -            -            -             -            -            -
Net income(loss)                         4,766        1,035          449         (604)          382          197         (813)

Earnings(loss) per common
   share - basic (2)(3):
    Income(loss) before
     cumulative effect of
     accounting change                    1.14         0.35         0.16        (0.23)         0.14         0.08        (0.34)
    Cumulative effect of
     accounting change                    0.43            -            -            -             -            -            -
    Net income(loss)                      1.57         0.35         0.16        (0.23)         0.14         0.08        (0.34)
Earnings(loss) per common
   share - diluted (2)(3):
    Income(loss) before
     cumulative effect of
     accounting change                    1.10         0.34         0.15        (0.23)         0.14         0.08        (0.34)
    Cumulative effect of
     accounting change                    0.42         -               -            -             -            -            -
    Net income(loss)                      1.52         0.34         0.15        (0.23)         0.14         0.08        (0.34)

Earnings(loss) per common
   share - pro forma(3)(4)                 n/a          n/a          n/a        (0.21)         0.13         0.07        (0.28)

Dividends per common share(3)             0.08       0.0775       0.0563       0.0375        0.0375            -            -

FINANCIAL POSITION
Total assets                          $ 38,775     $ 29,363     $ 25,006     $ 23,572      $ 23,572     $ 18,714       20,217
Working capital                         10,153        4,899(5)     2,529        2,728         2,728          523          (50)
Total debt                               7,026        4,640        4,203        3,997         3,997        4,196        4,018
Shareowners' equity                     13,584        7,709        4,379        3,462         3,462        3,198        1,917

OTHER INFORMATION
Selling, general and administrative
 expenses as a
 percentage of revenues                   22.0%        21.6%        22.7%        31.0%         26.6%        28.8%        33.0%
Research and development expenses
 as a percentage
 of revenues                              11.8         12.3         11.5         10.9          11.5         12.0         11.2
Gross margin percentage                   48.6         47.4         44.5         39.3          42.6         44.3         39.9

  Ratio of total debt
  to total capital
  (debt plus equity)                      34.1         37.6         49.0         53.6          53.6         56.7         67.7

Capital expenditures                  $  2,215     $  1,791     $  1,744     $  1,507      $  1,002     $    803     $  1,302
</TABLE>

<PAGE>   20

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

(1) Beginning September 30, 1996, Lucent changed its fiscal year-end from
    December 31 to September 30 and reported results for the nine-month
    transition period ended September 30, 1996.

(2) The calculation of earnings per share on a historical basis includes the
    retroactive recognition to January 1, 1995, of the 2,098,499,576 shares
    (524,624,894 shares on a pre-split basis) owned by AT&T on April 10, 1996.

(3) All per share data has been restated to reflect the two-for-one splits of
    Lucent's common stock that became effective on April 1, 1998, and April 1,
    1999.

(4) The calculation of earnings (loss) per share on a pro forma basis assumes
    that all 2,896,214,012 shares outstanding on April 10, 1996, were
    outstanding since January 1, 1995, and gives no effect to the use of
    proceeds from the IPO.

(5) Reflects the reclassification from debt maturing within one year to
    long-term debt as a result of the November 19, 1998, sale of $500 ($495 net
    of unamortized costs) of 10-year notes.

N/a  Not applicable.

               Pro Forma Segment Reporting Information (Unaudited)
                              (Dollars in millions)

The following table presents Lucent's revenues and operating income by
reportable operating segment for the years ended September 30, 1999, 1998, and
1997, and has been prepared giving effect to the mergers of Lucent with Excel
and INS under the pooling-of-interests method of accounting, on a pro forma
basis as if the mergers had occurred before Lucent's fiscal year-end.

<TABLE>
<CAPTION>
                                                                    1999        1998       1997
                                                                  --------    --------   --------
<S>                                                               <C>         <C>        <C>
External Revenues
-----------------
Service Provider Networks                                         $ 23,815    $ 19,274   $ 15,795
Enterprise Networks                                                  8,777       8,090      6,329
Microelectronics and Communications Technologies                     5,424       4,628      4,238
  Total reportable segments                                         38,016      31,992     26,362
Other and corporate                                                    758         116      1,441
Total revenues                                                    $ 38,774    $ 32,108   $ 27,803

Operating Income
----------------
Service Provider Networks                                         $  4,587    $  3,139   $  1,543
Enterprise Networks                                                    651         650        675
Microelectronics and Communications Technologies                       944         608        549
  Total reportable segments (a)                                      6,182       4,397      2,767
Acquisition/integration-related costs                                 (530)     (1,690)    (1,439)
Goodwill and existing technology amortization                         (396)       (149)       (32)
Other and corporate                                                    187         122        336
Operating income                                                     5,443       2,680      1,632
Other income-- net                                                     452         137        100
Interest expense                                                      (407)       (254)      (239)

  Income before income taxes                                      $  5,488    $  2,563   $  1,493
</TABLE>

(a) Segment operating income excludes goodwill and existing technology
    amortization, acquisition/integration-related costs, and one-time gains and
    charges.


<PAGE>   21

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

The following table provides external revenue for groups of similar products and
services, on a pro forma basis as if the Excel and INS mergers had occurred
before Lucent's fiscal year-end for the years ended September 30, 1999, 1998,
and 1997:

<TABLE>
<CAPTION>
                                             1999           1998          1997
                                            -------        -------       -------
<S>                                         <C>            <C>           <C>
Products and Services Revenues
Core Networking Systems (a)                 $17,906        $14,541       $12,621
Wireless Products                             5,516          4,456         2,984
Business Communications Systems (b)           6,977          6,399         5,077
Microelectronics                              2,827          2,405         2,214
NetCare Professional Services                 1,083            656           374
Other (c)                                     4,465          3,651         4,533
    Totals                                  $38,774        $32,108       $27,803
</TABLE>

a) Core Networking Systems includes switching and access products, data
   networking systems for service providers, optical networking products,
   communications software and engineering services.

b) Business Communications Systems includes advanced communications products and
   messaging services.

c) "Other" principally includes network products.


<PAGE>   22

REPORT OF MANAGEMENT

Management is responsible for the preparation of Lucent Technologies Inc.'s
consolidated financial statements and all related information appearing in this
Annual Report. The consolidated financial statements and notes have been
prepared in conformity with generally accepted accounting principles and include
certain amounts 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
directors who are not employees, meets periodically with management, the
internal auditors and the independent accountants to review the manner in which
these groups of individuals are performing their responsibilities and to carry
out the Audit and Finance Committee's oversight role with respect to auditing,
internal controls and financial reporting matters. Periodically, both the
internal auditors and the independent accountants meet privately with the Audit
and Finance Committee and have access to its individual members.

Lucent engaged PricewaterhouseCoopers LLP, independent accountants, to audit the
consolidated financial statements in accordance with generally accepted auditing
standards, which include consideration of the internal control structure. Their
report appears on the following page.


Richard A. McGinn                               Donald K. Peterson
Chairman and                                    Executive Vice President and
Chief Executive Officer                         Chief Financial Officer


<PAGE>   23


REPORT OF INDEPENDENT ACCOUNTANTS

To the Board of Directors and
Shareowners of Lucent Technologies Inc.:

In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of income and changes in shareowners' equity and of cash
flows present fairly, in all material respects, the financial position of Lucent
Technologies Inc. and its subsidiaries at September 30, 1999 and 1998, and the
results of their operations and their cash flows for each of the three years in
the period ended September 30, 1999, in conformity with accounting principles
generally accepted in the United States. 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 auditing standards generally
accepted in the United States, which require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements, assessing
the accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for the opinion expressed above.

PricewaterhouseCoopers LLP
New York, New York
October 25, 1999


<PAGE>   24

                    Lucent Technologies Inc. and Subsidiaries
                        CONSOLIDATED STATEMENTS OF INCOME
                 (Dollars in Millions, Except Per Share Amounts)

<TABLE>
<CAPTION>
                                                     Year Ended
                                                    September 30,
                                          ---------------------------------
                                            1999         1998        1997
-------------------------------------------------------------------------------

-------------------------------------------------------------------------------
<S>                                        <C>         <C>         <C>
Revenues                                   $38,303     $31,806     $27,611

Costs                                       19,688      16,715      15,318

Gross margin                                18,615      15,091      12,293

Operating expenses
Selling, general
  and administrative                         8,417       6,867       6,254
Research and development                     4,510       3,903       3,185
Purchased in-process
  research and development                     282       1,683       1,255
Total operating expenses                    13,209      12,453      10,694

Operating income                             5,406       2,638       1,599
Other income - net                             443         128          97
Interest expense                               406         254         238

Income before income taxes                   5,443       2,512       1,458

Provision for income taxes                   1,985       1,477       1,009

Income before cumulative
  effect of accounting change                3,458       1,035         449

Cumulative effect of accounting change
  (net of income taxes of $842)              1,308           -           -

Net income                                 $ 4,766     $ 1,035     $   449

Earnings per common share - basic:
   Income before cumulative
    effect of accounting change            $  1.14     $  0.35     $  0.16
   Cumulative effect of
    accounting change                         0.43           -           -

   Net income                              $  1.57     $  0.35     $  0.16

Earnings per common share - diluted
   Income before cumulative
    effect of accounting change            $  1.10     $  0.34     $  0.15
   Cumulative effect of
    accounting change                         0.42           -           -
   Net income                              $  1.52     $  0.34     $  0.15

Dividends per
  common share                             $  0.08     $0.0775     $0.0563
</TABLE>


See Notes to Consolidated Financial Statements.


<PAGE>   25

                    Lucent Technologies Inc. and Subsidiaries
                           CONSOLIDATED BALANCE SHEETS
                 (Dollars in Millions, Except Per Share Amounts)

<TABLE>
<CAPTION>
                                               September 30,     September 30,
                                                   1999              1998
                                               -------------     -------------
<S>                                            <C>               <C>
ASSETS
Cash and cash equivalents                      $   1,816         $   1,154
Receivables less allowances
  of $362 in 1999 and $416 in 1998                10,438             7,405
Inventories                                        5,048             3,279
Contracts in process (net of progress
  billings of $5,565 in 1999 and
  $3,036 in 1998)                                  1,103             1,259
Deferred income taxes - net                        1,583             1,775
Other current assets                               1,943               912
Total current assets                              21,931            15,784

Property, plant and equipment - net                6,847             5,693
Prepaid pension costs                              6,175             3,754
Deferred income taxes - net                            -               761
Capitalized software development costs               470               298
Other assets                                       3,352             3,073

Total assets                                   $  38,775         $  29,363

LIABILITIES
Accounts payable                               $   2,878         $   2,157
Payroll and benefit-related liabilities            2,300             2,592
Postretirement and postemployment
  benefit liabilities                                137               187
Debt maturing within one year                      2,864             2,231
Other current liabilities                          3,599             3,718

Total current liabilities                         11,778            10,885

Postretirement and postemployment
  benefit liabilities                              6,305             6,380
Long-term debt                                     4,162             2,409
Other liabilities                                  2,946             1,980

Total liabilities                              $  25,191         $  21,654
Commitments and contingencies

SHAREOWNERS' EQUITY
Preferred stock - par value $1 per share
 Authorized shares: 250,000,000                $       -         $       -
 Issued and outstanding shares: none
Common stock - par value $.01 per share
 Authorized shares: 6,000,000,000
 Issued and outstanding shares:
 3,071,750,726 at September 30, 1999;
 3,022,369,264 at September 30, 1998                  31                30
Additional paid-in capital                         7,731             6,589
Guaranteed ESOP obligation                           (33)              (49)
Retained earnings                                  6,099             1,422
Accumulated other comprehensive
 income(loss)                                       (244)             (283)

Total shareowners' equity                      $  13,584         $   7,709

Total liabilities and shareowners' equity      $  38,775         $  29,363
</TABLE>

See Notes to Consolidated Financial Statements.


<PAGE>   26


                    Lucent Technologies Inc. and Subsidiaries
                           CONSOLIDATED STATEMENTS OF
                         CHANGES IN SHAREOWNERS' EQUITY
                              (Dollars in Millions)

<TABLE>
<CAPTION>

                                                                                         Additional  Guaranteed
                                                                   Preferred   Common      Paid-in       ESOP       Retained
                                                                     Stock      Stock      Capital    Obligation    Earnings
------------------------------------------------------------------------------------------------------------------------------
<S>                                                                <C>        <C>         <C>         <C>           <C>
Balance at October 1, 1996                                              -         29       3,141        (106)         421
------------------------------------------------------------------------------------------------------------------------------
Net Income (excluding undistributed S-Corp earnings)                                                                  416
Reclass of undistributed earnings of S-Corp                                                   33
Foreign currency translation adjustment
Unrealized holding gains on certain investments
Minimum pension liability adjustment

Total comprehensive income
Effect of poolings                                                                            23                      (18)
Dividends declared                                                                                                   (146)
Amortization of ESOP obligation                                                                           29
Issuance of common stock                                                                     281
Tax benefit from employee stock options                                                       88
Issuance of common stock for acquisitions                                                    213
Conversion of common stock related to acquisitions                                           116
S-Corp distributions                                                                         (19)
Other                                                                                         27
------------------------------------------------------------------------------------------------------------------------------
Balance at September 30, 1997                                           -         29       3,903         (77)         673
------------------------------------------------------------------------------------------------------------------------------

Net Income (excluding undistributed S-Corp earnings)                                                                  950
Reclass of undistributed earnings of S-Corp                                                   85
Foreign currency translation adjustment
Unrealized holding losses on certain investments
Minimum pension liability adjustment

Total comprehensive income
Effect of poolings
Dividends declared                                                                                                   (201)
Amortization of ESOP obligation                                                                           28
Issuance of common stock                                                           1         645
Tax benefit from employee stock options                                                      271
Issuance of common stock for acquisitions                                                  1,525
Conversion of common stock related to acquisitions                                           186
S-Corp distributions                                                                         (26)
------------------------------------------------------------------------------------------------------------------------------
Balance at September 30, 1998                                           -         30       6,589         (49)       1,422
------------------------------------------------------------------------------------------------------------------------------

Net Income  (excluding undistributed S-Corp earnings)                                                               4,758
Reclass of undistributed earnings of S-Corp                                                    8
Foreign currency translation adjustment
Unrealized holding gains on certain investments (net of tax of $235)
Reclassification adjustment (net of tax of $178)
Minimum pension liability adjustment  (net of tax of $6)

Total comprehensive income
Effect of poolings                                                                           106                      (26)
Dividends declared                                                                                                   (222)
Amortization of ESOP obligation                                                                           16
Issuance of common stock                                                           1         695
Tax benefit from employee stock options                                                      367
Adjustment to conform pooled companies fiscal year                                                                    169
S-Corp distributions                                                                         (40)
Other                                                                                          6                       (2)
------------------------------------------------------------------------------------------------------------------------------
Balance at September 30, 1999                                           -         31       7,731         (33)       6,099
------------------------------------------------------------------------------------------------------------------------------

<CAPTION>

                                                                    Accumulated
                                                                       Other          Total           Total
                                                                   Comprehensive   Shareowners'   Comprehensive
                                                                    Income (Loss)     Equity         Income
---------------------------------------------------------------------------------------------------------------
<S>                                                                <C>             <C>            <C>
Balance at October 1, 1996                                             (23)          3,462
---------------------------------------------------------------------------------------------------------------
Net Income (excluding undistributed S-Corp earnings)                                                   416
Reclass of undistributed earnings of S-Corp                                                             33
Foreign currency translation adjustment                               (175)                           (175)
Unrealized holding gains on certain investments                         40                              40
Minimum pension liability adjustment                                     9                               9
                                                                                                     -----
Total comprehensive income                                                                             323
Effect of poolings
Dividends declared
Amortization of ESOP obligation
Issuance of common stock
Tax benefit from employee stock options
Issuance of common stock for acquisitions
Conversion of common stock related to acquisitions
S-Corp distributions
Other
---------------------------------------------------------------------------------------------------------------
Balance at September 30, 1997                                         (149)          4,379
---------------------------------------------------------------------------------------------------------------

Net Income (excluding undistributed S-Corp earnings)                                                   950
Reclass of undistributed earnings of S-Corp                                                             85
Foreign currency translation adjustment                                (89)                            (89)
Unrealized holding losses on certain investments                       (37)                            (37)
Minimum pension liability adjustment                                    (8)                             (8)
                                                                                                     -----
Total comprehensive income                                                                             901
Effect of poolings
Dividends declared
Amortization of ESOP obligation
Issuance of common stock
Tax benefit from employee stock options
Issuance of common stock for acquisitions
Conversion of common stock related to acquisitions
S-Corp distributions
---------------------------------------------------------------------------------------------------------------
Balance at September 30, 1998                                         (283)          7,709
---------------------------------------------------------------------------------------------------------------

Net Income  (excluding undistributed S-Corp earnings)                                                4,758
Reclass of undistributed earnings of S-Corp                                                              8
Foreign currency translation adjustment                                (33)                            (33)
Unrealized holding gains on certain investments (net of tax of $235    307                             307
Reclassification adjustment (net of tax of $178)                      (246)                           (246)
Minimum pension liability adjustment  (net of tax of $6)                11                              11
                                                                                                     -----
Total comprehensive income                                                                           4,805
Effect of poolings
Dividends declared
Amortization of ESOP obligation
Issuance of common stock
Tax benefit from employee stock options
Adjustment to conform pooled companies fiscal year
S-Corp distributions
Other
---------------------------------------------------------------------------------------------------------------
Balance at September 30, 1999                                         (244)         13,584
---------------------------------------------------------------------------------------------------------------
</TABLE>

See Notes to Consolidated Financial Statements.


<PAGE>   27


                    Lucent Technologies Inc. and Subsidiaries
                      CONSOLIDATED STATEMENTS OF CASH FLOWS
                              (Dollars in Millions)

<TABLE>
<CAPTION>
                                                    Year Ended
                                                   September 30,

                                        --------------------------------------
                                           1999          1998           1997
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
<S>                                      <C>            <C>            <C>
Operating Activities:
Net income                               $ 4,766        $ 1,035        $   449
Adjustments to reconcile
 net income
 to net cash (used in) provided by
 operating activities,
 net of effects from
 acquisitions of businesses:
  Cumulative effect of
    accounting change                     (1,308)             -              -
  Business restructuring reversal           (141)          (100)          (201)
  Asset impairment
    and other charges                        236              -             81
  Depreciation and
    amortization                           1,806          1,411          1,499
  Provision for
    uncollectibles                            75            149            136
  Tax benefit from stock options             367            271             88
  Deferred income taxes                    1,026             56            (21)
  Purchased in-process
    research and development                  15          1,683          1,255
  Adjustment to conform Ascend
    and Kenan's fiscal years                 169              -              -
  Increase in receivables - net           (3,183)        (2,161)          (484)
  Increase in inventories
    and contracts in process              (1,612)          (403)          (316)
  Increase(decrease) in
    accounts payable                         668            231            (18)
  Changes in other operating
    assets and liabilities                (2,320)           155           (397)
  Other adjustments for
    non-cash items - net                    (840)          (467)            58
Net cash (used in)provided by
  operating activities                      (276)         1,860          2,129

Investing Activities:
Capital expenditures                      (2,215)        (1,791)        (1,744)
Proceeds from the sale or
 disposal of property, plant
 and equipment                                97             57            108
Purchases of
 equity investments                         (307)          (212)          (149)
Sales of equity investments                  156             71             12
Purchases of investment
 securities                                 (450)        (1,082)          (483)
Sales or maturity
 of investment securities                  1,132            686            356
Dispositions of businesses                    72            329            181
Acquisitions of businesses -
 net of cash acquired                       (264)        (1,078)        (1,584)
Cash from mergers                             61              -              -
Other investing
 activities - net                            (69)           (80)           (68)
Net cash used in
 investing activities                     (1,787)        (3,100)        (3,371)
</TABLE>

See Notes to Consolidated Financial Statements.

                                    (CONT'D)


<PAGE>   28


                    Lucent Technologies Inc. and Subsidiaries
                CONSOLIDATED STATEMENTS OF CASH FLOWS - (CONT'D)
                              (Dollars in Millions)

<TABLE>
<CAPTION>
                                                   Year Ended
                                                  September 30,

                                     --------------------------------------
                                       1999           1998           1997
--------------------------------------------------------------------------------

--------------------------------------------------------------------------------
<S>                                <C>            <C>            <C>
Financing Activities:
Repayments of long-term debt           (13)           (93)           (16)
Issuance of long-term debt           2,175            375             52
Proceeds from issuance
 of common stock                       696            645            281
Dividends paid                        (222)          (201)          (192)
S-Corp distribution
 to stockholder                        (40)           (26)           (19)
Increase in short-term
 borrowings - net                       89            149            191
Net cash provided by
 financing activities                2,685            849            297

Effect of exchange rate
 changes on cash
 and cash equivalents                   40            (61)           (11)

Net increase(decrease)in
 cash and cash equivalents             662           (452)          (956)

Cash and cash equivalents
 at beginning of period              1,154          1,606          2,562

Cash and cash equivalents
 at end of period                  $ 1,816        $ 1,154        $ 1,606
</TABLE>



See Notes to Consolidated Financial Statements.


<PAGE>   29

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                 (Dollars in Millions, Except Per Share Amounts)

1. BASIS OF PRESENTATION

On June 24, 1999, Lucent Technologies Inc. (the "Company") merged with Ascend
Communications, Inc. Each share of Ascend common stock was converted into 1.65
shares of Lucent common stock. Lucent issued approximately 371 million shares in
exchange for all of the outstanding shares of Ascend. On February 26, 1999,
under the terms of the Kenan Systems Corporation merger agreement, Lucent issued
approximately 26 million shares (post April 1, 1999 stock split) of Lucent
common stock in exchange for all the outstanding shares of Kenan. These
transactions were accounted for as pooling-of-interests and, accordingly, the
consolidated financial statements of Lucent were restated for all periods prior
to the mergers to include the accounts and operations of Ascend and Kenan.

Before merging with Lucent, both Ascend and Kenan had December 31 fiscal year
ends. Lucent financial information for fiscal 1998 and earlier years was
computed by adding financial information for corresponding quarters of Ascend's
and Kenan's fiscal year. Thus, the consolidated statements of income for the
years ended September 30, 1998, and 1997 were derived by combining the results
of operations of Lucent for the years ended September 30, 1998, and 1997,
respectively, with the results of operations of Ascend and Kenan for the years
ended December 31, 1998, and 1997, respectively. The consolidated balance sheet
at September 30, 1998, was derived by combining the financial position of Lucent
at September 30, 1998, with the financial position of Ascend and Kenan at
December 31, 1998. The consolidated statements of cash flows for the years ended
September 30, 1998, and 1997 were derived by combining the cash flows of Lucent
for the years ended September 30, 1998, and 1997 with the cash flows of Ascend
and Kenan for the years ended December 31, 1998, and 1997.

The results of operations, financial position and cash flows as of and for the
three months ended December 31, 1998, for Ascend and Kenan were included in
Lucent's financial statements as of and for the year ended September 30, 1998.
The results of operations for the three months ended December 31, 1998, also
were included in Lucent's financial statements for the year ended September 30,
1999. As a result, the consolidated balance sheet of Lucent at September 30,
1999, includes an adjustment to retained earnings to eliminate the income
recognized from both Ascend and Kenan for the three months ended December 31,
1998. In addition, information from the statements of cash flows for Ascend and
Kenan for the three months ended December 31, 1998, has been eliminated from the
consolidated statements of cash flows for the year ended September 30, 1999,
since Ascend's and Kenan's activity for this period has been included in the
consolidated statements of cash flows for the year ended September 30, 1998.

On April 1, 1998, and April 1, 1999, two-for-one splits of Lucent's common stock
became effective. Shareowners' equity has been restated to give retroactive
recognition to the stock splits for all periods presented by reclassifying from
retained earnings to common stock the par value of the additional shares issued
as a result of the stock splits. In addition, all references in the financial
statements and notes to number of shares, per share amounts, stock option data
and market prices have been restated to reflect these stock splits.


<PAGE>   30

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                 (Dollars in Millions, Except Per Share Amounts)

ACQUISITIONS

Purchase Method

The following table presents information about certain acquisitions by Lucent in
the fiscal years ended September 30, 1999, 1998, and 1997. All the acquisitions
were accounted for under the purchase method of accounting, and the acquired
technology valuation included both existing technology and purchased in-process
research and development. All charges were recorded in the quarter in which the
transaction was completed.

<TABLE>
<CAPTION>
                                                                                             Amortization      Amortization
                                                                               Purchased        Period            Period
                 Acquisition       Purchase                     Existing         IPRD          Goodwill        Existing Tech.
                    Date            Price        Goodwill      Technology     (after-tax)     (in years)        (in years)
<S>              <C>               <C>           <C>           <C>            <C>            <C>               <C>
1999
STRATUS(1)          10/98           $ 917         $  0            $130          $267*             n/a                10
OTHER (2)          various            187          133              17            29              4-8               6-7

1998
YURIE(3)             5/98          $1,056         $292            $ 40          $620                7                 5
PROMINET(4)          1/98             199           35              23           157                5                 6
LIVINGSTON(5)       12/97             610          114              69           427                5                 8
OTHER (6)          various            453          137              67           208             5-10              5-10


1997
OCTEL(7)             9/97          $1,819         $181            $186          $945                7                 5
INTERCON(8)          2/97              22            0               3            18              n/a                 3
SAHARA(9)            1/97             219            0               0           213              n/a               n/a
</TABLE>



(1) Stratus Computer, Inc. was a manufacturer of fault-tolerant computer
    systems, acquired by Ascend.

(2) Other acquisitions include the Ethernet LAN business of Enable Semiconductor
    ("Enable Ethernet"), Sybarus Technologies, WaveAccess Ltd., and Quadritek
    Systems, Inc.

(3) Yurie Systems, Inc. was a provider of ATM access technology and equipment
for data, voice and video networking.

(4) Prominet Corporation was a participant in the emerging Gigabit Ethernet
networking industry. The merger involved $164 of Lucent stock and options. In
addition, under the terms of the agreement, Lucent had contingent obligations to
pay former Prominet shareowners $35 in stock. The $35 of stock was paid by
Lucent in July 1998 and recorded primarily as goodwill.

(5) Livingston Enterprises, Inc. was a global provider of equipment used by
Internet service providers to connect their subscribers to the Internet.

(6) Other acquisitions include JNA Telecommunications Limited, LANNET, MassMedia
Communications, Inc., SDX Business Systems plc, and Optimay GmbH. The purchase
price for MassMedia has been deemed immaterial.

(7) Octel Communications Corporation was a provider of voice, fax and electronic
messaging technologies.

(8) InterCon Systems Corporation was a developer of remote access client
software products, acquired by Ascend.

(9) Sahara Networks, Inc. was a developer of scalable high-speed broadband
access products, acquired by Ascend.

n/a Not applicable.

* $24 of purchased in-process research and development was subsequently reversed
in March 1999.

Included in the purchase price for the above acquisitions was purchased
in-process research and development, which was a non-cash charge to earnings as
this technology had not reached technological feasibility and had no future
alternative use. The remaining purchase price was allocated to tangible assets
and intangible assets, including goodwill and existing technology, less
liabilities assumed.


<PAGE>   31

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                 (Dollars in Millions, Except Per Share Amounts)

The value allocated to purchased in-process research and development was
determined utilizing an income approach that included an excess earnings
analysis reflecting the appropriate cost of capital for the investment.
Estimates of future cash flows related to the in-process research and
development were made for each project based on Lucent's estimates of revenue,
operating expenses and income taxes from the project. These estimates were
consistent with historical pricing, margins and expense levels for similar
products.

Revenues were estimated based on relevant market size and growth factors,
expected industry trends, individual product sales cycles and the estimated life
of each product's underlying technology. Estimated operating expenses, income
taxes, and charges for the use of contributory assets were deducted from
estimated revenues to determine estimated after-tax cash flows for each project.
Estimated operating expenses include cost of goods sold; selling, general and
administrative expenses; and research and development expenses. The research and
development expenses include estimated costs to maintain the products once they
have been introduced into the market and generate revenues and costs to complete
the in-process research and development.

The discount rates utilized to discount the projected cash flows were based on
consideration of Lucent's weighted average cost of capital, as well as other
factors including the 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.

Management is primarily responsible for estimating the fair value of the assets
and liabilities acquired, and has conducted due diligence in determining the
fair value. Management has made estimates and assumptions that affect the
reported amounts of assets, liabilities and expenses resulting from such
acquisitions. Actual results could differ from those amounts.

SpecTran Corporation

On July 21, 1999, Lucent began its cash tender offer for the outstanding shares
of SpecTran Corporation, a designer and manufacturer of specialty optical fiber
and fiber-optic products. The tender offer expired on August 31, 1999, and
Lucent thereafter accepted and paid for shares giving it a 61% interest in
SpecTran. The acquisition was accounted for under the purchase method of
accounting. Lucent expects to acquire the remaining shares of SpecTran by the
end of the first quarter of fiscal year 2000, resulting in a total purchase
price of approximately $68.


<PAGE>   32

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                 (Dollars in Millions, Except Per Share Amounts)

Pooling-of-Interests Mergers

Ascend Communications

On June 24, 1999, Lucent merged with Ascend, a developer, manufacturer and
seller of wide area networking solutions. As a result, the outstanding Ascend
common stock was converted into approximately 371 million shares of Lucent
common stock, based on an exchange ratio of 1.65 shares of Lucent common stock
for each share of Ascend common stock. In addition, Lucent assumed Ascend stock
options equivalent to approximately 65 million shares of Lucent common stock.
The merger was accounted for as a pooling-of-interests under Accounting
Principles Board Opinion No. 16, and accordingly, Lucent's consolidated
financial statements have been restated for all periods prior to the merger to
include the results of operations, financial position and cash flows of Ascend
as though it had always been a part of Lucent. Intercompany transactions for
fiscal 1999 have been eliminated. Intercompany transactions prior to 1999 were
immaterial. In connection with the merger, Lucent recorded a third fiscal
quarter charge to operating expenses of approximately $79 (non-tax deductible)
for merger-related costs. The merger-related costs consisted primarily of fees
for investment bankers, attorneys, accountants and financial printing. Certain
reclassifications were made to Ascend's accounts to conform to Lucent's
presentation. The results of operations for the separate companies and the
combined amounts presented in the consolidated financial statements are as
follows:

<TABLE>
<CAPTION>
                    Nine Months Ended          Twelve Months Ended
                         June 30,                September 30,

                    -----------------     ---------------------------
                          1999               1998               1997

<S>                    <C>                <C>                <C>
REVENUES
Lucent                 $ 26,256           $ 30,328           $ 26,444
Ascend                    1,610              1,478              1,167
Eliminations               (138)                 -                  -

Combined               $ 27,728           $ 31,806           $ 27,611

NET INCOME(LOSS)
Lucent                 $  3,838(a)        $  1,055 (c)       $    573 (e)

Ascend                       66(b)             (20)(d)           (124)(f)

Eliminations                (86)                 -                  -

Combined               $  3,818           $  1,035           $    449
</TABLE>

(a) Includes $108 of one-time after-tax charges related to Lucent's acquisitions
    of Quadritek, WaveAccess, Sybarus and Enable Ethernet and the merger-related
    costs for Ascend as well as $1,308 after-tax gain from the cumulative effect
    of the accounting change (see Note 10 - EMPLOYEE BENEFIT PLANS).

(b) Includes $243 of one-time after-tax charges related to Ascend's acquisition
    of Stratus. The original charge of $267 was reduced by $24 in the second
    fiscal quarter of 1999.

(c) Includes $1,412 of one-time after-tax charges related to Lucent's
    acquisitions of Livingston, Prominet, Optimay, Yurie, SDX, LANNET, MassMedia
    and JNA as well as the $95 after-tax gain on the sale of Advanced Technology
    Systems ("ATS") business.

(d) Includes $267 of one-time after-tax charges related to Ascend's acquisition
    of Stratus.

(e) Includes $966 of one-time after-tax charges related to Lucent's acquisition
    of Octel.

(f) Includes $335 one-time after-tax charges related to Ascend's acquisitions of
    Sahara and InterCon and Ascend's mergers with Whitetree, Inc. and Cascade
    Communications Corp.


<PAGE>   33

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                 (Dollars in Millions, Except Per Share Amounts)

Kenan Systems

On February 26, 1999, Lucent merged with Kenan Systems Corporation, a developer
of third-party billing and customer software. Under the terms of the Kenan
merger agreement, Lucent issued approximately 26 million shares (post April 1,
1999 stock split) of Lucent common stock in exchange for all the outstanding
shares of Kenan.

Mosaix

On July 15, 1999, Lucent completed its merger with Mosaix, a provider of
software that links companies' front and back offices and helps them deliver
more responsive and efficient customer service. Under the terms of the
agreement, the outstanding common stock of Mosaix was converted into the right
to receive approximately 2.6 million shares of Lucent common stock. Lucent has
not restated its historical financial statements to reflect its
pooling-of-interests with Mosaix.

Nexabit Networks

On July 19, 1999, Lucent completed its merger with Nexabit, a developer of
high-speed switching equipment and software that directs traffic along
telecommunications networks. Under the terms of the agreement, the outstanding
stock of Nexabit was converted into the right to receive approximately 13.7
million shares of Lucent common stock. Lucent has not restated its historical
financial statements to reflect its pooling-of-interests with Nexabit.

Cascade Communications

On June 30, 1997, Ascend completed its merger with Cascade, a developer and
manufacturer of wide area network switches.

Whitetree

On April 1, 1997, Ascend completed its merger with Whitetree, a developer and
manufacturer of high-speed ATM switching products. Ascend did not restate its
historical financial statements to reflect its pooling-of-interests with
Whitetree.

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

BASIS OF CONSOLIDATION
The consolidated financial statements include all majority-owned subsidiaries in
which Lucent exercises control. Investments in which Lucent exercises
significant influence, but which it does not control (generally a 20% - 50%
ownership interest), are accounted for under the equity method of accounting.
All material intercompany transactions and balances have been eliminated.

USE OF ESTIMATES
The preparation of financial statements and related disclosures in conformity
with generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and revenue and expenses during the period reported.
Actual results could differ from those estimates. Estimates are used in
accounting for long-term contracts, allowances for uncollectible receivables,
inventory obsolescence, product warranty, depreciation, employee benefits,
taxes, restructuring reserves and contingencies. Estimates and assumptions are
reviewed periodically and the effects of revisions are reflected in the
financial statements in the period they are determined to be necessary.

FOREIGN CURRENCY TRANSLATION
For operations outside the United States that prepare financial statements in
currencies other than the U.S. dollar, results of operations and cash flows are
translated at average exchange rates during the period, and assets and
liabilities are translated at end-of-period exchange rates. Translation
adjustments are included as a separate component of accumulated other
comprehensive income (loss) in shareowners' equity.

<PAGE>   34

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                 (Dollars in Millions, Except Per Share Amounts)

REVENUE RECOGNITION
Revenue is generally recognized when all significant contractual obligations
have been satisfied and collection of the resulting receivable is reasonably
assured. Revenue from product sales of hardware and software is recognized at
time of delivery and acceptance, and after consideration of all the terms and
conditions of the customer contract. Sales of services are recognized at time of
performance, and rental revenue is recognized proportionately over the contract
term. Revenues and estimated profits on long-term contracts are generally
recognized under the percentage-of-completion method of accounting using either
a units-of-delivery or a cost-to-cost methodology. Profit estimates are revised
periodically based on changes in facts. Any losses on contracts are recognized
immediately.

RESEARCH AND DEVELOPMENT COSTS
Research and development costs are charged to expense as incurred. However, the
costs incurred for the development of computer software that will be sold,
leased or otherwise marketed are capitalized when technological feasibility has
been established. These capitalized costs are subject to an ongoing assessment
of recoverability based on anticipated future revenues and changes in hardware
and software technologies. Costs that are capitalized include direct labor and
related overhead.

Amortization of capitalized software development costs begins when the product
is available for general release. Amortization is provided on a
product-by-product basis on either the straight-line method over periods not
exceeding two years or the sales ratio method. Unamortized capitalized software
development costs determined to be in excess of net realizable value of the
product are expensed immediately.

CASH AND CASH EQUIVALENTS
All highly liquid investments with original maturities of three months or less
are considered to be cash equivalents.

INVENTORIES
Inventories are stated at the lower of cost (determined principally on a
first-in, first-out basis) or market.

CONTRACTS IN PROCESS
Contracts in process are valued at cost plus accrued profits less progress
billings.

PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment are stated at cost less accumulated depreciation.
Depreciation is determined using a combination of accelerated and straight-line
methods on either the unit or group methods over the estimated useful lives of
the various asset classes. The unit method is used for manufacturing and
laboratory equipment and large computer systems. The group method is used for
other depreciable assets.

Long-lived assets are reviewed for impairment whenever events or changes in
circumstances indicate that the carrying amount may not be recoverable. If the
fair value is less than the carrying amount of the asset, a loss is recognized
for the difference.

FINANCIAL INSTRUMENTS
Lucent uses various financial instruments, including foreign currency exchange
contracts and interest rate swap agreements to manage and reduce risk to Lucent
by generating cash flows, which offset the cash flows of certain transactions in
foreign currencies or underlying financial instruments in relation to their
amount and timing. Lucent's derivative financial instruments are for purposes
other than trading and are not entered into for speculative purposes. Lucent's
non-derivative financial instruments include letters of credit, commitments to
extend credit and guarantees of debt. Lucent generally does not require
collateral to support its financial instruments.

GOODWILL
Goodwill is the excess of the purchase price over the fair value of identifiable
net assets acquired in business combinations accounted for as purchases.
Goodwill is amortized on a straight-line basis over the periods benefited,
principally in the range of 5 to 15 years. Goodwill is reviewed for impairment
whenever events or changes in circumstances indicate that the carrying amount
may not be recoverable.


<PAGE>   35

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                 (Dollars in Millions, Except Per Share Amounts)

RECLASSIFICATIONS
Certain prior year amounts have been reclassified to conform to the 1999
presentation.

3. RECENT PRONOUNCEMENTS

In June 1998, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standards ("SFAS") No. 133, "Accounting for Derivative
Instruments and Hedging Activities" ("SFAS 133"). SFAS 133 establishes new
accounting and reporting standards for derivative financial instruments and for
hedging activities. SFAS 133 requires Lucent to measure all derivatives at fair
value and to recognize them in the balance sheet as an asset or liability,
depending on Lucent's rights or obligations under the applicable derivative
contract. In June 1999, the FASB issued SFAS No. 137 which deferred the
effective date of adoption of SFAS 133 for one year. Lucent will adopt SFAS 133
no later than the first quarter of fiscal year 2001. SFAS 133 is not expected to
have a material impact on Lucent's consolidated results of operations, financial
position or cash flows.

In March 1998, the American Institute of Certified Public Accountants (the
"AICPA") issued Statement of Position 98-1, "Accounting for the Costs of
Computer Software Developed or Obtained for Internal Use" ("SOP 98-1"). SOP 98-1
provides guidance on accounting for the costs of computer software developed or
obtained for internal use. This pronouncement identifies the characteristics of
internal use software and provides guidance on new cost recognition principles.
Certain costs that were previously expensed as incurred will be capitalized and
amortized on a straight-line basis over three years. Lucent will adopt SOP 98-1
on October 1, 1999. The implementation of SOP 98-1 will decrease costs and
expenses in fiscal year 2000, the initial year of adoption, and thereafter is
expected to increase year-over-year costs and expenses as the capitalized
amounts are amortized. Costs for general and administrative, overhead,
maintenance and training, as well as the cost of software that does not add
functionality to the existing system, will be expensed as incurred.

4. SUPPLEMENTARY FINANCIAL INFORMATION

SUPPLEMENTARY INCOME STATEMENT INFORMATION

<TABLE>
<CAPTION>
                                                                         Year Ended
                                                                        September 30,
                                                              1999           1998           1997

<S>                                                        <C>            <C>            <C>
INCLUDED IN COSTS
Amortization of software development costs .........       $   249        $   234        $   380

INCLUDED IN SELLING, GENERAL AND
  ADMINISTRATIVE EXPENSES
Amortization of goodwill and existing
  technology .......................................       $   394        $   149        $    32

INCLUDED IN COSTS AND OPERATING EXPENSES
Depreciation and amortization of property,
  plant and equipment ..............................       $ 1,296        $   996        $ 1,057

OTHER INCOME -- NET
Interest income ....................................       $   124        $   112        $   155
Minority interests in earnings of subsidiaries .....           (27)           (24)           (35)
Net equity losses from investments .................           (25)          (209)           (64)
Gain (loss)on foreign currency transactions ........             1            (44)           (12)
Gain on sale of equity investments .................           359             38              -
Gain on businesses sold ............................            40            208              -
Miscellaneous -- net ...............................           (29)            47             53
                                                           -------        -------        -------
Total other income -- net ..........................       $   443        $   128        $    97


DEDUCTED FROM INTEREST EXPENSE
Capitalized interest ...............................       $    20        $    17        $    14
</TABLE>

<PAGE>   36

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                 (Dollars in Millions, Except Per Share Amounts)

SUPPLEMENTARY BALANCE SHEET INFORMATION

<TABLE>
<CAPTION>
                                                              September 30,
                                                         1999            1998

                                                       --------        --------
<S>                                                    <C>             <C>
INVENTORIES
Completed goods ..................................     $  2,946        $  1,644
Work in process and raw materials ................        2,102           1,635
                                                       --------        --------
Inventories ......................................     $  5,048        $  3,279

PROPERTY, PLANT AND EQUIPMENT -- NET
Land and improvements ............................     $    360        $    306
Buildings and improvements .......................        3,951           3,187
Machinery, electronic and other equipment ........        9,981           8,838
                                                       --------        --------
Total property, plant and equipment ..............       14,292          12,331
Less: Accumulated depreciation and amortization ..       (7,445)         (6,638)
                                                       --------        --------
Property, plant and equipment -- net .............     $  6,847        $  5,693

OTHER CURRENT LIABILITIES
Advance billings and customer deposits ...........     $    488        $    548
</TABLE>



SUPPLEMENTARY CASH FLOW INFORMATION


<TABLE>
<CAPTION>
                                                                    Year Ended
                                                                   September 30,
                                                          1999         1998         1997
                                                         ------       ------       ------

<S>                                                      <C>          <C>          <C>
Interest payments, net of amounts capitalized            $  409       $  255       $  240

Income tax payments ...............................      $1,025       $  776       $  826

Acquisitions of businesses:
Fair value of assets acquired,
 net of cash acquired .............................      $  394       $2,092       $1,838
Less: Fair value of liabilities assumed ...........      $  130       $1,014       $  254
                                                         ------       ------       ------
Acquisitions of businesses,
 net of cash acquired .............................      $  264       $1,078       $1,584
</TABLE>


For the year ended September 30, 1999, the Consolidated Statements of Cash Flows
excludes the issuance of common stock related to the mergers with Nexabit and
Mosaix.

On October 1, 1997, Lucent contributed its Consumer Products business to a new
venture formed by Lucent and Philips Electronics N.V. in exchange for 40%
ownership of Philips Consumer Communications ("PCC"). On October 22, 1998,
Lucent and Philips announced their intention to end the PCC venture and agreed
to regain control of their original businesses. The results of operations and
net assets of the remaining businesses Lucent previously contributed to PCC have
been consolidated as of October 1, 1998. However, for the years ended September
30, 1998, and 1999, the Consolidated Statements of Cash Flows exclude both the
contribution and the regaining of Lucent's Consumer Products business.

For the year ended September 30, 1999, costs and operating expenses include a
$236 charge primarily associated with asset impairments and integration-related
charges associated with the Ascend and Nexabit mergers.


<PAGE>   37


                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                 (Dollars in Millions, Except Per Share Amounts)

For the year ended September 30, 1998, Other income -- net includes a charge of
$110 related to a write-down associated with Lucent's investment in the PCC
venture. This charge was offset by gains of $103, primarily related to the sale
of an investment and the sale of certain business operations, including Bell
Laboratories Design Automation Group.

For the year ended September 30, 1998, the Consolidated Statements of Cash Flows
excludes the issuance of common stock related to the acquisitions of Livingston,
Prominet, and Stratus and the conversion of stock options related to the
acquisitions of Livingston, Prominet, Yurie, Optimay, and Stratus.

For the year ended September 30, 1997, the Consolidated Statements of Cash Flows
excludes the conversion of stock options related to the acquisition of Octel and
the issuance of common stock and the conversion of stock options related to the
acquisition of Sahara. For information on the 1999, 1998 and 1997 acquisitions,
see Note 1.

For the year ended September 30, 1997, research and development expenses include
a $127 write-down of special purpose Bell Laboratories assets no longer being
used.

5. EARNINGS PER COMMON SHARE

Basic earnings per common share was calculated by dividing net income by the
weighted average number of common shares outstanding during the period. Diluted
earnings per share was calculated by dividing net income by the sum of the
weighted average number of common shares outstanding plus all additional common
shares that would have been outstanding if potentially dilutive securities or
common stock equivalents had been issued.

The following table reconciles the number of shares utilized in the earnings per
share calculations:

<TABLE>
<CAPTION>
                                                           Year Ended
                                                           September 30,
                                                    1999        1998         1997

------------------------------------------------------------------------------------------------
<S>                                              <C>         <C>          <C>
Net income ...............................       $  4,766    $   1,035    $      449

Earnings per common share - basic:
 Income before cumulative effect
  of accounting change ...................       $   1.14    $    0.35    $     0.16
 Cumulative effect of accounting
  change .................................           0.43            -             -
 Net income ..............................       $   1.57    $    0.35    $     0.16

Earnings per common share - diluted:
 Income before cumulative effect
  of accounting change ...................       $   1.10    $    0.34    $     0.15
 Cumulative effect of accounting
  change .................................           0.42            -             -
 Net income ..............................       $   1.52    $    0.34    $     0.15


Number of shares (in millions)
------------------------------
Common shares - basic                             3,035.8      2,963.8       2,894.6

Effect of dilutive securities:
  Stock options                                     101.0         71.9          37.5
  Other                                               5.9          4.0           0.2
Common shares - diluted                           3,142.7      3,039.7       2,932.3

Options excluded from the computation
of earnings per share - diluted since
option exercise price was greater than the
average market price of the
common shares for the period                          5.5         13.4          15.9
</TABLE>


<PAGE>   38

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                 (Dollars in Millions, Except Per Share Amounts)

6. COMPREHENSIVE INCOME

Lucent has adopted SFAS No. 130, "Reporting Comprehensive Income" as of October
1, 1998, that requires new standards for reporting and display of comprehensive
income and its components that Lucent has displayed in its Consolidated
Statements of Changes in Shareowners' Equity. However, it does not affect net
income or total shareowners' equity.

The after-tax components of accumulated other comprehensive income (loss) are as
follows:

<TABLE>
<CAPTION>
                                                                                    Total
                                                                                 Accumulated
                                            Foreign     Unrealized   Minimum        Other
                                           Currency      Holding     Pension    Comprehensive
                                           Translation    Gains/    Liability      Income/
                                           Adjustment    (Losses)   Adjustment     (Loss)
<S>                                        <C>          <C>         <C>         <C>
Beginning balance October 1, 1996......... $  (16)       $   15      $  (22)     $  ( 23)
Current-period change.....................   (175)           40           9         (126)
Ending balance, September 30, 1997........ $ (191)       $   55      $  (13)     $  (149)
Current-period change.....................    (89)          (37)        ( 8)        (134)
Ending balance, September 30, 1998........ $ (280)       $   18      $  (21)     $  (283)
Current-period change.....................    (33)           61          11           39
Ending balance, September 30, 1999........ $ (313)       $   79      $  (10)     $  (244)
</TABLE>

The foreign currency translation adjustments are not currently adjusted for
income taxes since they relate to indefinite investments in non-United States
subsidiaries.

7. BUSINESS RESTRUCTURING AND OTHER CHARGES

In the fourth quarter of calendar year 1995, a pre-tax charge of $2,801 was
recorded to cover restructuring costs of $2,613 and asset impairment and other
charges of $188. The restructuring plans included the exit of certain businesses
as well as consolidating and re-engineering numerous corporate and business unit
operations.

Total deductions to Lucent's business restructuring reserves were $233 and $318
for the years ended September 30, 1999, and 1998, respectively. Included in
these deductions were cash payments of $77 and $176 and non-cash related charges
of $15 and $42 for the years ended September 30, 1999, and 1998, respectively.
The non-cash related charges were primarily related to assets for product lines
and businesses that Lucent exited as part of its restructuring activities. The
related costs were included in the 1995 restructuring plan. The assets did not
benefit activities that were to continue, nor were they used to generate future
revenues. The reserves were charged as the product lines and businesses were
exited during 1999 and 1998. In addition, Lucent reversed $141 and $100 of
business restructuring reserves primarily related to favorable experience in
employee separations as well as, other projects being completed at a cost lower
than originally estimated for the years ended September 30, 1999, and 1998,
respectively. As of September 30, 1999, all restructuring plans were
substantially completed and the remaining reserves of $18 are related to
outstanding litigation for certain product lines that were exited.

The following table displays a rollforward of the liabilities for business
restructuring from September 30, 1997, to September 30, 1999:

<TABLE>
<CAPTION>
                      September 30,    1998      September 30,    1999      September 30,
Type of Cost          1997 Balance  Deductions   1998 Balance   Deductions  1999 Balance
-----------------------------------------------------------------------------------------
<S>                      <C>         <C>          <C>          <C>           <C>
Employee separation      $   348     $(235)       $  113       $  (113)      $    -
Facility closing              66      ( 23)           43          ( 43)           -
Other                        155      ( 60)           95          ( 77)          18
Total                    $   569     $(318)       $  251       $  (233)      $   18
</TABLE>


<PAGE>   39

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                 (Dollars in Millions, Except Per Share Amounts)

In 1997, Lucent recorded a pre-tax charge of approximately $150 in connection
with the acquisition of Cascade Communications Corp. and Whitetree, Inc. The
total charge included $54 of merger-related costs and $96 of integration
expenses. Included in the integration expenses were $7 for severance and
outplacement costs for approximately 275 employees involved in duplicate
functions; $67 for redundant assets and assets related to duplicate product
lines; and $22 for the cancellation of redundant facility leases and other
contracts and obligations. In 1998, Lucent reversed $18 of these costs. There
were no reserves remaining as of September 30, 1998.

8. INCOME TAXES

The following table presents the principal reasons for the difference between
the effective tax rate and the United States federal statutory income tax rate:

<TABLE>
<CAPTION>
                                                                Year Ended
                                                               September 30,
                                                     1999           1998           1997
<S>                                                  <C>            <C>            <C>
U.S. federal statutory income tax rate               35.0%          35.0%          35.0%

State and local income taxes, net of federal
  income tax effect                                   2.5%           3.3%           5.4%
Foreign earnings and dividends taxed at
  different rates                                     0.3%           1.0%           0.8%
Research credits                                     (2.6)%         (2.6)%         (2.4)%
Acquisition-related costs (a)                         2.6%          23.5%          32.4%
Other differences - net                              (1.3)%         (1.4)%         (2.0)%

Effective income tax rate                            36.5%          58.8%          69.2%

Effective income tax rate excluding
  acquisition-related costs (a)                      33.9%          35.3%          36.8%
</TABLE>

(a) Includes non-tax deductible purchased in-process research and development
and merger-related expenses.

The following table presents the United States and foreign components of income
before income taxes and the provision for income taxes:

<TABLE>
<CAPTION>
                                            Year Ended
                                           September 30,
                                  1999         1998         1997

<S>                              <C>          <C>          <C>
INCOME BEFORE INCOME TAXES
United States                    $4,702       $2,144       $  861
Foreign                             741          368          597
Income before income taxes       $5,443       $2,512       $1,458
</TABLE>



<PAGE>   40

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                 (Dollars in Millions, Except Per Share Amounts)

PROVISION FOR INCOME TAXES

<TABLE>
<S>                              <C>            <C>           <C>
CURRENT
Federal                          $   505        $   987       $   554
State and local                       38            168           148
Foreign                              336            213           228
  Sub-total                          879          1,368           930

DEFERRED
Federal                              992             63            11
State and local                      183             36            72
Foreign                              (69)            10            (4)
  Sub-total                        1,106            109            79


Provision for income taxes       $ 1,985        $ 1,477       $ 1,009
</TABLE>


As of September 30, 1999, Lucent had tax credit carryforwards of $80 and
federal, state and local, and foreign net operating loss carryforwards (tax
effected) of $146, all of which expire primarily after the year 2000.

The components of deferred tax assets and liabilities at September 30, 1999, and
1998 are as follows:

<TABLE>
<CAPTION>
                                                      September 30,
                                                   1999           1998
<S>                                              <C>            <C>
Deferred Income Tax Assets

Employee pensions and other benefits - net       $   442        $ 1,520
Business restructuring                                 6            165
Reserves and allowances                            1,009          1,137
Net operating loss/credit carryforwards              226            239
Valuation allowance                                 (179)          (261)
Other                                                344            526


Total deferred tax assets                        $ 1,848        $ 3,326

Deferred Income Tax Liabilities

Property, plant and equipment                    $   628        $   399
Other                                                511            391

Total deferred tax liabilities                   $ 1,139        $   790
</TABLE>


Lucent has not provided for United States deferred income taxes or foreign
withholding taxes on $3,211 of undistributed earnings of its non-United States
subsidiaries as of September 30, 1999, since these earnings are intended to be
reinvested indefinitely.


<PAGE>   41

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                 (Dollars in Millions, Except Per Share Amounts)

9.  DEBT OBLIGATIONS

<TABLE>
<CAPTION>
                                           September 30,  September 30,
                                               1999          1998
                                           -------------  -------------
<S>                                           <C>           <C>
DEBT MATURING WITHIN ONE YEAR
Commercial paper ......................       $1,828        $2,106*
Long-term debt ........................           34            39
Secured borrowings and other ..........        1,002            86
                                              ------        ------
Total debt maturing within one year ...       $2,864        $2,231

WEIGHTED AVERAGE INTEREST RATES
  Commercial paper ....................          5.0%          5.6%
  Long-term debt, secured borrowings
     and other ........................          9.7%          7.9%
</TABLE>

Lucent had revolving credit facilities at September 30, 1999, aggregating $4,711
(a portion of which is used to support Lucent's commercial paper program),
$4,000 with domestic lenders and $711 with foreign lenders. The total credit
facilities available at September 30, 1999, with domestic and foreign lenders
were $4,000 and $351, respectively.

<TABLE>
<CAPTION>
                                                September 30,  September 30,
                                                    1999           1998
                                                -------------  -------------
<S>                                                <C>          <C>
LONG-TERM DEBT

6.90% notes due July 15, 2001                      $  750       $  750
7.25% notes due July 15, 2006                         750          750
5.50% notes due November 15, 2008                     500            -
6.50% debentures due January 15, 2028                 300          300
6.45% debentures due March 15, 2029                 1,360            -
Commercial paper refinanced after
  September 30, 1998                                    -          495*
Long-term lease obligations                            79            1
Secured borrowings and other (8.40% weighted
      average interest rate for both years)           502          164
Less: Unamortized discount                             45           12
                                                   ------       ------
Total long-term debt                                4,196        2,448
Less: Amounts maturing within one year                 34           39
                                                   ------       ------
Net long-term debt                                 $4,162       $2,409
                                                   ======       ======
</TABLE>

* On November 19, 1998, Lucent sold $500 ($495 net of unamortized costs) of
10-year 5.5% notes due November 15, 2008, and reclassified the amount from debt
maturing within one year to long-term debt. The proceeds were used to pay down a
portion of Lucent's commercial paper during the first quarter of fiscal 1999.

Lucent has an effective shelf registration statement for the issuance of debt
securities up to $1,800, all of which remains available at September 30, 1999.

This table shows the maturities, by year, of the $4,196 in total long-term debt
obligations:

<TABLE>
<CAPTION>
                                  September 30,
                    ----------------------------------------------
                    2000   2001   2002   2003   2004   Later Years
                    <S>    <C>    <C>    <C>    <C>    <C>
                     $34   $850    $26   $128   $107    $3,051
</TABLE>

In the normal course of business, Lucent sells trade accounts receivable and
notes receivable to unaffiliated financial institutions with and without
recourse. Certain sales with recourse are accounted for as secured borrowings
and amounted to $1,037 at September 30, 1999. As a result of these recourse
transactions, these receivables remained in the Consolidated Balance Sheets and
increased cash flows from financing activities in the Consolidated Statements of
Cash Flows by $1,037. See Note 13 for further discussion of sales of receivables
without recourse.

<PAGE>   42

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                 (Dollars in Millions, Except Per Share Amounts)

10. EMPLOYEE BENEFIT PLANS

PENSION AND POSTRETIREMENT BENEFITS

Lucent maintains defined benefit pension plans covering the majority of its
employees and retirees, and postretirement benefit plans for retirees that
include health care benefits and life insurance coverage.

<TABLE>
<CAPTION>
                                                                 Pension             Postretirement
                                                                Benefits                   Benefits
                                                            September 30,              September 30,
                                                      1999           1998          1999        1998
<S>                                                  <C>           <C>            <C>         <C>

Change in benefit obligation
Benefit obligation at October 1                      $27,846       $23,187        $9,193      $7,939
Service cost                                             509           331            80          63
Interest cost                                          1,671         1,631           537         540
Actuarial (losses)gains                               (2,182)        3,811          (240)        919
Amendments                                             1,534           626          (359)        324
Benefits paid                                         (1,977)       (1,740)         (607)       (592)
----------------------------------------------------------------------------------------------------
Benefit obligation at September 30                   $27,401       $27,846        $8,604      $9,193
----------------------------------------------------------------------------------------------------
Change in plan assets
Fair value of plan assets at October 1               $36,191       $36,204        $3,959      $4,152
Actual return on plan assets                           7,114         1,914           776         349
Company contributions                                     14            12            29          53
Benefits paid                                         (1,977)       (1,740)         (607)       (592)
Other (including transfer of assets from
 pension to postretirement plans)                       (275)         (199)          310          (3)
----------------------------------------------------------------------------------------------------
Fair value of plan assets at September 30            $41,067       $36,191        $4,467      $3,959
----------------------------------------------------------------------------------------------------
Funded (unfunded) status of the plan                 $13,666       $ 8,345       $(4,137)    $(5,234)
Unrecognized prior service cost                        2,583         1,509           121         533
Unrecognized transition asset                           (645)         (944)            -           -
Unrecognized net gain                                 (9,466)       (5,175)       (1,014)       (408)
----------------------------------------------------------------------------------------------------
Net amount recognized                                $ 6,138       $ 3,735       $(5,030)    $(5,109)
====================================================================================================
Amounts recognized in the Consolidated
 Balance Sheets consist of:
Prepaid pension costs                                $ 6,175       $ 3,754       $     -     $     -
Accrued benefit liability                                (63)          (44)       (5,030)     (5,109)
Intangible asset                                           9             4             -           -
Accumulated other comprehensive income                    17            21             -           -
----------------------------------------------------------------------------------------------------
Net amount recognized                                $ 6,138       $ 3,735       $(5,030)    $(5,109)
====================================================================================================
</TABLE>

Pension plan assets include $256 and $159 of Lucent common stock at September
30, 1999, and 1998, respectively. Postretirement plan assets include $20 and $11
of Lucent common stock at September 30, 1999, and 1998, respectively.


<PAGE>   43


                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                 (Dollars in Millions, Except Per Share Amounts)

Components of Net Periodic Benefit Cost

<TABLE>
<CAPTION>
                                                                Year Ended September 30,
Pension Cost                                             1999            1998            1997
------------
<S>                                                    <C>             <C>             <C>
Service cost                                           $   509         $   331         $   312

Interest cost on projected benefit obligation            1,671           1,631           1,604
Expected return on plan assets                          (2,957)         (2,384)         (2,150)

Amortization of unrecognized prior service costs           461             164             149

Amortization of transition asset                          (300)           (300)           (300)
Amortization of net loss                                     2               -               -
Charges for plan curtailments                                -               -              56
-----------------------------------------------------------------------------------------------
Net pension credit                                     $  (614)        $  (558)        $  (329)
===============================================================================================
Postretirement Cost
-------------------
Service cost                                           $    80         $    63         $    57
Interest cost on accumulated benefit obligation            537             540             554
Expected return on plan assets                            (308)           (263)           (264)
Amortization of unrecognized prior service costs            53              53              35
Amortization of net loss (gain)                              6               3             (15)
Charges for plan curtailments                                -               -              26
-----------------------------------------------------------------------------------------------
Net postretirement benefit cost                        $   368         $   396         $   393
===============================================================================================
Pension and Postretirement Benefits
Weighted-average assumptions
 as of September 30
-----------------------------------
Discount rate                                             7.25%            6.0%           7.25%
Expected return on plan assets                             9.0%            9.0%            9.0%
Rate of compensation increase                              4.5%            4.5%            4.5%
</TABLE>

Effective October 1, 1998, Lucent changed its method for calculating the
market-related value of plan assets used in determining the expected
return-on-asset component of annual net pension and postretirement benefit
costs. Under the previous accounting method, the calculation of the
market-related value of plan assets included only interest and dividends
immediately, while all other realized and unrealized gains and losses were
amortized on a straight-line basis over a five-year period. The new method used
to calculate market-related value includes immediately an amount based on
Lucent's historical asset returns and amortizes the difference between that
amount and the actual return on a straight-line basis over a five-year period.
The new method is preferable under Statement of Financial Accounting Standards
No. 87 because it results in calculated plan asset values that are closer to
current fair value, thereby lessening the accumulation of unrecognized gains and
losses while still mitigating the effects of annual market value fluctuations.


<PAGE>   44


                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                 (Dollars in Millions, Except Per Share Amounts)

The cumulative effect of this accounting change related to periods prior to
fiscal year 1999 of $2,150 ($1,308 after-tax, or $0.43 and $0.42 per basic and
diluted share, respectively) is a one-time, non-cash credit to fiscal 1999
earnings. This accounting change also resulted in a reduction in benefit costs
in the year ended September 30, 1999 that increased income by $427 ($260
after-tax, or $0.09 and $0.08 per basic and diluted share, respectively) as
compared with the previous accounting method. A comparison of pro forma amounts
below shows the effects if the accounting change were applied retroactively:

<TABLE>
<CAPTION>
                                                 Year Ended September 30,
                                                     1998       1997
<S>                                                <C>        <C>
Pro forma net income                               $ 1,276    $  657
            Earnings per share-basic               $  0.43    $ 0.23
            Earnings per share-diluted             $  0.42    $ 0.22
</TABLE>


In 1999, Lucent changed its pension plan benefit for management, technical pay
plan, and non-represented occupational employees hired on or after January 1,
1999, and certain U.S. employees of companies acquired since October 1, 1996,
who are not participating currently in a defined benefit pension plan. These
employees will receive a different pension benefit known as an account balance
program, effective January 1, 2000. All other employees will retain their
current pension benefits and are not affected by the new account balance
program.

Lucent has several non-pension postretirement benefit plans. For postretirement
health care benefit plans, Lucent assumed a 9.2% annual health care cost trend
rate for 2000, gradually declining to 3.9% by the year 2005, after which the
trend rate would remain at that level. 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:

<TABLE>
<CAPTION>
                                                         1 Percentage Point
                                                         Increase   Decrease

<S>                                                       <C>        <C>
Effect on total of service and interest cost components   $ 23       $ 20
Effect on postretirement benefit obligation               $371       $344
</TABLE>

SAVINGS PLANS
Lucent's 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. Lucent matches a percentage of the employee contributions up to
certain limits. Savings plan expense amounted to $314, $316 and $183 for the
years ended September 30, 1999, 1998, and 1997, respectively.

EMPLOYEE STOCK OWNERSHIP PLAN
Lucent's leveraged Employee Stock Ownership Plan ("ESOP") funds the employer
contributions to the Long-Term Savings and Security Plan ("LTSSP") for
non-management employees. The ESOP obligation is reported as debt and as a
reduction in shareowners' equity. Cash contributions to the ESOP are determined
based on the ESOP's total debt service less dividends paid on ESOP shares. As of
September 30, 1999, the ESOP contained 18.8 million shares of Lucent's common
stock. Of the 18.8 million shares, 16.2 million have been allocated under the
ESOP and 2.6 million were unallocated. As of September 30, 1999, the unallocated
shares had a fair value of $169.

11. STOCK COMPENSATION PLANS

Lucent has stock-based compensation plans under which outside directors and
certain 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 a 10-year
term and vest within four years from the date of grant. Subject to customary
anti-dilution adjustments and certain exceptions, the total number of shares of
common stock authorized for option grants under the plans was 264 million shares
at September 30, 1999.

<PAGE>   45

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                 (Dollars in Millions, Except Per Share Amounts)

In connection with certain of Lucent's acquisitions, outstanding stock options
held by employees of acquired companies became exercisable, according to their
terms, for Lucent common stock effective at the acquisition date. These options
did not reduce the shares available for grant under any of Lucent's other option
plans. For acquisitions accounted for as purchases, the fair value of these
options was included as part of the purchase price.

Lucent established an Employee Stock Purchase Plan (the "ESPP") effective
October 1, 1996. Under the terms of the ESPP, eligible employees may have up to
10% of eligible compensation deducted from their pay to purchase common stock
through June 30, 2001. The per share purchase price is 85% of the average high
and low per share trading price of common stock on the New York Stock Exchange
on the last trading day of each month. The amount that may be offered pursuant
to this plan is 200 million shares. In 1999, 1998 and 1997, 6.8 million, 8.9
million and 12.5 million shares, respectively, were purchased under the ESPP and
the employee stock purchase plan of an acquired company, at a weighted average
price of $46.04, $23.93 and $12.77, respectively.

Lucent has adopted the disclosure requirements of SFAS No. 123, "Accounting for
Stock-Based Compensation," and as permitted under SFAS No. 123, applies
Accounting Principles Board Opinion ("APB") No. 25 and related interpretations
in accounting for its plans. Compensation expense recorded under APB No. 25 was
$48, $77 and $37 for the years ended September 30, 1999, 1998, and 1997,
respectively. If Lucent had elected to adopt the optional recognition provisions
of SFAS No. 123 for its stock option plans and employee stock purchase plans,
net income and earnings per share would have been changed to the pro forma
amounts indicated below:

<TABLE>
<CAPTION>
                                           Year Ended September 30,
                                     1999            1998            1997
<S>                              <C>             <C>             <C>
NET INCOME
As reported                      $  4,766        $  1,035         $    449
Pro forma                        $  4,263        $    756         $    201

EARNINGS PER SHARE-BASIC
As reported                      $   1.57        $   0.35         $   0.16
Pro forma                        $   1.40        $   0.26         $   0.07

EARNINGS PER SHARE-DILUTED
As reported                      $   1.52        $   0.34         $   0.15
Pro forma                        $   1.31        $   0.24         $   0.07
</TABLE>

The fair value of stock options used to compute pro forma net income and
earnings per share disclosures is the estimated fair value at grant date using
the Black-Scholes option-pricing model with the following assumptions:

<TABLE>
<CAPTION>
WEIGHTED AVERAGE ASSUMPTIONS           1999        1998        1997
<S>                                    <C>         <C>         <C>
Dividend yield                         0.12%       0.18%       0.38%
Expected volatility:
  Lucent                               33.8%       28.2%       22.4%
  Acquisitions (1)                     57.5%       61.0%       66.0%
Risk-free interest rate                 5.2%        5.3%        6.3%
Expected holding period(in years)       3.6         4.1         4.4
</TABLE>

(1) Pre-merger assumptions for companies acquired in a pooling-of-interests.


<PAGE>   46

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                 (Dollars in Millions, Except Per Share Amounts)

Presented below is a summary of the status of Lucent stock options and the
related transactions for the years ended September 30, 1999, 1998, and 1997.

<TABLE>
<CAPTION>
                                                 Shares      Weighted Average
                                                 (000s)      Exercise Price
------------------------------------------------------------------------------
<S>                                             <C>          <C>
Options outstanding at October 1, 1996           86,266           $14.55
------------------------------------------------------------------------------
Granted/assumed* (1)(2)                         176,170           $15.19
Exercised                                       (15,967)          $ 6.88
Forfeited/expired (2)                           (63,310)          $24.92
------------------------------------------------------------------------------
Options outstanding at September 30, 1997       183,159           $12.26
------------------------------------------------------------------------------
Granted/assumed* (3)                            123,075           $27.95
Exercised                                       (39,404)          $ 9.78
Forfeited/expired                               (15,014)          $20.25
------------------------------------------------------------------------------
Options outstanding at September 30, 1998       251,816           $19.84
------------------------------------------------------------------------------
Granted/assumed*                                 52,576           $48.77
Exercised                                       (27,067)          $13.54
Forfeited/expired                               (10,870)          $23.00
------------------------------------------------------------------------------
Options outstanding at September 30, 1999       266,455           $26.06
==============================================================================
</TABLE>

* Includes options converted in acquisitions.

(1) Includes options covering 51,013 shares of common stock granted under a
    broad-based employee plan at a weighted average exercise price of $11.15.

(2) Grants and forfeitures include options covering 23,039 and 25,598 shares of
    common stock exchanged or amended under pre-merger stock option repricing
    programs of a company acquired in a pooling-of-interests, at new exercise
    prices of $21.18 and $14.81, respectively.

(3) Includes options covering 32,355 shares of common stock granted under a
    broad-based employee plan at a weighted average exercise price of $37.34.

The weighted average fair value of Lucent stock options, calculated using the
Black-Scholes option-pricing model, granted during the years ended September 30,
1999, 1998, and 1997 is $15.92, $12.26 and $3.65 per share, respectively.

The following table summarizes the status of stock options outstanding and
exercisable at September 30, 1999:

<TABLE>
<CAPTION>
                     --------------------------------     --------------------
                                       Stock Options            Stock Options
                                         Outstanding              Exercisable
                     --------------------------------     --------------------
                                Weighted
                                 Average    Weighted                Weighted
Range of                       Remaining     Average                 Average
exercise             Shares  Contractual    Exercise      Shares    Exercise
prices               (000s)  Life(Years)       Price      (000s)       Price
------------------------------------------------------------------------------
<S>                  <C>            <C>       <C>         <C>         <C>
$ 0.01 to $ 11.14    72,396(1)      6.7       $10.29      12,792      $ 7.42
$11.15 to $ 23.07    70,150(1)      7.5        16.59      31,110       15.52
$23.08 to $ 29.09    21,947         8.8        27.42      20,715       27.48
$29.10 to $ 40.87    60,567         8.9        35.15       9,005       34.78
$40.88 to $ 61.78    25,587         9.2        49.86       5,964       52.44
$61.79 to $102.48    15,808         9.9        65.08          72       67.37
------------------------------------------------------------------------------
Total               266,455                   $26.06      79,658      $22.32
==============================================================================
</TABLE>

(1) Approximately 43,869 options granted under a broad-based employee plan
    became exercisable on October 1, 1999.


<PAGE>   47

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                 (Dollars in Millions, Except Per Share Amounts)

Other stock unit awards are granted under certain award plans. The following
table presents the total number of shares of common stock represented by awards
granted to employees for the years ended September 30, 1999, 1998, and 1997:

<TABLE>
<CAPTION>
                                               Year Ended September 30,
                                           1999          1998         1997
<S>                                      <C>           <C>          <C>
Other stock unit awards granted (000s)      532         1,730        8,756
Weighted average market value of
  shares granted during the period       $31.82        $22.23       $12.00
</TABLE>


12.  OPERATING SEGMENTS

Lucent adopted SFAS No. 131, "Disclosures about Segments of an Enterprise and
Related Information," beginning with this Annual Report. This standard requires
disclosure of segment information on the same basis used internally for
evaluating segment performance and for deciding how to allocate resources to
segments.

Lucent operates in the global telecommunications networking industry and has
three reportable operating segments: Service Provider Networks ("SPN"),
Enterprise Networks ("Enterprise"), and Microelectronics and Communications
Technologies ("MCT"). SPN provides public networking systems and software to
telecommunications service providers and public network operators around the
world. Enterprise develops, manufactures, markets and services advanced
communications products and data networking systems for business customers. MCT
designs and manufactures high-performance integrated circuits, power systems and
optoelectronic components for applications in the communications and computing
industries. MCT also includes network products, new ventures and intellectual
property.

The three reportable operating segments are strategic market units that offer
distinct products and services. These segments were determined based on the
customers and the markets that Lucent serves. Each market unit is managed
separately as each operation requires different technologies and marketing
strategies. Intersegment transactions that occur are based on current market
prices and all intersegment profit is eliminated in consolidation.

Performance measurement and resource allocation for the reportable operating
segments are based on many factors. The primary financial measure used is
Operating income, exclusive of goodwill and existing technology amortization,
and of purchased in-process R&D and other costs from business acquisitions
(acquisition/integration-related costs).

Lucent employs shared service concepts to realize economies of scale and
efficient use of resources. The costs of shared services, and other corporate
center operations managed on a common basis, are allocated to the segments based
on usage, where possible, or other factors based on the nature of the activity.
The accounting policies of the reportable operating segments are the same as
those described in the Summary of Significant Accounting Policies (see Note 2).


<PAGE>   48

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                 (Dollars in Millions, Except Per Share Amounts)

<TABLE>
<CAPTION>
                                           REPORTABLE SEGMENTS
                                  --------------------------------------
                                                                               Other* &       Consolidated
YEAR ENDED 9/30/99                   SPN         ENTERPRISE        MCT         CORPORATE         TOTALS
-----------------------           --------       ----------     --------       ---------      ------------
<S>                               <C>            <C>            <C>            <C>             <C>
External revenues                 $ 23,562       $  8,559       $  5,424       $    758        $ 38,303
Intersegment revenues                  183            195          1,318         (1,696)              -
  Total revenues                    23,745          8,754          6,742           (938)         38,303
Depreciation & amortization            690            134            489            493           1,806
Operating income/(loss)              4,563            616            944           (717)          5,406
Assets                              16,939          3,884          4,095         13,857          38,775
Capital expenditures                   675            266            707            567           2,215
----------------------------------------------------------------------------------------------------------
</TABLE>

<TABLE>
<CAPTION>
                                                                            Other* &     Consolidated
YEAR ENDED 9/30/98                  SPN         ENTERPRISE      MCT         CORPORATE       TOTALS
-----------------------           --------      ----------    -------       ---------    ------------
<S>                               <C>           <C>           <C>           <C>            <C>
External revenues                 $19,108       $ 7,954       $ 4,628       $   116        $31,806
Intersegment revenues                 128           148         1,074        (1,350)             -
  Total revenues                   19,236         8,102         5,702        (1,234)        31,806
Depreciation & amortization           638           128           366           279          1,411
Operating income/(loss)             3,107           633           608        (1,710)         2,638
Assets                             12,978         3,421         3,298         9,666         29,363
Capital expenditures                  525           281           646           339          1,791
-----------------------------------------------------------------------------------------------------
</TABLE>

<TABLE>
<CAPTION>
                                                                               Other* &     Consolidated
YEAR ENDED 9/30/97                  SPN         ENTERPRISE         MCT         CORPORATE      TOTALS
-----------------------           --------      ----------      --------       ---------    ------------
<S>                               <C>            <C>            <C>            <C>             <C>
External revenues                 $ 15,675       $  6,257       $  4,238       $  1,441        $ 27,611
Intersegment revenues                  136            130            905         (1,171)              -
  Total revenues                    15,811          6,387          5,143            270          27,611
Depreciation & amortization            730            218            332            219           1,499
Operating income/(loss)              1,517            668            549         (1,135)          1,599
Assets                               9,057          2,486          2,928         10,535          25,006
Capital expenditures                   447            202            686            409           1,744
--------------------------------------------------------------------------------------------------------
</TABLE>

* The results of other smaller units and corporate operations are reported in
Other and Corporate, including eliminations of internal business. Assets
included in Other and Corporate consist principally of cash and cash
equivalents, deferred income taxes, and prepaid pension costs.


<PAGE>   49

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                 (Dollars in Millions, Except Per Share Amounts)

RECONCILING ITEMS

A reconciliation of the totals reported for the operating segments to the
applicable line items in the consolidated financial statements is as follows:

<TABLE>
<CAPTION>
                                                    Year ended September 30,
                                              1999            1998            1997
                                            --------        --------        --------
<S>                                         <C>             <C>             <C>
External Revenues
-----------------
Total reportable segments                   $ 37,545        $ 31,690        $ 26,170
Other operations                                 745              70           1,362
Corporate miscellaneous                           13              46              79
  Total revenues                            $ 38,303        $ 31,806        $ 27,611

Operating Income:
-----------------
Total reportable segments                   $  6,123        $  4,348        $  2,734
Acquisition/integration-related costs           (510)         (1,683)         (1,439)
Goodwill and existing technology
  amortization                                  (394)           (149)            (32)
Other and corporate                              187             122             336
Operating income                               5,406           2,638           1,599
Other income-net                                 443             128              97
Interest expense                                (406)           (254)           (238)

  Income before income taxes                $  5,443        $  2,512        $  1,458
</TABLE>


PRODUCTS AND SERVICES REVENUES

The table below presents external revenue for groups of similar products and
services:

<TABLE>
<CAPTION>
Year Ended 9/30                            1999          1998          1997
                                          -------       -------       -------
<S>                                       <C>           <C>           <C>
Core Networking Systems (a)               $17,750       $14,412       $12,529
Wireless Products                           5,516         4,456         2,984
Business Communications Systems (b)         6,977         6,399         5,077
Microelectronics                            2,827         2,405         2,214
NetCare Professional Services                 768           483           274
Other (c)                                   4,465         3,651         4,533
    Totals                                $38,303       $31,806       $27,611
</TABLE>

(a) Core Networking Systems includes switching and access products, data
    networking systems for service providers, optical networking products,
    communications software and engineering services.

(b) Business Communications Systems includes advanced communications products
    and messaging services.

(c) "Other" principally includes network products.

GEOGRAPHIC INFORMATION

<TABLE>
<CAPTION>
                               EXTERNAL REVENUES (a)           LONG-LIVED ASSETS (b)
                               -----------------               -----------------
                                    Year Ended
                              -------------------------
September 30,           1999        1998        1997        1999        1998        1997
-----------------     -------     -------     -------     -------     -------     -------

<S>                   <C>         <C>         <C>         <C>         <C>         <C>
United States         $26,116     $23,513     $20,858     $ 6,244     $ 5,422     $ 4,696

Foreign countries      12,187       8,293       6,753       1,812       1,531       1,188

          Totals      $38,303     $31,806     $27,611     $ 8,056     $ 6,953     $ 5,884
</TABLE>

(a) Revenues are attributed to geographic areas based on the location of
    customers.

(b) Represents property, plant and equipment (net), and goodwill and existing
    technology.


<PAGE>   50

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                 (Dollars in Millions, Except Per Share Amounts)

CONCENTRATIONS

Historically, Lucent has relied on a limited number of customers for a
substantial portion of its total revenues. Revenues from AT&T Corp. accounted
for approximately, 12%, 12% and 14% of consolidated revenues in the years 1999,
1998 and 1997, respectively, principally in the SPN segment. Lucent expects that
a significant portion of its future revenues will continue to be generated by a
limited number of customers. The loss of any of these customers or any
substantial reduction in orders by any of these customers could materially and
adversely affect Lucent's operating results. Lucent does not have a
concentration of available sources of supply materials, labor, services or other
rights that, if eliminated suddenly, could impact its operations severely.

13.  FINANCIAL INSTRUMENTS

The carrying values and estimated fair values of financial instruments,
including derivative financial instruments were as follows:

<TABLE>
<CAPTION>
                                            September 30, 1999             September 30, 1998
                                          Carrying         Fair          Carrying          Fair
                                           Amount          Value          Amount           Value
                                          -------         -------        --------         -------
<S>                                       <C>             <C>             <C>             <C>
ASSETS
Derivative and off-balance-sheet
instruments:
Foreign currency forward exchange
 contracts/options                        $    18         $    17         $    26         $     4
Letters of credit                               -               2               -               2
LIABILITIES
Long-term debt(1)(2)                      $ 4,083         $ 3,956         $ 2,408         $ 2,559
Derivative and off-balance-sheet
instruments:
Foreign currency forward exchange
 contracts/options                             36              27              25              (4)
</TABLE>

(1) Excluding long-term lease obligations of $79 at September 30, 1999 and $1 at
    September 30, 1998.

(2) For September 30, 1998 reflects the reclassification of debt maturing within
    one year to long-term debt as a result of the November 19, 1998 sale of $500
    ($495 net of unamortized costs) of 10-year notes.

The following methods were used to estimate the fair value of each class of
financial instruments:

<TABLE>
<CAPTION>
Financial Instrument                                Valuation Method
---------------------------------------------------------------------------------------
<S>                                    <C>
Long-term debt                         Market quotes for instruments with similar terms
                                        and maturities

Foreign currency forward exchange
 contracts/options                     Market quotes
Letters of credit                      Fees paid to obtain the obligations
</TABLE>

The carrying amounts of cash and cash equivalents, investments, receivables and
debt maturing within one year contained in the Consolidated Balance Sheets
approximate fair value.

CREDIT RISK AND MARKET RISK
By their nature, all financial instruments involve risk, including credit risk
for non-performance by counterparties. The contract or notional amounts of these
instruments reflect the extent of involvement Lucent has in particular classes
of financial instruments. The maximum potential loss may exceed any amounts
recognized in the Consolidated Balance Sheets. However, Lucent's maximum
exposure to credit loss in the event of nonperformance by the other party to the
financial instruments for commitments to extend credit and financial guarantees
is limited to the amount drawn and outstanding on those instruments.

<PAGE>   51

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                 (Dollars in Millions, Except Per Share Amounts)

Lucent seeks to reduce credit risk on financial instruments by dealing only with
financially secure counterparties. Exposure to credit risk is controlled through
credit approvals, credit limits and monitoring procedures. Lucent seeks to limit
its exposure to credit risks in any single country or region.

All financial instruments inherently expose the holders to market risk,
including changes in currency and interest rates. Lucent manages its exposure to
these market risks through its regular operating and financing activities and
when appropriate, through the use of derivative financial instruments.

DERIVATIVE FINANCIAL INSTRUMENTS
Lucent conducts its business on a multinational basis in a wide variety of
foreign currencies. Consequently, Lucent enters into various foreign exchange
forward and option contracts to manage its exposure against adverse changes in
those foreign exchange rates. The notional amounts for foreign exchange forward
and option contracts represent the U.S. dollar equivalent of an amount
exchanged. Generally, foreign currency exchange contracts are designated for
firmly committed or forecasted sales and purchases that are expected to occur in
less than one year. Gains and losses on all hedged contracts for firmly
committed transactions and option contracts for anticipated transactions are
deferred in Other current assets and liabilities, are recognized in income when
the transactions occur, and are not material to the consolidated financial
statements at September 30, 1999, and 1998. All other gains and losses on
foreign currency exchange contracts are recognized in Other income-net as the
exchange rates change.

Lucent engages in foreign currency hedging activities to reduce the risk that
changes in exchange rates will adversely affect the eventual net cash flows
resulting from the sale of products to foreign customers and purchases from
foreign suppliers. Hedge accounting treatment is appropriate for a derivative
instrument when changes in the value of the derivative instrument are
substantially equal, but opposite, to changes in the value of the exposure being
hedged. Lucent believes that it has achieved risk reduction and hedge
effectiveness, because the gains and losses on its derivative instruments
substantially offset the gains on the assets, liabilities and transactions being
hedged. Hedge effectiveness is periodically measured by comparing the change in
fair value of each hedged foreign currency exposure at the applicable market
rate with the change in market value of the corresponding derivative instrument.

The following table summarizes the notional amounts of these derivative
financial instruments in U.S. dollars. In 1999, these notional amounts
principally represent contracts in Canadian dollars, Brazilian reals, Singapore
dollars, British pounds and Euro currencies (primarily Dutch guilders and German
marks). Notional amounts represent the face amount of the contractual
arrangements and the basis on which U.S. dollars are to be exchanged and are not
a measure of market or credit exposure.

<TABLE>
<CAPTION>
                                         Notional Amounts
                                          September 30,
                                         1999       1998
<S>                                     <C>        <C>
Foreign exchange forward contracts      $1,871     $1,518
Foreign exchange option contracts       $  303     $  130
</TABLE>

Lucent may enter into certain interest rate swap agreements to manage its risk
between fixed, floating and variable interest rates and long-term and short-term
maturity debt instruments. There were no material interest rate swap agreements
in effect during 1999 and 1998.

NON-DERIVATIVE AND OFF-BALANCE-SHEET INSTRUMENTS
Requests for providing commitments to extend credit and financial guarantees are
reviewed and approved by senior management. Management regularly reviews all
outstanding commitments, letters of credit and financial guarantees, and the
results of these reviews are considered in assessing the adequacy of Lucent's
reserve for possible credit and guarantee losses. At September 30, 1999, and
1998, in management's opinion, there was no significant risk of loss in the
event of non-performance of the counterparties to these financial instruments.

<PAGE>   52

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                 (Dollars in Millions, Except Per Share Amounts)

The following table presents Lucent's non-derivative and off-balance-sheet
instruments for amounts committed but not drawn-down and the amounts drawn-down
on such instruments. These instruments may exist or expire without being drawn
upon. Therefore, the amounts committed but not drawn-down do not necessarily
represent future cash flows.

<TABLE>
<CAPTION>
                                  Amounts Committed          Amounts Drawn-
                                       But Not                 down and
                                     Drawn-down               Outstanding
                                     September 30,           September 30,
                                   1999        1998         1999       1998
                                 -------     -------      -------    -------
<S>                              <C>         <C>          <C>        <C>
Commitments to extend credit...  $5,544      $2,086       $1,574     $  536
Guarantees of debt.............  $  108      $   87       $  312     $  205
</TABLE>

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.

GUARANTEES OF DEBT
From time to time, Lucent guarantees the financing for product purchases by
customers and the debt of certain unconsolidated joint ventures. Requests for
providing such guarantees are reviewed and approved by senior management.
Certain financial guarantees are backed by amounts held in trust for Lucent or
assigned to a third-party reinsurer.

LETTERS OF CREDIT
Letters of credit are purchased guarantees that ensure Lucent's performance or
payment to third parties in accordance with specified terms and conditions which
amounted to $931 and $805 as of September 30, 1999 and 1998, respectively.

SECURITIZATION
In September 1999, a subsidiary of Lucent sold approximately $625 of accounts
receivable to a non-consolidated qualified special purpose entity ("QSPE")
which, in turn, sold an undivided ownership interest in these receivables to
entities managed by an unaffiliated financial institution. Additionally, Lucent
transferred a designated pool of qualified accounts receivable of approximately
$700 to the QSPE as collateral for the initial sale. Lucent's retained interest
in the QSPE's designated pool of qualified accounts receivable has been included
in Receivables. Lucent will continue to service, administer and collect the
receivables on behalf of the purchaser. The impact of the above transaction
reduced Receivables and increased cash flows from operating activities in the
Consolidated Statements of Cash Flows by $600.

14. COMMITMENTS AND CONTINGENCIES

In the normal course of business, Lucent is subject to proceedings, lawsuits and
other claims, including proceedings under laws and government regulations
related to environmental and other matters. Such matters are subject to many
uncertainties, and outcomes are not predictable with assurance. Consequently,
the ultimate aggregate amount of monetary liability or financial impact with
respect to these matters at September 30, 1999, cannot be ascertained. While
these matters could affect the operating results of any one quarter when
resolved in future periods and while there can be no assurance with respect
thereto, management believes that after final disposition, any monetary
liability or financial impact to Lucent beyond that provided for at September
30, 1999, would not be material to the annual consolidated financial statements.


<PAGE>   53

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                 (Dollars in Millions, Except Per Share Amounts)

In connection with the formation of Lucent from certain units of AT&T Corp. and
the associated assets and liabilities of those units (the "Separation") and
AT&T's distribution of its remaining interest in Lucent to its shareowners (the
"Distribution"), Lucent, AT&T and NCR Corporation executed and delivered the
Separation and Distribution Agreement, dated as of February 1, 1996, as amended
and restated (the "Separation and Distribution Agreement"), and certain related
agreements. The Separation and Distribution Agreement, among other things,
provides that Lucent will indemnify AT&T and NCR for all liabilities relating to
Lucent's business and operations and for all contingent liabilities relating to
Lucent's business and operations or otherwise assigned to Lucent. In addition to
contingent liabilities relating to the present or former business of Lucent, any
contingent liabilities relating to AT&T's discontinued computer operations
(other than those of NCR) were assigned to Lucent. The Separation and
Distribution Agreement provides for the sharing of contingent liabilities not
allocated to one of the parties, in the following proportions: AT&T: 75%,
Lucent: 22%, and NCR: 3%. The Separation and Distribution Agreement also
provides that each party will share specified portions of contingent liabilities
related to the business of any of the other parties that exceed specified
levels.

ENVIRONMENTAL MATTERS
Lucent's current and historical operations are subject to a wide range of
environmental protection laws. In the United States, these laws often require
parties to fund remedial action regardless of fault. Lucent has remedial and
investigatory activities under way at numerous current and former facilities. In
addition, Lucent was named a successor to AT&T as a potentially responsible
party ("PRP") at numerous "Superfund" sites pursuant to the Comprehensive
Environmental Response, Compensation and Liability Act of 1980 ("CERCLA") or
comparable state statutes. Under the Separation and Distribution Agreement,
Lucent is responsible for all liabilities primarily resulting from or relating
to the operation of Lucent's business as conducted at any time prior to or after
the Separation including related businesses discontinued or disposed of prior to
the Separation, and Lucent's assets including, without limitation, those
associated with these sites. In addition, under such Separation and Distribution
Agreement, Lucent is required to pay a portion of contingent liabilities paid
out in excess of certain amounts by AT&T and NCR, including environmental
liabilities.

It is often difficult to estimate the future impact of environmental matters,
including potential liabilities. Lucent records an environmental reserve when it
is probable that a liability has been incurred and the amount of the liability
is reasonably estimable. This practice is followed whether the claims are
asserted or unasserted. Management expects that the amounts reserved will be
paid out over the periods of remediation for the applicable sites, which
typically range from 5 to 30 years. Reserves for estimated losses from
environmental remediation are, depending on the site, based primarily on
internal or third-party environmental studies, and estimates as to the number,
participation level and financial viability of any other PRPs, the extent of the
contamination and the nature of required remedial actions. Accruals are adjusted
as further information develops or circumstances change. The amounts provided
for in Lucent's consolidated financial statements for environmental reserves are
the gross undiscounted amount of such reserves, without deductions for insurance
or third-party indemnity claims. In those cases where insurance carriers or
third-party indemnitors have agreed to pay any amounts and management believes
that collectibility of such amounts is probable, the amounts are reflected as
receivables in the financial statements. Although Lucent believes that its
reserves are adequate, there can be no assurance that the amount of capital
expenditures and other expenses which will be required relating to remedial
actions and compliance with applicable environmental laws will not exceed the
amounts reflected in Lucent's reserves or will not have a material adverse
effect on Lucent's financial condition, results of operations or cash flows. Any
possible loss or range of possible loss that may be incurred in excess of that
provided for at September 30, 1999, cannot be estimated.


<PAGE>   54

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                 (Dollars in Millions, Except Per Share Amounts)

LEASE COMMITMENTS
Lucent leases land, buildings and equipment under agreements that expire in
various years through 2020. Rental expense under operating leases was $545, $425
and $335 for the years ended September 30, 1999, 1998 and 1997, respectively.
The table below shows the future minimum lease payments due under non-cancelable
leases at September 30, 1999. Such payments total $1,509 for operating leases.
The net present value of such payments on capital leases was $81 after deducting
imputed interest of $15.

<TABLE>
<CAPTION>
                                            Year Ended September 30,
                                                                             Later
                                2000     2001     2002     2003     2004     Years
                                ----     ----     ----     ----     ----     -----

<S>                             <C>      <C>      <C>      <C>      <C>      <C>
Operating leases ...........    $321     $265     $200     $163     $114     $446

Capital leases .............       2       41       20       20       13        -


Minimum lease payments......    $323     $306     $220     $183     $127     $446
</TABLE>


15. SUBSEQUENT EVENTS

International Network Services

On October 15, 1999, Lucent merged with International Network Services "INS", a
global provider of network consulting, design and integration. Pursuant to the
merger agreement, the outstanding INS stock was converted into the right to
receive approximately 49 million shares of Lucent common stock. In addition,
Lucent assumed outstanding employee stock options covering approximately 16
million shares of Lucent common stock. The transaction will be accounted for as
a pooling-of-interests.

Excel Switching Corporation

On November 3, 1999, Lucent merged with Excel Switching Corporation, a Hyannis,
Massachusetts-based developer of programmable switches. Under the terms of the
agreement, the outstanding Excel stock was converted into the right to receive
approximately 22.3 million shares of Lucent common stock. The transaction will
be accounted for as a pooling-of-interests.

Xedia Corporation

On November 12, 1999, Lucent merged with Xedia Corporation, a privately held
Acton, Massachusetts-based maker of routers for corporate networks. Under the
terms of the agreement, the outstanding Xedia capital stock and warrants were
converted into the right to receive approximately 3.86 million shares of Lucent
common stock. The transaction will be accounted for as a pooling-of-interests.

<PAGE>   55


                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                (Dollars in Millions, Except Per Share Amounts)

16. QUARTERLY INFORMATION (UNAUDITED)

<TABLE>
<CAPTION>
                                               FISCAL YEAR QUARTERS
                                        FIRST       SECOND      THIRD        FOURTH        TOTAL
                                       -------     --------     ------      ---------    ----------
<S>                                    <C>         <C>         <C>         <C>           <C>
Year Ended
  September 30, 1999
Revenues.........................     $ 9,741      $8,672      $9,315       $10,575      $ 38,303
Gross margin.....................       5,159       4,178       4,481         4,797        18,615
Net income before cumulative            1,231(a)      529(b)      750(c)        948(d)      3,458(a,b,c,d)
   effect of accounting change...
Cumulative effect of accounting
   change........................       1,308           -           -            -          1,308
Net income.......................     $ 2,539(a)   $  529(b)   $  750(c)    $   948(d)   $  4,766(a,b,c,d)
Earnings per
 common share - basic:
  Income before cumulative
   effect of accounting change...     $  0.41(a)   $ 0.17(b)   $ 0.25(c)    $ 0.31(d)    $ 1.14(a,b,c,d)
  Cumulative effect of accounting
   change........................        0.43           -           -            -         0.43
  Net income ....................     $  0.84(a)   $ 0.17(b)   $ 0.25(c)    $ 0.31(d)    $ 1.57(a,b,c,d)
Earnings per common share - diluted:
  Income before cumulative
   effect of accounting change...     $  0.40(a)   $ 0.17(b)   $ 0.24(c)    $ 0.30(d)    $ 1.10(a,b,c,d)
  Cumulative effect of accounting
   change........................        0.42           -           -            -         0.42
  Net income.....................     $  0.82(a)   $ 0.17(b)   $ 0.24(c)    $ 0.30(d)    $ 1.52(a,b,c,d)


Dividends per share.............      $  0.04      $ 0.00      $ 0.02       $ 0.02       $ 0.08
Stock price:(i)
   High.........................      56 15/16     60          68 11/16     79  3/4      79   3/4
   Low..........................      26 23/32     47          51   7/8     60           26 23/32
   Quarter-end close............      54 31/32     54          67  7/16     64  7/8      64   7/8

Year Ended
  September 30, 1998
Revenues........................      $ 9,079      $6,511      $7,642       $8,574       $31,806
Gross margin....................        4,447       2,958       3,555        4,131        15,091
Net income(loss)................          877(e)       88(f)     (150)(g)      220(h)      1,035(e,f,g,h)
Earnings(loss) per
  common share - basic...........     $  0.30(e)   $ 0.03(f)   $(0.05)(g)   $ 0.07(h)    $ 0.35(e,f,g,h)
Earnings(loss) per
 common share - diluted.........      $  0.29(e)   $ 0.03(f)   $(0.05)(g)   $ 0.07(h)    $ 0.34(e,f,g,h)
Dividends per share.............      $  0.0375    $ 0.00      $ 0.02       $ 0.02       $ 0.0775
Stock price:(i)
   High.........................      22 35/64     32  1/16    41 27/32     54  1/4      54  1/4
   Low..........................      18  3/32     18 23/64    32           34 3/16      18 3/32
   Quarter-end close............      19 31/32     31 31/32    41 19/32     34  5/8      34  5/8
</TABLE>

(a) As a result of the 1999 acquisitions of Quadritek and Stratus, Lucent
    recorded an after-tax charge of $281 in the first quarter for purchased
    in-process research and development.

(b) As a result of the 1999 acquisitions of WaveAccess, Enable Ethernet, and
    Sybarus, Lucent recorded an after-tax charge of $15 in the second quarter
    for purchased in-process research and development. In addition, $24 of
    Stratus purchased in-process research and development was reversed.

(c) As a result of the merger with Ascend, Lucent recorded a charge to operating
    expenses of approximately $79 million (non-tax impacting)in the third
    quarter for direct merger-related costs.



<PAGE>   56

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                 (Dollars in Millions, Except Per Share Amounts)

(d) As a result of the mergers with Ascend and Nexabit, Lucent recorded pretax
costs of $258 million ($191 million after-tax) in the fourth quarter primarily
associated with assets impairments, integration-related charges and merger
expenses. These costs principally include the write-off of Livingston goodwill
and existing technology, certain product and system integration and direct
merger expenses related to Nexabit.

(e) As a result of the 1998 acquisition of Livingston, Lucent recorded a non-tax
    charge of $427 in the first quarter for purchased in-process research and
    development.

(f) As a result of the 1998 acquisition of Prominet, Lucent recorded a non-tax
    charge of $157 in the second quarter for purchased in-process research and
    development.

(g) As a result of the 1998 acquisitions of Yurie and Optimay, Lucent recorded a
    non-tax charge of $668 in the third quarter for purchased in-process
    research and development.

(h) As a result of the 1998 acquisitions of SDX, MassMedia, LANNET, JNA and
    Stratus, Lucent recorded a charge of $431 ($427 after-tax) in the fourth
    quarter for purchased in-process research and development.

(i) Obtained from the Composite Tape. Stock prices have been restated to reflect
    the two-for-one splits of the Company's common stock effective April 1,
    1998, and April 1, 1999.