##### 

EXHIBIT 13

LUCENT TECHNOLOGIES FINANCIAL REVIEW 2005

|                                                                                              |                                           |                                                                         |      |     
|--------------------------------------------------------------------------------------------- | ----------------------------------------- | ----------------------------------------------------------------------- | ---- | ----
|Managements
    Discussion and Analysis of Financial Condition and Results of
    Operations |                                           |                                                                        
|                                                                                              |                                           | Forward-Looking
    Statements                                          |      | F-2 
|                                                                                              |                                           | Executive
    Summary                                                   |      | F-2 
|                                                                                              |                                           | Application of
    Critical Accounting Estimates                        |      | F-6 
|                                                                                              |                                           | Consolidated
    Results of Operations                                  |      | F-12
|                                                                                              |                                           | Results of
    Operations by Segment                                    |      | F-23
|                                                                                              |                                           | Liquidity and
    Capital Resources                                     |      | F-27
|                                                                                              |                                           | Quantitative
    and Qualitative Disclosures About Market Risk          |      | F-33
|Five-Year
    Summary of Selected Financial Data                                              |                                           | F-35                                                                   
|Report on
    Internal Control Over Financial Reporting                                       |                                           | F-36                                                                   
|Report of
    Independent Registered Public Accounting Firm                                   |                                           | F-37                                                                   
|Consolidated
    Financial Statements                                                         |                                           |                                                                        
|                                                                                              |                                           | Consolidated
    Statements of Operations                               |      | F-38
|                                                                                              |                                           | Consolidated
    Balance Sheets                                         |      | F-39
|                                                                                              |                                           | Consolidated
    Statements of Changes in Shareowners Equity (Deficit) |      | F-40
|                                                                                              |                                           | Consolidated
    Statements of Cash Flows                               |      | F-41
|Notes to
    Consolidated Financial Statements                                                |                                           |                                                                        
|                                                                                              |                                           | 1. Summary
    of Significant Accounting Policies                       |      | F-42
|                                                                                              |                                           | 2. Business
    Restructuring                                           |      | F-46
|                                                                                              |                                           | 3. Business
    Acquisitions                                            |      | F-49
|                                                                                              |                                           | 4. Supplementary
    Financial Information                              |      | F-50
|                                                                                              |                                           | 5. Earnings
    (Loss) Per Common Share                                 |      | F-52
|                                                                                              |                                           | 6. Accumulated
    Other Comprehensive Loss                             |      | F-53
|                                                                                              |                                           | 7. Income
    Taxes                                                     |      | F-54
|                                                                                              |                                           | 8. Debt
    Obligations and Early Extinguishment of Debt                |      | F-57
|                                                                                              |                                           | 9. Employee
    Benefit Plans                                           |      | F-59
|                                                                                              | 10. Stock
    Compensation Plans          |                                                                         | F-66
|                                                                                              | 11. Operating
    Segments                |                                                                         | F-67
|                                                                                              | 12. Financial
    Instruments             |                                                                         | F-70
|                                                                                              | 13. Commitments
    and Contingencies     |                                                                         | F-74
|                                                                                              | 14. Subsequent
    Events                 |                                                                         | F-79
|                                                                                              | 15. Quarterly
    Information (Unaudited) |                                                                         | F-80

F-1



---



##### 

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





FORWARD-LOOKING STATEMENTS

This Managements Discussion and Analysis of Financial
Condition and Results of Operations (MD&A)
contains forward-looking statements that are based on current
expectations, estimates, forecasts and projections about us, our
future performance, the industries in which we operate, our
beliefs and our managements assumptions. In addition,
other written or oral statements that constitute forward-looking
statements may be made by us or on our behalf. Words such as
expects, anticipates,
targets, goals, projects,
intends, plans, believes,
seeks, estimates, variations of such
words and similar expressions are intended to identify such
forward-looking statements. These statements are not guarantees
of future performance and involve certain risks, uncertainties
and assumptions that are difficult to assess. Therefore, actual
outcomes and results may differ materially from what is
expressed or forecasted in such forward-looking statements.
These risks and uncertainties include: our ability to operate
effectively in a highly competitive industry with many
participants; our ability to keep pace with technological
advances and correctly identify and invest in the technologies
that become commercially accepted; our reliance on a small
number of key customers; fluctuations in the telecommunications
market; the pricing, cost and other risks inherent in our
long-term sales agreements; exposure to the credit risk of our
customers; our reliance on two contract manufacturers to supply
most of the products we sell; the social, political and economic
risks of our foreign operations; the costs and risks associated
with our pension and postretirement benefit obligations; the
complexity of our products; changes to existing regulations or
technical standards; existing and future litigation; our ability
to protect our intellectual property rights and exposure to
infringement claims by others; and compliance with
environmental, health and safety laws. For a more complete list
and description of such risks and uncertainties, see the reports
filed by us with the Securities and Exchange Commission. Except
as required under the federal securities laws and the rules and
regulations of the SEC, we do not have any intention or
obligation to update publicly any forward-looking statements
after the distribution of this MD&A, whether as a result of
new information, future events, changes in assumptions or
otherwise.





EXECUTIVE SUMMARY

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

There has been some consolidation among service providers as
they look to expand their scope and scale while improving cost
efficiencies. This industry dynamic presents both challenges and
opportunities for equipment vendors. One potential challenge may
come in the form of rationalized capital spending in the future.
However, we anticipate that there will also be opportunities, as
carriers will require assistance integrating these large,
complex networks. Also, depending on the service providers
involved, some of the consolidation could enable certain vendors
to extend their reach to customers that were previously focused
on different technologies or areas.

F-2



---



##### 

We believe the telecom industry is in the early stages of a
multiyear transformation to next-generation networks. As a
result we have been focusing on certain high-growth areas, such
as services, Internet protocol (IP) multimedia subsystem
(IMS), broadband access, optical and next generation mobile
high-speed data. As this transformation progresses, our
customers are increasingly focused on deploying new IP-based,
revenue-generating services that will differentiate their
businesses and build customer loyalty. However, the actual
trialing, testing and deployment of these new technologies will
take time. This is a long-term technology transition, which will
create opportunities for us and our customers in growth areas
such as mobile high-speed data, broadband access, metro optical
networking and voice over Internet protocol (VoIP) solutions, as
well as in professional and managed services. We are working to
turn these technologies and opportunities into cost-effective
offers for our customers.

Within this environment, certain service providers are currently
investing to meet growing capacity demands. These demands are
being driven by the coverage requirements, subscriber growth and
traffic increases that place demands on networks of all kinds.
In addition, service providers have increased investments in the
systems, software and technologies that enable next-generation
services that cut across wireline and wireless, as well as
voice, video and data. There is also a growing interest in
content such as games, music and entertainment.

To meet these challenges, we have been adapting our product
portfolio around a common IMS platform that gives our customers
the flexibility to build the types of networks and offer the
types of services required to best meet the demand for converged
broadband services. Effective October 1, 2005, we combined
our mobility and wireline businesses into a single unit, the
Network Solutions Group. We expect this change to:




    More efficiently deliver a common set of IMS-based solutions to
    our customers.
    Improve our time-to-market by streamlining supply and design
    chains and shortening our product development cycles.
    Further simplify our operations through increased
    standardization of processes and platforms.
    Further reduce our cost and expense structure by eliminating
    redundancies across all parts of the company, including support
    functions.
    And lastly, assure that we maximize the leverage of our complete
    breadth of end-to-end offers for example, providing optical
    back-haul solutions to our mobile customers.We expect to achieve operating efficiencies as a result of these
efforts. These changes will allow us to more effectively focus
our efforts and resources on pursuing high-growth areas where we
have strong technology, market or customer advantages. We
believe that focusing on these areas will allow us to serve our
customers better and provide us with the best opportunity to
profitably grow the business.

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

F-3



---



##### 

The following table includes certain financial information.

|                            |          |                           |       |       |      |   |       |        |  |   |       |    |  |        |       |       |  |   |        |    | 
|--------------------------- | -------- | ------------------------- | ----- | ----- | ---- | - | ----- | ------ |  | - | ----- | -- |  | ------ | ----- | ----- |  | - | ------ | -- | 
|                            |          | Years ended September 30, |      
|(in millions)               |          | 2005                      |       |       | 2004 |   |       | Change |  |   | 2003  |    |  | Change |      
|                            |          |                           |       |       |      |   |       |        |  |   |       |    |  |        |      
|Mobility                    |          | $                         | 4,600 |       |      | $ | 4,117 |        |  |   | 12%   |    |  | $      | 3,147 |       |  |   | 31%    |   
|INS                         |          |                           | 2,565 |       |      |   | 2,874 |        |  |   | (11%  | )  |  |        | 3,233 |       |  |   | (11%   | ) 
|Services                    |          |                           | 2,129 |       |      |   | 1,932 |        |  |   | 10%   |    |  |        | 1,840 |       |  |   | 5%     |   
|Patent licensing            |          |                           | 113   |       |      |   | 72    |        |  |   | 57%   |    |  |        | 202   |       |  |   | (64%   | ) 
|Other                       |          |                           | 34    |       |      |   | 50    |        |  |   | (32%  | )  |  |        | 48    |       |  |   | 4%     |   
|                            |          |                           |       |       |      |   |       |        |  |   |       |    |  |        |      
|                            | Revenues |                           | $     | 9,441 |      |   | $     | 9,045  |  |   |       | 4% |  |        | $     | 8,470 |  |   |        | 7% | 
|                            |          |                           |       |       |      |   |       |        |  |   |       |    |  |        |      
|Gross margin                |          | $                         | 4,124 |       |      | $ | 3,779 |        |  | $ | 345   |    |  | $      | 2,652 |       |  | $ | 1,127  |   
|Gross margin rate           |          |                           | 44%   |       |      |   | 42%   |        |  |   | 2 pts |    |  |        | 31%   |       |  |   | 11 pts |   
|                            |          |                           |       |       |      |   |       |        |  |   |       |    |  |        |      
|Operating expenses          |          | $                         | 2,863 |       |      | $ | 2,560 |        |  | $ | 303   |    |  | $      | 2,874 |       |  | $ | (314   | ) 
|Percentage of revenue       |          |                           | 30%   |       |      |   | 28%   |        |  |   | 2 pts |    |  |        | 34%   |       |  |   | (6 pts | ) 
|                            |          |                           |       |       |      |   |       |        |  |   |       |    |  |        |      
|Operating income (loss)     |          | $                         | 1,261 |       |      | $ | 1,219 |        |  | $ | 42    |    |  | $      | (222  | )     |  | $ | 1,441  |   
|Other income (expense), net |          |                           | 114   |       |      |   | 240   |        |  |   |       |    |  |        | (428  | )     |  |   |        |   
|Interest expense            |          |                           | 341   |       |      |   | 396   |        |  |   |       |    |  |        | 353   |       |  |   |        |   
|Income tax benefit          |          |                           | (151  | )     |      |   | (939  | )      |  |   |       |    |  |        | (233  | )     |  |   |        |   
|                            |          |                           |       |       |      |   |       |        |  |   |       |    |  |        |      
|Net income (loss)           |          | $                         | 1,185 |       |      | $ | 2,002 |        |  |   |       |    |  | $      | (770  | )     |  |   |        |   
|                            |          |                           |       |       |      |   |       |        |  |   |       |    |  |        |      





| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Mobility revenues continued to increase due to deployment of
    EVDO and CDMA network expansion in the U.S., as certain of our
    large customers increase network investment for high-speed
    mobile data services and deploy additional capacity to support
    subscriber growth. INS revenues continued to decrease due to
    lower sales of legacy circuit switching and personal handyphone
    systems (PHS), as declines in these product sales continue to
    outpace growth in spending on next-generation technologies.
    Services revenues increased due to higher professional services
    and government contracts.                
|
| |  | The gross margin rate continued to increase during fiscal 2005
    as a result of a more favorable mix. The impact of competitive
    pricing pressures was offset by cost reductions. The improvement
    during fiscal 2004 primarily resulted from the impact of cost
    reductions and product mix, as well as certain other items,
    including lower inventory-related and warranty-related charges.
    The Mobility and Services gross margin rates increased during
    fiscal 2005, although to a lesser extent than in fiscal 2004.
    The INS gross margin rate decreased during fiscal 2005,
    following an increase during fiscal 2004.
|
| |  | Fiscal 2005 operating expenses increased primarily due to lower
    recoveries of bad debt and customer financing, additional
    selling expenses to support the Global Sales Organization and
    Services growth initiatives and higher charges related to
    various litigation matters. Fiscal 2004 operating expenses
    decreased as a result of the restructuring actions taken in the
    prior periods.                                                                                                                                                                                                                                       
|
| |  | The net pension and postretirement credit was $718 million,
    $868 million and $669 million (excluding the impact of
    restructuring actions) during fiscal 2005, 2004 and 2003,
    respectively, and is expected to decline by approximately
    $300 million during fiscal 2006. Also, additional stock
    compensation charges of approximately $100 million are
    expected to be recognized as a result of the adoption of
    SFAS 123R during fiscal 2006.                                                                                                                                                                                  

F-4



---



##### 


    Other income (expense) includes, among other items, the
    impact of charges that were recognized due to changes in the
    estimated fair value of the warrants issued as part of the
    global settlement of our shareowner litigation and interest
    income related to income tax settlements.
    Valuation allowances were maintained on substantially all of our
    net deferred tax assets. As a result, federal and certain state
    and non-U.S. income taxes attributable to pre-tax income
    were not provided during fiscal 2005 and 2004, nor were income
    tax benefits attributable to pre-tax losses recognized during
    fiscal 2003. However, income tax benefits were recognized
    primarily as a result of valuation allowance reversals related
    to certain carryback claims and other potential sources of
    taxable income, including an $816 million federal net
    operating loss carryback claim recognized during fiscal 2004 and
    additional benefits from the favorable resolution of certain
    income tax audit matters.
    We expect to recognize approximately $170 million of income
    taxes during fiscal 2006, including non-cash impacting
    U.S. deferred taxes of approximately $100 million. The
    balance is attributable to non-U.S. income taxes. The
    expected tax expense will be recognized throughout the year and
    is likely to change during fiscal 2006 as a result of a number
    of variables, including our assessment of the realization of
    deferred tax assets.
    Cash and cash equivalents and marketable securities were
    $4.9 billion as of September 30, 2005 and 2004. The
    fiscal 2005 statement of cash flows includes a federal
    income tax refund of $902 million, a final payment in
    connection with the shareowner litigation settlement of
    $215 million and repayment of certain debt obligations and
    convertible securities of $547 million.We are taking certain actions that are designed to improve our
efficiency, market approach and cost structure, including:




    The formation of the Network Solutions Group and the related
    benefits that were discussed above.
    The implementation of a services-led software strategy that will
    combine the network operations software business with the
    Services business, which is expected to bring better alignment,
    focus and efficiency.
    The optimization of our supply chain network, including the
    consolidation of our EMS (electronic manufacturing service)
    providers from four to two.
    The continuation of business process simplification efforts
    across the company, including corporate centers.Our expectations regarding fiscal 2006 results are as follows:




    An annual revenue growth rate on a percentage basis to be in the
    mid-single digits, with slightly higher revenues during the
    second half of the fiscal year compared to the first half of the
    fiscal year.
    An increase in Mobility revenues, but at a more modest annual
    growth rate than the fiscal 2005 annual growth rate of 12%.
    INS revenues stabilizing at or slightly below the fiscal 2005
    level of about $2.45 billion, adjusted for the transfer of
    the Network Operations Software unit to the Services business
    effective October 1, 2005.
    An increase in Services revenues at an annual rate comparable to
    or slightly above the fiscal 2005 annual growth rate of 10%.
    An annual gross margin rate in the 41% to 43% range.
    Annual operating expenses as a percentage of revenue of about
    30%.The above items are forward-looking statements about our
expectations for future performance. Actual results could differ
materially.

F-5



---



##### 

APPLICATION OF CRITICAL ACCOUNTING ESTIMATES

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

There were no accounting policies adopted during fiscal 2005
that had a material effect on our financial condition or results
of operations. Refer to Note 1 to our consolidated
financial statements for our significant accounting policies.

Revenue recognition

Most of our sales are generated from complex contractual
arrangements that require significant revenue recognition
judgments in determining the units of delivery and related
values, as well as determining whether acceptance milestones
have been achieved. These judgments are particularly important
in the areas of multiple-element arrangements, the application
of software revenue recognition rules and contract accounting
and the assessment of collectibility.

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

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

The percentage-of-completion method of accounting is used for
sales generated from certain contracts, primarily those related
to customized network solutions and network build-outs with
durations of at least six months. We make important judgments in
estimating revenue and cost and in measuring progress toward
completion. These judgments underlie our determinations
regarding overall contract value, contract profitability and
timing of revenue recognition. Revenue and cost estimates are
revised periodically based on changes in circumstances. Revenues
recognized under the percentage-of-completion method of
accounting have increased during recent fiscal years,
representing 25%, 24% and 18% of total revenues during fiscal
2005, 2004 and 2003, respectively. The threshold for contracts
that qualify for the percentage-of-completion method of
accounting was lowered to $5 million from $20 million,
which resulted in $44 million of additional revenue
recognized during fiscal 2005.

F-6



---



##### 

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

Deferred revenues were $529 million and $593 million
as of September 30, 2005 and 2004, respectively.

Pension and postretirement benefits

Our results of operations include the impact of significant
pension and postretirement benefits that are measured using
actuarial valuations. Inherent in these valuations are key
assumptions, including assumptions about discount rates,
expected return on plan assets and expected participation rates
in retirement health care plans. These assumptions are updated
on an annual basis at the beginning of each fiscal year or more
frequently upon the occurrence of significant events. Changes in
the related pension and postretirement benefit costs or credits
may occur in the future due to changes in the assumptions. Our
net pension and postretirement credit (net pension
credit) was $718 million, $868 million and
$669 million during fiscal 2005, 2004 and 2003,
respectively, excluding the impact of restructuring actions.
Approximately two-thirds of these amounts are allocated to
operating expenses, with the balance in costs used to determine
gross margin. The allocation is based on a recent comparison of
salaries that are related to costs and those that are related to
operating expenses. Refer to our Consolidated Results of
Operations section of this MD&A for a further
discussion of changes in the net pension credit and the related
impact on our results.

The expected rate of return on pension plan assets used to
develop our pension credit was 8.5%, 8.75% and 8.75% during
fiscal 2005, 2004 and 2003, respectively, and is determined at
the beginning of the period. We plan to use an expected rate of
return of 8.5% during fiscal 2006. Changes in the rate were
generally due to lower expected future returns based on studies
performed by our external investment advisors. Similar changes
were made to our expected rate of return on postretirement plan
assets due to lower expected future returns, as well as for
changes in the mix of assets held. A lower expected rate of
return reduces our net pension credit and profitability.

The discount rate used to determine our pension credit was 5.5%,
5.75% and 6.5% during fiscal 2005, 2004 and 2003, respectively.
The discount rate is determined at the beginning of the period.
We plan to use a discount rate of 5.5% during fiscal 2006.
Changes in the discount rate were due to declining long-term
interest rates. The discount rate is also somewhat volatile
because it is determined based upon the prevailing rate as of
the measurement date. Similar adjustments were made to the
discount rate used to determine our postretirement benefit cost.
The discount rate used to determine the postretirement benefit
costs is slightly lower due to a shorter expected duration of
postretirement plan obligations as compared to pension plan
obligations. A lower discount rate increases the plan
obligations and reduces our net pension credit and profitability
for those plans where actuarial losses are being amortized.
Otherwise, a lower discount rate increases our net pension
credit and profitability.

The expected rate of return on pension plan assets and the
discount rate as well as the amortization of unrecognized
actuarial gains and losses were determined in accordance with
consistent methodologies, as described in Note 9 to our
consolidated financial statements.

Mortality assumptions were updated as of September 30,
2005, using actual company experience during the most recent
four years for retirees and the RP2000 Mortality Table for all
other participants. This resulted in an increase in the
management pension obligation of approximately $500 million
and a decrease in the occupational pension obligation of
approximately $200 million. Additionally, this change is
expected to reduce the fiscal 2006 net pension credit by
approximately $50 million.

F-7



---



##### 

Holding all other assumptions constant, a 0.5% increase or
decrease in the discount rate would have decreased the fiscal
2005 net pension credit by approximately $50 million
and $20 million, respectively. The impact of changes in the
discount rate is different if the resulting actuarial gains or
losses are subject to amortization. A 0.5% increase or decrease
in the expected return on plan assets would have increased or
decreased the fiscal 2005 net pension credit by
approximately $180 million. In addition, a 0.5% increase or
decrease in the discount rate would have decreased or increased
the fiscal 2005 pension obligation by approximately
$1.4 billion and the postretirement obligation by
approximately $250 million.

There have been several recent developments related to retiree
health care benefits, including changes in benefits, cost
sharing and legislation, such as Medicare Part D of the
Medicare Prescription Drug Improvement and Modernization Act of
2003. These legislative changes and recent experience with
participation rates for management retiree plans have required
us to assess the expected future participation rates of certain
retirees in the existing plans. Generally, we assume that
approximately 3% to 5% of all retirees subject to cost sharing
will opt out of our plans on an annual basis. The impact of
these participation rates favorably impacted our annual net
pension credit and profitability by approximately
$60 million during fiscal 2005. The impact of differences
between actual and assumed experience will affect our net
pension credit and profitability in the future through the
amortization of actuarial gains or losses.

We have taken various actions to reduce our share of retiree
health care costs during recent periods, including the shifting
of certain costs to our retirees. Our retiree health care
obligations are determined using the terms of the current plans.
Health care benefits for employees who retired prior to
March 1, 1990 are not subject to annual dollar caps on the
Companys share of future benefit costs. The benefit
obligation associated with this retiree group approximated 60%
of the total retiree health care obligation. Management
employees who retired on or after March 1, 1990 have paid
amounts above their caps since 2001. The obligation related to
plans covering formerly represented retirees who retired on or
after March 1, 1990 assumed that annual dollar caps are
effective and were enforced beginning November 1, 2004. We
either waived or increased these caps in two prior negotiations.
Our collective bargaining agreements were ratified during
December 2004 and will expire on May 26, 2012.

The agreements address retiree health care benefits, among other
items. We agreed to continue to subsidize these benefits up to
the established cap level consistent with our current actuarial
assumptions. Except for costs attributable to an implementation
period that ended on February 1, 2005, costs that are in
excess of this capped level are being borne by the retirees in
the form of premiums and plan design changes. We also agreed to
establish a new $400 million trust that is being funded by
us over eight years and managed jointly by trustees appointed by
the Company and the unions. The trust is being used to mitigate
the cost impact on retirees of premiums or plan design changes.
The agreements also acknowledge that retiree health care
benefits will no longer be a subject of bargaining between the
Company and the unions.

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

The estimated accumulated benefit obligation related to the
U.S. management employees pension plan and several
other smaller pension plans exceeded the fair value of the plan
assets as of September 30, 2005, 2004 and 2003. Changes in
the minimum pension liability increased our shareowners
equity by $46 million and $150 million during fiscal
2005 and 2004, respectively, and increased our shareowners
deficit by $594 million during fiscal 2003.

F-8



---



##### 

The discount rate used to determine the minimum pension
liability was 5.5%, 5.5% and 5.75% as of September 30,
2005, 2004 and 2003, respectively. Changes in the discount rate
were due to the reasons described above. Market conditions and
interest rates significantly affect the future assets and
liabilities of our pension plans. Holding all other assumptions
constant, a 0.5% decrease or increase in the discount rate would
have increased or decreased the minimum pension liability by
approximately $900 million as of September 30, 2005.

Income taxes

Changes in valuation allowances favorably impacted our results
of operations by $357 million and $1.2 billion during
fiscal 2005 and 2004, respectively, and unfavorably impacted our
results of operations by $129 million during fiscal 2003.
Our valuation allowance for net deferred tax assets was
$7.3 billion and $8.0 billion as of September 30,
2005 and 2004, respectively.

We have significant deferred tax assets, resulting from tax
credit carryforwards, net operating loss carryforwards and
deductible temporary differences that may reduce taxable income
in future periods. We also have significant deferred tax
liabilities resulting from taxable temporary differences that
may result in taxable amounts in future periods. Valuation
allowances have been established and maintained for deferred tax
assets based on a more likely than not threshold.
Refer to Note 7 to our consolidated financial statements
for further components of the deferred tax assets and
liabilities and related valuation allowances.

The realization of deferred tax assets depends upon the
existence of sufficient taxable income within the carryback or
carryforward periods under the tax law for each tax
jurisdiction. We have considered the following possible sources
of taxable income when assessing the realization of the deferred
tax assets:




    Future taxable income exclusive of reversing temporary
    differences and carryforwards.
    Future reversals of existing taxable temporary differences.
    Taxable income in prior carryback years.
    Tax planning strategies.We have not relied upon future taxable income exclusive of
temporary differences and carryforwards for the realization of
U.S. deferred tax assets during recent periods. Reliance on
this source is difficult when there is negative evidence such as
cumulative losses in recent years, even if income is reported in
the current period. Cumulative losses weigh heavily in the
overall assessment. We determine cumulative losses on a rolling
twelve-quarter basis. We are no longer in a cumulative loss
position in the U.S. as of September 30, 2005, and as
a result, considered the extent to which we could rely on income
forecasts to support the realization of our U.S. deferred
tax assets. Income forecasts were considered in conjunction with
other positive and negative evidence, including our current
financial performance, our market environment and other factors.
Although profits were generated in recent periods, a substantial
amount of the profits were generated from a pension credit that
is not currently taxable and from non-U.S. sources. As a
result, we concluded that there was not sufficient positive
evidence to enable us to conclude that it was more likely than
not that the net U.S. deferred tax assets would be
realized. Therefore, we have maintained a valuation allowance on
our net U.S. deferred tax assets. This assessment will
continue to be undertaken in the future. Our results of
operations might be favorably impacted in the future by
reversals of valuation allowances if we are able to demonstrate
sufficient positive evidence that our deferred tax assets will
be realized.

We have assumed that all of our deferred tax liabilities will
generate taxable income or reduce potential tax deductions. Most
of these deferred tax liabilities are related to prepaid pension
costs that result primarily from pension credits that are not
currently taxable. The tax impacts for pension, retiree health
care and other retiree benefits are usually driven by funding
requirements. Valuation allowances were reversed in recent
periods as a result of reductions in net deferred tax assets
driven by pension credits. These reversals have resulted in more
reliance on the expected reversal of taxable temporary
differences for the realization of deferred tax assets, rather
than valuation allowances. We have limited this potential source
of future taxable income to the extent of the related deferred
tax assets for retiree benefits after considering potential
funding scenarios and actions such as Section 420
transfers. We expect that the deferred taxes associated with
retiree benefits will be in a net liability position by
approximately $100 million as of September 30, 2006,
which would result in a corresponding deferred tax charge during
fiscal 2006, beginning in the first quarter.

F-9



---



##### 

Our assumptions regarding the future tax consequences of retiree
benefits might change for various reasons, including changes in
legislation, actual return on plan assets, Section 420
transfers, or changes in plan design. Such changes could impact
our valuation allowance assessment and necessitate additional
charges. In addition, we have deferred tax assets attributed to
additional minimum pension liabilities that were established
through direct charges to equity. If these liabilities were to
reverse in future periods, charges to our results of operations
will be required for the related deferred tax impacts. The
potential deferred tax charges associated with these liabilities
were $1.3 billion as of September 30, 2005.

During the fourth quarter of fiscal 2003, we filed a net
operating loss carryback claim related to the carryback of our
fiscal 2001 federal net operating loss to 1996, a year in which
we filed our federal income tax return as part of the AT&T
consolidated group. We reached a tentative agreement with the
Internal Revenue Service (IRS) on September 1, 2004 that
allowed for a tax refund of $816 million (plus statutory
interest to the date of payment), subject to approval by the
Congressional Joint Committee on Taxation. The tax benefit
related to the claim was not recognized at that time or prior to
that time, because it was related to a complex matter and there
was no assurance that the approval from the Joint Committee
would be obtained. On November 8, 2004, we received written
confirmation from the IRS that the Joint Committee had approved
our tentative agreement with the IRS and that our agreement with
the IRS was final. We were required to reassess the realization
of our net operating loss carryforwards as of September 30,
2004, because the Joint Committees final approval was
received prior to the issuance of our consolidated financial
statements. As a result, an $816 million income tax benefit
and $45 million of interest income was recognized during
the fourth quarter of fiscal 2004 from the reversal of valuation
allowances. An additional $41 million of interest income
was recognized during fiscal 2005. The $902 million refund
was received during the fourth quarter of fiscal 2005.

We assess the realization of deferred tax assets in each
jurisdiction in a manner similar to that discussed above. We
reversed $81 million and $17 million of valuation
allowances related to non-U.S. tax jurisdictions during
fiscal 2005 and 2004, respectively. We determined that it was
more likely than not that these net deferred tax assets were
realizable based upon actual financial performance and future
income projections and certain other factors for those
jurisdictions. We were not in a cumulative loss position in
these jurisdictions at the time of the reversals.

We assess the likelihood of the ultimate determination of
various contingent tax liabilities that arise in many different
tax jurisdictions. These tax matters can be complex in nature
and uncertain as to the ultimate outcome. We establish reserves
for tax contingencies when we believe an unfavorable outcome is
likely to occur and the liability can be reasonably estimated,
similar to accounting for other contingencies. Although we
believe these positions are fully supportable, we consider the
likelihood of potential challenges and the sustainability of
such challenges upon examination. Changes in our tax reserves
have occurred and are likely to continue to occur as our
assessments change based on current facts and circumstances,
such as further developments and progress of tax examinations in
various jurisdictions. The net impact of the reassessments of
such changes, primarily from the finalization of tax audits,
resulted in the recognition of income tax benefits of
$130 million, $142 million and $77 million during
fiscal 2005, 2004 and 2003, respectively.

F-10



---



##### 

Legal contingencies

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

Intangible assets

Our intangible assets include goodwill and other acquired
intangibles of $419 million, development costs for software
to be sold, leased or otherwise marketed of $254 million
and internal use software development costs of $120 million
as of September 30, 2005. As a result of the Telica
acquisition in fiscal 2004, goodwill and other acquired
intangible assets of $238 million were recorded. Refer to
Note 3 to our consolidated financial statements for
information related to the purchase price allocation.

Goodwill is not amortized but is tested for impairment annually,
or more often, if an event or circumstance indicates that an
impairment loss may have been incurred. Other intangible assets
are amortized on a straight-line basis over their estimated
useful lives and reviewed for impairment whenever events such as
product discontinuances, plant closures, product dispositions or
other changes in circumstances indicate that the carrying amount
may not be recoverable.

The initial goodwill impairment test under
SFAS No. 142 was completed during the first quarter of
fiscal 2003 and resulted in no transitional impairment loss. We
assessed the realization of goodwill related to our
multi-service switching reporting unit currently referred to as
the data networking group within INS during the third quarter of
fiscal 2003 as a result of business decisions to partner with
other suppliers to use their products in our sales offerings.
The reporting units fair value was determined using
projected cash flows over a seven-year period discounted at 15%
after considering terminal value and related cash flows
associated with service revenues. The excess of the carrying
amount of the reporting units goodwill over its implied
fair value in the amount of $35 million was recognized as
an impairment charge in the third quarter of fiscal 2003. The
annual goodwill impairment tests completed during the fourth
quarter of fiscal 2005, 2004 and 2003 did not result in an
impairment loss.

Goodwill and acquired intangible assets of $295 million are
assigned to reporting units in INS as of September 30,
2005, including $63 million to the data networking group
and $169 million to the next-generation convergence
solutions group, which includes Telica-related products. The
estimated fair value of the reporting units used in the most
recent impairment test was determined using projected cash flows
over a seven-year period discounted at a range of 10% to 12%
plus a terminal value. The carrying amounts for the data
networking group and next-generation convergence solutions group
exceeded the estimated fair value without considering the
terminal value. If the expected results for these two reporting
units are not realized, particularly the next-generation
convergence solutions reporting unit, which generated losses in
fiscal 2005 and 2004, impairment charges may be required in the
future.

F-11



---



##### 

A $50 million capitalized software impairment charge was
recognized during fiscal 2003 as a result of delays and
uncertainties in the development of the universal mobile
telecommunications systems (UMTS) market. Software
development costs related to UMTS technology were expensed as
incurred during fiscal 2005, 2004 and 2003.





CONSOLIDATED RESULTS OF OPERATIONS

Revenues

|                                                       |  |                           |  |      |  |         |  |      |  |         |  |     
|------------------------------------------------------ |  | ------------------------- |  | ---- |  | ------- |  | ---- |  | ------- |  | ----
|                                                       |  | Years ended September 30,
|(in millions)                                          |  | 2005                      |  |      |  | 2004    |  |      |  | 2003    |  |     
|                                                       |  |                           |  |      |  |         |  |      |  |         |  |     
|Mobility                                               |  | $ 4,600                   |  | 49%  |  | $ 4,117 |  | 46%  |  | $ 3,147 |  | 37% 
|INS                                                    |  | 2,565                     |  | 27%  |  | 2,874   |  | 32%  |  | 3,233   |  | 38% 
|Services                                               |  | 2,129                     |  | 23%  |  | 1,932   |  | 21%  |  | 1,840   |  | 22% 
|Patent licensing                                       |  | 113                       |  | 1%   |  | 72      |  | 1%   |  | 202     |  | 2%  
|Other                                                  |  | 34                        |  | -    |  | 50      |  | -    |  | 48      |  | 1%  
|                                                       |  |                           |  |      |  |         |  |      |  |         |  |     
|Revenues                                               |  | $ 9,441                   |  | 100% |  | $ 9,045 |  | 100% |  | $ 8,470 |  | 100%
|                                                       |  |                           |  |      |  |         |  |      |  |         |  |     
|U.S.                                                   |  | $ 5,936                   |  | 63%  |  | $ 5,517 |  | 61%  |  | $ 5,149 |  | 61% 
|Other Americas (Canada,
    Caribbean & Latin America) |  | 729                       |  | 8%   |  | 538     |  | 6%   |  | 424     |  | 5%  
|EMEA (Europe, Middle
    East & Africa)                |  | 1,336                     |  | 14%  |  | 1,293   |  | 14%  |  | 1,207   |  | 14% 
|APaC (Asia Pacific & China)                            |  | 1,440                     |  | 15%  |  | 1,697   |  | 19%  |  | 1,690   |  | 20% 
|                                                       |  |                           |  |      |  |         |  |      |  |         |  |     
|Revenues                                               |  | $ 9,441                   |  | 100% |  | $ 9,045 |  | 100% |  | $ 8,470 |  | 100%
|                                                       |  |                           |  |      |  |         |  |      |  |         |  |     

Fiscal 2005 vs. 2004








Fiscal 2004 vs. 2003




F-12



---



##### 

The increase in the U.S. was primarily due to higher
spending by Verizon Wireless and Sprint to upgrade their CDMA
wireless networks and deploy additional capacity to support
subscriber growth. Sales to these two customers increased by
approximately $1.0 billion and accounted for 32% of our
consolidated sales during fiscal 2004. The increase in Other
Americas was primarily due to higher DSL and wireless sales in
Canada, Mexico and Brazil. The increase in EMEA was primarily
due to higher sales of optical products and UMTS data cards in
Europe and sales in Iraq. Revenues from customers in China
represented 10% and 11% of consolidated revenues during fiscal
2004 and 2003, respectively.

Gross Margin

|                  |  |                           |         |  |      |  |         |      |  |  |         | 
|----------------- |  | ------------------------- | ------- |  | ---- |  | ------- | ---- |  |  | ------- | 
|                  |  | Years ended September 30, |        
|(in millions)     |  | 2005                      |         |  | 2004 |  |         | 2003 | 
|                  |  |                           |         |  |      |  |         |      | 
|Gross margin      |  |                           | $ 4,124 |  |      |  | $ 3,779 |      |  |  | $ 2,652 | 
|Gross margin rate |  |                           | 44%     |  |      |  | 42%     |      |  |  | 31%     | 







F-13



---



##### 

Our gross margin rate may also be impacted by other factors,
such as competitive pricing pressures, the initial impact of
sales of certain next-generation products, our efforts to enter
emerging markets and our ability to continue realizing cost
reductions. We operate in highly competitive markets that are
subject to pricing pressures for various reasons, including
technological changes, new entrants and supply and demand
fluctuations. Although we believe that these impacts have
reduced our relative revenue levels from prior periods, our
gross margin has not been significantly impacted due to our
ability to realize cost reductions.

The following factors impacted our consolidated gross margin
rate during fiscal 2005:




    The consolidated gross margin rate increased due to lower
    employee incentive awards and decreased due to a lower net
    pension and postretirement benefit credit. The net impact of
    these items increased the consolidated gross margin rate by one
    percentage point.
    The net impact of higher provisions for slow moving and obsolete
    inventories, customer and supplier contract settlements,
    warranty expenses, and certain customer obligations decreased
    the consolidated gross margin rate by one percentage point.
    Historically, our gross margin rate is generally higher in
    Mobility than in INS and Services, and higher in the
    U.S. than in non-U.S. regions. The favorable impact of
    the higher percentage of Mobility and U.S. revenues on the
    consolidated revenues, cost reductions and revised estimates
    related to long-term contracts was offset by other factors
    including pricing and product mix. The net effect of these items
    increased the consolidated gross margin rate by approximately
    two percentage points from the comparable prior year period.The following factors impacted our consolidated gross margin
rate during fiscal 2004:




    The net impact of lower provisions for slow-moving and obsolete
    inventories, including inventories associated with customers
    experiencing financial difficulties; supplier and customer
    contract settlements; adjustments to long-term contracts;
    warranty expenses; and certain customer obligations and product
    performance issues increased the consolidated gross margin rate
    by four percentage points.
    Sales volume increased the gross margin rate by approximately
    one percentage point, because the fixed costs were spread over
    higher revenue levels.
    Lower intellectual property licensing revenues decreased the
    gross margin rate by approximately one percentage point.
    Higher employee incentive awards decreased the gross margin rate
    by approximately one percentage point.
    Cost reductions and the impact of product and geographic mix
    accounted for eight percentage points of improvement in the
    gross margin rate. Cost reductions were realized primarily from
    supply chain rationalization and efficiency gains, as well as
    from product redesign. We also realized savings from employee
    workforce reductions primarily in the Services segment in fiscal
    2004. Increased U.S. sales of certain Mobility products
    with higher gross margin contributed to the gross margin rate
    improvement.F-14



---



##### 

Operating Expenses

|                                                                                                |  |                           |         |   |      |  |         |        |  |  |       |   |  |        |         |   |  |  |        |   |  |  |  | 
|----------------------------------------------------------------------------------------------- |  | ------------------------- | ------- | - | ---- |  | ------- | ------ |  |  | ----- | - |  | ------ | ------- | - |  |  | ------ | - |  |  |  | 
|                                                                                                |  | Years ended September 30, |         |   |     
|(in millions)                                                                                   |  | 2005                      |         |   | 2004 |  |         | Change |  |  | 2003  |   |  | Change |         |   | 
|                                                                                                |  |                           |         |   |      |  |         |        |  |  |       |   |  |        |         |   | 
|Marketing and sales (M&S)                                                                       |  |                           | $  955  |   |      |  | $  903  |        |  |  | $  52 |   |  |        | $  915  |   |  |  | $  (12 | ) |  |  |  | 
|General and administration (G&A)                                                                |  |                           | 794     |   |      |  | 620     |        |  |  | 174   |   |  |        | 802     |   |  |  | (182   | ) |  |  |  | 
|                                                                                                |  |                           |         |   |      |  |         |        |  |  |       |   |  |        |         |   |  | 
|Selling, general and administrative
    (SG&A) expenses,
    excluding the following two items: |  |                           | 1,749   |   |      |  | 1,523   |        |  |  | 226   |   |  |        | 1,717   |   |  |  | (194   | ) |  |  |  | 
|Recovery of bad debts and customer
    financings                                               |  |                           | (69     | ) |      |  | (230    | )      |  |  | 161   |   |  |        | (223    | ) |  |  | (7     | ) |  |  |  | 
|Amortization of other acquired
    intangible assets                                            |  |                           | 16      |   |      |  | 3       |        |  |  | 13    |   |  |        | 15      |   |  |  | (12    | ) |  |  |  | 
|                                                                                                |  |                           |         |   |      |  |         |        |  |  |       |   |  |        |         |   |  | 
|SG&A                                                                                            |  |                           | 1,696   |   |      |  | 1,296   |        |  |  | 400   |   |  |        | 1,509   |   |  |  | (213   | ) |  |  |  | 
|Research and development (R&D)                                                                  |  |                           | 1,177   |   |      |  | 1,270   |        |  |  | (93   | ) |  |        | 1,488   |   |  |  | (218   | ) |  |  |  | 
|In-process research and development
    (IPR&D)                                                 |  |                           | -       |   |      |  | 14      |        |  |  | (14   | ) |  |        | -       |   |  |  | 14     |   |  |  |  | 
|Goodwill impairment                                                                             |  |                           | -       |   |      |  | -       |        |  |  | -     |   |  |        | 35      |   |  |  | (35    | ) |  |  |  | 
|Business restructuring                                                                          |  |                           | (10     | ) |      |  | (20     | )      |  |  | 10    |   |  |        | (158    | ) |  |  | 138    |   |  |  |  | 
|                                                                                                |  |                           |         |   |      |  |         |        |  |  |       |   |  |        |         |   |  | 
|Operating expenses                                                                              |  |                           | $ 2,863 |   |      |  | $ 2,560 |        |  |  | $ 303 |   |  |        | $ 2,874 |   |  |  | $ (314 | ) |  |  |  | 
|                                                                                                |  |                           |         |   |      |  |         |        |  |  |       |   |  |        |         |   |  | 







| |     
| | ----
| | SG&A



| |                     
| | --------------------
| | Fiscal 2005 vs. 2004





F-15



---



##### 

Fiscal 2004 vs. 2003SG&A decreased by 11% in fiscal 2004, excluding the impact
of bad debts and customer financings and amortization of other
acquired intangibles. The decrease was primarily a result of
employee workforce reductions under our restructuring program
and other cost saving initiatives that limited discretionary
spending.

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



Recovery of Bad Debts and Customer FinancingsNet recoveries were due to the favorable settlement or sale of
certain fully reserved notes receivable and accounts receivable
and significantly lower bad debt and customer financing
exposure. These settlements generally occur as a result of the
resolution of work-outs and consummation of bankruptcy
proceedings. These net recoveries included charges for bad debts
and customer financings of $14 million, $24 million,
and $100 million during fiscal 2005, 2004 and 2003,
respectively.

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



R&DOur R&D investment is focused on enhancing and expanding our
broad portfolio of leading edge technologies. In Mobility, our
R&D investment is focused primarily on CDMA and UMTS
next-generation technologies and includes expenses associated
with UMTS product trials with certain customers. This investment
continues to support our leadership position in spread-spectrum
technology and our development of high-speed mobile data
solutions. Our INS R&D investment supports a broad array of
current and next-generation technologies, including VoIP, metro
optical and broadband networking solutions. Together, Mobility
and INS share R&D investment in a unified softswitch
platform to support both wireless and wireline applications. Our
R&D investment also supports reshaping our product portfolio
to capture convergence opportunities and Bell Labs long-term
research programs in such areas as computer science, materials
science and bioengineering. We believe our current R&D
spending levels and plans are aligned with current and expected
market opportunities.

|                 |  |                           |       |  |      |  |       |      |  |  |       | 
|---------------- |  | ------------------------- | ----- |  | ---- |  | ----- | ---- |  |  | ----- | 
|                 |  | Years ended September 30, |      
|(in millions)    |  | 2005                      |       |  | 2004 |  |       | 2003 | 
|                 |  |                           |       |  |      |  |       |      | 
|Cost capitalized |  |                           | $ 232 |  |      |  | $ 258 |      |  |  | $ 313 | 
|Amortization     |  |                           | 262   |  |      |  | 281   |      |  |  | 291   | 

F-16



---



##### 

R&D costs are charged to expense as incurred. However, the
costs incurred for the development of computer software that
will be sold, leased or otherwise marketed are capitalized when
technological feasibility has been established. The amortization
of these costs is reflected as a cost component in determining
our gross margin. Unamortized software development costs
determined to be in excess of the net realizable value of the
product are expensed immediately and reflected in R&D if
such determination is made prior to when the product is
available for general release to customers.

Fiscal 2005 vs. 2004

R&D decreased by 7% in fiscal 2005, primarily due to changes
in compensation and benefit matters as well as to recent
cost-reduction actions in INS. During fiscal 2005, R&D
included approximately $135 million of lower employee
incentive awards and approximately $55 million of a lower
net pension credit.

Fiscal 2004 vs. 2003

R&D decreased by 15% in fiscal 2004, primarily due to
employee workforce reductions and product rationalizations under
our restructuring program. R&D included approximately
$175 million of higher employee incentive awards during
fiscal 2004 and a $50 million UMTS impairment charge during
fiscal 2003.

IPR&D

IPR&D charges of $14 million resulted from the
acquisition of Telica in the fourth quarter of fiscal 2004.
Refer to Note 3 to our consolidated financial statements
for information regarding the purchase price allocation.

Goodwill Impairment and Amortization of Other Acquired
Intangible Assets

The increase in the fiscal 2005 amortization of other acquired
intangible assets was related to the acquisition of Telica. The
fiscal 2003 goodwill impairment charge was related to the
multiservice switching reporting unit. Refer to the
Application of Critical Accounting Estimates for
further discussion.

Business Restructuring

|                        |  |                           |        |   |      |  |        |      |  |  |        |  
|----------------------- |  | ------------------------- | ------ | - | ---- |  | ------ | ---- |  |  | ------ | -
|                        |  | Years ended September 30, |       
|                        |  | 2005                      |        |   | 2004 |  |        | 2003 | 
|(in millions)           |  |                           |        |   |      |  |        |      | 
|Employee separations    |  |                           | $  (5  | ) |      |  | $ (14  | )    |  |  | $  (47 | )
|Contract settlements    |  |                           | (2     | ) |      |  | (15    | )    |  |  | (16    | )
|Facility closings       |  |                           | (3     | ) |      |  | 12     |      |  |  | 17     |  
|Other                   |  |                           | -      |   |      |  | (3     | )    |  |  | (18    | )
|                        |  |                           |        |   |      |  |        |      | 
|Restructuring reversals |  |                           | (10    | ) |      |  | (20    | )    |  |  | (64    | )
|Asset write-downs       |  |                           | -      |   |      |  | 1      |      |  |  | (120   | )
|Net gains on sales      |  |                           | -      |   |      |  | (1     | )    |  |  | -      |  
|Impairment of goodwill  |  |                           | -      |   |      |  | -      |      |  |  | 35     |  
|                        |  |                           |        |   |      |  |        |      | 
|Net reversal            |  |                           | $ (10  | ) |      |  | $ (20  | )    |  |  | $ (149 | )
|                        |  |                           |        |   |      |  |        |      | 
|Included in:            |  |                           |        |   |      |  |        |      |  |  |        |  
|Costs                   |  |                           | $    - |   |      |  | $    - |      |  |  | $  (26 | )
|Operating expenses      |  |                           | (10    | ) |      |  | (20    | )    |  |  | (158   | )
|Goodwill impairment     |  |                           | -      |   |      |  | -      |      |  |  | 35     |  
|                        |  |                           |        |   |      |  |        |      | 
|Total                   |  |                           | $ (10  | ) |      |  | $ (20  | )    |  |  | $ (149 | )
|                        |  |                           |        |   |      |  |        |      | 

F-17



---



##### 

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

The restructuring actions have been completed. However, the
related reserves reflected many estimates, including those
pertaining to employee separation costs, inventory, contractual
obligations, facility exit costs and proceeds from asset sales.
The individual plans reserve requirement under our
restructuring program was reassessed at the end of each
reporting period. Actual experience has been and may continue to
be different from these estimates. Reversals or charges related
to revisions of our estimates for certain restructuring plans
initiated in prior periods were primarily due to the following:




    Reversals of employee separation charges were primarily due to
    differences in the actual versus assumed demographics of
    separated employees, including age, length of service and
    salaries.
    The net contract settlement reversals were the result of
    settlements of certain contractual obligations and purchase
    commitments for amounts lower than originally estimated.
    Charges or reversals related to facility closings were primarily
    due to revised estimates of costs and expected sublease rental
    income on certain properties resulting from changes in the
    commercial real estate market.
    The adjustment to prior asset write-downs includes changes to
    original plans for certain owned facility closings and reversals
    of inventory reserves as we utilized more discontinued product
    inventory than anticipated.Most of the remaining reserve requirements are related to leases
on exited facilities as of September 30, 2005. Facility
exit costs of $145 million are expected to be paid over the
remaining lease terms and are reflected net of expected sublease
rental income of $125 million. Expected market conditions
for commercial real estate are received from real estate brokers
for most facilities and are considered in estimating the
sublease rental income. Additional charges or reversals may be
required if the expected amount of sublease rental income
changes in the future or if other circumstances change.

Pension, Postretirement and Postemployment Benefits

|                                                                  |  |                           |         |   |      |  |          |      |  |  |          |  
|----------------------------------------------------------------- |  | ------------------------- | ------- | - | ---- |  | -------- | ---- |  |  | -------- | -
|                                                                  |  | Years ended September 30, |        
|                                                                  |  | 2005                      |         |   | 2004 |  |          | 2003 | 
|(in millions)                                                     |  |                           |         |   |      |  |          |      | 
|Pension benefit credit                                            |  |                           | $ (973  | ) |      |  | $ (1,111 | )    |  |  | $ (1,097 | )
|Postretirement benefit cost                                       |  |                           | 255     |   |      |  | 243      |      |  |  | 351      |  
|                                                                  |  |                           |         |   |      |  |          |      | 
|Net pension and postretirement
    benefit credit                 |  |                           | (718    | ) |      |  | (868     | )    |  |  | (746     | )
|Postemployment benefit cost (credit)                              |  |                           | 72      |   |      |  | 40       |      |  |  | (93      | )
|                                                                  |  |                           |         |   |      |  |          |      | 
|Net pension, postretirement and
    postemployment benefit credit |  |                           | $ (646  | ) |      |  | $   (828 | )    |  |  | $   (839 | )
|                                                                  |  |                           |         |   |      |  |          |      | 
|                                                                 
|Included in:                                                      |  |                           |         |   |      |  |          |      |  |  |          |  
|Business restructuring                                            |  |                           | $     - |   |      |  | $     -  |      |  |  | $   (118 | )
|Other costs and expenses                                          |  |                           | (646    | ) |      |  | (828     | )    |  |  | (721     | )
|                                                                  |  |                           |         |   |      |  |          |      | 
|Net credit                                                        |  |                           | $ (646  | ) |      |  | $   (828 | )    |  |  | $   (839 | )
|                                                                  |  |                           |         |   |      |  |          |      | 

F-18



---



##### 

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

The pension credit is determined under complex rules using
actuarial assumptions. The rules provide for various smoothing
techniques under which gains and losses are spread over future
periods. The largest component of the pension credit is the
expected return on plan assets. This amount is partially offset
by the assumed interest cost on the benefit obligations, the
service costs and amortization of unrecognized gains and losses.
Our pension plans are well funded. The fair value of pension
plan assets was $34.0 billion and exceeded the related
benefit obligation by $2.7 billion as of September 30,
2005. Significant actuarial assumptions include an 8.5% expected
rate of return on plan assets and a 5.5% discount rate used in
determining the interest cost. This 3 percent rate
differential is a significant reason why we recognize a pension
credit. The postretirement benefit costs are determined in a
similar manner. However, most of these benefit obligations are
unfunded, and therefore the interest costs on the benefit
obligations exceed the expected return on plan assets.

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

The following items decreased the net credit during fiscal 2005:


    Reduction in the market-related value of plan assets due to the
    impact of actual losses incurred on plan assets during fiscal
    2002 and 2001.
    Reduction in the expected rate of return on pension plan assets.
    Impact of the collective bargaining agreements that were
    ratified during December 2004.However, these items were partially offset by the impact of the
following items:


    Reduction in the discount rate.
    Full year recognition of the prescription drug benefit under
    Medicare Part D of the Medicare Prescription Drug
    Improvement and Modernization Act of 2003 (the Act)
    and expected reduction in plan participation rates as a result
    of recent experience and the Act.The following items decreased the net credit during fiscal 2004:


    Reduction in the market-related value of plan assets.
    Revised estimates of termination benefits and curtailments
    during fiscal 2003 that related to restructuring actions.
    Accelerated gain amortization related to postemployment benefits
    during fiscal 2003.These items were partially offset by the impact of the following
items:


    Reduction in the discount rate.
    Partial year recognition of the Act and expected reduction in
    plan participation rates.
    Elimination of certain pension death benefits and reductions in
    certain retiree health care benefits.The net pension and postretirement benefit credit is expected to
decrease by approximately $300 million during fiscal 2006,
primarily due to amortization of differences between the
market-related value and fair value of pension and
postretirement plan assets and updated mortality rate
assumptions. Further changes in actuarial assumptions could also
significantly impact the net credit in the future.

On January 21, 2005, the Centers for Medicare and Medicaid
Services issued a Final Rule in the Federal Register for
implementing the Medicare Prescription Drug Benefit that
clarified the methodology for determining actuarial equivalence
and the amount of the federal subsidy. The impact of the Final
Rule did not materially affect our postretirement benefit cost
and related obligation.

Refer to Note 9 to the consolidated financial statements
and the Application of Critical Accounting Estimates
for further information.

F-19



---



##### 

Other Income (Expense), Net

|                                                                   |  |                           |       |   |      |  |       |      |  |  |        |  
|------------------------------------------------------------------ |  | ------------------------- | ----- | - | ---- |  | ----- | ---- |  |  | ------ | -
|                                                                   |  | Years ended September 30, |      
|                                                                   |  | 2005                      |       |   | 2004 |  |       | 2003 | 
|(in millions)                                                      |  |                           |       |   |      |  |       |      | 
|Legal settlements                                                  |  |                           | $ (65 | ) |      |  | $ (84 | )    |  |  | $ (401 | )
|SEC settlement                                                     |  |                           | -     |   |      |  | (25   | )    |  |  | -      |  
|Interest income on tax refunds and
    settlements                 |  |                           | 88    |   |      |  | 135   |      |  |  | 16     |  
|Interest income                                                    |  |                           | 121   |   |      |  | 89    |      |  |  | 86     |  
|Minority interest                                                  |  |                           | (30   | ) |      |  | (6    | )    |  |  | (10    | )
|Other-than-temporary write-down of
    investments                 |  |                           | (20   | ) |      |  | (22   | )    |  |  | (63    | )
|Gain (loss) on sale of investments                                 |  |                           | 1     |   |      |  | 75    |      |  |  | (10    | )
|Gain on sale of businesses, net                                    |  |                           | -     |   |      |  | -     |      |  |  | 49     |  
|Loss on extinguishment of
    convertible securities and debt, net |  |                           | (11   | ) |      |  | (7    | )    |  |  | (97    | )
|Other, net                                                         |  |                           | 30    |   |      |  | 85    |      |  |  | 2      |  
|                                                                   |  |                           |       |   |      |  |       |      | 
|Other income (expense), net                                        |  |                           | $ 114 |   |      |  | $ 240 |      |  |  | $ (428 | )
|                                                                   |  |                           |       |   |      |  |       |      | 

Fiscal 2005








Fiscal 2004










F-20



---



##### 

Fiscal 2003

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

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

The other-than-temporary write-down of investments was due to
sustained weakness in the private equity market, which impacted
the fair value of several investments. Refer to the section
Quantitative and Qualitative Disclosures About Market
Risk for a discussion of equity price risk.

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

Interest Expense

Fiscal 2005 vs. 2004

Interest expense decreased by $55 million to
$341 million during fiscal 2005, primarily due to the early
extinguishment of convertible securities and certain other debt
obligations.

Fiscal 2004 vs. 2003

Interest expense increased by $43 million to
$396 million during fiscal 2004, primarily due to the
exchange of our 8.00% redeemable convertible preferred stock for
8.00% subordinated debentures in November 2003. The impact
of additional interest on the 2.75% convertible securities
that were issued in the third quarter of fiscal 2003 was largely
offset by our debt recapitalization efforts.

Income Taxes

|                                                                 |  |                           |       |   |      |  |       |      |  |  |       |  
|---------------------------------------------------------------- |  | ------------------------- | ----- | - | ---- |  | ----- | ---- |  |  | ----- | -
|                                                                 |  | Years ended September 30, |      
|                                                                 |  | 2005                      |       |   | 2004 |  |       | 2003 | 
|(in millions)                                                    |  |                           |       |   |      |  |       |      | 
|Carryback claims                                                 |  |                           | $  19 |   |      |  | $ 844 |      |  |  | $ 213 |  
|Favorable resolution of
    prior-period tax audits              |  |                           | 130   |   |      |  | 142   |      |  |  | 77    |  
|Reversal of non-U.S. valuation
    allowances                    |  |                           | 81    |   |      |  | 17    |      |  |  | -     |  
|Non-U.S. and state income
    taxes attributed to pre-tax income |  |                           | (79   | ) |      |  | (64   | )    |  |  | (57   | )
|                                                                 |  |                           |       |   |      |  |       |      | 
|Income tax benefit                                               |  |                           | $ 151 |   |      |  | $ 939 |      |  |  | $ 233 |  
|                                                                 |  |                           |       |   |      |  |       |      | 
|                                                                
|Interest income on tax refunds and
    settlements               |  |                           | $  88 |   |      |  | $ 135 |      |  |  | $  16 |  
|                                                                 |  |                           |       |   |      |  |       |      | 

F-21



---



##### 

Valuation allowances were reversed due to the recognition of
certain net operating loss carryback claims, including a claim
of $816 million that was recognized during fiscal 2004 that
was related to the carryback of our fiscal 2001 federal net
operating loss to 1996, a year in which we filed our federal
income tax return as part of the AT&T consolidated group.
The other carryback claims recognized were primarily related to
taxes paid in prior years by our former foreign sales
corporation and previously merged companies, including a
$21 million tax refund (including interest of
$2 million) received during the first quarter of fiscal
2006. This tax refund was not previously recognized until the
fourth quarter of fiscal 2005 due to the uncertainty of
receiving the refund from an unaffiliated third party. Interest
income related to these claims was $43 million,
$45 million and $16 million during fiscal 2005, 2004,
and 2003, respectively.

Certain income tax benefits were recognized due to the favorable
settlement of audit matters related to the years 1990 through
2002, including matters with a previously merged company and the
settlement of certain matters under tax-sharing agreements with
AT&T, Avaya and Agere. We also recognized interest income
related to these settlements of $45 million and
$90 million during fiscal 2005 and 2004, respectively.

Valuation allowances related to certain non-U.S. tax
jurisdictions that exited a cumulative loss position were
reversed based on our assessment that it was more likely than
not that those deferred tax assets will be realizable based on
income projections and certain other factors for those
jurisdictions.

The realization of our deferred tax assets is dependent upon the
existence of taxable income during future periods. During fiscal
2004 and 2005, most of our pretax income in the U.S. was
generated from a pension credit that is not currently taxable.
As a result, even though we exited a cumulative loss position
during the fourth quarter of fiscal 2005, we have concluded that
there was not sufficient positive evidence to enable us to
conclude that it was more likely than not that the
U.S. deferred tax assets would be realized. Therefore, we
have continued to maintain a valuation allowance on our net
U.S. deferred tax assets.

However, the expected future tax consequences of deferred tax
liabilities generated primarily from our pension credit continue
to be relied upon to support the deferred tax assets of other
retiree benefits. This resulted in not providing taxes
attributable to U.S. income during fiscal 2005 and 2004 as
valuation allowances were reversed to the extent of increases in
deferred tax liabilities. We expect that the U.S. deferred
taxes associated with retiree benefits will be in a net
liability position as of September 30, 2006.

We expect to recognize approximately $170 million of income
tax expense during fiscal 2006, including non-cash impacting
U.S. deferred taxes of approximately $100 million for
the above item. The remaining amounts are attributable to
non-U.S. income taxes. The expected tax expense will be
recognized throughout the year and is likely to change during
fiscal 2006 as a result of a number of variables, including our
assessment of the future realization of deferred tax assets.

The U.S. Congress passed the American Jobs Creation Act of
2004, which the President signed into law on October 22,
2004. Key provisions of the Jobs Creation Act include a
temporary incentive for U.S. multinational corporations to
repatriate foreign earnings, a domestic manufacturing deduction
and international tax reforms designed to improve the global
competitiveness of U.S. businesses. The Jobs Creation
Acts provisions are not expected to have a material effect
on our financial condition or results of operations.

Refer to the Application of Critical Accounting
Estimates in this MD&A and Note 7 to our
consolidated financial statements for more detail regarding
income taxes.

F-22



---



##### 

RESULTS OF OPERATIONS BY SEGMENT

Mobility

|                |  |                           |  |         |  |        |  |          |  |        
|--------------- |  | ------------------------- |  | ------- |  | ------ |  | -------- |  | -------
|                |  | Years ended September 30,
|                |  | 2005                      |  | 2004    |  | Change |  | 2003     |  | Change 
|(in millions)   |  |                           |  |         |  |        |  |          |  |        
|U.S.            |  | $ 3,418                   |  | $ 2,942 |  | 16%    |  | $ 2,169  |  | 36%    
|Non-U.S.        |  | 1,182                     |  | 1,175   |  | 1%     |  | 978      |  | 20%    
|                |  |                           |  |         |  |        |  |          |  |        
|Total revenues  |  | $ 4,600                   |  | $ 4,117 |  | 12%    |  | $ 3,147  |  | 31%    
|                |  |                           |  |         |  |        |  |          |  |        
|Gross margin %  |  | 53%                       |  | 51%     |  | 2 pts  |  | 40%      |  | 11 pts 
|                |  |                           |  |         |  |        |  |          |  |        
|Segment income  |  | $ 1,572                   |  | $ 1,238 |  | $ 334  |  | $    156 |  | $ 1,082
|                |  |                           |  |         |  |        |  |          |  |        
|Return on sales |  | 34%                       |  | 30%     |  | 4 pts  |  | 5%       |  | 25 pts 
|                |  |                           |  |         |  |        |  |          |  |        

Fiscal 2005 vs. 2004












F-23



---



##### 

Fiscal 2004 vs. 2003Mobility revenues increased $970 million.
U.S. revenues increased $773 million primarily due to
higher CDMA sales to Verizon Wireless and Sprint as they
continued to upgrade their wireless networks and deploy
additional capacity to support subscriber growth. The
$197 million increase in the non-U.S. regions was
primarily due to higher UMTS data card sales in EMEA and higher
CDMA sales in APaC and Other Americas as certain customers
continued to expand their networks. Approximately 89% of fiscal
2004 wireless product revenue was derived from CDMA technology.

Segment income improved by $1.1 billion. This improvement
was driven by an $833 million increase in gross margin and
a $249 million decrease in operating expenses. Gross margin
increased due to higher sales volume and an 11 percentage
point increase in the gross margin rate. The increase in the
gross margin rate was driven by favorable product and geographic
mix, continued cost reductions, lower inventory and warranty
charges and better absorption of fixed costs due to the higher
revenues. R&D and SG&A expenses declined, primarily due
to the impact of restructuring actions and relocating certain
activities to areas with lower cost structures. We also
recognized a $50 million impairment charge for UMTS
capitalized software during fiscal 2003. UMTS software
development costs continued to be expensed as incurred. Lower
R&D expenses accounted for 87% of the decrease in operating
expenses.

INS

|                            |  |                           |  |          |  |         |  |          |  |       
|--------------------------- |  | ------------------------- |  | -------- |  | ------- |  | -------- |  | ------
|                            |  | Years ended September 30,
|                            |  | 2005                      |  | 2004     |  | Change  |  | 2003     |  | Change
|(in millions)               |  |                           |  |          |  |         |  |          |  |       
|Voice networking            |  | $    889                  |  | $ 1,193  |  | (25%)   |  | $ 1,472  |  | (19%) 
|Data and network management |  | 859                       |  | 925      |  | (7%)    |  | 1,001    |  | (8%)  
|Optical networking          |  | 817                       |  | 756      |  | 8%      |  | 760      |  | (1%)  
|                            |  |                           |  |          |  |         |  |          |  |       
|Total revenues              |  | $ 2,565                   |  | $ 2,874  |  | (11%)   |  | $ 3,233  |  | (11%) 
|                            |  |                           |  |          |  |         |  |          |  |       
|                           
|U.S.                        |  | $ 1,161                   |  | $ 1,389  |  | (16%)   |  | $ 1,700  |  | (18%) 
|Non-U.S.                    |  | 1,404                     |  | 1,485    |  | (5%)    |  | 1,533    |  | (3%)  
|                            |  |                           |  |          |  |         |  |          |  |       
|Total revenues              |  | $ 2,565                   |  | $ 2,874  |  | (11%)   |  | $ 3,233  |  | (11%) 
|                            |  |                           |  |          |  |         |  |          |  |       
|Gross margin %              |  | 32%                       |  | 35%      |  | (3 pts) |  | 27%      |  | 8 pts 
|                            |  |                           |  |          |  |         |  |          |  |       
|Segment income              |  | $    195                  |  | $    348 |  | ($ 153) |  | $    117 |  | $ 231 
|                            |  |                           |  |          |  |         |  |          |  |       
|Return on sales             |  | 8%                        |  | 12%      |  | (4 pts) |  | 4%       |  | 8 pts 
|                            |  |                           |  |          |  |         |  |          |  |       

Fiscal 2005 vs. 2004






F-24



---



##### 

Optical networking revenues increased by $61 million due to
higher sales of next-generation optical products.

Although customer spending levels for INS products may not
change significantly in the aggregate, the mix of what is
purchased is likely to continue to change or fluctuate. Our
future revenues will be impacted by our success in offering a
product portfolio that effectively addresses customer needs.
Although we believe INS revenues are stabilizing, they may
decline as customers consider alternatives in transitioning to
next-generation networks.

Segment income decreased due to a $186 million decrease in
gross margin that was partially offset by a $33 million
decrease in operating expenses. The lower gross margin was due
to lower sales and a three-percentage-point decrease in the
gross margin rate. The gross margin rate decreased due to the
impact of lower sales volume, unfavorable product mix and
higher-inventory related charges, as well as certain reserve
reversals and settlements recognized during the prior period.
Operating expenses decreased due to additional expenses related
to the Telica acquisition and a legal settlement in fiscal 2004.

Fiscal 2004 vs. 2003

INS revenues declined by $359 million primarily due to a
significant reduction in sales to AT&T as it completed
certain capital spending programs in prior periods and reduced
its annual spending during fiscal 2004. Lower
non-U.S. sales were primarily in APaC as a result of
competitive pricing pressures and the timing of completing
certain project deployments. The decreases in APaC sales were
primarily in the data and network management and optical product
lines.

Voice networking revenues declined by $279 million. The
decline was due to lower circuit switching product sales.
Traditional circuit switching product sales declined at a faster
rate than the rate of growth in next-generation technologies.
The decline was also more prevalent in the U.S., where certain
customers shifted their spending to other areas, such as
broadband access (DSL). Circuit switching represented
approximately 47% and 59% of voice networking revenues during
fiscal 2004 and 2003, respectively. Beginning in fiscal 2004,
INS voice networking revenues include an allocation of revenue
earned from switching equipment common platform sales to
Mobility customers. This allocation was intended to better match
revenue from these common platforms with the underlying R&D
investment. Voice networking results included $85 million
relating to this allocation for fiscal 2004. Data and network
management revenues declined $76 million due primarily to
lower revenues from multi-service switching products. Optical
networking revenues decreased by $4 million due to lower
revenues from legacy optical products offset by higher sales of
metro optical products in the U.S. and EMEA. We transitioned
most of our optical product contracts with key customers to
next-generation optical products.

Quarterly revenues declined sequentially each quarter except in
the fourth quarter and ranged from $673 million to
$784 million during fiscal 2004.

Segment income improved by $231 million. This improvement
was driven by a $130 million increase in gross margin and a
$101 million decrease in operating expenses. The higher
gross margin was due to an eight-percentage point increase in
the gross margin rate, which more than offset the impact of
lower revenues. The increase in the gross margin rate primarily
resulted from lower inventory-and warranty-related charges,
which accounted for four percentage points of the improvement,
and continued cost reductions. R&D and SG&A expenses
declined due to the impact of restructuring actions during
fiscal 2003. However, operating expenses included charges of
$23 million related to the Telica acquisition for
IPR&D, employee compensation expense and amortization of
intangible assets during fiscal 2004.

F-25



---



##### 

Services

|                |  |                           |         |  |      |  |         |        |  |       |  |  |         |  |  |      
|--------------- |  | ------------------------- | ------- |  | ---- |  | ------- | ------ |  | ----- |  |  | ------- |  |  | -----
|                |  | Years ended September 30,
|(in millions)   |  | 2005                      |         |  | 2004 |  |         | Change |  | 2003  |  |  | Change 
|                |  |                           |         |  |      |  |         |        |  |       |  |  |        
|U.S.            |  |                           | $ 1,211 |  |      |  | $ 1,063 |        |  | 14%   |  |  | $ 1,006 |  |  | 6%   
|Non-U.S.        |  |                           | 918     |  |      |  | 869     |        |  | 6%    |  |  | 834     |  |  | 4%   
|                |  |                           |         |  |      |  |         |        |  |       |  |  |        
|Total revenues  |  |                           | $ 2,129 |  |      |  | $ 1,932 |        |  | 10%   |  |  | $ 1,840 |  |  | 5%   
|                |  |                           |         |  |      |  |         |        |  |       |  |  |        
|Gross margin %  |  |                           | 27%     |  |      |  | 25%     |        |  | 2 pts |  |  | 19%     |  |  | 6 pts
|                |  |                           |         |  |      |  |         |        |  |       |  |  |        
|Segment income  |  |                           | $   335 |  |      |  | $   282 |        |  | $ 53  |  |  | $   225 |  |  | $ 57 
|                |  |                           |         |  |      |  |         |        |  |       |  |  |        
|Return on sales |  |                           | 16%     |  |      |  | 15%     |        |  | 1 pt  |  |  | 12%     |  |  | 3 pts
|                |  |                           |         |  |      |  |         |        |  |       |  |  |        

Fiscal 2005 vs. 2004










Fiscal 2004 vs. 2003






F-26



---



##### 

LIQUIDITY AND CAPITAL RESOURCES

Cash, cash equivalents and marketable securities were
approximately $4.9 billion as of September 30, 2005
and 2004. As discussed in more detail below, the fiscal 2005
cash flows included a significant federal tax refund of
$902 million, the early extinguishment of certain debt
obligations and convertible securities of $547 million, and
a final payment related to our shareholder lawsuit of
$215 million. Summarized annual cash flow information and
key working capital metrics are as follows:

|                                                  |  |      |        |   |      |   |       |      |  |   |       |  
|------------------------------------------------- |  | ---- | ------ | - | ---- | - | ----- | ---- |  | - | ----- | -
|                                                  |  | 2005 |        |   | 2004 |   |       | 2003 | 
|(in millions)                                     |  |      |        |   |      |   |       |      | 
|Net income                                        |  | $    | 1,185  |   |      | $ | 2,002 |      |  | $ | (770  | )
|Non-cash items                                    |  |      | (361   | ) |      |   | (587  | )    |  |   | 204   |  
|Changes in working capital                        |  |      | (133   | ) |      |   | 18    |      |  |   | 549   |  
|Other changes                                     |  |      | 26     |   |      |   | (799  | )    |  |   | (931  | )
|                                                  |  |      |        |   |      |   |       |      | 
|Operating activities                              |  | $    | 717    |   |      | $ | 634   |      |  | $ | (948  | )
|                                                  |  |      |        |   |      |   |       |      | 
|                                                 
|Investing activities                              |  | $    | (1,268 | ) |      | $ | (869  | )    |  | $ | 758   |  
|                                                  |  |      |        |   |      |   |       |      | 
|                                                 
|Financing activities                              |  | $    | (421   | ) |      | $ | (239  | )    |  | $ | 1,051 |  
|                                                  |  |      |        |   |      |   |       |      | 
|                                                 
|Days sales outstanding in accounts
    receivable |  |      | 52     |   |      |   | 51    |      |  |   | 67    |  
|Inventory turnover                                |  |      | 7.2    |   |      |   | 6.9   |      |  |   | 7.4   |  
|Days sales outstanding in working
    capital     |  |      | 30     |   |      |   | 23    |      |  |   | 27    |  

Operating Activities










F-27



---



##### 

The timing of certain payments will also impact our cash flow.
For example, while employee incentive awards are accrued
throughout the fiscal year, they are generally paid during the
first quarter of the subsequent fiscal year. Annual incentive
awards of approximately $600 million were paid during the
first quarter of fiscal 2005. Annual incentive awards of
approximately $350 million are expected to be paid during
the first quarter of fiscal 2006. In addition, approximately
$100 million will be paid under a three- year long-term
incentive program (2003-2005 cycle) during the first quarter of
fiscal 2006. This long-term incentive program was introduced for
the top 1,100 employees in fiscal 2003.

Fiscal 2005 other changes included the impact of changes in
tax-related assets and liabilities of $627 million,
primarily due to tax refunds that were accrued for in fiscal
2004 and proceeds of $201 million from a welfare benefits
trust as reimbursement for management health care contributions
that were made during fiscal 2004. Offsetting these impacts were
a $215 million payment related to our shareowner lawsuit
settlement, cash outlays for restructuring of $69 million
and capitalized software of $232 million, as well as higher
accruals for employee incentive awards during fiscal 2004 that
were paid during fiscal 2005.

Fiscal 2004 other changes included an $861 million tax
refund that was received during fiscal 2005, cash outlays for
restructuring of $227 million and capitalized software of
$258 million. Partially offsetting these impacts were
certain insurance and customer settlements and customer
financing recoveries of approximately $600 million.

Fiscal 2003 other changes included cash outlays for
restructuring of $629 million and capitalized software of
$313 million.

Investing Activities

Fiscal 2005 investing activities included net purchases of
marketable securities of $1.0 billion and capital
expenditures of $221 million, of which $60 million was
for internal-use software. We may continue to purchase
marketable securities in an attempt to improve our investment
returns. We do not expect to receive any significant cash
proceeds from business or asset dispositions in the near future.

Fiscal 2004 investing activities included net purchases of
marketable securities of $821 million and capital
expenditures of $157 million, of which $54 million was
for internal use software. Partially offsetting these cash
outflows were cash proceeds of $63 million from the sale of
certain manufacturing and real estate facilities in the United
States and China.

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

Financing Activities

We are authorized by our Board of Directors to issue shares of
our common stock or use cash in exchange for certain of our
convertible securities and other debt obligations. From the
fourth quarter of fiscal 2002 through September 30, 2005,
we retired approximately $3.0 billion of our convertible
securities and certain other debt obligations in exchange for
approximately 643 million shares of our common stock and
$1.3 billion in cash, in multiple, privately-negotiated
transactions. We may use cash or issue more of our common shares
in similar transactions in the future. If our common stock is
issued, it would result in additional dilution to our common
shareowners.

Fiscal 2005 financing activities included $547 million of
cash to repay or repurchase certain debt obligations and
convertible securities. We also received net proceeds of
$126 million from the issuance of 48 million common
shares primarily for certain employee benefit plans.

F-28



---



##### 

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

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

Cash Management

Achieving optimal returns on our cash balance involves
concentrating domestic cash in a primary account with our lead
bank in order to make efficient investment decisions in various
instruments and maturities. Short-term domestic cash is invested
daily in money market funds. Strategic short- and long-term
domestic cash is outsourced to various fund managers and the
portfolio consists of investment-grade debt securities such as
treasury notes, corporate bonds, high-quality asset-backed
securities and government agency bonds, with various maturities.
International cash is invested in international money market
funds, time deposits and other bank accounts. Approximately 82%
of our cash, cash equivalents and marketable securities were
held domestically as of September 30, 2005.

Future Capital Requirements and Funding Sources

We do not expect that our operations will generate cash on a
sustainable basis until our pre-tax income exceeds the amount of
net non-cash income items, which have been driven primarily by
our pension credit. Our pension credit was $973 million,
$1.1 billion and $1.1 billion during the fiscal years
ended September 30, 2005, 2004 and 2003, respectively. Our
cash requirements during the next few years are primarily
related to funding our operations, retiree health care
obligations, capital expenditures, debt obligations and related
interest and other matters discussed below. Our 7.25% notes
of $368 million mature during the fourth quarter of fiscal
2006. Our 8% convertible securities of $501 million
are redeemable at the option of the holder on August 2,
2007. We have the right to redeem the 8% convertible
securities after August 14, 2006 through cash, shares of
our common stock or a combination of both.

We believe our cash and cash equivalents of $2.4 billion
and marketable securities of $2.5 billion as of
September 30, 2005 are sufficient to fund our cash
requirements for fiscal 2006 as well as the following few years.
However, we cannot provide assurance that our actual cash
requirements will not be greater than we currently expect. If
sources of liquidity are not available or if we cannot generate
sufficient cash flow from operations, we might be required to
obtain additional sources of funds through additional operating
improvements, capital market transactions, asset sales or
financing from third parties, or a combination thereof. We
cannot provide assurance that these additional sources of funds
will be available or, if available, would have reasonable terms.

The expected remaining cash requirements for our restructuring
program is $147 million. These future cash requirements are
primarily for lease obligations over the remaining lease terms,
net of sublease rental income of $125 million. The cash
requirements could increase in the future if we do not receive
this expected sublease income.

F-29



---



##### 

We currently do not expect to make contributions to our
qualified U.S. pension plans through fiscal 2007. We are
unable to provide an estimate of future funding requirements
beyond fiscal 2007 for our U.S. pension plans. Based on our
actuarial projections and current law, we believe it is unlikely
that any required contributions would have a material effect on
our liquidity during fiscal 2008 through fiscal 2010. Several
legislative changes were recently proposed that would impact
U.S. pension plans, if adopted. These proposals would alter
the manner in which liabilities and asset values are determined
for the purpose of calculating required pension contributions
and the timing and manner in which required contributions to
under funded pension plans would be made. The proposals are
progressing, however, many details need to be specified, and the
proposals then approved by Congress. The funding requirements
for our U.S. pension plans could be significantly affected
by these proposed changes, if they are adopted.

Annual contributions to our non-qualified and
non-U.S. pension plans are expected to be approximately
$60 million in each of the next five fiscal years.

We currently provide retiree health care benefits for our
retirees in the United States, including 46,000 management
retirees and 68,000 formerly represented retirees as well as an
additional 68,000 dependents of retirees. The obligations and
plan assets for management and formerly represented retirees are
accounted for separately. Historically, retiree health care
benefits were funded through plan assets set aside in trusts and
transfers of excess pension assets. There are currently no plan
assets available in these trusts to fund the obligations of the
management retirees. There are approximately $550 million
of assets in trusts that are available to fund the obligations
of the formerly represented retirees as of September 30,
2005, including approximately $400 million of plan assets
that were set aside in a welfare benefits trust during fiscal
2005.

We are permitted to transfer pension plan assets that are in
excess of 125% of pension plan obligations under
Section 420 of the Internal Revenue Code to fund annual
retiree health care benefits. Our cumulative Section 420
transfers during the past several years were $1.9 billion,
although no transfers were made within the management retiree
plan since fiscal 2002 or within the formerly represented
retiree plan since fiscal 2003. If a Section 420 transfer
is made, we are required to maintain a certain level of cost per
participant for a period of five years beginning with the year
of transfer. As a result, although these excess pension asset
transfers can help fund retiree health care benefits, they limit
the ability to implement cost reductions in the future.

Together with our unions, we are seeking legislative changes to
allow an employer to fund more than one years retiree
health care benefits through a Section 420 transfer and
permit the terms of an enforceable collective bargaining
agreement to serve as an alternative to the maintenance of cost
requirements described above. There were approximately
$1.6 billion of pension plan assets that would be eligible
for Section 420 transfers in our formerly represented
retiree plan as of the January 1, 2005 valuation date. The
next valuation date will be January 1, 2006. The funding
levels for our management retiree pension plans were below the
required thresholds that would allow for Section 420
transfers. If we are successful in obtaining the legislative
changes, we believe that a majority of our funding requirements
for formerly represented retirees could be addressed through
Section 420 transfers based on current actuarial
assumptions. However, no assurances can be given that we will be
successful in these efforts or that other legislative changes
will not be adopted that will adversely affect the amount of
pension plan assets that would be available for Section 420
transfers.

If the legislative changes that we are seeking are not obtained
by September 1, 2006, our obligation to fund a
$400 million trust for represented retiree health care by
2012 will terminate, and we can change the level of the subsidy
for represented retiree health care at our sole discretion
beginning January 1, 2007, subject to the maintenance of
cost requirements that expire on September 30, 2007.

F-30



---



##### 

Our expected cash requirements for funding retiree health care
benefits and other postretirement benefits are expected to be
$254 million during fiscal 2006. These cash requirements
are expected to increase to $431 million,
$526 million, $502 million and $474 million
during the next four consecutive fiscal years due to the
depletion of plan assets held in trusts. These amounts exclude
potential Section 420 transfers, but include the expected
annual Medicare Part D subsidies of approximately
$50 million in fiscal 2007 and $80 million annually
thereafter. These expected funding requirements are subject to
change.

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

Contractual Obligations and Other Commercial Commitments and
Contingencies

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

Contractual obligations

|                                           |  |                                                    |  |          |  |          |  |          |  |           
|------------------------------------------ |  | -------------------------------------------------- |  | -------- |  | -------- |  | -------- |  | ----------
|                                           |  | Payments due during the years ending September 30,
|                                           |  |                                                    |  | 2007 and |  | 2009 and |  | 2011 and
|(in millions)                              |  | Total                                              |  | 2006     |  | 2008     |  | 2010     |  | thereafter
|                                           |  |                                                    |  |          |  |          |  |          |  |           
|Long-term debt (a)                         |  | $ 5,464                                            |  | $ 368    |  | $ 501    |  | $  202   |  | $ 4,393   
|Interest on long-term debt (a)             |  | 3,928                                              |  | 317      |  | 541      |  | 478      |  | 2,592     
|Operating leases (b)                       |  | 868                                                |  | 156      |  | 215      |  | 152      |  | 345       
|Unconditional purchase
    obligations (c) |  | 662                                                |  | 615      |  | 39       |  | 8        |  | -         
|                                           |  |                                                    |  |          |  |          |  |          |  |           
|Total (d) (e)                              |  | $10,922                                            |  | $1,456   |  | $1,296   |  | $  840   |  | $ 7,330   
|                                           |  |                                                    |  |          |  |          |  |          |  |           



| |     |                                                                                                                                                                                                                                                                                                                                                                                        
| | --- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | (a) | The long-term debt principal amounts exclude $30 million of
    fair value basis adjustments and unamortized discounts. Refer to
    Note 8 to our consolidated financial statements for
    additional information related to long-term debt and convertible
    securities, including early redemption features.                                                                     
|
| | (b) | The contractual obligations under operating leases exclude
    approximately $192 million of potential lease obligations
    that were assigned to Avaya, Agere and other entities for which
    we remain secondarily liable. The operating lease obligations
    for facilities reserved under our restructuring program of
    approximately $215 million are included in the table.



| |     |                                                                                                                                                                                                                                                                                                                                                                                                                
| | --- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | (c) | Unconditional purchase obligations include all commitments to
    purchase goods or services that are noncancelable or would
    impose a penalty if the agreements were cancelled prior to
    expiration. In these situations, the amount of the penalty was
    included in the 2006 column in the table above.
    Amounts exclude obligations included in accounts payable as of
    September 30, 2005.



| |     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
| | --- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | (d) | Certain other long-term liabilities of $878 million are
    excluded in the above table because they do not represent
    contractual obligations as defined by the SECs rules.
    These liabilities are primarily contingencies related to tax,
    litigation and insurance matters, long-term employee
    compensation and non-cash items, such as minority interests and
    deferred income. The estimated future cash payments for these
    items are expected to be $317 million during fiscal years
    2007 through 2008, $115 million during fiscal years 2009
    through 2010, and $126 million during 2011 and thereafter.
    Other long-term liabilities related to facility reserves in
    connection with our restructuring plans are included in the
    operating leases caption.
|
| | (e) | Obligations related to pensions, postretirement health and
    welfare benefits and post-employment benefit obligations are
    excluded from the table. Refer to Note 9 to our
    consolidated financial statements and the above discussion for a
    summary of our expected contributions to these plans.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           

F-31



---



##### 

Other commercial commitments

|                             |  |                                                        |  |          |  |          |  |          |  |           
|---------------------------- |  | ------------------------------------------------------ |  | -------- |  | -------- |  | -------- |  | ----------
|                             |  | Amounts expiring during the years ending September 30,
|                             |  |                                                        |  | 2007 and |  | 2009 and |  | 2011 and
|(in millions)                |  | Total                                                  |  | 2006     |  | 2008     |  | 2010     |  | thereafter
|                             |  |                                                        |  |          |  |          |  |          |  |           
|Letters of credit (a)        |  | $ 269                                                  |  | $ 231    |  | $ 23     |  | $ -      |  | $ 15      
|Undrawn customer commitments |  | 6                                                      |  | -        |  | -        |  | 6        |  | -         
|                             |  |                                                        |  |          |  |          |  |          |  |           
|Total                        |  | $ 275                                                  |  | $ 231    |  | $ 23     |  | $ 6      |  | $ 15      
|                             |  |                                                        |  |          |  |          |  |          |  |           



|    |                                                                                       
|--- | --------------------------------------------------------------------------------------
|(a) | Refer to Note 12 to our consolidated financial statements
    for further information.

Customer Financing Commitments




Credit Ratings




|                          |  |           |  |             |  |               |  |                          
|------------------------- |  | --------- |  | ----------- |  | ------------- |  | -------------------------
|                          |  |           |  |             |  | Liability to  |  |                          
|                          |  |           |  |             |  | subsidiary    |  |                          
|                          |  |           |  | 8.00%       |  | trust issuing |  |                          
|                          |  | Long-term |  | convertible |  | preferred     |  |                          
|Rating Agency             |  | debt      |  | securities  |  | securities    |  | Last change              
|                          |  |           |  |             |  |               |  |                          
|Standard &
    Poors (a) |  | B         |  | CCC+        |  | CCC           |  | Upgraded March 10, 2004  
|Moodys (a)               |  | B1        |  | B3          |  | B3            |  | Upgraded May 16, 2005    
|Fitch (b)                 |  | BB-       |  | B           |  | B             |  | Upgraded October 26, 2005




|    |                             
|--- | ----------------------------
|(a) | Ratings outlook is positive.
|(b) | Rating outlook is stable.   

F-32



---



##### 

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

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

Foreign Currency Risk

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

Our primary net foreign currency exposures included the euro,
Brazilian real, Japanese yen, Mexican peso and Chinese yuan. The
fair value of foreign exchange contracts is subject to changes
in foreign currency exchange rates.

We use the Monte Carlo simulation model to calculate VAR. This
model estimates the potential loss in fair value of foreign
currency forwards and options over a defined period of time
within a certain confidence level by randomly generating
different foreign currency exchange rates repeatedly and then
applying those exchange rates to our outstanding forwards and
options. As a result of our foreign currency VAR calculations,
we estimated with 95 percent confidence that the fair value
of our foreign currency derivatives would not decline by more
than $9 million and $12 million over a quarterly
period during fiscal 2005 and 2004, respectively. Consistent
with the nature of the economic hedge, any changes in the value
of the forwards and options would be offset by reciprocal
changes in the underlying exposure.

Interest Rate Risk

We are exposed to various forms of interest rate risk. Refer to
Note 12 to our consolidated financial statements for
further information related to interest rate risk.

F-33



---



##### 

The impacts of a sensitivity analysis we performed under a model
that assumes a hypothetical 100 basis point increase in
interest rates are as follows:

|                                                                                          |  |                  |  |                  |  |                  |  |                 
|----------------------------------------------------------------------------------------- |  | ---------------- |  | ---------------- |  | ---------------- |  | ----------------
|                                                                                          |  |                  |  | Hypothetical     |  |                  |  | Hypothetical    
|                                                                                          |  |                  |  | decrease in fair |  |                  |  | decrease in fair
|                                                                                          |  | Fair value as of |  | value as of      |  | Fair value as of |  | value as of     
|                                                                                          |  | September 30,    |  | September 30,    |  | September 30,    |  | September 30,   
|(in millions)                                                                             |  | 2005             |  | 2005             |  | 2004             |  | 2004            
|                                                                                          |  |                  |  |                  |  |                  |  |                 
|Assets:                                                                                   |  |                  |  |                  |  |                  |  |                 
|Short-term marketable securities                                                          |  | $   357          |  | $   2            |  | $   858          |  | $   4           
|Long-term marketable securities                                                           |  | 2,163            |  | 34               |  | 636              |  | 12              
|Interest rate swaps                                                                       |  | -                |  | -                |  | 12               |  | 8               
|Liabilities:                                                                             
|Debt maturing within one year                                                             |  | 372              |  | 3                |  | 1                |  | -               
|Long-term debt (including liability
    to subsidiary trust issuing preferred securities) |  | 5,144            |  | 303              |  | 6,325            |  | 424             
|Interest rate swaps                                                                       |  | 5                |  | 7                |  | -                |  | -               



Equity Price Risk










F-34



---



##### 

FIVE-YEAR SUMMARY OF SELECTED FINANCIAL DATA

(IN MILLIONS, EXCEPT PER SHARE AMOUNTS)

|                                                                     |  |                           |          |   |      |  |          |      |  |  |          |   |  |      |          |   |  |  |          |  
|-------------------------------------------------------------------- |  | ------------------------- | -------- | - | ---- |  | -------- | ---- |  |  | -------- | - |  | ---- | -------- | - |  |  | -------- | -
|                                                                     |  | Years ended September 30, |         
|                                                                     |  | 2005                      |          |   | 2004 |  |          | 2003 |  |  | 2002     |   |  | 2001 |         
|                                                                     |  |                           |          |   |      |  |          |      |  |  |          |   |  |      |         
|RESULTS OF OPERATIONS                                                |  |                           |          |   |      |  |          |      |  |  |          |   |  |      |          |   |  |  |          |  
|Revenues                                                             |  |                           | $  9,441 |   |      |  | $  9,045 |      |  |  | $  8,470 |   |  |      | $ 12,321 |   |  |  | $ 21,294 |  
|Business restructuring                                               |  |                           | (10      | ) |      |  | (20      | )    |  |  | (184     | ) |  |      | 1,490    |   |  |  | 7,567    |  
|Goodwill impairment                                                  |  |                           | -        |   |      |  | -        |      |  |  | 35       |   |  |      | 826      |   |  |  | 3,849    |  
|Income taxes                                                         |  |                           | (151     | ) |      |  | (939     | )    |  |  | (233     | ) |  |      | 4,757    |   |  |  | (5,734   | )
|Income (loss) from continuing
    operations                         |  |                           | 1,185    |   |      |  | 2,002    |      |  |  | (770     | ) |  |      | (11,826  | ) |  |  | (14,170  | )
|Earnings (loss) per common share
    from
    continuing operations: |  |                           |          |   |      |  |          |      |  |  |          |   |  |      |          |   |  |  |          |  
|Basic                                                                |  |                           | 0.27     |   |      |  | 0.47     |      |  |  | (0.29    | ) |  |      | (3.51    | ) |  |  | (4.18    | )
|Diluted                                                              |  |                           | 0.24     |   |      |  | 0.42     |      |  |  | (0.29    | ) |  |      | (3.51    | ) |  |  | (4.18    | )
|Dividends per common share                                           |  |                           | -        |   |      |  | -        |      |  |  | -        |   |  |      | -        |   |  |  | 0.06     |  
|FINANCIAL POSITION                                                   |  |                           |          |   |      |  |          |      |  |  |          |   |  |      |          |   |  |  |          |  
|Cash, cash equivalents and
    marketable securities                 |  |                           | $  4,930 |   |      |  | $  4,873 |      |  |  | $  4,507 |   |  |      | $  4,420 |   |  |  | $  2,390 |  
|Assets                                                               |  |                           | 16,400   |   |      |  | 16,963   |      |  |  | 15,911   |   |  |      | 17,791   |   |  |  | 33,664   |  
|Debt                                                                 |  |                           | 5,434    |   |      |  | 5,990    |      |  |  | 5,980    |   |  |      | 5,106    |   |  |  | 4,409    |  
|Liabilities                                                          |  |                           | 16,025   |   |      |  | 18,342   |      |  |  | 19,282   |   |  |      | 20,845   |   |  |  | 20,807   |  
|8.00% redeemable convertible
    preferred stock                     |  |                           | -        |   |      |  | -        |      |  |  | 868      |   |  |      | 1,680    |   |  |  | 1,834    |  
|Shareowners equity (deficit)                                        |  |                           | 375      |   |      |  | (1,379   | )    |  |  | (4,239   | ) |  |      | (4,734   | ) |  |  | 11,023   |  

F-35



---



##### 

REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING

Our management is responsible for establishing and maintaining
adequate internal control over financial reporting for the
Company. Internal control over financial reporting is defined in
Rule 13a-15(f) or 15d-15(f) promulgated under the
Securities Exchange Act of 1934 as a process designed by, or
under the supervision of, our principal executive and principal
financial officers and effected by our Board of Directors,
management and other personnel, to provide reasonable assurance
regarding the reliability of financial reporting and the
preparation of financial statements for external purposes in
accordance with generally accepted accounting principles and
includes those policies and procedures that:




    Pertain to the maintenance of records that in reasonable detail
    accurately and fairly reflect the transactions and dispositions
    of our assets;
    Provide reasonable assurance that transactions are recorded as
    necessary to permit preparation of financial statements in
    accordance with generally accepted accounting principles, and
    that receipts and expenditures of the Company are being made
    only in accordance with authorizations of our management and
    directors; and
    Provide reasonable assurance regarding prevention or timely
    detection of unauthorized acquisition, use or disposition of the
    Companys assets that could have a material effect on the
    financial statements.Because of its inherent limitations, internal control over
financial reporting may not prevent or detect misstatements.
Also, projections of any evaluation of effectiveness to future
periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree
of compliance with the policies or procedures may deteriorate.

Management assessed the effectiveness of the Companys
internal control over financial reporting as of
September 30, 2005. In making this assessment, management
used the criteria set forth by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO) in its
Internal Control-Integrated Framework.

Based on this assessment, management concluded that, as of
September 30, 2005, the Companys internal control
over financial reporting is effective based on those criteria.

Our assessment of the effectiveness of the Companys
internal control over financial reporting has been audited by
PricewaterhouseCoopers LLP, an independent registered public
accounting firm, as stated in their report, which is included
herein. This report appears on page F-37.

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

F-36



---



##### 

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Shareowners of

LUCENT TECHNOLOGIES INC.:

We have completed an integrated audit of Lucent Technologies
Inc.s 2005 consolidated financial statements and of its
internal control over financial reporting as of
September 30, 2005 and audits of its 2004 and 2003
consolidated financial statements in accordance with the
standards of the Public Company Accounting Oversight Board
(United States). Our opinions, based on our audits, are
presented below.

Consolidated financial statements

In our opinion, the accompanying consolidated balance sheets and
the related consolidated statements of operations, changes in
shareowners equity (deficit) and cash flows present
fairly, in all material respects, the financial position of
Lucent Technologies Inc. and its subsidiaries at
September 30, 2005 and 2004, and the results of their
operations and their cash flows for each of the three years in
the period ended September 30, 2005, in conformity with
accounting principles generally accepted in the United States of
America. These financial statements are the responsibility of
the Companys management. Our responsibility is to express
an opinion on these financial statements based on our audits. We
conducted our audits of these statements in accordance with the
standards of the Public Company Accounting Oversight Board
(United States). Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether
the financial statements are free of material misstatement. An
audit of financial statements includes examining, on a test
basis, evidence supporting the amounts and disclosures in the
financial statements, assessing the accounting principles used
and significant estimates made by management, and evaluating the
overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.

Internal control over financial reporting

Also, in our opinion, managements assessment, included in
the Report on Internal Control Over Financial Reporting
appearing on page F-36 of the 2005 Annual Report to Shareowners,
that the Company maintained effective internal control over
financial reporting as of September 30, 2005 based on
criteria established in Internal Control-Integrated Frameworkissued by the Committee of Sponsoring Organizations of the
Treadway Commission (COSO), is fairly stated, in all material
respects, based on those criteria. Furthermore, in our opinion,
the Company maintained, in all material respects, effective
internal control over financial reporting as of
September 30, 2005, based on criteria established in
Internal Control-Integrated Frameworkissued by the COSO.
The Companys management is responsible for maintaining
effective internal control over financial reporting and for its
assessment of the effectiveness of internal control over
financial reporting. Our responsibility is to express opinions
on managements assessment and on the effectiveness of the
Companys internal control over financial reporting based
on our audit. We conducted our audit of internal control over
financial reporting in accordance with the standards of the
Public Company Accounting Oversight Board (United States). Those
standards require that we plan and perform the audit to obtain
reasonable assurance about whether effective internal control
over financial reporting was maintained in all material
respects. An audit of internal control over financial reporting
includes obtaining an understanding of internal control over
financial reporting, evaluating managements assessment,
testing and evaluating the design and operating effectiveness of
internal control, and performing such other procedures as we
consider necessary in the circumstances. We believe that our
audit provides a reasonable basis for our opinions.

A companys internal control over financial reporting is a
process designed to provide reasonable assurance regarding the
reliability of financial reporting and the preparation of
financial statements for external purposes in accordance with
generally accepted accounting principles. A companys
internal control over financial reporting includes those
policies and procedures that (i) pertain to the maintenance
of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the
company; (ii) provide reasonable assurance that
transactions are recorded as necessary to permit preparation of
financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the
company are being made only in accordance with authorizations of
management and directors of the company; and (iii) provide
reasonable assurance regarding prevention or timely detection of
unauthorized acquisition, use, or disposition of the
companys assets that could have a material effect on the
financial statements.

Because of its inherent limitations, internal control over
financial reporting may not prevent or detect misstatements.
Also, projections of any evaluation of effectiveness to future
periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree
of compliance with the policies or procedures may deteriorate.

/s/ PRICEWATERHOUSECOOPERS LLP

Florham Park, New Jersey

December 14, 2005

F-37



---



##### 

LUCENT TECHNOLOGIES INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(in millions, except per share amounts)

|                                                                  |                                     |                           |         |         |       |  |         |         |       |  |          |           |       | 
|----------------------------------------------------------------- | ----------------------------------- | ------------------------- | ------- | ------- | ----- |  | ------- | ------- | ----- |  | -------- | --------- | ----- | 
|                                                                  |                                     | Years ended September 30, |        
|                                                                  |                                     | 2005                      |         |         | 2004  |  |         | 2003    |      
|                                                                  |                                     |                           |         |         |       |  |         |         |      
|Revenues:                                                         |                                     |                           |         |         |       |  |         |         |       |  |          |          
|                                                                  | Products                            |                           |         | $ 7,312 |       |  |         | $ 7,113 |       |  |          | $  6,630  |      
|                                                                  | Services                            |                           |         | 2,129   |       |  |         | 1,932   |       |  |          | 1,840     |      
|                                                                  |                                     |                           |         |         |       |  |         |         |      
|                                                                  |                                     | Total revenues            |         |         | 9,441 |  |         |         | 9,045 |  |          |           | 8,470 | 
|                                                                  |                                     |                           |         |         |       |  |         |         |      
|Costs:                                                            |                                     |                           |         |         |       |  |         |         |       |  |          |          
|                                                                  | Products                            |                           |         | 3,760   |       |  |         | 3,824   |       |  |          | 4,329     |      
|                                                                  | Services                            |                           |         | 1,557   |       |  |         | 1,442   |       |  |          | 1,489     |      
|                                                                  |                                     |                           |         |         |       |  |         |         |      
|                                                                  |                                     | Total costs               |         |         | 5,317 |  |         |         | 5,266 |  |          |           | 5,818 | 
|                                                                  |                                     |                           |         |         |       |  |         |         |      
|Gross margin                                                      |                                     |                           | 4,124   |         |       |  | 3,779   |         |       |  | 2,652    |          
|Operating expenses:                                               |                                     |                           |         |         |       |  |         |         |       |  |          |          
|                                                                  | Selling, general and administrative |                           |         | 1,696   |       |  |         | 1,296   |       |  |          | 1,509     |      
|                                                                  | Research and development            |                           |         | 1,177   |       |  |         | 1,270   |       |  |          | 1,488     |      
|                                                                  | In-process research and development |                           |         | -       |       |  |         | 14      |       |  |          | -         |      
|                                                                  | Goodwill impairment                 |                           |         | -       |       |  |         | -       |       |  |          | 35        |      
|                                                                  | Business restructuring              |                           |         | (10     | )     |  |         | (20     | )     |  |          | (158      | )    
|                                                                  |                                     |                           |         |         |       |  |         |         |      
|                                                                  |                                     | Total operating expenses  |         |         | 2,863 |  |         |         | 2,560 |  |          |           | 2,874 | 
|                                                                  |                                     |                           |         |         |       |  |         |         |      
|Operating income (loss)                                           |                                     |                           | 1,261   |         |       |  | 1,219   |         |       |  | (222     | )        
|Other income (expense), net                                       |                                     |                           | 114     |         |       |  | 240     |         |       |  | (428     | )        
|Interest expense                                                  |                                     |                           | 341     |         |       |  | 396     |         |       |  | 353      |          
|                                                                  |                                     |                           |         |         |       |  |         |         |      
|Income (loss) before income taxes                                 |                                     |                           | 1,034   |         |       |  | 1,063   |         |       |  | (1,003   | )        
|Income tax benefit                                                |                                     |                           | (151    | )       |       |  | (939    | )       |       |  | (233     | )        
|                                                                  |                                     |                           |         |         |       |  |         |         |      
|Net income (loss)                                                 |                                     |                           | 1,185   |         |       |  | 2,002   |         |       |  | (770     | )        
|Conversion and redemption
    cost  8% preferred stock           |                                     |                           | -       |         |       |  | (1      | )       |       |  | (287     | )        
|Preferred stock dividends and
    accretion                       |                                     |                           | -       |         |       |  | 12      |         |       |  | (103     | )        
|                                                                  |                                     |                           |         |         |       |  |         |         |      
|Net income (loss) applicable to
    common shareowners            |                                     |                           | $ 1,185 |         |       |  | $ 2,013 |         |       |  | $ (1,160 | )        
|                                                                  |                                     |                           |         |         |       |  |         |         |      
|Net income (loss) per share
    applicable to common shareowners: |                                     |                           |         |         |       |  |         |         |       |  |          |          
|                                                                  | Basic                               |                           |         | $  0.27 |       |  |         | $  0.47 |       |  |          | $   (0.29 | )    
|                                                                  | Diluted                             |                           |         | $  0.24 |       |  |         | $  0.42 |       |  |          | $   (0.29 | )    
|Weighted average number of common
    shares outstanding:         |                                     |                           |         |         |       |  |         |         |       |  |          |          
|                                                                  | Basic                               |                           |         | 4,426   |       |  |         | 4,258   |       |  |          | 3,950     |      
|                                                                  | Diluted                             |                           |         | 5,218   |       |  |         | 5,313   |       |  |          | 3,950     |      



F-38



---



##### 

LUCENT TECHNOLOGIES INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(in millions, except per share amounts)

|                                                                                                         |                                                                                                                                                                                   |                           |                                                         |    |               |           |           |    |           |           |  
|-------------------------------------------------------------------------------------------------------- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ------------------------- | ------------------------------------------------------- | -- | ------------- | --------- | --------- | -- | --------- | --------- | -
|                                                                                                         |                                                                                                                                                                                   | September 30,             |                                                         |    | September 30, |          
|                                                                                                         |                                                                                                                                                                                   | 2005                      |                                                         |    | 2004          |          
|                                                                                                         |                                                                                                                                                                                   |                           |                                                         |    |               |          
|ASSETS                                                                                                   |                                                                                                                                                                                   |                           |                                                         |    |               |           |           |   
|Cash and cash equivalents                                                                                |                                                                                                                                                                                   |                           | $   2,410                                               |    |               |           | $   3,379 |   
|Marketable securities                                                                                    |                                                                                                                                                                                   |                           | 357                                                     |    |               |           | 858       |   
|Receivables, net                                                                                         |                                                                                                                                                                                   |                           | 1,395                                                   |    |               |           | 1,359     |   
|Inventories                                                                                              |                                                                                                                                                                                   |                           | 731                                                     |    |               |           | 822       |   
|Other current assets                                                                                     |                                                                                                                                                                                   |                           | 690                                                     |    |               |           | 1,813     |   
|                                                                                                         |                                                                                                                                                                                   |                           |                                                         |    |               |          
|                                                                                                         |                                                                                                                                                                                   | Total current assets      |                                                         |    | 5,583         |           |           |    | 8,231     |          
|Marketable securities                                                                                    |                                                                                                                                                                                   |                           | 2,163                                                   |    |               |           | 636       |   
|Property, plant and equipment, net                                                                       |                                                                                                                                                                                   |                           | 1,295                                                   |    |               |           | 1,376     |   
|Prepaid pension costs                                                                                    |                                                                                                                                                                                   |                           | 6,010                                                   |    |               |           | 5,358     |   
|Goodwill and other acquired
    intangibles, net                                                         |                                                                                                                                                                                   |                           | 419                                                     |    |               |           | 434       |   
|Other assets                                                                                             |                                                                                                                                                                                   |                           | 930                                                     |    |               |           | 928       |   
|                                                                                                         |                                                                                                                                                                                   |                           |                                                         |    |               |          
|                                                                                                         |                                                                                                                                                                                   | Total assets              |                                                         |    | $  16,400     |           |           |    | $  16,963 |          
|                                                                                                         |                                                                                                                                                                                   |                           |                                                         |    |               |          
|                                                                                                        
|LIABILITIES                                                                                              |                                                                                                                                                                                   |                           |                                                         |    |               |           |           |   
|Accounts payable                                                                                         |                                                                                                                                                                                   |                           | $     769                                               |    |               |           | $     872 |   
|Payroll and benefit-related
    liabilities                                                              |                                                                                                                                                                                   |                           | 1,095                                                   |    |               |           | 1,232     |   
|Debt maturing within one year                                                                            |                                                                                                                                                                                   |                           | 368                                                     |    |               |           | 1         |   
|Other current liabilities                                                                                |                                                                                                                                                                                   |                           | 1,588                                                   |    |               |           | 2,361     |   
|                                                                                                         |                                                                                                                                                                                   |                           |                                                         |    |               |          
|                                                                                                         |                                                                                                                                                                                   | Total current liabilities |                                                         |    | 3,820         |           |           |    | 4,466     |          
|Postretirement and postemployment
    benefit liabilities                                                |                                                                                                                                                                                   |                           | 4,751                                                   |    |               |           | 4,881     |   
|Pension liabilities                                                                                      |                                                                                                                                                                                   |                           | 1,423                                                   |    |               |           | 1,874     |   
|Long-term debt                                                                                           |                                                                                                                                                                                   |                           | 5,066                                                   |    |               |           | 5,989     |   
|Other liabilities                                                                                        |                                                                                                                                                                                   |                           | 965                                                     |    |               |           | 1,132     |   
|                                                                                                         |                                                                                                                                                                                   |                           |                                                         |    |               |          
|                                                                                                         |                                                                                                                                                                                   | Total liabilities         |                                                         |    | 16,025        |           |           |    | 18,342    |          
|Commitments and contingencies                                                                            |                                                                                                                                                                                   |                           |                                                         |    |               |           |           |   
|                                                                                                        
|SHAREOWNERS EQUITY (DEFICIT)                                                                            |                                                                                                                                                                                   |                           |                                                         |    |               |           |           |   
|Preferred stock par value
    $1.00 per share; authorized shares: 250; issued and
    outstanding: none |                                                                                                                                                                                   |                           | -                                                       |    |               |           | -         |   
|Common stock par value
    $.01 per share;                                                              |                                                                                                                                                                                   |                           |                                                         |    |               |           |           |   
|                                                                                                         | Authorized shares: 10,000; 4,457
    issued and 4,447 outstanding shares as of September 30,
    2005, and 4,396 issued and 4,395 outstanding shares as of
    September 30, 2004 |                           |                                                         | 45 |               |           |           | 44 |          
|Additional paid-in capital                                                                               |                                                                                                                                                                                   |                           | 23,513                                                  |    |               |           | 23,005    |   
|Accumulated deficit                                                                                      |                                                                                                                                                                                   |                           | (19,608                                                 | )  |               |           | (20,793   | ) 
|Accumulated other comprehensive loss                                                                     |                                                                                                                                                                                   |                           | (3,575                                                  | )  |               |           | (3,635    | ) 
|                                                                                                         |                                                                                                                                                                                   |                           |                                                         |    |               |          
|                                                                                                         |                                                                                                                                                                                   |                           | Total shareowners equity
    (deficit)                 |    |               | 375       |           |    |           | (1,379    | )
|                                                                                                         |                                                                                                                                                                                   |                           |                                                         |    |               |          
|                                                                                                         |                                                                                                                                                                                   |                           | Total liabilities and
    shareowners equity (deficit) |    |               | $  16,400 |           |    |           | $  16,963 |  
|                                                                                                         |                                                                                                                                                                                   |                           |                                                         |    |               |          



F-39



---



##### 

LUCENT TECHNOLOGIES INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREOWNERS
EQUITY (DEFICIT)

(in millions)

|                                                                                                                                                         |  |           |       |  |        |  |            |         |  |             |             |       |  |               |           |   |                  |  |          |   |  |  |          |  
|-------------------------------------------------------------------------------------------------------------------------------------------------------- |  | --------- | ----- |  | ------ |  | ---------- | ------- |  | ----------- | ----------- | ----- |  | ------------- | --------- | - | ---------------- |  | -------- | - |  |  | -------- | -
|                                                                                                                                                         |  |           |       |  |        |  |            |         |  | Accumulated |             |       | 
|                                                                                                                                                         |  | Shares of |       |  |        |  | Additional |         |  |             |             | Other |  |               | Total     |  
|                                                                                                                                                         |  | Common    |       |  | Common |  |            | Paid-In |  |             | Accumulated |       |  | Comprehensive |           |   | Shareowners     | 
|                                                                                                                                                         |  | Stock     |       |  | Stock  |  |            | Capital |  |             | Deficit     |       |  | Loss          |           |   | Equity (Deficit) | 
|                                                                                                                                                         |  |           |       |  |        |  |            |         |  |             |             |       |  |               |           |   |                  | 
|Balance as of September 30,
    2002                                                                                                                     |  |           | 3,490 |  |        |  | $ 35       |         |  |             | $ 20,606    |       |  |               | $ (22,025 | ) |                  |  | $ (3,350 | ) |  |  | $ (4,734 | )
|Net loss                                                                                                                                                 |  |           |       |  |        |  |            |         |  |             |             |       |  |               | (770      | ) |                  |  |          |   |  |  | (770     | )
|Minimum pension liability adjustment                                                                                                                     |  |           |       |  |        |  |            |         |  |             |             |       |  |               |           |   |                  |  | (594     | ) |  |  | (594     | )
|Foreign currency translation
    adjustment                                                                                                              |  |           |       |  |        |  |            |         |  |             |             |       |  |               |           |   |                  |  | 135      |   |  |  | 135      |  
|Unrealized holding gains on certain
    investments                                                                                                      |  |           |       |  |        |  |            |         |  |             |             |       |  |               |           |   |                  |  | 71       |   |  |  | 71       |  
|                                                                                                                                                         |  |           |       |  |        |  |            |         |  |             |             |       |  |               |           |   |                  | 
|Comprehensive loss                                                                                                                                       |  |           |       |  |        |  |            |         |  |             |             |       |  |               |           |   |                  |  |          |   |  |  | (1,158   | )
|                                                                                                                                                         |  |           |       |  |        |  |            |         |  |             |             |       |  |               |           |   |                  | 
|Issuance of common stock in
    connection with the exchange of convertible securities and
    certain other debt obligations                            |  |           | 563   |  |        |  | 6          |         |  |             | 1,430       |       |  |               |           |   |                  |  |          |   |  |  | 1,436    |  
|Conversion costs in connection with
    the exchange of 7.75% trust preferred securities                                                                 |  |           |       |  |        |  |            |         |  |             | 129         |       |  |               |           |   |                  |  |          |   |  |  | 129      |  
|Issuance of common stock in
    connection with the payment of preferred stock dividend                                                                  |  |           | 46    |  |        |  | 1          |         |  |             | 85          |       |  |               |           |   |                  |  |          |   |  |  | 86       |  
|Issuance of common stock in
    connection with contribution to Lucent Technologies Inc.
    Represented Employees Post-retirement Health Benefits Trust |  |           | 46    |  |        |  |            |         |  |             | 76          |       |  |               |           |   |                  |  |          |   |  |  | 76       |  
|Issuance of common stock related to
    employee benefit plans                                                                                           |  |           | 24    |  |        |  |            |         |  |             | 51          |       |  |               |           |   |                  |  |          |   |  |  | 51       |  
|Preferred stock dividends and
    accretion                                                                                                              |  |           |       |  |        |  |            |         |  |             | (103        | )     |  |               |           |   |                  |  |          |   |  |  | (103     | )
|Other                                                                                                                                                    |  |           |       |  |        |  |            |         |  |             | (22         | )     |  |               |           |   |                  |  |          |   |  |  | (22      | )
|                                                                                                                                                         |  |           |       |  |        |  |            |         |  |             |             |       |  |               |           |   |                  | 
|Balance as of September 30,
    2003                                                                                                                     |  |           | 4,169 |  |        |  | 42         |         |  |             | 22,252      |       |  |               | (22,795   | ) |                  |  | (3,738   | ) |  |  | (4,239   | )
|                                                                                                                                                         |  |           |       |  |        |  |            |         |  |             |             |       |  |               |           |   |                  | 
|Net income                                                                                                                                               |  |           |       |  |        |  |            |         |  |             |             |       |  |               | 2,002     |   |                  |  |          |   |  |  | 2,002    |  
|Minimum pension liability adjustment                                                                                                                     |  |           |       |  |        |  |            |         |  |             |             |       |  |               |           |   |                  |  | 150      |   |  |  | 150      |  
|Reclassification adjustment for
    realized gains on investments                                                                                        |  |           |       |  |        |  |            |         |  |             |             |       |  |               |           |   |                  |  | (75      | ) |  |  | (75      | )
|Foreign currency translation
    adjustments                                                                                                             |  |           |       |  |        |  |            |         |  |             |             |       |  |               |           |   |                  |  | 34       |   |  |  | 34       |  
|Unrealized holding losses on
    investments                                                                                                             |  |           |       |  |        |  |            |         |  |             |             |       |  |               |           |   |                  |  | (6       | ) |  |  | (6       | )
|                                                                                                                                                         |  |           |       |  |        |  |            |         |  |             |             |       |  |               |           |   |                  | 
|Comprehensive income                                                                                                                                     |  |           |       |  |        |  |            |         |  |             |             |       |  |               |           |   |                  |  |          |   |  |  | 2,105    |  
|                                                                                                                                                         |  |           |       |  |        |  |            |         |  |             |             |       |  |               |           |   |                  | 
|Issuance of common stock in
    connection with the exchange of certain debt obligations                                                                 |  |           | 22    |  |        |  |            |         |  |             | 92          |       |  |               |           |   |                  |  |          |   |  |  | 92       |  
|Issuance of common stock related to
    employee benefit plans                                                                                           |  |           | 93    |  |        |  | 1          |         |  |             | 291         |       |  |               |           |   |                  |  |          |   |  |  | 292      |  
|Issuance of common stock in
    connection with settlement of shareowner lawsuits                                                                        |  |           | 33    |  |        |  |            |         |  |             | 105         |       |  |               |           |   |                  |  |          |   |  |  | 105      |  
|Issuance of common stock related to
    Telica acquisition                                                                                               |  |           | 78    |  |        |  | 1          |         |  |             | 253         |       |  |               |           |   |                  |  |          |   |  |  | 254      |  
|Preferred stock dividends and
    accretion                                                                                                              |  |           |       |  |        |  |            |         |  |             | 12          |       |  |               |           |   |                  |  |          |   |  |  | 12       |  
|                                                                                                                                                         |  |           |       |  |        |  |            |         |  |             |             |       |  |               |           |   |                  | 
|Balance as of September 30,
    2004                                                                                                                     |  |           | 4,395 |  |        |  | 44         |         |  |             | 23,005      |       |  |               | (20,793   | ) |                  |  | (3,635   | ) |  |  | (1,379   | )
|                                                                                                                                                         |  |           |       |  |        |  |            |         |  |             |             |       |  |               |           |   |                  | 
|Net income                                                                                                                                               |  |           |       |  |        |  |            |         |  |             |             |       |  |               | 1,185     |   |                  |  |          |   |  |  | 1,185    |  
|Minimum pension liability adjustment                                                                                                                     |  |           |       |  |        |  |            |         |  |             |             |       |  |               |           |   |                  |  | 46       |   |  |  | 46       |  
|Foreign currency translation
    adjustments                                                                                                             |  |           |       |  |        |  |            |         |  |             |             |       |  |               |           |   |                  |  | 27       |   |  |  | 27       |  
|Unrealized holding losses on
    investments                                                                                                             |  |           |       |  |        |  |            |         |  |             |             |       |  |               |           |   |                  |  | (13      | ) |  |  | (13      | )
|                                                                                                                                                         |  |           |       |  |        |  |            |         |  |             |             |       |  |               |           |   |                  | 
|Comprehensive income                                                                                                                                     |  |           |       |  |        |  |            |         |  |             |             |       |  |               |           |   |                  |  |          |   |  |  | 1,245    |  
|                                                                                                                                                         |  |           |       |  |        |  |            |         |  |             |             |       |  |               |           |   |                  | 
|Issuance of warrants to purchase
    common stock in connection with settlement of shareowner lawsuits                                                   |  |           |       |  |        |  |            |         |  |             | 323         |       |  |               |           |   |                  |  |          |   |  |  | 323      |  
|Issuance of common stock related to
    employee benefit plans                                                                                           |  |           | 48    |  |        |  | 1          |         |  |             | 143         |       |  |               |           |   |                  |  |          |   |  |  | 144      |  
|Issuance of common stock related to
    Telica acquisition                                                                                               |  |           | 3     |  |        |  |            |         |  |             | 8           |       |  |               |           |   |                  |  |          |   |  |  | 8        |  
|Other                                                                                                                                                    |  |           | 1     |  |        |  |            |         |  |             | 34          |       |  |               |           |   |                  |  |          |   |  |  | 34       |  
|                                                                                                                                                         |  |           |       |  |        |  |            |         |  |             |             |       |  |               |           |   |                  | 
|Balance as of September 30,
    2005                                                                                                                     |  |           | 4,447 |  |        |  | $ 45       |         |  |             | $ 23,513    |       |  |               | $ (19,608 | ) |                  |  | $ (3,575 | ) |  |  | $  375   |  
|                                                                                                                                                         |  |           |       |  |        |  |            |         |  |             |             |       |  |               |           |   |                  | 



F-40



---



##### 

LUCENT TECHNOLOGIES INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in millions)

|                                                                                                       |                                                                         |                           |          |        |      |  |          |        |   |  |          |        |  
|------------------------------------------------------------------------------------------------------ | ----------------------------------------------------------------------- | ------------------------- | -------- | ------ | ---- |  | -------- | ------ | - |  | -------- | ------ | -
|                                                                                                       |                                                                         | Years ended September 30, |         
|                                                                                                       |                                                                         | 2005                      |          |        | 2004 |  |          | 2003   |  
|                                                                                                       |                                                                         |                           |          |        |      |  |          |        |  
|Operating activities:                                                                                  |                                                                         |                           |          |        |      |  |          |        |   |  |          |       
|Net income (loss)                                                                                      |                                                                         |                           | $  1,185 |        |      |  | $  2,002 |        |   |  | $   (770 | )     
|Adjustments to reconcile net income
    (loss) to net cash provided by (used in) operating activities: |                                                                         |                           |          |        |      |  |          |        |   |  |          |       
|                                                                                                       | Non-cash portion of business
    restructuring                          |                           |          | -      |      |  |          | 1      |   |  |          | (205   | )
|                                                                                                       | Depreciation and amortization                                           |                           |          | 599    |      |  |          | 693    |   |  |          | 978    |  
|                                                                                                       | Recovery of bad debts and customer
    financings                       |                           |          | (69    | )    |  |          | (230   | ) |  |          | (223   | )
|                                                                                                       | Deferred income taxes                                                   |                           |          | (84    | )    |  |          | (19    | ) |  |          | -      |  
|                                                                                                       | Pension credit                                                          |                           |          | (973   | )    |  |          | (1,111 | ) |  |          | (1,018 | )
|                                                                                                       | Other adjustments for non-cash items                                    |                           |          | 166    |      |  |          | 79     |   |  |          | 672    |  
|Changes in operating assets and
    liabilities:                                                       |                                                                         |                           |          |        |      |  |          |        |   |  |          |       
|                                                                                                       | Receivables                                                             |                           |          | 42     |      |  |          | 200    |   |  |          | 205    |  
|                                                                                                       | Inventories and contracts in process                                    |                           |          | 50     |      |  |          | (59    | ) |  |          | 747    |  
|                                                                                                       | Accounts payable                                                        |                           |          | (160   | )    |  |          | (203   | ) |  |          | (257   | )
|                                                                                                       | Deferred revenue                                                        |                           |          | (65    | )    |  |          | 80     |   |  |          | (146   | )
|                                                                                                       | Other operating assets and
    liabilities                              |                           |          | 26     |      |  |          | (799   | ) |  |          | (931   | )
|                                                                                                       |                                                                         |                           |          |        |      |  |          |        |  
|Net cash provided by (used in)
    operating activities                                                |                                                                         |                           | 717      |        |      |  | 634      |        |   |  | (948     | )     
|                                                                                                       |                                                                         |                           |          |        |      |  |          |        |  
|Investing activities:                                                                                  |                                                                         |                           |          |        |      |  |          |        |   |  |          |       
|                                                                                                       | Capital expenditures                                                    |                           |          | (221   | )    |  |          | (157   | ) |  |          | (291   | )
|                                                                                                       | Purchases of marketable securities                                      |                           |          | (4,950 | )    |  |          | (2,091 | ) |  |          | (684   | )
|                                                                                                       | Maturities of marketable securities                                     |                           |          | 939    |      |  |          | 918    |   |  |          | 1,529  |  
|                                                                                                       | Sales of marketable securities                                          |                           |          | 2,966  |      |  |          | 352    |   |  |          | -      |  
|                                                                                                       | Proceeds from the sale or disposal
    of property, plant and equipment |                           |          | 2      |      |  |          | 63     |   |  |          | 158    |  
|                                                                                                       | Other investing activities                                              |                           |          | (4     | )    |  |          | 46     |   |  |          | 46     |  
|                                                                                                       |                                                                         |                           |          |        |      |  |          |        |  
|Net cash (used in) provided by
    investing activities                                                |                                                                         |                           | (1,268   | )      |      |  | (869     | )      |   |  | 758      |       
|                                                                                                       |                                                                         |                           |          |        |      |  |          |        |  
|Financing activities:                                                                                  |                                                                         |                           |          |        |      |  |          |        |   |  |          |       
|                                                                                                       | Issuance of convertible senior debt                                     |                           |          | -      |      |  |          | -      |   |  |          | 1,631  |  
|                                                                                                       | Net proceeds of other short-term
    borrowings                         |                           |          | -      |      |  |          | 2      |   |  |          | 46     |  
|                                                                                                       | Repayments of long-term debt                                            |                           |          | (547   | )    |  |          | (479   | ) |  |          | (535   | )
|                                                                                                       | Issuance of common stock                                                |                           |          | 126    |      |  |          | 276    |   |  |          | 38     |  
|                                                                                                       | Redemptions of preferred stock                                          |                           |          | -      |      |  |          | (21    | ) |  |          | (69    | )
|                                                                                                       | Other financing activities                                              |                           |          | -      |      |  |          | (17    | ) |  |          | (60    | )
|                                                                                                       |                                                                         |                           |          |        |      |  |          |        |  
|Net cash (used in) provided by
    financing activities                                                |                                                                         |                           | (421     | )      |      |  | (239     | )      |   |  | 1,051    |       
|Effect of exchange rate changes on
    cash and cash equivalents                                       |                                                                         |                           | 3        |        |      |  | 32       |        |   |  | 66       |       
|                                                                                                       |                                                                         |                           |          |        |      |  |          |        |  
|Net (decrease) increase in cash and
    cash equivalents                                               |                                                                         |                           | (969     | )      |      |  | (442     | )      |   |  | 927      |       
|Cash and cash equivalents at
    beginning of year                                                     |                                                                         |                           | 3,379    |        |      |  | 3,821    |        |   |  | 2,894    |       
|                                                                                                       |                                                                         |                           |          |        |      |  |          |        |  
|Cash and cash equivalents at end of
    year                                                           |                                                                         |                           | $  2,410 |        |      |  | $  3,379 |        |   |  | $  3,821 |       
|                                                                                                       |                                                                         |                           |          |        |      |  |          |        |  
|Income tax refunds, net                                                                                |                                                                         |                           | $    755 |        |      |  | $     52 |        |   |  | $    109 |       
|                                                                                                       |                                                                         |                           |          |        |      |  |          |        |  
|Interest payments                                                                                      |                                                                         |                           | $    341 |        |      |  | $    371 |        |   |  | $    336 |       
|                                                                                                       |                                                                         |                           |          |        |      |  |          |        |  



F-41



---



##### 

1.
    SUMMARY OF SIGNIFICANT ACCOUNTING POLICIESBasis of Consolidation

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

Use of Estimates

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

Foreign Currency Translation and Transactions

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

Revenue Recognition

Revenue is recognized when persuasive evidence of an agreement
exists, delivery has occurred, the amount is fixed or
determinable, and collection of the resulting receivable is
probable.

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

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

F-42



---



##### 

Software revenue recognition rules are applied when software is
sold on a standalone basis, or when software is embedded with
our hardware and the software is considered more than
incidental. Software is determined to be more than incidental
when it is apparent that it is a significant factor in the
customers purchasing decision, such as when a transaction
also includes software upgrades or enhancements. In
multiple-element arrangements, where software is considered more
than incidental, fair value of an undelivered element is
determined using vendor-specific objective evidence (VSOE). If
VSOE cannot be determined or any undelivered element is
essential to the functionality of the delivered element, revenue
is deferred until such criteria are met or until the last
element is delivered.

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

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

Research and Development and Software Development Costs

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

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

Internal Use Software

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

Stock-Based Compensation

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

F-43



---



##### 

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

|                                                                                                         |  |                           |          |   |      |  |         |      |  |  |          |  
|-------------------------------------------------------------------------------------------------------- |  | ------------------------- | -------- | - | ---- |  | ------- | ---- |  |  | -------- | -
|                                                                                                         |  | Years ended September 30, |         
|(in millions, except per share amounts)                                                                  |  | 2005                      |          |   | 2004 |  |         | 2003 | 
|                                                                                                         |  |                           |          |   |      |  |         |      | 
|Net income (loss), as reported                                                                           |  |                           | $ 1,185  |   |      |  | $ 2,002 |      |  |  | $  (770  | )
|Add: Stock-based employee
    compensation expense included in net income (loss), as reported            |  |                           | 35       |   |      |  | 16      |      |  |  | 17       |  
|Deduct: Total stock-based employee
    compensation expense determined under the fair value based method |  |                           | (267     | ) |      |  | (338    | )    |  |  | (285     | )
|                                                                                                         |  |                           |          |   |      |  |         |      | 
|Pro forma net income (loss)                                                                              |  |                           | $    953 |   |      |  | $ 1,680 |      |  |  | $ (1,038 | )
|                                                                                                         |  |                           |          |   |      |  |         |      | 
|Income (loss) per share applicable
    to common shareowners:                                            |  |                           |          |   |      |  |         |      |  |  |          |  
|Basic  as reported                                                                                      |  |                           | $  0.27  |   |      |  | $  0.47 |      |  |  | $  (0.29 | )
|Diluted  as reported                                                                                    |  |                           | 0.24     |   |      |  | 0.42    |      |  |  | (0.29    | )
|Basic  pro forma                                                                                        |  |                           | 0.22     |   |      |  | 0.40    |      |  |  | (0.36    | )
|Diluted  pro forma                                                                                      |  |                           | 0.20     |   |      |  | 0.36    |      |  |  | (0.36    | )





|                                                   |  |      |        |  |      |  |        |      |  |  |        | 
|-------------------------------------------------- |  | ---- | ------ |  | ---- |  | ------ | ---- |  |  | ------ | 
|                                                   |  | 2005 |        |  | 2004 |  |        | 2003 | 
|                                                   |  |      |        |  |      |  |        |      | 
|Dividend yield                                     |  |      | 0.0%   |  |      |  | 0.0%   |      |  |  | 0.0%   | 
|Expected volatility                                |  |      | 82.0%  |  |      |  | 90.2%  |      |  |  | 95.1%  | 
|Risk-free interest rate                            |  |      | 3.5%   |  |      |  | 2.6%   |      |  |  | 2.2%   | 
|Expected holding period (in years)                 |  |      | 3.8    |  |      |  | 3.2    |      |  |  | 3.0    | 
|Weighted average fair value of
    options granted |  |      | $ 2.34 |  |      |  | $ 1.83 |      |  |  | $ 0.87 | 



F-44



---



##### 

Cash and Cash Equivalents

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

Marketable Securities

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

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

Inventories

Inventories are stated at the lower of cost (which approximates
cost determined on a first-in, first-out basis) or market.
Excess and obsolete inventory reserves are generally determined
by future demand forecasts.

Property, Plant and Equipment

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

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

Goodwill and Other Acquired Intangible Assets

Goodwill is tested for impairment in the fourth quarter of each
fiscal year or more often if an event or circumstances indicate
that an impairment loss has been incurred. An impairment charge
is recognized if a reporting units goodwill carrying
amount exceeds its implied fair value. Other acquired intangible
assets are amortized on a straight-line basis over the periods
benefited, primarily over four years. The following table
summarizes the changes in the carrying value of goodwill and
other acquired intangible assets.

F-45



---



##### 



|                          |  |          |  |            |  |          |  |       |  |       
|------------------------- |  | -------- |  | ---------- |  | -------- |  | ----- |  | ------
|                          |  | Goodwill |  |           
|                          |  |          |  | Other     
|                          |  |          |  | acquired  
|                          |  |          |  | intangible
|(in millions)             |  | INS      |  | Mobility   |  | Services |  | Total |  | assets
|                          |  |          |  |            |  |          |  |       |  |       
|As of September 30, 2003  |  | $ 131    |  | $ 16       |  | $ 38     |  | $ 185 |  | $   3 
|Acquisition/contingencies |  | 127      |  | 11         |  | 53       |  | 191   |  | 60    
|Impairment/amortization   |  | -        |  | -          |  | -        |  | -     |  | (3)   
|Other                     |  | (1)      |  | (2)        |  | -        |  | (3)   |  | 1     
|                          |  |          |  |            |  |          |  |       |  |       
|As of September 30, 2004  |  | 257      |  | 25         |  | 91       |  | 373   |  | 61    
|Amortization              |  | -        |  | -          |  | -        |  | -     |  | (16)  
|Reclassification/other    |  | (7)      |  | 7          |  | 1        |  | 1     |  | -     
|                          |  |          |  |            |  |          |  |       |  |       
|As of September 30, 2005  |  | $ 250    |  | $ 32       |  | $ 92     |  | $ 374 |  | $ 45  
|                          |  |          |  |            |  |          |  |       |  |       





|              |  |        |      | 
|------------- |  | ------ | ---- | 
|(in millions) |  | Amount |     
|Fiscal Year:  |  |        |     
|2006          |  |        | $ 16 | 
|2007          |  |        | 15   | 
|2008          |  |        | 14   | 
|              |  |        |     
|Total         |  |        | $ 45 | 
|              |  |        |     

Impairment of Other Long-Lived Assets




Reclassifications









|   |                       
|-- | ----------------------
|2. | BUSINESS RESTRUCTURING



F-46



---



##### 

We have completed the restructuring actions but continue to
evaluate the remaining restructuring reserves at the end of each
reporting period. Most of the remaining reserve requirements are
related to leases on exited facilities as of September 30,
2005. Additional charges or reversals may be required if the
expected amount of sublease rental income changes in the future
or if other circumstances change.

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

|                                                                |  |                           |       |   |      |  |       |      |  |  |        |  
|--------------------------------------------------------------- |  | ------------------------- | ----- | - | ---- |  | ----- | ---- |  |  | ------ | -
|                                                                |  | Years ended September 30, |      
|(in millions)                                                   |  | 2005                      |       |   | 2004 |  |       | 2003 | 
|                                                                |  |                           |       |   |      |  |       |      | 
|Restructuring costs                                             |  |                           | $ (10 | ) |      |  | $ (20 | )    |  |  | $  (64 | )
|Asset write-downs                                               |  |                           | -     |   |      |  | 1     |      |  |  | (120   | )
|Business dispositions                                           |  |                           | -     |   |      |  | (1    | )    |  |  | -      |  
|Impairment of goodwill and other
    acquired intangible assets |  |                           | -     |   |      |  | -     |      |  |  | 35     |  
|                                                                |  |                           |       |   |      |  |       |      | 
|Net reversals                                                   |  |                           | $ (10 | ) |      |  | $ (20 | )    |  |  | $ (149 | )
|                                                                |  |                           |       |   |      |  |       |      | 
|Reflected in:                                                   |  |                           |       |   |      |  |       |      |  |  |        |  
|Costs                                                           |  |                           | $   - |   |      |  | $   - |      |  |  | $  (26 | )
|Operating expenses                                              |  |                           | (10   | ) |      |  | (20   | )    |  |  | (158   | )
|Impairment of goodwill                                          |  |                           | -     |   |      |  | -     |      |  |  | 35     |  
|                                                                |  |                           |       |   |      |  |       |      | 
|Net reversals                                                   |  |                           | $ (10 | ) |      |  | $ (20 | )    |  |  | $ (149 | )
|                                                                |  |                           |       |   |      |  |       |      | 

Restructuring Costs




|                                                   |  |             |       |   |             |  |       |          |  |  |       |   |  |       |      |   |  |  |         |  
|-------------------------------------------------- |  | ----------- | ----- | - | ----------- |  | ----- | -------- |  |  | ----- | - |  | ----- | ---- | - |  |  | ------- | -
|                                                   |  | Employee    |       |   | Contract    |  |       | Facility |  |  |       |   | 
|(in millions)                                      |  | separations |       |   | settlements |  |       | closings |  |  | Other |   |  | Total |     
|                                                   |  |             |       |   |             |  |       |          |  |  |       |   |  |       |     
|Restructuring reserve as of
    September 30, 2002 |  |             | $ 367 |   |             |  | $ 150 |          |  |  | $ 483 |   |  |       | $ 69 |   |  |  | $ 1,069 |  
|                                                   |  |             |       |   |             |  |       |          |  |  |       |   |  |       |     
|Charges related to current year
    plans          |  |             | 18    |   |             |  | 17    |          |  |  | -     |   |  |       | 1    |   |  |  | 36      |  
|Charges related to prior year plans                |  |             | 163   |   |             |  | 27    |          |  |  | 54    |   |  |       | 5    |   |  |  | 249     |  
|Reversals related to prior year
    plans          |  |             | (228  | ) |             |  | (60   | )        |  |  | (37   | ) |  |       | (24  | ) |  |  | (349    | )
|                                                   |  |             |       |   |             |  |       |          |  |  |       |   |  |       |     
|Total restructuring costs for
    fiscal 2003      |  |             | (47   | ) |             |  | (16   | )        |  |  | 17    |   |  |       | (18  | ) |  |  | (64     | )
|Utilization of reserves                            |  |             | (258  | ) |             |  | (100  | )        |  |  | (133  | ) |  |       | (47  | ) |  |  | (538    | )
|                                                   |  |             |       |   |             |  |       |          |  |  |       |   |  |       |     
|Restructuring reserve as of
    September 30, 2003 |  |             | 62    |   |             |  | 34    |          |  |  | 367   |   |  |       | 4    |   |  |  | 467     |  
|                                                   |  |             |       |   |             |  |       |          |  |  |       |   |  |       |     
|Charges related to prior year plans                |  |             | -     |   |             |  | -     |          |  |  | 44    |   |  |       | -    |   |  |  | 44      |  
|Reversals related to prior year
    plans          |  |             | (14   | ) |             |  | (15   | )        |  |  | (32   | ) |  |       | (3   | ) |  |  | (64     | )
|                                                   |  |             |       |   |             |  |       |          |  |  |       |   |  |       |     
|Total restructuring costs for
    fiscal 2004      |  |             | (14   | ) |             |  | (15   | )        |  |  | 12    |   |  |       | (3   | ) |  |  | (20     | )
|Utilization of reserves                            |  |             | (38   | ) |             |  | (11   | )        |  |  | (177  | ) |  |       | (1   | ) |  |  | (227    | )
|                                                   |  |             |       |   |             |  |       |          |  |  |       |   |  |       |     
|Restructuring reserve as of
    September 30, 2004 |  |             | 10    |   |             |  | 8     |          |  |  | 202   |   |  |       | -    |   |  |  | 220     |  
|                                                   |  |             |       |   |             |  |       |          |  |  |       |   |  |       |     
|Charges related to prior year plans                |  |             | 1     |   |             |  | -     |          |  |  | 16    |   |  |       | -    |   |  |  | 17      |  
|Reversals related to prior year
    plans          |  |             | (6    | ) |             |  | (2    | )        |  |  | (19   | ) |  |       | -    |   |  |  | (27     | )
|                                                   |  |             |       |   |             |  |       |          |  |  |       |   |  |       |     
|Total restructuring costs for
    fiscal 2005      |  |             | (5    | ) |             |  | (2    | )        |  |  | (3    | ) |  |       | -    |   |  |  | (10     | )
|Utilization of reserves                            |  |             | (4    | ) |             |  | (5    | )        |  |  | (54   | ) |  |       | -    |   |  |  | (63     | )
|                                                   |  |             |       |   |             |  |       |          |  |  |       |   |  |       |     
|Restructuring reserve as of
    September 30, 2005 |  |             | $   1 |   |             |  | $   1 |          |  |  | $ 145 |   |  |       | $  - |   |  |  | $  147  |  
|                                                   |  |             |       |   |             |  |       |          |  |  |       |   |  |       |     

F-47



---



##### 

Employee Separations

There were approximately 53,600 employee separations associated
with employee separation charges from fiscal 2001 through fiscal
2003. Substantially all of the employee separations were
completed as of September 30, 2003.

The fiscal 2003 charges for new plans were for approximately 200
employee separations associated with the discontinuance of the
TMX Multi-Service Switching and Spring Tide product lines in the
INS segment.

The fiscal 2005, 2004 and 2003 revisions to prior-year plans
were due to actual termination benefits and curtailment costs
being lower than the estimated amounts as a result of certain
differences in assumed demographics, including the age, service
lives and salaries of the separated employees. Fiscal 2003 also
included a reversal of approximately 900 employee separations
due to higher than expected attrition rates. Components of the
fiscal 2003 net reversal included non-cash reversals for
pension and postretirement termination benefits to certain
former U.S. employees funded through our pension assets, as
well as pension, postretirement and postemployment benefit
curtailments.

Contract Settlements

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

Facility Closings

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

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

The facility closings charges, since the inception of our plan,
were net of expected sublease rental income of
$377 million. This expected sublease rental income was
subsequently reduced by $226 million, including
$3 million, $105 million and $55 million during
fiscal 2005, 2004 and 2003, respectively. The remaining reserve
as of September 30, 2005 of $145 million is expected
to be paid over the remaining lease terms ranging from several
months to over 10 years, and is reflected net of expected
sublease income of $125 million. We have received
commitments for approximately $36 million of this expected
sublease rental income as of September 30, 2005. Additional
charges may be required in the future if the expected sublease
income is not realized.

Utilization of Business Restructuring Reserves

|                                                                                                                                     |  |                           |       |   |      |  |        |      |  |  |        |  
|------------------------------------------------------------------------------------------------------------------------------------ |  | ------------------------- | ----- | - | ---- |  | ------ | ---- |  |  | ------ | -
|                                                                                                                                     |  | Years ended September 30, |      
|                                                                                                                                     |  | 2005                      |       |   | 2004 |  |        | 2003 | 
|(in millions)                                                                                                                        |  |                           |       |   |      |  |        |      | 
|Cash payments                                                                                                                        |  |                           | $ (69 | ) |      |  | $ (227 | )    |  |  | $ (629 | )
|Net pension and postretirement
    termination benefits to certain former
    U.S. employees to be funded through our pension assets |  |                           | -     |   |      |  | -      |      |  |  | 33     |  
|Net pension and postretirement
    benefit curtailments                                                                              |  |                           | -     |   |      |  | -      |      |  |  | 44     |  
|Net postemployment benefit
    curtailments                                                                                          |  |                           | -     |   |      |  | -      |      |  |  | 41     |  
|Other                                                                                                                                |  |                           | 6     |   |      |  | -      |      |  |  | (27    | )
|                                                                                                                                     |  |                           |       |   |      |  |        |      | 
|Utilization of reserves                                                                                                              |  |                           | $ (63 | ) |      |  | $ (227 | )    |  |  | $ (538 | )
|                                                                                                                                     |  |                           |       |   |      |  |        |      | 

F-48



---



##### 

Asset Write-downs

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

|                                          |  |           |       |                 |               |  |        |       |  |  |       |   |  |  |        |  
|----------------------------------------- |  | --------- | ----- | --------------- | ------------- |  | ------ | ----- |  |  | ----- | - |  |  | ------ | -
|                                          |  |           |       | Property, plant |               |  |        |       | 
|(in millions)                             |  | Inventory |       |                 | and equipment |  |        | Other |  |  | Total |  
|                                          |  |           |       |                 |               |  |        |       |  |  |       |  
|Charges related to current-year
    plans |  |           | $  3  |                 |               |  | $    2 |       |  |  | $  -  |   |  |  | $    5 |  
|Charges related to prior-year plans       |  |           | 26    |                 |               |  | 24     |       |  |  | -     |   |  |  | 50     |  
|Reversals related to prior-year
    plans |  |           | (55   | )               |               |  | (113   | )     |  |  | (7    | ) |  |  | (175   | )
|                                          |  |           |       |                 |               |  |        |       |  |  |       |  
|Fiscal 2003 asset write-downs             |  |           | $ (26 | )               |               |  | $  (87 | )     |  |  | $ (7  | ) |  |  | $ (120 | )
|                                          |  |           |       |                 |               |  |        |       |  |  |       |  
|Fiscal 2004 asset write-downs             |  |           | $   - |                 |               |  | $    - |       |  |  | $ 1   |   |  |  | $    1 |  
|                                          |  |           |       |                 |               |  |        |       |  |  |       |  





Impairment of Goodwill and Other Acquired Intangible
Assets







3. BUSINESS ACQUISITIONS






F-49



---



##### 

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

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

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



4.
    SUPPLEMENTARY FINANCIAL INFORMATION

|                                                                   |  |                           |       |   |      |  |       |      |  |  |        |  
|------------------------------------------------------------------ |  | ------------------------- | ----- | - | ---- |  | ----- | ---- |  |  | ------ | -
|                                                                   |  | Years ended September 30, |      
|(in millions)                                                      |  | 2005                      |       |   | 2004 |  |       | 2003 | 
|                                                                   |  |                           |       |   |      |  |       |      | 
|Supplementary Statement of
    Operations Information:             |  |                           |       |   |      |  |       |      |  |  |        |  
|Depreciation of property, plant and
    equipment                  |  |                           | $ 230 |   |      |  | $ 284 |      |  |  | $ 559  |  
|Amortization of software
    development costs                     |  |                           | 342   |   |      |  | 376   |      |  |  | 393    |  
|Amortization of other acquired
    intangible assets               |  |                           | 16    |   |      |  | 3     |      |  |  | 15     |  
|Other amortization                                                 |  |                           | 11    |   |      |  | 30    |      |  |  | 11     |  
|                                                                   |  |                           |       |   |      |  |       |      | 
|Depreciation and amortization                                      |  |                           | $ 599 |   |      |  | $ 693 |      |  |  | $ 978  |  
|                                                                   |  |                           |       |   |      |  |       |      | 
|Legal settlements                                                  |  |                           | $ (65 | ) |      |  | $ (84 | )    |  |  | $ (401 | )
|SEC settlement                                                     |  |                           | -     |   |      |  | (25   | )    |  |  | -      |  
|Interest income on tax refunds and
    settlements                 |  |                           | 88    |   |      |  | 135   |      |  |  | 16     |  
|Interest income                                                    |  |                           | 121   |   |      |  | 89    |      |  |  | 86     |  
|Minority interest                                                  |  |                           | (30   | ) |      |  | (6    | )    |  |  | (10    | )
|Other-than-temporary write-down of
    investments                 |  |                           | (20   | ) |      |  | (22   | )    |  |  | (63    | )
|Gain (loss) on sale of investments                                 |  |                           | 1     |   |      |  | 75    |      |  |  | (10    | )
|Gain on sale of businesses, net                                    |  |                           | -     |   |      |  | -     |      |  |  | 49     |  
|Loss on extinguishment of
    convertible securities and debt, net |  |                           | (11   | ) |      |  | (7    | )    |  |  | (97    | )
|Other, net                                                         |  |                           | 30    |   |      |  | 85    |      |  |  | 2      |  
|                                                                   |  |                           |       |   |      |  |       |      | 
|Other income (expense), net                                        |  |                           | $ 114 |   |      |  | $ 240 |      |  |  | $ (428 | )
|                                                                   |  |                           |       |   |      |  |       |      | 

F-50



---



##### 



|                                                       |  |               |         |   |      |  |         |  
|------------------------------------------------------ |  | ------------- | ------- | - | ---- |  | ------- | -
|                                                       |  | September 30, |        
|(in millions)                                          |  | 2005          |         |   | 2004 | 
|                                                       |  |               |         |   |      | 
|Supplementary Balance Sheet
    Information:           |  |               |         |   |      |  |         |  
|Completed goods                                        |  |               | $593    |   |      |  | $   604 |  
|Work in process                                        |  |               | 42      |   |      |  | 49      |  
|Raw materials                                          |  |               | 96      |   |      |  | 169     |  
|                                                       |  |               |         |   |      | 
|Inventories                                            |  |               | $731    |   |      |  | $   822 |  
|                                                       |  |               |         |   |      | 
|Contracts in process, gross                            |  |               | $ 6,240 |   |      |  | $ 3,696 |  
|Less: progress billings                                |  |               | 6,252   |   |      |  | 3,798   |  
|                                                       |  |               |         |   |      | 
|Contracts in process                                   |  |               | $   (12 | ) |      |  | $  (102 | )
|                                                       |  |               |         |   |      | 
|Costs and recognized income not yet
    billed         |  |               | $208    |   |      |  | $   106 |  
|Billings in excess of costs and
    recognized income  |  |               | (220    | ) |      |  | (208    | )
|                                                       |  |               |         |   |      | 
|Contracts in process                                   |  |               | $   (12 | ) |      |  | $  (102 | )
|                                                       |  |               |         |   |      | 
|Land and improvements                                  |  |               | $75     |   |      |  | $76     |  
|Buildings and improvements                             |  |               | 1,495   |   |      |  | 1,505   |  
|Machinery, electronic and other
    equipment          |  |               | 2,097   |   |      |  | 2,223   |  
|                                                       |  |               |         |   |      | 
|Property, plant and equipment, gross                   |  |               | 3,667   |   |      |  | 3,804   |  
|Less: accumulated depreciation                         |  |               | 2,372   |   |      |  | 2,428   |  
|                                                       |  |               |         |   |      | 
|Property, plant and equipment, net                     |  |               | $ 1,295 |   |      |  | $ 1,376 |  
|                                                       |  |               |         |   |      | 
|Income tax receivables, including
    related interest |  |               | $85     |   |      |  | $868    |  
|Non-trade receivables                                  |  |               | 117     |   |      |  | 360     |  
|Deferred income taxes                                  |  |               | 237     |   |      |  | 197     |  
|Prepaid expenses                                       |  |               | 206     |   |      |  | 187     |  
|Restricted cash                                        |  |               | 41      |   |      |  | 148     |  
|Other                                                  |  |               | 4       |   |      |  | 53      |  
|                                                       |  |               |         |   |      | 
|Other current assets                                   |  |               | $690    |   |      |  | $ 1,813 |  
|                                                       |  |               |         |   |      | 
|Marketed software                                      |  |               | $254    |   |      |  | $   284 |  
|Internal use software                                  |  |               | 120     |   |      |  | 142     |  
|Restricted cash                                        |  |               | 137     |   |      |  | 125     |  
|Deferred income taxes                                  |  |               | 78      |   |      |  | -       |  
|Investments                                            |  |               | 65      |   |      |  | 77      |  
|Non-trade receivables                                  |  |               | 20      |   |      |  | 62      |  
|Retainage receivables                                  |  |               | 8       |   |      |  | 16      |  
|Other                                                  |  |               | 248     |   |      |  | 222     |  
|                                                       |  |               |         |   |      | 
|Other assets                                           |  |               | $930    |   |      |  | $   928 |  
|                                                       |  |               |         |   |      | 
|Deferred revenue                                       |  |               | $529    |   |      |  | $   593 |  
|Shareholder lawsuit settlement                         |  |               | -       |   |      |  | 572     |  
|Warranty                                               |  |               | 188     |   |      |  | 221     |  
|Contracts in process                                   |  |               | 12      |   |      |  | 102     |  
|Business restructuring                                 |  |               | 44      |   |      |  | 88      |  
|Other                                                  |  |               | 815     |   |      |  | 785     |  
|                                                       |  |               |         |   |      | 
|Other current liabilities                              |  |               | $ 1,588 |   |      |  | $ 2,361 |  
|                                                       |  |               |         |   |      | 
|Deferred income taxes                                  |  |               | $205    |   |      |  | $   178 |  
|Deferred compensation                                  |  |               | 112     |   |      |  | 155     |  
|Business restructuring                                 |  |               | 102     |   |      |  | 122     |  
|Environmental                                          |  |               | 72      |   |      |  | 83      |  
|Warranty                                               |  |               | 69      |   |      |  | 76      |  
|Minority interest                                      |  |               | 63      |   |      |  | 35      |  
|Other, including contingencies                         |  |               | 342     |   |      |  | 483     |  
|                                                       |  |               |         |   |      | 
|Other liabilities                                      |  |               | $965    |   |      |  | $ 1,132 |  
|                                                       |  |               |         |   |      | 

F-51



---



##### 



|                                                     |  |                           |       |   |      |  |        |      |  |  |         |  
|---------------------------------------------------- |  | ------------------------- | ----- | - | ---- |  | ------ | ---- |  |  | ------- | -
|                                                     |  | Years ended September 30, |      
|(in millions)                                        |  | 2005                      |       |   | 2004 |  |        | 2003 | 
|                                                     |  |                           |       |   |      |  |        |      | 
|Valuation and Qualifying
    Accounts                |  |                           |       |   |      |  |        |      |  |  |         |  
|Allowance for uncollectible
    accounts receivable: |  |                           |       |   |      |  |        |      |  |  |         |  
|Allowance at beginning of year                       |  |                           | $ 110 |   |      |  | $  246 |      |  |  | $  325  |  
|Recoveries, net                                      |  |                           | (18   | ) |      |  | (42    | )    |  |  | (67     | )
|Other account transfers                              |  |                           | 11    |   |      |  | 7      |      |  |  | 134     |  
|Write-offs                                           |  |                           | (19   | ) |      |  | (101   | )    |  |  | (146    | )
|                                                     |  |                           |       |   |      |  |        |      | 
|Allowance at end of year                             |  |                           | $  84 |   |      |  | $  110 |      |  |  | $  246  |  
|                                                     |  |                           |       |   |      |  |        |      | 
|                                                    
|Inventory valuation
    reserves:                    |  |                           |       |   |      |  |        |      |  |  |         |  
|Reserve at beginning of year                         |  |                           | $ 710 |   |      |  | $  980 |      |  |  | $ 1,490 |  
|Charges                                              |  |                           | 71    |   |      |  | 21     |      |  |  | 56      |  
|Other account transfers                              |  |                           | 20    |   |      |  | (36    | )    |  |  | 109     |  
|Write-offs                                           |  |                           | (89   | ) |      |  | (255   | )    |  |  | (675    | )
|                                                     |  |                           |       |   |      |  |        |      | 
|Reserve at end of year                               |  |                           | $ 712 |   |      |  | $  710 |      |  |  | $  980  |  
|                                                     |  |                           |       |   |      |  |        |      | 






|   |                                 
|-- | --------------------------------
|5. | EARNINGS (LOSS) PER COMMON SHARE





|                                                                  |  |                           |         |  |      |  |         |      |  |  |          |  
|----------------------------------------------------------------- |  | ------------------------- | ------- |  | ---- |  | ------- | ---- |  |  | -------- | -
|                                                                  |  | Years ended September 30, |        
|(in millions, except per share amounts)                           |  | 2005                      |         |  | 2004 |  |         | 2003 | 
|                                                                  |  |                           |         |  |      |  |         |      | 
|Net income (loss)                                                 |  |                           | $ 1,185 |  |      |  | $ 2,002 |      |  |  | $  (770  | )
|Conversion and redemption
    cost  8.00% convertible securities |  |                           | -       |  |      |  | (1      | )    |  |  | (287     | )
|Preferred stock dividends and
    accretion                       |  |                           | -       |  |      |  | 12      |      |  |  | (103     | )
|                                                                  |  |                           |         |  |      |  |         |      | 
|Net income (loss) applicable to
    common shareowners  basic    |  |                           | 1,185   |  |      |  | 2,013   |      |  |  | (1,160   | )
|Adjustment for dilutive securities
    on net income (loss):      |  |                           |         |  |      |  |         |      |  |  |          |  
|Interest expense related to
    convertible securities            |  |                           | 86      |  |      |  | 200     |      |  |  | -        |  
|                                                                  |  |                           |         |  |      |  |         |      | 
|Net income (loss) applicable to
    common shareowners  diluted  |  |                           | $ 1,271 |  |      |  | $ 2,213 |      |  |  | $ (1,160 | )
|                                                                  |  |                           |         |  |      |  |         |      | 
|Weighted average shares
    outstanding  basic                   |  |                           | 4,426   |  |      |  | 4,258   |      |  |  | 3,950    |  
|Effect of dilutive securities:                                    |  |                           |         |  |      |  |         |      |  |  |          |  
|Stock options                                                     |  |                           | 60      |  |      |  | 72      |      |  |  | -        |  
|Warrants                                                          |  |                           | 15      |  |      |  | -       |      |  |  | -        |  
|2.75% convertible securities                                      |  |                           | 542     |  |      |  | 496     |      |  |  | -        |  
|8.00% convertible securities                                      |  |                           | 167     |  |      |  | 249     |      |  |  | -        |  
|7.75% convertible securities                                      |  |                           | 8       |  |      |  | 238     |      |  |  | -        |  
|                                                                  |  |                           |         |  |      |  |         |      | 
|Weighted average shares
    outstanding  diluted                 |  |                           | 5,218   |  |      |  | 5,313   |      |  |  | 3,950    |  
|                                                                  |  |                           |         |  |      |  |         |      | 
|EPS:                                                              |  |                           |         |  |      |  |         |      |  |  |          |  
|Basic                                                             |  |                           | $  0.27 |  |      |  | $  0.47 |      |  |  | $  (0.29 | )
|Diluted                                                           |  |                           | 0.24    |  |      |  | 0.42    |      |  |  | (0.29    | )

F-52



---



##### 

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

|                                                                                                                                                                |  |                           |  |      |     |  |      |      
|--------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------------------- |  | ---- | --- |  | ---- | -----
|                                                                                                                                                                |  | Years ended September 30,
|(in millions)                                                                                                                                                   |  | 2005                      |  | 2004 |     |  | 2003
|                                                                                                                                                                |  |                           |  |      |     |  |     
|8.00% convertible securities                                                                                                                                    |  | 70                        |  |      | 3   |  |      | 685  
|7.75% convertible securities                                                                                                                                    |  | 228                       |  |      | -   |  |      | 273  
|2.75% convertible securities                                                                                                                                    |  | -                         |  |      | -   |  |      | 326  
|Stock options                                                                                                                                                   |  | -                         |  |      | -   |  |      | 14   
|                                                                                                                                                                |  |                           |  |      |     |  |     
|Potentially dilutive shares                                                                                                                                     |  | 298                       |  |      | 3   |  |      | 1,298
|                                                                                                                                                                |  |                           |  |      |     |  |     
|                                                                                                                                                               
|Stock options excluded from the
    diluted per share calculation because the exercise price was
    greater than the average market price of the common shares |  | 297                       |  |      | 252 |  |      | 300  
|                                                                                                                                                                |  |                           |  |      |     |  |     








6. ACCUMULATED OTHER COMPREHENSIVE LOSS




|                                     |  |             |        |   |                    |  |        |            |  |  |                   |   |  |  |           |  
|------------------------------------ |  | ----------- | ------ | - | ------------------ |  | ------ | ---------- |  |  | ----------------- | - |  |  | --------- | -
|                                     |  | Foreign     |        |   | Change in net      |  |        | Minimum    |  |  | Total accumulated |  
|                                     |  | currency    |        |   | unrealized holding |  |        | pension    |  |  | other             |  
|                                     |  | translation |        |   | gains / losses on  |  |        | liability  |  |  | comprehensive     |  
|(in millions)                        |  | adjustment  |        |   | investments        |  |        | adjustment |  |  | loss              |  
|                                     |  |             |        |   |                    |  |        |            |  |  |                   |  
|Balance as of September 30,
    2002 |  |             | $ (413 | ) |                    |  | $    4 |            |  |  | $  (2,941         | ) |  |  | $  (3,350 | )
|Current-period change                |  |             | 135    |   |                    |  | 71     |            |  |  | (594              | ) |  |  | (388      | )
|                                     |  |             |        |   |                    |  |        |            |  |  |                   |  
|Balance as of September 30,
    2003 |  |             | (278   | ) |                    |  | 75     |            |  |  | (3,535            | ) |  |  | (3,738    | )
|Current-period change                |  |             | 34     |   |                    |  | (81    | )          |  |  | 150               |   |  |  | 103       |  
|                                     |  |             |        |   |                    |  |        |            |  |  |                   |  
|Balance as of September 30,
    2004 |  |             | (244   | ) |                    |  | (6     | )          |  |  | (3,385            | ) |  |  | (3,635    | )
|Current-period change                |  |             | 27     |   |                    |  | (13    | )          |  |  | 46                |   |  |  | 60        |  
|                                     |  |             |        |   |                    |  |        |            |  |  |                   |  
|Balance as of September 30,
    2005 |  |             | $ (217 | ) |                    |  | $  (19 | )          |  |  | $  (3,339         | ) |  |  | $  (3,575 | )
|                                     |  |             |        |   |                    |  |        |            |  |  |                   |  

F-53



---



##### 

7. INCOME TAXES

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

|                                   |  |                           |         |   |      |  |         |      |  |  |          |  
|---------------------------------- |  | ------------------------- | ------- | - | ---- |  | ------- | ---- |  |  | -------- | -
|                                   |  | Years ended September 30, |        
|                                   |  | 2005                      |         |   | 2004 |  |         | 2003 | 
|(in millions)                      |  |                           |         |   |      |  |         |      | 
|Income (loss) before income taxes: |  |                           |         |   |      |  |         |      |  |  |          |  
|U.S.                               |  |                           | $   742 |   |      |  | $   985 |      |  |  | $ (1,048 | )
|Non-U.S.                           |  |                           | 292     |   |      |  | 78      |      |  |  | 45       |  
|                                   |  |                           |         |   |      |  |         |      | 
|Income (loss) before income taxes  |  |                           | $ 1,034 |   |      |  | $ 1,063 |      |  |  | $ (1,003 | )
|                                   |  |                           |         |   |      |  |         |      | 
|Benefit for income taxes:          |  |                           |         |   |      |  |         |      |  |  |          |  
|Current:                           |  |                           |         |   |      |  |         |      |  |  |          |  
|Federal                            |  |                           | $  (117 | ) |      |  | $  (967 | )    |  |  | $   (309 | )
|State and local                    |  |                           | (21     | ) |      |  | (10     | )    |  |  | 4        |  
|Non-U.S.                           |  |                           | 71      |   |      |  | 57      |      |  |  | 72       |  
|                                   |  |                           |         |   |      |  |         |      | 
|Subtotal                           |  |                           | (67     | ) |      |  | (920    | )    |  |  | (233     | )
|                                   |  |                           |         |   |      |  |         |      | 
|Deferred:                          |  |                           |         |   |      |  |         |      |  |  |          |  
|Non-U.S.                           |  |                           | (84     | ) |      |  | (19     | )    |  |  | -        |  
|                                   |  |                           |         |   |      |  |         |      | 
|Subtotal                           |  |                           | (84     | ) |      |  | (19     | )    |  |  | -        |  
|                                   |  |                           |         |   |      |  |         |      | 
|Benefit for income taxes           |  |                           | $  (151 | ) |      |  | $  (939 | )    |  |  | $   (233 | )
|                                   |  |                           |         |   |      |  |         |      | 



|                                                                           |  |                           |        |    |      |  |          |      |  |  |        |   
|-------------------------------------------------------------------------- |  | ------------------------- | ------ | -- | ---- |  | -------- | ---- |  |  | ------ | --
|                                                                           |  | Years ended September 30, |       
|                                                                           |  | 2005                      |        |    | 2004 |  |          | 2003 | 
|(in millions)                                                              |  |                           |        |    |      |  |          |      | 
|Provision (benefit) for income
    taxes at 35% statutory rate             |  |                           | $  362 |    |      |  | $   372  |      |  |  | $ (351 | ) 
|State and local income tax
    (benefit), net of federal income tax effect |  |                           | 21     |    |      |  | 33       |      |  |  | (36    | ) 
|Foreign earnings taxed at different
    rates                              |  |                           | (16    | )  |      |  | (24      | )    |  |  | 84     |   
|Conversions of 7.75% trust
    preferred securities                        |  |                           | -      |    |      |  | -        |      |  |  | 45     |   
|Tax audit-related adjustments                                              |  |                           | (130   | )  |      |  | (142     | )    |  |  | (77    | ) 
|Medicare Part D subsidy                                                    |  |                           | (24    | )  |      |  | (6       | )    |  |  | -      |   
|Other differences, net                                                     |  |                           | (7     | )  |      |  | 16       |      |  |  | (27    | ) 
|Change in valuation allowance                                              |  |                           | (357   | )  |      |  | (1,188   | )    |  |  | 129    |   
|                                                                           |  |                           |        |    |      |  |          |      | 
|Benefit for income taxes                                                   |  |                           | $ (151 | )  |      |  | $   (939 | )    |  |  | $ (233 | ) 
|                                                                           |  |                           |        |    |      |  |          |      | 
|                                                                          
|Effective income tax (benefit) rate                                        |  |                           | (14.6  | )% |      |  | (88.4    | )%   |  |  | (23.2  | )%
|                                                                           |  |                           |        |    |      |  |          |      | 



|                                                   |  |               |         |   |      |  |          |      |  |  |          |  
|-------------------------------------------------- |  | ------------- | ------- | - | ---- |  | -------- | ---- |  |  | -------- | -
|                                                   |  | September 30, |        
|                                                   |  | 2005          |         |   | 2004 |  |          | 2003 | 
|(in millions)                                      |  |               |         |   |      |  |          |      | 
|Valuation allowance at beginning of
    year       |  |               | $ 8,027 |   |      |  | $ 10,021 |      |  |  | $  9,989 |  
|Charged (credited) to expense                      |  |               | (357    | ) |      |  | (1,188   | )    |  |  | 129      |  
|Charged (credited) to other
    comprehensive loss |  |               | (13     | ) |      |  | (29      | )    |  |  | 205      |  
|Write-offs                                         |  |               | (359    | ) |      |  | (756     | )    |  |  | (302     | )
|Acquisitions and other                             |  |               | -       |   |      |  | (21      | )    |  |  | -        |  
|                                                   |  |               |         |   |      |  |          |      | 
|Valuation allowance at end of year                 |  |               | $ 7,298 |   |      |  | $  8,027 |      |  |  | $ 10,021 |  
|                                                   |  |               |         |   |      |  |          |      | 

F-54



---



##### 

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

|                                                   |  |               |         |   |      |  |         |  
|-------------------------------------------------- |  | ------------- | ------- | - | ---- |  | ------- | -
|                                                   |  | September 30, |        
|(in millions)                                      |  | 2005          |         |   | 2004 | 
|                                                   |  |               |         |   |      | 
|Bad debt and customer financing
    reserves       |  |               | $    60 |   |      |  | $    98 |  
|Inventory reserves                                 |  |               | 192     |   |      |  | 216     |  
|Business restructuring reserves                    |  |               | 58      |   |      |  | 86      |  
|Pension and postretirement benefits                |  |               | 2,498   |   |      |  | 2,653   |  
|Other employee benefits                            |  |               | 300     |   |      |  | 440     |  
|Other reserves                                     |  |               | 384     |   |      |  | 702     |  
|Net operating loss/credit
    carryforwards        |  |               | 6,368   |   |      |  | 6,140   |  
|Valuation allowance                                |  |               | (7,298  | ) |      |  | (8,027  | )
|                                                   |  |               |         |   |      | 
|Deferred tax assets                                |  |               | $ 2,562 |   |      |  | $ 2,308 |  
|                                                   |  |               |         |   |      | 
|Pension benefits                                   |  |               | $ 2,357 |   |      |  | $ 2,102 |  
|Other, including depreciation and
    amortization |  |               | 101     |   |      |  | 187     |  
|                                                   |  |               |         |   |      | 
|Deferred tax liabilities                           |  |               | $ 2,458 |   |      |  | $ 2,289 |  
|                                                   |  |               |         |   |      | 
|                                                  
|Net deferred tax assets                            |  |               | $   104 |   |      |  | $    19 |  
|                                                   |  |               |         |   |      | 
|                                                  
|Included in:                                       |  |               |         |   |      |  |         |  
|Other current assets                               |  |               | $   237 |   |      |  | $   197 |  
|Other non-current assets                           |  |               | 78      |   |      |  | -       |  
|Other current liabilities                          |  |               | (6      | ) |      |  | -       |  
|Other non-current liabilities                      |  |               | (205    | ) |      |  | (178    | )
|                                                   |  |               |         |   |      | 
|Total                                              |  |               | $   104 |   |      |  | $    19 |  
|                                                   |  |               |         |   |      | 



|                                     |  |        |         |  |            |  |                    | 
|------------------------------------ |  | ------ | ------- |  | ---------- |  | ------------------ | 
|(in millions)                        |  | Amount |         |  | Expiration | 
|                                     |  |        |         |  |            | 
|Federal net operating losses         |  |        | $ 3,537 |  |            |  | 2022 to 2025       | 
|State net operating losses           |  |        | 879     |  |            |  | 2006 to 2025       | 
|Capital losses                       |  |        | 214     |  |            |  | 2007 to 2009       | 
|Foreign net operating losses/credits |  |        | 528     |  |            |  | 2006 to indefinite | 
|Foreign tax credits                  |  |        | 219     |  |            |  | 2010               | 
|Research credits                     |  |        | 778     |  |            |  | 2017 to 2022       | 
|State credits (various)              |  |        | 213     |  |            |  | 2007 to 2018       | 
|                                     |  |        |         |  |            | 
|Total as of September 30, 2005       |  |        | $ 6,368 |  |            |  |                    | 
|                                     |  |        |         |  |            | 







| |   |                                                                                          
| | - | -----------------------------------------------------------------------------------------
| |  | Future taxable income exclusive of reversing temporary
    differences and carry-forwards
| |  | Future reversals of existing taxable temporary differences                               
| |  | Taxable income in prior carry-back years                                                 
| |  | Tax planning strategies                                                                  

F-55



---



##### 

We have not relied upon future taxable income exclusive of
temporary differences and carryforwards for the realization of
U.S. deferred tax assets during recent periods. Reliance on
this source is difficult when there is negative evidence such as
cumulative losses in recent years, even if income is reported in
the current period. Although profits were generated in recent
periods, a substantial amount of the profits were generated from
a pension credit that is not currently taxable and from
non-U.S. sources. As a result, we concluded that there was
not sufficient positive evidence to enable us to conclude that
it was more likely than not that the net U.S. deferred tax
assets would be realized. Therefore, we have maintained a
valuation allowance on our net U.S. deferred tax assets as
of September 30, 2005 and 2004.

We have assumed that all of our deferred tax liabilities will
generate taxable income or reduce potential tax deductions. Most
of these deferred tax liabilities are related to prepaid pension
costs that result primarily from pension credits that are not
currently taxable.

During the fourth quarter of fiscal 2003, we filed a net
operating loss carryback claim related to the carryback of our
fiscal year 2001 federal net operating loss to 1996, a year in
which we filed our federal income tax return as part of the
AT&T consolidated group. We reached a tentative agreement
with the Internal Revenue Service (IRS) on September 1,
2004 that allowed for a tax refund of $816 million (plus
statutory interest to the date of payment), subject to approval
by the Congressional Joint Committee on Taxation. The tax
benefit related to the claim was not recognized at that time or
prior to that time, because it was related to a complex matter
and there was no assurance that approval from the Joint
Committee would be obtained. On November 8, 2004, we
received written confirmation from the IRS that the Joint
Committee approved our tentative agreement with the IRS and that
our agreement with the IRS was final. We were required to
reassess the realization of our net operating loss carryforwards
as of September 30, 2004, because the Joint
Committees final approval was received prior to the
issuance of our consolidated financial statements. As a result,
we recognized an $816 million income tax benefit from the
reversal of valuation allowances due to the realization of
deferred tax assets and interest income of $45 million
during the fourth quarter of fiscal 2004. This refund plus
additional interest was received during fiscal 2005.

We have not provided for U.S. deferred income taxes or
foreign withholding taxes on undistributed earnings of
$536 million of our non-U.S. subsidiaries, since these
earnings are intended to be reinvested indefinitely. As a result
of our U.S. net operating loss carryforwards and valuation
allowance, the amount of additional taxes that might be payable
on such undistributed earnings is not expected to be
significant. However, if significant changes to our net
operating loss carryforwards and valuation allowance occur in
the future, the amount of additional taxes on undistributed
earnings could be significant. As a result, it is not practical
to estimate the amount of additional taxes that might be payable
on such undistributed earnings.

We are subject to ongoing tax examinations and assessments in
various jurisdictions. Accordingly, we may record incremental
tax expense based upon the probable outcomes of such matters. In
addition, we adjust the previously reported tax expense to
reflect the expected results of these examinations. The net
income tax benefit recognized as a result of the expected
favorable resolution of certain tax audit matters were
$130 million, $142 million and $77 million during
fiscal 2005, 2004 and 2003, respectively.

F-56



---



##### 

8. DEBT OBLIGATIONS AND EARLY EXTINGUISHMENT OF DEBT

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

|                                                                        |  |               |         |   |      |  |         |  
|----------------------------------------------------------------------- |  | ------------- | ------- | - | ---- |  | ------- | -
|                                                                        |  | September 30, |        
|                                                                        |  | 2005          |         |   | 2004 | 
|(in millions)                                                           |  |               |         |   |      | 
|7.25% notes due July 15,
    2006                                       |  |               | $   368 |   |      |  | $   450 |  
|8% convertible securities
    redeemable on August 2, 2007              |  |               | 501     |   |      |  | 817     |  
|5.50% notes due
    November 15, 2008                                   |  |               | 202     |   |      |  | 291     |  
|7.75% convertible securities
    due March 15, 2017                     |  |               | 1,102   |   |      |  | 1,152   |  
|2.75% Series A convertible
    debentures due June 15, 2023             |  |               | 750     |   |      |  | 750     |  
|2.75% Series B convertible
    debentures due June 15, 2025             |  |               | 881     |   |      |  | 881     |  
|6.50% debentures due
    January 15, 2028                               |  |               | 300     |   |      |  | 300     |  
|6.45% debentures due
    March 15, 2029                                 |  |               | 1,360   |   |      |  | 1,360   |  
|Unamortized discount                                                    |  |               | (28     | ) |      |  | (30     | )
|Fair value basis adjustment
    attributable to hedged debt obligations |  |               | (3      | ) |      |  | 17      |  
|Other                                                                   |  |               | 1       |   |      |  | 2       |  
|                                                                        |  |               |         |   |      | 
|Subtotal long-term debt                                                 |  |               | 5,434   |   |      |  | 5,990   |  
|Amounts maturing within one year                                        |  |               | (368    | ) |      |  | (1      | )
|                                                                        |  |               |         |   |      | 
|Long-term debt                                                          |  |               | $ 5,066 |   |      |  | $ 5,989 |  
|                                                                        |  |               |         |   |      | 



2.75% Series A and B Convertible Debentures










F-57



---



##### 

The following table summarizes the specific terms of these
securities.

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

7.75% Convertible Securities (Liability to Subsidiary
Trust Issuing Preferred Securities)










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

8% Convertible Securities




|                                                   |  |                                     
|-------------------------------------------------- |  | ------------------------------------
|Conversion ratio of common shares
    per security |  | 168.3502                            
|Conversion price                                   |  | $ 5.94                              
|Redemption period at our option                    |  | After August 14, 2006               
|Redemption dates at the option of
    the holder   |  | On August 2, 2007, 2010 and
    2016
|Mandatory redemption date                          |  | August 1, 2031                      

F-58



---



##### 

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

Early Extinguishment of Convertible Securities and Debt
Obligations

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

|                                                                 |  |                           |        |   |      |  |        |      |  |  |         |  
|---------------------------------------------------------------- |  | ------------------------- | ------ | - | ---- |  | ------ | ---- |  |  | ------- | -
|                                                                 |  | Years ended September 30, |       
|                                                                 |  | 2005                      |        |   | 2004 |  |        | 2003 | 
|(in millions)                                                    |  |                           |        |   |      |  |        |      | 
|8% convertible securities                                        |  |                           | $ 316  |   |      |  | $  58  |      |  |  | $   835 |  
|7.75% convertible securities                                     |  |                           | 50     |   |      |  | -      |      |  |  | 598     |  
|                                                                 |  |                           |        |   |      |  |        |      | 
|Total convertible securities                                     |  |                           | 366    |   |      |  | 58     |      |  |  | 1,433   |  
|Other debt obligations                                           |  |                           | 170    |   |      |  | 274    |      |  |  | 519     |  
|                                                                 |  |                           |        |   |      |  |        |      | 
|                                                                
|Total convertible securities and
    debt extinguished           |  |                           | $ 536  |   |      |  | $ 332  |      |  |  | $ 1,952 |  
|                                                                 |  |                           |        |   |      |  |        |      | 
|                                                                
|Shares of our common stock exchanged                             |  |                           | -      |   |      |  | 22     |      |  |  | 563     |  
|                                                                 |  |                           |        |   |      |  |        |      | 
|                                                                
|Cash used for early extinguishments                              |  |                           | $ 547  |   |      |  | $ 249  |      |  |  | $   487 |  
|                                                                 |  |                           |        |   |      |  |        |      | 
|                                                                
|8% convertible
    securities  conversion/redemption costs      |  |                           | $   (9 | ) |      |  | $   (4 | )    |  |  | $  (287 | )
|7.75% convertible
    securities  conversion costs              |  |                           | 3      |   |      |  | -      |      |  |  | (129    | )
|Debt obligations  gains
    (losses)                            |  |                           | (5     | ) |      |  | (4     | )    |  |  | 32      |  
|                                                                 |  |                           |        |   |      |  |        |      | 
|Impact on net income (loss)
    applicable to common shareowners |  |                           | $ (11  | ) |      |  | $   (8 | )    |  |  | $  (384 | )
|                                                                 |  |                           |        |   |      |  |        |      | 








|   |                       
|-- | ----------------------
|9. | EMPLOYEE BENEFIT PLANS



F-59



---



##### 

The following tables summarize changes in the benefit
obligation, the plan assets and the funded status of our pension
and postretirement benefit plans as well as the components of
net periodic benefit costs, including key assumptions. The
measurement dates for plan assets and obligations were
September 30, 2005 and 2004.

|                                                                                  |  |                  |          |                |               |  |          |      |  |  |           |   |  |  |           |  
|--------------------------------------------------------------------------------- |  | ---------------- | -------- | -------------- | ------------- |  | -------- | ---- |  |  | --------- | - |  |  | --------- | -
|                                                                                  |  |                  |          | Postretirement |              
|                                                                                  |  | Pension benefits |          |                | benefits      | 
|                                                                                  |  | September 30,    |          |                | September 30, | 
|                                                                                  |  | 2005             |          |                | 2004          |  |          | 2005 |  |  | 2004      |  
|(in millions)                                                                     |  |                  |          |                |               |  |          |      |  |  |           |  
|Change in benefit obligation:                                                     |  |                  |          |                |               |  |          |      |  |  |           |   |  |  |           |  
|Benefit obligation at beginning of
    year                                       |  |                  | $ 31,301 |                |               |  | $ 31,235 |      |  |  | $  6,487  |   |  |  | $  8,511  |  
|Service cost                                                                      |  |                  | 158      |                |               |  | 150      |      |  |  | 7         |   |  |  | 8         |  
|Interest cost                                                                     |  |                  | 1,658    |                |               |  | 1,716    |      |  |  | 344       |   |  |  | 434       |  
|Actuarial (gains) losses                                                          |  |                  | 931      |                |               |  | 832      |      |  |  | 48        |   |  |  | (1,489    | )
|Amendments                                                                        |  |                  | 78       |                |               |  | (11      | )    |  |  | 248       |   |  |  | (110      | )
|Benefits paid                                                                     |  |                  | (2,802   | )              |               |  | (2,671   | )    |  |  | (940      | ) |  |  | (967      | )
|Plan participant contributions                                                    |  |                  | 4        |                |               |  | 3        |      |  |  | 112       |   |  |  | 100       |  
|Settlements                                                                       |  |                  | (11      | )              |               |  | (5       | )    |  |  | -         |   |  |  | -         |  
|Curtailments                                                                      |  |                  | 1        |                |               |  | (1       | )    |  |  | -         |   |  |  | -         |  
|Exchange rate changes                                                             |  |                  | (23      | )              |               |  | 53       |      |  |  | -         |   |  |  | -         |  
|Other                                                                             |  |                  | 16       |                |               |  | -        |      |  |  | -         |   |  |  | -         |  
|                                                                                  |  |                  |          |                |               |  |          |      |  |  |           |  
|Benefit obligation at end of year                                                 |  |                  | $ 31,311 |                |               |  | $ 31,301 |      |  |  | $  6,306  |   |  |  | $  6,487  |  
|                                                                                  |  |                  |          |                |               |  |          |      |  |  |           |  
|                                                                                 
|Change in plan assets:                                                            |  |                  |          |                |               |  |          |      |  |  |           |   |  |  |           |  
|Fair value of plan assets at
    beginning of year                                |  |                  | $ 32,073 |                |               |  | $ 30,148 |      |  |  | $  1,630  |   |  |  | $  2,327  |  
|Actual return on plan assets                                                      |  |                  | 4,689    |                |               |  | 4,507    |      |  |  | 102       |   |  |  | 162       |  
|Benefits paid                                                                     |  |                  | (2,802   | )              |               |  | (2,671   | )    |  |  | (940      | ) |  |  | (967      | )
|Plan participant contributions                                                    |  |                  | 4        |                |               |  | 3        |      |  |  | 112       |   |  |  | 100       |  
|Company contributions                                                             |  |                  | 60       |                |               |  | 57       |      |  |  | 284       |   |  |  | 27        |  
|Exchange rate changes                                                             |  |                  | (23      | )              |               |  | 48       |      |  |  | -         |   |  |  | -         |  
|Settlement                                                                        |  |                  | (11      | )              |               |  | -        |      |  |  | -         |   |  |  | -         |  
|Other (including transfer of assets
    from pension to
    postretirement plans) |  |                  | 14       |                |               |  | (19      | )    |  |  | 12        |   |  |  | (19       | )
|                                                                                  |  |                  |          |                |               |  |          |      |  |  |           |  
|Fair value of plan assets at end of
    year                                      |  |                  | $ 34,004 |                |               |  | $ 32,073 |      |  |  | $  1,200  |   |  |  | $  1,630  |  
|                                                                                  |  |                  |          |                |               |  |          |      |  |  |           |  
|                                                                                 
|Funded status of the plan                                                         |  |                  | $  2,693 |                |               |  | $    772 |      |  |  | $ (5,106  | ) |  |  | $ (4,857  | )
|Unrecognized prior service cost
    (credit)                                      |  |                  | 81       |                |               |  | 85       |      |  |  | (996      | ) |  |  | (1,282    | )
|Unrecognized transition obligation                                                |  |                  | 1        |                |               |  | 1        |      |  |  | -         |   |  |  | -         |  
|Unrecognized net loss                                                             |  |                  | 5,137    |                |               |  | 6,017    |      |  |  | 1,254     |   |  |  | 1,263     |  
|                                                                                  |  |                  |          |                |               |  |          |      |  |  |           |  
|Net asset
    (liability) recognized                                              |  |                  | $  7,912 |                |               |  | $  6,875 |      |  |  | $ (4,848  | ) |  |  | $ (4,876  | )
|                                                                                  |  |                  |          |                |               |  |          |      |  |  |           |  
|                                                                                 
|Amounts recognized in the
    consolidated balance sheets:                        |  |                  |          |                |               |  |          |      |  |  |           |   |  |  |           |  
|Prepaid pension costs                                                             |  |                  | $  6,010 |                |               |  | $  5,358 |      |  |  | $       - |   |  |  | $       - |  
|Other assets                                                                      |  |                  | 8        |                |               |  | 11       |      |  |  | -         |   |  |  | -         |  
|Payroll and benefit-related
    liabilities                                       |  |                  | (22      | )              |               |  | (5       | )    |  |  | (240      | ) |  |  | (258      | )
|Postretirement and postemployment
    benefit liabilities                         |  |                  | -        |                |               |  | -        |      |  |  | (4,608    | ) |  |  | (4,618    | )
|Pension liabilities                                                               |  |                  | (1,423   | )              |               |  | (1,874   | )    |  |  | -         |   |  |  | -         |  
|Accumulated other comprehensive loss                                              |  |                  | 3,339    |                |               |  | 3,385    |      |  |  | -         |   |  |  | -         |  
|                                                                                  |  |                  |          |                |               |  |          |      |  |  |           |  
|Net asset
    (liability) recognized                                              |  |                  | $  7,912 |                |               |  | $  6,875 |      |  |  | $ (4,848  | ) |  |  | $ (4,876  | )
|                                                                                  |  |                  |          |                |               |  |          |      |  |  |           |  

F-60



---



##### 

Additional Information

|                                                                         |  |                  |        |                |               |   |        |      |  |   |       |  |  |   |       | 
|------------------------------------------------------------------------ |  | ---------------- | ------ | -------------- | ------------- | - | ------ | ---- |  | - | ----- |  |  | - | ----- | 
|                                                                         |  |                  |        | Postretirement |              
|                                                                         |  | Pension benefits |        |                | benefits      |  
|                                                                         |  | September 30,    |        |                | September 30, |  
|                                                                         |  | 2005             |        |                | 2004          |   |        | 2005 |  |   | 2004  | 
|(in millions)                                                            |  |                  |        |                |               |   |        |      |  |   |       | 
|Benefit obligation by major plans:                                       |  |                  |        |                |               |   |        |      |  |   |       |  |  |   |       | 
|U.S. management                                                          |  | $                | 18,014 |                |               | $ | 17,684 |      |  | $ | -     |  |  | $ | -     | 
|U.S. occupational                                                        |  |                  | 11,936 |                |               |   | 12,459 |      |  |   | -     |  |  |   | -     | 
|Non-U.S. and supplemental                                                |  |                  | 1,361  |                |               |   | 1,158  |      |  |   | -     |  |  |   | -     | 
|Non-represented health                                                   |  |                  | -      |                |               |   | -      |      |  |   | 1,472 |  |  |   | 1,503 | 
|Formerly represented health                                              |  |                  | -      |                |               |   | -      |      |  |   | 3,298 |  |  |   | 3,369 | 
|Group life and other                                                     |  |                  | -      |                |               |   | -      |      |  |   | 1,536 |  |  |   | 1,615 | 
|                                                                         |  |                  |        |                |               |   |        |      |  |   |       | 
|Benefit obligation at end of year                                        |  | $                | 31,311 |                |               | $ | 31,301 |      |  | $ | 6,306 |  |  | $ | 6,487 | 
|                                                                         |  |                  |        |                |               |   |        |      |  |   |       | 
|                                                                        
|Plan assets by major plans:                                              |  |                  |        |                |               |   |        |      |  |   |       |  |  |   |       | 
|U.S. management                                                          |  | $                | 16,771 |                |               | $ | 15,974 |      |  | $ | -     |  |  | $ | -     | 
|U.S. occupational                                                        |  |                  | 16,404 |                |               |   | 15,354 |      |  |   | -     |  |  |   | -     | 
|Non-U.S. and supplemental                                                |  |                  | 829    |                |               |   | 745    |      |  |   | -     |  |  |   | -     | 
|Formerly represented health                                              |  |                  | -      |                |               |   | -      |      |  |   | 544   |  |  |   | 612   | 
|Group life and other                                                     |  |                  | -      |                |               |   | -      |      |  |   | 656   |  |  |   | 1,018 | 
|                                                                         |  |                  |        |                |               |   |        |      |  |   |       | 
|Fair value of plan assets at end of
    year                             |  | $                | 34,004 |                |               | $ | 32,073 |      |  | $ | 1,200 |  |  | $ | 1,630 | 
|                                                                         |  |                  |        |                |               |   |        |      |  |   |       | 
|                                                                        
|Accumulated benefit obligation                                           |  | $                | 30,920 |                |               | $ | 30,953 |      |  |   | n/a   |  |  |   | n/a   | 
|                                                                        
|Plans with underfunded or
    non-funded benefit obligation:             |  |                  |        |                |               |   |        |      |  |   |       |  |  |   |       | 
|Aggregate benefit obligation                                             |  |                  | 18,735 |                |               |   | 18,287 |      |  |   | 6,306 |  |  |   | 6,487 | 
|Aggregate fair value of plan assets                                      |  |                  | 16,931 |                |               |   | 16,090 |      |  |   | 1,200 |  |  |   | 1,630 | 
|Plans with underfunded or
    non-funded accumulated benefit obligation: |  |                  |        |                |               |   |        |      |  |   |       |  |  |   |       | 
|Aggregate accumulated benefit
    obligation                             |  |                  | 18,350 |                |               |   | 17,957 |      |  |   | n/a   |  |  |   | n/a   | 
|Aggregate fair value of plan assets                                      |  |                  | 16,914 |                |               |   | 16,086 |      |  |   | n/a   |  |  |   | n/a   | 

Components of Net Periodic Benefit Cost


|                                                     |  |                           |        |   |      |   |        |      |  |   |        |  
|---------------------------------------------------- |  | ------------------------- | ------ | - | ---- | - | ------ | ---- |  | - | ------ | -
|                                                     |  | Years ended September 30, |       
|                                                     |  | 2005                      |        |   | 2004 |   |        | 2003 | 
|(in millions)                                        |  |                           |        |   |      |   |        |      | 
|Pension credit:                                      |  |                           |        |   |      |   |        |      |  |   |        |  
|Service cost                                         |  | $                         | 158    |   |      | $ | 150    |      |  | $ | 155    |  
|Interest cost on benefit obligation                  |  |                           | 1,658  |   |      |   | 1,716  |      |  |   | 1,859  |  
|Expected return on plan assets                       |  |                           | (2,897 | ) |      |   | (3,059 | )    |  |   | (3,137 | )
|Amortization of unrecognized prior
    service costs |  |                           | 82     |   |      |   | 70     |      |  |   | 94     |  
|Amortization of transition asset                     |  |                           | -      |   |      |   | -      |      |  |   | (9     | )
|Amortization of net loss                             |  |                           | 21     |   |      |   | 6      |      |  |   | 1      |  
|                                                     |  |                           |        |   |      |   |        |      | 
|Subtotal                                             |  |                           | (978   | ) |      |   | (1,117 | )    |  |   | (1,037 | )
|Termination benefits                                 |  |                           | 1      |   |      |   | -      |      |  |   | (21    | )
|Curtailments                                         |  |                           | -      |   |      |   | 1      |      |  |   | (48    | )
|Settlements                                          |  |                           | 4      |   |      |   | 5      |      |  |   | 9      |  
|                                                     |  |                           |        |   |      |   |        |      | 
|Pension credit                                       |  | $                         | (973   | ) |      | $ | (1,111 | )    |  | $ | (1,097 | )
|                                                     |  |                           |        |   |      |   |        |      | 
|Distribution of pension credit:                      |  |                           |        |   |      |   |        |      |  |   |        |  
|Business restructuring                               |  | $                         | -      |   |      | $ | -      |      |  | $ | (79    | )
|Other costs and expenses                             |  |                           | (973   | ) |      |   | (1,111 | )    |  |   | (1,018 | )
|                                                     |  |                           |        |   |      |   |        |      | 
|Pension credit                                       |  | $                         | (973   | ) |      | $ | (1,111 | )    |  | $ | (1,097 | )
|                                                     |  |                           |        |   |      |   |        |      | 

F-61



---



##### 



|                                                     |  |                           |        |   |      |  |         |      |  |  |         |  
|---------------------------------------------------- |  | ------------------------- | ------ | - | ---- |  | ------- | ---- |  |  | ------- | -
|                                                     |  | Years ended September 30, |       
|(in millions)                                        |  | 2005                      |        |   | 2004 |  |         | 2003 | 
|                                                     |  |                           |        |   |      |  |         |      | 
|Postretirement benefit cost:                         |  |                           |        |   |      |  |         |      |  |  |         |  
|Service cost                                         |  |                           | $   7  |   |      |  | $    8  |      |  |  | $    8  |  
|Interest cost on benefit obligation                  |  |                           | 344    |   |      |  | 434     |      |  |  | 583     |  
|Expected return on plan assets                       |  |                           | (98    | ) |      |  | (161    | )    |  |  | (280    | )
|Amortization of unrecognized prior
    service costs |  |                           | (38    | ) |      |  | (97     | )    |  |  | (51     | )
|Amortization of net loss                             |  |                           | 40     |   |      |  | 59      |      |  |  | 91      |  
|                                                     |  |                           |        |   |      |  |         |      | 
|Subtotal                                             |  |                           | 255    |   |      |  | 243     |      |  |  | 351     |  
|Termination benefits                                 |  |                           | -      |   |      |  | -       |      |  |  | 6       |  
|Curtailments                                         |  |                           | -      |   |      |  | -       |      |  |  | (6      | )
|                                                     |  |                           |        |   |      |  |         |      | 
|Postretirement benefit cost                          |  |                           | $ 255  |   |      |  | $  243  |      |  |  | $  351  |  
|                                                     |  |                           |        |   |      |  |         |      | 
|                                                    
|Distribution of net postretirement
    benefit cost: |  |                           |        |   |      |  |         |      |  |  |         |  
|Business restructuring                               |  |                           | $    - |   |      |  | $     - |      |  |  | $     2 |  
|Other costs and expenses                             |  |                           | 255    |   |      |  | 243     |      |  |  | 349     |  
|                                                     |  |                           |        |   |      |  |         |      | 
|Postretirement benefit cost                          |  |                           | $ 255  |   |      |  | $  243  |      |  |  | $  351  |  
|                                                     |  |                           |        |   |      |  |         |      | 
|                                                    
|Key assumptions                                      |  |                           |        |   |      |  |         |      |  |  |         |  
|                                                    
|Assumptions used to determine:                       |  |                           |        |   |      |  |         |      |  |  |         |  
|Benefit obligations 
    discount rate:             |  |                           |        |   |      |  |         |      |  |  |         |  
|Pension                                              |  |                           | 5.50   | % |      |  | 5.50    | %    |  |  | 5.75    | %
|Postretirement health care and other                 |  |                           | 5.25   | % |      |  | 5.25    | %    |  |  | 5.75    | %
|Postretirement life                                  |  |                           | 5.50   | % |      |  | 5.25    | %    |  |  | 5.75    | %
|Rate of compensation increase                        |  |                           | 4.00   | % |      |  | 4.00    | %    |  |  | 3.50    | %
|                                                    
|Net cost or credit 
    discount rate:              |  |                           |        |   |      |  |         |      |  |  |         |  
|Pension                                              |  |                           | 5.50   | % |      |  | 5.75    | %    |  |  | 6.50    | %
|Postretirement health care and other                 |  |                           | 5.25   | % |      |  | 5.75    | %    |  |  | 6.50    | %
|Postretirement life                                  |  |                           | 5.25   | % |      |  | 5.75    | %    |  |  | 6.50    | %
|                                                    
|Expected return on plan assets:                      |  |                           |        |   |      |  |         |      |  |  |         |  
|Pension                                              |  |                           | 8.50   | % |      |  | 8.75    | %    |  |  | 8.75    | %
|Postretirement health care                           |  |                           | 2.75   | % |      |  | 3.25    | %    |  |  | 7.00    | %
|Postretirement life                                  |  |                           | 7.50   | % |      |  | 7.75    | %    |  |  | 8.75    | %
|Rate of compensation increase                        |  |                           | 4.00   | % |      |  | 3.50    | %    |  |  | 3.50    | %





|                                                                                                 |  |               |      |   |      |  |      |  
|------------------------------------------------------------------------------------------------ |  | ------------- | ---- | - | ---- |  | ---- | -
|                                                                                                 |  | September 30, |     
|                                                                                                 |  | 2005          |      |   | 2004 | 
|                                                                                                 |  |               |      |   |      | 
|Assumed health care cost trend
    rates:                                                        |  |               |      |   |      |  |      |  
|Health care cost trend rate assumed
    for next year                                            |  |               | 10.8 | % |      |  | 11.1 | %
|Health care cost trend rate assumed
    for next year (excluding postretirement dental benefits) |  |               | 11.1 | % |      |  | 11.4 | %
|Rate that the cost trend rate
    gradually declines to                                          |  |               | 5.0  | % |      |  | 5.0  | %
|Year that the rate reaches the rate
    it is assumed to remain at                               |  |               | 2011 |   |      |  | 2010 |  

F-62



---



##### 

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

|                                                            |  |                    |     |  |          |   |       | 
|----------------------------------------------------------- |  | ------------------ | --- |  | -------- | - | ----- | 
|                                                            |  | 1 percentage point |    
|(in millions)                                               |  | Increase           |     |  | Decrease |  
|                                                            |  |                    |     |  |          |  
|Effect on total of service and
    interest cost components |  | $                  | 13  |  |          | $ | (12)  | 
|Effect on postretirement benefit
    obligation             |  |                    | 249 |  |          |   | (222) | 











F-63



---



##### 

We elected to prospectively recognize the effects of the Act
during the fourth quarter of fiscal 2004, which reduced the
accumulated benefit obligation by approximately
$600 million. The impact of the Act is expected to reduce
the annual expense of providing the prescription drug benefit by
approximately $90 million, including lower participation
rates. Approximately 25% of this impact was recognized during
the fourth quarter of fiscal 2004. This included an estimated
impact for retirees who may determine that the addition of
Part D makes the complete reliance on Medicare more
financially attractive than remaining a participant in our
retiree medical plans. On January 21, 2005, the Centers for
Medicare and Medicaid Services issued a Final Rule in the
Federal Register for implementing the Medicare Prescription Drug
Benefit that clarified the methodology for determining actuarial
equivalence and the amount of the federal subsidy. The impact of
the Final Rule did not materially affect our postretirement
benefit cost and related obligation.

Plan Assets

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

|                         |  |                        |         |                       |                   |  |     |                       |                            |  |                     |   |  |      |     |  |      |  |     |   |  |  |     |  
|------------------------ |  | ---------------------- | ------- | --------------------- | ----------------- |  | --- | --------------------- | -------------------------- |  | ------------------- | - |  | ---- | --- |  | ---- |  | --- | - |  |  | --- | -
|                         |  |                        |         |                       |                   |  |     | Percentage of         |                           
|                         |  |                        |         | Percentage of pension |                   |  |     |                       | postretirement plan assets | 
|                         |  | Pension target         |         |                       | plan assets as of |  |     | Postretirement target |                            |  | as of September 30, |  
|                         |  | allocation range as of |         |                       | September 30,     |  |     | allocation as of      |                            |  |                    
|Asset category:          |  | September 30, 2005     |         |                       | 2005              |  |     | 2004                  |                            |  | September 30, 2005  |   |  | 2005 |     |  | 2004 | 
|                         |  |                        |         |                       |                   |  |     |                       |                            |  |                     |   |  |      |     |  |      | 
|Equity securities        |  |                        | 52%70% |                       |                   |  | 62  | %                     |                            |  | 61                  | % |  |      | 27% |  |      |  | 28  | % |  |  | 51  | %
|Fixed income securities  |  |                        | 20%28% |                       |                   |  | 25  |                       |                            |  | 25                  |   |  |      | 73  |  |      |  | 69  |   |  |  | 48  |  
|Real estate              |  |                        | 5%9%   |                       |                   |  | 6   |                       |                            |  | 6                   |   |  |      | n/a |  |      |  | -   |   |  |  | -   |  
|Private equity and other |  |                        | 6%10%  |                       |                   |  | 7   |                       |                            |  | 8                   |   |  |      | n/a |  |      |  | 3   |   |  |  | 1   |  
|                         |  |                        |         |                       |                   |  |     |                       |                            |  |                     |   |  |      |     |  |      | 
|Total                    |  |                        |         |                       |                   |  | 100 | %                     |                            |  | 100                 | % |  |      |     |  |      |  | 100 | % |  |  | 100 | %
|                         |  |                        |         |                       |                   |  |     |                       |                            |  |                     |   |  |      |     |  |      | 





Contributions






F-64



---



##### 

The following table summarizes expected contributions to our
various pension and postretirement plans through fiscal 2015. We
do not expect to make contributions to our qualified
U.S. pension plans during fiscal 2006 or 2007. We are
unable to estimate the expected contributions to our qualified
U.S. pension plans beyond fiscal 2007. Actual contributions
may differ from expected contributions, due to various factors,
including performance of plan assets, interest rates and
potential legislative changes.

|              |  |               |        |          |                |  |         |                |  |  |               |  |  |  |        | 
|------------- |  | ------------- | ------ | -------- | -------------- |  | ------- | -------------- |  |  | ------------- |  |  |  | ------ | 
|              |  | Pension       |        |          | Postretirement | 
|              |  |               |        |          |                | 
|              |  |               |        | Formerly |                |  | Non-    |                |  | 
|              |  | Non-qualified |        |          | represented    |  |         | represented    |  |  |              
|              |  | and non-U.S.  |        |          | retiree health |  |         | retiree health |  |  | Other         | 
|(in millions) |  | pension plans |        |          | plans          |  |         | plans          |  |  | benefit plans | 
|              |  |               |        |          |                |  |         |                |  |  |               | 
|2006          |  |               | $   56 |          |                |  | $    25 |                |  |  | $   218       |  |  |  | $   11 | 
|2007          |  |               | 57     |          |                |  | 247     |                |  |  | 173           |  |  |  | 11     | 
|2008          |  |               | 59     |          |                |  | 359     |                |  |  | 157           |  |  |  | 10     | 
|2009          |  |               | 60     |          |                |  | 343     |                |  |  | 149           |  |  |  | 10     | 
|2010          |  |               | 61     |          |                |  | 324     |                |  |  | 140           |  |  |  | 10     | 
|201115       |  |               | 331    |          |                |  | 1,438   |                |  |  | 568           |  |  |  | 182    | 

Benefit Payments




|              |  |                |         |          |                |  |         |               |  |  |              |  |  |              |         |  |         |  |       |  |  |  |        | 
|------------- |  | -------------- | ------- | -------- | -------------- |  | ------- | ------------- |  |  | ------------ |  |  | ------------ | ------- |  | ------- |  | ----- |  |  |  | ------ | 
|              |  | Pension        |         |          | Postretirement | 
|              |  |                |         |          |                | 
|              |  |                |         | Formerly |                |  | Non-    |               |  | 
|              |  | Qualified U.S. |         |          | Qualified U.S. |  |         | Non-qualified |  |  | represented  |  |  | represented  |         |  | Other   | 
|              |  | management     |         |          | occupational   |  |         | and non-U.S.  |  |  | retiree      |  |  | retiree      |         |  | benefit | 
|(in millions) |  | pension plans  |         |          | pension plans  |  |         | pension plans |  |  | health plans |  |  | health plans |         |  | plans   | 
|              |  |                |         |          |                |  |         |               |  |  |              |  |  |              |         |  |         | 
|2006          |  |                | $ 1,375 |          |                |  | $ 1,074 |               |  |  | $  72        |  |  |              | $   445 |  |         |  | $ 218 |  |  |  | $   90 | 
|2007          |  |                | 1,362   |          |                |  | 1,051   |               |  |  | 55           |  |  |              | 385     |  |         |  | 173   |  |  |  | 91     | 
|2008          |  |                | 1,350   |          |                |  | 1,028   |               |  |  | 59           |  |  |              | 359     |  |         |  | 157   |  |  |  | 92     | 
|2009          |  |                | 1,338   |          |                |  | 1,004   |               |  |  | 58           |  |  |              | 343     |  |         |  | 149   |  |  |  | 95     | 
|2010          |  |                | 1,325   |          |                |  | 980     |               |  |  | 56           |  |  |              | 324     |  |         |  | 140   |  |  |  | 96     | 
|201115       |  |                | 6,431   |          |                |  | 4,524   |               |  |  | 300          |  |  |              | 1,438   |  |         |  | 568   |  |  |  | 497    | 

Savings Plans




Postemployment Benefits




F-65



---



##### 

10.
    STOCK COMPENSATION PLANSWe have stock-based compensation plans under which directors,
officers and other eligible employees receive stock options and
other equity-based awards. The plans provide for the grant of
stock options, stock appreciation rights, performance awards,
restricted stock awards and other stock unit awards.

Stock options generally are granted with an exercise price equal
to 100% of the market value of a share of common stock on the
date of grant, have terms of five to 10 years and vest
within four years of the date of grant. Subject to customary
antidilution adjustments and certain exceptions, the total
number of shares of common stock authorized for option and other
equity grants under the plans was 530 million shares as of
September 30, 2005.

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

Under the terms of the Employee Stock Purchase Plan (2001
ESPP), eligible employees may have up to 10% of eligible
compensation deducted from their pay to purchase shares of
common stock, subject to plan limits, at a discount of 15% of
the market value either at the purchase date or at certain
earlier dates defined in the plan. During fiscal 2005, 2004 and
2003, 17 million, 18 million and 12 million
shares of common stock were purchased, respectively. As of
September 30, 2005, 193 million shares were available
for issuance under the 2001 ESPP. Effective November 1,
2005, the 2001 ESPP was modified to reduce the discount to 5% of
the market value at the purchase date, with no lookback feature.

The following table summarizes stock option activity.

|                                         |  |               |     |                  |                |  |         | 
|---------------------------------------- |  | ------------- | --- | ---------------- | -------------- |  | ------- | 
|                                         |  |               |     | Weighted average |               
|                                         |  | Shares        |     |                  | exercise price | 
|                                         |  | (in millions) |     |                  | per share      | 
|                                         |  |               |     |                  |                | 
|Outstanding as of
    September 30, 2002 |  |               | 287 |                  |                |  | $ 16.73 | 
|Granted                                  |  |               | 162 |                  |                |  | 1.67    | 
|Exercised                                |  |               | (1  | )                |                |  | 1.40    | 
|Forfeited/expired                        |  |               | (60 | )                |                |  | 8.79    | 
|                                         |  |               |     |                  |                | 
|Outstanding as of
    September 30, 2003 |  |               | 388 |                  |                |  | 11.70   | 
|                                         |  |               |     |                  |                | 
|Granted/assumed                          |  |               | 55  |                  |                |  | 3.05    | 
|Exercised                                |  |               | (9  | )                |                |  | 1.67    | 
|Forfeited/expired                        |  |               | (31 | )                |                |  | 10.46   | 
|                                         |  |               |     |                  |                | 
|Outstanding as of
    September 30, 2004 |  |               | 403 |                  |                |  | 10.84   | 
|                                         |  |               |     |                  |                | 
|Granted/assumed                          |  |               | 50  |                  |                |  | 3.92    | 
|Exercised                                |  |               | (13 | )                |                |  | 1.63    | 
|Forfeited/expired                        |  |               | (22 | )                |                |  | 7.26    | 
|                                         |  |               |     |                  |                | 
|Outstanding as of
    September 30, 2005 |  |               | 418 |                  |                |  | 10.50   | 
|                                         |  |               |     |                  |                | 

F-66



---



##### 

The following table summarizes information about stock options.

|                                     |  |                           |     |             |                           |  |          |           |  |  |               |          |  |           |     |  |  |  |         | 
|------------------------------------ |  | ------------------------- | --- | ----------- | ------------------------- |  | -------- | --------- |  |  | ------------- | -------- |  | --------- | --- |  |  |  | ------- | 
|                                     |  | Stock options outstanding |     |             | Stock options exercisable | 
|                                     |  |                           |     |             |                           | 
|                                     |  |                           |     | Weighted    |                           |  |          |           | 
|                                     |  |                           |     | average     |                           |  | Weighted |           |  |  |               | Weighted | 
|                                     |  |                           |     | remaining   |                           |  | average  |           |  |  |               | average  | 
|                                     |  |                           |     | contractual |                           |  | exercise |           |  |  |               | exercise | 
|                                     |  | Shares                    |     |             | life                      |  |          | price     |  |  | Shares        |          |  | price     |    
|Range of exercise prices per share   |  | (in millions)             |     |             | (years)                   |  |          | per share |  |  | (in millions) |          |  | per share |    
|                                     |  |                           |     |             |                           |  |          |           |  |  |               |          |  |           |    
|$ 0.04 to $ 2.25                     |  |                           | 106 |             |                           |  | 3.0      |           |  |  | $  1.63       |          |  |           | 85  |  |  |  | $  1.69 | 
|$ 2.26 to $ 3.50                     |  |                           | 47  |             |                           |  | 5.2      |           |  |  | 3.19          |          |  |           | 12  |  |  |  | 3.20    | 
|$ 3.51 to $ 5.00                     |  |                           | 48  |             |                           |  | 6.0      |           |  |  | 3.96          |          |  |           | 2   |  |  |  | 4.21    | 
|$ 5.01 to $ 9.00                     |  |                           | 57  |             |                           |  | 1.3      |           |  |  | 6.27          |          |  |           | 55  |  |  |  | 6.27    | 
|$ 9.01 to $16.03                     |  |                           | 105 |             |                           |  | 1.1      |           |  |  | 11.56         |          |  |           | 105 |  |  |  | 11.56   | 
|$16.04 to $77.10                     |  |                           | 55  |             |                           |  | 3.5      |           |  |  | 42.07         |          |  |           | 55  |  |  |  | 42.07   | 
|                                     |  |                           |     |             |                           |  |          |           |  |  |               |          |  |           |    
|Amounts as of September 30,
    2005 |  |                           | 418 |             |                           |  |          |           |  |  | $ 10.50       |          |  |           | 314 |  |  |  | $ 12.93 | 
|                                     |  |                           |     |             |                           |  |          |           |  |  |               |          |  |           |    
|Amounts as of September 30,
    2004 |  |                           | 403 |             |                           |  |          |           |  |  | $ 10.84       |          |  |           | 282 |  |  |  | $ 14.47 | 
|                                     |  |                           |     |             |                           |  |          |           |  |  |               |          |  |           |    
|Amounts as of September 30,
    2003 |  |                           | 388 |             |                           |  |          |           |  |  | $ 11.70       |          |  |           | 246 |  |  |  | $ 16.54 | 
|                                     |  |                           |     |             |                           |  |          |           |  |  |               |          |  |           |    








|    |                   
|--- | ------------------
|11. | OPERATING SEGMENTS





F-67



---



##### 

Performance measurement and resource allocation for the
reportable segments are based on many factors. The primary
financial measure includes the revenues, costs and expenses
directly controlled by each reportable segment and excludes the
following:



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

|                                                        |  |                           |          |   |      |  |          |      |  |  |           |  
|------------------------------------------------------- |  | ------------------------- | -------- | - | ---- |  | -------- | ---- |  |  | --------- | -
|                                                        |  | Years ended September 30, |         
|                                                        |  | 2005                      |          |   | 2004 |  |          | 2003 | 
|(in millions)                                           |  |                           |          |   |      |  |          |      | 
|Revenues:                                               |  |                           |          |   |      |  |          |      |  |  |           |  
|Mobility                                                |  |                           | $  4,600 |   |      |  | $  4,117 |      |  |  | $  3,147  |  
|INS                                                     |  |                           | 2,565    |   |      |  | 2,874    |      |  |  | 3,233     |  
|Services                                                |  |                           | 2,129    |   |      |  | 1,932    |      |  |  | 1,840     |  
|                                                        |  |                           |          |   |      |  |          |      | 
|Reportable segments                                     |  |                           | 9,294    |   |      |  | 8,923    |      |  |  | 8,220     |  
|Patent licensing                                        |  |                           | 113      |   |      |  | 72       |      |  |  | 202       |  
|Other                                                   |  |                           | 34       |   |      |  | 50       |      |  |  | 48        |  
|                                                        |  |                           |          |   |      |  |          |      | 
|Revenues                                                |  |                           | $  9,441 |   |      |  | $  9,045 |      |  |  | $  8,470  |  
|                                                        |  |                           |          |   |      |  |          |      | 
|Operating income (loss):                                |  |                           |          |   |      |  |          |      |  |  |           |  
|Mobility                                                |  |                           | $  1,572 |   |      |  | $  1,238 |      |  |  | $     156 |  
|INS                                                     |  |                           | 195      |   |      |  | 348      |      |  |  | 117       |  
|Services                                                |  |                           | 335      |   |      |  | 282      |      |  |  | 225       |  
|                                                        |  |                           |          |   |      |  |          |      | 
|Reportable segments                                     |  |                           | 2,102    |   |      |  | 1,868    |      |  |  | 498       |  
|Global Sales Organization                               |  |                           | (553     | ) |      |  | (515     | )    |  |  | (527      | )
|Shared services such as general
    corporate functions |  |                           | (1,143   | ) |      |  | (1,162   | )    |  |  | (1,499    | )
|Unallocated personnel costs and
    benefits            |  |                           | 927      |   |      |  | 859      |      |  |  | 1,207     |  
|Recovery of bad debts and customer
    financings       |  |                           | 69       |   |      |  | 230      |      |  |  | 223       |  
|Business restructuring                                  |  |                           | 10       |   |      |  | 20       |      |  |  | 184       |  
|Other                                                   |  |                           | (151     | ) |      |  | (81      | )    |  |  | (308      | )
|                                                        |  |                           |          |   |      |  |          |      | 
|Operating income (loss)                                 |  |                           | $  1,261 |   |      |  | $  1,219 |      |  |  | $  (222   | )
|                                                        |  |                           |          |   |      |  |          |      | 

F-68



---



##### 

Supplemental Segment Information

|                               |  |                           |       |  |      |  |       |      |  |  |       | 
|------------------------------ |  | ------------------------- | ----- |  | ---- |  | ----- | ---- |  |  | ----- | 
|                               |  | Years ended September 30, |      
|(in millions)                  |  | 2005                      |       |  | 2004 |  |       | 2003 | 
|                               |  |                           |       |  |      |  |       |      | 
|Depreciation and amortization: |  |                           |       |  |      |  |       |      |  |  |       | 
|Mobility                       |  |                           | $ 185 |  |      |  | $ 181 |      |  |  | $ 177 | 
|INS                            |  |                           | 146   |  |      |  | 171   |      |  |  | 231   | 
|Services                       |  |                           | 17    |  |      |  | 26    |      |  |  | 41    | 
|                               |  |                           |       |  |      |  |       |      | 
|Reportable segments            |  |                           | 348   |  |      |  | 378   |      |  |  | 449   | 
|Non-segment                    |  |                           | 251   |  |      |  | 315   |      |  |  | 529   | 
|                               |  |                           |       |  |      |  |       |      | 
|Depreciation and amortization  |  |                           | $ 599 |  |      |  | $ 693 |      |  |  | $ 978 | 
|                               |  |                           |       |  |      |  |       |      | 

Products and Services Revenues


|                            |  |                           |         |  |      |  |         |      |  |  |         | 
|--------------------------- |  | ------------------------- | ------- |  | ---- |  | ------- | ---- |  |  | ------- | 
|                            |  | Years ended September 30, |        
|(in millions)               |  | 2005                      |         |  | 2004 |  |         | 2003 | 
|                            |  |                           |         |  |      |  |         |      | 
|Wireless                    |  |                           | $ 4,600 |  |      |  | $ 4,117 |      |  |  | $ 3,147 | 
|Voice networking            |  |                           | 889     |  |      |  | 1,193   |      |  |  | 1,472   | 
|Data and network management |  |                           | 859     |  |      |  | 925     |      |  |  | 1,001   | 
|Optical networking          |  |                           | 817     |  |      |  | 756     |      |  |  | 760     | 
|Services                    |  |                           | 2,129   |  |      |  | 1,932   |      |  |  | 1,840   | 
|Patent Licensing            |  |                           | 113     |  |      |  | 72      |      |  |  | 202     | 
|Other                       |  |                           | 34      |  |      |  | 50      |      |  |  | 48      | 
|                            |  |                           |         |  |      |  |         |      | 
|Totals                      |  |                           | $ 9,441 |  |      |  | $ 9,045 |      |  |  | $ 8,470 | 
|                            |  |                           |         |  |      |  |         |      | 

Geographic Information


|              |  |                           |  |                       |  |         |  |         |  |         |  |        
|------------- |  | ------------------------- |  | --------------------- |  | ------- |  | ------- |  | ------- |  | -------
|              |  | Revenues (a)              |  | Long-lived assets (b)
|              |  | Years ended September 30, |  | September 30,        
|              |  | 2005                      |  | 2004                  |  | 2003    |  | 2005    |  | 2004    |  | 2003   
|(in millions) |  |                           |  |                       |  |         |  |         |  |         |  |        
|U.S.          |  | $ 5,936                   |  | $ 5,517               |  | $ 5,149 |  | $ 1,496 |  | $ 1,567 |  | $ 1,397
|Non-U.S.      |  | 3,505                     |  | 3,528                 |  | 3,321   |  | 218     |  | 243     |  | 384    
|              |  |                           |  |                       |  |         |  |         |  |         |  |        
|Totals        |  | $ 9,441                   |  | $ 9,045               |  | $ 8,470 |  | $ 1,714 |  | $ 1,810 |  | $ 1,781
|              |  |                           |  |                       |  |         |  |         |  |         |  |        








Concentrations






F-69



---



##### 

Changes in Fiscal 2006 Reportable Segments

On April 19, 2005, we announced organization changes
related to combining our mobility and wireline businesses into a
single unit, the Network Solutions Group (NSG). NSG will consist
of the following operating units: Mobility Access Solutions,
Applications Solutions, Convergence Solutions and Multimedia
Network Solutions. The Applications Solutions unit results are
not expected to be material and do not meet the requirements for
being reported separately; therefore, they will be aggregated
with Mobility Access Solutions. This combined unit will be
similar to the Mobility segment as currently reported. The
Convergence Solutions unit will consist primarily of voice
networking products. The Multimedia Network Solutions unit will
consist primarily of optical, data and access products. The
Network Operations Software unit will be transferred to
Services. Services will continue to be a reportable segment. The
new reporting structure will begin during the first quarter of
fiscal 2006.







12.
    FINANCIAL INSTRUMENTSFair Values

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

|               |  |                           |       |  |       |   |       |          |  |   |       |  |  |   |       | 
|-------------- |  | ------------------------- | ----- |  | ----- | - | ----- | -------- |  | - | ----- |  |  | - | ----- | 
|               |  | Years ended September 30, |      
|               |  | 2005                      |       |  | 2004  |  
|               |  |                           |       |  |       |  
|               |  | Carrying                  |       |  | Fair  |   |       | Carrying |  |   | Fair  | 
|(in millions)  |  | value                     |       |  | value |   |       | value    |  |   | value | 
|               |  |                           |       |  |       |   |       |          |  |   |       | 
|Long-term debt |  | $                         | 5,066 |  |       | $ | 5,144 |          |  | $ | 5,989 |  |  | $ | 6,325 | 



|                                                        |  |           |       |       |            |   |       |            |  |   |                |   |  |   |       | 
|------------------------------------------------------- |  | --------- | ----- | ----- | ---------- | - | ----- | ---------- |  | - | -------------- | - |  | - | ----- | 
|                                                        |  |           |       | Gross |            |   | Gross |            |  |  
|                                                        |  | Amortized |       |       | unrealized |   |       | unrealized |  |   | Estimated fair |  
|(in millions)                                           |  | Cost      |       |       | gains      |   |       | losses     |  |   | value          |  
|                                                        |  |           |       |       |            |   |       |            |  |   |                |  
|U.S. Treasury and government
    agency debt securities |  | $         | 1,350 |       |            | $ | -     |            |  | $ | (10            | ) |  | $ | 1,340 | 
|Corporate bonds                                         |  |           | 572   |       |            |   | -     |            |  |   | (6             | ) |  |   | 566   | 
|Asset-backed securities                                 |  |           | 618   |       |            |   | -     |            |  |   | (4             | ) |  |   | 614   | 
|                                                        |  |           |       |       |            |   |       |            |  |   |                |  
|Total as of September 30, 2005                          |  | $         | 2,540 |       |            | $ | -     |            |  | $ | (20            | ) |  | $ | 2,520 | 
|                                                        |  |           |       |       |            |   |       |            |  |   |                |  
|Classified as:                                          |  |           |       |       |            |   |       |            |  |   |                |   |  |   |       | 
|Current                                                 |  | $         | 359   |       |            | $ | -     |            |  | $ | (2             | ) |  | $ | 357   | 
|Non-current                                             |  |           | 2,181 |       |            |   | -     |            |  |   | (18            | ) |  |   | 2,163 | 
|                                                        |  |           |       |       |            |   |       |            |  |   |                |  
|Total as of September 30, 2005                          |  | $         | 2,540 |       |            | $ | -     |            |  | $ | (20            | ) |  | $ | 2,520 | 
|                                                        |  |           |       |       |            |   |       |            |  |   |                |  
|U.S. Treasury and government
    agency debt securities |  | $         | 979   |       |            | $ | -     |            |  | $ | (3             | ) |  | $ | 976   | 
|Corporate bonds                                         |  |           | 340   |       |            |   | 1     |            |  |   | (1             | ) |  |   | 340   | 
|Asset-backed securities                                 |  |           | 179   |       |            |   | -     |            |  |   | (1             | ) |  |   | 178   | 
|                                                        |  |           |       |       |            |   |       |            |  |   |                |  
|Total as of September 30, 2004                          |  | $         | 1,498 |       |            | $ | 1     |            |  | $ | (5             | ) |  | $ | 1,494 | 
|                                                        |  |           |       |       |            |   |       |            |  |   |                |  
|Classified as:                                          |  |           |       |       |            |   |       |            |  |   |                |   |  |   |       | 
|Current                                                 |  | $         | 859   |       |            | $ | -     |            |  | $ | (1             | ) |  | $ | 858   | 
|Non-current                                             |  |           | 639   |       |            |   | 1     |            |  |   | (4             | ) |  |   | 636   | 
|                                                        |  |           |       |       |            |   |       |            |  |   |                |  
|Total as of September 30, 2004                          |  | $         | 1,498 |       |            | $ | 1     |            |  | $ | (5             | ) |  | $ | 1,494 | 
|                                                        |  |           |       |       |            |   |       |            |  |   |                |  

F-70



---



##### 

Gross unrealized losses on our available-for-sale securities
were primarily caused by increases in interest rates. Unrealized
losses of $4 million were related to securities that were
in a continuous loss position for more than one year as of
September 30, 2005. We do not consider these investments to
be other-than-temporarily impaired because we have the ability
and intent to hold them until maturity or until the fair value
is recovered.

Proceeds from the sale of marketable debt securities were
$2,966 million and $352 million during fiscal 2005 and
2004. The realized gains and (losses) on these sales were
$2 million and $(8) million for fiscal 2005 and
$1 million and $(2) million for fiscal 2004.

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

|                    |  |                |  |                     
|------------------- |  | -------------- |  | --------------------
|(in millions)       |  | Amortized cost |  | Estimated fair value
|                    |  |                |  |                     
|2006                |  | $   359        |  | $   357             
|2007  2011         |  | 1,847          |  | 1,831               
|2012  2016         |  | 11             |  | 11                  
|2017 and thereafter |  | 323            |  | 321                 



|                                    |  |               |  |     
|----------------------------------- |  | ------------- |  | ----
|                                    |  | September 30,
|(in millions)                       |  | 2005          |  | 2004
|                                    |  |               |  |     
|Available-for-sale                  |  | $  2          |  | $  2
|Cost method                         |  | 58            |  | 70  
|Equity method                       |  | 5             |  | 5   
|                                    |  |               |  |     
|Non-consolidated equity investments |  | $ 65          |  | $ 77
|                                    |  |               |  |     





Credit Risk






F-71



---



##### 

Derivative Financial Instruments and Market Risk

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

Foreign Currency Risk

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

Foreign exchange forward and option contracts are used to manage
our foreign currency risk. We also have hedged foreign exchange
risk in certain sales and purchase contracts with cash flows
indexed to changes in or denominated in a currency that neither
party to the contract uses as its functional currency. These
embedded derivative terms affect the ultimate amount of cash
flows under the contract. Our primary net foreign currency
exposures include the euro, Brazilian real, Japanese yen,
Mexican peso and Chinese yuan.

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

|                   |  |               |  |      
|------------------ |  | ------------- |  | -----
|                   |  | September 30,
|                   |  | 2005          |  | 2004 
|(in millions)      |  |               |  |      
|Purchase contracts |  | $ 192         |  | $ 208
|Sale contracts     |  | 329           |  | 532  





Interest Rate Risk






F-72



---



##### 

Equity Price Risk

We hold equity investments in publicly held companies that are
classified as available-for-sale and other strategic equity
holdings in privately held companies and venture funds. These
equity investments are exposed to price fluctuations and are
generally concentrated in the high-technology industries. We
generally do not hedge our equity price risk due to hedging
restrictions imposed by the issuers, illiquid capital markets or
our inability to hedge non-marketable equity securities in
privately held companies. We had no outstanding hedging
instruments for our equity price risk as of September 30,
2005.

Customer Financing Commitments

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

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

|                        |  |                    |      |                    |       |      |             |      |            |       |       |       |            |     
|----------------------- |  | ------------------ | ---- | ------------------ | ----- | ---- | ----------- | ---- | ---------- | ----- | ----- | ----- | ---------- | ----
|                        |  | September 30, 2005 |      | September 30, 2004
|                        |  | Total loans        |      |                    |       |      | Total loans |      |           
|                        |  | and                |      |                    |       |      | and         |      |           
|(in millions)           |  | guarantees         |      |                    | Loans |      | Guarantees  |      | guarantees |       | Loans |       | Guarantees
|                        |  |                    |      |                    |       |      |             |      |            |       |       |       |           
|Drawn commitments       |  |                    | $ 45 |                    |       | $ 30 |             | $ 15 |            | $ 139 |       | $ 125 |            | $ 14
|Available but not drawn |  |                    | 6    |                    |       | -    |             | 6    |            | 11    |       | 3     |            | 8   
|                        |  |                    |      |                    |       |      |             |      |            |       |       |       |           
|Total                   |  |                    | $ 51 |                    |       | $ 30 |             | $ 21 |            | $ 150 |       | $ 128 |            | $ 22
|                        |  |                    |      |                    |       |      |             |      |            |       |       |       |           



|                             |  |                           |       |   |      |  |        |      |  |  |        |  
|---------------------------- |  | ------------------------- | ----- | - | ---- |  | ------ | ---- |  |  | ------ | -
|                             |  | Years ended September 30, |      
|(in millions)                |  | 2005                      |       |   | 2004 |  |        | 2003 | 
|                             |  |                           |       |   |      |  |        |      | 
|Reserve at beginning of year |  |                           | $ 135 |   |      |  | $  415 |      |  |  | $  951 |  
|Recoveries, net              |  |                           | (51   | ) |      |  | (188   | )    |  |  | (156   | )
|Other account transfers      |  |                           | (37   | ) |      |  | (29    | )    |  |  | 116    |  
|Write-offs                   |  |                           | (10   | ) |      |  | (63    | )    |  |  | (496   | )
|                             |  |                           |       |   |      |  |        |      | 
|Reserve at end of year       |  |                           | $  37 |   |      |  | $  135 |      |  |  | $  415 |  
|                             |  |                           |       |   |      |  |        |      | 



F-73



---



##### 

Commitments to Extend Credit

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

Letters of Credit

Letters of credit are obtained to ensure the performance or
payment to third parties in accordance with specified terms and
conditions. Secured and unsecured outstanding letters of credit
were $269 million and $353 million as of
September 30, 2005 and 2004, respectively. The estimated
fair value of letters of credit was $4 million and
$8 million as of September 30, 2005 and 2004,
respectively. On October 1, 2004, we amended and restated
our two primary agreements. The first agreement provides for the
issuance of up to $215 million of new letters of credit
until September 30, 2006. The second agreement permits us
to request renewal of $199 million of letters of credit
until September 30, 2006. Under these revised agreements,
we are no longer required to meet specified levels of quarterly
consolidated minimum operating income or to provide cash
collateral for letters of credit issued. However, we are
required to maintain a minimum amount of unrestricted cash and
short-term investments greater than $2 billion, as defined
in the agreements.

On October 1, 2004, we also amended our Guarantee and
Collateral Agreement and Collateral Sharing Agreement. Under
these agreements, certain of our U.S. subsidiaries
guaranteed certain of our obligations. We, along with these
subsidiaries, pledged significant portions of our assets as
collateral. These agreements secure certain obligations,
including letters of credit, specified hedging arrangements,
guarantees to lenders for vendor financing, lines of credit,
cash management and other bank operating arrangements. These
outstanding obligations amounted to $226 million as of
September 30, 2005.

Transfers of Financial Instruments

We have agreements that allow us to sell receivables from
selected customers at a discount to various financial
institutions on a non-recourse basis. We sold approximately
$297 million and $468 million of accounts and notes
receivable during fiscal 2005 and 2004, respectively. These
transactions were accounted for as sales. Discounting fees were
$9 million and $5 million during fiscal 2005 and 2004,
respectively. Sales and transfers that do not meet the criteria
for surrender of control are accounted for as secured
borrowings. There were no secured borrowings or receivables held
for sale as of September 30, 2005.

Warrants

In connection with our shareholder lawsuit settlement, we issued
warrants to purchase 200 million shares of our common
stock during December 2004, of which 199 million were
outstanding as of September 30, 2005. The warrants have an
exercise price of $2.75 per share and expire on
December 10, 2007.







13.
    COMMITMENTS AND CONTINGENCIESLegal Proceedings

We are subject to legal proceedings, lawsuits and other claims,
including proceedings by government authorities. In addition, we
may be subject to liabilities of some of our former affiliates
under separation agreements with them. Legal proceedings are
subject to uncertainties, and the outcomes are difficult to
predict. Consequently, unless otherwise indicated, we are unable
to estimate the ultimate aggregate amounts of monetary liability
or ranges of possible losses with respect to our pending
litigation matters as of September 30, 2005. The resolution
of these matters could have a material impact on our
consolidated results of operations, financial position and cash
flows. In addition to the charges related to the global
settlement of our shareowner litigation discussed below, other
charges of $139 million, $64 million, and
$25 million were recognized during fiscal 2005, 2004, and
2003, respectively, primarily due to settlements, dispositions
and changes in estimates related to various litigation matters,
none of which was material individually to our consolidated
results of operations.

F-74



---



##### 

Securities and Related Cases

We settled the majority of the assorted securities, ERISA and
derivative class action and other related lawsuits against us
and certain of our current and former directors, officers and
employees. The settlement covers all claims generally relating
to the purchase of Lucent securities during different class
periods and is a global settlement of 53 separate lawsuits,
including a consolidated shareowner class action lawsuit in the
U.S. District Court of New Jersey, and related ERISA,
bondholder, derivative, and other state securities cases. The
net charges related to our global securities and related cases,
including changes in the fair market value of warrants that were
issued as part of the settlement and insurance recoveries, were
$54 million, $56 million and $481 million during
fiscal 2005, 2004 and 2003, respectively. Presently, with the
exception of one case, all other cases brought by individual
investors who opted out of the class action settlement have been
resolved. We will defend any lawsuits that may be brought by
parties that have opted out or that were not part of the
settlement. We currently do not have any material opt out or
related securities cases pending.

Government Investigations

During August 2003, the U.S. Department of Justice
(DOJ) and the SEC informed us that they had each commenced
an investigation into possible violations of the Foreign Corrupt
Practices Act (FCPA) with respect to our operations
in Saudi Arabia. These investigations followed allegations made
by the National Group for Communications and Computers Ltd.
(NGC) in an action filed against us on August 8, 2003,
which is described below. In April 2004, we reported to the DOJ
and the SEC that an internal FCPA compliance audit and an
outside counsel investigation found incidents and internal
control deficiencies in our operations in China that potentially
involve FCPA violations. We are cooperating with those agencies.
We believe these incidents and deficiencies did not have a
material effect on our results of operations. However, we cannot
determine whether this continuing investigation will affect our
future business operations in China.

As disclosed in a Form 8-K filing on November 8, 2004,
our former chairman and chief executive officer, the former head
of our Saudi Arabia operations and a third former employee
received Wells notices from the SEC. In early May
2005, the SEC Enforcement Staff notified representatives of
these individuals that the Staff would not be recommending
enforcement action against these individuals. We have not
received a Wells notice at this time, but the investigation is
continuing with respect to both China and Saudi Arabia.

During the third quarter of fiscal 2005, we received subpoenas
on two different matters, requesting specific documents and
records. One of the subpoenas relates to a DOJ investigation of
potential antitrust and other violations by various participants
in connection with the federal E-Rate program. The subpoena
requires us to produce documents before a grand jury of the
U.S. District Court in Georgia. The second subpoena was
from the Office of Inspector General, U.S. General Services
Administration and relates to a federal investigation into
certain sales to the federal government of telecommunications
equipment and related maintenance services. We are unable to
determine if either of these matters will have a material effect
on our business, financial position, results of operations or
cash flows.

Employment and Benefits Related Cases

We have implemented various actions to address the rising costs
of providing retiree health care benefits and the funding of our
pension plans. These actions have led to the filing of cases
against us and may lead to the filing of additional cases.
Purported class action lawsuits have been filed against us in
connection with the elimination of the death benefit from our
U.S. management pension plan in early 2003. Three such
cases have been consolidated into a single action pending in the
U.S. District Court in New Jersey, captioned In Re
Lucent Death Benefits ERISA Litigation. The elimination of
this benefit reduced our future pension obligations by
approximately $400 million. The benefit was paid out of the
pension plan assets to certain qualified surviving dependents,
such as spouses or dependent children of management retirees.
The case alleges that we wrongfully terminated this death
benefit and requests that the benefit be reinstated, along with
other remedies. Another such case, Chastain,
et al. v. AT&T, was filed in the
U.S. District Court in the Western District of Oklahoma.
The Chastaincase also involves claims related to changes
to retiree health care benefits. In October 2005, a purported
class action was filed by Peter A.

F-75



---



##### 

Raetsch, Geraldine Raetsch and Curtis Shiflett, on behalf of
themselves and all others similarly situated, in the
U.S. District Court for the District of New Jersey. The
plaintiffs allege that Lucent failed to maintain health care
benefits for retired management employees as required by the
Internal Revenue Code, the Employee Retirement Income Security
Act, and the Lucent pension and medical plans. Lucent has not
been formally served with the complaint, but is actively
investigating and evaluating the claims asserted.

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

Intellectual Property Cases

We are defendants in various cases in which third parties claim
infringement of their patents, including certain cases where
infringement claims have been made against our customers in
connection with products we have provided to them. During our
first quarter of fiscal 2006, we settled the case of Tantivy
Communications, Inc. v. Lucent Technologies, which was
pending in the U.S. District Court in Texas. As part of the
settlement, we received a license for nine CDMA2000-related
patents that were the subject of the lawsuit.

Other Matters

A lawsuit involving investors in Actel Integrated Communications
was filed against us seeking $60 million in damages and
punitive damages, claiming we misled these investors as to
certain technology, which influenced their decision to invest in
Actel. This case, Sandler Capital Partners IV, L.P.
et al. v. Lucent Technologies, filed in New York
State Court, was settled during our first quarter of fiscal
2006. During fiscal 2004, we settled cases filed against us by
Actel. In addition, two other cases were filed against us
alleging that we failed to deliver working products related to
this technology: Maxcess, Inc. v. Lucent Technologies
Inc. et al., filed in the U.S. District Court for the
Middle District of Florida, and Official Plan Committee of
Omniplex, Inc. v. Lucent Technologies Inc., filed in
Missouri State Court. The claims against us in the Maxcesscase have been dismissed, and the plaintiff has appealed
this decision. We settled the Omniplexcase during the
first quarter of fiscal 2006.

We are a defendant in an adversary proceeding originally filed
in U.S. Bankruptcy Court in Delaware by Winstar and Winstar
Wireless, Inc. in connection with the bankruptcy of Winstar and
various related entities. The trial for this matter concluded in
June 2005. The trial pertained to breach of contract and other
claims against us, for which the trustee for Winstar is seeking
compensatory damages of approximately $60 million, as well
as costs and expenses associated with litigation. The trustee is
also seeking recovery of a payment to us of approximately
$190 million in December 2000, plus interest. Although the
trial was completed, the judge has not rendered his decision in
the case. Thus we do not know whether any of these claims
against us will be awarded and, if so, what impact this matter
may have on us.

On August 8, 2003, NGC filed an action in the
U.S. District Court for the Southern District of New York
against us, certain former officers and employees, our
subsidiary Lucent Technologies International Inc., certain
unaffiliated individuals and an unaffiliated company, alleging
violations of the Racketeer Influenced Corrupt Organizations Act
(RICO) and other improper activities. These allegations
relate to activities in Saudi Arabia in connection with certain
telecommunications contracts involving Lucent, the Kingdom of
Saudi Arabia and other entities. The complaint seeks damages in
excess of $63 million, which could be tripled under RICO.
The allegations in this complaint appear to arise out of certain
contractual disputes between NGC and Lucent that are the subject
of a separate case that NGC previously filed against us in
U.S. District Court in New Jersey and other related
proceedings brought by NGC in Saudi Arabia. We have filed a
motion to dismiss the New York action. Some of the claims
brought by NGC in the New Jersey action have been dismissed, but
that case and the other claims in Saudi Arabia are still pending.

F-76



---



##### 

In the case of Pf.Net Supply Corp. v. Lucent
Technologies, pending in the U.S. District Court in New
Jersey, the plaintiff claimed that we breached an alleged
purchase commitment and sought to compel us to meet this
purchase commitment or pay damages. This lawsuit was settled
during our first quarter of fiscal 2006.

Separation Agreements

We are party to various agreements that were entered into in
connection with the separation of Lucent and former affiliates,
including AT&T, Avaya, Agere Systems and NCR Corporation.
Pursuant to these agreements, we and the former affiliates have
agreed to allocate certain liabilities related to each
others business, and we have agreed to share liabilities
based on certain allocations and thresholds. We are not aware of
any material liabilities to our former affiliates as a result of
the separation agreements that are not otherwise reflected in
our consolidated financial statements. Nevertheless, it is
possible that potential liabilities for which the former
affiliates bear primary responsibility may lead to contributions
by us.

Other Commitments

Contract Manufacturers

We have outsourced most of our manufacturing operations to
electronic manufacturing service (EMS) providers. One
supplier, Celestica Corporation, provided a majority of our
requirements for Lucent designed switching and wireless
products. Purchases from this supplier were approximately
$690 million, $750 million and $695 million
during fiscal 2005, 2004 and 2003, respectively. Three other
suppliers provided the majority of our requirements for other
Lucent designed products. Purchases from these suppliers were
approximately $473 million, $532 million and
$548 million during fiscal 2005, 2004 and 2003,
respectively. We are generally not committed to unconditional
purchase obligations in these contract-manufacturing
relationships. However, there is exposure to short-term purchase
commitments when they occur within the contract
manufacturers lead-time for specific products or raw
materials. These commitments were $312 million as of
September 30, 2005. Sudden and significant changes in
forecasted demand requirements within the lead-time of those
products or raw materials could adversely affect our results of
operations and cash flows.

We are transitioning to two EMS providers to supply most of our
Lucent designed wireless and wireline products. Celestica has
the exclusive right to manufacture and provide most of our
existing wireless products. In addition, we signed an agreement
with Solectron Corporation to essentially consolidate the
outsourced manufacturing of our portfolio of wireline products.
The agreements with Celestica and Solectron are for a minimum of
three years, with no right to terminate for convenience.

Guarantees and Indemnification Agreements

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

F-77



---



##### 

We remain secondarily liable for approximately $192 million
of lease obligations as of September 30, 2005, that were
assigned to Avaya, Agere and purchasers of our other businesses.
The remaining terms of these assigned leases and our
corresponding guarantees range from one month to 14 years.
The primary obligor under assigned leases may terminate or
restructure the lease obligation before its original maturity
and thereby relieve us of our secondary liability. We generally
have the right to receive indemnity or reimbursement from the
assignees and have not reserved for losses on this form of
guarantee.

We are party to a tax-sharing agreement to indemnify AT&T
and are liable for tax adjustments that are attributable to our
lines of business, as well as a portion of certain other shared
tax adjustments during the years prior to our separation from
AT&T. We have similar agreements with Avaya and Agere. In
addition to the fiscal year 2001 federal net operating loss
carryback claim discussed in Note 7 to our
September 30, 2005 consolidated financial statements,
certain tax adjustments have been proposed or assessed subject
to these tax-sharing agreements. The outcome of these other
matters is not expected to have a material adverse effect on our
consolidated results of operations, consolidated financial
position or near-term liquidity.

We license to our customers software and rights to use
intellectual property that might provide the licensees with an
indemnification against any liability arising from third-party
claims of patent, copyright or trademark infringement. We cannot
determine the maximum amount of losses that we could incur under
this type of indemnification.

We indemnify our directors and certain of our current and former
officers for third-party claims alleging certain breaches of
their fiduciary duties as directors or officers. Certain costs
incurred for providing such indemnification may be recovered
under various insurance policies. We are unable to reasonably
estimate the maximum amount that could be payable under these
arrangements since these obligations are not capped but are
conditional to the unique facts and circumstances involved in
each agreement. Historically, payments made under these
agreements have not had a material effect on our business,
financial condition, results of operations or cash flows.

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

|                             |  |      |       |   |      |  |       |  
|---------------------------- |  | ---- | ----- | - | ---- |  | ----- | -
|(in millions)                |  | 2005 |       |   | 2004 | 
|                             |  |      |       |   |      | 
|Reserve at beginning of year |  |      | $ 297 |   |      |  | $ 330 |  
|Accruals for warranties, net |  |      | 47    |   |      |  | 61    |  
|Payments                     |  |      | (87   | ) |      |  | (94   | )
|                             |  |      |       |   |      | 
|Reserve at end of year       |  |      | $ 257 |   |      |  | $ 297 |  
|                             |  |      |       |   |      | 

Environmental Matters






F-78



---



##### 

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




    The extent and degree of contamination and the nature of
    required remedial actions.
    The timing and various types of environmental expenditures, such
    as investigatory, remedial, capital and operations, and
    maintenance costs.
    Applicable legal requirements defining remedial goals and
    methods.
    Progress and stage of existing remedial programs in achieving
    remedial goals.
    Innovations in remedial technology and expected trends in
    environmental costs and legal requirements.
    The number, participation level and financial viability of other
    potentially responsible parties.
    The timing and likelihood of potential recoveries or
    contributions from other third parties.
    Historical experience.
    The degree of certainty and reliability of all the factors
    considered.It is often difficult to estimate the future impact of
environmental matters, including potential liabilities, due to
the above factors and the lengthy time periods involved in
resolving them, which may be up to 30 years or longer.
Although we believe that our reserves are currently adequate,
there can be no assurance that the amount of capital
expenditures and other expenses that will be required for
remedial actions and compliance with applicable environmental
laws will not exceed the amounts reflected in reserves or will
not have a material adverse effect on our consolidated financial
condition, results of operations or cash flows. Any possible
loss or range of possible loss that may be incurred in excess of
amounts provided for as of September 30, 2005, cannot be
reasonably estimated.

Lease Commitments

We lease land, buildings and equipment under agreements that
expire in various years through 2020. Rental expense under
operating leases was $191 million, $230 million and
$267 million, net of sublease rental income of
$32 million, $38 million and $53 million, for
fiscal 2005, 2004 and 2003, respectively. Future minimum lease
payments due under non-cancelable operating leases as of
September 30, 2005, were $156 million in 2006,
$120 million in 2007, $95 million in 2008,
$78 million in 2009, $74 million in 2010 and
$345 million thereafter. These future minimum lease
payments do not include future sublease rental income of
$23 million in 2006, $19 million in 2007,
$17 million in 2008, $16 million in 2009,
$16 million in 2010 and $119 million thereafter. All
above amounts include leases that are associated with our
restructuring actions.





14. SUBSEQUENT EVENTS

Subsequent to our fourth quarter of fiscal 2005 earnings
release, we received a federal income tax refund, settled
pending lawsuits, and adjusted the minority interest in a
subsidiary. The impact of these items reduced our previously
released net income by $2 million during the three and
twelve months ended September 30, 2005. The previously
released diluted earnings per share also decreased from
8 cents per share to 7 cents per share during the
three months ended September 30, 2005.

F-79



---



##### 

15.
    QUARTERLY INFORMATION (UNAUDITED)

|                                                                  |  |       |         |   |        |  |         |       |  |  |         |   |  |       |         |   |  |  |         |  
|----------------------------------------------------------------- |  | ----- | ------- | - | ------ |  | ------- | ----- |  |  | ------- | - |  | ----- | ------- | - |  |  | ------- | -
|                                                                  |  | First |         |   | Second |  |         | Third |  |  | Fourth  |   |  | Total |        
|(in millions, except per share amounts)                           |  |       |         |   |        |  |         |       |  |  |         |   |  |       |        
|Year ended September 30,
    2005                                 |  |       |         |   |        |  |         |       |  |  |         |   |  |       |         |   |  |  |         |  
|Revenues                                                          |  |       | $ 2,335 |   |        |  | $ 2,335 |       |  |  | $ 2,340 |   |  |       | $ 2,431 |   |  |  | $ 9,441 |  
|Gross margin                                                      |  |       | 984     |   |        |  | 975     |       |  |  | 1,052   |   |  |       | 1,113   |   |  |  | 4,124   |  
|Provision for (recovery of) bad
    debts and customer financings |  |       | (11     | ) |        |  | (11     | )     |  |  | (53     | ) |  |       | 6       |   |  |  | (69     | )
|Business restructuring charges
    (reversals), net               |  |       | 1       |   |        |  | (8      | )     |  |  | 6       |   |  |       | (9      | ) |  |  | (10     | )
|Other income (expense), net                                       |  |       | (46     | ) |        |  | 43      |       |  |  | 52      |   |  |       | 65      |   |  |  | 114     |  
|Income taxes                                                      |  |       | 10      |   |        |  | (41     | )     |  |  | (34     | ) |  |       | (86     | ) |  |  | (151    | )
|Net income                                                        |  |       | 174     |   |        |  | 267     |       |  |  | 372     |   |  |       | 372     |   |  |  | 1,185   |  
|Income per common share:                                          |  |       |         |   |        |  |         |       |  |  |         |   |  |       |         |   |  |  |         |  
|Net income  basic                                                |  |       | 0.04    |   |        |  | 0.06    |       |  |  | 0.08    |   |  |       | 0.08    |   |  |  | 0.27    |  
|Net income  diluted                                              |  |       | 0.04    |   |        |  | 0.06    |       |  |  | 0.07    |   |  |       | 0.07    |   |  |  | 0.24    |  
|                                                                 
|Year ended September 30,
    2004                                 |  |       |         |   |        |  |         |       |  |  |         |   |  |       |         |   |  |  |         |  
|Revenues                                                          |  |       | $ 2,259 |   |        |  | $ 2,194 |       |  |  | $ 2,190 |   |  |       | $ 2,402 |   |  |  | $ 9,045 |  
|Gross margin                                                      |  |       | 919     |   |        |  | 938     |       |  |  | 947     |   |  |       | 975     |   |  |  | 3,779   |  
|Recovery of bad debts and customer
    financings                 |  |       | (14     | ) |        |  | (99     | )     |  |  | (90     | ) |  |       | (27     | ) |  |  | (230    | )
|Business restructuring charges
    (reversals), net               |  |       | 29      |   |        |  | (17     | )     |  |  | (27     | ) |  |       | (5      | ) |  |  | (20     | )
|Other income (expense), net                                       |  |       | 79      |   |        |  | (172    | )     |  |  | 128     |   |  |       | 205     |   |  |  | 240     |  
|Income taxes                                                      |  |       | (101    | ) |        |  | (22     | )     |  |  | (4      | ) |  |       | (812    | ) |  |  | (939    | )
|Net income                                                        |  |       | 338     |   |        |  | 68      |       |  |  | 387     |   |  |       | 1,209   |   |  |  | 2,002   |  
|Conversion/ redemption
    cost  8% preferred stock              |  |       | (1      | ) |        |  | -       |       |  |  | -       |   |  |       | -       |   |  |  | (1      | )
|Preferred stock dividends and
    accretion                       |  |       | 12      |   |        |  | -       |       |  |  | -       |   |  |       | -       |   |  |  | 12      |  
|Net income applicable to common
    shareowners                   |  |       | 349     |   |        |  | 68      |       |  |  | 387     |   |  |       | 1,209   |   |  |  | 2,013   |  
|Income per common share:                                          |  |       |         |   |        |  |         |       |  |  |         |   |  |       |         |   |  |  |         |  
|Net income applicable to common
    shareowners  basic           |  |       | 0.08    |   |        |  | 0.02    |       |  |  | 0.09    |   |  |       | 0.28    |   |  |  | 0.47    |  
|Net income applicable to common
    shareowners  diluted         |  |       | 0.07    |   |        |  | 0.02    |       |  |  | 0.08    |   |  |       | 0.23    |   |  |  | 0.42    |  





|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Charges (benefits), primarily to adjust the fair value of the
    warrants that were issued in connection with the settlement of
    our shareowner class action lawsuits and related insurance
    recoveries, were $71 million and $(17) million for the
    first and third quarters of fiscal 2005 and $54 million,
    $192 million, $(72) million and $(118) million
    for the four quarters of fiscal 2004.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
| 
| | The results for the four quarters of fiscal 2004 included the
    impact of certain discrete tax items related to the reversal of
    valuation allowances and the favorable settlement of certain
    prior-year federal and state tax audit matters. Tax-related
    benefits recognized were $55 million, $56 million and
    $119 million for the second, third and fourth quarters of
    fiscal 2005, respectively, and were $123 million,
    $37 million, $15 million and $828 million,
    including the recognition of an $816 million net operating
    loss carryback claim, for the four quarters of fiscal 2004. We
    also recognized interest income related to these settlements of
    $5 million, $53 million, $20 million and
    $10 million during the four quarters of fiscal 2005 and
    $68 million, $18 million, $4 million and
    $45 million during the four quarters of fiscal 2004.

F-80