<PAGE>   1

1                                                                     Exhibit 13


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

HIGHLIGHTS

Lucent Technologies Inc.("Lucent" or the "Company") is one of the world's
leading designers, developers and manufacturers of communications systems,
software and products. These integrated systems and software applications enable
network operators and business enterprises to connect, route, manage and store
information between and within locations. Lucent is a global market leader in
the sale of public communications systems, and is a supplier of systems and
software to the world's largest networks. Lucent is also a global leader in the
sale of business communications systems and microelectronic components for
communications systems and computer manufacturers. Lucent was formed from the
systems and technology units that were formerly part of AT&T Corp. ("AT&T"),
including the research and development capabilities of Bell Laboratories.

In 1996, Lucent changed its fiscal year to begin October 1st and end September
30th. Due to this change, Lucent reported 1996 audited financial results for a
short fiscal period beginning on January 1, 1996 and ending on September 30,
1996. For comparability to the audited financial statements, Lucent has provided
unaudited statements of income and cash flows for the twelve months ended
September 30, 1996 and for the nine months ended September 30, 1995.

For the fiscal year ended September 30, 1997, Lucent reported net income of $541
million or $0.84 per share compared with a net loss of $793 million or $1.37 per
share for the twelve months ended September 30, 1996. During fiscal 1997, Lucent
recognized one-time charges related to its acquisition of Octel Communications
Corporation ("Octel"), including $945 million for purchased in-process research
and development costs. For the twelve months ended September 30, 1996, Lucent
recorded $2,801 million of business restructuring and other charges. Excluding
these charges from both periods, net income was $1,507 million or $2.34 per
share in fiscal 1997 compared with $1,054 million or $1.65 per share (computed
on a pro forma basis) for the twelve months ended September 30, 1996. The pro
forma presentation assumes that all 636,661,931 common shares outstanding
following the completion of Lucent's Initial Public Offering ("IPO") on April
10, 1996 were outstanding since January 1, 1995, and gives no effect to the use
of proceeds from the IPO.

STRATEGIC TRANSACTIONS

Since October 1, 1996, Lucent has completed a number of strategic transactions
intended to improve the Company's focus on its core businesses. In October 1996,
Lucent acquired Agile Networks, Inc.("Agile"), a provider of advanced
intelligent data switching products that support Ethernet as well as emerging
asynchronous transfer mode ("ATM") technology. These products enable business
customers to manage multimedia networks more effectively. In September 1997,
Lucent acquired Octel, a provider of voice, fax and electronic messaging
technologies that complement those offered by Lucent. In October 1997, Lucent
agreed to acquire Livingston Enterprises, Inc., a global provider of equipment
used by Internet service providers to connect their subscribers to the Internet.
Such investments provide Lucent additional ways to invest in research and
development of leading edge technologies.

On October 1, 1997, Lucent contributed its Consumer Products business to a new
venture formed by Lucent and Philips Electronics N.V. ("Philips"). The venture,
which is 40% owned by Lucent, is a worldwide provider of a complete range of
personal communications products, including digital and analog wireless phones,
corded and cordless phones, answering machines, screen phones and pagers.

During fiscal 1996, Lucent completed the sale of its Paradyne subsidiary. In
addition, Lucent completed the sale of its interconnect products and Custom
Manufacturing Services businesses in December 1996, and its Advanced Technology
Systems ("ATS") unit in October 1997.
<PAGE>   2

2                                                                      


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

The following chart provides Lucent's revenues trend from its three core
businesses and excludes revenues from its Consumer Products unit and from Other
Systems and Products:

LUCENT'S FORMATION

Prior to February 1, 1996, AT&T conducted Lucent's business through various
divisions and subsidiaries. On February 1, 1996, AT&T began executing its
decision to separate Lucent into a stand-alone company (the "Separation") by
transferring to Lucent the assets and liabilities related to its business.
Additionally, AT&T retained $2,000 million of accounts receivable. In April
1996, Lucent completed the IPO and on September 30, 1996, became independent of
AT&T when AT&T distributed to its shareowners all of its Lucent shares.

Lucent's consolidated financial statements for periods prior to February 1, 1996
reflect the financial position, results of operations and cash flows of the
operations transferred to Lucent from AT&T in the Separation and were carved out
from the financial statements of AT&T using the historical results of operations
and historical basis of the assets and liabilities of the business.
Additionally, Lucent's 1995 consolidated financial statements include certain
assets, liabilities, revenues and expenses which were not historically recorded
at the level of, but are primarily associated with, the business. Management
believes the assumptions underlying these financial statements are reasonable,
although these financial statements may not necessarily reflect the results of
operations or financial position had Lucent been a separate, stand-alone entity.

THREE CORE BUSINESSES - ANNUAL REVENUES
(in billions of dollars)
FOR THE TWELVE MONTHS ENDED SEPTEMBER 30
------------------------------------------------------------------
                                     1995        1996       1997
Total Core Business Revenues        $17.5       $21.0      $24.8

Systems for Network Operators        10.6        13.2       15.6
Business Communications Systems       5.1         5.5        6.4
Microelectronic Products              1.8         2.3        2.8
------------------------------------------------------------------

Revenues for 1997 from Lucent's three core businesses: Systems for Network
Operators, Business Communications Systems and Microelectronic Products,
increased 17.9% compared with 1996.

KEY BUSINESS CHALLENGES

Lucent continues to face significant competition and expects that the level of
competition on pricing and product offerings will intensify. Lucent expects that
new competitors will enter its markets as a result of both the trend toward
global expansion by foreign and domestic competitors as well as continued
changes in technology and public policy. These competitors may include entrants
from the telecommunications, software, data networking and semiconductor
industries. Existing competitors have, and new competitors may have, strong
financial capability, technological expertise and well-recognized brand names.
As a result, Lucent's management periodically assesses market conditions and
redirects the Company's resources to meet the challenges of competition. Steps
Lucent may take include acquiring and investing in new businesses, partnering
with existing businesses, delivering new technologies, closing and consolidating
facilities, disposing of assets, reducing workforce levels or withdrawing from
markets.

Lucent's sales continue to be highly seasonal. Many of Lucent's large customers
have historically delayed a disproportionate percentage of their capital
expenditures until the fourth quarter of the calendar year. Consequently,
Lucent's results of operations for the first three quarters of each
<PAGE>   3

3                                                                      


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

calendar year historically have, in the aggregate, been significantly less
profitable than the fourth calendar quarter. However, Lucent has taken steps to
manage the seasonality by changing its year-end and its compensation programs
for employees.

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

To manage the fluctuation caused by the buying behaviors of large customers,
Lucent continues to seek out new types of customers both in the United States
and internationally, such as competitive access providers, cable television
network operators and computer manufacturers.

Historically, Lucent has relied on a limited number of customers for a
substantial portion of its total revenues, including AT&T which continues to be
a significant customer. Lucent is seeking to diversify its customer base;
nevertheless, Lucent expects that a significant portion of its future revenues
will continue to be generated by a limited number of customers. The loss of any
of these customers or any substantial reduction in orders by any of these
customers could materially adversely affect the Company's operating results.

QUARTERLY REVENUES - AS A PERCENTAGE OF ANNUAL REVENUES
NEW FISCAL YEAR BASIS
------------------------------------------------------------------
                                      1995        1996       1997

1st Qtr. December 31                   31%         32%        30%
2nd Qtr. March 31                      21%         20%        20%
3rd Qtr. June 30                       25%         23%        24%
4th Qtr. September 30                  23%         25%        26%
------------------------------------------------------------------

Lucent is taking steps to manage seasonality and moderate wide fluctuations in
revenues from quarter to quarter.
<PAGE>   4

4

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

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

<TABLE>
<CAPTION>
                              Year Ended     Nine Months Ended
                              September 30,     September 30,      Year Ended December 31,
                             ---------------  ------------------  -----------------------
                              1997     1996     1996     1995     1995     1994     1993
                                        (1)      (5)               (1)
<S>                         <C>      <C>      <C>      <C>      <C>      <C>      <C>    
RESULTS OF OPERATIONS
Revenues                    $26,360  $23,286  $15,859  $13,986  $21,413  $19,765  $17,734
Gross margin                 11,462    8,894    6,569    6,143    8,468    8,428    7,646
Operating income(loss)        1,631     (947)     487      434   (1,000)     971      669
Income(loss) before
 cumulative effects
 of accounting changes          541     (793)     224      150     (867)     482      430
Cumulative effects of
 accounting changes               -        -        -        -        -        -   (4,208)
Net income(loss)                541     (793)     224      150     (867)     482   (3,778)
Earnings(loss) per common
 share - Historical(2)         0.84    (1.37)    0.38     0.28    (1.65)     n/a      n/a
Earnings(loss) per common
 share - Pro Forma(3)           n/a    (1.25)    0.35     0.24    (1.36)     n/a      n/a
Dividends per
 common share                  0.225    0.15     0.15        -        -      n/a      n/a

FINANCIAL POSITION
Total assets                $23,811  $22,626  $22,626  $18,219  $19,722  $17,340  $17,109
Working capital               1,763    2,068    2,068      188     (384)     246    1,773
Total debt                    4,203    3,997    3,997    4,192    4,014    3,164    3,195
Shareowners' equity           3,387    2,686    2,686    2,783    1,434    2,476    2,580

OTHER INFORMATION
Selling, general
 and administrative
 expenses as a
 percentage of revenues       21.9%    31.3%    26.8%    28.9%     33.1%    27.1%    28.3%
Research and development
 expenses as a
 percentage of revenues       11.5 (4) 11.0     11.6     12.0      11.1     10.6     11.1
Gross margin percentage       43.5     38.2     41.4     43.9      39.5     42.6     43.1
</TABLE>

(1)   Includes pretax restructuring and other charges of $2,801 ($1,847 after
      taxes) recorded as $892 of costs, $1,645 of selling, general and
      administrative expenses and $264 of research and development expenses.
(2)   The calculation of earnings per share on a historical basis includes the
      retroactive recognition to January 1, 1995 of the 524,624,894 shares owned
      by AT&T on April 10, 1996.
(3)   The calculation of earnings per share on a pro forma basis assumes that
      all 636,661,931 common shares outstanding on April 10, 1996 were
      outstanding since January 1, 1995 and gives no effect to the use of
      proceeds from the IPO.
(4)   Excludes one-time charges of $1,024 million of purchased in-process
      research and development costs from acquisitions of Octel and Agile.
      Including these charges, research and development expenses as a percentage
      of revenues were 15.4% for 1997.
(5)   Beginning September 30, 1996, Lucent changed its fiscal year-end from
      December 31 to September 30, and reported results for the nine-month
      transition period ended September 30, 1996.
<PAGE>   5

5   


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

TWELVE MONTHS ENDED SEPTEMBER 30, 1997 VERSUS TWELVE MONTHS ENDED SEPTEMBER 30,
1996

REVENUES

Total revenues increased $3,074 million or 13.2% for 1997 compared with 1996,
primarily due to gains in sales from Systems for Network Operators, Business
Communications Systems and Microelectronic Products. The overall revenue growth
was partially offset by the expected decline in revenue from Consumer Products
and Other Systems and Products. Revenues for Lucent's three core businesses
increased 17.9% for 1997 compared with 1996. Revenue growth continued to be
generated from sales both in the United States and internationally (including
exports). International revenues increased 11.9% compared with 1996 and
represented 24.1% of total revenues in 1997. The increased international sales
reflect Lucent's targeted approach toward international revenue expansion for
increased profitability. The following table presents Lucent's revenues by
product line, and the related percentage of total revenues for the twelve months
ended September 30, 1997 and 1996:

<TABLE>
<CAPTION>
                                                              Twelve Months Ended
                                                                 September 30,
Dollars in Millions                              ----------------------------------------
                                                 As a Percentage          As a Percentage
                                         1997    of Total Revenue   1996  of Total Revenue
                                        -------  ---------------- ------- ----------------
<S>                                     <C>            <C>        <C>           <C> 
Systems for Network Operators........   $15,614         59%       $13,192        57%
Business Communications Systems......     6,411         24          5,509        24
Microelectronic Products.............     2,755         11          2,315        10
Consumer Products....................     1,013          4          1,431         6
Other Systems and Products...........       567          2            839         3
Total................................   $26,360        100%       $23,286       100%
</TABLE>

Revenues from SYSTEMS FOR NETWORK OPERATORS increased $2,422 million or 18.4%
compared with 1996. The increase resulted from higher sales of both switching
and wireless systems with associated software, fiber-optic cable and
professional services. Demand for second lines in businesses and residences for
Internet services and data connectivity contributed to the revenue growth for
1997.

Software sales increased $414 million or 21.7% compared with the same period in
1996. The increase was primarily driven by strong demand for associated software
for Lucent's new Access Interface Unit ("AIU") as well as software sales to
support number portability. The AIU is used in the 5ESS switch and helps speed
voice and Internet traffic.

Sales from Systems for Network Operators in the United States increased 22.2%.
The revenue increase in the United States was led by sales to traditional
service providers and non-traditional customers such as personal communications
services ("PCS") wireless providers, competitive access providers and cable
television companies. International revenues increased 8.2% compared with 1996,
resulting from increased sales in the Europe/Middle East/Africa, Asia/Pacific
and Caribbean/Latin America regions. International revenues represented 25.1% of
Systems for Network Operators revenues for 1997.
<PAGE>   6

6  


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

For 1997, sales of wireless infrastructure increased significantly compared with
the same period in 1996 primarily due to PCS contracts as customers accepted
networks for commercial service in 1997 using various digital technologies.
These technologies include Code Division Multiple Access ("CDMA"), Global System
for Mobile Communications ("GSM") and Time Division Multiple Access ("TDMA").
The Lucent digital technologies continue to show acceptance in both the
international and domestic markets.

Revenues from BUSINESS COMMUNICATIONS SYSTEMS increased $902 million or 16.4%
compared with the same period in 1996. This increase was led by sales of
DEFINITY(R) products, SYSTIMAX(R) structured cabling, messaging systems,
integrated offers such as call centers and higher revenues from service
contracts. This increase was partially offset by the continued erosion of the
rental base. Revenues in the United States increased 17.0% compared with 1996.
International revenues increased by 13.2%, reflecting growth in all
international regions. The increase in the United States and internationally was
primarily due to sales of DEFINITY(R) products, call centers and messaging
systems. In addition, higher sales of SYSTIMAX(R) structured cabling contributed
to the revenue growth in the United States. International revenues represented
15.8% of revenue for 1997.

During fiscal 1997, Lucent acquired Octel and Agile. Combined with Octel, Lucent
offers a wide array of messaging products and services to reach most customer
segments: wireless customers, central-office-based customers and business
customers of any size, while Agile contributes technology that supports a closer
integration of applications that combine voice and data. Through these
acquisitions, Lucent has added new in-process and existing technologies to its
voice and data networking capabilities. Utilizing these acquired in-process
technologies, the development of the next generation of products will involve
certain risks due to the complexity and uncertainty inherent in research and
development efforts.

---------- 
(R) Registered trademark of Lucent
<PAGE>   7

7 


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

Sales of MICROELECTRONIC PRODUCTS increased $440 million or 19.0% compared with
1996, due to higher sales of customized chips for computing and communications,
including components for local area networks, data networking, high-end computer
workstations and wireless telephones. Higher sales of power systems and
optoelectronic components also contributed to the increase for 1997. Domestic
revenues increased 12.5% compared with 1996, led by sales to original equipment
manufacturers ("OEMs"). The growth in international revenues of 25.9% was driven
by application specific integrated circuits ("ASICs") sales in the Asia/Pacific
region as well as the growth of wireless and multimedia integrated circuits and
power products sold to customers in Europe for cellular applications.
International revenues represented 51.3% of the Microelectronic Products sales
for 1997. Microelectronic Products continues to bring to market new
technologies, such as the introduction of the K56flex(TM) modem technology.

Revenues from CONSUMER PRODUCTS decreased $418 million or 29.2% compared with
1996. The decline in revenues was primarily due to decreased product sales
related to the closing of the Phone Center Stores, the discontinuation of
unprofitable product lines and the continued decrease in phone rental revenues.
Lucent's Consumer Products unit was contributed to the venture between Lucent
and Philips on October 1, 1997.

Revenues from OTHER SYSTEMS AND PRODUCTS decreased $272 million or 32.4%
compared with 1996. The decrease is largely due to the sale of Lucent's Custom
Manufacturing Services business in fiscal year 1997 and its Paradyne subsidiary
in fiscal year 1996. Revenues in this product line are expected to continue to
decline, reflecting the sale of Lucent's ATS unit to General Dynamics
Corporation on October 1, 1997. ATS designed and manufactured custom defense
systems for the United States government.

GROSS MARGIN

Gross margin percentage increased to 43.5% from 38.2% in 1996 primarily due to
the restructuring charges recorded in the quarter ended December 31, 1995.
Excluding restructuring charges, gross margin for 1996 was 42.0%. The increase
in gross margin percentage for 1997 was due to an overall favorable mix of
higher margin product revenues and the benefits associated with the business
productivity improvement initiatives.

(TM) Trademark of Lucent
<PAGE>   8

8


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

OPERATING EXPENSES

Selling, general and administrative expenses decreased $1,506 million or 20.7%
compared with 1996. Excluding the $1,645 million of restructuring charges
recorded in December 1995, selling, general and administrative expenses
increased $139 million compared with 1996. This increase was due to expenditures
associated with higher sales levels, investment in growth initiatives, and the
implementation of SAP, an integrated software platform. These increases were
partially offset by the reversal of $174 million of business restructuring
liabilities in 1997, the lower start-up costs incurred in 1997, and business
productivity improvement initiatives, including lower expenses since some
businesses were exited in fiscal 1997 and 1996. Selling, general and
administrative expenses as a percentage of revenue declined 2.3 percentage
points to 21.9% of revenue compared with 24.2% of revenues, excluding
restructuring charges in 1996.

Research and development expenses increased $472 million or 18.5% compared with
1996. Excluding the impact of restructuring charges for the quarter ended
December 31, 1995, research and development expenses increased by $736 million,
primarily due to expenditures in support of wireless infrastructure,
microelectronic products and advanced multimedia communications systems as well
as a $127 million write-down of special-purpose Bell Labs assets no longer being
used. Research and development expenses represented 11.5% of revenues as
compared with 11.0% of revenues in 1996. Research and development expenses as a
percentage of revenues increased 1.7 percentage points from 9.8%, excluding
restructuring charges in 1996.

Purchased in-process research and development for 1997 reflects one-time
write-offs totaling $1,024 million of in-process research and development in
connection with the acquisitions of Octel (see Note 1) and Agile.

OTHER INCOME, INTEREST EXPENSE AND PROVISION FOR INCOME TAXES

Other income-net decreased $77 million compared with 1996. This decrease was
largely due to gains recognized on the sale of certain investments and insurance
recoveries in 1996, offset in part by increased interest income in 1997.

Interest expense increased $12 million compared with 1996 due primarily to
replacing a portion of commercial paper with long-term debt in July 1996.

The effective tax rate of 63.1% for 1997 increased from the effective tax rate
of 22.4% for the same period of 1996 due to the 1997 write-offs of in-process
research and development costs and the tax impact of restructuring charges
incurred in 1996. Excluding charges related to the acquisition of Agile and
Octel, the effective tax rate for 1997 was 37.2%, a decrease of 3.6 percentage
points from the 1996 effective tax rate of 40.8% before considering the effects
of restructuring charges incurred in 1996. This decrease is primarily
attributable to the tax impact of foreign earnings.
<PAGE>   9

9


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

CASH FLOWS

Cash provided by operating activities was $1,946 million in 1997, an increase of
$967 illion compared with the same period in 1996. This increase in cash was
largely due to the retention of $2,000 million of customer accounts receivable
by AT&T in 1996 as well as the increase in sales associated with higher cash
collections. This was offset by changes in accounts payable due to the end of
payments to AT&T related to the Separation and the change in other operating
assets and liabilities over 1996. The change in other operating assets and
liabilities was primarily due to the receipt of a $500 million cash advance made
to Lucent in April 1996 by AT&T and the utilization by AT&T of that advance in
1997.

Cash payments of $483 million were charged against the December 1995 business
restructuring reserves in 1997. As of September 30, 1997, the workforce had been
reduced by approximately 17,900 positions in connection with business
restructuring. In addition, approximately 1,000 employees left Lucent's
workforce as part of the sale of Paradyne in 1996. Actual experience in employee
separations, combined with redeploying employees into other areas of the
business, has resulted in lower separation costs than originally anticipated.

Comparing 1997 and 1996, cash used in investing activities increased to $3,121
million from $1,638 million primarily due to the acquisition of Octel.

Capital expenditures were $1,635 million and $1,432 million for 1997 and 1996,
respectively. Capital expenditures include expenditures for equipment and
facilities used in manufacturing and research and development, including
expansion of manufacturing capacity and international growth.

Cash provided by financing activities for 1997 was $295 million compared $2,503
million in 1996. This decrease was primarily due to the proceeds received from
the IPO in the year-ago period.

In 1995, Lucent relied on AT&T to provide financing for its operations. The cash
flows from financing activities for the period ended September 30, 1996 reflect
changes in the Company's assumed capital structure. These cash flows are not
necessarily indicative of the cash flows that would have resulted if the Company
had been a stand-alone entity.
<PAGE>   10

10


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

NINE MONTHS ENDED SEPTEMBER 30, 1996 VERSUS NINE MONTHS ENDED SEPTEMBER 30, 1995

REVENUES

Total revenues increased $1,873 million or 13.4% for the nine-month period of
1996, compared with the same period of 1995, primarily due to gains in sales
from Systems for Network Operators, Microelectronic Products and Business
Communications Systems. The overall revenue growth was partially offset by the
expected decline in revenues from Consumer Products due to the closing of the
Phone Center Stores, discontinuance of unprofitable product lines and the
decreased telephone rental revenues. Revenue growth continued to be generated
from sales both in the United States and internationally (including exports).
International revenues represented 23.1% of total revenues in 1996. The
following table presents Lucent's revenues by product line, and the related
percentage of total revenues for the nine months ended September 30, 1996 and
1995 (1995 has been restated to align intellectual property and other service
revenues with Lucent's operating units):

<TABLE>
<CAPTION>
                                                         Nine Months
                                                            Ended
                                                        September 30,
Dollars in Millions                     --------------------------------------------------
                                                  As a Percentage        As a Percentage
                                         1996    of Total Revenue  1995  of Total Revenue
                                        -------  ---------------- ------- ----------------
<S>                                     <C>             <C>       <C>           <C>
Systems for Network Operators........   $ 8,637          54%      $ 6,914        49%
Business Communications Systems......     3,983          25         3,710        27
Microelectronic Products.............     1,756          11         1,420        10
Consumer Products....................       880           6         1,238         9
Other Systems and Products...........       603           4           704         5
Total................................   $15,859         100%      $13,986       100%
</TABLE>

Revenues from SYSTEMS FOR NETWORK OPERATORS increased $1,723 million or 24.9%
compared with the same period in 1995. The increase was driven by higher sales
of switching, transmission, fiber-optic cable products and professional
services. Demand for those products was driven by second-line subscriber growth
and customer demand for continued network upgrades.

Software sales increased $117 million or 15.0% compared with the same period in
1995. For 1996, sales of wireless infrastructure increased $69 million or 6.4%
compared with the same period in 1995.

Sales from Systems for Network Operators in the United States increased 23.4%
and international revenues increased 29.6% compared with the same period in
1995. The revenue increase in the United States was led by sales to AT&T and the
Regional Bell Operating Companies, partially offset by a revenue decrease
resulting from Lucent's exit from the copper cable business in 1995. Increased
sales of infrastructure systems and services drove the international revenue
growth in the Asia/Pacific and Europe/Middle East/Africa regions. In addition,
the international revenue increase included approximately $298 million in
revenue from several manufacturing and other operations of certain subsidiaries
of Philips Electronics N.V. acquired in 1996 ("Philips Acquisition").
International revenues represented 24.8% of revenues from Systems for Network
Operators in the nine-month period of 1996.
<PAGE>   11

11


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

In 1996, Lucent focused resources on marketing CDMA technology since this
technology had shown acceptance in both the international and domestic markets.
In addition, Lucent made progress in the buildout of CDMA infrastructure for
PrimeCo Personal Communications LP in 1996. During the first calendar quarter of
1996, Lucent was awarded a contract from Sprint Spectrum Holdings LP ("Sprint
PCS") to supply equipment and services for approximately 60% of Sprint PCS's
market areas for its nationwide PCS wireless network over a five-year period.

Revenues from BUSINESS COMMUNICATIONS SYSTEMS increased $273 million or 7.4%
compared with the same period in 1995. This increase was primarily due to higher
sales in the United States and internationally, partially offset by the
continued erosion of the rental base. The revenue growth in the United States
was led by sales of DEFINITY(R) products, SYSTIMAX(R) structured cabling systems
and INTUITY(TM) voice messaging products as well as higher revenue from call
centers and maintenance contracts.
International revenues increased by 24.7%, reflecting growth in all
international regions.

Sales of MICROELECTRONIC PRODUCTS increased $336 million or 23.7% compared with
the same period in 1995 due to higher sales of DSPs and ASICs to OEMs, both
internationally and in the United States. Domestic revenues increased 14.7%
compared with the same period in 1995, led by sales to OEMs. The growth in
international revenues of 34.6% was driven by continued strength of DSPs and
ASICs sales in the Asia/Pacific region. International revenues represented 49.0%
of the Microelectronic Products sales for the nine-month period of 1996.

Revenues from CONSUMER PRODUCTS decreased $358 million or 28.9% compared with
the same period in 1995. The expected decline in revenues was primarily due to
the decrease in product sales resulting from the closing of the Phone Center
Stores, the discontinuance of unprofitable product lines and the decrease in
telephone rentals.

Revenues from OTHER SYSTEMS AND PRODUCTS decreased $101 million or 14.3%
compared with the same period in 1995. These revenues included sales from the
Paradyne subsidiary sold in July 1996 as well as the Custom Manufacturing
Services business, which Lucent sold in December 1996.

GROSS MARGIN

Gross margin percent declined to 41.4% from 43.9% in the year-ago period due to
changes in the mix of revenues, erosion of high margin rental revenues and lower
margins on products from the Philips Acquisition. The revenue mix reflected a
high proportion of hardware sales and a high proportion of revenues from
contracts accounted for on a percentage of completion basis.

OPERATING EXPENSES

Selling, general and administrative expenses increased $207 million or 5.1%
compared with the same period in 1995. Included are approximately $160 million
due to expenditures associated with start-up related costs such as advertising
and creating a new information systems infrastructure, as well as the additional
expenses resulting from the Philips Acquisition.

----------
(R)  Registered trademark of Lucent
(TM) Trademark of Lucent
<PAGE>   12

12

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

Selling, general and administrative expenses were 26.8% of revenues for the
nine-month period of 1996 compared with 28.9% of revenues for the same period in
1995.

Research and development expenses increased $166 million or 9.9% compared with
the same period in 1995. Research and development expenses represented 11.6% of
revenues for the nine-month period of 1996 compared with 12.0% of revenues for
the same period in 1995.

OTHER INCOME AND PROVISION FOR INCOME TAXES

Other income--net increased $54 million compared with the same period in 1995.
The increase was primarily due to interest income on short-term investments.

The effective income tax rate of 39.0% for the nine-month period of 1996
decreased from 40.2% in the same period of 1995, primarily due to increased
federal research tax credits.

CASH FLOWS

Cash used in operating activities was $4 million compared with $505 million in
the same period in 1995. The change was due to an increase in prepayments from
customers. Additionally, inventory in 1996 remained relatively level versus the
buildup reported in 1995. These activities were offset by AT&T's retention of
$2,000 million of accounts receivable in 1996.

Cash payments of $456 million related to business restructuring were made during
the nine months of 1996. The September 30, 1996 remaining balance will result in
future cash payments over the next two years. Of the 22,000 employee separations
announced as part of the 1995 business restructuring, approximately 11,400
people left the workforce as of September 30, 1996. In addition, approximately
1,000 employees left Lucent's workforce as part of the sale of Paradyne. Actual
experience in employee separations, combined with redeployment of employees into
other areas of the business, has resulted in lower separation costs than
originally anticipated. Lucent anticipates that approximately 70% of the total
expected employee separations will be complete by the end of December 1996.

Comparing the nine-month periods ended September 30, 1996 and 1995, cash used in
investing activities increased to $1,066 million from $770 million. The increase
in cash used in investing activities was largely the result of the Philips
Acquisition and higher capital expenditures compared with the same period in
1995. Capital expenditures were $939 million and $784 million for the nine-month
periods ended September 30, 1996 and 1995, respectively. These expenditures
related to the expansion of manufacturing capacity of Microelectronic Products
and the necessary expansion of various other facilities.

Cash provided by financing activities increased primarily due to the proceeds
from the IPO in 1996 compared with the same period in 1995.

In 1995, Lucent relied on AT&T to provide financing for its operations. Cash
flows from financing activities in 1995 principally reflect changes in Lucent's
assumed capital structure. These cash flows are not necessarily indicative of
the cash flows from financing activities that would have resulted if Lucent was
a stand-alone entity.
<PAGE>   13

13                                                                     

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

FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES

Total assets as of September 30, 1997, increased $1,185 million or 5.2% from
September 30, 1996, due to increases in contracts in process and other assets
offset by decreases in cash and inventory. The increase in contracts in process
reflects the buildout for large contracts while the increase in other assets
reflects the goodwill associated with the acquisition of Octel. The decrease in
cash was largely due to Lucent's cash payments in connection with the
acquisition of Octel offset by increased cash collections from customers.

For the year ended September 30, 1997, Lucent's inventory turnover ratio was 4.0
times compared with 3.3 times for the twelve months ended September 30, 1996.
The increase was primarily due to improved inventory management at the factories
and in the distribution channels. Inventory turnover is defined as cost of sales
(excluding costs related to long-term contracts) divided by average inventory
during the year.

Accounts receivable were outstanding an average of 64 days for the period ended
September 30, 1997 compared with 68 days for the same period in 1996. The
decrease in days outstanding was due to a faster level of cash collections in
1997 compared with 1996.

Working capital, defined as current assets less current liabilities, decreased
$305 million from September 30, 1996 largely due to the decrease in cash.

The fair value of Lucent's pension plan assets is greater than the projected
pension obligations. Lucent records pension income when the expected return on
plan assets plus amortization of the transition asset is greater than the
interest cost on the projected benefit obligation plus service cost for the
year. Consequently, Lucent continued to have a net pension credit that added to
prepaid pension costs in 1997 and beyond.

Lucent expects that, from time to time, outstanding commercial paper balances
may be replaced with short- or long-term borrowings as market conditions permit.
At September 30, 1997, Lucent maintained approximately $5,200 million in credit
facilities of which a portion is used to support Lucent's commercial paper
program. At September 30, 1997, approximately $5,000 million of these credit
facilities were unused. Future financings will be arranged to meet Lucent's
requirements with the timing, amount and form of issue depending on prevailing
market and general economic conditions. Lucent anticipates that borrowings under
its bank credit facilities, the issuance of additional commercial paper, cash
generated from operations and short- and long-term debt financings will be
adequate to satisfy its future cash requirements, although there can be no
assurance that this will be the case.

Network operators, domestically and internationally, increasingly have required
their suppliers to arrange or provide long-term financing for them as a
condition to obtaining or bidding on infrastructure projects. These projects may
require financing in amounts ranging from modest sums to over a billion dollars.
In this regard, Lucent entered into a credit agreement in October 1996 to
provide Sprint PCS long-term financing of $1,800 million for purchasing
equipment and services for its PCS network.

In May 1997, under the $1,800 million credit facility provided by Lucent to
Sprint PCS, Lucent closed transactions to lay off $500 million of loans and
undrawn commitments and $300 million of undrawn commitments to a group of
institutional investors and Sprint Corporation (a partner in Sprint PCS),
respectively. As of September 30, 1997, $146 million of these commitments were
not yet drawn down by Sprint PCS.

As part of the revenue recognition process, Lucent has assessed the
collectibility of the accounts receivable relating to the Sprint PCS purchase
contract in light of its financing commitment to Sprint PCS. Lucent has
determined that the receivables under the contract are reasonably assured of
collection based on various factors among which was the ability of Lucent to
sell the loans and commitments without recourse. Lucent intends to continue
pursuing opportunities for the sale of future loans and commitments.
<PAGE>   14

14                                                                     

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

Lucent has also entered into agreements to extend credit of up to an aggregate
of approximately $850 million to three other PCS operators for possible future
sales. As of September 30, 1997, no amounts had been advanced under these
agreements. On October 1, 1997, a commitment for $300 million included in the
$850 million expired and was not extended. The agreement relating to about $200
million of credit is subject to fulfillment of certain conditions and completion
of final contract documentation. Lucent is continuing to propose, and commit to
provide, financing where appropriate for its business, in addition to the above
arrangements. The ability of Lucent to arrange or provide financing for network
operators will depend on a number of factors, including Lucent's capital
structure and level of available credit.

Lucent believes that it will be able to access the capital markets on terms and
in amounts that will be satisfactory, and that it will be able to obtain bid and
performance bonds, to arrange or provide customer financing as necessary, and to
engage in hedging transactions on commercially acceptable terms, although there
can be no assurance that this will be the case.

The ratio of total debt to total capital (debt plus equity) was 55.4% at
September 30, 1997 compared with 59.8% at September 30, 1996. Excluding the
one-time charges related to the acquisition of Octel for the twelve months ended
September 30, 1997, the return on assets was 6.5% compared with 5.3% for the
twelve months ended September 30, 1996, excluding business restructuring and
other charges.

RISK MANAGEMENT

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

Lucent uses foreign currency derivative instruments to reduce its exposure to
the risk that the eventual net cash inflows and outflows resulting from the sale
of products to foreign customers and purchases from foreign suppliers will be
adversely affected by changes in exchange rates. The foreign currency exchange
contracts are designated for firmly committed or forecasted purchases and sales.
The use of these derivative financial instruments allows Lucent to reduce its
overall exposure to exchange rate movements, since the gains and losses on these
contracts substantially offset losses and gains on the assets, liabilities and
transactions being hedged. As of September 30, 1997 and 1996, Lucent's primary
foreign currency market exposures include Deutsche marks, Japanese yen and Dutch
guilders. There have been no changes in how such exposures are managed since the
nine-month period ended September 30, 1996. Management does not foresee or
expect any significant changes in foreign currency exposure or in the strategies
it employs to manage such exposures in the near future.

Foreign currency exchange contracts are sensitive to changes in foreign currency
exchange rates. As of September 30, 1997, 10% appreciations from the prevailing
market rates of Deutsche marks, Japanese yen and Dutch guilders would increase
the related unrealized gain by $16 million. Conversely, 10% depreciations of
these currencies from the prevailing market rates would decrease the related
unrealized gain by $20 million. Unrealized gains/losses in foreign currency
exchange contracts are defined as the difference between the hypothetical rates
and the current market exchange rates. Consistent with the nature of the
economic hedge of such foreign currency exchange contracts, such unrealized
gains or losses would be offset by corresponding decreases or increases,
respectively, of the underlying instrument or transaction being hedged.
<PAGE>   15

15                                   
                     MANAGEMENT'S DISCUSSION AND ANALYSIS OF
                  RESULTS OF OPERATIONS AND FINANCIAL CONDITION

While Lucent hedges actual and anticipated transactions with customers, the
decline in value of the Asia/Pacific currencies may, if not reversed, adversely
affect future product sales because Lucent products may become more expensive
for customers to purchase in their local currency.

Lucent manages its ratio of fixed to floating rate debt with the objective of
achieving a mix that management believes is appropriate. To manage this mix in a
cost effective manner, Lucent, from time to time, enters into interest rate swap
agreements, in which it agrees to exchange various combinations of fixed and/or
variable interest rates based on agreed upon notional amounts. Lucent had no
material interest rate swap agreements in effect as of September 30, 1997 and
1996. The strategy employed by Lucent to manage its exposure to interest rate
fluctuations is unchanged from that date. Management does not foresee or expect
any significant changes in its exposure to interest rate fluctuations or in how
such exposure is managed in the near future.

Various financial instruments held or issued by Lucent are sensitive to changes
in interest rates. Interest rate changes would result in gains/losses in the
market value of Lucent's term debt, commercial paper and investments due to
differences between the market interest rates and rates at the inception of
these financial instruments. Based on Lucent's term debt and commercial paper
outstanding at September 30, 1997 and current market perception, a 100 basis
point increase in the interest rates as of September 30, 1997 would result in a
net reduction of the market value of these instruments of $80 million.
Conversely, a 100 basis point decrease in the interest rates would result in an
$86 million net increase in the market value of Lucent's term debt and
commercial paper outstanding at September 30, 1997. Neither a 100 basis point
increase nor decrease from current interest rates would have a material impact
on the market value of Lucent's investments.

OTHER

Lucent's current and historical operations are subject to a wide range of
environmental protection laws. In the United States, these laws often require
parties to fund remedial action regardless of fault. Lucent has remedial and
investigatory activities underway at about 40 current and former facilities. In
addition, Lucent was named a successor to AT&T as a potentially responsible
party ("PRP") at numerous "Superfund" sites pursuant to the Comprehensive
Environmental Response, Compensation and Liability Act of 1980 ("CERCLA") or
comparable state statutes. Under the Separation and Distribution Agreement,
among AT&T, Lucent and NCR Corporation ("NCR") dated as of February 1, 1996, and
amended and restated as of March 29, 1996 ("Separation and Distribution
Agreement"), Lucent is responsible for all liabilities primarily resulting from
or related to the operation of Lucent's business as conducted at any time prior
to or after the Separation including related businesses discontinued or disposed
of prior to the Separation, and Lucent's assets including, without limitation,
those associated with these sites. In addition, under the Separation and
Distribution Agreement, Lucent is required to pay a portion of contingent
liabilities paid out in excess of certain amounts by AT&T and NCR, including
environmental liabilities.

It is often difficult to estimate the future impact of environmental matters,
including potential liabilities. Lucent records an environmental reserve when it
is probable that a liability has been incurred and the amount of the liability
is reasonably estimable. This practice is followed whether the claims are
asserted or unasserted. Management expects that the amounts reserved will be
paid out over the period of remediation for the applicable site which ranges
from 5 to 30 years. Reserves for estimated losses from environmental remediation
are, depending on the site, based primarily upon internal or third party
environmental studies, and estimates as to the number, participation level and
financial viability of any other PRPs, the extent of the contamination and the
nature of required remedial actions. Accruals are adjusted as further
information develops or
<PAGE>   16

16                                         

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

circumstances change. The amounts provided for in Lucent's consolidated
financial statements in respect to environmental reserves are the gross
undiscounted amount of such reserves, without deductions for insurance or third
party indemnity claims. In those cases where insurance carriers or third party
indemnitors have agreed to pay any amounts and management believes that
collectibility of such amounts is probable, the amounts are reflected as
receivables in the financial statements. Although Lucent believes that its
reserves are adequate, there can be no assurance that the amount of capital and
other expenditures that will be required relating to remedial actions and
compliance with applicable environmental laws will not exceed the amounts
reflected in Lucent's reserves or will not have a material adverse effect on
Lucent's financial condition, results of operations or cash flows.

FORWARD-LOOKING STATEMENTS

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

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

For a further description of Future Factors that could cause actual results to
differ materially from such forward-looking statements, see below in this Annual
Report and also see the discussion in the Company's Form 10-K for the year ended
September 30, 1997 in Item 1 under the section entitled "OUTLOOK-Forward Looking
Statements" and the remainder of the OUTLOOK section.

Competition:

See discussion above under KEY BUSINESS CHALLENGES.
<PAGE>   17

17

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

Dependence On New Product Development:

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

Reliance on Major Customers:

See discussion above under KEY BUSINESS CHALLENGES.

Readiness for Year 2000:

Lucent has taken actions to understand the nature and extent of the work
required to make its systems, products and infrastructure Year 2000 compliant.
Lucent began work several years ago to prepare its products and its financial,
information and other computer-based systems for the Year 2000, including
replacing and/or updating existing legacy systems. Lucent continues to evaluate
the estimated costs associated with these efforts based on actual experience.
While these efforts will involve additional costs, Lucent believes, based on
available information, that it will be able to manage its total Year 2000
transition without any material adverse effect on its business operations,
products or financial prospects.

Multi-Year Contracts:

See discussion above under FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES,
AND KEY BUSINESS CHALLENGES

Seasonality:

See discussion above under KEY BUSINESS CHALLENGES.

Future Capital Requirements:

See discussion above under FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES

International Growth:

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

Foreign Exchange:

See discussion above under RISK MANAGEMENT.
<PAGE>   18

18

REPORT OF MANAGEMENT

Management is responsible for the preparation of Lucent Technologies Inc.'s
consolidated financial statements and all related information appearing in this
Annual Report. The financial statements and notes have been prepared in
conformity with generally accepted accounting principles and include certain
amounts which are estimates based upon currently available information and
management's judgment of current conditions and circumstances.

To provide reasonable assurance that assets are safeguarded against loss from
unauthorized use or disposition and that accounting records are reliable for
preparing financial statements, management maintains a system of accounting and
other controls, including an internal audit function. Even an effective internal
control system, no matter how well designed, has inherent limitations including
the possibility of circumvention or overriding of controls - and therefore can
provide only reasonable assurance with respect to financial statement
presentation. The system of accounting and other controls is improved and
modified in response to changes in business conditions and operations and
recommendations made by the independent public accountants and the internal
auditors.

The Audit and Finance Committee of the Board of Directors, which is composed of
directors who are not employees, meets periodically with management, the
internal auditors and the independent auditors to review the manner in which
these groups of individuals are performing their responsibilities and to carry
out the Audit and Finance Committee's oversight role with respect to auditing,
internal controls and financial reporting matters. Periodically, both the
internal auditors and the independent auditors meet privately with the Audit and
Finance Committee and have access to its individual members.

Lucent engaged Coopers & Lybrand L.L.P., independent public accountants, to
audit the consolidated financial statements in accordance with generally
accepted auditing standards, which include consideration of the internal control
structure. Their report appears on this page.


Richard A. McGinn - signed                 Donald K. Peterson - signed
Chief Executive Officer                    Executive Vice President,
and President                              Chief Financial Officer
<PAGE>   19

20

REPORT OF INDEPENDENT ACCOUNTANTS

To the Shareowners of Lucent Technologies Inc.:

We have audited the consolidated balance sheets of Lucent Technologies Inc. and
subsidiaries as of September 30, 1997 and 1996 and the related consolidated
statements of income, changes in shareowners' equity, and cash flows for the
year and nine-month period ended September 30, 1997 and 1996, respectively and
the year ended December 31, 1995. 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 in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Lucent
Technologies Inc. and subsidiaries as of September 30, 1997 and 1996, and the
consolidated results of their operations, and their cash flows for the year and
nine-month period ended September 30, 1997 and 1996, respectively and the year
ended December 31, 1995, in conformity with generally accepted accounting
principles.


Coopers & Lybrand L.L.P. - Signed
1301 Avenue of the Americas
New York, New York
October 21, 1997
<PAGE>   20

20

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

<TABLE>
<CAPTION>
                               Year Ended           Nine Months Ended         Year Ended
                              September 30,            September 30,          December 31,
                            -----------------      ---------------------    --------------
                              1997      1996            1996       1995          1995
------------------------------------------------------------------------------------------
                                      UNAUDITED                 UNAUDITED
------------------------------------------------------------------------------------------
<S>                         <C>        <C>            <C>        <C>          <C>     
Revenues                    $26,360    $23,286        $15,859    $13,986      $ 21,413

Costs                        14,898     14,392          9,290      7,843        12,945

Gross margin                 11,462      8,894          6,569      6,143         8,468

Operating expenses
Selling, general
  and administrative          5,784      7,290          4,244      4,037         7,083
Research and development      3,023      2,551          1,838      1,672         2,385
Purchased in-process
  research and development    1,024          -              -          -             -
Total operating expenses      9,831      9,841          6,082      5,709         9,468

Operating income(loss)        1,631       (947)           487        434        (1,000)
Other income - net              141        218             96         42           164
Interest expense                305        293            216        225           302
Income(loss) before           1,467     (1,022)           367        251        (1,138)
  income taxes
Provision(benefit) for
  income taxes                  926       (229)           143        101          (271)
Net income(loss)            $   541    $  (793)       $   224    $   150      $   (867)

Weighted average
  common shares
  outstanding (millions)      644.1      578.1          595.9      524.6         524.6

Earnings(loss) per
  common share              $  0.84    $ (1.37)       $  0.38    $  0.28      $  (1.65)
Dividends per
  common share              $ 0.225    $  0.15        $  0.15    $     -      $      -
</TABLE>

See Notes to Consolidated Financial Statements.
<PAGE>   21

21
                    Lucent Technologies Inc. and Subsidiaries
                          CONSOLIDATED BALANCE SHEETS
                  (Dollars in Millions, Except Per Share Amounts)

                                                September 30,     September 30,
                                                    1997              1996
                                               -------------     ------------
ASSETS
Cash and cash equivalents                        $  1,350         $  2,241
Accounts receivable less
  allowances of $352 in 1997 and
  $273 in 1996                                      5,373            4,914
Inventories                                         2,926            3,288
Contracts in process (net of progress
 billings of $2,003 in 1997 and
 $708 in 1996)                                      1,046              505
Deferred income taxes - net                         1,333            1,617
Other current assets                                  473              216
Total current assets                               12,501           12,781

Property, plant and equipment, net                  5,147            4,687
Prepaid pension costs                               3,172            2,828
Deferred income taxes - net                         1,262              979
Capitalized software development costs                293              362
Other assets                                        1,436              989

Total assets                                     $ 23,811         $ 22,626

LIABILITIES
Accounts payable                                 $  1,931         $  1,900
Payroll and benefit-related
  liabilities                                       2,178            2,492
Postretirement and postemployment
  benefit liabilities                                 239              220
Debt maturing within one year                       2,538            2,363
Other current liabilities                           3,852            3,738

Total current liabilities                          10,738           10,713

Postretirement and postemployment
  benefit liabilities                               6,073            5,642
Long-term debt                                      1,665            1,634
Other liabilities                                   1,948            1,951

Total liabilities                                $ 20,424         $ 19,940
Commitments and contingencies

SHAREOWNERS' EQUITY
Preferred stock - par value $1 per share
 Authorized 250,000,000 shares                   $      -         $      -
 Issued and outstanding shares: none
Common stock - par value $.01 per share
 Authorized shares: 3,000,000,000
 Issued and outstanding shares:
 642,062,656 at September 30, 1997;
 636,662,634 at September 30, 1996                      6                6
Additional paid-in capital                          3,047            2,595
Guaranteed ESOP obligation                            (77)            (106)
Foreign currency translation                         (191)             (16)
Retained earnings                                     602              207

Total shareowners' equity                        $  3,387         $  2,686

Total liabilities and shareowners' equity        $ 23,811         $ 22,626

See Notes to Consolidated Financial Statements.
<PAGE>   22

22                                                                     

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

<TABLE>
<CAPTION>
                                    Year Ended      Nine Months Ended       Year Ended
                                September 30, 1997  September 30, 1996   December 31,1995
                                ------------------  ------------------   ----------------
<S>                                     <C>               <C>               <C>    
PREFERRED STOCK

COMMON STOCK
 Balance at beginning of period         $    6            $    -            $     -
 Issuance of common shares                   -                 6                  -
 Balance at end of period                    6                 6                  -

ADDITIONAL PAID-IN CAPITAL
 Balance at beginning of period          2,595             1,406                  -
 Issuance of common shares                 260             2,881                  -
 Conversion of Octel stock options         116                 -                  -
 Net loss from 1/1/96 through 1/31/96        -               (72)                 -
 Dividends declared                          -                (7)                 -
 Accounts receivable holdback
  by AT&T                                    -            (2,000)                 -
 Unrealized gain on investments             40                15                  -
 Acceptance of ESOP                          -               120                  -
 Other contributions from AT&T               -               252              1,406
 Other                                      36                 -                  -
 Balance at end of period                3,047             2,595              1,406

GUARANTEED ESOP OBLIGATION
 Balance at beginning of period           (106)                -                  -
 Acceptance of ESOP                          -              (120)                 -
 Amortization of ESOP obligation            29                14                  -
 Balance at end of period                  (77)             (106)                 -

FOREIGN CURRENCY
  TRANSLATION ADJUSTMENTS
 Balance at beginning of period            (16)               28                 92
 Translation adjustments                  (175)              (44)               (64)
 Balance at end of period                 (191)              (16)                28

SHAREOWNER'S NET INVESTMENT
 Balance at beginning of period              -                 -              2,384
 Net loss                                    -                 -               (867)
 Transfers to AT&T                           -                 -               (111)
 Transfer to additional paid-in capital      -                 -             (1,406)
 Balance at end of period                    -                 -                  -

RETAINED EARNINGS
 Balance at beginning of period            207                 -                  -
 Net income                                541                 -                  -
 Net income from 2/1/96
  through 9/30/96                            -               296                  -
 Dividends declared                       (146)              (89)                 -
 Balance at end of period                  602               207                  -

TOTAL SHAREOWNERS' EQUITY             $  3,387           $ 2,686            $ 1,434
</TABLE>

See Notes to Consolidated Financial Statements.
<PAGE>   23

23                                                                     
                    Lucent Technologies Inc. and Subsidiaries
                      CONSOLIDATED STATEMENTS OF CASH FLOWS
                              (Dollars in Millions)

<TABLE>
<CAPTION>
                                  Year Ended        Nine Months Ended         Year Ended
                                 September 30,         September 30,          December 31,
                              ------------------   ---------------------    --------------
                                1997       1996         1996       1995          1995
------------------------------------------------------------------------------------------
                                         UNAUDITED               UNAUDITED
------------------------------------------------------------------------------------------
<S>                              <C>        <C>          <C>         <C>          <C>     
Operating Activities:
Net income(loss)                 $  541     $  (793)     $   224     $  150       $  (867)
Adjustments to reconcile
 net income(loss)
 to net cash provided by
 (used in)operating activities:
  Business restructuring
    charge                         (201)      2,515          (98)         -         2,613
  Asset impairment
    and other charges                81         293          105          -           188
  Depreciation and
    amortization                  1,450       1,326          937      1,104         1,493
  Provision for
    uncollectibles                  127          73           54         50            69
  Deferred income taxes               9        (996)        (251)        92          (653)
  Purchased in-process
    research and development      1,024           -            -          -             -
  (Increase)decrease in
    accounts receivable            (389)     (3,114)      (1,506)       405        (1,203)
  Increase in inventories
    and contracts in process       (273)       (309)        (524)    (1,304)       (1,089)
  Increase(decrease) in
    accounts payable                (16)      1,021          629       (121)          271
  Changes in other operating
    assets and liabilities         (315)      1,040          537       (744)         (241)
  Other adjustments for
    noncash items - net             (92)        (77)        (111)      (137)         (103)
Net cash provided by(used in)
  operating activities            1,946         979           (4)      (505)          478

Investing Activities:
Capital expenditures             (1,635)     (1,432)        (939)      (784)       (1,277)
Proceeds from the sale or
 disposal of property, plant
 and equipment                      108         119           15         14           118
Purchases of
 equity investments                (149)        (96)         (46)       (36)          (86)
Sales of equity investments          12         102          102          -             -
Dispositions of businesses          181          58           58         10            10
Acquisitions of businesses,
 net of cash acquired            (1,568)       (234)        (234)         -             -
Other investing
 activities - net                   (70)       (155)         (22)        26          (107)
Net cash used in
 investing activities            (3,121)     (1,638)      (1,066)      (770)       (1,342)
</TABLE>

See Notes to Consolidated Financial Statements.
                                                   (CONT'D)
<PAGE>   24

24                                                                     

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

<TABLE>
<CAPTION>
                                  Year Ended         Nine Months Ended        Year Ended
                                 September 30,         September 30,          December 31,
                              ------------------   ---------------------    --------------
                                1997       1996         1996       1995          1995
------------------------------------------------------------------------------------------
                                         UNAUDITED              UNAUDTIED
------------------------------------------------------------------------------------------

<S>                           <C>         <C>          <C>        <C>          <C> 
Financing Activities:
Repayments of long-term debt      (16)        (53)         (39)       (32)          (46)
Issuance of long-term debt         52       1,499        1,499          -             -
Proceeds of issuance
 of common stock                  260       2,887        2,887          -             -
Dividends paid                   (192)        (48)         (48)         -             -
Proceeds(repayments) of
 debt sharing
 agreement - net                    -         (67)           -        948           881
Transfers from(to) AT&T             -        (190)          13         92          (111)
(Increase)decrease in
 short-term borrowings - net      191      (1,525)      (1,436)        89             -
Net cash provided by
 financing activities             295       2,503        2,876      1,097           724

Effect of exchange rate
 changes on cash
 and cash equivalents             (11)        (16)         (13)        11             8

Net increase(decrease)
 in cash and
 cash equivalents                (891)      1,828        1,793       (167)         (132)

Cash and cash equivalents
 at beginning of period         2,241         413          448        580           580

Cash and cash equivalents
 at end of period             $ 1,350     $ 2,241      $ 2,241    $   413      $    448
</TABLE>

See Notes to Consolidated Financial Statements.
<PAGE>   25

25                                                                     

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

1. BACKGROUND AND BASIS OF PRESENTATION

BACKGROUND

Lucent Technologies Inc. ("Lucent" or the "Company") was formed from the systems
and technology units of AT&T Corp. ("AT&T") and the associated assets and
liabilities of those units, including Bell Laboratories (the "Separation").
Lucent was incorporated on November 29, 1995 with 1,000 shares of common stock
("Common Stock"), authorized and outstanding, all of which were owned by AT&T.
On April 2, 1996, AT&T obtained an additional 524,623,894 shares of Common Stock
and on April 10, 1996, Lucent issued 112,037,037 shares in an Initial Public
Offering. On September 30, 1996, AT&T distributed to its shareowners all of its
remaining interest in Lucent (the "Distribution").

BASIS OF PRESENTATION

The consolidated financial statements for the nine months ended September 30,
1996 and the year ended December 31, 1995 reflect the results of operations,
changes in shareowners' equity and cash flows, and the financial position of the
business that was transferred to Lucent from AT&T as if Lucent were a separate
entity. The consolidated financial statements have been prepared using the
historical basis of the assets and liabilities and historical results of
operations of these businesses. Additionally, the aforementioned financial
statements include an allocation of certain AT&T corporate headquarters assets,
liabilities and expenses related to the businesses that were transferred to
Lucent from AT&T. Management believes the allocations reflected in the
consolidated financial statements are reasonable. The aforementioned financial
statements may not necessarily reflect the consolidated results of Lucent's
operations, financial position, changes in shareowners' equity or cash flows in
the future or what they would have been had Lucent been a separate, stand-alone
company during such periods.

ACQUISITION

In September 1997, Lucent completed the purchase of all outstanding stock of
Octel Communications Corporation ("Octel"), a provider of voice, fax and
electronic messaging technologies, at an aggregate purchase price of
approximately $1,819 ($1,703 in cash). Lucent paid for the Octel shares from its
general funds which consist of cash from operations and proceeds from short-term
borrowings. The acquisition was accounted for using the purchase method of
accounting. The fair market value of Octel's assets and liabilities, which was
independently determined, has been included in the statement of financial
position as of September 30, 1997. The purchase price was allocated as follows:

     Fair value of assets acquired............   $  664
     Fair value of liabilities assumed........     (157)
     Goodwill.................................      181
     Acquired existing technology.............      186
     Purchased in-process research
      and development costs...................      945
     Total....................................   $1,819

Acquired technology valuation included both existing technology and that
represented by in-process research and development. The valuation was made by
applying the income forecast method which considers the present value of cash
flows by product lines.

The fair value of existing technology products was valued at $186 and is being
amortized over five years. In-process research and development was valued at
$945 and was charged to expense since this technology had not reached
technological feasibility and has no alternative use. This technology will
require varying additional development, coding and testing efforts over the next
one and a half years before assessment of technological feasibility can be
determined.

Goodwill is being amortized over seven years.
<PAGE>   26

26                                                                     

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

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

CONSOLIDATION

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

USE OF ESTIMATES

The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
revenue and expenses during the period reported. Actual results could differ
from those estimates. Estimates are used when accounting for long-term
contracts, allowance for uncollectible accounts receivable, inventory
obsolescence, product warranty, depreciation, employee benefits, taxes,
restructuring reserves and contingencies, among others.

EARNINGS PER COMMON SHARE

Earnings per common share was calculated by dividing the net income by the
weighted average shares of common stock and common stock equivalents outstanding
during the periods. Included in the calculation of the weighted average shares
outstanding is the retroactive recognition to January 1, 1995 of the 524,624,894
shares owned by AT&T.

FOREIGN CURRENCY TRANSLATION

For operations outside the United States that prepare financial statements in
currencies other than the United States dollar, results of operations and cash
flows are translated at average exchange rates during the period, and assets and
liabilities are translated at end of period exchange rates. Translation
adjustments are included as a separate component of shareowners' equity.

REVENUE RECOGNITION

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

RESEARCH AND DEVELOPMENT COSTS

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

Amortization of capitalized software development costs begins when the product
is available for general release. Amortization is provided on a
product-by-product basis on either the straight-line method over periods not
exceeding two years or the sales ratio method. Unamortized capitalized software
development costs determined to be in excess of net realizable value of the
product are expensed immediately.
<PAGE>   27

27                                                                     

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

CASH AND CASH EQUIVALENTS

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

INVENTORIES

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

CONTRACTS IN PROCESS

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

PROPERTY, PLANT AND EQUIPMENT

Property, plant and equipment is stated at cost less accumulated depreciation.
Depreciation is determined using primarily the unit and group methods. The unit
method is used for manufacturing and laboratory equipment and large computer
systems. The group method is used for other depreciable assets. When assets that
were depreciated using the unit method are sold or retired, the gains or losses
are included in operating results. When assets that were depreciated using the
group method are sold or retired, the original cost is deducted from the
appropriate account and accumulated depreciation. Any proceeds are applied
against accumulated depreciation.

Accelerated depreciation is used for certain high technology computer processing
equipment. All other facilities and equipment are depreciated on a straight-line
basis over their estimated useful lives.

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

GOODWILL

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

RECLASSIFICATIONS

Certain prior year amounts have been reclassified to conform with the 1997
presentation.
<PAGE>   28

28                                                                     

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

3. CHANGES IN ACCOUNTING POLICIES

In February 1997, the Financial Accounting Standards Board (the "FASB") issued
Statement of Financial Accounting Standards (the "SFAS") No. 128, "Earnings Per
Share" ("SFAS 128"). SFAS 128 simplifies the standards for computing earnings
per share and is effective for financial statements for both interim and annual
periods ending after December 15, 1997. Earlier application is not permitted.
The adoption of SFAS 128 is not expected to have a material impact on Lucent's
previously reported earnings per share.

In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive Income"
("SFAS No. 130"). SFAS No. 130 establishes standards for reporting and display
of comprehensive income and its components in the financial statements. SFAS No.
130 is effective for fiscal years beginning after December 15, 1997.
Reclassification of financial statements for earlier periods provided for
comparative purposes is required. Lucent is in the process of determining its
preferred format. The adoption of SFAS no. 130 will have no impact on Lucent's
consolidated results of operations, financial position or cash flows.

In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments of an
Enterprise and Related Information" ("SFAS No. 131"). SFAS No. 131 establishes
standards for the way that public business enterprises report information about
operating segments in annual financial statements and requires that those
enterprises report selected information about operating segments in interim
financial reports issued to shareholders. It also establishes standards for
related disclosures about products and services, geographic areas, and major
customers. SFAS No. 131 is effective for financial statements for fiscal years
beginning after December 15, 1997. Financial statement disclosures for prior
periods are required to be restated. Lucent is in the process of evaluating the
disclosure requirements. The adoption of SFAS No. 131 will have no impact on
Lucent's consolidated results of operations, financial position or cash flows.

4. SUPPLEMENTARY FINANCIAL INFORMATION

SUPPLEMENTARY INCOME STATEMENT INFORMATION

<TABLE>
<CAPTION> 
                                                                   Nine
                                                 Year Ended     Months Ended     Year Ended
                                                 September 30,  September 30,   December 31,
                                                    1997           1996            1995
                                                 -------------  -------------   ------------
                                                 
<S>                                              <C>            <C>           <C>     
INCLUDED IN COSTS                                
Amortization of software development costs.....  $    380       $  218        $    312
                                                 
INCLUDED IN SELLING, GENERAL AND                 
  ADMINISTRATIVE EXPENSES                        
Amortization of goodwill.......................  $     32       $   25        $     40
                                                 
INCLUDED IN COSTS AND OPERATING EXPENSES         
Depreciation and amortization of property,       
  plant and equipment..........................  $  1,008       $  674        $  1,109
                                                 
OTHER INCOME                                     
Interest income................................  $    132       $   71        $     44
Minority interests in earnings of subsidiaries.       (35)         (21)            (20)
Net equity losses from investments.............       (64)         (26)            (25)
Increase in cash surrender value                 
  of life insurance............................        54           35              40
Loss on foreign currency transactions..........       (12)          (4)            (26)
Miscellaneous -- net...........................        66           41             151
                                                   -------      -------         -------
Total other income -- net......................  $    141       $   96        $    164
</TABLE>
<PAGE>   29

29

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

DEDUCTED FROM INTEREST EXPENSE
Capitalized interest...........................  $     14     $   14    $    14

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

SUPPLEMENTARY BALANCE SHEET INFORMATION
                                                   September 30,   September 30,
                                                       1997            1996
                                                   -------------   -------------
INVENTORIES
Completed goods..................................  $  1,611          $ 1,837
Work in process and raw materials................     1,315            1,451
                                                     --------         -------
Inventories......................................  $  2,926          $ 3,288

PROPERTY, PLANT AND EQUIPMENT -- NET
Land and improvements............................  $    299          $   275
Buildings and improvements.......................     2,852            2,875
Machinery, electronic and other equipment........     8,403            7,870
Total property, plant and equipment..............    11,554           11,020
Less: Accumulated depreciation and amortization..    (6,407)          (6,333)
                                                     --------         -------
Property, plant and equipment -- net.............  $  5,147          $ 4,687

OTHER CURRENT LIABILITIES
Advance billings and customer deposits             $    844         $  1,202

SUPPLEMENTARY CASH FLOW INFORMATION

<TABLE>
<CAPTION>
                                                                 Nine
                                               Year Ended    Months Ended     Year Ended
                                              September 30,  September 30,   December 31,
                                                  1997           1996           1995
                                              ------------   -------------   -----------

<S>                                              <C>            <C>            <C>  
Interest payments, net of amounts capitalized    $  307         $ 209          $ 303

Income tax payments .........................    $  781        $  142          $ 224
</TABLE>

For information related to the acquisition of Octel, see Note 1.

In addition, the statement of cash flows for the nine-month period ended
September 30, 1996 excludes $2,000 of customer accounts receivable retained by
AT&T as well as net asset transfers of $239 received from AT&T. These
transactions have not been reflected on the consolidated statement of cash flows
because they were noncash events accounted for as changes in paid-in capital.

5. BUSINESS RESTRUCTURING AND OTHER CHARGES

In the fourth quarter of calendar year 1995, a pretax charge of $2,801 was
recorded to cover restructuring costs of $2,613 and asset impairment and other
charges of $188. The restructuring plans included restructuring Lucent's
Consumer Products business, including closing all of the Company-owned retail
Phone Center Stores; consolidating and reengineering numerous corporate and
business unit operations; and selling the Microelectronics interconnect and
Paradyne businesses.
<PAGE>   30

30

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

The 1995 business restructuring charge of $2,613 included restructuring
liabilities of $1,774, asset impairments of $497 and $342 of benefit plan
losses. Benefit plan losses were related to pension and other employee benefit
plans and primarily represented losses in 1995 from the actuarial changes that
otherwise might have been amortized over future periods.

The pretax total charge for restructuring, impairments and other charges of
$2,801 for 1995 was recorded as $892 of costs, $1,645 of selling, general and
administrative expenses, and $264 of research and development expenses. The
charges included $1,509 for employee separations; $627 for asset write-downs;
$202 for closing, selling and consolidating facilities; and $463 for other
items. The total charges reduced net income by $1,847.

The restructuring charge of $2,613 incorporated the separation costs, both
voluntary and involuntary, for nearly 22,000 employees. As of September 30,
1997, the workforce has been reduced by approximately 17,900 positions due to
business restructuring. In addition, approximately 1,000 employees left Lucent's
workforce as part of the sale of Paradyne in 1996. Actual experience in employee
separations, combined with redeploying employees into other areas of the
business, has resulted in lower separation costs than originally anticipated.
Lucent anticipates that approximately 90% of the total expected employee
reductions in positions will be complete by September 1998.

The following table displays a rollforward of the liabilities for business
restructuring from December 31, 1995 to September 30, 1997:

<TABLE>
<CAPTION>
                         December 31,       -------------1996---------------  September 30,
Type of Cost             1995 Balance    Additions          Other  Usage      1996 Balance
-------------------------------------------------------------------------------------------
<S>                      <C>             <C>             <C>        <C>        <C>   
Employee Separation      $ 1,219         $    -          $(81)      $(372)     $  766
Facility Closing             272              -           (35)        (62)        175
Other                        416              -            18         (86)        348
Total                    $ 1,907         $    -          $(98)      $(520)     $1,289

<CAPTION>
                         September 30,    --------------1997-------------     September 30,
Type of Cost             1996 Balance     Additions       Other      Usage    1997 Balance
-------------------------------------------------------------------------------------------
<S>                      <C>             <C>          <C>        <C>           <C>   
Employee Separation      $   766         $    -       $(154)     $(264)        $  348
Facility Closing             175              -         (24)       (85)            66
Other                        348              -         (23)      (170)           155
Total                    $ 1,289         $    -       $(201)     $(519)         $ 569
</TABLE>

Management believes that the remaining reserves for business restructuring are
adequate to complete its plan.

Cash payments of $483 and $456 and noncash related charges of $36 and $64
primarily associated with asset write-offs were charged against the business
restructuring reserves for the year and nine-month period ended September 30,
1997 and 1996, respectively. Lucent reversed $201 and $98 of business
restructuring reserves primarily related to employee separations for the year
and nine-month period ended September 30, 1997 and 1996, respectively.

For the year and nine-month period ended September 30, 1997 and 1996,
respectively, the reversals of business restructuring reserves were offset by a
write-down of $127 for special purpose Bell Labs assets no longer being used in
1997 and $105 of non-recurring and other charges in 1996, principally associated
with the separation from AT&T.
<PAGE>   31

31

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                 (Dollars In Millions, Except Per Share Amounts)
6. INCOME TAXES

The following table presents the principal reasons for the difference between
the effective tax rate and the United States federal statutory income tax rate:
<TABLE>
<CAPTION>
                                                                 Nine
                                               Year Ended    Months Ended       Year Ended
                                              September 30,  September 30,     December 31,
                                                 1997           1996             1995
                                              -------------  -------------     ------------
<S>                                               <C>            <C>             <C>  
U.S federal statutory income tax rate.....        35.0%          35.0%           35.0%
                                                 -------        -------         -------
State and local income taxes, net of
  federal income tax effect...............         5.4            1.4             5.0
Amortization of intangibles...............         0.2              -            (2.5)
Foreign earnings and dividends taxed at
  different rates.........................         0.9            4.1           (12.3)

Research credits..........................        (2.6)          (5.0)            0.3
Other differences - net...................        (1.7)           3.5            (1.7)
                                                 -------        -------         -------
Effective income tax rate before purchased
in-process research and development costs.        37.2%          39.0%           23.8%

Purchased in-process research and
  development costs.......................        25.9            0.0             0.0
                                                 -------        -------         -------
Effective income tax rate.................        63.1%          39.0%           23.8%
                                                 =======        =======         =======
</TABLE>

The following table presents the U.S. and foreign components of income before
income taxes and the provision for income taxes:

<TABLE>
<CAPTION>
                                                                 Nine
                                               Year Ended    Months Ended     Year Ended
                                              September 30,  September 30,   December 31,
                                                 1997           1996            1995
                                              ------------   -------------   -----------

<S>                                             <C>             <C>           <C>      
INCOME(LOSS) BEFORE INCOME TAXES
United States.............................      $   873         $   101       $ (1,253)
Foreign...................................          594             266            115
                                                 -------          ------        -------
                                                $ 1,467         $   367       $ (1,138)
                                                 =======          ======        =======
PROVISION(BENEFIT) FOR INCOME TAXES

CURRENT
Federal...................................      $   464         $   242       $    199
State and local...........................          129              53             42
Foreign...................................          226              98            141
                                                 -------          ------        -------
                                                    819             393            382
                                                 -------          ------        -------
DEFERRED
Federal...................................           35            (198)          (523)
State and local...........................           77            ( 45)          (130)
Foreign and other.........................         (  5)           (  7)             -
                                                 -------          ------        -------
                                                    107            (250)          (653)
                                                 -------          ------        -------
Provision(benefit) for income taxes.......      $   926         $   143       $   (271)
                                                 =======          ======        =======
</TABLE>
<PAGE>   32

32


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

As of September 30, 1997, Lucent had state and local, and foreign net operating
loss carryforwards (tax effected) of $103, which expire primarily after 2000.

The components of deferred tax assets and liabilities at September 30, 1997 and
1996 are as follows:

<TABLE>
<CAPTION>
                                                         September 30,   September 30,
                                                             1997            1996
                                                         -------------   -------------
<S>                                                         <C>             <C>
DEFERRED INCOME TAX ASSETS:

  Employee pensions and other benefits, net.........        $ 1,777         $ 1,900
  Business restructuring............................            112             417
  Reserves and allowances...........................            887             658
  Net operating loss/credit carryforwards...........            107              67
  Valuation allowance...............................           (234)           (208)
  Other.............................................            664             555
                                                             -------         -------
Total deferred income tax assets....................        $ 3,313         $ 3,389
                                                            ========        =======

DEFERRED INCOME TAX LIABILITIES:
  Property, plant and equipment.....................        $   478          $  519
  Other.............................................            240             274
                                                             ------          -------
Total deferred income tax liabilities...............        $   718          $  793
                                                            =======          ======
</TABLE>

Lucent has not provided for United States deferred income taxes or foreign
withholding taxes on $2,029 of undistributed earnings of its non-United States
subsidiaries as of September 30, 1997, since these earnings are intended to be
reinvested indefinitely.

7.  DEBT OBLIGATIONS

                                        September 30,     September 30,
                                              1997             1996
                                       -------------     -------------

DEBT MATURING WITHIN ONE YEAR
Commercial paper......................  $    2,364         $   2,225
Long-term debt........................          56                59
Other.................................         118                79
Total debt maturing within one year...  $    2,538            $2,363

WEIGHTED AVERAGE INTEREST RATES
Commercial paper......................         5.5%              5.4%
Long-term debt and other..............         6.3%              7.1%

Lucent had revolving credit facilities at September 30, 1997 aggregating $5,181
(a portion of which is used to support Lucent's commercial paper program),
$4,000 with domestic lenders and $1,181 with foreign lenders. At September 30,
1997, $4,000 with domestic lenders and $955 with foreign lenders were available.
<PAGE>   33

33


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

                                       September 30,     September 30,
                                            1997             1996
                                      -------------     -------------
LONG-TERM DEBT

6.90% notes due July 15, 2001              $  750          $   750
7.25% notes due July 15, 2006                 750              750
Long-term lease obligations                     2                4
Other                                         229              201
Less: Unamortized discount                     10               12
Total long-term debt                        1,721            1,693
Less: Amounts maturing within one year         56               59
Net long-term debt                         $1,665          $ 1,634


Lucent has an effective shelf registration statement for the issuance of debt
securities up to $3,500, of which 1,960 remains available at September 30, 1997.

This table shows the maturities, by year, of the $1,721 in total long-term debt
obligations:

                               September 30,
              -------------------------------------------------------
              1998    1999     2000     2001     2002     Later Years
               $56     $52      $23     $761       $0        $829

8.  EMPLOYEE BENEFIT PLANS

PENSION AND POSTRETIREMENT BENEFITS

Lucent maintains noncontributory defined benefit pension plans covering the
majority of its employees and retirees, and postretirement benefit plans for
retirees that include health care benefits, life insurance coverage and
telephone reimbursement. Prior to October 1, 1996, Lucent participated in AT&T's
noncontributory defined benefit pension and postretirement plans . Accordingly,
Lucent's financial statements reflect estimates of the costs experienced for its
employees and retirees while they were included in the AT&T plans.

Pension-related benefits for management employees are based principally on
career-average pay while benefits for occupational employees are not directly
pay-related. Pension contributions are determined principally using the
aggregate cost method and are made primarily to trust funds held for the sole
benefit of plan participants.

Effective October 1, 1996, pension obligations under the AT&T plans relating to
Lucent's employees and retirees were transferred to Lucent plans. Assets that
were formerly held by AT&T's Group Pension Trust were subsequently divided
between the master pension trusts for qualified pension plans of Lucent and
AT&T. The pension benefit obligation and plan assets transferred to Lucent as of
September 30, 1996 were $21,269 and $29,805, respectively.

Also effective October 1, 1996, Lucent established separate postretirement
benefit plans for its employees and retirees. Postretirement benefit assets were
transferred from AT&T, pro rata, on the basis of the present value of future
benefit obligations of the applicable plan. The accumulated postretirement
benefit obligation and plan assets transferred to Lucent as of September 30,
1996 were $7,399 and $3,711, respectively.
<PAGE>   34

34


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

The following table shows the Lucent plans' funded status reconciled with
amounts reported in Lucent's consolidated balance sheets, and the assumptions
used in determining the actuarial present value of the benefit obligation:

<TABLE>
<CAPTION>
                                              Pension               Postretirement
                                            September 30,            September 30,
-----------------------------------------------------------------------------------
<S>                                     <C>        <C>           <C>        <C>
Plan assets at fair value               $ 36,204   $ 29,805      $  4,152   $ 3,711
Less: benefit obligation                  23,187     21,269         7,939     7,399
-----------------------------------------------------------------------------------
Funded(Unfunded) status of the plan       13,017      8,536        (3,787)   (3,688)
Unrecognized prior service costs           1,048      1,115           261       367
Unrecognized transition asset             (1,244)    (1,543)            -         -
Unrecognized net gain                     (9,669)    (5,308)       (1,256)   (1,110)
Net minimum liability of nonqualified
  plans                                      (23)       (19)            -         -
-----------------------------------------------------------------------------------
Prepaid(Accrued) benefit cost            $ 3,129   $  2,781      $ (4,782)  $(4,431)
===================================================================================
Accumulated pension benefit obligation    22,669     20,475           n/a      n/a
Vested pension benefit obligation         21,246     19,077           n/a      n/a
----------------------------------------------------------------------------------
Accumulated postretirement benefit
 obligation:
    Retirees                                 n/a        n/a         5,902    5,510
Fully eligible active plan
      participants                           n/a        n/a           777      821
Other active plan participants               n/a        n/a         1,260    1,068
----------------------------------------------------------------------------------
Accumulated postretirement benefit
  obligation                                 n/a        n/a      $  7,939  $ 7,399
==================================================================================
Assumptions:
Weighted average discount rate             7.25%        8.0%         7.25%    8.0%
Rate of increase in future
 compensation levels                       4.50%        5.0%         n/a      n/a
==================================================================================
</TABLE>

Pension plan assets consist primarily of listed stocks (of which $73 and $6
represent Lucent common stock at September 30, 1997 and September 30, 1996,
respectively). Postretirement plan assets include listed stocks (of which $2 and
$8 represent Lucent common stock at September 30, 1997 and 1996, respectively).
Assets in both plans also include corporate and governmental debt, and cash and
cash equivalents. Pension plan assets also include real estate investments, and
postretirement plan assets also include life insurance contracts.

The prepaid pension benefit costs shown above are net of pension liabilities for
plans where accumulated plan benefits exceed assets. Such liabilities are
included in other liabilities in the Consolidated Balance Sheets.
<PAGE>   35

35

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

<TABLE>
<CAPTION>
                                                              Nine
                                            Year Ended   Months Ended    Year Ended
                                           September 30,  September 30,  December 31,
PENSION COST                                    1997          1996          1995
----------------------------------------------------------------------------------------
<S>                                          <C>            <C>           <C>   
Service cost-benefits                        $   312        $  277        $  308
  earned during the period
Interest cost on projected
  benefit obligation                           1,604         1,172         1,589
Expected return on plan
  assets (1)                                  (2,150)       (1,589)       (2,000)
Amortization of unrecognized
  prior service costs                            149           113           160
Amortization of transition
  asset                                         (300)         (222)         (289)
Charges(credits) for plan
  curtailments (2)                                56           (16)           97
---------------------------------------------------------------------------------------
Net pension credit                           $  (329)       $ (265)       $ (135)
=======================================================================================
POSTRETIREMENT COST
---------------------------------------------------------------------------------------
Service cost-benefits earned
  during the period                          $    57        $   51        $   53
Interest cost on accumulated
  postretirement benefit
  obligation                                     554           408           599
Expected return on plan
  assets (3)                                    (264)         (189)         (220)
Amortization of unrecognized
  prior service costs                             35            53            40
Amortization of net (gain)loss                   (15)            8            (6)
Charges(credits) for plan
 curtailments(2)                                  26            (2)            2
---------------------------------------------------------------------------------------
Net postretirement benefit cost              $   393          $329          $468
=======================================================================================
</TABLE>

(1) A 9.0% long-term rate of return on pension plan assets was assumed for 1997,
    1996 and 1995. The actual return on plan assets was $8,523 and $2,204 for
    the year and nine-month period ended September 30, 1997 and 1996,
    respectively, and $5,471 for the year ended December 31, 1995.
(2) The 1997 pension and postretirement charges for plan curtailments of $56 and
    $26, respectively, reflect the final determination of 1996 curtailment
    effects.
(3) A 9.0% long-term rate of return on postretirement plan assets was assumed
    for 1997, 1996 and 1995. The actual return on plan assets was $1,040 and
    $219 for the year and nine-month period ended September 30, 1997 and 1996,
    respectively, and $602 for the year ended December 31, 1995.

Pension cost was computed using the projected unit credit method. Lucent is
amortizing over approximately 16 years the unrecognized pension transition asset
related to the adoption of SFAS No. 87, "Employers' Accounting for Pensions," in
1986. Prior service pension costs are amortized primarily on a straight-line
basis over the average remaining service period of active employees.
<PAGE>   36

36                                                                     


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

For postretirement benefit plans, Lucent assumed a 5.4% annual rate of increase
in the per capita cost of covered health care benefits (the health care cost
trend rate) for 1998, gradually declining to 4.8% by the year 2005, after which
the costs would remain level. This assumption has a significant effect on the
amounts reported. Increasing the assumed trend rate by 1% in each year would
increase Lucent's accumulated postretirement benefit obligation as of September
30, 1997 by $394 and the interest and service cost by $31 for the year then
ended.

SAVINGS PLANS

Effective October 1, 1996 the AT&T's savings plans assets and liabilities
related to Lucent employees and retirees were transferred to Lucent plans.
Lucent's savings plans allow employees to contribute a portion of their pretax
and/or after-tax income in accordance with specified guidelines. Lucent matches
a percentage of the employee contributions up to certain limits. The expense
amounted to $180 and $131 for the year and nine-month period ended September 30,
1997 and 1996, respectively, and $196 for the year ended December 31, 1995.

EMPLOYEE STOCK OWNERSHIP PLAN

As of September 30, 1996, Lucent established a leveraged Employee Stock
Ownership Plan ("ESOP"), after receiving its portion of the ESOP obligation from
AT&T, to fund the employer's contributions to the long-term savings and security
plan for nonmanagement employees (the "LTSS Plan"). The ESOP obligation is
reported as debt and as a reduction in shareowners' equity. Cash contributions
to the ESOP are determined based on the ESOP's total debt service less dividends
paid on ESOP shares. As of September 30, 1997, the ESOP contained 5.8 million
shares of Lucent's common stock. Of the 5.8 million shares, 4.0 million have
been allocated to the LTSS Plan and 1.8 million were unallocated. As of
September 30, 1997, the unallocated shares had a fair value of $146.

9.  STOCK COMPENSATION PLANS

Prior to Lucent's separation from AT&T, certain Lucent employees participated in
AT&T stock-based compensation plans under which they received stock options and
other equity-based awards. Effective October 1, 1996, such awards held by Lucent
employees were replaced by substitute awards under the Lucent Technologies Inc.
1996 Long-Term Incentive Program ("1996 LTIP").

The 1996 LTIP provides for the grant of stock options, stock appreciation
rights, performance awards, restricted stock awards and other stock unit awards.
Awards under the 1996 LTIP are generally made to executives. Lucent also awards
stock options to selected employees below executive levels under the Lucent
Technologies Inc. 1997 Long-Term Incentive Plan ("1997 LTIP"), and awarded a
one-time option grant to each full-time employee as of October 1, 1996 to
acquire 100 shares of Common Stock under the Lucent Technologies Inc. Founders
Grant Stock Option Plan ("FGP"). Stock options are granted with an exercise
price equal to or greater than 100% of market value at the date of grant,
generally have a ten-year term, and vest three years from date of grant. Subject
to customary anti-dilution adjustments and certain exceptions, the total number
of shares of Common Stock authorized for grant under the 1996 LTIP and the 1997
LTIP in each calendar year amounted to 2.5% of the total outstanding shares of
Common Stock as of the first day of the calendar year. Substitute awards do not
reduce the shares available for grant under these two plans. The total number of
shares of Common Stock authorized for grant under the FGP was 15 million.

Options to purchase Common Stock may be granted either alone or in addition to
other awards. The term of each option will be fixed by a Committee of Lucent's
Board of Directors ("Committee"), provided that no incentive stock options, as
defined in the Internal Revenue Code, will be exercisable after the expiration
of ten years from the date the option is granted. Options will be exercisable at
such time or times as determined by the Committee at or subsequent to grant.
<PAGE>   37

37


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

In connection with Lucent's acquisition of Octel, all Octel stock options held
by Octel employees will become exercisable for Lucent common stock, effective
September 29, 1997. The value of these options was included as part of the
purchase price related to the acquisition of Octel(see Note 1).

Lucent established an Employee Stock Purchase Plan (the "ESPP") effective
October 1, 1996. Under the terms of the ESPP, eligible employees may have up to
10% of eligible compensation deducted from their pay to purchase Common Stock
through June 30, 2001. On the date of exercise, which is the last trading day of
each month, the per share purchase price is 85% of the average high and low
per-share trading price of Common Stock on the New York Stock Exchange on that
date. The amount that may be offered pursuant to this plan is 50 million shares.
Since inception of this plan, 3.1 million shares have been purchased at a
weighted average price of $50.31.

Lucent has adopted the disclosure requirements of SFAS No. 123 "Accounting for
Stock-Based Compensation" and, as permitted under SFAS No. 123, applies
Accounting Principles Board Opinion No. 25 and related interpretations in
accounting for its plans. Compensation expense was $36 and $11 for the year and
nine month periods ended September 30, 1997 and 1996, respectively, and $11 for
the year ended December 31, 1995. If Lucent had elected to adopt the optional
recognition provisions of SFAS No. 123 for its stock option plans and the ESPP,
net income(loss) and earnings(loss) per share would have been changed to the pro
forma amounts indicated below:

<TABLE>
<CAPTION>
                                                           Nine
                                          Year Ended   Months Ended   Year Ended
                                         September 30, September 30,  December 31,
                                             1997          1996          1995
                                      -----------------------------------------------
<S>                                           <C>          <C>          <C> 
Net income (loss)
 As reported........................          $541         $224         $(867)
 Pro forma..........................          $444         $202         $(870)
                                      -----------------------------------------------
Earnings (loss)
  per share
 As reported........................          $0.84       $0.38         $(1.65)
 Pro forma..........................          $0.69       $0.34         $(1.66)
                                      ----------------------------------------------
</TABLE>

Note: The pro forma disclosures shown may not be representative of the effects
on net income and earnings per share in future years because the year ended
September 30, 1997 and the nine months ended September 30, 1996 include the
incremental fair value of the Lucent stock options that were substituted for
AT&T stock options.

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

------------------------------------------------------------------------------
                                            Lucent      AT&T
Assumptions:                              (1)    (2)     (3)
------------
Dividend yield........................   0.65%  0.75%    2.4%
Expected volatility...................  22.4%  22.4%    19.4%
Risk-free interest rate...............   6.4%   6.1%     6.4%
Expected holding period(in years).....   5.1    4.5      5.0
------------------------------------------------------------------------------
(1) Assumptions for Lucent options awarded during 1997.
(2) Assumptions for Lucent options substituted for AT&T options effective
    October 1, 1996. 
(3) Assumptions for AT&T options for the years 1996 and 1995.
<PAGE>   38

38                                                                    


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

Presented below is a summary of the status of the Lucent stock options held by
Lucent employees and the related transactions for the year ended September 30,
1997. Also shown are the AT&T stock options held by Lucent's employees for the
nine months ended September 30, 1996 and the year ended December 31, 1995.

                                                              Weighted
                                                               Average
                                                   Shares     Exercise
                                                   (000's)      Price
-----------------------------------------------------------------------
AT&T options outstanding at January 1, 1995         4,824    $ 42.66
Granted                                             2,046      55.08
Exercised                                            (476)     35.86
Forfeited/Expired                                      (2)     38.75
-----------------------------------------------------------------------
AT&T options outstanding at December 31, 1995       6,392      47.44
-----------------------------------------------------------------------
Granted                                             1,690      65.81
Exercised                                            (183)     38.27
Forfeited/Expired                                      (3)     63.18
-----------------------------------------------------------------------
AT&T options outstanding at September 30, 1996      7,896      51.36
-----------------------------------------------------------------------
Lucent options substituted for AT&T options, and
  outstanding at October 1, 1996                    9,786      41.43
-----------------------------------------------------------------------
Granted*                                           25,623      46.37
Exercised                                          (2,022)     33.56
Forfeited/Expired                                    (980)     47.60
-----------------------------------------------------------------------
Lucent options outstanding at September 30, 1997   32,407     $45.66
-----------------------------------------------------------------------

* Includes options covering 12,753 shares of Common Stock granted under the FGP
on October 1, 1996 (at a weighted average exercise price of $44.61), and the
substitution of 2,471 Lucent options for Octel options on September 29, 1997 (at
a weighted average exercise price of $39.99).

The weighted average fair value of Lucent stock options, calculated using the
Black-Scholes option-pricing model, granted during the year ended September 30,
1997 is $14.60 per share. The weighted average fair value of AT&T stock options,
calculated using the Black-Scholes option-pricing model, granted during the nine
months ended September 30, 1996 and the year ended December 31, 1995 is $14.13
and $14.15 per share, respectively.
<PAGE>   39

39


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

The following table summarizes the status of Lucent's stock options outstanding
and exercisable at September 30, 1997:

                  ----------------------------------        --------------------
                                       Stock Options               Stock Options
                                         Outstanding                 Exercisable
--------------------------------------------------------------------------------
                                Weighted
                                 Average    Weighted                    Weighted
Range of                       Remaining     Average                     Average
Exercise             Shares  Contractual    Exercise       Shares       Exercise
Prices               (000's)        Life       Price       (000's)         Price
--------------------------------------------------------------------------------
$ 3.91 to $42.60     6,138           4.8      $35.83       4,466         $35.85
$42.61 to $44.56    17,547           9.0       44.55         142          43.71
$44.57 to $53.90     7,073           8.6       50.71         810          52.30
$53.91 to $82.09     1,565           8.1       71.74          44          64.04
$83.78                  84           9.7       83.78          18          83.78
--------------------------------------------------------------------------------
Total               32,407                    $45.66        5,480        $38.87
--------------------------------------------------------------------------------

Performance awards, restricted stock awards and other stock unit awards may also
be granted. Presented below is the total number of shares of Common Stock
represented by awards granted to Lucent employees for the year ended September
30, 1997, and the total number of AT&T shares represented by awards granted to
Lucent employees for the nine-month period ended September 30, 1996 and the year
ended December 31, 1995:


                                                    Nine Months
                                     Year Ended        Ended         Year Ended
                                    September 30,   September 30,   December 31,
                                        1997            1996            1995
--------------------------------------------------------------------------------
Lucent shares granted (000's).......    2,141            n/a             n/a
AT&T shares granted (000's).........     n/a             262             295
Weighted average market
 value of shares granted
 during the period..................   $46.38          $66.24          $56.46
--------------------------------------------------------------------------------
<PAGE>   40

40


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

10. SEGMENT INFORMATION

INDUSTRY SEGMENT

Lucent operates in the global communications networking industry segment. This
segment includes wire-line and wireless systems, software and products used for
voice, data and video communications.

GEOGRAPHIC SEGMENTS

Transfers between geographic areas are on terms and conditions comparable with
sales to external customers. The methods followed in developing the geographic
segment data require the use of estimates and do not take into account the
extent to which product development, manufacturing and marketing depend upon
each other. Thus, the information may not be indicative of results if the
geographic areas were independent organizations.

Corporate assets are principally cash and temporary cash investments. Data on
other geographic areas pertain to operations that are located outside the United
States. Revenues from all international activities (other geographic areas
revenues plus export revenues) provided 24.1% and 23.1% of consolidated revenues
for the year and nine-month period ended September 30, 1997 and 1996,
respectively, and 23.3% for the year ended December 31, 1995.

<TABLE>
<CAPTION>
                                                                Nine Months
                                                  Year Ended       Ended       Year Ended
                                                 September 30,  September 30,   December 31,
                                                      1997          1996           1995
                                                  ---------      ---------       ---------
<S>                                               <C>             <C>             <C>
REVENUES
United States.....................................$  21,807       $13,334         $17,826
Other geographic areas............................    4,553         2,525           3,587
                                                     -------      -------         -------
                                                  $  26,360       $15,859         $21,413
                                                     =======      =======         =======
TRANSFERS BETWEEN GEOGRAPHIC AREAS
 (Eliminated in Consolidation)
United States.....................................$   1,927       $ 1,353         $ 1,081
Other geographic areas............................    1,267           648             911
                                                     -------      -------         -------
                                                  $   3,194       $ 2,001         $ 1,992
                                                     =======      =======         =======
OPERATING INCOME(LOSS)
United States.....................................$   1,514      $   940          $  (679)
Other geographic areas............................      410         (108)             (67)
Corporate, eliminations and nonoperating..........     (457)        (465)            (392)
                                                     -------      -------          -------
Income(loss) before income taxes                  $   1,467      $   367          $(1,138)
                                                     =======      =======         ========
ASSETS (End of Period)
United States.....................................$  17,054      $16,492          $15,043
Other geographic areas............................    5,600        3,912            4,696
Corporate assets..................................    1,778        2,744              738
Eliminations......................................     (621)        (522)            (755)
                                                     -------     -------          -------
                                                  $  23,811      $22,626          $19,722
                                                     =======     =======          =======
</TABLE>
<PAGE>   41

41


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

CONCENTRATIONS

Historically, Lucent has relied on a limited number of customers for a
substantial portion of its total revenues. In terms of total revenues, Lucent's
largest customer has been AT&T, although other customers may purchase more of
any particular system or product line. Revenues from AT&T were $3,731 and $1,970
for the year and nine-month period ended September 30, 1997 and 1996,
respectively, and $2,119 for the year ended December 31, 1995. Lucent expects
that a significant portion of its future revenues will continue to be generated
by a limited number of customers. The loss of any of these customers or any
substantial reduction in orders by any of these customers could materially
adversely affect Lucent's operating results. Lucent does not have a
concentration of available sources of supply materials, labor, services or other
rights that, if suddenly eliminated, could severely impact its operations.

11. FINANCIAL INSTRUMENTS

In the normal course of business, Lucent uses various financial instruments,
including derivative financial instruments, for purposes other than trading.
Derivative financial instruments are not entered into for speculative purposes.
Lucent's derivative financial instruments include foreign currency exchange
contracts and interest rate swap agreements. Lucent's nonderivative financial
instruments include letters of credit, commitments to extend credit, and
guarantees of debt. Lucent generally does not require collateral to support
these financial instruments.

By their nature, all such instruments involve risk, including market risk and
the credit risk of nonperformance by counterparties. The contract or notional
amounts of these instruments reflect the extent of involvement Lucent has in
particular classes of financial instruments. The maximum potential loss may
exceed any amounts recognized in the balance sheet. However, Lucent's maximum
exposure to credit loss in the event of nonperformance by the other party to the
financial instrument for commitments to extend credit and financial guarantees
is limited to the amount drawn and outstanding on those instruments.

Exposure to credit risk is controlled through credit approvals, credit limits
and monitoring procedures. Requests for providing commitments to extend credit
and financial guarantees are reviewed and approved by senior management.
Management conducts regular reviews of all outstanding commitments, letters of
credit and financial guarantees, and the results of these reviews are considered
in assessing the adequacy of Lucent's reserve for possible credit and guarantee
losses. At September 30, 1997 and 1996, in management's opinion, there was no
significant risk of loss in the event of nonperformance of the counterparties to
these financial instruments and there was no significant exposure to any
individual customer or counterparty.

LETTERS OF CREDIT

Letters of credit are purchased guarantees that ensure Lucent's performance or
payment to third parties in accordance with specified terms and conditions.
<PAGE>   42

42                                                                     


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

COMMITMENTS TO EXTEND CREDIT

Commitments to extend credit to third parties are legally binding, conditional
agreements generally having fixed expiration or termination dates and specified
interest rates and purposes.

In October 1996, Lucent entered into a credit agreement with Sprint Spectrum LP
("Sprint PCS") to provide long-term financing of $1,800 for its purchase of
equipment and services for its nationwide personal communication services
("PCS") wireless network. In May 1997, under the $1,800 credit facility provided
by Lucent to Sprint PCS, Lucent closed transactions to lay off $500 of loans and
undrawn commitments and $300 of undrawn commitments to a group of institutional
investors and Sprint Corporation (a partner in Sprint PCS), respectively. As of
September 30, 1997, $146 of these commitments were not yet drawn down by Sprint
PCS.

As part of the revenue recognition process, Lucent has assessed the
collectibility of the accounts receivable relating to the Sprint PCS purchase
contract in light of its financing commitment to Sprint PCS. Lucent has
determined that the receivables under the contract are reasonably assured of
collection based on various factors, among which was the ability of Lucent to
sell the loans and commitments without recourse. Lucent intends to continue
pursuing opportunities for the sale of future loans and commitments.

During 1997, Lucent also entered into credit agreements to extend credit of up
to approximately $850 in total to three other PCS operators for possible future
sales. On October 1, 1997, a commitment for $300 included in the $850 expired
and was not extended. The agreement relating to about $200 of credit is subject
to fulfillment of certain conditions and completion of final contract
documentation.

GUARANTEES OF DEBT

From time to time, Lucent guarantees the financing for product purchases by
customers and the debt of certain unconsolidated joint ventures. Requests for
providing such guarantees are reviewed and approved by senior management. Lucent
seeks to limit its exposure to credit risks in any single country or region.
Certain financial guarantees are backed by amounts held in trust for Lucent.

FOREIGN CURRENCY EXCHANGE CONTRACTS

Foreign currency exchange contracts, including forward and option contracts, are
used to manage exposure to changes in currency exchange rates, principally Dutch
guilders, Deutsche marks and Japanese yen. The use of derivative financial
instruments allows Lucent to reduce its exposure to the risk that the eventual
net cash inflows and outflows resulting from the sale of products to foreign
customers and purchases from foreign suppliers will be adversely affected by
changes in exchange rates. Generally, foreign currency exchange contracts are
designated for firmly committed or forecasted sales and purchases that are
expected to occur in less than one year. Gains and losses on foreign currency
exchange contracts that are designated for firmly committed transactions are
deferred in other current assets and liabilities. At September 30, 1997 and
1996, deferred gains and losses associated with foreign exchange currency
contracts designated for firm commitments are not material to the consolidated
financial statements. Gains and losses on foreign currency exchange contracts
that are designated for forecasted transactions are recognized in other income
as the exchange rates change.
<PAGE>   43

43                                                                   


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

FAIR VALUE OF FINANCIAL INSTRUMENTS INCLUDING DERIVATIVE FINANCIAL INSTRUMENTS

The tables that follow present the valuation methods and the carrying or
notional amounts and estimated fair values of material financial instruments.
The notional amounts represent agreed-upon amounts on which calculations of cash
to be exchanged are based. Letters of credit, commitments to extend credit and
guarantees of debt may exist or expire without being drawn upon. Therefore, the
total notional or contract amounts do not necessarily represent future cash
flows. For derivative financial instruments, the notional amounts do not
represent amounts exchanged by the parties and, therefore, are not a measure of
the instruments. Lucent's exposure on its derivative financial instruments is
limited to the fair value of the contracts with a positive fair value at the
reporting date.

FINANCIAL INSTRUMENT                        VALUATION METHOD

Debt maturing within one year               The carrying amount is a reasonable
                                            estimate of fair value.
Long-term debt                              Market quotes for similar terms and 
                                            maturities.
Letters of credit                           Fees paid to obtain the obligations.
Foreign currency exchange contracts         Market quotes.
Commitments to extend credit                *
Guarantees of debt                          *

* It is not practicable to estimate the fair value of these financial
  obligations because there are no quoted market prices for transactions that
  are similar in nature.

<TABLE>
<CAPTION>
                                          September 30,  1997    September 30,  1996
                                           Carrying      Fair     Carrying      Fair
                                            Amount       Value     Amount       Value
                                          -----------    -----    ---------    ------
<S>                                       <C>           <C>       <C>          <C>
ON BALANCE SHEET INSTRUMENTS 
Liabilities: 
Long-term debt                            $ 1,663       $1,748    $ 1,630      $ 1,638

DERIVATIVES AND OFF BALANCE
 SHEET INSTRUMENTS 
Assets:
Foreign currency exchange contracts       $   28        $   54    $   14       $   17
Letters of credit                              -             2         -            1
 
Liabilities: 
Foreign currency exchange contracts       $   31        $   36    $   11       $   14
Letters of credit                              -             -         -            -
</TABLE>
<PAGE>   44

44                                                                     


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

The following table presents the contract/notional amount of Lucent's
derivatives and off balance sheet instruments and the amounts drawn down on such
instruments:

<TABLE>
<CAPTION>
                                                                       Amounts Drawn
                                     September 30,  September 30,         Down and
                                         1997          1996             Outstanding
                                       Contract/     Contract/   -----------------------
                                       Notional      Notional  September 30, September 30,
                                        Amount        Amount        1997          1996
                                     ------------   -----------    ------        ------
<S>                                   <C>            <C>          <C>            <C>
Foreign exchange forward contracts:
    British pounds                    $  136         $    7
    Dutch guilders                       186            128
    Deutsche marks                       558            228
    French francs                        116             35
    Japanese yen                         249            436
    Spanish pesetas                      109             47
    Other                                388            276
                                      $1,742         $1,157

Foreign exchange
  option contracts                         -            109
Letters of credit                        832            847
Commitments to extend credit           1,898            156       $  25          $   7
Guarantees of debt                       309            494         118            346
</TABLE>
<PAGE>   45

45


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

12.  TRANSACTIONS AND AGREEMENTS WITH AT&T

SEPARATION AND DISTRIBUTION AGREEMENT

In connection with the Separation and Distribution, Lucent, AT&T and NCR
Corporation ("NCR") executed and delivered the Separation and Distribution
Agreement, dated as of February 1, 1996 and amended and restated as of March 29,
1996 (the "Separation and Distribution Agreement"), and certain related
agreements. The Separation and Distribution Agreement, among other things,
provides that Lucent will indemnify AT&T and NCR for all liabilities relating to
Lucent's business and operations and for all contingent liabilities relating to
Lucent's business and operations or otherwise assigned to Lucent. In addition to
contingent liabilities relating to the present or former business of Lucent, any
contingent liabilities relating to AT&T's discontinued computer operations
(other than those of NCR) were assigned to Lucent. The Separation and
Distribution Agreement provides for the sharing of contingent liabilities not
allocated to one of the parties, in the following proportions: AT&T: 75%,
Lucent: 22%, and NCR: 3%. The Separation and Distribution Agreement also
provides that each party will share specified portions of contingent liabilities
related to the business of any of the other parties that exceed specified
levels. In addition, Lucent had a number of other agreements with AT&T for
federal, state and local tax allocation, tax sharing, general purchase, interim
services, system replication and real estate sharing.

13. COMMITMENTS AND CONTINGENCIES

In the normal course of business, Lucent is subject to proceedings, lawsuits and
other claims, including proceedings under government laws and regulations
related to environmental and other matters. Such matters are subject to many
uncertainties, and outcomes are not predictable with assurance. Consequently,
the ultimate aggregate amount of monetary liability or financial impact with
respect to these matters at September 30, 1997 cannot be ascertained. While
these matters could affect the operating results of any one quarter when
resolved in future periods and while there can be no assurance with respect
thereto, management believes that after final disposition, any monetary
liability or financial impact to Lucent beyond that provided for at September
30, 1997 would not be material to the annual consolidated financial statements.
<PAGE>   46

46                                                                   


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

ENVIRONMENTAL MATTERS

Lucent's current and historical operations are subject to a wide range of
environmental protection laws. In the United States, these laws often require
parties to fund remedial action regardless of fault. Lucent has remedial and
investigatory activities underway at about 40 current and former facilities. In
addition, Lucent was named a successor to AT&T as a potentially responsible
party ("PRP") at numerous "Superfund" sites pursuant to the Comprehensive
Environmental Response, Compensation and Liability Act of 1980 ("CERCLA") or
comparable state statutes. Under the Separation and Distribution Agreement,
Lucent is responsible for all liabilities primarily resulting from or relating
to the operation of Lucent's business as conducted at any time prior to or after
the Separation including related businesses discontinued or disposed of prior to
the Separation, and Lucent's assets including, without limitation, those
associated with these sites. In addition, under such Separation and Distribution
Agreement, Lucent is required to pay a portion of contingent liabilities paid
out in excess of certain amounts by AT&T and NCR, including environmental
liabilities.

It is often difficult to estimate the future impact of environmental matters,
including potential liabilities. Lucent records an environmental reserve when it
is probable that a liability has been incurred and the amount of the liability
is reasonably estimable. This practice is followed whether the claims are
asserted or unasserted. Management expects that the amounts reserved will be
paid out over the periods of remediation for the applicable sites which range
from 5 to 30 years. Reserves for estimated losses from environmental remediation
are, depending on the site, based primarily upon internal or third party
environmental studies, and estimates as to the number, participation level and
financial viability of any other PRPs, the extent of the contamination and the
nature of required remedial actions. Accruals are adjusted as further
information develops or circumstances change. The amounts provided for in
Lucent's consolidated financial statements for environmental reserves are the
gross undiscounted amount of such reserves, without deductions for insurance or
third party indemnity claims. In those cases where insurance carriers or third
party indemnitors have agreed to pay any amounts and management believes that
collectibility of such amounts is probable, the amounts are reflected as
receivables in the financial statements. Although Lucent believes that its
reserves are adequate, there can be no assurance that the amount of capital
expenditures and other expenses which will be required relating to remedial
actions and compliance with applicable environmental laws will not exceed the
amounts reflected in Lucent's reserves or will not have a material adverse
effect on the financial condition of Lucent or Lucent's results of operations or
cash flows. Any amounts of environmental costs that may be incurred in excess of
those provided for at September 30, 1997 cannot be determined.
<PAGE>   47

47


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

LEASE COMMITMENTS

Lucent leases land, buildings and equipment under agreements that expire in
various years through 2016. Rental expense under operating leases was $324 and
$182 for the year and nine-month period ended September 30, 1997 and 1996,
respectively, and $209 for the year ended December 31, 1995. The table below
shows the future minimum lease payments due under noncancelable operating leases
at September 30, 1997. Such payments total $1,037.

<TABLE>
<CAPTION>
                                                                 Year Ended September 30,
                                                                                    Later
                                  1998      1999      2000      2001      2002      Years
                                 -----     -----     -----     -----     -----      -----

<S>                               <C>       <C>       <C>       <C>       <C>       <C> 
Operating leases...............   $300      $235      $171      $103      $55       $173
</TABLE>
<PAGE>   48

48


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

14. QUARTERLY INFORMATION (UNAUDITED)

<TABLE>
                                         FISCAL YEAR QUARTERS
                              FIRST     SECOND    THIRD   FOURTH        TOTAL
                              -------  --------  ------   ---------  ----------
<S>                           <C>        <C>       <C>     <C>        <C>    
Year Ended
 September 30, 1997
Revenues....................  $7,938     $5,149    $6,340  $6,933     $26,360
Gross margin................   3,642      2,168     2,600   3,052      11,462
Net income(loss)............     859         66       213    (597)(b)     541 (b)
Earnings(loss) per
 weighted average share.....  $ 1.35     $ 0.10    $ 0.33  $(0.92)(b) $  0.84 (b)
Dividends per share.........    0.075      0.000     0.075   0.075       0.225
Stock price:(d)
   High.....................   53 1/8    60 5/8    74 3/16   90 3/4     90 3/4
   Low......................   42 1/8    44 3/4    49 7/8    72 3/16    42 1/8
   Quarter-end close........   46 1/4    52 1/2    72 1/16   81 3/8     81 3/8

Year Ended
September 30, 1996
Revenues....................  $7,427     $4,577    $5,364   $5,918    $23,286
Gross margin................   2,325 (a)  1,824     2,170    2,575      8,894 (a)
Net income(loss)............  (1,017)(a)   (103)       72      255       (793)(a)
Earnings(loss) per
 weighted average share(c)..  $(1.94)(a) $(0.20)   $ 0.11   $ 0.40    $ (1.37)(a)
Dividends per share.........    0.00       0.00     0.075     0.075      0.15
Stock price:(d)
   High.....................    n/a        n/a      39 1/4    45 7/8   45 7/8
   Low......................    n/a        n/a      29 3/4    30 5/8   29 3/4
   Quarter-end close........    n/a        n/a      37 7/8    45 7/8   45 7/8
</TABLE>

(a) 1996 includes a pretax charge of $2,801 ($1,847 after taxes), to cover
    restructuring costs of $2,613 and asset impairment and other charges of
    $188.

(b) As a result of the 1997 acquisition of Octel, Lucent took a charge of $979
    ($966 after tax) in the fourth quarter for acquired in-process research and
    development.

(c) The number of weighted average shares outstanding increased in 1996 as new
    common shares were issued through the IPO. For this reason, the sum of the
    quarterly earnings(loss) per weighted average share amounts for 1996 does
    not equal the earnings per weighted average share for the year. The
    calculation of earnings per share on a historical basis includes the
    retroactive recognition to January 1, 1995 of the 524,624,894 shares owned
    by AT&T.

(d) Obtained from the Composite Tape.
<PAGE>   49
49


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

15.  SUBSEQUENT EVENTS

On October 1, 1997, Lucent formed a venture with Philips Electronics N.V. called
Philips Consumer Communications, L.P. ("PCC"). Lucent's Consumer Products
business unit was contributed to PCC at net book value in return for an initial
equity interest of 40%. Lucent will account for its interest in PCC under the
equity method of accounting. The Consumer Products business unit was not
material to the consolidated financial position, results of operations or cash
flows of Lucent.

On October 1, 1997, Lucent sold the Advanced Technology Systems unit of its
Government Solutions division ("ATS") to General Dynamics Corporation for $265
in cash. A pretax gain of $149 was realized on the sale. ATS was not material to
the consolidated financial position, results of operations or cash flows of
Lucent.

On October 15, 1997, Lucent announced that it will acquire Livingston
Enterprises, Inc., a provider of remote access networking solutions, in a merger
involving approximately $610 worth of Lucent common stock and options. Lucent
will account for the transaction under purchase accounting.

It is anticipated that approximately $427 of the purchase price would be
allocated to in-process research and development. This amount would be charged
to income at the date of acquisition, which is currently expected to be in the
quarter ending December 31, 1997. The remaining purchase price would be
allocated to tangible assets, acquired technology and goodwill, less liabilities
assumed. Based on current estimates, Lucent anticipates goodwill and acquired
technology to be approximately $180, which will be amortized over periods not
exceeding eight years.