**SELECTED PAGES OF****LUCENT TECHNOLOGIES****ANNUAL REPORT2002**

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**LUCENT TECHNOLOGIES FINANCIAL REVIEW 2002**

| **Management’s Discussion and Analysis of Results of Operations and Financial Condition** |       |
|------------------------------------------------------------------------------------------------|------------|
|                                                                                           | **•** | Forward-Looking Statements | 6 |
|                                                                                           | **•** | Overview | 6 |
|                                                                                           | **•** | Application of Critical Accounting Policies | 7 |
|                                                                                           | **•** | Results of Operations | 9 |
|                                                                                           | **•** | Liquidity and Capital Resources | 15 |
|                                                                                           | **•** | Risk Management | 18 |
|                                                                                           |       |   |   |
| **Five-Year Summary of Selected FinancialData**                                                | 20         |
|                                                                                           |       |   |   |
| **Report of Management and Report of IndependentAccountants**                                  | 21         |
|                                                                                           |       |   |   |
| **Consolidated Financial Statements**                                                          |       |
|                                                                                           | **•** | Consolidated Statements of Operations | 22 |
|                                                                                           | **•** | Consolidated Balance Sheets | 23 |
|                                                                                           | **•** | Consolidated Statements of Changes in Shareowners’(Deficit) Equity | 24 |
|                                                                                           | **•** | Consolidated Statements of Cash Flows | 25 |
|                                                                                           |       |   |   |
| **Notes to Consolidated Financial Statements**                                                 |       |
|                                                                                           | **•** | Summary of Significant AccountingPolicies | 26 |
|                                                                                           | **•** | Business Restructuring Charges and Asset Impairments,Net | 28 |
|                                                                                           | **•** | Discontinued Operations | 30 |
|                                                                                           | **•** | Business Dispositions and Combinations | 31 |
|                                                                                           | **•** | Supplementary Financial Information | 33 |
|                                                                                           | **•** | Earnings (Loss) Per Common Share | 34 |
|                                                                                           | **•** | Comprehensive Income (Loss) | 34 |
|                                                                                           | **•** | Income Taxes | 35 |
|                                                                                           | **•** | Debt Obligations | 36 |
|                                                                                           | **•** | Redeemable Convertible Preferred Stock | 37 |
|                                                                                           | **•** | Employee Benefit Plans | 37 |
|                                                                                           | **•** | Stock Compensation Plans | 40 |
|                                                                                           | **•** | Operating Segments | 42 |
|                                                                                           | **•** | Financial Instruments | 44 |
|                                                                                           | **•** | Securitizations and Transfers of FinancialInstruments | 46 |
|                                                                                           | **•** | Accounting Changes | 47 |
|                                                                                           | **•** | Commitments and Contingencies | 47 |
|                                                                                           | **•** | Recent Pronouncements | 50 |
|                                                                                           | **•** | Quarterly Information (Unaudited) | 51 |

**5**

**MANAGEMENT’S DISCUSSION AND ANALYSIS**of Results ofOperations and Financial Condition

**FORWARD-LOOKING STATEMENTS**

         This Management’s Discussion and Analysisof Results of Operations and Financial Condition (“MD&A”) contains forward-looking statements that are based on currentexpectations, estimates, forecasts and projections about us, our future performance, the industries in which we operate, our beliefs and ourmanagement’s assumptions. In addition, other written or oral statements that constitute forward-looking statements may be made by or onbehalf of us. Words such as “expects,” “anticipates,” “targets,” “goals,”“projects,” “intends,” “plans,” “believes,” “seeks,” “estimates,”variations of such words and similar expressions are intended to identify such forward-looking statements. These statements are not guarantees offuture performance and involve certain risks, uncertainties andassumptions that are difficult to predict. Therefore, actual outcomes and results may differ materially from what is expressed or forecasted in suchforward-looking statements. These risks and uncertainties include: the failure of the telecommunications market to improve or improve at the pace weanticipate; continued net losses may reduce or impair our legally available surplus; our ability to realize the benefits we expect from our strategicdirection and restructuring program; our ability to secure additional sources of funds on reasonable terms; our credit ratings; our ability to competeeffectively; our reliance on a limited number of key customers; our exposure to the credit risk of our customers as a result of our vendor financingarrangements and accounts receivable; our reliance on third parties to manufacture most of our products; the cost and other risks inherent in ourlong-term sales agreements; our product portfolio and ability to keep pace with technological advances inour industry; the complexity of our products; our ability to retain and recruit key personnel; existing and future litigation; our ability to protect ourintellectual property rights and the expenses we may incur in defending such rights; changes in environmental health and safety law; changes to existingregulations or technical standards; the social, political and economic risks of our foreign operations; the impact if our common stock is de-listed fromthe New York Stock Exchange; and the costs and risks associated with our pension and postretirement benefit obligations. For a further list anddescription of such risks and uncertainties, see the reports filed by us with the Securities and Exchange Commission. Except as required under thefederal securities laws and the rules and regulations of the SEC, we do not have any intention or obligation to update publicly any forward-lookingstatements after the distribution of this MD&A, whether as a result of new information, futureevents, changes in assumptions, or otherwise.

**OVERVIEW**

         We design and deliver networks for theworld’s largest communications service providers. Backed by Bell Labs research and development, we rely on our strengths in mobility,optical, data and voice networking technologies, as well as software and services, to develop next-generation networks. Our systems, services andsoftware are designed to help customers quickly deploy and better manage their networks and create new, revenue-generating services that helpbusinesses and consumers.

         Beginning in fiscal 2001, the globaltelecommunications market deteriorated, reflecting a significant decrease in the competitive local exchange carrier market and a significant reductionin capital spending by established service providers. This trend intensified during fiscal 2002. We believe that large service providers, primarily in thewireline market, have reduced their capital spending by more than 25% since the end of 2001. The U.S. wireline service provider capital spendingdeclined by about 40%. Additional capital spending reductions may occur during 2003. Reasons for this reduction include the general economicslowdown, network overcapacity, customer bankruptcies, network build-out delays and limited capital availability. As a result, our sales and resultsof operations have been and may continue to be adversely affected. The significant slowdown in capital spending has created uncertainty asto the level of demand in our target markets. In addition, the level of demand can change quickly and can vary over short periods of time, includingfrom month to month. As a result of the uncertainty and variations in our markets, accurately forecasting future results, earnings and cash flow isincreasingly difficult.

         As discussed in more detail throughout ourMD&A:

| **•** |   | our results of operations during the past two years were adversely affected by the rapidand sustained deterioration of the telecommunications market. After several years of significant growth, our revenues declined during fiscal 2002 and2001 by 42% and 26%, respectively, as compared to the respective prior year. The significant reduction in capital spending by service providers,among other factors, contributed to this decline; |
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| **•** |   | our gross margin rates, which historically had been at least 40%, declined to 12.6% and9.7% during fiscal 2002 and 2001, respectively. The significant and rapid decline in revenue from decreased market demand and product linediscontinuances led to significant inventory charges and high-unabsorbed fixed costs, which, among other factors, adversely affected our grossmargin rates; |
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| **•** |   | we were able to reduce our operating expenses as a result of cost reductions under ourrestructuring actions; however, these actions resulted in net business restructuring and asset impairment charges of $2.3 billion and $10.2 billionduring fiscal 2002 and 2001, respectively; |
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| **•** |   | we recorded significant provisions for bad debts and customer financings of $1.3 billionand $2.2 billion during fiscal 2002 and 2001, respectively, as a result of the significant deterioration of the financial health of certain customers. Mostof these provisions were related to commitments made and loans drawn under our customer-financing program during prior years;and |
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| **•** |   | we recorded a full valuation allowance on our net deferred tax assets during fiscal 2002,which resulted in a tax provision of $4.8 billion despite a pre-tax loss from continuing operations of $7.1billion. |
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**6**

**MANAGEMENT’S DISCUSSION AND ANALYSIS**

         All of these factors contributed significantly to ourloss from continuing operations of $11.8 billion and $14.2 billion during fiscal 2002 and 2001, respectively. The fiscal 2001 results were alsoadversely affected by $3.2 billion of net losses from discontinued operations, which primarily related to our share of Agere’s estimated lossesthrough the June 1, 2002 spinoff date. We also completed several dispositions during the past two years, the most significant being the sale of ouroptical fiber business ( “ OFS ” ), resulting in a $664 million gain during fiscal 2002. Our dispositions did not have a significant effect onour results from continuing operations, except for the sale of OFS, which had revenues of $2.0 billion and pretax income of $541 million during fiscal2001.

         In fiscal 2002, we restructured our operations intodistinct wireline and wireless units, and targeted the large service providers in each segment. We believe structuring our business along customer lines- wireline and wireless – enables us to better serve the needs of our large service provider customers.

         Our wireline segment, Integrated Network Solutions( “ INS ” ), focuses on global wireline service providers, including long distance carriers, traditional local telephone companies andInternet service providers. INS primarily sells and services core switching and access and optical networking products. Our wireless segment,Mobility Solutions ( “ Mobility ” ), offers products to support the needs of its customers for radio access and core networks andprimarily sells and services wireless products to wireless service providers. Both segments offer network management and application and servicedelivery products. We support these two new segments through a number of central organizations, including our services organization and corporateheadquarters. Manufacturing and supply chain functions are part of a single global supply chain network organization that manages the materials andactivities necessary to produce and deliver products to our customers.

         During this prolonged market downturn, we haveworked closely with our customers to position the full breadth of our products and services, significantly reducing our cost structure and reducing ourquarterly earnings per share ( “ EPS ” ) breakeven revenue figure. If capital investment levels continue to decline, or if thetelecommunications market does not improve or improves at a slower pace than we anticipate, our revenues and profitability will continue to beadversely affected. We are financially planning for our revenues to decline by about 20% during fiscal 2003. However, our results are expected toimprove by realizing higher gross margin rates and lower operating expenses resulting from improved product mix, cost reductions related to ourrestructuring actions, lower inventory-related charges, and lower provisions for bad debts and customer financings.

**APPLICATION OF CRITICAL ACCOUNTING POLICIES**

         Our consolidated financial statements are based onthe selection and application of significant accounting policies, which require management to make significant estimates and assumptions. We believethat the following are some of the more critical judgment areas in the application of our accounting policies that affect our financial condition andresults of operations.

         The impact of changes in the estimates and judgmentspertaining to revenue recognition, receivables and inventories is directly reflected in our segments’ operating loss. Although any charges relatedto our net deferred tax assets and goodwill and other acquired intangibles are not reflected in the segment results, the long-term forecasts supportingthe realization of those assets and changes in them are significantly affected by the actual and expected results of each segment. Generally, thechanges in estimates related to pension and postretirement benefits, our restructuring program and litigation will not affect our segment results,although execution of the restructuring plans by each segment may cause related changes in the estimates.

         We have discussed the application of these criticalaccounting policies with our board of directors and Audit and Finance Committee. There was no initial adoption of any accounting policies duringfiscal 2002. See Note 18 to the consolidated financial statements for recent accounting pronouncements.

**Revenue recognition**

         Most of our sales are generated from complexcontractual arrangements, which require significant revenue recognition judgments, particularly in the areas of multiple element arrangements andcollectibility. Revenues from contracts with multiple element arrangements, such as those including installation and integration services, are recognizedas each element is earned based on objective evidence of the relative fair value of each element and when there are no undelivered elements that areessential to the functionality of the delivered elements. We have determined that the customer or a third party can install most of our equipment, andas a result, revenue may be recognized upon delivery of the equipment, provided all other revenue recognition criteria are met. The assessment ofcollectibility is particularly critical in determining whether revenues should be recognized in the current market environment.As part of the revenue recognition process, we determine whether trade and notes receivable are reasonably assured of collection based on variousfactors, including our ability to sell those receivables and whether there has been deterioration in the credit quality of our customers that could result inour being unable to collect or sell the receivables. In situations where we have the ability to sell the receivable, revenue is recognized to the extent ofthe value we could reasonably expect to realize from the sale. We will defer revenue and related costs if we are uncertain as to whether we will beable to sell or collect the receivable. We will defer revenue but recognize costs when we determine that the collection or sale of the receivable isunlikely. For sales generated from long-term contracts, primarily those related to customized network solutions and network build-outs, we generallyuse the percentage of completion method of accounting. In doing so, we make importantjudgments in estimating revenue and cost and in measuring progress towards completion. These judgments underlie our determinations regardingoverall contract value, contract profitability and timing of revenue recognition. Revenue and cost estimates are revised periodically based on changesin circumstances; any losses on contracts are recognized immediately. We also sell products through multiple distribution channels, including resellersand distributors. For products sold through these channels, revenue is generally recognized when the reseller or distributor sells the product to the enduser. The total amount of deferred revenue, including deferrals relating to collectibility concerns, undelivered elements and multiple distributionchannels was approximately $228 million and $550 million at September 30, 2002 and 2001, respectively.

**7**

**MANAGEMENT’S DISCUSSION AND ANALYSIS**

**Receivables and customer financing**

         We are required to estimate the collectibility of ourtrade receivables and notes receivable. A considerable amount of judgment is required in assessing the realization of these receivables, including thecurrent creditworthiness of each customer and related aging of the past due balances. Our provisions for bad debts and customer financings duringfiscal 2002, 2001, and 2000 amounted to approximately $1.3 billion, $2.2 billion, and $500 million, respectively. At September 30, 2002 and 2001,our receivables of $1.6 billion and $4.6 billion, respectively, included reserves of $325 million and $634 million, respectively. Under our customerfinancing program, there were approximately $950 million and $2.1 billion of reserves on the $1.1 billion and $3.0 billion of drawn commitments atSeptember 30, 2002 and 2001, respectively. We evaluate specific accounts when we become aware of a situation where a customermay not be able to meet its financial obligations due to a deterioration of its financial condition, credit ratings or bankruptcy. The reserve requirementsare based on the best facts available to us and re-evaluated and adjusted as additional information is received. Our reserves also are determined byusing percentages applied to certain aged receivable categories. Significant increases in reserves have been recorded during fiscal 2002 and 2001,and may occur in the future due to the market environment. In addition, at September 30, 2002, we had approximately $500 million of net assetsfrom long-term projects that have been winding down in Saudi Arabia (primarily long-term receivables included in other assets). We have concludedthat these net assets are realizable based on our contractual rights and past collection history.

**Inventories**

         We are required to state our inventories at the lowerof cost or market. In assessing the ultimate realization of inventories, we are required to make judgments as to future demand requirements andcompare these with the current or committed inventory levels. Our reserve requirements generally increase as our projected demand requirementsdecrease due to market conditions, technological and product life cycle changes, and longer than previously expected usage periods. We haveexperienced significant changes in required reserves in recent periods due to changes in strategic direction, such as discontinuances of product lines,as well as declining market conditions. As a result, we incurred net inventory charges of approximately $620 million, $2.4 billion and $360 millionduring fiscal 2002, 2001 and 2000, respectively. At September 30, 2002 and 2001, inventories of $1.4 billion and $3.6 billionrespectively, are net of reserves of approximately $1.4 billion and $1.1 billion, respectively. It is possible that significant changes in required inventoryreserves may continue to occur in the future if there is a further decline in market conditions and if additional restructuring actions aretaken.

**Income taxes**

         We currently have significant deferred tax assetsresulting from tax credit carryforwards, net operating loss carryforwards and deductible temporary differences, which will reduce taxable income infuture periods. At September 30, 2001 and continuing through March 31, 2002 we provided valuation allowances on future tax benefits withrelatively short carryforward periods such as foreign tax credits, foreign net operating losses, capital losses and most state net operating losses. Atthat time, we believed it was more likely than not that the remaining net deferred tax assets of $5.2 billion at both September 30, 2001 and March31, 2002 would be realized principally based upon forecasted taxable income, generally within the twenty-year research and development ( “R&D ” ) credit and net operating loss carryforward periods, giving consideration to substantial benefits realized to date throughour restructuring program. A valuation allowance is required when it is more likely than not that all or a portion of a deferred tax asset will not berealized. Forming a conclusion that a valuation allowance is not needed is difficult when there is negative evidence such as cumulative losses in recentyears. Cumulative losses weigh heavily in the overall assessment. During the fiscal 2002 third quarter-end review, several significant developmentswere considered in determining the need for a full valuation allowance, including the continuing and recently more severe market decline, uncertaintyand lack of visibility in the telecommunications market as a whole, a significant decrease in sequential quarterly revenue levels, a decrease insequential earnings after several quarters of sequential improvement and the necessity for further restructuring and cost reduction actions to attainprofitability. As a result of our assessment, we established a full valuation allowance for ourremaining net deferred tax assets at June 30, 2002. During the fourth quarter of fiscal 2002, we maintained a full valuation allowance on our netdeferred tax assets. Until we reach an appropriate level of profitability we do not expect to recognize any significant tax benefits in our future resultsof operations. Our income tax provision (benefit) included charges related to changes in valuation allowances of approximately $7.9 billion, $540million and $40 million during fiscal 2002, 2001, and 2000, respectively. As of September 30, 2002 and 2001, our total valuation allowance on netdeferred tax assets was approximately $10.0 billion and $740 million, respectively.

**Intangible assets**

         We currently have intangible assets, includinggoodwill and other acquired intangibles of $224 million and capitalized software development costs of $570 million. The determination of relatedestimated useful lives and whether these assets are impaired involves significant judgments based upon short and long-term projections of futureperformance. Certain of these forecasts reflect assumptions regarding our ability to successfully develop and ultimately commercialize acquiredtechnology. Changes in strategy and/or market conditions may result in adjustments to recorded asset balances. For example, we had takensignificant impairment charges, including $4.1 billion related to goodwill and other acquired intangibles and $362 million related to capitalizedsoftware under our restructuring program during fiscal 2001. During fiscal 2002, the continued and recently sharper decline in the telecommunicationsmarket prompted a re-assessment of all key assumptions underlying our goodwill valuation judgments, including those relating to short andlonger-term growth rates. As a result of our analysis, during fiscal 2002 we determined that impairment charges of $975 million were requiredbecause the forecasted undiscounted cash flows were less than the book values of certain businesses. The charges were measured on the basis ofcomparison of estimated fair values with corresponding book values and relate primarily to goodwill recorded in connection with our September2000 acquisition of Spring Tide Networks. Fair values were determined on the basis of discounted cash flows. In addition, in the fourth quarter offiscal 2002, we recorded

**8**

**MANAGEMENT’S DISCUSSION AND ANALYSIS**

approximately $200 million of capitalized software impairments and $50 million in property, plant and equipmentimpairments, primarily as a result of delays and increasing uncertainties in the development of the universal mobile telecommunications systems(“UMTS”) market. Goodwill and other acquired intangibles at September 30, 2002, is primarily related to our acquisition of YurieSystems, Inc., which provides asynchronous transfer mode access equipment. We have concluded that this amount is realizable based uponprojected undiscounted cash flows through 2006. Due to uncertain market conditions and potential changes in our strategy and product portfolio, it ispossible that forecasts used to support our intangible assets may change in the future, which could result in additional non-cash charges that wouldadversely affect our results of operations and financial condition.

**Pension and postretirement benefits**

         We have significant pension and postretirementbenefit costs and credits, which are developed from actuarial valuations. Inherent in these valuations are key assumptions, including discount rates andexpected return on plan assets, which are usually updated on an annual basis at the beginning of each fiscal year. We are required to consider currentmarket conditions, including changes in interest rates, in making these assumptions. Changes in the related pension and postretirement benefit costs orcredits may occur in the future due to changes in the assumptions. The key assumptions used in developing our fiscal 2002 net pension andpostretirement benefit credit were a 7% discount rate, a 9% expected return on plan assets and a 4.5% rate of compensation increase. These wereconsistent with the prior year assumptions except that the discount rate was reduced by one-half of a percent due to current marketconditions. Compared with the prior year, our net pension and postretirement benefit credit in fiscal 2002 was reduced by $111 million to $972million, excluding the impact of restructuring actions. Our net pension and postretirement benefit credit is expected to be reduced to approximately$500 million during fiscal 2003, primarily as a result of lower plan assets, a reduction in the discount rate from 7% to 6.5%, a reduction in theexpected return on plan assets from 9% to 8.5% for pensions and from 9% to 7.93% for postretirement benefits. Holding all other assumptionsconstant, a one-half percent increase or decrease in the discount rate would have increased or decreased annual fiscal 2002 pre-tax loss byapproximately $125 million. Likewise, a one-half percent increase or decrease in the expected return on plan assets would have increased ordecreased annual fiscal 2002 pre-tax loss by $200 million.

         In addition, the estimated accumulated benefitobligation (“ABO”) related to the U.S. management employees pension plan, as well as several other smaller pension plans, exceededthe fair value of the plan assets at September 30, 2002. This was due primarily to negative returns on the pension funds as a result of the overalldecline in the equity markets and a decline in the discount rate used to estimate the pension liability as a result of declining interest rates in the U.S.Therefore, we were required to establish a minimum liability and record a $2.9 billion direct charge to equity for the difference to the extent theminimum liability exceeded the unrecognized prior service cost. Market conditions and interest rates significantly impact future assets and liabilities ofour pension plans, and similar charges might be required in the future upon measurement of plan obligations which areusually completed by us at the end of a fiscal year.

         We expect to have minimal, if any, cash requirementsrelated to our pension and postretirement benefit plans during fiscal 2003. However during fiscal 2004, it is likely that we will be required to fundsome portion of retiree health benefits and, depending on market conditions, we may be required to make a contribution to the pension plan of ourU.S. management employees. Although it is difficult to estimate these potential fiscal 2004 cash requirements due to uncertain market conditions, wecurrently expect that the cash requirements for the retiree health benefits would be approximately $350 million. For more information, see the detailedrisk factor included in our Form 10-K for the year ended September 30, 2002.

**Business restructuring**

         During fiscal 2002 and 2001, we recorded significantcharges in connection with our restructuring program. The related reserves reflect many estimates, including those pertaining to separation costs,inventory, settlements of contractual obligations and proceeds from asset sales. We reassess the reserve requirements to complete each individualplan under our restructuring program at the end of each reporting period. Actual experience has been and may continue to be different from theseestimates. For example, we revised our estimates for certain fiscal 2001 restructuring plans during fiscal 2002 which resulted in a net credit of $333million. As of September 30, 2002 and 2001, liabilities associated with our restructuring program were $1.1 billion and $1.6 billion, respectively. Formore information, see Note 2 to the consolidated financial statements.

**Legal contingencies**

         We are subject to proceedings, lawsuits and otherclaims, including proceedings under laws and government regulations related to securities, environmental, labor, product and other matters. We arerequired to assess the likelihood of any adverse judgments or outcomes to these matters, as well as potential ranges of probable losses. Adetermination of the amount of reserves required, if any, for these contingencies is based on a careful analysis of each individual issue with theassistance of outside legal counsel. The required reserves may change in the future due to new developments in each matter or changes in approachsuch as a change in settlement strategy in dealing with these matters. For more information, see Note 17 to the consolidated financialstatements.

**RESULTS OF OPERATIONS**

**Revenues**

         The following table presents our U.S. and non-U.S.revenues and the approximate percentage of total revenues (dollars in millions):

|  |  | *Years ended September 30,*                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         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|  |  | **2002****2001****2000**U.S. revenues $8,148 $13,776 $19,829 Non-U.S. revenues  4,173  7,518  9,075 **Total revenues** **$****12,321** **$****21,294** **$****28,904** *As a percentage of total revenues*U.S. revenues  66.1% 64.7% 68.6%Non-U.S. revenues  33.9% 35.3% 31.4%**Total revenues**  **100.0****%** **100.0****%** **100.0****%**9
**MANAGEMENT’S DISCUSSION AND ANALYSIS**

***Fiscal 2002 vs. 2001***

         Continued reductions in capital spending in fiscal2002 by service providers, primarily affecting our INS segment, and business dispositions were the primary reasons for the lower revenues in fiscal2002 than in fiscal 2001. The revenue decline resulting from business dispositions was $2.3 billion for fiscal 2002, of which approximately 84% wasa result of the sale of the OFS business in the first quarter of fiscal 2002. The impact of product rationalizations and discontinuances under ourrestructuring program has not had a significant effect on our overall trend of revenues.

***Fiscal 2001 vs. 2000***

         A significant decrease in the competitive localexchange carrier (“CLEC”) market and a significant reduction in capital spending by service providers were the primary reasons for thedecline in revenues. In addition, we implemented a more selective customer-financing program, which also had a negative impact on revenues. InDecember 1999, the Securities and Exchange Commission issued Staff Accounting Bulletin 101, “Revenue Recognition in FinancialStatements” (“SAB 101”). SAB 101 provides guidance on the recognition, presentation and disclosure of revenues in financialstatements. The adoption of SAB 101 in fiscal 2001 did not have a significant impact on revenues or the comparability of results of operations for theperiods presented (see Note 16 to the consolidated financial statements).

**Gross Margin**

         The following table presents our gross margin and thepercentage to total revenues (dollars in millions):
*Years ended September 30,***2002****2001****2000**Gross margin $1,552 $2,058 $11,714 Gross margin rate  12.6% 9.7% 40.5%
         Inventory and other charges negatively affected thegross margin rate in fiscal 2002 and 2001 by approximately 13 percentage points and 11 percentage points, respectively. The total dollar amount ofcharges was lower in fiscal 2002, primarily due to lower inventory levels resulting from our strategy of focusing on large service providers, ourrestructuring program and improved inventory management. However, due to the significant revenue decline in fiscal 2002, the charges had a greaterimpact on the gross margin rate. These charges were primarily related to items or events associated with customers experiencing financial difficultiesand in some cases declaring bankruptcy or becoming insolvent, costs associated with supplier and customer contract settlements, higher provisionsfor slow-moving and obsolete inventory, adjustments to certain long-term projects and higher than expected costs due to certaincustomer obligations and product performance issues.

         During fiscal 2002 and 2001, we recorded $64million and $1.2 billion, respectively, of inventory charges associated with product line rationalizations and product line discontinuances under ourrestructuring program. These inventory charges negatively affected the gross margin rate for fiscal 2002 and 2001 by 1 percentage point and 6percentage points, respectively. Our product mix in fiscal 2002 was adversely affected by the sale of OFS.

         Also, significant reductions in capital spending byservice providers reduced sales volumes across all product lines and services more quickly than the reduction in our fixed costs, which resulted in lessabsorption of fixed costs. The net change in unabsorbed fixed costs as well as all other factors affecting gross margin, including changes in geographicand product mix, negatively affected the gross margin rate for fiscal 2002 and 2001.

**Operating Expenses**

         The following table presents our operating expenses(dollars in millions):
*Years ended September 30,***2002****2001****2000**Selling, general and administrative (“SG&A”) expenses, excluding the    following two items $2,466 $4,240 $4,743 Provision for bad debts and customer financings  1,253  2,249  505 Amortization of goodwill and other acquired intangibles  250  921  362 Total SG&A  3,969  7,410  5,610 Research and development (“R&D”)  2,310  3,520  3,179 Purchased in-process research and development (“IPRD”)  —  —  559 Business restructuring charges and asset impairments, net  2,252  10,157  — **Operating expenses** **$****8,531** **$****21,087** **$****9,348** 
***SG&A expenses***

         Excluding provisions for bad debts and customerfinancings and amortization of goodwill and other acquired intangibles, SG&A expenses decreased by 41.8% during fiscal 2002 as comparedwith fiscal 2001 and decreased by 10.6% in fiscal 2001 as compared with fiscal 2000. The decreases in fiscal 2002 and 2001 were primarily a resultof headcount reductions under our restructuring program and other cost savings initiatives that limited discretionary spending. Approximately 80% ofthe fiscal 2002 reductions were in the INS segment due to the greater degree of product rationalization efforts in INS as well as the required costreductions due to the significant INS revenue decline.

***Provision for bad debts and customer financings***

         Many of our customers have been negatively affectedby the continued decline in telecommunications market conditions. As a result, the creditworthiness of certain customers has declined, resulting insome having to file for bankruptcy protection or having been declared insolvent. As a result, we have provided reserves for certain trade and notesreceivable and sold others at significant discounts in the periods presented. We may have to record additional reserves or write-offs in thefuture.

***Fiscal 2002 vs. 2001***

         During fiscal 2002, $765 million of provisions relatedto customer financings with the balance relating to trade receivables. Approximately one-third of the provision for customer financings was related toone customer that defaulted under the terms and conditions of its customer financing agreement. Approximately 55% of the totalprovisions
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**MANAGEMENT’S DISCUSSION AND ANALYSIS**

were related to INS customers and 39% were related to Mobility customers. The remaining provisions were not relatedto reportable segments.

***Fiscal 2001 vs. 2000***

         The deterioration of the creditworthiness of certaincustomers resulted in higher provisions for bad debts and customer financings in fiscal 2001 as compared with fiscal 2000. Provisions for threecustomer financings, including provisions for amounts due from One.Tel and Winstar, accounted for approximately 60% of fiscal 2001 expense. OnApril 18, 2001, Winstar filed for Chapter 11 bankruptcy protection, and in late May 2001, One.Tel filed for voluntary administration (bankruptcy).Approximately 63% of the total provisions were related to INS customers and 34% were related to Mobility customers. The remaining provisionswere not related to reportable segments.

***Amortization of goodwill and other acquired intangibles***

***Fiscal 2002 vs. 2001***

         Amortization of goodwill and other acquiredintangibles was significantly lower in fiscal 2002 as compared with fiscal 2001 as a result of restructuring actions committed to in fiscal 2001 thatreduced total goodwill and other acquired intangibles by $4.1 billion, primarily related to the discontinuance of the Chromatis Networks, Inc. productportfolio. In addition, as a result of the continued downturn in the telecommunications market during fiscal 2002, impairment charges of $975 millionwere recognized in fiscal 2002, primarily related to goodwill associated with Spring Tide.

***Fiscal 2001 vs. 2000***

         The full-year effect of the acquisitions of Chromatis inJune 2000 and Spring Tide in September 2000 were the primary reasons for the increase in the amortization of goodwill and other acquiredintangibles in fiscal 2001 as compared with fiscal 2000.

***R&D***

***Fiscal 2002 vs. 2001***

         The decrease in R&D expenses in fiscal 2002 ascompared with fiscal 2001 was primarily due to headcount reductions and product rationalizations under our restructuring program. Approximately75% of the fiscal 2002 reductions were in the INS segment due to the greater degree of product rationalizations in INS.

         During fiscal 2002, 53% of our R&D wasattributable to our INS segment, and most of the remaining amounts were attributable to our Mobility segment. The INS spending was primarilyrelated to next-generation products, including optical products for both long haul and metro networks, multi-service switches that can handle bothInternet protocol services and multiple network traffic protocols, network operations software solutions, and digital subscriber line products. TheMobility spending was primarily related to code division multiple access (“CDMA”) and UMTS next-generationtechnologies.

***Fiscal 2001 vs. 2000***

         The increase in R&D expenses for fiscal 2001as compared with fiscal 2000 was primarily due to acquisitions made late in fiscal 2000 and new product development, particularly in next-generationoptical networking and wireless products, partially offset by headcount reductions and product rationalizations under our restructuringprogram.

         During fiscal 2001, 60% of our R&D wasattributable to our INS segment and most of the remaining amounts were attributable to our Mobility segment.

***IPRD***

         In connection with the acquisitions in fiscal 2000 ofChromatis and Spring Tide, we allocated non-tax impacting charges of $428 million and $131 million, respectively, of the total purchase price toIPRD. As part of the process of analyzing each of these acquisitions, we made a decision to buy technology that had not yet been commercializedrather than develop the technology internally. We based this decision on a number of factors, including the amount of time it would take to bring thetechnology to market. We also considered Bell Labs’ resource allocation and its progress on comparable technology, if any. We expect touse the same decision process in the future.

         On June 28, 2000, we completed the purchase ofChromatis. Chromatis was involved in the development of next-generation optical transport solutions that provide telecommunications carriers withimprovements in the cost, efficiency, scale and management of multi-service metropolitan networks. At the acquisition date, costs to complete theresearch and development efforts related to the product were expected to be $7.8 million. A risk-adjusted discount rate of 25% was used todiscount projected cash flows. As part of our restructuring program in fiscal 2001, the Chromatis product portfolio was discontinued and all of theremaining assets, primarily goodwill and other acquired intangibles, were written off (see Note 2 to the consolidated financial statements).

         On September 19, 2000, we completed the purchaseof Spring Tide. Spring Tide was involved in the development of carrier-class network equipment that enables service providers to offer new,value-added Internet protocol (“IP”) services and virtual private networks with low cost and complexity. At the acquisition date, coststo complete the research and development efforts related to the product were expected to be $0.5 million and $4.3 million in fiscal 2000 and 2001,respectively. A risk-adjusted discount rate of 25% was used to discount projected cash flows. In fiscal 2002, our remaining goodwill from theacquisition of Spring Tide was written off.

         We estimated the fair value of IPRD for each of theabove acquisitions using an income approach. This involved estimating the fair value of the IPRD using the present value of the estimated after-taxcash flows expected to be generated by the IPRD, using risk-adjusted discount rates and revenue forecasts as appropriate. The selection of thediscount rate was based on consideration of our weighted average cost of capital, as well as other factors, including the expected useful life of eachtechnology, estimated profitability levels of each technology, the uncertainty of technology advances that were known at the time, and the stage ofcompletion of each technology. We believe that the estimated IPRD amounts so determined represented fair value and did not exceed the amount athird party would pay for the projects.
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**MANAGEMENT’S DISCUSSION AND ANALYSIS**

         Where appropriate, we deducted an amountreflecting the contribution of the core technology from the anticipated cash flows from an IPRD project. At the date of acquisition, the IPRD projectshad not yet reached technological feasibility and had no alternative future uses. Accordingly, the value allocated to these projects was capitalized andimmediately expensed at acquisition.

***Business restructuring charges and asset impairments, net***

         Since beginning our restructuring program during thesecond quarter of fiscal 2001, we have realigned our resources to focus on the opportunities that we currently believe to be the most profitable for us– the large service provider market. We evaluated our manufacturing operations and decided to sell or otherwise lease certain of ourmanufacturing facilities and make greater use of contract manufacturers. We assessed our product portfolio and associated R&D, madedecisions based on the needs of our largest service provider customers, deployed our resources to meet those needs and then streamlined the rest ofour operations to support those reassessments. We eliminated some marginally profitable or non-strategic product lines, merged certain technologyplatforms, consolidated development activities, eliminated management positions and eliminated many duplications in marketing functions andprograms, and centralized our sales support functions, which resulted in reduced associated product development costs. We sold the assets relatingto a number of product lines whose products did not support our large service provider customers or our strategy. We closed facilities and reducedthe workforces in many of the countries that we operated in at the end of fiscal 2000. As a result we incurred net business restructuring charges andasset impairments in fiscal 2001 of $11.4 billion. Due to continuing market declines in fiscal 2002, we committed to additional restructuring actionsthat resulted in net business restructuring charges and asset impairments of $1.3 billion. These actions are designed to enable us to achieve a coststructure that will result in EPS breakeven at a quarterly revenue level in late fiscal 2003 of $2.5 billion with a targeted gross margin rate of 35%. Wegenerally expect to complete each restructuring plan within 12 months of committing to it.

         During fiscal 2002, we recorded in operatingexpenses net business restructuring charges and related asset impairments of $1.3 billion and other impairment charges of $975 million, primarilyrelated to Spring Tide’s goodwill. This compares to $10.2 billion of net business restructuring charges and asset impairments recorded duringfiscal 2001.We believe the restructuring actions committed to in fiscal 2001 will yield annual cost savings of approximately $5.0 billion, $4.0 billion ofwhich will be reflected in operating expenses. We began to realize the full effect of these cost savings during the second quarter of fiscal 2002. Infiscal 2002, we committed to additional restructuring actions, primarily in the third and fourth quarters. These actions are expected to yield additionalcost savings of approximately $2.0 billion, $1.4 billion of which is expected from reduced operating expenses. See Note 2to the consolidated financial statements for more information.

**Other Income (Expense), Net**

         Other income (expense), net consisted of thefollowing items (dollars in millions):
*Years ended September 30,***2002****2001****2000**Interest income $114 $255 $118 Minority interests in earnings of consolidated subsidiaries  (12) (81) (50)Net income (loss) from equity method investments  14  (60) (31)Other-than-temporary write-downs of investments  (209) (266) (14)Loss on foreign currency transactions  (46) (58) (18)Net gains on sales of businesses  725  56  30 Legal settlements  (212) —  — Net gains (losses) on sales and settlements of financial instruments  (22) 18  347 Write-off of embedded derivative assets  —  (42) — Miscellaneous, net  (60) (179) (49)**Other income (expense), net** **$****292** **$****(357****)****$****333** 
***Fiscal 2002***

         Other income (expense), net included $725 million ofgains from business dispositions, $664 million of which was from the sale of the OFS business and China joint ventures, and interest income of $114million related to our cash and cash equivalents. This was partially offset by a legal settlement of $162 million related to our former consumerproducts telephone leasing business and a $50 million purchase price adjustment to settle a claim with VTech Holdings Limited and VTechElectronics Netherlands B.V., and other-than-temporary investment write-downs of $209 million, primarily related to our investment inCommscope.

***Fiscal 2001***

         Other income (expense), net primarily includedother-than-temporary write-downs on several of our investments due to adverse market conditions and net losses from minority interests and equitymethod investments, offset in part by interest income. The write-off of the embedded derivative assets was primarily related to One.Tel.

***Fiscal 2000***

         In fiscal 2000, other income (expense), net primarilyincluded interest income and net gains on sales and settlements of financial instruments, including equity investments.

**Interest Expense**

***Fiscal 2002 vs. 2001***

         Interest expense for fiscal 2002 decreased to $382million as compared with $518 million for fiscal 2001. The decrease resulted from a significant reduction in short-term debt, partially offset by interestexpense related to our trust preferred securities, which were issued in March 2002.
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**MANAGEMENT’S DISCUSSION AND ANALYSIS**

***Fiscal 2001 vs. 2000***

         Despite lowering debt levels by approximately $2.1billion in the latter half of fiscal 2001, interest expense increased to $518 million as compared with $342 million for fiscal 2000. The increase ininterest expense was due to higher weighted average short-term debt levels, primarily related to borrowings under our credit facilities. In addition,interest expense in fiscal 2001 included the amortization of fees associated with entering into our credit facility arrangements.

**Provision (Benefit) for Income Taxes**

         The following table presents our provision (benefit)for income taxes and the related effective tax (benefit) rates (dollars in millions):
*Years ended September 30,***2002****2001****2000**Provision (benefit) for income taxes $4,757 $(5,734)$924 Effective tax (benefit) rate  67.3% (28.8)% 39.2%
         As discussed in more detail under“APPLICATION OF CRITICAL ACCOUNTING POLICIES,”, “the effective tax rate for fiscal 2002 was significantly morethan the U.S. statutory rate primarily due to providing for a full valuation allowance on our net deferred tax assets and not reflecting any significant taxbenefits for the current fiscal year’s losses.

         The effective tax benefit rate for fiscal 2001 waslower than the U.S. statutory rate, primarily from the impact of non-tax deductible goodwill amortization, certain non-tax deductible businessrestructuring charges and asset impairments, as well as an increase in our deferred tax valuation allowances, all of which decreased the effective taxbenefit rate. Such decrease was offset in part by research and development tax credits, which increased the effective tax benefit rate on the pre-taxloss.

         The effective tax rate exceeded the U.S. statutoryrate for fiscal 2000, primarily due to the write-offs of IPRD costs that were not deductible for tax purposes.

**Income (Loss) from Continuing Operations**

         As a result of the above, income (loss) fromcontinuing operations and related per share amounts are as follows (amounts in millions, except per share amounts):
*Years ended September 30,***2002****2001****2000**Income (loss) from continuing operations $(11,826)$(14,170)$1,433 Basic earnings (loss) per share from continuing operations $(3.51)$(4.18)$0.44 Diluted earnings (loss) per share from continuing operations $(3.51)$(4.18)$0.43 Weighted average number of common shares outstanding – basic  3,426.7  3,400.7  3,232.3 Weighted average number of common shares outstanding – diluted  3,426.7  3,400.7  3,325.9 
**Income (Loss) from Discontinued Operations, Net**

         Income (loss) from discontinued operations, net forfiscal 2002, 2001 and 2000 was $73 million or $0.02 per basic and diluted share, ($3.2) billion or ($0.93) per basic and diluted share and ($214)million or ($0.06) per basic and diluted share, respectively (see Note 3 to the consolidated financial statements).

**Extraordinary Gain, Net**

         During fiscal 2001, we recorded a gain of $1.2billion, net of a $780 million tax provision, or $0.35 per basic and diluted share, from the sale of our power systems business.

**Cumulative Effect of Accounting Changes, Net**

         Effective October 1, 2000, we recorded a net $38million charge for the cumulative effect of certain accounting changes. This was comprised of a $30 million earnings credit ($0.01 per basic anddiluted share) from the adoption of Statement of Financial Accounting Standards No.133, “Accounting for Derivative Instruments andHedging Activities,” and a $68 million charge to earnings ($0.02 per basic and diluted share) from the adoption of SAB 101.

**Results of Operations by Segment**

***INS***

         The following table presents external revenues, U.S.and non-U.S., and operating income (loss) (dollars in millions):
*Years ended September 30,***2002****2001****2000**U.S. revenues $3,490 $7,065 $12,548 Non-U.S. revenues  2,925  5,198  6,106 Total revenues $6,415 $12,263 $18,654 Operating income (loss) $(2,769)$(4,724)$1,685 Return on sales  (43.2%) (38.5%) 9.0%
***Fiscal 2002 vs. 2001***

         During fiscal 2002, INS revenues declined by 47.7%as a result of continuing reductions and delays in capital spending by service providers. The decline was reflected in all product lines and geographicregions, except for China. The deterioration of creditworthiness or financial condition of certain service providers also adversely affected revenues,although to a much lesser degree. Approximately, 60% of the decline was in the United States, and about 40% was non-U.S., primarily in EMEA(Europe, Middle East, and Africa). The five largest INS customers represented about 40% of INS revenues during fiscal 2002, and accounted forabout 45% of the revenue decline as compared with fiscal 2001.

         During fiscal 2002, the operating loss declined by$2.0 billion to an operating loss of approximately $2.8 billion. The $2.8 billion operating loss was driven by a 2.2% gross margin rate and $2.9 billionof operating expenses, which included $683 million of provisions for bad debts. The INS gross margin rate continues to be under significantpressure
13
**MANAGEMENT’S DISCUSSION AND ANALYSIS**

and declined from 10.3% in fiscal 2001 to 2.2% in fiscal 2002. The low gross margin rates were primarily a result ofunabsorbed fixed costs as a result of significantly lower revenue levels, as well as significant inventory charges. The decline from fiscal 2001 wasprimarily due to the continued decrease in sales volume, partially offset by lower inventory charges and cost reductions. Operating expenses declined$3.1 billion, of which $2.3 billion resulted from headcount reductions and less discretionary spending. The remaining decrease was from a decrease inprovisions for bad debts and customer financings of $742 million, primarily due to the significant charges incurred for amounts due from Winstar inthe prior year.

***Fiscal 2001 vs. 2000***

         During fiscal 2001, INS revenues declined by 34%.The decline primarily resulted from reductions and delays in capital spending by large service providers and was reflected in all product lines. Themost significant declines were in the U.S., especially associated with large service providers. Our five largest customers represented about 45% ofINS revenues during fiscal 2001, and about 40% of the revenue decline as compared with revenues realized from those customers in fiscal 2000.The deterioration of creditworthiness or financial condition of certain service providers and CLECs also adversely affected revenues, although to alesser degree. The decrease in non-U.S. revenues for fiscal 2001 was also attributable to the continued wind-down of a project with SaudiTelecommunications Company (“STC”).

         During fiscal 2001, the operating income (loss)declined by approximately $6.4 billion to a loss of $4.7 billion. Lower gross margin of $6.0 billion and higher operating expenses of $412 milliondrove this decline. The gross margin decrease resulted from a significant decline in the gross margin rate from 38.9% to 10.3%, primarily due tolower sales volume and significant inventory-related charges. The $412 million increase in operating expenses resulted from $993 million of higherprovisions for bad debts and customer financings, partially offset by $581 million of lower expenses, primarily due to headcount reductions and lessdiscretionary spending. The higher provisions for bad debts and customer financings primarily related to significant charges incurred for amounts duefrom Winstar.

***Mobility***

         The following table presents external revenues, U.S.and non-U.S., and operating income (loss) (dollars in millions):
*Years ended September 30,***2002****2001****2000**U.S. revenues $4,315 $4,929 $4,913 Non-U.S. revenues  1,065  1,225  1,924 Total revenues $5,380 $6,154 $6,837 Operating income (loss) $(655)$(1,517)$939 Return on sales  (12.2%) (24.7%) 13.7%
***Fiscal 2002 vs. 2001***

         During fiscal 2002, Mobility revenues decreased by12.6%. The decrease in the U.S. resulted primarily from reductions in capital spending by certain service providers. The decrease in non-U.S.revenues for fiscal 2002 resulted from reductions in the CALA (Caribbean and Latin America) and Asia Pacific regions primarily due to a loss offiscal 2002 revenues from One.Tel, which went into receivership during 2001, partially offset by higher revenues in the China and EMEA regions.The five largest customers represented approximately 75% of Mobility revenues during fiscal 2002, and approximately 35% of the revenue declinecompared with fiscal 2001. In addition, approximately 20% of the decline was related to lower revenues from a U.S. customer that defaulted on itscustomer financing commitment.

         During fiscal 2002, the operating loss declined by$862 million to $655 million. Increases in gross margin of $188 million and decreases in operating expenses of $674 million drove the improvement.The gross margin rate increased from 21.0% to 27.5% due to lower inventory and warranty-related charges and cost reductions. However, the grossmargin rate in fiscal 2002 was still affected by these charges. The reduction in operating expenses resulted from a reduction in provisions for baddebts and customer financings of $278 million, as well as a reduction in other operating expenses of $396 million, primarily related to headcountreductions and less discretionary spending. In fiscal 2002, approximately 50% of Mobility’s provisions for bad debts and customer financingswas due to the one customer that defaulted on its customer financing commitment. In fiscal 2001, Mobility incurred significantprovisions for bad debts and customer financings for amounts due from One.Tel and another customer that experienced financialdifficulties.

***Fiscal 2001 vs. 2000***

         During fiscal 2001, Mobility revenues decreased by10%. The decrease primarily resulted from lower non-U.S. revenues due to the wind-down of various projects and certain customers thatexperienced financial difficulties, including a loss of revenues from One.Tel, which went into receivership during the third fiscal quarter of 2001.Revenues from our five largest customers represented about 70% of Mobility revenues during fiscal 2001 and were slightly higher as compared withthe revenues realized from those customers in fiscal 2000.

         During fiscal 2001, operating income (loss) declinedby $2.5 billion to a loss of $1.5 billion. Lower gross margin of $1.5 billion and higher operating expenses of $960 million drove this decline. Thegross margin rate decreased from 40.7% to 21.0% primarily due to lower sales volume and higher inventory and warranty-related charges. The $960million increase in operating expenses primarily resulted from higher provisions for bad debts and customer financings of $696 million. Substantially allof the increase in provisions for bad debts and customer financings was related to One.Tel and one other customer with specific credit concerns forwhich financing was provided. Most of the remaining increases in operating expenses were primarily related to higher R&D expenses fornext-generation CDMA and UMTS technology.
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**MANAGEMENT’S DISCUSSION AND ANALYSIS**

**LIQUIDITY AND CAPITAL RESOURCES**

**Cash Flow for the Years Ended September 30, 2002, 2001 and 2000**

***Operating activities***

         Net cash used in operating activities was $756 millionfor fiscal 2002. This primarily resulted from the loss from continuing operations of $2.9 billion (adjusted for non-cash items) and changes in otheroperating assets and liabilities of $2.4 billion, offset in part by a reduction in working capital requirements (accounts receivable, inventories andcontracts in process and accounts payable) of $4.5 billion. The reduction in working capital primarily resulted from the significant decrease in salesvolume during fiscal 2002 as compared with fiscal 2001. Consistent with the decrease in receivables of $2.5 billion, the average receivable days salesoutstanding decreased from 80 days at September 30, 2001 to 77 days at September 30, 2002. In addition to reduced sales volume, the decline ininventory and contracts in process was also a result of our continued efforts to streamline inventory supply chainoperations and higher billings for our long-term contracts. The changes in other operating assets and liabilities include cash outlays under ourrestructuring program of $1.0 billion and a reduction in other operating assets and liabilities due to the decrease in sales volume and lower headcount.Federal and state income tax refunds in fiscal 2002 amounted to approximately $1.0 billion including $616 million received in connection withchanges to tax legislation.

         Net cash used in operating activities was $3.4 billionfor fiscal 2001. This primarily resulted from the loss from continuing operations (adjusted for non-cash items) of $6.6 billion, a decrease in accountspayable of $759 million and changes in other operating assets and liabilities of $602 million. Changes in other operating assets and liabilities primarilyinclude a net increase in notes receivable and higher software development assets, offset in part by business restructuring liabilities. The increases innet cash used in operating activities were partially offset by decreases in receivables of $3.6 billion and in inventories and contracts in process of$881 million. Receivable improvement was largely due to improved collections and lower sales volumes in fiscal 2001 as compared with fiscal 2000.Average receivable days outstanding improved by 34 days from 114 days at September 30, 2000 to 80 days atSeptember 30, 2001. Improvements in inventory and contracts in process resulted from streamlining inventory supply chain operations, as well aslower amounts in net contracts in process due to the wind-down of the STC project in Saudi Arabia.

         Net cash used in operating activities was $703 millionfor fiscal 2000. This primarily resulted from increases in receivables of $1.6 billion and inventories and contracts in process of $2.2 billion andchanges in other operating assets and liabilities of $1.8 billion. Changes in other operating assets and liabilities primarily include higher softwaredevelopment assets and decreases in accrued income tax and payroll- and benefit-related liabilities. Net cash used in operating activities was partiallyoffset by income from continuing operations (adjusted for non-cash items) of $3.6 billion and tax benefits from stock options of $1.1 billion and anincrease in accounts payable of $263 million. The receivable deterioration in fiscal 2000 resulted from slower collections, partially offset by smallerrevenue growth in the fourth fiscal quarter of 2000 as compared with the same period in fiscal 1999. Averagereceivable days outstanding increased by 19 days to 114 days at September 30, 2000. The increase in inventories and contracts in process resultedfrom our increased production to meet current and anticipated sales commitments to customers and the start-up of several long-termprojects.

***Investing activities***

         The net cash provided by investing activities of $757million for fiscal 2002 was primarily from the $2.6 billion of net cash proceeds received from the disposition of businesses and the sale of certainmanufacturing operations, partially offset by $1.5 billion of purchases of short-term investments and capital expenditures of $449 million. Cashproceeds from dispositions primarily included the $2.1 billion received from the sale of our OFS businesses, $60 million from the sale of our voiceenhancement and echo cancellation business, $93 million from the sale of New Venture Partners II LP, approximately $250 million from the sale ofour billing and customer care business and $96 million from the sale of certain manufacturing operations to Solectron. The short-term investmentsprimarily consisted of U.S. treasury bills and government agency notes, bank instruments and top tier corporate debt securities.

         Net cash provided by investing activities was $2.0billion for fiscal 2001 and was primarily from $2.5 billion in proceeds from the sale of the power systems business, $572 million from the sale of twoof our manufacturing operations to Celestica and sales or disposals of property, plant and equipment of $177 million. These proceeds were partiallyoffset by capital expenditures of $1.4 billion.

         Net cash used in investing activities was $1.6 billionfor fiscal 2000, primarily from capital expenditures of $1.9 billion and purchases of investments of $680 million, offset in part by proceeds from thesales or maturity of investments of $820 million and from the disposition of businesses of $250 million, largely related to the sale of the remainingconsumer products business.

         We currently expect about $400 million of capitalexpenditures during fiscal 2003, $100 million of which relates to the repurchase of certain real estate, under synthetic lease agreements we had inplace as of September 30, 2002, which were designed to fund certain real estate construction costs. We expect to sell the property that werepurchased under the synthetic lease agreements during fiscal 2003, which may result in additional charges. We do not expect significant proceedsfrom business or asset dispositions.

***Financing activities***

         Net cash provided by financing activities of $468million for fiscal 2002 included $1.75 billion of proceeds from the sale of 7.75% convertible trust preferred securities in March 2002. Fees paid inconnection with this transaction were approximately $46 million. Partially offsetting these proceeds were repayments under our credit facilities andother short-term borrowings of $1.1 billion and preferred stock dividend payments related to our 8% convertible redeemable preferred stock of$149 million.
15
**MANAGEMENT’S DISCUSSION AND ANALYSIS**

         During September 2002, we repurchasedapproximately 175 thousand shares of 8% redeemable convertible preferred stock for approximately 58 million shares of our common stock. SinceSeptember 30, 2002, we have repurchased an additional 380 thousand shares of preferred stock for approximately 143 million shares of commonstock. No gain or loss was recognized on these exchanges. The total carrying value of the preferred stock repurchased was approximately $555million ($175 million was reflected as of September 30, 2002) and resulted in a corresponding increase to our common stock and additional paid-incapital. The fair value of the additional common shares issued to the preferred shareowners to prompt the exchange over the shares obligated forexchange pursuant to the original conversion terms amounted to $125 million ($29 million of which was recognized in fiscal 2002 and was included inthe net lossapplicable to the common shareowners). We may issue more common stock for similiar transactions in the future.

         Net cash provided by financing activities for fiscal2001 was $2.6 billion and was primarily due to net proceeds received from the issuance of 8% redeemable convertible preferred stock in August2001 of $1.8 billion (a portion of the proceeds received were used to reduce borrowings under our credit facilities), net borrowings under our creditfacilities of $3.5 billion ($2.5 billion of the debt associated with borrowings was assumed by Agere), and proceeds from a real estate debt financingof $302 million under which certain real estate was transferred to a separate, consolidated wholly-owned subsidiary. Borrowings under our creditfacilities were used to fund our operations and to pay down $2.1 billion of short-term borrowings, which primarily represented commercial paper.We had no commercial paper outstanding as of September 30, 2001. In addition, we repaid the current portion of long-term debt thatmatured in July 2001 of $750 million. Dividends paid on our common stock in fiscal 2001 were $204 million.

         Net cash provided by financing activities for fiscal2000 of $2.2 billion resulted primarily from issuances of common stock related to the exercise of stock options of $1.4 billion and a net increase inshort-term borrowings of $1.4 billion, partially offset by repayments of long-term debt of $387 million and common stock dividend payments of$255 million.

**Cash Requirements**

         Our cash requirements over the next 12 months areprimarily to fund operations, including spending on R&D, our restructuring program, capital expenditures, capital requirements in connectionwith our existing customer financing commitments, and debt service and preferred stock dividend requirements. We expect to use cash to fund ouroperations in fiscal 2003. Although we believe we will realize additional cash savings upon completion of our restructuring actions, including a full yearimpact of those actions completed during fiscal 2002, these savings will be offset by less working capital reductions and income tax refunds that wererealized in fiscal 2002. We expect to have minimal, if any, cash requirements related to our pension and postretirement benefit plans during fiscal2003. For more information on these obligations, see the detailed risk factor included in our Form 10-K for the year endedSeptember 30, 2002.

***Restructuring***

         Total cash requirements under the restructuringprogram since its inception are expected to be approximately $2.6 billion. Approximately $530 million was paid during fiscal 2001 and $1.0 billionwas paid during fiscal 2002. The majority of the remaining $1.1 billion is expected to be paid in fiscal 2003, except for lease obligations ofapproximately $300 million, of which approximately $200 million would be paid in fiscal 2004 and 2005. Upon completion of the actions duringfiscal 2003, we expect to realize annual cash savings of approximately $1.8 billion. These anticipated savings result primarily from reducedheadcount. Our restructuring program may not achieve all of the cost and expense reductions and other benefits we anticipate and may not becompleted on the timetable contemplated.

         If we do not complete our restructuring program andachieve our anticipated expense reductions in the time frame we contemplate, our cash requirements to fund our operations are likely to besignificantly higher than we currently anticipate. In addition, because market demand continues to be uncertain and because we are currentlyimplementing our restructuring program and business strategy, it is difficult to estimate our ongoing cash requirements. Our restructuring program mayalso have other unanticipated adverse effects on our business.

***Customer financing commitments***

         The following table presents our customer financingcommitments at September 30, 2002 and September 30, 2001 (dollars in billions):
*September 30, 2002**Total**loansand**guarantees**Loans**Guarantees*Drawn commitments $1.1 $0.9 $0.2 Available but not drawn  0.1  0.1  — Not available  0.1  0.1  — Total commitments $1.3 $1.1 $0.2 Reserves $1.0       *September 30, 2001**Total**loansand**guarantees**Loans**Guarantees*Drawn commitments $3.0 $2.6 $0.4 Available but not drawn  1.4  1.4  — Not available  0.9  0.6  0.3 Total commitments $5.3 $4.6 $0.7 Reserves $2.1       
         We have provided substantial long-term financing tosome of our customers worldwide as a condition of obtaining or bidding on infrastructure projects, in the form of both commitments to extend creditand providing third party financial guarantees. These commitments were extended to established companies as well as start up companies and rangedfrom modest amounts to more than a billion dollars. As a result, customer financing commitments increased to $8.1 billion at September 30, 2000.Our overall customer financing exposure, coupled with the rapid and sustained decline in telecommunications market conditions, negatively affectedour results of operations and cash flows in fiscal 2001 and 2002. These market conditions led to the deteriora-
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**MANAGEMENT’S DISCUSSION AND ANALYSIS**

tion of certain customer’s creditworthiness or bankruptcy filings and corresponding defaults. We were also unable tosell or transfer significant amounts of the drawn and undrawn commitments to financial institutions or other investors on reasonable terms or at all.These adverse conditions resulted in significant charges for customer financings of approximately $1.8 billion and $765 million during fiscal 2001 and2002, respectively, and additional charges may be required in the future.

         We expect to continue to provide or commit tofinancing on a much more limited basis. We are focusing on the largest service providers who typically have less demand for such financing. Wecurrently have the ability to offer limited customer financing due to our capital structure, credit rating, level of available credit and liquidity. As a resultof significant customer defaults that led to significant charges and the cancellation or restructuring of several financing arrangements, our customerfinancing commitments were reduced to $1.3 billion at September 30, 2002. We expect that approximately $50 million of the undrawn commitmentswill be drawn during the next twelve months and the rest will likely expire undrawn.

         Although on a very limited basis, we considerrequests for customer financing on a case-by-case basis and may consider offering financing only after a careful review that considers the creditquality of the individual borrowers, their respective business plans and market conditions. We also consider the likelihood of our ability to sell ortransfer the undrawn commitments and drawn borrowings to unrelated third parties. We continue to monitor the drawn borrowings and undrawncommitments by assessing, among other things, the customer’s short-term and long-term liquidity position, current operating performanceversus plan, execution challenges facing the company, changes in the competitive landscape, and management experience and depth. We undertakecertain mitigating actions, including cancellation of commitments if corrective measures are not taken, depending upon the extent of any deteriorationof acustomer’s credit profile or non-compliance with our loan conditions. Although these actions can limit the extent of our losses, substantialexposure remains to the extent of drawn amounts, which may not be recoverable.

***Debt service and preferred dividend requirements***

         Debt service primarily represents interest paymentson our short- and long-term debt and trust preferred securities. Preferred dividend requirements represent payments on our 8% redeemableconvertible preferred stock. We expect debt service and preferred dividend requirements for fiscal 2003 to be approximately $500million.

**Sources of Cash**

         We expect to fund our cash requirements duringfiscal 2003 through a combination of cash and cash equivalents of $2.9 billion and short-term investments of $1.5 billion, both as of September 30,2002.

***Credit facility and accounts receivable securitization facility***

         On October 17, 2002, we cancelled our $1.5 billioncredit facility and our $500 million accounts receivable securitization facility to avoid an anticipated default on the financial covenants contained inthese agreements. We had no outstanding balance on the credit facility, which was scheduled to expire in February 2003, and nothing drawn againstthe accounts receivable securitization facility. We are currently in negotiations with our bankers concerning a new and smaller credit facility, howeverwe can not provide assurance that one will be obtained.

         Although the credit facility was cancelled,substantially all of our domestic U.S. assets remained collateralized as a result of extending through December 18, 2002, the Guarantee andCollateral Agreement with our banks. This agreement provides security for commercial bankers in extending, among other things, credit facilities tonon-U.S. subsidiaries, letters of credit and foreign exchange hedging. If this agreement is not renewed or replaced with a similar agreement, we maybe required to collateralize certain new or existing obligations or financial instruments, such as letters of credit with cash. Any cash collateralrequirements would be expected to occur over time.

***Future capital requirements***

         We believe our cash and cash equivalents andshort-term investments are currently sufficient to meet our requirements in fiscal 2003. However, we cannot assure that these sources will be availablewhen needed or that our actual cash requirements will not be greater than we currently expect. If our sources of liquidity are not available or if wecannot generate sufficient cash flow from operations, we might be required to obtain additional sources of funds through additional operatingimprovements, asset sales and financing from third parties, or a combination thereof. We cannot provide assurance that these additional sources offunds will be available, or if available, would have reasonable terms.

***Credit ratings***

         Our credit ratings as of November 30, 2002, are asfollows:
*Long-term**debt**Convertible**preferred**stock**Trust**preferred**securities**Last update*Rating Agency             Standard & Poor’s  B–(a)  CCC–  CCC–  October 11, 2002 Moody’s  Caa1(a)  Ca  Caa3  November 1, 2002   (a) Ratings outlook is negative.
         Our credit ratings are below investment grade. As aresult of past downgrades, we no longer have the ability to participate in the commercial paper market and are unable to sell trade and notesreceivables to the Trust (see “Customer financing commitments”). In addition, a credit downgrade affects our ability to enter into andmaintain certain contracts on favorable terms, and increases our cost of borrowing.

**Special Purpose Entities**

         We have used special purpose entities for the salesand securitizations of receivables and in real estate financing arrangements. The Financial Accounting Standards Board is currently proposingamendments to existing accounting standards that will require the consolidation of certain special purpose entities. If these proposed amendments areapproved in their existing form, we may be required to consolidate the Trust described below, that we have used to sell certain customer financingloans and receivables to, and this will result in the addition
17
**MANAGEMENT’S DISCUSSION AND ANALYSIS**

of approximately $350 million of long-term notes receivable and debt obligations to our balance sheet. We are currentlyanalyzing these proposed amendments to existing accounting standards; we believe that if they are adopted in their existing form, we will be requiredto consolidate the aforementioned special purpose entity beginning July 1, 2003.

         In September 2000, we and a third party created anon-consolidated Special Purpose Trust (“Trust”) for the purpose of allowing us from time to time to sell on a limited-recourse basiscustomer finance loans and receivables (“Loans”) at any given point in time to the Trust. Due to our credit downgrade in February2001, we are unable to sell additional Loans to the Trust. As of September 30, 2002, the Trust held approximately $350 million in Loans relating tofive obligors, all of which are in default. Because we and the Trust collectively hold significant portions of the total outstanding debt of each of the fiveobligors, we and the Trust currently are reviewing alternatives related to recovery of defaulted Loans currently held in the Trust. Our wholly-ownedcaptive insurance company assumed the credit risk of the loans that are held in the Trust. It also reinsured the exposure to anunaffiliated insurer for amounts in excess of an initial loss of $90 million. The self-insured loss reserve related to these loans (including accruedinterest) was $379 million and the corresponding receivable due from the unaffiliated insurer was $298 million. We also indemnify the Trust for anyactions that we may take that impairs the Trust’s ability to obtain payment.

**Contractual Cash Obligations and Other Commercial Commitments and Contingencies**

         The following tables quantify our future contractualobligations and commercial commitments as of September 30, 2002 (dollars in millions):

***Contractual Obligations***
*Payments due in fiscal**Total**2003**2004**2005**2006**2007**Thereafter*Long-term debt (including company- obligated     trustpreferred securities) $5,025 $31 $37 $42 $948 $2 $3,965 8% redeemable convertible preferred stock(a)  1,680  —  —  —  —  —  1,680 Operating leases (b)  1,590  253  208  169  129  106  725 Unconditional purchase obligations  775  350  425  —  —  —  — **Total** **$****9,070** **$****634** **$****670** **$****211** **$****1,077** **$****108** **$****6,370**   (a) Subsequent to September 30, 2002, $380 of convertible preferred stock was exchanged for our common stock (see“Financing activities”). The convertible preferred stock is redeemable, at our option after August 15, 2006 and at the option of theholders on August 2 of 2004, 2007, 2010 and 2016.  (b) The contractual obligations under operating leases exclude approximately $250 of potential lease obligations that wereassigned to Avaya, Agere and other dispositions for which Lucent remained secondarily liable.
***Other Commercial Commitments(a)***
*Amounts expiring in fiscal**Total**2003**2004**2005**2006**2007**Thereafter*Standby letters of credit $668 $374 $98 $22 $130 $4 $40 Undrawn customer commitments  244  209  33  —  —  2  — **Total** **$****912** **$****583** **$****131** **$****22** **$****130** **$****6** **$****40**   (a) At September 30, 2002, we had $90 of surety bonds that remain outstanding until specific events or projects arecompleted and claims are settled.
**RISK MANAGEMENT**

         We are exposed to market risk from changes inforeign currency exchange rates, interest rates and equity prices. We manage our exposure to these market risks through the use of derivativefinancial instruments coupled with other strategies. Our risk management objective is to minimize the effects of volatility on our cash flows byidentifying the assets, liabilities or forecasted transactions exposed to these risks and hedging them with either forward or option contracts or swapderivatives or by embedding terms into certain contracts that affect the ultimate amount of cash flows under the contract. Since there is a highcorrelation between the hedging instruments and the underlying exposures, the gains and losses on these exposures are generally offset by reciprocalchanges in value of the hedging instruments when used. We use derivative financial instruments as risk management tools and not for tradingor speculative purposes.

**Foreign Currency Risk**

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

         Our primary net foreign currency exposures as ofSeptember 30, 2002 include the euro, the Chinese renminbi and the Indian rupee and at September 30, 2001, include the euro, Brazilian real,Australian dollar and Danish kroner. We use a sensitivity analysis to determine the effects that market risk exposures may have on the fair value of theforeign currency forwards and options and results of operations. To perform the sensitivity analysis, we assess the risk of loss in fair values from theeffect of a hypothetical 10% change in the value of foreign
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**MANAGEMENT’S DISCUSSION AND ANALYSIS**

currencies, assuming no change in interest rates. For contracts outstanding as of September 30, 2002 and 2001, a 10%adverse movement in the value of foreign currencies against the U.S. dollar from the prevailing market rates, including the primary foreign currencyexposures noted above, would result in an incremental pretax net unrealized loss of $21 million and $63 million, respectively. Consistent with thenature of the economic hedge, any unrealized gains or losses on these forwards and options would be offset by corresponding decreases orincreases, respectively, of the underlying instrument or transaction being hedged. The model to determine sensitivity assumes a parallel shift in allforeign currency exchange spot rates, although exchange rates rarely move in the same direction. We have not changed our foreign exchange riskmanagement strategy from the prior year.

**Interest Rate Risk**

         The fair values of our fixed-rate long-term debt,interest rate swaps, company-obligated 7.75% mandatorily redeemable convertible preferred securities of subsidiary trust and short-term investmentsare sensitive to changes in interest rates. Our portfolio of customer finance notes receivable is predominantly comprised of variable-rate notes atLIBOR plus a stated percentage and subjects us to variability in cash flows and earnings due to the effect of changes in LIBOR. Prior to May 2002,our debt obligations primarily consisted of fixed-rate debt instruments while our interest rate sensitive assets were primarily variable-rate instruments.In the latter half of fiscal 2002, we began to mitigate this interest rate sensitivity by adding short-term fixed-rate assets to our investment portfolio andsimultaneously entering into interest rate swaps on a portion of our debt obligations to make them variable-ratedebt instruments. Under these swaps, we receive a fixed interest rate of 7.25% and pay an average floating rate of LIBOR plus 2.91% on thenotional amounts of the swaps. As of September 30, 2002, LIBOR was approximately 1.79%. The objective of maintaining the mix of fixed andfloating-rate debt and investments is to mitigate the variability of cash inflows and outflows resulting from interest rate fluctuations, as well as reducethe overall cost of borrowing. We do not enter into derivative transactions on our cash equivalents since their relatively short maturities do not createsignificant risk. We do not foresee any significant changes in our risk management strategy or in our exposure to interest rate fluctuations.

         The impacts of a sensitivity analysis we performedunder a model that assumes a hypothetical 150 basis point parallel shift in interest rates is as follows (dollars in millions):
*Fair value**asof**September 30,**2002**Hypothetical**increaseor**decrease in**fair value**asof**September 30,**2002**Fair value**asof**September 30,**2001**Hypothetical**increaseor**decrease in**fair value**asof**September 30,**2001***Assets:**             Short-term invesments $1,515 $14 $— $— Interest rate swaps  28  27  —  —              **Liabilities:**             Long-term debt obligations  998  60  2,009  210 Company-obligated 7.75% mandatorily redeemable    convertible preferred securities of subsidiary trust  400  19  —  — 
         The changes in fair values of our fixed-rate liabilitiesare not necessarily indicative of actual changes that may occur as a result of changes in interest rates alone when also considered with the result ofpotential future changes in our credit ratings. Our sensitivity analysis on debt obligations excludes variable-rate debt instruments, secured borrowingsand bank loans because the changes in interest rates would not significantly affect the fair value of such instruments. In addition, our variable-ratecustomer finance notes have been excluded since a significant portion of the principle balances and related receivables for accrued interest are fullyreserved.

**Equity Price Risk**

         Our investment portfolio includes equity investmentsin publicly held companies that are classified as available-for-sale and other strategic equity holdings in privately held companies. These securities areexposed to price fluctuations and are generally concentrated in the high-technology and telecommunications industries. At September 30, 2002, thefair value of two available-for-sale securities (Commscope and Corning) that were obtained in connection with the sale of our optical fiber businessestotaled $101 million out of a total available-for-sale portfolio valued at $117 million. The process of determining the fair values of our privately heldequity investments inherently requires subjective judgments. These valuation assumptions and judgments include consideration of the investee’searnings and cash flow position, cash flow projections and rate of cash consumption, recent rounds of equityinfusions by us and other investors, strength of investee’s management and valuation data provided by the investee that may be compared withpeers. Due to a sustained weakness in the economic environment in both public and private equity markets, we have and may continue to recordimpairment losses and write down the carrying value of certain equity investments when the declines in fair value are other-than-temporary.Impairment charges recorded in 2002 and 2001 were $209 million and $266 million, respectively.

         We generally do not hedge our equity price risk dueto hedging restrictions imposed by the issuers, illiquid capital markets or inability to hedge non-marketable equity securities in privately heldcompanies. As of September 30, 2002 and 2001, a 20% adverse change in equity prices would result in an approximate $23 million and $12 milliondecrease, respectively, in the fair value of our available-for-sale equity securities. The model to determine sensitivity assumes a corresponding shift inall equity prices. This analysis excludes stock purchase warrants as we do not believe that the value of such warrants is significant. An adversemovement in the equity prices of our holdings in privately held companies can not be easily quantified as our ability to realize returns on investmentsdepends on the investees’ ability to raise additional capital or derive sales from continuing operations or throughliquidity events such as initial public offerings, mergers or private sales. As of September 30, 2002 and 2001, we had no outstanding hedginginstruments for our equity price risk. However, during December 2002, we entered into a prepaid forward sales agreement for 50% of the Corningstock we own, under which we received approximately $60 million and locked in approximately $35 million of unrealized appreciation.
19
**FIVE-YEAR SUMMARY OF SELECTED FINANCIAL DATA**
*(Amounts in Millions, Except Per ShareAmounts)**Years ended September 30,***RESULTS OF OPERATIONS****2002****2001****2000****1999****1998**Revenues $12,321 $21,294 $28,904 $26,993 $21,307 Gross margin (a)  1,552  2,058  11,714  12,969  9,817 Operating income (loss) (a)  (6,979) (19,029) 2,366  3,786  1,384 Income (loss) from continuing operations (a)  (11,826)(b) (14,170) 1,433  2,369  360 Earnings (loss) per common share from continuing    operations (c) (d):                   Basic  (3.51) (4.18) 0.44  0.76  0.12    Diluted  (3.51) (4.18) 0.43  0.74  0.12 Dividends per common share (c)  0.00  0.06  0.08  0.08  0.0775                 **FINANCIAL POSITION**                Cash, cash equivalents and short-term investments $4,420 $2,390 $1,467 $1,686 $1,144 Total assets  17,791  33,664  47,512  34,246  24,289 Total debt  5,106(e) 4,409  6,498  5,788  2,861 8.00% redeemable convertible preferred stock  1,680  1,834  —  —  — Shareowners’ (deficit) equity  (4,734)(f) 11,023  26,172  13,936  7,960   (a) Operating income (loss) and Income (loss) from continuing operations includes net business restructuring charges andasset impairments of $2,316 and $11,416 in fiscal 2002 and 2001, respectively, of which $64 and $1,259 of inventory write-downs affected grossmargin, in fiscal 2002 and 2001, respectively.  (b) Includes a full valuation allowance on the net deferred tax assets as of September 30,2002.  (c) All per share data have been restated to reflect the two-for-one splits of our common stock that became effective onApril 1, 1998 and April 1, 1999.  (d) Includes the impact of preferred dividends and accretion of $167 and $28 in fiscal 2002 and 2001, respectively. Inaddition, fiscal 2002 includes the effect of conversion cost of $29 associated with the exchange of 8% redeemable convertible preferred stock forLucent common stock.  (e) Includes company-obligated 7.75% mandatorily redeemable convertible preferred securities of subsidiary trust of$1,750.  (f) Includes a non-cash charge of $2,927 related to the minimum liability adjustment for the management pensionplan.20
**REPORT OF MANAGEMENT**

         Management is responsible for the preparation ofLucent Technologies Inc.’s consolidated financial statements and all related information appearing in this Annual Report. The consolidatedfinancial statements and notes have been prepared in conformity with accounting principles generally accepted in the United States of America andinclude certain amounts that are estimates based upon currently available information and management’s judgment of current conditions andcircumstances.

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

         The Audit and Finance Committee of the board ofdirectors, which is composed of independent directors, meets periodically with management, the internal auditors and the independent accountants toreview the manner in which these groups are performing their responsibilities and to carry out the Audit and Finance Committee’s oversightrole with respect to auditing, internal controls and financial reporting matters. Both the internal auditors and the independent accountants periodicallymeet privately with the Audit and Finance Committee and have access to its individual members.

         Lucent engaged PricewaterhouseCoopers LLP,independent accountants, to audit the consolidated financial statements in accordance with auditing standards generally accepted in the United Statesof America, which include consideration of the internal control structure.
     **Patricia F. Russo**President andChief Executive Officer  **Frank A. D’Amelio**Chief Financial Officer
**REPORT OF INDEPENDENT ACCOUNTANTS**

To the Board of Directors andShareowners of LUCENT TECHNOLOGIESINC.:

         In our opinion, the accompanying consolidatedbalance sheets and the related consolidated statements of operations, changes in shareowners’ (deficit) equity and cash flows present fairly, inall material respects, the financial position of Lucent Technologies Inc. and its subsidiaries at September 30, 2002 and 2001, and the results of theiroperations and their cash flows for each of the three years in the period ended September 30, 2002, in conformity with accounting principlesgenerally accepted in the United States of America. These financial statements are the responsibility of the Company’s management; ourresponsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordancewith auditing standards generally accepted in the United States of America, which require that we plan and perform the audit to obtainreasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidencesupporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made bymanagement, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

         As discussed in Note 16 to the consolidated financialstatements, in 2001 the Company changed its accounting methods for revenue recognition and for derivative financial instruments.
     **PRICEWATERHOUSECOOPERS LLP**New York, New YorkOctober 23, 2002,except for the second paragraph of Note 4,the third paragraph of Note 10 and the first paragraph of Note 12, as to which the date is December 4, 2002   21
LUCENT TECHNOLOGIES INC. AND SUBSIDIARIES**CONSOLIDATEDSTATEMENTS OF OPERATIONS**
*(Amounts in Millions, Except Per ShareAmounts)**Years ended September 30,***2002****2001****2000**Revenues:             Products $9,632 $17,132 $23,978    Services  2,689  4,162  4,926 Total revenues  12,321  21,294  28,904 Costs:             Products  8,452  15,596  13,265    Services  2,317  3,640  3,925 Total costs  10,769  19,236  17,190 Gross margin  1,552  2,058  11,714 Operating expenses:             Selling, general and administrative  3,969  7,410  5,610    Research and development  2,310  3,520  3,179    Purchased in-process research and development  —  —  559    Business restructuring charges and asset impairments, net  2,252  10,157  — Total operating expenses  8,531  21,087  9,348 Operating income (loss)  (6,979) (19,029) 2,366 Other income (expense), net  292  (357) 333 Interest expense  382  518  342 Income (loss) from continuing operations before income taxes  (7,069) (19,904) 2,357 Provision (benefit) for income taxes  4,757  (5,734) 924 **Income (loss) from continuing operations**  **(11,826****)** **(14,170****)** **1,433** Income (loss) from discontinued operations, net  73  (3,172) (214)Income (loss) before extraordinary item and cumulative effect of    accounting changes  (11,753) (17,342) 1,219 Extraordinary gain, net  —  1,182  — Cumulative effect of accounting changes, net  —  (38) — Net income (loss)  (11,753) (16,198) 1,219 Conversion cost – 8% redeemable convertible preferred stock  (29) —  — Preferred stock dividends and accretion  (167) (28) — **Net income (loss) applicable to common shareowners** **$****(11,949****)****$****(16,226****)****$****1,219**           **EARNINGS (LOSS) PER COMMON SHARE –BASIC**          Income (loss) from continuing operations $(3.51)$(4.18)$0.44 Net income (loss) applicable to common shareowners $(3.49)$(4.77)$0.38           **EARNINGS (LOSS) PER COMMON SHARE –DILUTED**          Income (loss) from continuing operations $(3.51)$(4.18)$0.43 Net income (loss) applicable to common shareowners $(3.49)$(4.77)$0.37           Weighted average number of common shares outstanding – basic  3,426.7  3,400.7  3,232.3 Weighted average number of common shares outstanding – diluted  3,426.7  3,400.7  3,325.9 
See Notes to Consolidated Financial Statements.
22
LUCENT TECHNOLOGIES INC. AND SUBSIDIARIES**CONSOLIDATEDBALANCE SHEETS**
*(Dollars in Millions, Except Per ShareAmounts)**September 30,***2002****2001****ASSETS**       Cash and cash equivalents $2,894 $2,390 Short-term investments  1,526  — Receivables, less allowance of $325 in 2002 and $634 in 2001  1,647  4,594 Inventories  1,363  3,646 Contracts in process, net  10  1,027 Deferred income taxes, net  —  2,658 Other current assets  1,715  1,788 **Total current assets**  9,155  16,103 Property, plant and equipment, net  1,977  4,416 Prepaid pension costs  4,355  4,958 Deferred income taxes, net  —  2,695 Goodwill and other acquired intangibles, net of accumulated amortization of $910 in 2002 and    $832 in 2001  224  1,466 Other assets  2,080  2,724 Net long-term assets of discontinued operations  —  1,302 **Total assets** **$****17,791** **$****33,664**        **LIABILITIES**       Accounts payable $1,298 $1,844 Payroll and benefit-related liabilities  1,094  1,500 Debt maturing within one year  120  1,135 Other current liabilities  3,814  5,285 Net current liabilities of discontinued operations  —  405 **Total current liabilities**  **6,326**  **10,169** Postretirement and postemployment benefit liabilities  5,230  5,481 Pension liability  2,752  80 Long-term debt  3,236  3,274 Company-obligated 7.75% mandatorily redeemable convertible preferred securities ofsubsidiary     trust  1,750  — Deferred income taxes, net  —  152 Other liabilities  1,551  1,651 **Total liabilities**  **20,845**  **20,807**        **Commitments and contingencies**              **8.00% redeemable convertible preferred stock**  **1,680**  **1,834**        **SHAREOWNERS’ (DEFICIT) EQUITY**       Preferred Stock – par value $1.00 per share; authorized shares: 250,000,000; issuedand     outstanding none  —  — Common stock – par value $.01 per share; Authorized shares: 10,000,000,000;3,491,585,126     issued and 3,490,310,034 outstanding shares at September 30, 2002 and 3,414,815,908 issued    and 3,414,167,155 outstanding shares at September 30, 2001  35  34 Additional paid-in capital  20,606  21,702 Accumulated deficit  (22,025) (10,272)Accumulated other comprehensive loss  (3,350) (441)**Total shareowners’ (deficit) equity**  **(4,734****)** **11,023** **Total liabilities, redeemable convertible preferred stock and shareowners’ (deficit)equity** **$****17,791** **$****33,664** 
See Notes to Consolidated Financial Statements.
23
LUCENT TECHNOLOGIES INC. AND SUBSIDIARIES**CONSOLIDATEDSTATEMENTS OF CHANGES IN SHAREOWNERS’ (DEFICIT) EQUITY**
*(Dollars in Millions)**Common**Stock**Additional**Paid-In**Capital**Retained**Earnings**(Accumulated**Deficit)**Accumulated**Other**Comprehensive**Loss**Total**Shareowners’**(Deficit)**Equity**Total**Comprehensive**Income (Loss)***Balance at September 30, 1999** **$****31** **$****7,961** **$****6,188** **$****(244****)****$****13,936**    Net income        1,219       $1,219 Foreign currency translation adjustment           (185)    (185)Reclassification of foreign currency translation losses    realized upon spin-off of Avaya           64     64 Unrealized holding gains on certain investments (net of tax of    $124)           190     190 Reclassification adjustment for realized holding gains on    certain investments (net of tax benefit of $126)           (194)    (194)Common stock dividends declared        (255)         Issuance of common stock     1,397             Tax benefit from employee stock options     1,064             Issuance of common stock and conversion of stock options    for acquisitions  3  9,901             Other     45  (14) 2     2 Spin off of Avaya     6  (1,009) 2       **Total comprehensive income**                **$****1,096** **Balance at September 30, 2000**  **34**  **20,374**  **6,129**  **(365****)** **26,172**    Net loss        (16,198)      $(16,198)Foreign currency translation adjustment (net of tax benefit of    $16)           (30)    (30)Reclassification of foreign currency translation losses    realized upon the sale of foreign entities (net of tax of $2)           (3)    (3)Unrealized holding losses on certain investments (net of tax    benefit of $72)           (95)    (95)Reclassification adjustment for realized holding gains and    impairment losses on certain investments (net of tax of     $32)           50     50 Common stock dividends declared        (204)         Issuance of common stock     234             Tax benefit from employee stock options     18             Preferred stock dividends and accretion     (28)            Cumulative effect of accounting change (SFAS 133)           11     11 Agere initial public offering     922             Compensation on equity-based awards     87             Other     95  1  (9)    (9)**Total comprehensive loss**                **$****(16,274****)****Balance at September 30, 2001**  **34**  **21,702**  **(10,272****)** **(441****)** **11,023**    Net loss        (11,753)      $(11,753)Minimum pension liability adjustment           (2,927)    (2,927)Foreign currency translation adjustment           40     40 Reclassification of foreign currency translation gain realized    upon the sale of foreign entities           20     20 Unrealized holding losses on certain investments           (27)    (27)Reclassification adjustment for realized holding losses and    impairment losses on certain investments           (8)    (8)Issuance of common stock in connection with exchange of    8% convertible redeemable preferred stock  1  174             Other issuance of common stock     55             Preferred stock dividends and accretion     (167)            Spin off of Agere     (1,191)    (6)    (6)Other     33     (1)    (1)**Total comprehensive loss**                **$****(14,662****)****Balance at September 30, 2002** **$****35** **$****20,606** **$****(22,025****)****$****(3,350****)****$****(4,734****)**   
See Notes to Consolidated Financial Statements.
24
LUCENT TECHNOLOGIES INC. AND SUBSIDIARIES**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**
*(Dollars inMillions)**Years ended September 30,***2002****2001****2000****OPERATING ACTIVITIES**          Net income (loss) $(11,753)$(16,198)$1,219 Less: Income (loss) from discontinued operations  73  (3,172) (214)        Extraordinary gain  —  1,182  —         Cumulative effect of accountingchanges  —  (38) — Income (loss) from continuing operations  (11,826) (14,170) 1,433           Adjustments to reconcile income (loss) from continuing operations to net cash    used in operating activities, net of effects of acquisitions and dispositions of    businesses and manufacturing operations:             Non-cash portion of business restructuring charges, net  827  9,322  —    Asset impairment charges  975  —  —    Depreciation and amortization  1,470  2,536  1,667    Provision for bad debts and customer financings  1,253  2,249  505    Tax benefit from employee stock options  —  18  1,064    Deferred income taxes  5,268  (5,935) 491    Purchased in-process research and development  —  —  559    Net pension and postretirement benefit credit  (972) (1,083) (802)   Gains on sales of businesses  (725) (56) (30)   Other adjustments for non-cash items  843  551  (222)Changes in operating assets and liabilities:             Decrease (increase) in receivables  2,493  3,627  (1,626)   Decrease (increase) in inventories and contracts inprocess  2,552  881  (2,242)   (Decrease) increase in accounts payable  (539) (759) 263    Changes in other operating assets and liabilities  (2,375) (602) (1,763)**Net cash used in operating activities from continuing operations**  **(756****)** **(3,421****)** **(703**)          **INVESTING ACTIVITIES**          Capital expenditures  (449) (1,390) (1,915)Dispositions of businesses and manufacturing operations, net of cash disposed  2,576  3,187  250 Sales or maturity of investments  31  57  820 Purchases of non-consolidated investments  (30) (101) (680)Purchases of short-term investments  (1,518) —  — Proceeds from the sale or disposal of property, plant and equipment  194  177  26 Other investing activities  (47) 21  (60)**Net cash provided by (used in) investing activities from continuingoperations**  **757**  **1,951**  **(1,559**)          **FINANCING ACTIVITIES**          Issuance of company-obligated 7.75% mandatorily redeemable convertible    preferred securities of subsidiary trust  1,750  —  — (Repayments of) proceeds from credit facilities  (1,000) 3,500  — Net (repayments of) proceeds from other short-term borrowings  (104) (2,147) 1,355 Issuance of long-term debt  —  302  72 Repayments of long-term debt  (47) (754) (387)Issuance of 8% redeemable convertible preferred stock  —  1,831  — Issuance of common stock  64  222  1,444 Dividends paid on preferred and common stock  (149) (204) (255)Other financing activities  (46) (125) — **Net cash provided by financing activities from continuing operations**  **468**  **2,625**  **2,229**           Effect of exchange rate changes on cash and cash equivalents  35  4  10 Net cash provided by (used in) continuing operations  504  1,159  (23)Net cash used in discontinued operations  —  (236) (196)Net increase (decrease) in cash and cash equivalents  504  923  (219)Cash and cash equivalents at beginning of year  2,390  1,467  1,686 **Cash and cash equivalents at end of year** **$****2,894** **$****2,390** **$****1,467** 
See Notes to Consolidated Financial Statements.
25
**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**(Dollars inMillions, Except Per Share Amounts)

**1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES**

**Basis of Consolidation**

         The consolidated financial statements include allmajority-owned subsidiaries in which Lucent Technologies Inc. (“Lucent” or “the Company”) exercises control.Investments in which Lucent exercises significant influence, but which it does not control (generally a 20% to 50% ownership interest), are accountedfor under the equity method of accounting. All material intercompany transactions and balances have been eliminated. Except as otherwise noted, allamounts and disclosures reflect only Lucent’s continuing operations.

**Use of Estimates**

         The consolidated financial statements are prepared inconformity with generally accepted accounting principles. Management is required to make estimates and assumptions that affect the amountsreported in the consolidated financial statements and accompanying disclosures. Actual results could differ from those estimates. Among other things,estimates are used in accounting for long-term contracts, allowances for bad debts and customer financings, inventory obsolescence, restructuringreserves, product warranty, amortization and impairment of intangibles, goodwill, and capitalized software, depreciation and impairment of property,plant and equipment, employee benefits, income taxes, contingencies, and loss reserves for discontinued operations. Estimates and assumptions areperiodically reviewed and the effects of any material revisions are reflected in the consolidated financial statements in the periodthat they are determined to be necessary.

**Foreign Currency Translation**

         For operations outside the U.S. that prepare financialstatements in currencies other than the U.S. dollar, results of operations and cash flows are translated at average exchange rates during the period,and assets and liabilities are translated at end-of-period exchange rates. Translation adjustments are included as a separate component ofaccumulated other comprehensive loss in shareowners’ (deficit) equity.

**Revenue Recognition**

         Revenue is recognized when persuasive evidence ofan agreement exists, delivery has occurred, the fee is fixed and determinable, and collection of the resulting receivable, including receivables ofcustomers to which Lucent has provided customer financing, is probable. For sales generated from long-term contracts, primarily those related tocustomized network solutions and network build-outs, Lucent generally uses the percentage of completion method of accounting. In doing so, Lucentmakes important judgments in estimating revenue and costs and in measuring progress toward completion. These judgments underlie thedeterminations regarding overall contract value, contract profitability and timing of revenue recognition. Revenue and cost estimates are revisedperiodically based on changes in circumstances; any losses on contracts are recognized immediately. Lucent also sells products through multipledistribution channels, including resellers and distributors. For products sold through these channels, revenue is generally recognized when the reselleror distributor sells the product to the end user.

         Most sales are generated from complex contractualarrangements that require significant revenue recognition judgments, particularly in the areas of multiple element arrangements and collectibility.Revenues from contracts with multiple element arrangements, such as those including installation and integration services, are recognized as eachelement is earned based on the relative fair value of each element and when there are no undelivered elements that are essential to the functionality ofthe delivered elements. Lucent has determined that most equipment is generally installed by Lucent within 90 days, but can be installed by thecustomer or a third party, and as a result, revenue is recognized when title passes to the customer, which usually is upon delivery of the equipment,provided all other revenue recognition criteria are met. Services revenues are generally recognized at time of performance. Theassessment of collectibility is particularly critical in determining whether revenue should be recognized in the current market environment. As part ofthe revenue recognition process, Lucent determines whether trade and notes receivables are reasonably assured of collection based on variousfactors, including the ability to sell those receivables and whether there has been deterioration in the credit quality of customers that could result in theinability to collect or sell the receivables. In situations where Lucent has the ability to sell the receivables, revenue is recognized to the extent of thevalue Lucent could reasonably expect to realize from the sale. Lucent defers revenue and related costs when it is uncertain as to whether it will beable to collect or sell the receivable. Lucent defers revenue but recognizes costs when it determines that the collection or sale of the receivables isunlikely.

**Research and Development and Software Development Costs**

         Research and development costs are charged toexpense as incurred. However, the costs incurred for the development of computer software that will be sold, leased or otherwise marketed arecapitalized when technological feasibility has been established, generally when all of the planning, designing, coding and testing activities that arenecessary in order to establish that the product can be produced to meet its design specifications including functions, features and technicalperformance requirements are completed. These capitalized costs are subject to an ongoing assessment of recoverability based on anticipated futurerevenues and changes in hardware and software technologies. Costs that are capitalized include direct labor and related overhead.

         Amortization of capitalized software developmentcosts begins when the product is available for general release. Amortization is provided on a product-by-product basis on the straight-line methodover periods not exceeding 18 months. Unamortized capitalized software development costs determined to be in excess of the net realizable value ofthe product are expensed immediately.
26
**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**Cash and Cash Equivalents**

         All highly liquid investments with original maturities ofthree months or less are considered cash equivalents. These primarily consist of money market funds and to a lesser extent certificates of deposit andcommercial paper.

         At September 30, 2002 and 2001, approximately$324 and $138, respectively, of cash was held as collateral or escrowed for contingent liabilities and was classified in other current assets on theconsolidated balance sheets.

**Short-Term Investments**

         All investments with original maturities greater thanthree months and with maturities less than one year are considered short-term investments. They are of investment grade quality and are not subjectto significant market risk. These investments are designated as available-for-sale, and are recorded at fair value, which approximates their cost. Anyunrealized holding gains or losses are excluded from net loss and are reported as a component of accumulated other comprehensive loss.

**Inventories**

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

**Contracts in Process**

         Net contracts in process are stated at cost plusaccrued profits less progress billings. Gross contracts in process, before progress billings were $10,324 and $8,868, at September 30, 2002 and2001, respectively. Contract progress billings were $10,314 and $7,841 at September 30, 2002 and 2001, respectively. Net contracts in processalso includes unbilled receivables of $286 and $1,128 at September 30, 2002 and 2001, respectively; unbilled receivables are generally billable andcollectible within one year.

         Long-term contract receivables include amountsbilled but unpaid due to contractual retainage provisions of $356 and $464 at September 30, 2002 and 2001, respectively, and are included in otherassets.

**Property, Plant and Equipment**

         Property, plant and equipment are stated at cost lessaccumulated depreciation. Depreciation is determined using accelerated and straight-line methods over the estimated useful lives of the various assetclasses. Useful lives for buildings and building improvements, furniture and fixtures and machinery and equipment principally range from five to 40years, five to 10 years and two to 10 years, respectively.

**Financial Instruments**

         Various financial instruments, including foreignexchange forward and option contracts and interest rate swap agreements are used to manage risk by generating cash flows that offset the cash flowsof certain transactions in foreign currencies or underlying financial instruments in relation to their amount and timing. Lucent’s derivativefinancial instruments are for purposes other than trading. Non-derivative financial instruments include letters of credit, commitments to extend creditand guarantees of debt.

         Lucent’s investment portfolio includessecurities accounted for under the cost and equity methods as well as equity investments in publicly held companies that are generally concentrated inthe high-technology and telecommunications industries. These investments are included in other assets. Marketable equity securities with readilydeterminable fair values are classified as available-for-sale securities and reported at fair value. Unrealized gains and losses on the changes in fairvalue of these securities are reported as a component of accumulated other comprehensive loss until sold or considered to be other than temporarilyimpaired. At the time of sale, any such gains or losses are recognized in other income (expense), net. All equity investments are periodically reviewedto determine if declines in fair value below cost basis are other-than-temporary. Significant and sustained decreases inquoted market prices, a series of historic and projected operating losses by the investee or other factors are considered as part of the review. If thedecline in fair value has been determined to be other-than-temporary, an impairment loss is recorded in other income (expense), net and the individualsecurity is written down to a new cost basis.

**Securitizations and Transfers of Financial Instruments**

         Lucent may sell trade and notes receivables with orwithout recourse and/or discounts in the normal course of business. The receivables are removed from the consolidated balance sheet at the time theyare sold. Sales and transfers that do not meet the criteria for surrender of control are accounted for as secured borrowings.

         The value assigned to undivided interests retained insecuritized trade receivables is based on the relative fair values of the interests retained and sold in the securitization. Fair values are measured by thepresent value of estimated future cash flows of the securitization facility. See Note 15 for further discussions on securitizations and transfers offinancial instruments.

**Goodwill and Other Acquired Intangibles**

         Goodwill and other acquired intangibles areamortized on a straight-line basis over the periods benefited, principally in the range of five to seven years. Goodwill is the excess of the purchaseprice over the fair value of identifiable net assets acquired in business combinations accounted for as purchases.

**Impairment of Goodwill and Other Long-Lived Assets**

         Goodwill and other long-lived assets are reviewed forimpairment whenever events such as product discontinuances, plant closures, product dispositions or other changes in circumstances indicate that thecarrying amount may not be recoverable. When such events occur, Lucent compares the carrying amount of the assets with undiscounted expectedfuture cash flows. If this comparison indicates that there is an impairment, the amount of the impairment is typically calculated using discountedexpected future cash flows. The discount rate applied to these cash flows is based on Lucent’s weighted average cost of capital, whichrepresents the blended after-tax costs of debt and equity.

**Reclassifications**

         Certain prior-year amounts have been reclassified toconform to the fiscal 2002 presentation.
27
**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**2. BUSINESS RESTRUCTURING CHARGES AND ASSET IMPAIRMENTS, NET**

***Fiscal 2002***

         In fiscal 2002, due to the continuing decline anduncertainty in the telecommunications market, Lucent committed to additional restructuring actions to align the business with market conditions thatresulted in net business restructuring charges and asset impairments of $1,341. Since Lucent’s restructuring program is an aggregation of manyindividual plans that are currently being executed, actual costs have differed from estimated amounts. The fiscal 2002 charges were primarilycomprised of headcount reductions, facility consolidations and property, plant and equipment write-downs. Business restructuring charges and assetimpairments, net for fiscal 2002 and 2001, are recorded as a separate line item in the consolidated statements of operations, except for inventorycharges which are included in costs.

         Lucent continues to evaluate the current restructuringreserve as plans are being executed. As a result, there may be additional charges or reversals. This table displays the activity of the restructuringreserve for fiscal 2002, the balance at September 30, 2002, and the components of the net charges for fiscal 2002:
*Revisions to fiscal**2001plans**Sept. 30,**2001**reserve**Fiscal**2002**charge**charge**reversal**Net**charge/**(reversal)**Deductions**Sept. 30,**2002**reserve*Employee separations $588 $944 $5 $(150)$799(a)$(1,020)(a)$367 Contract settlements  610  90  18  (201) (93) (367) 150 Facility closings  296  210  123  (32) 301  (114) 483 Other  125  34  2  (20) 16  (72) 69 Total restructuring costs $1,619 $1,278 $148 $(403)$1,023 $(1,573)(b)**$****1,069**                                             Total asset write-downs    $536 $148 $(226)$458(c)      Net gains on sales     (140) —  —  (140)      Total net charges on business     restructuring    $1,674 $296 $(629)$1,341       Impairment of goodwill and     other assets    $975  —  — $975       **Total**    **$****2,649** **$****296** **$****(629****)****$****2,316**(d)        (a) Includes charges for pension termination benefits of $241, of which $205 are non-cash charges for certain U.S.employees expected to be funded through Lucent’s pension assets; pension and postretirement benefit curtailment charges of $337 andpostemployment benefit curtailment credits of $34.  (b) Includes cash payments of $1,022 and other non-cash settlements.  (c) At September 30, 2002, the remaining restructuring reserve for inventory was $129.  (d) Net inventory charges of $64 was included in costs.
         The components of the fiscal 2002 net chargeincluded:
**•** employee separation charges were associated with approximately 15,100 employees.Revisions for fiscal 2001 employee separation reserves were due to higher than expected attrition rates that resulted in a reduction in expectedterminations by 2,200 employees. Also, the actual severance cost per person was lower than the original estimates after execution of the variousplans in many countries. Including the 15,100 headcount reductions, the total voluntary and involuntary employee separations associated with theemployee separations net charges recorded in fiscal 2001 and 2002 were 54,300. As of September 30, 2002, approximately 42,200 separationswere completed. The completed and future employee separations affect all business groups and geographic regions. Approximately 70% of theseseparations were related to management employees and were involuntary. The majority of the remaining separations are expected to be completedby theend of the second quarter of fiscal 2003. In addition, since December 31, 2000, 16,600 employee separations have occurred through attrition anddivestitures of businesses;**•** contract settlement charges were for settlements of purchase commitments with suppliersand contract renegotiations or cancellations of contracts with customers, all of which resulted from the discontinuance of various product lines.Revisions to fiscal 2001 plans were primarily for settling certain purchase commitments for amounts lower than originallyplanned;**•** fiscal 2002 charges for facility closings represented the expected remaining future cashoutlays associated with trailing lease liabilities, lease termination payments and expected restoration costs, net of expected sublease income of $136.Revisions to fiscal 2001 plans were primarily due to additional space consolidation as well as changes in estimates for the amount and timing ofexpected sublease rental income of $63 as a result of changes in the current commercial real estate market. As part of the fiscal 2001 and 2002restructuring actions, charges were recognized in connection with plans to reduce a significant number of owned and leased facilities, totalingapproximately 16.6 million square feet. As of September 30, 2002, owned and leased sites aggregating 12.0 million square feet have been exited andthe remaining sites are expected to be exited during fiscal 2003;28
**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**
**•** net asset write-downs for fiscal 2002 included property, plant and equipment write-downsof $304 primarily related to facility closings and product rationalizations, capitalized software of $72, inventory charges of $129, that were associatedwith product exits in certain switching and access and optical networking products in the Integrated Network Solutions (“INS”)segment, goodwill and other acquired intangibles write-down of $22 and other charges of $9. Net revisions to fiscal 2001 plans were primarilyrelated to adjustments to estimated inventory charges. In establishing the initial charge for inventory, Lucent included an estimate of amounts relatingto products rationalized or discontinued that were not required to fulfill existing customer obligations. To the extent the fulfillment of those customerobligations differed from amounts estimated, additional inventory charges or reserve reductions were required; and**•** net gains on sales included $193 of gains primarily related to the sale of the billing andcustomer care business and losses of $53 which were primarily related to the sale of the enterprise professional services business. Net gains on salesare included in business restructuring if the disposition of these businesses was contemplated as part of Lucent’s overall restructuringprogram.
**Impairment of goodwill and other assets**

         The continued and recently sharper decline in thetelecommunications market prompted an assessment of all key assumptions underlying goodwill valuation judgments, including those relating to short-and long-term growth rates. As a result of the analysis, Lucent determined that impairment charges of $975 were required because the forecastedundiscounted cash flows were less than the book values of the goodwill and other intangible assets of certain businesses. The charges were measuredon the basis of comparison of estimated fair values with corresponding book values and related primarily to goodwill recorded in connection with theSeptember 2000 acquisition of Spring Tide. Fair values were determined on the basis of discounted cash flows.

***Fiscal 2001***

         In fiscal 2001, Lucent committed to variousrestructuring actions in which it exited certain non-strategic wireless, optical networking and switching and access product lines and streamlined itscost structure in various businesses and corporate operations. This resulted in a pre-tax charge to earnings totaling $11,416 for fiscal2001.

         This table displays the components of the fiscal 2001charge, the activity of the restructuring reserve for fiscal 2001, and the balance at September 30, 2001:
*Fiscal**2001**charge**Deductions**September 30,**2001**reserve*Employee separations $3,440 $(2,852)(a)$588 Contract settlements  944  (334) 610 Facility closings  304  (8) 296 Other  79  46(b) 125 Total restructuring costs $4,767 $(3,148)(c)$1,619 Total asset write-downs $6,649(d)      **Total** **$****11,416**(e)        (a) Includes non-cash charges of $2,113 for net pension and postretirement termination benefits to certain U.S.employeesexpected to be funded through Lucent’s pension assets, $632 for pension and postretirement benefit curtailment charges and $72 forpostemployment benefit curtailment credits.  (b) Includes proceeds from the sale of a product line.  (c) Includes cash payments of $531 at September 30, 2001.  (d) At September 30, 2001, the remaining restructuring reserve for inventory was $689.  (e) Net inventory charges of $1,259 was included in costs.
         The components of the fiscal 2001 chargeincluded:
**•** employee separation charges for approximately 39,200 employees, including 8,500related to a voluntary early-retirement offer to qualified U.S. paid management employees. During fiscal 2001, approximately 23,700 separationswere completed;**•** contract settlement charges consisted of settlements of purchase commitments withsuppliers of $508 and contract renegotiations or cancellations of contracts with customers of $436. Approximately 50% of total purchasecommitments related to the rationalization of certain optical networking products, including charges relating to the discontinuance of the Chromatisproduct portfolio. Customer settlements included charges associated with switching and access product rationalizations and Lucent’s strategicdecision to limit its investment in research and development in certain wireless technologies;**•** facility closings charges represented the expected remaining future cash outlays associatedwith trailing lease liabilities, lease termination payments and expected restoration costs, net of expected sublease income of $241;and29
**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**
**•** asset write-downs primarily related to the write-down of goodwill and other acquiredintangibles of $4,081 and inventory charges of $1,259. Impairment losses related to the write-down of goodwill and other acquired intangibles wereestimated by discounting the expected future cash flows. These impairment charges largely relate to the write-off of $3,707 of goodwill relating to thediscontinuance of the Chromatis product portfolio, the write-off of acquired intangibles related to the impairment of Lucent’s TeraBeaminvestment and rationalizations of products associated with the DeltaKabel, Stratus and Ignitus acquisitions. Inventory write-downs resulted primarilyfrom optical networking, switching, access and wireless product rationalizations and discontinuances. The remainder of the asset write-downsconsisted of property, plant and equipment of $425, capitalized software of $362 and other assets of $522 associated withLucent’s product and system rationalizations resulting in sales of assets, closures and consolidation of offices, research and developmentfacilities and factories.
**3. DISCONTINUED OPERATIONS**

         On June 1, 2002, Lucent completed the spinoff ofAgere Systems Inc. (“Agere”), Lucent’s microelectronics business, by distributing its remaining 37.0 million shares of AgereClass A common stock and 908.1 million shares of Agere Class B common stock to Lucent common shareowners of record on May 3, 2002. EachLucent shareowner received one share of Agere Class A common stock for every 92.768991 shares of Lucent’s common stock held and oneshare of Agere Class B common stock for every 3.779818 shares of Lucent’s common stock held. The historical carrying amount of the netassets transferred to Agere of $1,191 was recorded as a reduction to shareowners’ (deficit) equity.

         On April 2, 2001, Agere, completed an initial publicoffering (“IPO”) of 600 million shares of Class A common stock, resulting in net proceeds of $3,440 to Agere.As a result of the IPOand the planned spinoff of Agere, Lucent recorded an increase to shareowners’ equity of $922 in fiscal 2001. In addition, on April 2, 2001,Morgan Stanley exercised its overallotment option to purchase an additional 90 million shares of Agere Class A common stock from Lucent. MorganStanley exchanged $519 of Lucent commercial paper for the Agere common shares. This transaction resulted in a gain of $141, which was includedin the loss on disposal of Agere in fiscal 2001. After the exercise of the overallotment option by Morgan Stanley and before the spinoff, Lucentowned 57.8% of Agere common stock.

         On December 29, 2000, Lucent completed the saleof its power systems business (see Note 4).

         On September 30, 2000, Lucent completed thespinoff of Avaya Inc., Lucent’s former enterprise networks business, in a tax-free distribution to its shareowners. The historical carryingamount of the net assets transferred to Avaya was recorded as a reduction to shareowners’ equity of $1,009. As a result of the final transferof assets and liabilities to Avaya, the stock dividend was adjusted by $47 and reflected as a reduction to additional paid-in capital during fiscal 2001.Summarized results of operations for discontinued operations are as follows:
*Years ended September 30,***2002****2001****2000****REVENUES**          Agere and powersystems $1,247 $3,838 $4,909 Avaya  —  —  7,607  |