AS FILED WITH THE SEC ON May 9,
2006

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington,
D.C. 20549

FORM 10-Q

xQUARTERLY REPORT PURSUANT TO
SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2006

OR

oTRANSITION REPORT PURSUANT TO
SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from
________________to ________________

Commission file
number 001-11639

LUCENT TECHNOLOGIES INC.

| |             |  |                
| | ----------- |  | ---------------
| | A Delaware  |  | I.R.S. Employer
| | Corporation |  | No. 22-3408857 

|                                                    
|----------------------------------------------------
|600
  Mountain Avenue, Murray Hill, New Jersey 07974
|                                                    
|Telephone
  Number: 908-582-8500                    

Indicate by check mark whether the registrant
(1) has filed all reports required to be filed by Section 13 or 15(d) of the
Securities Exchange Act of 1934 during the preceding 12 months (or for such
shorter period that the registrant was required to file such reports), and (2)
has been subject to such filing requirements for the past 90 days. Yes xNoo

Indicate by check mark whether the registrant
is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes xNoo

At April 30, 2006, 4,479,915,613 common shares were
  outstanding.

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|         |                   
|-------- | ------------------
|<PAGE> 2 | Form 10-Q - Part I

INDEX

|                                |                                                                                                    |  |   
|------------------------------- | -------------------------------------------------------------------------------------------------- |  | --
|Part I  Financial Information: |                                                                                                    | 
|                                |                                                                                                    |  |   
|Item 1.                         | Financial Statements                                                                               |  |   
|                                |                                                                                                    |  |   
|                                | Consolidated Statements of Operations for
  the Three and Six Months Ended March 31, 2006 and 2005 |  | 3 
|                                |                                                                                                    |  |   
|                                | Consolidated Balance Sheets as of March 31,
  2006 and September 30, 2005                          |  | 4 
|                                |                                                                                                    |  |   
|                                | Consolidated Statement of Changes in
  Shareowners Equity for the Six Months Ended March 31, 2006 |  | 5 
|                                |                                                                                                    |  |   
|                                | Consolidated Statements of Cash Flows for
  the Six Months Ended March 31, 2006 and 2005           |  | 6 
|                                |                                                                                                    |  |   
|                                | Notes to Consolidated Financial Statements                                                         |  | 7 
|                                |                                                                                                    |  |   
|Item 2.                         | Managements Discussion and Analysis of
  Financial Condition and Results of Operations            |  | 21
|                                |                                                                                                    |  |   
|Item 3.                         | Quantitative and Qualitative Disclosures
  About Market Risk                                       |  | 37
|                                |                                                                                                    |  |   
|Item 4.                         | Controls and Procedures                                                                            |  | 38
|                                |                                                                                                    |  |   
|Part II  Other Information:    |                                                                                                    | 
|                                |                                                                                                    |  |   
|Item 1.                         | Legal Proceedings                                                                                  |  | 39
|                                |                                                                                                    |  |   
|Item 4.                         | Submission of Matters to a Vote of Security
  Holders                                              |  | 39
|                                |                                                                                                    |  |   
|Item 6.                         | Exhibits                                                                                           |  | 39

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|         |                   
|-------- | ------------------
|<PAGE> 3 | Form 10-Q - Part I

PART 1 -
Financial Information

Item 1. Financial Statements

LUCENT TECHNOLOGIES INC. AND
SUBSIDIARIESCONSOLIDATED STATEMENTS OF OPERATIONS
(Amounts in Millions, Except Per Share Amounts)(Unaudited)

|                                              |  |                               |       |                              |   |       |   |      |       |   |   |       |  
|--------------------------------------------- |  | ----------------------------- | ----- | ---------------------------- | - | ----- | - | ---- | ----- | - | - | ----- | -
|                                              |  | Three months
  endedMarch 31, |       | Six months ended
  March 31, |  
|                                              |  | 2006                          |       | 2005                         |   | 2006  |   | 2005 |      
|                                              |  |                               |       |                              |   |       |   |      |      
|Revenues:                                     |  |                               |       |                              |   |       |   |      |       |   |   |       |  
|Products                                      |  | $                             | 1,590 |                              | $ | 1,815 |   | $    | 3,097 |   | $ | 3,602 |  
|Services                                      |  |                               | 548   |                              |   | 520   |   |      | 1,088 |   |   | 1,068 |  
|                                              |  |                               |       |                              |   |       |   |      |       |   |   |       |  
|Total revenues                                |  |                               | 2,138 |                              |   | 2,335 |   |      | 4,185 |   |   | 4,670 |  
|                                              |  |                               |       |                              |   |       |   |      |       |   |   |       |  
|Costs:                                        |  |                               |       |                              |   |       |   |      |       |   |   |       |  
|Products                                      |  |                               | 775   |                              |   | 974   |   |      | 1,579 |   |   | 1,924 |  
|Services                                      |  |                               | 437   |                              |   | 386   |   |      | 829   |   |   | 787   |  
|                                              |  |                               |       |                              |   |       |   |      |       |   |   |       |  
|Total costs                                   |  |                               | 1,212 |                              |   | 1,360 |   |      | 2,408 |   |   | 2,711 |  
|                                              |  |                               |       |                              |   |       |   |      |       |   |   |       |  
|Gross margin                                  |  |                               | 926   |                              |   | 975   |   |      | 1,777 |   |   | 1,959 |  
|Operating
  expenses:                         |  |                               |       |                              |   |       |   |      |       |   |   |       |  
|Selling, general and
administrative           |  |                               | 384   |                              |   | 423   |   |      | 1,040 |   |   | 808   |  
|Research and development                      |  |                               | 297   |                              |   | 292   |   |      | 580   |   |   | 571   |  
|Business restructuring                        |  |                               | (4    | )                            |   | (8    | ) |      | (3    | ) |   | (7    | )
|                                              |  |                               |       |                              |   |       |   |      |       |   |   |       |  
|Total operating expenses                      |  |                               | 677   |                              |   | 707   |   |      | 1,617 |   |   | 1,372 |  
|                                              |  |                               |       |                              |   |       |   |      |       |   |   |       |  
|Operating income                              |  |                               | 249   |                              |   | 268   |   |      | 160   |   |   | 587   |  
|Other income
  (expense), net                 |  |                               | 45    |                              |   | 43    |   |      | 129   |   |   | (3    | )
|Interest expense                              |  |                               | 82    |                              |   | 85    |   |      | 165   |   |   | 174   |  
|                                              |  |                               |       |                              |   |       |   |      |       |   |   |       |  
|Income
  before income taxes                  |  |                               | 212   |                              |   | 226   |   |      | 124   |   |   | 410   |  
|Income
  taxes                                |  |                               | 31    |                              |   | (41   | ) |      | 47    |   |   | (31   | )
|                                              |  |                               |       |                              |   |       |   |      |       |   |   |       |  
|Net income                                    |  | $                             | 181   |                              | $ | 267   |   | $    | 77    |   | $ | 441   |  
|                                              |  |                               |       |                              |   |       |   |      |       |   |   |       |  
|                                              |  |                               |       |                              |   |       |   |      |       |   |   |       |  
|Net income per
  share:                       |  |                               |       |                              |   |       |   |      |       |   |   |       |  
|Basic                                         |  | $                             | 0.04  |                              | $ | 0.06  |   | $    | 0.02  |   | $ | 0.10  |  
|Diluted                                       |  | $                             | 0.04  |                              | $ | 0.06  |   | $    | 0.02  |   | $ | 0.09  |  
|Weighted
  average common shares outstanding: |  |                               |       |                              |   |       |   |      |       |   |   |       |  
|Basic                                         |  |                               | 4,463 |                              |   | 4,421 |   |      | 4,457 |   |   | 4,412 |  
|Diluted                                       |  |                               | 5,128 |                              |   | 5,047 |   |      | 4,509 |   |   | 5,013 |  

See Notes to Unaudited Consolidated Financial
Statements.

---



|         |                   
|-------- | ------------------
|<PAGE> 4 | Form 10-Q - Part I

LUCENT TECHNOLOGIES INC. AND SUBSIDIARIESCONSOLIDATED BALANCE SHEETS
(Amounts in Millions, Except Per Share Amounts)
(Unaudited)

|                                                                                                                                                                                                                |  |                  |         |                      |   |         |  
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ---------------- | ------- | -------------------- | - | ------- | -
|                                                                                                                                                                                                                |  | March 31,
  2006 |         | September 30,
  2005 |  
|                                                                                                                                                                                                                |  |                  |         |                      |  
|ASSETS                                                                                                                                                                                                          |  |                  |         |                      |   |         |  
|Cash and cash equivalents                                                                                                                                                                                       |  | $                | 1,377   |                      | $ | 2,410   |  
|Marketable securities                                                                                                                                                                                           |  |                  | 479     |                      |   | 357     |  
|Receivables, net                                                                                                                                                                                                |  |                  | 1,390   |                      |   | 1,395   |  
|Inventories                                                                                                                                                                                                     |  |                  | 763     |                      |   | 731     |  
|Other current assets                                                                                                                                                                                            |  |                  | 991     |                      |   | 690     |  
|                                                                                                                                                                                                                |  |                  |         |                      |   |         |  
|Total current assets                                                                                                                                                                                            |  |                  | 5,000   |                      |   | 5,583   |  
|Marketable securities                                                                                                                                                                                           |  |                  | 2,113   |                      |   | 2,163   |  
|Property, plant and equipment, net                                                                                                                                                                              |  |                  | 1,247   |                      |   | 1,295   |  
|Prepaid pension costs                                                                                                                                                                                           |  |                  | 6,319   |                      |   | 6,010   |  
|Goodwill and other acquired intangibles,
  net                                                                                                                                                                  |  |                  | 439     |                      |   | 419     |  
|Other assets                                                                                                                                                                                                    |  |                  | 911     |                      |   | 930     |  
|                                                                                                                                                                                                                |  |                  |         |                      |   |         |  
|Total assets                                                                                                                                                                                                    |  | $                | 16,029  |                      | $ | 16,400  |  
|                                                                                                                                                                                                                |  |                  |         |                      |   |         |  
|LIABILITIES                                                                                                                                                                                                     |  |                  |         |                      |   |         |  
|Accounts payable                                                                                                                                                                                                |  | $                | 621     |                      | $ | 769     |  
|Payroll and benefit-related liabilities                                                                                                                                                                         |  |                  | 879     |                      |   | 1,095   |  
|Debt maturing within one year                                                                                                                                                                                   |  |                  | 368     |                      |   | 368     |  
|Other current liabilities                                                                                                                                                                                       |  |                  | 1,684   |                      |   | 1,588   |  
|                                                                                                                                                                                                                |  |                  |         |                      |   |         |  
|Total current liabilities                                                                                                                                                                                       |  |                  | 3,552   |                      |   | 3,820   |  
|Postretirement and postemployment benefit
  liabilities                                                                                                                                                         |  |                  | 4,683   |                      |   | 4,751   |  
|Pension liabilities                                                                                                                                                                                             |  |                  | 1,342   |                      |   | 1,423   |  
|Long-term debt                                                                                                                                                                                                  |  |                  | 5,047   |                      |   | 5,066   |  
|Other liabilities                                                                                                                                                                                               |  |                  | 850     |                      |   | 965     |  
|                                                                                                                                                                                                                |  |                  |         |                      |   |         |  
|Total liabilities                                                                                                                                                                                               |  |                  | 15,474  |                      |   | 16,025  |  
|                                                                                                                                                                                                                |  |                  |         |                      |   |         |  
|Commitments and contingencies                                                                                                                                                                                   |  |                  |         |                      |   |         |  
|                                                                                                                                                                                                                |  |                  |         |                      |   |         |  
|SHAREOWNERS
  EQUITY                                                                                                                                                                                           |  |                  |         |                      |   |         |  
|Preferred stock par value $1.00 per share;
  authorized shares: 250; issued and outstanding: none                                                                                                              |  |                  |        |                      |   |        |  
|Common stock par value $.01 per share;
  authorized shares: 10,000; 4,478 issued and 4,477 outstanding shares as of
  March 31, 2006, and 4,457 issued and 4,447 outstanding shares as of September
  30, 2005 |  |                  | 45      |                      |   | 45      |  
|Additional paid-in capital                                                                                                                                                                                      |  |                  | 23,615  |                      |   | 23,513  |  
|Accumulated deficit                                                                                                                                                                                             |  |                  | (19,531 | )                    |   | (19,608 | )
|Accumulated other comprehensive loss                                                                                                                                                                            |  |                  | (3,574  | )                    |   | (3,575  | )
|                                                                                                                                                                                                                |  |                  |         |                      |   |         |  
|Total shareowners equity                                                                                                                                                                                       |  |                  | 555     |                      |   | 375     |  
|                                                                                                                                                                                                                |  |                  |         |                      |   |         |  
|Total liabilities and shareowners
equity                                                                                                                                                                       |  | $                | 16,029  |                      | $ | 16,400  |  
|                                                                                                                                                                                                                |  |                  |         |                      |   |         |  

See Notes to Unaudited
Consolidated Financial Statements.

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|         |                   
|-------- | ------------------
|<PAGE> 5 | Form 10-Q - Part I

LUCENT TECHNOLOGIES INC. AND SUBSIDIARIESCONSOLIDATED STATEMENT OF
CHANGES IN SHAREOWNERS EQUITY
(Amounts in Millions)
(Unaudited)

|                                                             |  |                            |       |                |   |                                |  |                       |        |                                            |   |                               |   |   |        |   |   |     |  
|------------------------------------------------------------ |  | -------------------------- | ----- | -------------- | - | ------------------------------ |  | --------------------- | ------ | ------------------------------------------ | - | ----------------------------- | - | - | ------ | - | - | --- | -
|                                                             |  | Shares of
  Common
  Stock |       | Common
  Stock |   | Additional
  Paid-In
  Capital |  | Accumulated
  Deficit |        | Accumulated
  Other
  Comprehensive
  Loss |   | Total
  Shareowners
  Equity |  
|                                                             |  |                            |       |                |   |                                |  |                       |        |                                            |   |                               |  
|Balance as of September 30, 2005                             |  |                            | 4,447 |                | $ | 45                             |  | $                     | 23,513 |                                            | $ | (19,608                       | ) | $ | (3,575 | ) | $ | 375 |  
|Net income                                                   |  |                            |       |                |   |                                |  |                       |        |                                            |   | 77                            |   |   |        |   |   | 77  |  
|Foreign currency translation adjustments                     |  |                            |       |                |   |                                |  |                       |        |                                            |   |                               |   |   | 6      |   |   | 6   |  
|Unrealized holding losses on investments                     |  |                            |       |                |   |                                |  |                       |        |                                            |   |                               |   |   | (5     | ) |   | (5  | )
|Issuance of common stock related to
  employee benefit plans |  |                            | 19    |                |   |                                |  |                       | 34     |                                            |   |                               |   |   |        |   |   | 34  |  
|Stock-based compensation                                     |  |                            | 2     |                |   |                                |  |                       | 42     |                                            |   |                               |   |   |        |   |   | 42  |  
|Release of Telica escrow shares                              |  |                            | 9     |                |   |                                |  |                       | 29     |                                            |   |                               |   |   |        |   |   | 29  |  
|Other                                                        |  |                            |       |                |   |                                |  |                       | (3     | )                                          |   |                               |   |   |        |   |   | (3  | )
|                                                             |  |                            |       |                |   |                                |  |                       |        |                                            |   |                               |   |   |        |   |   |     |  
|Balance as of March 31, 2006                                 |  |                            | 4,477 |                | $ | 45                             |  | $                     | 23,615 |                                            | $ | (19,531                       | ) | $ | (3,574 | ) | $ | 555 |  
|                                                             |  |                            |       |                |   |                                |  |                       |        |                                            |   |                               |   |   |        |   |   |     |  

See Notes
to Unaudited Consolidated Financial Statements.

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|         |                   
|-------- | ------------------
|<PAGE> 6 | Form 10-Q - Part I

LUCENT TECHNOLOGIES INC. AND
SUBSIDIARIESCONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in Millions)
(Unaudited)

|                                                                                |  |                              |        |      |   |        |  
|------------------------------------------------------------------------------- |  | ---------------------------- | ------ | ---- | - | ------ | -
|                                                                                |  | Six Months ended
  March 31, |       
|                                                                                |  | 2006                         |        | 2005 |  
|                                                                                |  |                              |        |      |  
|Operating activities:                                                           |  |                              |        |      |   |        |  
|Net income                                                                      |  | $                            | 77     |      | $ | 441    |  
|Adjustments to reconcile net income to net cash used in
operating
  activities: |  |                              |        |      |   |        |  
|Depreciation and amortization                                                   |  |                              | 259    |      |   | 310    |  
|Pension credit                                                                  |  |                              | (329   | )    |   | (486   | )
|Stock-based compensation expense                                                |  |                              | 44     |      |   | 14     |  
|Other adjustments for non-cash items                                            |  |                              | (25    | )    |   | 60     |  
|Changes in operating assets and liabilities:                                    |  |                              |        |      |   |        |  
|Receivables                                                                     |  |                              | (20    | )    |   | (150   | )
|Inventories and contracts in process                                            |  |                              | (60    | )    |   | (23    | )
|Accounts payable                                                                |  |                              | (119   | )    |   | (151   | )
|Deferred revenue                                                                |  |                              | 16     |      |   | 112    |  
|Other operating assets and liabilities                                          |  |                              | (408   | )    |   | (803   | )
|                                                                                |  |                              |        |      |   |        |  
|Net cash used in operating activities                                           |  |                              | (565   | )    |   | (676   | )
|                                                                                |  |                              |        |      |   |        |  
|                                                                                |  |                              |        |      |   |        |  
|Investing activities:                                                           |  |                              |        |      |   |        |  
|Capital expenditures                                                            |  |                              | (84    | )    |   | (77    | )
|Net purchases of marketable securities                                          |  |                              | (81    | )    |   | (662   | )
|Changes in restricted cash                                                      |  |                              | (324   | )    |   |       |  
|Other investing activities                                                      |  |                              | (2     | )    |   |       |  
|                                                                                |  |                              |        |      |   |        |  
|Net cash used in investing activities                                           |  |                              | (491   | )    |   | (739   | )
|                                                                                |  |                              |        |      |   |        |  
|                                                                                |  |                              |        |      |   |        |  
|Financing activities:                                                           |  |                              |        |      |   |        |  
|Repayment of long-term debt                                                     |  |                              | (15    | )    |   | (101   | )
|Issuance of common stock                                                        |  |                              | 34     |      |   | 85     |  
|Other financing activities                                                      |  |                              |       |      |   | 4      |  
|                                                                                |  |                              |        |      |   |        |  
|Net cash provided by (used in) financing
activities                             |  |                              | 19     |      |   | (12    | )
|Effect of exchange rate changes on cash and cash
equivalents                    |  |                              | 4      |      |   | 15     |  
|                                                                                |  |                              |        |      |   |        |  
|Net decrease in cash and cash equivalents                                       |  |                              | (1,033 | )    |   | (1,412 | )
|Cash and cash equivalents at beginning of year                                  |  |                              | 2,410  |      |   | 3,379  |  
|                                                                                |  |                              |        |      |   |        |  
|Cash and cash equivalents at end of period                                      |  | $                            | 1,377  |      | $ | 1,967  |  
|                                                                                |  |                              |        |      |   |        |  
|                                                                                |  |                              |        |      |   |        |  
|Income tax payments, net                                                        |  | $                            | (6     | )    | $ | (58    | )
|Interest payments                                                               |  | $                            | (157   | )    | $ | (174   | )

See Notes to Unaudited Consolidated Financial Statements.

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|         |                   
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|<PAGE> 7 | Form 10-Q - Part I

Notes to Consolidated Financial Statements
(Unaudited)

1. BASIS OF PRESENTATION

Lucent Technologies Inc.s (referred
to in this report as the Company, we, us, our or Lucent) unaudited
consolidated financial statements reflect
all adjustments (consisting of normal recurring accruals) that are considered
necessary for a fair presentation of consolidated results of operations,
financial position and cash flows as of and for the periods presented.  Certain reclassifications were made to
conform to the current period presentation.

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

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

The results for
the periods presented are not necessarily indicative of the results for the
full year and should be read in conjunction with the audited consolidated
financial statements for the year ended September 30, 2005 included in our
Current Report on Form 8-K, filed on May 5, 2006.

2. MERGER AGREEMENT WITH ALCATEL

On April 2, 2006, Lucent and Alcatel entered into an
  Agreement and Plan of Merger (the Merger Agreement), pursuant to
  which Lucent and Alcatel will combine their businesses through a merger. Under
  the terms of the Merger Agreement, each Lucent share will be converted into
  a right to receive 0.1952 of an American Depository Share (ADS) of Alcatel,
  with each Alcatel ADS representing one ordinary share of Alcatel. The completion
  of the merger, subject to various closing conditions, including obtaining the
  approval of Lucent and Alcatel shareholders, receiving antitrust and other regulatory
  approvals and decisions, is expected to close within 6-12 months. The merger
  is intended to qualify as a reorganization for federal income tax purposes.
  If the merger agreement is terminated under certain circumstances specified
  in the Merger Agreement, Lucent or Alcatel will be required to pay the other
  a termination fee of $250 million or $500 million, depending upon certain criteria.
  The terms of the Merger Agreement also include certain restrictions or limitations
  on future transactions of the Company prior to the closing of the merger, including
  acquisitions or dispositions, additional borrowings or customer financing, issuance
  of equity and changes in employee benefit plans. The terms of certain contracts,
  employee benefit arrangements and debt agreements have provisions which could
  result in changes to the terms or settlement amounts upon a change in control
  of Lucent.

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|         |                   
|-------- | ------------------
|<PAGE> 8 | Form 10-Q - Part I

Notes to
Consolidated Financial Statements
(Unaudited)

3. PENSION AND POSTRETIREMENT BENEFITS

The following tables summarize the
components of the pension and postretirement benefits:

|                                   |  |                              |      |                            |   |      |   |      |        |   |   |        |  
|---------------------------------- |  | ---------------------------- | ---- | -------------------------- | - | ---- | - | ---- | ------ | - | - | ------ | -
|                                   |  | Pension benefits             |     
|                                   |  | Three months ended March 31, |      | Six months ended March 31, |  
|(in millions)                      |  | 2006                         |      | 2005                       |   | 2006 |   | 2005 |       
|                                   |  |                              |      |                            |   |      |   |      |       
|Service cost                       |  | $                            | 38   |                            | $ | 40   |   | $    | 77     |   | $ | 79     |  
|Interest cost                      |  |                              | 411  |                            |   | 414  |   |      | 821    |   |   | 828    |  
|Expected return on plan assets     |  |                              | (680 | )                          |   | (726 | ) |      | (1,364 | ) |   | (1,448 | )
|Amortization of prior service cost |  |                              | 15   |                            |   | 23   |   |      | 29     |   |   | 42     |  
|Amortization of actuarial losses   |  |                              | 54   |                            |   | 4    |   |      | 108    |   |   | 9      |  
|                                   |  |                              |      |                            |   |      |   |      |        |   |   |        |  
|Subtotal                           |  |                              | (162 | )                          |   | (245 | ) |      | (329   | ) |   | (490   | )
|Settlements                        |  |                              |     |                            |   |     |   |      |       |   |   | 3      |  
|Terminations benefits              |  |                              |     |                            |   | 1    |   |      |       |   |   | 1      |  
|                                   |  |                              |      |                            |   |      |   |      |        |   |   |        |  
|Benefit credit                     |  | $                            | (162 | )                          | $ | (244 | ) | $    | (329   | ) | $ | (486   | )
|                                   |  |                              |      |                            |   |      |   |      |        |   |   |        |  

|                                   |  |                              |     |                            |   |      |   |      |     |   |   |     |  
|---------------------------------- |  | ---------------------------- | --- | -------------------------- | - | ---- | - | ---- | --- | - | - | --- | -
|                                   |  | Postretirement benefits      |    
|                                   |  | Three months ended March 31, |     | Six months ended March 31, |  
|(in millions)                      |  | 2006                         |     | 2005                       |   | 2006 |   | 2005 |    
|                                   |  |                              |     |                            |   |      |   |      |    
|Service cost                       |  | $                            | 1   |                            | $ | 2    |   | $    | 3   |   | $ | 4   |  
|Interest cost                      |  |                              | 79  |                            |   | 85   |   |      | 158 |   |   | 170 |  
|Expected return on plan assets     |  |                              | (17 | )                          |   | (24  | ) |      | (33 | ) |   | (49 | )
|Amortization of prior service cost |  |                              | (17 | )                          |   | (7   | ) |      | (35 | ) |   | (9  | )
|Amortization of actuarial losses   |  |                              | 2   |                            |   | 8    |   |      | 18  |   |   | 15  |  
|                                   |  |                              |     |                            |   |      |   |      |     |   |   |     |  
|Benefit cost                       |  | $                            | 48  |                            | $ | 64   |   | $    | 111 |   | $ | 131 |  
|                                   |  |                              |     |                            |   |      |   |      |     |   |   |     |  

4. STOCK-BASED COMPENSATION

Effective October 1, 2005, we
adopted Statement of Financial Accounting Standards (SFAS) No. 123R, Share
Based Payment.  We elected to use the
modified prospective transition method, therefore, prior period results were
not restated.  Prior to the adoption of
SFAS 123R, stock-based compensation expense related to stock options was not
recognized in the results of operations if the exercise price was at least
equal to the market value of the common stock on the grant date, in accordance
with Accounting Principles Board Opinion No. 25, Accounting for Stock Issued
to Employees.  As a result, the
recognition of stock-based compensation expense was generally limited to the
expense attributed to restricted stock unit awards and stock option
modifications, as well as the amortization of certain acquisition-related
deferred compensation.

SFAS 123R requires all share-based payments to
employees, including grants of employee stock options, to be recognized as
compensation expense over the service period (generally the vesting period) in
the consolidated financial statements based on their fair values.  For options with graded vesting, we value
the stock option grants and recognize compensation expense as if each vesting
portion of the award was a separate award.
Under the modified prospective method, awards that were granted,
modified, or settled on or after October 1, 2005 are measured and accounted for
in accordance with SFAS 123R.  Unvested
equity-classified awards that were granted prior to October 1, 2005 will
continue to be accounted for in accordance with SFAS 123, except that all
awards are recognized in the results of operations over the remaining vesting
periods.  The impact of forfeitures that
may occur prior to vesting is also estimated and considered in the amount
recognized.  In addition, the
realization of tax benefits in excess of amounts recognized for financial
reporting purposes will be recognized as a financing activity rather than an
operating activity as in the past.

---



|         |                   
|-------- | ------------------
|<PAGE> 9 | Form 10-Q - Part I

Notes to
Consolidated Financial Statements
(Unaudited)

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

Historically, stock options have
been granted to broad groups of employees at most levels on a discretionary
basis.  Beginning in fiscal 2006, employees
at mid-level leadership and below are eligible to receive restricted stock
units (RSUs) instead of stock options.
Employees in more advanced leadership positions (approximately 1,100
employees) continue to be eligible to receive stock options.  In addition, the long-term incentive award
program was modified for the current three-year cycle beginning in fiscal 2006,
to change the denomination of any targeted awards to performance shares for
officers. Performance shares will also represent 25% of any targeted awards for
all other participants.  The
administration of the Employee Stock Purchase Plan (ESPP) was also modified to
reduce the discount from 15% to 5% and eliminate the lookback feature. As a
result, the ESPP is no longer compensatory beginning November 1, 2005.

Stock options are generally granted with an exercise
  price equal to the market value of a share of common stock on the date of grant.
  Stock options also expire within five to 10 years and vest within four years
  from the date of grant. Subsequent to December 2002, stock option grants have
  a term of seven years with graded vesting of 25% per year.

Restricted stock unit awards
generally vest over three to four years. The initial broad-based RSU awards
granted during the first quarter of fiscal 2006 vest ratably over three years.

Performance share awards under the
long-term incentive award program are earned over three years.  The number of shares earned for the
three-year performance cycle is based on achievement of annual financial
targets established at the beginning of each fiscal year in the cycle.  These awards are subject to fair value
adjustments for any changes in the underlying market value of our common stock,
until the performance levels have been determined at the end of each fiscal
year.

The following table summarizes stock
option activity.

|                                     |  |                        |     |                                               |   |       | 
|------------------------------------ |  | ---------------------- | --- | --------------------------------------------- | - | ----- | 
|                                     |  | Shares
  (in millions) |     | Weighted average
  exercise price
  per share |  
|                                     |  |                        |     |                                               |  
|Outstanding as of September 30, 2005 |  |                        | 418 |                                               | $ | 10.50 | 
|Granted/assumed                      |  |                        | 26  |                                               |   | 2.82  | 
|Exercised                            |  |                        | (12 | )                                             |   | 1.64  | 
|Forfeited/expired                    |  |                        | (66 | )                                             |   | 10.70 | 
|                                     |  |                        |     |                                               |   |       | 
|Outstanding as of March 31, 2006     |  |                        | 366 |                                               |   | 10.20 | 
|                                     |  |                        |     |                                               |   |       | 
|                                     |  |                        |     |                                               |   |       | 
|Exercisable as of March 31, 2006     |  |                        | 274 |                                               | $ | 12.55 | 
|                                     |  |                        |     |                                               |   |       | 

The weighted average remaining term for stock options
  outstanding and exercisable was 3.1 years and 2.3 years, respectively, as of
  March 31, 2006. The aggregate intrinsic value for stock options outstanding
  and exercisable was $138 million and $115 million, respectively, as of March
  31, 2006. The intrinsic value of stock options is calculated as the amount by
  which the market price of our common stock exceeds the exercise price of the
  option.

---



|          |                   
|--------- | ------------------
|<PAGE> 10 | Form 10-Q - Part I

Notes to
Consolidated Financial Statements
(Unaudited)

The following table summarizes
unvested restricted stock unit activity.

|                                  |  |                        |    |                                          |   |      | 
|--------------------------------- |  | ---------------------- | -- | ---------------------------------------- | - | ---- | 
|                                  |  | Shares
  (in millions) |    | Weighted average
  grant date fair value |  
|                                  |  |                        |    |                                          |  
|Unvested as of September 30, 2005 |  |                        | 3  |                                          | $ | 4.36 | 
|Granted                           |  |                        | 10 |                                          |   | 2.82 | 
|Vested                            |  |                        | (2 | )                                        |   | 4.50 | 
|Forfeited                         |  |                        | (1 | )                                        |   | 3.18 | 
|                                  |  |                        |    |                                          |   |      | 
|Unvested as of March 31, 2006     |  |                        | 10 |                                          | $ | 3.01 | 
|                                  |  |                        |    |                                          |   |      | 

Proceeds received from the exercise of stock options
  were $19 million and $10 million during the six months ended March 31, 2006
  and 2005, respectively. The intrinsic value related to the exercise of stock
  options was $15 million and $11 million during the six months ended March 31,
  2006 and 2005, respectively, of which the majority is currently deductible for
  tax purposes. However, these tax benefits were not realized due to net operating
  loss carryforwards.

The following table summarizes the pro forma effect of stock-based
compensation as if the fair value method of accounting for stock compensation
had been applied.

|                                                                                                         |  |                    |      |                  |   |      |  
|-------------------------------------------------------------------------------------------------------- |  | ------------------ | ---- | ---------------- | - | ---- | -
|                                                                                                         |  | Three months ended |      | Six months ended |  
|(in millions, except per share amounts)                                                                  |  | March 31, 2005     |      | March 31, 2005   |  
|                                                                                                         |  |                    |      |                  |  
|Net income, as reported                                                                                  |  | $                  | 267  |                  | $ | 441  |  
|Add: Stock-based employee compensation expense included in as reported net income                        |  |                    | 5    |                  |   | 14   |  
|Deduct:
  Total stock-based employee compensation expense determined under the fair
  value based method |  |                    | (80  | )                |   | (166 | )
|                                                                                                         |  |                    |      |                  |   |      |  
|Pro forma net income                                                                                     |  | $                  | 192  |                  | $ | 289  |  
|                                                                                                         |  |                    |      |                  |   |      |  
|Income per
  share applicable to common shareowners:                                                     |  |                    |      |                  |   |      |  
|As
  reported:                                                                                           |  |                    |      |                  |   |      |  
|Basic                                                                                                    |  | $                  | 0.06 |                  | $ | 0.10 |  
|Diluted                                                                                                  |  | $                  | 0.06 |                  | $ | 0.09 |  
|Pro forma:                                                                                               |  |                    |      |                  |   |      |  
|Basic                                                                                                    |  | $                  | 0.04 |                  | $ | 0.07 |  
|Diluted                                                                                                  |  | $                  | 0.04 |                  | $ | 0.06 |  

No tax benefits were attributed to the stock-based compensation expense
because a valuation allowance was maintained for substantially all net deferred
tax assets.  We elected to adopt the
alternative method of calculating the historical pool of windfall tax benefits as
permitted by FASB Staff Position (FSP) No. SFAS 123R-c, Transition Election
Related to Accounting for the Tax Effects of Share-Based Payment Awards.  This is a simplified method to determine the
pool of windfall tax benefits that is used in determining the tax effects of
stock compensation in the results of operations and cash flow reporting for
awards that were outstanding as of the adoption of SFAS 123R.

---



|          |                   
|--------- | ------------------
|<PAGE> 11 | Form 10-Q - Part I

Notes to Consolidated Financial Statements
(Unaudited)

The following table summarizes the components and classification of
stock-based compensation expense.

|                                         |  |                                |    |                              |   |      |  |      |    |  |   |    | 
|---------------------------------------- |  | ------------------------------ | -- | ---------------------------- | - | ---- |  | ---- | -- |  | - | -- | 
|                                         |  | Three
  months ended March 31, |    | Six months
  ended March 31, |  
|                                         |  | 2006                           |    | 2005                         |   | 2006 |  | 2005 |   
|                                         |  |                                |    |                              |   |      |  |      |   
|Stock options                            |  | $                              | 15 |                              | $ |     |  | $    | 35 |  | $ |   | 
|Restricted stock units                   |  |                                | 4  |                              |   | 3    |  |      | 7  |  |   | 7  | 
|Other                                    |  |                                | 1  |                              |   | 2    |  |      | 2  |  |   | 7  | 
|                                         |  |                                |    |                              |   |      |  |      |    |  |   |    | 
|Total stock-based compensation
  expense |  | $                              | 20 |                              | $ | 5    |  | $    | 44 |  | $ | 14 | 
|                                         |  |                                |    |                              |   |      |  |      |    |  |   |    | 
|                                        
|Costs                                    |  | $                              | 3  |                              | $ |     |  | $    | 6  |  | $ |   | 
|Selling, general and
  administrative    |  |                                | 11 |                              |   | 5    |  |      | 24 |  |   | 13 | 
|Research and development                 |  |                                | 6  |                              |   |     |  |      | 14 |  |   | 1  | 
|                                         |  |                                |    |                              |   |      |  |      |    |  |   |    | 
|Total stock-based compensation
  expense |  | $                              | 20 |                              | $ | 5    |  | $    | 44 |  | $ | 14 | 
|                                         |  |                                |    |                              |   |      |  |      |    |  |   |    | 

The fair value of stock options was estimated using the Black-Scholes
option-pricing model. This model requires the input of subjective assumptions
that will usually have a significant impact on the fair value estimate. The
assumptions for the current period grants were developed based on SFAS 123R and
SEC guidance contained in Staff Accounting Bulletin (SAB) No. 107, Share-Based
Payment. The following table summarizes the assumptions used to compute the
weighted average fair value of stock option grants.

|                                                 |  |                                |      |                              |   |      |   |      |      |   |   |      |  
|------------------------------------------------ |  | ------------------------------ | ---- | ---------------------------- | - | ---- | - | ---- | ---- | - | - | ---- | -
|                                                 |  | Three
  months ended March 31, |      | Six months
  ended March 31, |  
|                                                 |  | 2006                           |      | 2005                         |   | 2006 |   | 2005 |     
|                                                 |  |                                |      |                              |   |      |   |      |     
|Dividend yield                                   |  |                                | 0.0  | %                            |   | 0.0  | % |      | 0.0  | % |   | 0.0  | %
|Weighted average volatility                      |  |                                | 53.6 | %                            |   | 80.2 | % |      | 54.6 | % |   | 82.1 | %
|Risk-free interest rate                          |  |                                | 4.4  | %                            |   | 3.6  | % |      | 4.4  | % |   | 3.5  | %
|Expected holding period (in
  years)             |  |                                | 4.8  |                              |   | 3.8  |   |      | 4.8  |   |   | 3.8  |  
|Weighted average fair value of
  options granted |  | $                              | 1.32 |                              | $ | 2.00 |   | $    | 1.42 |   | $ | 2.36 |  



| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | No dividend yield
  was assumed because we currently do not pay cash dividends on our common
  stock and have no plans to reinstate a dividend. An increase in the dividend
  yield will decrease stock compensation expense.                                                                                                                                                                                                                                                                                                                                    
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
| |  | The weighted
  average volatility for the current period was developed using equal weight
  from (a) implied volatilities of traded options and warrants to purchase the
  companys common stock at prices that approximate the options exercise price
  and have a life in excess of one year, and (b) historical volatility for
  periods equal to the expected life of the options. Prior to fiscal 2006, only
  historical volatility was considered. An increase in the weighted average
  volatility assumption will increase stock compensation expense.
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
| |  | The risk-free
  interest rate was developed using the U.S. Treasury yield curve for periods
  equal to the expected life of the options on the grant date. An increase in
  the risk-free interest rate will increase stock compensation expense.                                                                                                                                                                                                                                                                                                                
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
| |  | The expected
  holding period for the current period grants was calculated using the average
  of the vesting period and the term of the option based on guidance contained
  in SAB 107. Prior to fiscal 2006, this assumption was developed after
  considering vesting schedules, life of the option, historical experience and
  estimates of future exercise behavior patterns. An increase in the expected holding
  period will increase stock compensation expense.                                                                                      

---



|          |                   
|--------- | ------------------
|<PAGE> 12 | Form 10-Q - Part I

Notes to Consolidated Financial Statements
(Unaudited)

SFAS 123R requires the recognition of stock-based compensation for the
number of awards that are ultimately expected to vest. As a result, for most
awards, recognized stock compensation was reduced for estimated forfeitures
prior to vesting primarily based on historical annual forfeiture rates of
approximately 7%. Estimated forfeitures will be reassessed in subsequent
periods and may change based on new facts and circumstances. Prior to October
1, 2005, actual forfeitures were accounted for as they occurred for purposes of
required pro forma stock compensation disclosures.

As of March 31, 2006, approximately $118 million of unrecognized stock
compensation related to unvested awards (net of estimated forfeitures) is
expected to be recognized over a weighted-average period of 1.5 years.

5. BUSINESS
RESTRUCTURING

|                                                 |  |                         |   |                         |   |                      |  |       |     |   |   |     |  
|------------------------------------------------ |  | ----------------------- | - | ----------------------- | - | -------------------- |  | ----- | --- | - | - | --- | -
|(in millions)                                    |  | Employee 
  separations |   | Contract 
  settlements |   | Facility 
  closings |  | Total |    
|                                                 |  |                         |   |                         |   |                      |  |       |    
|Restructuring
  reserve as of September 30, 2005 |  | $                       | 1 |                         | $ | 1                    |  | $     | 145 |   | $ | 147 |  
|Revisions to prior
  year plans                  |  |                         |  |                         |   |                     |  |       | (3  | ) |   | (3  | )
|Utilization of
  reserves                        |  |                         |  |                         |   |                     |  |       | (18 | ) |   | (18 | )
|                                                 |  |                         |   |                         |   |                      |  |       |     |   |   |     |  
|Restructuring
  reserve as of March 31, 2006     |  | $                       | 1 |                         | $ | 1                    |  | $     | 124 |   | $ | 126 |  
|                                                 |  |                         |   |                         |   |                      |  |       |     |   |   |     |  

Facility closing reserves are for the expected remaining future cash
outlays associated with trailing lease liabilities, lease termination payments
and expected restoration costs in connection with plans to reduce a significant
number of leased facilities. The remaining liability is expected to be
paid over the remaining lease terms and is reflected net of expected sublease
income of $119 million. Additional charges may be required in the future if the
expected sublease income is not realized.

6. ACQUISITIONS

On April 27, 2006, certain net assets of Riverstone Networks, a maker
of carrier-grade Ethernet routers for the telecommunications industry, was
acquired for $207 million in cash. The sale conditions are set forth in a
definitive asset purchase agreement initially entered into on February 7, 2006,
which was amended following an auction of those assets. In accordance with the
agreement, we made an initial deposit of approximately $12 million into an
escrow account. The transaction was completed on April 27, 2006.

---



|          |                   
|--------- | ------------------
|<PAGE> 13 | Form 10-Q - Part I

Notes to Consolidated Financial Statements
(Unaudited)

7. SUPPLEMENTARY
BALANCE SHEET INFORMATION

|                                                                                              |  |                   |       |                         |   |       |  
|--------------------------------------------------------------------------------------------- |  | ----------------- | ----- | ----------------------- | - | ----- | -
|(in millions)                                                                                 |  | March 31, 
  2006 |       | September
  30, 
  2005 |  
|                                                                                              |  |                   |       |                         |  
|                                                                                              |  |                   |       |                         |   |       |  
|Completed goods                                                                               |  | $                 | 567   |                         | $ | 580   |  
|Work in process                                                                               |  |                   | 68    |                         |   | 39    |  
|Raw materials                                                                                 |  |                   | 128   |                         |   | 112   |  
|                                                                                              |  |                   |       |                         |   |       |  
|Inventories, net of reserves of $681 as
of
  March 31, 2006 and $712 as of September 30, 2005 |  | $                 | 763   |                         | $ | 731   |  
|                                                                                              |  |                   |       |                         |   |       |  
|                                                                                              |  |                   |       |                         |   |       |  
|Costs and recognized income not yet
billed                                                    |  | $                 | 278   |                         | $ | 208   |  
|Billings in excess of costs and
recognized
  income                                           |  |                   | (260  | )                       |   | (220  | )
|                                                                                              |  |                   |       |                         |   |       |  
|Contracts in process reflected in other
  current assets (liabilities)                        |  | $                 | 18    |                         | $ | (12   | )
|                                                                                              |  |                   |       |                         |   |       |  
|                                                                                              |  |                   |       |                         |   |       |  
|Restricted cash                                                                               |  | $                 | 363   |                         | $ | 41    |  
|Deferred income taxes                                                                         |  |                   | 240   |                         |   | 237   |  
|Prepaid expenses                                                                              |  |                   | 217   |                         |   | 206   |  
|Non-trade receivables                                                                         |  |                   | 95    |                         |   | 117   |  
|Income tax receivables, including
related interest                                            |  |                   | 44    |                         |   | 85    |  
|Contracts in process                                                                          |  |                   | 18    |                         |   |      |  
|Other                                                                                         |  |                   | 14    |                         |   | 4     |  
|                                                                                              |  |                   |       |                         |   |       |  
|Other current assets                                                                          |  | $                 | 991   |                         | $ | 690   |  
|                                                                                              |  |                   |       |                         |   |       |  
|                                                                                              |  |                   |       |                         |   |       |  
|Marketed software                                                                             |  | $                 | 265   |                         | $ | 254   |  
|Internal use software                                                                         |  |                   | 108   |                         |   | 120   |  
|Restricted cash                                                                               |  |                   | 139   |                         |   | 137   |  
|Deferred income taxes                                                                         |  |                   | 76    |                         |   | 78    |  
|Investments                                                                                   |  |                   | 65    |                         |   | 65    |  
|Non-trade receivables                                                                         |  |                   | 19    |                         |   | 20    |  
|Retainage receivables                                                                         |  |                   | 9     |                         |   | 8     |  
|Other                                                                                         |  |                   | 230   |                         |   | 248   |  
|                                                                                              |  |                   |       |                         |   |       |  
|Other assets                                                                                  |  | $                 | 911   |                         | $ | 930   |  
|                                                                                              |  |                   |       |                         |   |       |  
|                                                                                              |  |                   |       |                         |   |       |  
|Deferred revenue                                                                              |  | $                 | 546   |                         | $ | 529   |  
|Winstar litigation reserve                                                                    |  |                   | 281   |                         |   |      |  
|Warranty                                                                                      |  |                   | 169   |                         |   | 188   |  
|Contracts in process                                                                          |  |                   |      |                         |   | 12    |  
|Business restructuring                                                                        |  |                   | 34    |                         |   | 44    |  
|Other                                                                                         |  |                   | 654   |                         |   | 815   |  
|                                                                                              |  |                   |       |                         |   |       |  
|Other current liabilities                                                                     |  | $                 | 1,684 |                         | $ | 1,588 |  
|                                                                                              |  |                   |       |                         |   |       |  
|                                                                                              |  |                   |       |                         |   |       |  
|Deferred income taxes                                                                         |  | $                 | 221   |                         | $ | 205   |  
|Deferred compensation                                                                         |  |                   | 58    |                         |   | 112   |  
|Business restructuring                                                                        |  |                   | 91    |                         |   | 102   |  
|Environmental                                                                                 |  |                   | 59    |                         |   | 72    |  
|Warranty                                                                                      |  |                   | 67    |                         |   | 69    |  
|Minority interests                                                                            |  |                   | 29    |                         |   | 63    |  
|Other, including contingencies                                                                |  |                   | 325   |                         |   | 342   |  
|                                                                                              |  |                   |       |                         |   |       |  
|Other liabilities                                                                             |  | $                 | 850   |                         | $ | 965   |  
|                                                                                              |  |                   |       |                         |   |       |  

---



|          |                   
|--------- | ------------------
|<PAGE> 14 | Form 10-Q - Part I

Notes to Consolidated Financial Statements
(Unaudited)

8. GOODWILL AND OTHER
ACQUIRED INTANGIBLE ASSETS

The following table summarizes the changes in the carrying value of
goodwill and other acquired intangible assets.

|                         |  |                                                  |    |                                  |   |                              |  |          |     |       |   |                                        |   |   |     |   |   |    |  
|------------------------ |  | ------------------------------------------------ | -- | -------------------------------- | - | ---------------------------- |  | -------- | --- | ----- | - | -------------------------------------- | - | - | --- | - | - | -- | -
|                         |  | Goodwill                                         |    |                                  |   |                             
|                         |  |                                                  |    |                                  |   |                             
|(in millions)            |  | Mobility
  Access and
  Applications
  Solutions |    | Multimedia
  Network
  Solutions |   | Converged
  Core
  Solutions |  | Services |     | Total |   | Other
  acquired
  intangible
  assets |  
|                         |  |                                                  |    |                                  |   |                              |  |          |     |       |   |                                        |  
|As of September 30, 2005 |  | $                                                | 32 |                                  | $ | 86                           |  | $        | 154 |       | $ | 102                                    |   | $ | 374 |   | $ | 45 |  
|Telica escrow release    |  |                                                  |   |                                  |   |                             |  |          | 20  |       |   | 9                                      |   |   | 29  |   |   |   |  
|Amortization             |  |                                                  |   |                                  |   |                             |  |          |    |       |   |                                       |   |   |    |   |   | (8 | )
|Other                    |  |                                                  |   |                                  |   |                             |  |          |    |       |   | (1                                     | ) |   | (1  | ) |   |   |  
|                         |  |                                                  |    |                                  |   |                              |  |          |     |       |   |                                        |   |   |     |   |   |    |  
|As of March 31, 2006     |  | $                                                | 32 |                                  | $ | 86                           |  | $        | 174 |       | $ | 110                                    |   | $ | 402 |   | $ | 37 |  
|                         |  |                                                  |    |                                  |   |                              |  |          |     |       |   |                                        |   |   |     |   |   |    |  

During February 2006, nine million shares of our common stock, valued
at $29 million, were released from an escrow account established for possible
post-closing claims related to the Telica acquisition. The escrow agreement
expired and there were no pending claims against the escrow.

9. COMPREHENSIVE
INCOME

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

|                                                |  |                              |     |                            |   |      |   |      |    |   |   |     |  
|----------------------------------------------- |  | ---------------------------- | --- | -------------------------- | - | ---- | - | ---- | -- | - | - | --- | -
|                                                |  | Three months ended March 31, |     | Six months ended March 31, |  
|(in millions)                                   |  | 2006                         |     | 2005                       |   | 2006 |   | 2005 |   
|                                                |  |                              |     |                            |   |      |   |      |   
|Net income                                      |  | $                            | 181 |                            | $ | 267  |   | $    | 77 |   | $ | 441 |  
|Minimum pension
  liability adjustment          |  |                              |    |                            |   |     |   |      |   |   |   | (4  | )
|Foreign currency
  translation adjustments      |  |                              | 23  |                            |   | (52  | ) |      | 6  |   |   | 47  |  
|Unrealized holding
  losses on investments, net |  |                              | (3  | )                          |   | (10  | ) |      | (5 | ) |   | (12 | )
|                                                |  |                              |     |                            |   |      |   |      |    |   |   |     |  
|Comprehensive
  income                          |  | $                            | 201 |                            | $ | 205  |   | $    | 78 |   | $ | 472 |  
|                                                |  |                              |     |                            |   |      |   |      |    |   |   |     |  

---



|          |                   
|--------- | ------------------
|<PAGE> 15 | Form 10-Q - Part I

Notes to Consolidated Financial Statements
(Unaudited)

10. EARNINGS PER
COMMON SHARE (EPS)

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

The following table summarizes the computation of basic and diluted
EPS:

|                                                    |  |                              |       |                            |   |       |  |      |       |  |   |       | 
|--------------------------------------------------- |  | ---------------------------- | ----- | -------------------------- | - | ----- |  | ---- | ----- |  | - | ----- | 
|                                                    |  | Three months ended March 31, |       | Six months ended March 31, |  
|(in millions, except per share amounts)             |  | 2006                         |       | 2005                       |   | 2006  |  | 2005 |      
|                                                    |  |                              |       |                            |   |       |  |      |      
|Net income                                          |  | $                            | 181   |                            | $ | 267   |  | $    | 77    |  | $ | 441   | 
|Adjustment for dilutive securities on net
  income: |  |                              |       |                            |   |       |  |      |       |  |   |       | 
|2.75% convertible securities                        |  |                              | 11    |                            |   | 11    |  |      |      |  |   | 22    | 
|                                                    |  |                              |       |                            |   |       |  |      |       |  |   |       | 
|Net income  diluted                                |  | $                            | 192   |                            | $ | 278   |  | $    | 77    |  | $ | 463   | 
|                                                    |  |                              |       |                            |   |       |  |      |       |  |   |       | 
|                                                    |  |                              |       |                            |   |       |  |      |       |  |   |       | 
|Weighted average shares outstanding
 basic         |  |                              | 4,463 |                            |   | 4,421 |  |      | 4,457 |  |   | 4,412 | 
|Effect of dilutive securities:                      |  |                              |       |                            |   |       |  |      |       |  |   |       | 
|Stock options                                       |  |                              | 45    |                            |   | 62    |  |      | 46    |  |   | 69    | 
|Warrants                                            |  |                              | 2     |                            |   | 28    |  |      | 6     |  |   | 20    | 
|2.75% convertible securities                        |  |                              | 618   |                            |   | 536   |  |      |      |  |   | 512   | 
|                                                    |  |                              |       |                            |   |       |  |      |       |  |   |       | 
|Weighted average shares outstanding

  diluted     |  |                              | 5,128 |                            |   | 5,047 |  |      | 4,509 |  |   | 5,013 | 
|                                                    |  |                              |       |                            |   |       |  |      |       |  |   |       | 
|                                                    |  |                              |       |                            |   |       |  |      |       |  |   |       | 
|EPS:                                                |  |                              |       |                            |   |       |  |      |       |  |   |       | 
|Basic                                               |  | $                            | 0.04  |                            | $ | 0.06  |  | $    | 0.02  |  | $ | 0.10  | 
|Diluted                                             |  | $                            | 0.04  |                            | $ | 0.06  |  | $    | 0.02  |  | $ | 0.09  | 
|                                                    |  |                              |       |                            |   |       |  |      |       |  |   |       | 

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

|                                                                                                                                                     |  |                              |     |                            |  |      |  |      |       |  |  |     | 
|---------------------------------------------------------------------------------------------------------------------------------------------------- |  | ---------------------------- | --- | -------------------------- |  | ---- |  | ---- | ----- |  |  | --- | 
|                                                                                                                                                     |  | Three months ended March 31, |     | Six months ended March 31, | 
|(in millions)                                                                                                                                        |  | 2006                         |     | 2005                       |  | 2006 |  | 2005 |      
|                                                                                                                                                     |  |                              |     |                            |  |      |  |      |      
|2.75% convertible
  securities                                                                                                                       |  |                              |    |                            |  |     |  |      | 604   |  |  |    | 
|8.00% convertible
  securities                                                                                                                       |  |                              | 184 |                            |  | 269  |  |      | 186   |  |  | 250 | 
|7.75% convertible
  securities                                                                                                                       |  |                              | 228 |                            |  | 238  |  |      | 228   |  |  | 238 | 
|                                                                                                                                                     |  |                              |     |                            |  |      |  |      |       |  |  |     | 
|Total potentially
  dilutive shares                                                                                                                  |  |                              | 412 |                            |  | 507  |  |      | 1,018 |  |  | 488 | 
|                                                                                                                                                     |  |                              |     |                            |  |      |  |      |       |  |  |     | 
|                                                                                                                                                     |  |                              |     |                            |  |      |  |      |       |  |  |     | 
|Stock options
  excluded from diluted earnings per share because the exercise price was
  greater than the average market price of the common shares |  |                              | 271 |                            |  | 317  |  |      | 287   |  |  | 281 | 
|                                                                                                                                                     |  |                              |     |                            |  |      |  |      |       |  |  |     | 

11. OPERATING
SEGMENTS

Our wireless and wireline businesses were combined into a single unit,
the Network Solutions Group (NSG). NSG consists of the following operating
segments: Mobility Access Solutions, Applications Solutions, Multimedia Network
Solutions and Converged Core Solutions. Applications Solutions is
aggregated with Mobility Access Solutions because its results are not material
and do not meet the requirements for being reported separately. Applications
Solutions was previously reported with our wireless business. Multimedia
Network Solutions consists primarily of optical, data and access products.
Converged Core Solutions consists primarily of voice networking products,
including circuit switching, personal handyphone systems and next-generation
switching products. The Network Operations Software reporting unit that was
previously reported within the wireline business was transferred to Lucent
Worldwide Services (Services). Services provides deployment, maintenance, professional
and managed services in support of our product offerings and multivendor
networks.

---



|          |                   
|--------- | ------------------
|<PAGE> 16 | Form 10-Q - Part I

Notes to
Consolidated Financial Statements
(Unaudited)

Other changes to the previous
reporting structure included the elimination of certain internal revenue
sharing arrangements between our wireless and wireline businesses, the internal
transfer of certain organizations and revised allocations of employee benefit
costs that are more closely aligned with actual benefit costs for active
employees. The prior period segment results were revised to conform to the
new reporting structure. In addition, the revenues attributed to products and
services were revised in the Consolidated Statements of Operations to conform
to the new reporting structure. The accounting policies of the reportable
segments are the same as those applied in the consolidated financial statements.

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

| |   |                                                                                                                                                                                                                                                                                                                          
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Global sales organization expenses.                                                                                                                                                                                                                                                                                      
| |   |                                                                                                                                                                                                                                                                                                                          
| |  | Certain costs related to shared services, such as general
  corporate functions, which are managed on a common basis in order to realize
  economies of scale and efficient use of resources.                                                                                                                            
| |   |                                                                                                                                                                                                                                                                                                                          
| |  | Certain employee compensation and benefits, including
  stock-based compensation, differences between actual and budgeted employee
  benefit costs, differences between actual and budgeted employee incentive
  awards, as well as most of the impacts related to pension, postretirement and
  postemployment benefits.
| |   |                                                                                                                                                                                                                                                                                                                          
| |  | Bad debt and customer financing expenses and recoveries.                                                                                                                                                                                                                                                                 
| |   |                                                                                                                                                                                                                                                                                                                          
| |  | Business restructuring.                                                                                                                                                                                                                                                                                                  
| |   |                                                                                                                                                                                                                                                                                                                          
| |  | Revenues and expenses associated with licensing and
  protecting intellectual property rights.                                                                                                                                                                                                                           
| |   |                                                                                                                                                                                                                                                                                                                          
| |  | Certain other general and miscellaneous costs and expenses
  not directly used in assessing the performance of the operating segments.                                                                                                                                                                                   

|                                                    |  |                                |       |                              |   |       |   |      |       |   |   |       |  
|--------------------------------------------------- |  | ------------------------------ | ----- | ---------------------------- | - | ----- | - | ---- | ----- | - | - | ----- | -
|                                                    |  | Three months ended
  March 31, |       | Six months ended
  March 31, |  
|(in millions)                                       |  | 2006                           |       | 2005                         |   | 2006  |   | 2005 |      
|                                                    |  |                                |       |                              |   |       |   |      |      
|Revenues:                                           |  |                                |       |                              |   |       |   |      |       |   |   |       |  
|MobilityAccess and
Applications
  Solutions         |  | $                              | 1,002 |                              | $ | 1,219 |   | $    | 1,947 |   | $ | 2,389 |  
|Multimedia Network Solutions                        |  |                                | 388   |                              |   | 360   |   |      | 783   |   |   | 726   |  
|Converged Core Solutions                            |  |                                | 151   |                              |   | 192   |   |      | 296   |   |   | 425   |  
|Services                                            |  |                                | 548   |                              |   | 520   |   |      | 1,088 |   |   | 1,068 |  
|                                                    |  |                                |       |                              |   |       |   |      |       |   |   |       |  
|Reportable
  segments                               |  |                                | 2,089 |                              |   | 2,291 |   |      | 4,114 |   |   | 4,608 |  
|Intellectual
  property                             |  |                                | 42    |                              |   | 34    |   |      | 60    |   |   | 42    |  
|Other                                               |  |                                | 7     |                              |   | 10    |   |      | 11    |   |   | 20    |  
|                                                    |  |                                |       |                              |   |       |   |      |       |   |   |       |  
|Revenues                                            |  | $                              | 2,138 |                              | $ | 2,335 |   | $    | 4,185 |   | $ | 4,670 |  
|                                                    |  |                                |       |                              |   |       |   |      |       |   |   |       |  
|                                                    |  |                                |       |                              |   |       |   |      |       |   |   |       |  
|Operating
  income (loss):                          |  |                                |       |                              |   |       |   |      |       |   |   |       |  
|Mobility
  Access and Applications Solutions        |  | $                              | 371   |                              | $ | 437   |   | $    | 688   |   | $ | 859   |  
|Multimedia Network Solutions                        |  |                                | 42    |                              |   | (16   | ) |      | 87    |   |   | 4     |  
|Converged Core Solutions                            |  |                                | 16    |                              |   | (5    | ) |      | 16    |   |   | (14   | )
|Services                                            |  |                                | 46    |                              |   | 58    |   |      | 135   |   |   | 134   |  
|                                                    |  |                                |       |                              |   |       |   |      |       |   |   |       |  
|Reportable
  segments                               |  |                                | 475   |                              |   | 474   |   |      | 926   |   |   | 983   |  
|Global sales organization                           |  |                                | (101  | )                            |   | (134  | ) |      | (219  | ) |   | (265  | )
|Shared services such as general corporate
functions |  |                                | (271  | )                            |   | (281  | ) |      | (546  | ) |   | (546  | )
|Unallocated compensation and benefits               |  |                                | 131   |                              |   | 194   |   |      | 270   |   |   | 427   |  
|Bad debts and customer financings                   |  |                                | (2    | )                            |   | 11    |   |      | 5     |   |   | 22    |  
|Business
  restructuring                            |  |                                | 4     |                              |   | 8     |   |      | 3     |   |   | 7     |  
|Winstar litigation charge                           |  |                                |      |                              |   |      |   |      | (278  | ) |   |      |  
|Other                                               |  |                                | 13    |                              |   | (4    | ) |      | (1    | ) |   | (41   | )
|                                                    |  |                                |       |                              |   |       |   |      |       |   |   |       |  
|Operating
  income                                  |  | $                              | 249   |                              | $ | 268   |   | $    | 160   |   | $ | 587   |  
|                                                    |  |                                |       |                              |   |       |   |      |       |   |   |       |  

---



|          |                   
|--------- | ------------------
|<PAGE> 17 | Form 10-Q - Part I

Notes to
Consolidated Financial Statements
(Unaudited)

One customer accounted for 35% of
consolidated revenues during the three months ended March 31, 2006. Two
customers accounted for 30% and 11% of consolidated revenues during the six
months ended March 31, 2006. Two customers accounted for 33% and 10% of
consolidated revenues during the three months ended March 31, 2005 and 29% and
13% of consolidated revenues during the six months ended March 31, 2005.

12. COMMITMENTS AND
CONTINGENCIES

Legal Proceedings

We are subject to legal proceedings,
lawsuits, and other claims, including proceedings by government authorities. In
addition, we may be subject to liabilities of some of our former affiliates
under separation agreements with them. Legal proceedings are subject to
uncertainties, and the outcomes are difficult to predict. Consequently, unless
otherwise indicated, we are unable to estimate the ultimate aggregate amounts
of monetary liability or ranges of possible losses with respect to our pending
litigation matters as of March 31, 2006. The resolution of these matters could
have a material impact on our consolidated results of operations, financial
position and cash flows. Charges of $4 million and $287 million were recognized
during the three and six months ended March 31, 2006, primarily due to the
Winstar judgment discussed below.

Winstar

We were a defendant in an adversary
proceeding originally filed in U.S. Bankruptcy Court in Delaware by Winstar and
Winstar Wireless, Inc. in connection with the bankruptcy of Winstar and various
related entities. The trial for this matter concluded in June 2005. The trial
pertained to breach of contract and other claims against us, for which the
trustee for Winstar was seeking compensatory damages of approximately $60
million, as well as costs and expenses associated with litigation. The trustee
was also seeking recovery of a payment to us of approximately $190 million in
December 2000, plus interest. On December 21, 2005, the judge rendered his decision
and the verdict resulted in a judgment against Lucent for approximately $244
million, plus statutory interest and other costs. As a result, we recognized a
$278 million charge (including related interest and other costs of
approximately $34 million) in the first quarter of fiscal 2006 and an
additional $3 million charge for post-judgment interest in the second quarter
of fiscal 2006. In addition, $311 million of cash was used to collateralize a
letter of credit that was issued during the second quarter of fiscal 2006 in
connection with this matter. This judgment is under appeal with the U.S.
District Court for the District of Delaware. Additional charges for
post-judgment interest will be recognized in subsequent periods until this
matter is resolved.

Government
Investigations

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

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

---



|          |                   
|--------- | ------------------
|<PAGE> 18 | Form 10-Q - Part I

Notes to
Consolidated Financial Statements
(Unaudited)

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

Employment and
Benefits Related Cases

We have implemented various actions
to address the rising costs of providing retiree health care benefits and the
funding of our pension plans. These actions have led to the filing of cases
against us and may lead to the filing of additional cases. Purported class
action lawsuits have been filed against us in connection with the elimination
of the death benefit from our U.S. management pension plan in early 2003. Three
such cases have been consolidated into a single action pending in the U.S.
District Court in New Jersey, captioned In
Re Lucent Death Benefits ERISA Litigation. The elimination of this
benefit reduced our future pension obligations by approximately $400 million.
The benefit was paid out of the pension plan assets to certain qualified
surviving dependents, such as spouses or dependent children of management
retirees. The case alleges that we wrongfully terminated this death benefit and
requests that it be reinstated, along with other remedies. We have filed a
motion to dismiss, which is pending. Another such case, Chastain, et al. v. AT&T, was filed in the U.S. District Court in
the
Western District of Oklahoma. The Chastain
case also involves claims related to changes to retiree health care benefits.
In October 2005, a purported class action was filed by Peter A. Raetsch,
Geraldine Raetsch and Curtis Shiflett, on behalf of themselves and all others
similarly situated, in the U.S. District Court for the District of New Jersey.
The plaintiffs allege that Lucent failed to maintain health care benefits for
retired management employees as required by the Internal Revenue Code, the
Employee Retirement Income Security Act, and the Lucent pension and medical
plans. We have filed a motion to dismiss, which is pending.

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

Intellectual
Property Cases

We are defendants in various cases
in which third parties claim infringement of their patents, including certain
cases where infringement claims have been made against our customers in
connection with products we have provided to them.

Other Matters

On April 3, 2006, a putative class action entitled
  *Resnick v. Lucent Technologies Inc.*, et al was filed against the Company
  and members of its board of directors in the Superior Court of New Jersey, Law
  Division, Union County. The named plaintiffs propose to represent a class of
  Lucents public shareholders and claim that, among other things, the proposed
  merger with Alcatel is the product of breaches of duty by Lucents board
  of directors in that they allegedly failed to maximize shareholder value in
  the transaction. Along with other relief, the complaint seeks an injunction
  against the closing of the proposed merger. We believe the action is without
  merit and that the company has substantial defenses to the claims.

On August 8, 2003, NGC filed an
action in the U.S. District Court for the Southern District of New York against
us, certain former officers and employees, our subsidiary Lucent Technologies
International Inc., certain unaffiliated individuals and an unaffiliated
company, alleging violations of the Racketeer Influenced Corrupt

---



|          |                   
|--------- | ------------------
|<PAGE> 19 | Form 10-Q - Part I

Notes to
Consolidated Financial Statements
(Unaudited)

Organizations Act (RICO) and other
improper activities. These allegations relate to activities in Saudi Arabia in
connection with certain telecommunications contracts involving Lucent, the
Kingdom of Saudi Arabia and other entities. The complaint seeks damages in
excess of $63 million, which could be tripled under RICO. The allegations in
this complaint appear to arise out of certain contractual disputes between NGC
and Lucent that are the subject of a separate case that NGC previously filed
against us in U.S. District Court in New Jersey and other related proceedings
brought by NGC in Saudi Arabia. On March 1, 2006, the District Court in New
York granted our motion to dismiss the case in its entirety. NGC has filed a
notice of appeal. Some of the claims brought by NGC in the New Jersey action
have been dismissed, but that case and the other claims in Saudi Arabia are
still pending.

Separation
Agreements

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

Guarantees and
Indemnification Agreements

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

We remain secondarily liable for
approximately $160 million of lease obligations as of March 31, 2006, that were
assigned to Avaya, Agere and purchasers of other businesses that were divested.
The remaining terms of these assigned leases and our corresponding guarantees
range from two months to 14 years. The primary obligor under assigned leases
may terminate or restructure the lease obligation before its original maturity
and thereby relieve us of our secondary liability. We generally have the right
to receive indemnity or reimbursement from the assignees and have not reserved
for losses on this form of guarantee.

We are party to a tax-sharing
agreement to indemnify AT&T and are liable for tax adjustments that are
attributable to our lines of business, as well as a portion of certain other
shared tax adjustments during the years prior to our separation from AT&T.
We have similar agreements with Avaya and Agere. Certain tax adjustments have
been proposed or assessed subject to these tax-sharing agreements. The outcome
of these other matters is not expected to have a material adverse effect on our
consolidated results of operations, consolidated financial position or
near-term liquidity.

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

We indemnify our directors and
certain of our current and former officers for third-party claims alleging
certain breaches of their fiduciary duties as directors or officers. Certain
costs incurred for providing such indemnification may be recovered under
various insurance policies. We are unable to reasonably estimate the maximum
amount that could be payable under these arrangements since these exposures are
not capped and due to the conditional nature of our obligations and the unique
facts and circumstances involved in each

---



|          |                   
|--------- | ------------------
|<PAGE> 20 | Form 10-Q - Part I

Notes to
Consolidated Financial Statements
(Unaudited)

agreement. Historically, payments
made under these agreements have not had a material effect on our business,
financial condition, results of operations or cash flows.

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

|                             |  |      |     |      |   |     |  
|---------------------------- |  | ---- | --- | ---- | - | --- | -
|(in millions)                |  | 2006 |     | 2005 |  
|                             |  |      |     |      |  
|Reserve as of September 30   |  | $    | 257 |      | $ | 297 |  
|Accruals for warranties, net |  |      | 38  |      |   | 21  |  
|Payments                     |  |      | (59 | )    |   | (37 | )
|                             |  |      |     |      |   |     |  
|Reserve as of March 31       |  | $    | 236 |      | $ | 281 |  
|                             |  |      |     |      |   |     |  

Environmental
Matters

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

Environmental reserves of $92
million have been established for environmental liabilities that can be
reasonably estimated as of March 31, 2006. These reserves are not discounted to
present value. We have receivables of $19 million with respect to environmental
matters due from third-party indemnitors as of March 31, 2006. Receivables are
recorded only if the indemnitors have agreed to pay the claims and management
believes collection of the receivables is reasonably assured. Environmental
matters did not have a significant impact on our consolidated results of
operations, financial position and cash flows for all periods presented.

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

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

It is often difficult to estimate
the future impact of environmental matters, including potential liabilities,
due to the above factors and the lengthy time periods involved in resolving
them, which may be up to 30 years or longer. Although we believe that our
reserves are currently adequate, there can be no assurance that the amount of
capital expenditures and other expenses that will be required for remedial
actions and compliance with applicable environmental laws will not exceed the
amounts reflected in reserves or will not have a material adverse effect on our
consolidated financial condition, results of operations or cash flows. Any
possible loss or range of possible loss that may be incurred in excess of
amounts provided for as of March 31, 2006 cannot be reasonably estimated.

---



|          |                   
|--------- | ------------------
|<PAGE> 21 | Form 10-Q - Part I

Item 2.  Managements Discussion
and Analysis of Financial Condition and Results of Operations

FORWARD-LOOKING
STATEMENTS

This quarterly report, including the Managements
  Discussion and Analysis of Financial Condition and Results of Operations (MD&A),
  contains statements regarding future performance, events or developments, including
  the proposed transaction between Lucent and Alcatel, the expected timetable
  for completing the proposed transaction and other statements about Lucent managements
  future expectations, beliefs, goals, plans or prospects that are based on current
  expectations, estimates, forecasts and projections about Lucent, as well as
  Lucents future performance and the industries in which it operates, in
  addition to managements assumptions. These statements constitute forward-looking
  statements within the meaning of the U.S. Private Securities Litigation Reform
  Act of 1995. 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 which are not statements of historical facts. These forward-looking
  statements are not guarantees of future performance and involve certain risks,
  uncertainties and assumptions that are difficult to assess. Therefore, actual
  outcomes and results may differ materially from what is expressed or forecasted
  in such forward-looking statements. These risks and uncertainties are based
  upon a number of important factors including, among others: our ability to operate
  effectively in a highly competitive industry with many participants; our ability
  to keep pace with technological advances and correctly identify and invest in
  the technologies that become commercially accepted; our reliance on a small
  number of key customers; the ability to consummate the proposed transaction
  with Alcatel; difficulties and delays in achieving synergies and cost savings;
  potential difficulties in meeting conditions set forth in the definitive merger
  agreement entered into by Lucent; fluctuations in the telecommunications market;
  the pricing, cost and other risks inherent in long-term sales agreements; exposure
  to the credit risk of customers; reliance on a limited number of contract manufacturers
  to supply products we sell; the social, political and economic risks of our
  global operations; the costs and risks associated with pension and postretirement
  benefit obligations; the complexity of products sold; changes to existing regulations
  or technical standards; existing and future litigation; difficulties and costs
  in protecting intellectual property rights and exposure to infringement claims
  by others; and compliance with environmental, health and safety laws. For a
  more complete list and description of such risks and uncertainties, refer to
  Lucents Form 10-K for the year ended September 30, 2005 as well as other
  filings by Lucent with the US Securities and Exchange Commission (the SEC).
  Except as required under the US federal securities laws and the rules and regulations
  of the SEC, we disclaim any intention or obligation to update any forward-looking
  statements after the distribution of this press release, whether as a result
  of new information, future events, developments, changes in assumptions or otherwise.

EXECUTIVE SUMMARY

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

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

We continue to believe the telecom
industry is in the early stages of a multiyear transformation to
next-generation networks. As a result we have been focusing on certain
high-growth areas, such as services, Internet protocol (IP) multimedia
subsystem (IMS), broadband access, optical and next generation mobile
high-speed data. As this transformation progresses, our customers are
increasingly focused on deploying new IP-based, revenue-generating services
that will differentiate their businesses and build customer loyalty. However,
the

---



|          |                   
|--------- | ------------------
|<PAGE> 22 | Form 10-Q - Part I

Item 2.  Managements Discussion and Analysis of
Financial Condition and Results of Operations

actual trialing, testing and
deployment of these new technologies will take time. This is a long-term
technology transition, which will create opportunities for us and our customers
in growth areas such as mobile high-speed data, broadband access, metro optical
networking and voice over Internet protocol (VoIP) solutions, as well as in
professional and managed services. We are working to turn these technologies and
opportunities into cost-effective offers for our customers.

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

To meet these challenges, we have
been adapting our product portfolio around a common IMS platform that gives our
customers the flexibility to build the types of networks and offer the types of
services required to best meet the demand for converged broadband services. We
combined our mobility and wireline businesses into a single unit, the Network
Solutions Group. This change is enabling us to improve our efficiency, market
approach and cost structure. We are also focused on the following actions:

| |   |                                                                                                                                                                                                                 
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | The implementation of a services-led software strategy
  that combined the network operations software business with the Services
  business, which is expected to bring better alignment, focus and efficiency.
| |   |                                                                                                                                                                                                                 
| |  | The optimization of our supply chain network, including
  the consolidation of our EMS (electronic manufacturing service) providers
  from four to two.                                                         
| |   |                                                                                                                                                                                                                 
| |  | The continuation of business process simplification
  efforts across the Company, including corporate center functions.                                                                                         

We expect to achieve operating
efficiencies as a result of these efforts. These changes will allow us to more
effectively focus our efforts and resources on pursuing high-growth areas where
we have strong technology, market or customer advantages. We believe that
focusing on these areas will allow us to serve our customers better and provide
us with the best opportunity to profitably grow the business.

Our revenues are subject to fluctuation
as a result of changes in customer spending patterns and short-term capital
requirements, as well as the timing of customer acceptances. Revenues during
the first half of fiscal 2006 were lower than the comparable prior year period,
primarily due to lower sales in the APaC region, including China and India, and
to a lesser extent, wireless deployments in the U.S. We expect this trend in
APaC to continue in the second half of fiscal 2006.

Capital spending in our target
markets can change rapidly and can vary over short periods of time. In addition, the timing of customer orders,
deployments and acceptances
for large network buildouts as well as the general availability of products and
software releases may also impact future revenues.As a result of this uncertainty, it
is difficult to make accurate forecasts of near- and long-term results and cash
flow. In addition, because a limited number of customers accounts for a
significant amount of our revenue, our results are subject to fluctuation due
to changes in spending by one or more of these customers.

---



|          |                   
|--------- | ------------------
|<PAGE> 23 | Form 10-Q - Part I

Item 2. Managements Discussion and Analysis of Financial Condition and
Results of Operations

The following table includes certain financial information.

|                                             |  |                              |       |                            |   |        |   |      |          |      |   |        |   |   |       |   |   |           |    | 
|-------------------------------------------- |  | ---------------------------- | ----- | -------------------------- | - | ------ | - | ---- | -------- | ---- | - | ------ | - | - | ----- | - | - | --------- | -- | 
|                                             |  | Three months ended March 31, |       | Six months ended March 31, |  
|(in millions)                                |  | 2006                         |       | 2005                       |   | change |   | 2006 |          | 2005 |   | change |   |  
|                                             |  |                              |       |                            |   |        |   |      |          |      |   |        |   |  
|Mobility Access and
  Applications Solutions |  | $                            | 1,002 |                            | $ | 1,219  |   |      | (18      | %)   | $ | 1,947  |   | $ | 2,389 |   |   | (19       | %) | 
|Multimedia Network Solutions                 |  |                              | 388   |                            |   | 360    |   |      | 8        | %    |   | 783    |   |   | 726   |   |   | 8         | %  | 
|Converged Core Solutions                     |  |                              | 151   |                            |   | 192    |   |      | (21      | %)   |   | 296    |   |   | 425   |   |   | (30       | %) | 
|Services                                     |  |                              | 548   |                            |   | 520    |   |      | 5        | %    |   | 1,088  |   |   | 1,068 |   |   | 2         | %  | 
|Other                                        |  |                              | 49    |                            |   | 44     |   |      |          |      |   | 71     |   |   | 62    |   |   |           |    | 
|                                             |  |                              |       |                            |   |        |   |      |          |      |   |        |   |   |       |   |   |           |    | 
|Revenues                                     |  | $                            | 2,138 |                            | $ | 2,335  |   |      | (8       | %)   | $ | 4,185  |   | $ | 4,670 |   |   | (10       | %) | 
|                                             |  |                              |       |                            |   |        |   |      |          |      |   |        |   |   |       |   |   |           |    | 
|                                             |  |                              |       |                            |   |        |   |      |          |      |   |        |   |   |       |   |   |           |    | 
|Gross margin                                 |  | $                            | 926   |                            | $ | 975    |   | $    | (49      | )    | $ | 1,777  |   | $ | 1,959 |   | $ | (182      | )  | 
|Gross margin rate                            |  |                              | 43    | %                          |   | 42     | % |      | 1 point  |      |   | 42     | % |   | 42    | % |   |          |    | 
|                                             |  |                              |       |                            |   |        |   |      |          |      |   |        |   |   |       |   |   |           |    | 
|                                             |  |                              |       |                            |   |        |   |      |          |      |   |        |   |   |       |   |   |           |    | 
|Operating expenses                           |  | $                            | 677   |                            | $ | 707    |   | $    | (30      | )    | $ | 1,617  |   | $ | 1,372 |   | $ | 245       |    | 
|Percentage of revenue                        |  |                              | 32    | %                          |   | 30     | % |      | 2 points |      |   | 39     | % |   | 29    | % |   | 10 points |    | 
|                                             |  |                              |       |                            |   |        |   |      |          |      |   |        |   |   |       |   |   |           |    | 
|                                             |  |                              |       |                            |   |        |   |      |          |      |   |        |   |   |       |   |   |           |    | 
|Operating income                             |  | $                            | 249   |                            | $ | 268    |   | $    | (19      | )    | $ | 160    |   | $ | 587   |   | $ | (427      | )  | 
|Other income (expense), net                  |  |                              | 45    |                            |   | 43     |   |      |          |      |   | 129    |   |   | (3    | ) |   |           |    | 
|Interest expense                             |  |                              | 82    |                            |   | 85     |   |      |          |      |   | 165    |   |   | 174   |   |   |           |    | 
|Income taxes                                 |  |                              | 31    |                            |   | (41    | ) |      |          |      |   | 47     |   |   | (31   | ) |   |           |    | 
|                                             |  |                              |       |                            |   |        |   |      |          |      |   |        |   |   |       |   |   |           |    | 
|                                             |  |                              |       |                            |   |        |   |      |          |      |   |        |   |   |       |   |   |           |    | 
|Net income                                   |  | $                            | 181   |                            | $ | 267    |   | $    | (86      | )    | $ | 77     |   | $ | 441   |   | $ | (364      | )  | 
|                                             |  |                              |       |                            |   |        |   |      |          |      |   |        |   |   |       |   |   |           |    | 

As discussed in more detail throughout our MD&A:

| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Mobility Access
  and Applications Solutions revenues decreased primarily due to lower CDMA
  sales in the U.S. and China. Multimedia Network Solutions revenues increased
  due to higher sales of optical products. Converged Core Solutions revenues
  decreased due to lower sales of legacy circuit switching and Personal
  Handyphone Systems (PHS), as declines in these product sales continue to
  outpace growth in spending on next generation technologies. Services revenues
  increased due to higher deployment services.
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
| |  | The gross margin
  rates were fairly consistent in all periods presented. The favorable impact
  of product and geographic mix and cost reductions, offset the unfavorable
  impact of lower revenues, competitive pricing pressures and a lower net
  pension and postretirement benefit credit (net pension credit).                                                                                                                                                                                                                   
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
| |  | Operating expenses
  increased from the six-month comparable prior-year period primarily due to
  the Winstar litigation charge of $278 million recognized during the first
  quarter of fiscal 2006.                                                                                                                                                                                                                                                                                                                                    
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
| |  | The net pension
  credit was $114 million and $218 million during the three and six months
  ended March 31, 2006, a decrease of $66 million and $137 million,
  respectively.                                                                                                                                                                                                                                                                                                                                                           
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
| |  | In addition to
  interest income realized in both periods, other income (expense) included the
  impact of a minority interest share of losses for one of our joint ventures
  during the first quarter of fiscal 2006 and charges related to changes in the
  estimated fair value of the warrants issued as part of the global settlement
  of our shareowner litigation during the first quarter of fiscal 2005.                                                                                                                      
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
| |  | Income taxes were
  attributed to non-U.S. earnings and to U.S. deferred taxes associated with
  retiree benefits. We expect to recognize
  approximately $170 million of income taxes during fiscal 2006, including
  non-cash U.S. deferred taxes of approximately $100 million. The balance is
  attributable to non-U.S. income taxes.                                                                                                                                                                                               
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
| |  | Cash and cash
  equivalents and marketable securities decreased $961 million to $4.0 billion
  during the six months ended March 31, 2006, primarily due to the timing of
  annual and long-term employee incentive award payments, additional use of
  working capital, legal settlements and cash used to collateralize a letter of
  credit that was issued in connection with the Winstar judgment.                                                                                                                                  

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|          |                   
|--------- | ------------------
|<PAGE> 24 | Form 10-Q - Part I

Item 2. Managements Discussion and Analysis of Financial Condition and
Results of Operations

We expect annual revenues to decrease year over year, with
significantly higher revenues in the second half of the fiscal year than the first
half of the fiscal year.

Given our pending merger with Alcatel, we have withdrawn our previously
reported guidance and will no longer provide specific annual guidance.

APPLICATION
OF CRITICAL ACCOUNTING ESTIMATES

Our unaudited consolidated financial statements are based on the
selection of accounting policies and the application of significant accounting
estimates, some of which require management to make significant assumptions.
Actual results could differ materially from the estimated amounts. We believe
that some of the more critical estimates and related assumptions that affect
our financial condition and results of operations are in the areas of revenue
recognition, pension and postretirement benefits, income taxes, legal
contingencies and intangible assets. We
discuss our critical accounting estimates with our Audit and Finance Committee
of the Board of Directors at least annually. For more information on critical
accounting estimates, refer to the MD&A included in our Form 8-K for the
year ended September 30, 2005, filed on May 5, 2006.

SFAS 123R was adopted on October 1, 2005.
Refer to Note 4 to our unaudited consolidated financial statements for further
information. There were no other accounting policies adopted during the six
months ended March 31, 2006 that had a material effect on our financial
condition and results of operations.

CONSOLIDATED RESULTS
OF OPERATIONS - THREE AND SIX MONTHS ENDED
MARCH 31, 2006 VERSUS THREE AND SIX MONTHS ENDED MARCH 31, 2005

Revenues

|                                                     |  |                              |       |  |     |                            |   |       |  |      |   |   |       |      |     |   |   |       |  |     |  
|---------------------------------------------------- |  | ---------------------------- | ----- |  | --- | -------------------------- | - | ----- |  | ---- | - | - | ----- | ---- | --- | - | - | ----- |  | --- | -
|                                                     |  | Three months ended March 31, |       |  |     | Six months ended March 31, |   |       | 
|(in millions)                                        |  | 2006                         |       |  |     | 2005                       |   |       |  | 2006 |   |   |       | 2005 |     |   |  
|                                                     |  |                              |       |  |     |                            |   |       |  |      |   |   |       |      |     |   |  
|Mobility Access and
  Applications Solutions         |  | $                            | 1,002 |  | 47  | %                          | $ | 1,219 |  | 52   | % | $ | 1,947 |      | 47  | % | $ | 2,389 |  | 51  | %
|Multimedia Network Solutions
  (MNS)                 |  |                              | 388   |  | 18  | %                          |   | 360   |  | 16   | % |   | 783   |      | 19  | % |   | 726   |  | 16  | %
|Converged Core Solutions (CCS)                       |  |                              | 151   |  | 7   | %                          |   | 192   |  | 8    | % |   | 296   |      | 7   | % |   | 425   |  | 9   | %
|Services                                             |  |                              | 548   |  | 26  | %                          |   | 520   |  | 22   | % |   | 1,088 |      | 26  | % |   | 1,068 |  | 23  | %
|Intellectual property                                |  |                              | 42    |  | 2   | %                          |   | 34    |  | 2    | % |   | 60    |      | 1   | % |   | 42    |  | 1   | %
|Other                                                |  |                              | 7     |  |    |                            |   | 10    |  |     |   |   | 11    |      |    |   |   | 20    |  |    |  
|                                                     |  |                              |       |  |     |                            |   |       |  |      |   |   |       |      |     |   |   |       |  |     |  
|Revenues                                             |  | $                            | 2,138 |  | 100 | %                          | $ | 2,335 |  | 100  | % | $ | 4,185 |      | 100 | % | $ | 4,670 |  | 100 | %
|                                                     |  |                              |       |  |     |                            |   |       |  |      |   |   |       |      |     |   |   |       |  |     |  
|                                                     |  |                              |       |  |     |                            |   |       |  |      |   |   |       |      |     |   |   |       |  |     |  
|U.S.                                                 |  | $                            | 1,496 |  | 70  | %                          | $ | 1,449 |  | 62   | % | $ | 2,839 |      | 68  | % | $ | 2,899 |  | 62  | %
|Other Americas (Canada,
  Caribbean & Latin America) |  |                              | 157   |  | 7   | %                          |   | 169   |  | 7    | % |   | 343   |      | 8   | % |   | 350   |  | 8   | %
|EMEA (Europe, Middle East
  & Africa)                |  |                              | 290   |  | 14  | %                          |   | 335   |  | 14   | % |   | 591   |      | 14  | % |   | 655   |  | 14  | %
|APaC (Asia Pacific &
  China)                        |  |                              | 195   |  | 9   | %                          |   | 382   |  | 17   | % |   | 412   |      | 10  | % |   | 766   |  | 16  | %
|                                                     |  |                              |       |  |     |                            |   |       |  |      |   |   |       |      |     |   |   |       |  |     |  
|Revenues                                             |  | $                            | 2,138 |  | 100 | %                          | $ | 2,335 |  | 100  | % | $ | 4,185 |      | 100 | % | $ | 4,670 |  | 100 | %
|                                                     |  |                              |       |  |     |                            |   |       |  |      |   |   |       |      |     |   |   |       |  |     |  

Revenues decreased by 8% and 10% during the three and six months ended
March 31, 2006, primarily within the Mobility Access and Applications Solutions
and CCS segments. Refer to the segment discussion later in this MD&A for
information on changes in revenues by segment and product.

The increase in the U.S. during the three
months ended March 31, 2006 was due to higher services revenues and higher
spending by certain large service providers in 3G investments. The decrease in
APaC was primarily due to lower CDMA sales in China driven by further delays in
the issuance of 3G licenses, the continuing reduction in PHS sales in China and
our selective participation in highly competitive market opportunities in
India. The decrease in EMEA was primarily due to lower UMTS data cards and CDMA
sales. The decrease in Other Americas was due to lower CDMA sales in Venezuela.

The decrease in the U.S. during the six
months ended March 31, 2006 was due to lower CDMA sales to our two largest
customers. The decreases in the other regions are similar to the reasons noted
above.

Changes in foreign currency rates unfavorably
impacted our consolidated revenues by approximately 1% during the interim
fiscal 2006 periods.

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|          |                   
|--------- | ------------------
|<PAGE> 25 | Form 10-Q - Part I

Item 2. Managements Discussion and Analysis of Financial Condition and
Results of Operations

Gross Margin

|                    |  |                              |     |                            |   |      |   |      |       |   |   |       |  
|------------------- |  | ---------------------------- | --- | -------------------------- | - | ---- | - | ---- | ----- | - | - | ----- | -
|                    |  | Three months ended March 31, |     | Six months ended March 31, |  
|(in millions)       |  | 2006                         |     | 2005                       |   | 2006 |   | 2005 |      
|                    |  |                              |     |                            |   |      |   |      |      
|Gross margin        |  | $                            | 926 |                            | $ | 975  |   | $    | 1,777 |   | $ | 1,959 |  
|Gross
  margin rate |  |                              | 43  | %                          |   | 42   | % |      | 42    | % |   | 42    | %

Our gross margin rate is subject to fluctuation due to changes in
volume, geographic, product and service mix, the impact of inventory-related or
warranty charges and revisions to estimates related to long-term contracts.
Changes in estimates related to long-term contracts could occur throughout
the execution of a project as a result of changes in previously expected
costs, contract change orders or the resolution of project contingencies, among
other items. Changes in the expected
profitability for a contract are reflected in results
during the period that they are determined based on the projects percentage
of completion to date. As a result, the cumulative effect of any
changes would be reflected in the results of the current period.

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

The following factors impacted our gross margin rate:

| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | The impact of a lower
net pension credit decreased the gross margin rate by one percentage point from
the comparable prior year periods.                                                                                                                                                                                                                                                                                                                                                                                                                                          
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
| |  | Historically, our
gross margin rates are generally higher in our wireless business as compared to
our wireline and services businesses, and higher in the U.S. as compared to
non-U.S. regions. The favorable impact of the higher percentage of U.S.
revenues to the consolidated revenues was offset by other factors including
volume, pricing, product mix and revised estimates related to long-term
contracts in certain periods. The net effect of these items accounted for most
of the remaining changes in the gross margin rate from the comparable prior
year periods.

Operating Expenses

|                                                                                              |  |                              |     |                            |   |        |   |      |     |      |   |        |   |   |       |   |   |     |   | 
|--------------------------------------------------------------------------------------------- |  | ---------------------------- | --- | -------------------------- | - | ------ | - | ---- | --- | ---- | - | ------ | - | - | ----- | - | - | --- | - | 
|                                                                                              |  | Three months ended March 31, |     | Six months ended March 31, |   |       
|(in millions)                                                                                 |  | 2006                         |     | 2005                       |   | change |   | 2006 |     | 2005 |   | change |   |  
|                                                                                              |  |                              |     |                            |   |        |   |      |     |      |   |        |   |  
|Marketing and sales (M&S)                                                                     |  | $                            | 223 |                            | $ | 249    |   | $    | (26 | )    | $ | 443    |   | $ | 480   |   | $ | (37 | ) | 
|General and administration (G&A)                                                              |  |                              | 155 |                            |   | 181    |   |      | (26 | )    |   | 316    |   |   | 342   |   |   | (26 | ) | 
|                                                                                              |  |                              |     |                            |   |        |   |      |     |      |   |        |   |   |       |   |   |     |   | 
|Selling, general and administrative (SG&A)
  expenses, excluding the following three
  items: |  |                              | 378 |                            |   | 430    |   |      | (52 | )    |   | 759    |   |   | 822   |   |   | (63 | ) | 
|Winstar
  litigation                                                                          |  |                              |    |                            |   |       |   |      |    |      |   | 278    |   |   |      |   |   | 278 |   | 
|Provision
  for (recovery of) bad debts and customer financings                               |  |                              | 2   |                            |   | (11    | ) |      | 13  |      |   | (5     | ) |   | (22   | ) |   | 17  |   | 
|Amortization of other acquired
  intangibles assets                                           |  |                              | 4   |                            |   | 4      |   |      |    |      |   | 8      |   |   | 8     |   |   |    |   | 
|                                                                                              |  |                              |     |                            |   |        |   |      |     |      |   |        |   |   |       |   |   |     |   | 
|SG&A                                                                                          |  |                              | 384 |                            |   | 423    |   |      | (39 | )    |   | 1,040  |   |   | 808   |   |   | 232 |   | 
|Research and development (R&D)                                                                |  |                              | 297 |                            |   | 292    |   |      | 5   |      |   | 580    |   |   | 571   |   |   | 9   |   | 
|Business restructuring                                                                        |  |                              | (4  | )                          |   | (8     | ) |      | 4   |      |   | (3     | ) |   | (7    | ) |   | 4   |   | 
|                                                                                              |  |                              |     |                            |   |        |   |      |     |      |   |        |   |   |       |   |   |     |   | 
|Operating expenses                                                                            |  | $                            | 677 |                            | $ | 707    |   | $    | (30 | )    | $ | 1,617  |   | $ | 1,372 |   | $ | 245 |   | 
|                                                                                              |  |                              |     |                            |   |        |   |      |     |      |   |        |   |   |       |   |   |     |   | 

Operating expenses decreased from the three-months comparable prior
year period primarily due to lower compensation expense in SG&A. Operating
expenses increased from the six-months comparable prior year period mainly due
to the Winstar litigation charges. Refer to Note 12 to our unaudited
consolidated financial statements for further discussion on this matter.

---



|          |                   
|--------- | ------------------
|<PAGE> 26 | Form 10-Q - Part I

Item 2. Managements Discussion and Analysis of Financial Condition and
Results of Operations

A $40 million reversal of payroll and benefit-related liabilities was
included in the first quarter of fiscal 2005. This reversal included $24
million related to the fiscal 2004 annual employee incentive awards, as those
incentive payments were less than expected, and $16 million of out-of-period
adjustments in connection with certain non-U.S. benefit plans. These reversals
reduced operating expenses by $28 million and the remainder favorably impacted
gross margin during the first quarter of fiscal 2005. An $11 million reversal
of payroll and benefit-related liabilities was included in the first quarter of
fiscal 2006, as employee incentive awards payments were less than expected.
This reversal reduced operating expenses by $8 million and the remainder
favorably impacted gross margin.

SG&A

Excluding the impact of bad debt and customer financing,
  SG&A decreased by $52 million during the three months ended March 31, 2006.
  Reductions of $35 million are primarily attributed to lower average workforce
  levels and discretionary spending. Lower litigation charges of $15 million,
  more favorable settlements on non-income tax matters and other disputes of $13
  million and lower accruals for employee incentive awards of $15 million (including
  lower sales compensation) also contributed to the decrease.

The impact of these items more
than offset a $20 million lower net pension and postretirement benefit credit
and a $6 million higher stock-based compensation expense.

Excluding the impact of the Winstar litigation charge
  and bad debt and customer financing, SG&A decreased by $63 million during
  the six months ended March 31, 2006. Reductions of $61 million were primarily
  attributed to lower average workforce levels and discretionary spending. Lower
  litigation charges of $12 million, more favorable settlements of non-income
  tax matters and other disputes of $21 million and lower accruals for employee
  incentive awards of $28 million (including lower sales compensation) also contributed
  to the decrease.

The impact of these items more
than offset a $41 million lower net pension and postretirement benefit credit,
$11 million of higher stock based compensation expense and the $7 million net
impact of payroll and benefit-related liability reversals discussed above.

R&D

Our R&D programs are focused on enhancing and expanding our broad
portfolio of leading edge technologies and reshaping our product portfolio to
capture convergence opportunities. In addition, our R&D investment also
supports Bell Labs long-term research programs in such areas as computer science,
materials science and bioengineering. We believe our current R&D spending
levels and plans are aligned with current and expected market opportunities.

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

|                  |  |                              |    |                            |   |      |  |      |     |  |   |     | 
|----------------- |  | ---------------------------- | -- | -------------------------- | - | ---- |  | ---- | --- |  | - | --- | 
|                  |  | Three months ended March 31, |    | Six months ended March 31, |  
|(in millions)     |  | 2006                         |    | 2005                       |   | 2006 |  | 2005 |    
|                  |  |                              |    |                            |   |      |  |      |    
|Costs capitalized |  | $                            | 57 |                            | $ | 56   |  | $    | 119 |  | $ | 115 | 
|Amortization      |  |                              | 57 |                            |   | 62   |  |      | 108 |  |   | 135 | 



R&D increased by $5 million during the three months ended March 31,
2006. The increase was primarily attributed to a $25 million lower net pension
credit and $6 million of higher stock-based compensation expense.

The impact of these items more than offset the effect of lower average
workforce levels and less discretionary spending of $18 million and lower
accruals for fiscal 2006 employee incentive awards of $8 million.

---



|          |                   
|--------- | ------------------
|<PAGE> 27 | Form 10-Q - Part I

Item 2. Managements Discussion and Analysis of Financial Condition and
Results of Operations

R&D increased by $9 million during the six months ended March 31,
2006. The increase was primarily attributed to a $53 million lower net pension
credit, $13 million of higher stock-based compensation expense and the $13
million net impact of payroll and benefit-related liability reversals
previously discussed above.

The impact of these items more than offset the effect of lower average
workforce levels and less discretionary spending of $55 million as well as
lower accruals for fiscal 2006 employee incentive awards of $15 million.

Business restructuring

We have essentially completed our restructuring actions but continue to
evaluate the remaining restructuring reserves at the end of each reporting
period. There may be additional charges or reversals, primarily related to
estimates of facility closing costs, including expected sublease income. Actual
costs have differed from estimated amounts in the past. Refer to Note 5 to our
unaudited consolidated financial statements for details on the changes in our
business restructuring reserve.

Pension, Postretirement and Postemployment
Benefits

We maintain defined benefit pension plans covering the majority of
employees and retirees, as well as postretirement benefit plans for retirees
that include health care, dental benefits and life insurance coverage.
Additionally, we offer various postemployment benefits to certain employees
after employment but before retirement, including disability benefits,
severance pay and workers compensation. Refer to Note 3 to our unaudited
consolidated financial statements for further information.

|                                                |  |                              |      |                            |   |      |   |      |      |   |   |      |   | 
|----------------------------------------------- |  | ---------------------------- | ---- | -------------------------- | - | ---- | - | ---- | ---- | - | - | ---- | - | 
|                                                |  | Three months ended March 31, |      | Six months ended March 31, |   |     
|(in millions)                                   |  | 2006                         |      | 2005                       |   | 2006 |   | 2005 |      |  
|                                                |  |                              |      |                            |   |      |   |      |      |  
|Pension
  benefit credit                        |  | $                            | (162 | )                          | $ | (244 | ) | $    | (329 | ) | $ | (486 | ) | 
|Postretirement benefit cost                     |  |                              | 48   |                            |   | 64   |   |      | 111  |   |   | 131  |   | 
|                                                |  |                              |      |                            |   |      |   |      |      |   |   |      |   | 
|Net
  pension and postretirement benefit credit |  | $                            | (114 | )                          | $ | (180 | ) | $    | (218 | ) | $ | (355 | ) | 
|                                                |  |                              |      |                            |   |      |   |      |      |   |   |      |   | 
|                                               
|Postemployment
  benefit cost                   |  | $                            | 18   |                            | $ | 16   |   | $    | 42   |   | $ | 34   |   | 
|                                                |  |                              |      |                            |   |      |   |      |      |   |   |      |   | 

Approximately two-thirds of the net credit is reflected in operating
expenses, with the balance in costs used to determine gross margin. The
decrease in the net credit was primarily due to lower expected return on plan
assets and higher amortization of actuarial losses resulting from:

| |   |                                                                                                                                                  
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Reductions in the
  market-related value of plan assets due to the impact of actual losses
  incurred on plan assets during fiscal 2002 and 2001.
| |   |                                                                                                                                                  
| |  | Changes in
  mortality assumptions as of September 30, 2005.                                                                                     

The net pension credit is expected to decrease by approximately $300
million during fiscal 2006, primarily due to the factors discussed above.
Changes in actuarial assumptions could also significantly impact the net credit
in the future.

Stock-Based Compensation Expense

SFAS 123R was adopted on October 1, 2005, which now
  requires among other items, the recognition of stock option expense in the results
  of operations. The modified prospective transition method was elected, therefore
  prior period results were not restated. Stock-based compensation expense was
  $20 million and $5 million during the three months ended March 31, 2006 and
  2005, respectively, and $44 million and $14 million during the six months ended
  March 31, 2006 and 2005, respectively. Stock-based compensation expense is expected
  to be approximately $100 million during fiscal 2006.

---



|          |                   
|--------- | ------------------
|<PAGE> 28 | Form 10-Q - Part I

Item 2. Managements Discussion and Analysis of Financial Condition and
Results of Operations

Stock-based compensation expense recognized in the
  results of operations during the three and six months ended March 31, 2006 was
  $60 million and $122 million lower than the pro forma amount determined
  under the fair value-based method and disclosed in accordance with SFAS
  123 for the respective comparable prior year periods. This reduction was primarily
  due to the amortization of previously unvested awards over the original
  vesting periods and lower fair value amounts attributed to the
  more recent awards. There were no significant modifications to existing awards or
  acceleration of vesting periods during fiscal 2005 and the six months
  ended March 31, 2006.

Refer to Note 4 to our unaudited consolidated financial statements for
more information on stock-based compensation.

Other Income (Expense), net

|                                                  |  |                              |    |                            |   |      |   |      |    
|------------------------------------------------- |  | ---------------------------- | -- | -------------------------- | - | ---- | - | ---- | ---
|                                                  |  | Three months ended March 31, |    | Six months ended March 31, |  
|(in millions)                                     |  | 2006                         |    | 2005                       |   | 2006 |   | 2005 |    
|                                                  |  |                              |    |                            |   |      |   |      |    
|Legal
  settlements                               |  | $                            |   |                            | $ | (14  | ) | $    |   
|Winstar
  post-judgment interest                  |  |                              | (3 | )                          |   |     |   |      | (3 
|Interest
  on tax matters                         |  |                              |   |                            |   | 54   |   |      | 2  
|Interest
  income                                 |  |                              | 44 |                            |   | 29   |   |      | 89 
|Loss
  on sale of investments, net                |  |                              | (4 | )                          |   | (2   | ) |      | (9 
|Minority
  interest                               |  |                              | 2  |                            |   | (13  | ) |      | 35 
|Other-than-temporary
  write-downs of investments |  |                              |   |                            |   | (5   | ) |      | (2 
|Miscellaneous,
  net                              |  |                              | 6  |                            |   | (6   | ) |      | 17 
|                                                  |  |                              |    |                            |   |      |   |      |    
|Other
  income (expense), net                     |  | $                            | 45 |                            | $ | 43   |   | $    | 129
|                                                  |  |                              |    |                            |   |      |   |      |    

The legal settlement charge during the six months ended March 31, 2005
was primarily related to the changes in fair market value of warrants issued in
connection with the global settlement of our shareowner lawsuit of $71 million
and other litigation settlements of $14 million.

Interest on tax matters was related to our favorable resolution of
income tax audits, including the favorable resolution of certain tax issues
under tax sharing agreements with AT&T, Avaya and Agere.

The increase in interest income was primarily due to higher average
marketable securities balances and higher interest rate yields.

One of our joint ventures recognized a loss during the three and six
months ended March 31, 2006 resulting in a minority interest share of the
losses. The loss recognized by the joint venture during the six months ended
March 31, 2006 included internal pricing adjustments related to certain prior
periods.

Interest Expense

Interest expense decreased by $3 million and $9 million
  during the three and six months ended March 31, 2006, respectively, due to the
  early extinguishment of convertible securities and other debt obligations.

---



|          |                   
|--------- | ------------------
|<PAGE> 29 | Form 10-Q - Part I

Item 2. Managements Discussion and Analysis of Financial Condition and
Results of Operations

Income Taxes

|                                                               |  |                              |    |                            |   |      |   |      |    |  |   |     |  
|-------------------------------------------------------------- |  | ---------------------------- | -- | -------------------------- | - | ---- | - | ---- | -- |  | - | --- | -
|                                                               |  | Three months ended March 31, |    | Six months ended March 31, |  
|(in millions)                                                  |  | 2006                         |    | 2005                       |   | 2006 |   | 2005 |   
|                                                               |  |                              |    |                            |   |      |   |      |   
|Favorable
  resolution of tax matters                          |  | $                            |   |                            | $ | (55  | ) | $    |   |  | $ | (55 | )
|Non-U.S.
  and state income taxes attributed to pre-tax income |  |                              | 15 |                            |   | 14   |   |      | 31 |  |   | 24  |  
|U.S.
  deferred taxes                                          |  |                              | 16 |                            |   |     |   |      | 16 |  |   |    |  
|                                                               |  |                              |    |                            |   |      |   |      |    |  |   |     |  
|Income
  taxes                                                 |  | $                            | 31 |                            | $ | (41  | ) | $    | 47 |  | $ | (31 | )
|                                                               |  |                              |    |                            |   |      |   |      |    |  |   |     |  
|                                                               |  |                              |    |                            |   |      |   |      |    |  |   |     |  
|Interest
  on tax matters                                      |  | $                            |   |                            | $ | 54   |   | $    | 2  |  | $ | 59  |  
|                                                               |  |                              |    |                            |   |      |   |      |    |  |   |     |  

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

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

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

Results of Operations
by Segment

MobilityAccess
and Applications Solutions

|                 |  |                              |       |                            |   |        |  |      |     |      |   |        |  |   |       |  |   |      |   
|---------------- |  | ---------------------------- | ----- | -------------------------- | - | ------ |  | ---- | --- | ---- | - | ------ |  | - | ----- |  | - | ---- | --
|                 |  | Three months ended March 31, |       | Six months ended March 31, |  
|(in millions)    |  | 2006                         |       | 2005                       |   | change |  | 2006 |     | 2005 |   | change | 
|                 |  |                              |       |                            |   |        |  |      |     |      |   |        | 
|U.S.             |  | $                            | 835   |                            | $ | 896    |  |      | (7  | %)   | $ | 1,598  |  | $ | 1,770 |  |   | (10  | %)
|NonU.S.         |  |                              | 167   |                            |   | 323    |  |      | (48 | %)   |   | 349    |  |   | 619   |  |   | (44  | %)
|                 |  |                              |       |                            |   |        |  |      |     |      |   |        |  |   |       |  |   |      |   
|Total revenues   |  | $                            | 1,002 |                            | $ | 1,219  |  |      | (18 | %)   | $ | 1,947  |  | $ | 2,389 |  |   | (19  | %)
|                 |  |                              |       |                            |   |        |  |      |     |      |   |        |  |   |       |  |   |      |   
|                 |  |                              |       |                            |   |        |  |      |     |      |   |        |  |   |       |  |   |      |   
|Segment
  income |  | $                            | 371   |                            | $ | 437    |  | $    | (66 | )    | $ | 688    |  | $ | 859   |  | $ | (171 | ) 
|                 |  |                              |       |                            |   |        |  |      |     |      |   |        |  |   |       |  |   |      |   

Three months ended March 31, 2006 versus
March 31, 2005

Mobility Access and Applications Solutions revenues
  decreased due to a $220 million decrease in Mobility Access Solutions and $3
  million increase in Applications Solutions. U.S. revenues decreased primarily
  due to lower CDMA sales to our two largest customers as certain initial stages
  of large high-speed data network build outs are nearing completion. Expansion
  and upgrades for these high-speed data network build outs, combined with similar
  deployments by other customers, will continue to drive our CDMA revenues in
  the U.S. These two customers accounted for 67% and 64% of total Mobility Access
  and Applications Solutions revenues during the second quarter of fiscal 2006
  and 2005, respectively. Including these two customers, the five largest Mobility
  Access and Applications Solutions customers accounted for 86% and 85% of revenues
  during the second quarter of fiscal 2006 and 2005, respectively. Non-U.S. revenues
  decreased primarily due to lower CDMA sales in China driven by the delay of
  3G licenses and to a lesser extent, lower UMTS data card sales in EMEA and our
  selective participation in highly competitive market opportunities in India.

---



|          |                   
|--------- | ------------------
|<PAGE> 30 | Form 10-Q - Part I

Item 2. Managements Discussion and Analysis of Financial Condition and
Results of Operations

Substantially all of Mobility Access Solutions revenues are currently
generated from CDMA technology. We expect revenues related to a large UMTS
contract in the U.S. will continue to grow during fiscal 2006. We are
conducting third-generation UMTS / W-CDMA trials in China and Japan.

Consolidation has occurred with several large U.S. wireless service
providers and may have impacted capital spending in certain situations. These
events may continue to present opportunities for us to assist in integration
efforts or to expand our products/services or technologies in certain networks
where they were not previously utilized. However, events may impact our future
revenue trends as these service providers assess potential technology
migrations to common platforms or leverage excess capacity. In addition, the
timing of awards of licenses and spectrum to service providers and the
technologies that ultimately will be deployed in certain markets, such as
China, may also impact future revenue.

Future quarterly revenue trends may be volatile as a result of the high
concentration of revenue among a limited number of customers and the resulting
exposure to their spending patterns.

R&D investment in Mobility Access and Application Solutions is
focused primarily on CDMA and UMTS next generation technologies and includes
expenses associated with UMTS product trials with certain customers. This
investment continues to support our leadership position in spread-spectrum
technology and our development of high-speed mobile data solutions.

Segment income decreased due to a $61 million decrease in gross margin
and a $5 million increase in operating expenses. The decrease in gross margin
was primarily due to lower sales volume partially offset by a higher gross
margin rate. The increase in the gross margin rate was due to the favorable
impact of revised cost estimates related to long-term contracts and a more
favorable geographic and product mix.

Six months ended March 31, 2006 versus March
31, 2005

Mobility Access and Applications Solutions revenues decreased due to a
$437 million decrease in Mobility Access Solutions and $5 million decrease in
Applications Solutions. U.S. revenues decreased primarily due to lower CDMA
sales to our two largest customers. These two customers accounted for 66% and
63% of total Mobility Access and Applications Solutions revenues during the six
months ended March 31, 2006 and 2005, respectively. Including these two
customers, the five largest Mobility Access and Applications Solutions
customers accounted for 80% of Mobility Access and Applications Solutions
revenues during the six months ended March 31, 2006 and 2005. Non-U.S. revenues
decreased primarily due to lower CDMA sales in China driven by the delay of 3G
licenses and to a lesser extent, lower UMTS data card sales in EMEA and our
selective participation in highly competitive market opportunities in India.

Segment income decreased primarily due to a $170 million decrease in
gross margin. The decrease in gross margin was primarily due to similar reasons
described in the three-month discussion above.

Multimedia Network Solutions (MNS)

|                        |  |                              |     |                            |   |        |   |      |     |      |   |        |  |   |     |  |   |    |   
|----------------------- |  | ---------------------------- | --- | -------------------------- | - | ------ | - | ---- | --- | ---- | - | ------ |  | - | --- |  | - | -- | --
|                        |  | Three months ended March 31, |     | Six months ended March 31, |  
|(in millions)           |  | 2006                         |     | 2005                       |   | change |   | 2006 |     | 2005 |   | change | 
|                        |  |                              |     |                            |   |        |   |      |     |      |   |        | 
|Data
  and access       |  | $                            | 140 |                            | $ | 193    |   |      | (27 | %)   | $ | 334    |  | $ | 353 |  |   | (5 | %)
|Optical
  networking    |  |                              | 248 |                            |   | 167    |   |      | 49  | %    |   | 449    |  |   | 373 |  |   | 20 | % 
|                        |  |                              |     |                            |   |        |   |      |     |      |   |        |  |   |     |  |   |    |   
|Total
  revenues        |  | $                            | 388 |                            | $ | 360    |   |      | 8   | %    | $ | 783    |  | $ | 726 |  |   | 8  | % 
|                        |  |                              |     |                            |   |        |   |      |     |      |   |        |  |   |     |  |   |    |   
|                        |  |                              |     |                            |   |        |   |      |     |      |   |        |  |   |     |  |   |    |   
|U.S.                    |  | $                            | 202 |                            | $ | 135    |   |      | 50  | %    | $ | 368    |  | $ | 274 |  |   | 34 | % 
|NonU.S.                |  |                              | 186 |                            |   | 225    |   |      | (17 | %)   |   | 415    |  |   | 452 |  |   | (8 | %)
|                        |  |                              |     |                            |   |        |   |      |     |      |   |        |  |   |     |  |   |    |   
|Total revenues          |  | $                            | 388 |                            | $ | 360    |   |      | 8   | %    | $ | 783    |  | $ | 726 |  |   | 8  | % 
|                        |  |                              |     |                            |   |        |   |      |     |      |   |        |  |   |     |  |   |    |   
|                        |  |                              |     |                            |   |        |   |      |     |      |   |        |  |   |     |  |   |    |   
|Segment
  income (loss) |  | $                            | 42  |                            | $ | (16    | ) | $    | 58  |      | $ | 87     |  | $ | 4   |  | $ | 83 |   
|                        |  |                              |     |                            |   |        |   |      |     |      |   |        |  |   |     |  |   |    |   

---



|          |                   
|--------- | ------------------
|<PAGE> 31 | Form 10-Q - Part I

Item 2. Managements Discussion and Analysis of Financial Condition and
Results of Operations

Three months ended March 31, 2006 versus
March 31, 2005

MNS revenues increased by $28 million. U.S. revenues increased
primarily due to higher optical networking sales. Non-U.S. revenues decreased
primarily from lower data and access sales in APaC and EMEA. Five customers
accounted for 50% and 39% of MNS revenues during the second quarter of fiscal
2006 and 2005, respectively.

R&D investment in MNS supports a broad array of current and next
generation technologies, including metro optical and broadband networking
solutions.

Segment income increased due to a $46 million increase in gross margin
and $12 million decrease in operating expenses. The higher gross margin
resulted from an increase in the gross margin rate and higher revenue. The
increase in the gross margin rate was due to a more favorable product mix and
lower inventory related charges. The decrease in operating expenses was
primarily due to lower R&D spending attributed to lower average employee
workforce levels and discretionary expenses.

Six months ended March 31, 2006 versus March
31, 2005

MNS revenues increased by $57 million. U.S. revenues increased
primarily due to higher optical networking sales. Non-U.S. revenues decreased
primarily from lower data and access sales in APaC and EMEA. Five customers
accounted for 44% and 38% of MNS revenues during the six months ended March 31,
2006 and 2005, respectively.

Segment income increased due to a $47 million increase in gross margin
and $36 million decrease in operating expenses due to similar reasons described
in the three-month discussion above.

Converged Core Solutions (CCS)

|                        |  |                              |     |                            |   |        |   |      |     |      |   |        |  |   |     |   |   |     |   
|----------------------- |  | ---------------------------- | --- | -------------------------- | - | ------ | - | ---- | --- | ---- | - | ------ |  | - | --- | - | - | --- | --
|                        |  | Three months ended March 31, |     | Six months ended March 31, |  
|(in millions)           |  | 2006                         |     | 2005                       |   | change |   | 2006 |     | 2005 |   | change | 
|                        |  |                              |     |                            |   |        |   |      |     |      |   |        | 
|U.S.                    |  | $                            | 95  |                            | $ | 94     |   |      | 1   | %    | $ | 165    |  | $ | 205 |   |   | (20 | %)
|NonU.S.                |  |                              | 56  |                            |   | 98     |   |      | (43 | %)   |   | 131    |  |   | 220 |   |   | (40 | %)
|                        |  |                              |     |                            |   |        |   |      |     |      |   |        |  |   |     |   |   |     |   
|Total revenues          |  | $                            | 151 |                            | $ | 192    |   |      | (21 | %)   | $ | 296    |  | $ | 425 |   |   | (30 | %)
|                        |  |                              |     |                            |   |        |   |      |     |      |   |        |  |   |     |   |   |     |   
|                        |  |                              |     |                            |   |        |   |      |     |      |   |        |  |   |     |   |   |     |   
|Segment
  income (loss) |  | $                            | 16  |                            | $ | (5     | ) | $    | 21  |      | $ | 16     |  | $ | (14 | ) | $ | 30  |   
|                        |  |                              |     |                            |   |        |   |      |     |      |   |        |  |   |     |   |   |     |   

Three months ended March 31, 2006 versus
March 31, 2005

CCS revenues declined by $41 million. Lower non-U.S. sales were
attributed to lower PHS sales in China. Five customers accounted for 50% and
60% of CCS revenues during the second quarter of fiscal 2006 and 2005,
respectively.

Circuit switching revenues declined by $15 million to $85 million. PHS
revenues declined by $36 million to $20 million. Traditional circuit switching
product sales have been declining at a faster rate than the growth in next
generation technologies. This decline is more prevalent in the U.S. PHS sales
declined as service providers in China curtailed their spending in preparation
for transitioning to 3G networks. CCSs remaining revenues consisted primarily
of sales of next generation switching products and refurbished equipment.

Although customer-spending levels for CCS products may not change
significantly in the aggregate, the mix of what is purchased is likely to
continue to change or fluctuate. Our future revenues will be impacted by our
success in offering a product portfolio that effectively addresses customer
needs. CCS revenues may continue to decline due to the transition to next
generation networks.

R&D investment in CCS supports a broad array of current and next
generation technologies, including IMS and VoIP.

---



|          |                   
|--------- | ------------------
|<PAGE> 32 | Form 10-Q - Part I

Item 2. Managements Discussion and Analysis of Financial Condition and
Results of Operations

Segment income increased due to a $9 million increase in gross margin
and $12 million decrease in operating expenses. The increase in gross margin
was due to an increase in the gross margin rate attributed to a software
licensing settlement and lower software amortization costs and inventory
charges. The decrease in operating expense was due to lower R&D spending
attributed to lower average employee workforce levels and higher SG&A
expense from a legal settlement in the prior year period.

Six months ended March 31, 2006 versus March
31, 2005

CCS revenues declined by $129 million. The decline in U.S. revenues was
attributed to circuit switching products. Lower non-U.S. sales were attributed
to lower PHS sales in China. Five customers accounted for 48% and 58% of CCS
revenues during the six months ended March 31, 2006 and 2005, respectively.

Circuit switching revenues declined by $53 million to $153 million. PHS
revenues declined by $79 million to $48 million. The declines in circuit
switching and PHS are similar to the reasons noted above. CCSs remaining
revenues consisted primarily of sales of next generation products and
refurbished equipment.

Segment income increased due to a $16 million increase in gross margin
and $14 million decrease in operating expense due to similar reasons described
in the three-month discussion above.

Services

|                        |  |                              |     |                            |   |        |  |      |     |      |   |        |  |   |       |  |   |    |   
|----------------------- |  | ---------------------------- | --- | -------------------------- | - | ------ |  | ---- | --- | ---- | - | ------ |  | - | ----- |  | - | -- | --
|                        |  | Three months ended March 31, |     | Six months ended March 31, |  
|(in millions)           |  | 2006                         |     | 2005                       |   | change |  | 2006 |     | 2005 |   | change | 
|                        |  |                              |     |                            |   |        |  |      |     |      |   |        | 
|U.S.                    |  | $                            | 315 |                            | $ | 281    |  |      | 12  | %    | $ | 637    |  | $ | 589   |  |   | 8  | % 
|NonU.S.                |  |                              | 233 |                            |   | 239    |  |      | (3  | %)   |   | 451    |  |   | 479   |  |   | (6 | %)
|                        |  |                              |     |                            |   |        |  |      |     |      |   |        |  |   |       |  |   |    |   
|Total revenues          |  | $                            | 548 |                            | $ | 520    |  |      | 5   | %    | $ | 1,088  |  | $ | 1,068 |  |   | 2  | % 
|                        |  |                              |     |                            |   |        |  |      |     |      |   |        |  |   |       |  |   |    |   
|                        |  |                              |     |                            |   |        |  |      |     |      |   |        |  |   |       |  |   |    |   
|Segment
  income (loss) |  | $                            | 46  |                            | $ | 58     |  | $    | (12 | )    | $ | 135    |  | $ | 134   |  | $ | 1  |   
|                        |  |                              |     |                            |   |        |  |      |     |      |   |        |  |   |       |  |   |    |   

Three months ended March 31, 2006 versus
March 31, 2005

Services revenues increased by $28 million. U.S. revenues increased
primarily due to deployment services related to a UMTS contract. Non-U.S.
revenues decreased primarily in the APaC region. Five customers accounted for
47% and 44% of Services revenues during the second quarter of fiscal 2006 and
2005, respectively.

Segment income decreased due to a $23 million decrease in gross margin
offset by an $11 million decrease in operating expenses. The decrease in gross
margin was driven by a lower gross margin rate, reflecting impacts from revised
cost estimates for a long term contract, the completion of a Non-U.S. network
integration project and an unfavorable service mix. The decrease in operating
expense was primarily attributed to lower average workforce levels.

Six months ended March 31, 2006 versus March
31, 2005

Services revenues increased by $20 million. U.S. revenues increased due
to multi-vendor maintenance contracts, managed services and deployment services
related to a UMTS contract. Non-U.S. revenues decreased primarily in the APaC
region. Five customers accounted for 48% and 45% of Services revenues during
the six months of fiscal 2006 and 2005, respectively.

Professional services revenues decreased by $18 million primarily due
to the reason noted above.

Segment income was essentially flat as a $22 million decrease in gross
margin was offset by a $23 million decrease in operating expenses due to
similar reasons described in the three-month discussion above.

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|          |                   
|--------- | ------------------
|<PAGE> 33 | Form 10-Q - Part I

Item 2. Managements Discussion and Analysis of Financial Condition and
Results of Operations

LIQUIDITY
AND CAPITAL RESOURCES

Cash, cash equivalents and marketable securities decreased by $961
million to $4.0 billion during the six months ended March 31, 2006 primarily
due to the payment of employee incentive awards and cash used to collateralize
a letter of credit that was issued in connection with the Winstar judgment.
Summarized cash flow information and key working capital metrics are as
follows:

|                                                |  |                            |      |      |   |        |   |   |      |  
|----------------------------------------------- |  | -------------------------- | ---- | ---- | - | ------ | - | - | ---- | -
|                                                |  | Six months ended March 31, |     
|                                                |  | 2006                       |      | 2005 |   | change |  
|(in millions)                                   |  |                            |      |      |   |        |  
|Net income                                      |  | $                          | 77   |      | $ | 441    |   | $ | (364 | )
|Non-cash items                                  |  |                            | (51  | )    |   | (102   | ) |   | 51   |  
|Changes in working capital                      |  |                            | (183 | )    |   | (212   | ) |   | 29   |  
|Other changes                                   |  |                            | (408 | )    |   | (803   | ) |   | 395  |  
|                                                |  |                            |      |      |   |        |   |   |      |  
|Operating activities                            |  | $                          | (565 | )    | $ | (676   | ) | $ | 111  |  
|                                                |  |                            |      |      |   |        |   |   |      |  
|                                                |  |                            |      |      |   |        |   |   |      |  
|Investing activities                            |  | $                          | (491 | )    | $ | (739   | ) | $ | 248  |  
|                                                |  |                            |      |      |   |        |   |   |      |  
|                                                |  |                            |      |      |   |        |   |   |      |  
|Financing activities                            |  | $                          | 19   |      | $ | (12    | ) | $ | 31   |  
|                                                |  |                            |      |      |   |        |   |   |      |  
|                                                |  |                            |      |      |   |        |   |   |      |  
|Days sales outstanding in accounts
  receivable |  |                            | 59   |      |   | 60     |   |   | (1   | )
|Inventory turnover                              |  |                            | 6.4  |      |   | 6.2    |   |   | 0.2  |  
|Days sales outstanding in working capital       |  |                            | 42   |      |   | 34     |   |   | 8    |  

Operating Activities

Our operating results and resulting cash flows have generally been
impacted during the past few years due to changes in revenue levels, cost
reductions and other factors discussed throughout this MD&A. The following
discussion is intended to further explain differences between net income and
cash flow.

Non-cash items include items that are not expected to generate or
require the use of cash, such as the pension credit and depreciation and
amortization. In addition, a charge related to the changes in the fair value of
warrants issued in connection with the global settlement of our shareowner
lawsuit impacted non-cash items during fiscal 2005.

Changes in working capital requirements include changes in receivables,
inventories and contracts in process, accounts payable and deferred revenue.
Working capital requirements are impacted by the timing of cash collections,
customer billings and accounts payable disbursements. We periodically sell
certain non-U.S. receivables with extended payment terms where it is cost
effective to do so. We sold $69 million and $147 million of receivables during
the six months ended March 31, 2006 and 2005, respectively. This impact is
reflected in the changes in receivables. Receivables with extended billing
terms were $292 million and $225 million as of March 31, 2006 and September 30,
2005, respectively.

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

Changes in other operating assets and liabilities (reflected above as
other changes) during the six months ended March 31, 2006 included the
payment of fiscal 2005 incentive awards, capitalized software of $119 million,
legal settlement payments of $80 million, partially offset by the impact of
$281 million of reserves (including $3 million of post judgment interest)
provided for as a result of the Winstar judgment. Changes reflected in the
comparable prior year period included the payment of fiscal 2004 employee
incentive awards of

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|          |                   
|--------- | ------------------
|<PAGE> 34 | Form 10-Q - Part I

Item 2. Managements Discussion and Analysis of Financial Condition and
Results of Operations

$600 million, the final payment related to our shareowner lawsuit
settlement of $215 million, cash outlays for our restructuring program of $40
million, capitalized software of $115 million, partially offset by $201 million
of proceeds from our welfare benefits trusts as a reimbursement for prior
period management health care contributions. Cash flow from operating
activities also included net tax refunds of $1 million and net tax payments of
$63 million (including related interest) during the six months ended March 31,
2006 and 2005, respectively.

Investing Activities

Investing activities included net purchases
of marketable securities of $81 million and $662 million during the six months
ended March 31, 2006 and 2005, respectively. We may continue to purchase and sell
marketable securities in an attempt to improve our investment returns. Changes
in restricted cash included $311 million of cash used to collateralize a letter
of credit issued in connection with the Winstar judgment during the second
quarter of fiscal 2006. The remaining cash used in investing activities was for
capital expenditures, including internal use software.

Financing Activities

Cash used in connection with the early extinguishment of
certain debt obligations was $15 million and $101 million during the six months
ended March 31, 2006 and 2005, respectively. Cash provided from the issuance ofcommon shares
for certain employee benefit plans was $34 million and $85 million during the
six months ended March 31, 2006 and 2005, respectively.

We are currently authorized by our board of directors
  to extinguish certain of our convertible securities and other debt obligations
  prior to maturity. During the past few years, we retired convertible securities
  and certain other debt obligations in exchange for shares of our common stock
  and cash, in separate, multiple and privately-negotiated transactions. We may
  only use cash in similar transactions in the future pending completion of the
  merger transaction with Alcatel.

Future Capital Requirements and Funding Sources

We do not expect that our operations will generate cash on a
sustainable basis until our pre-tax income exceeds the amount of net non-cash
income items, which have been driven primarily by our pension credit. Our
pension credit was $973 million and $329 million during fiscal 2005 and the six
months ended March 31, 2006, respectively. Our cash requirements during the
next few years are primarily related to funding our operations, retiree health
care obligations, capital expenditures, potential acquisitions, debt
obligations and related interest and other matters discussed below. Our 7.25%
notes of $368 million mature during the fourth quarter of fiscal 2006. We also
have the right to redeem the $486 million of 8% convertible securities for cash
after August 14, 2006. Our 8% convertible securities are redeemable at the
option of the holders on August 2, 2007. We have the right to satisfy the
redemption with cash, shares of our common stock, or a combination of both.

We believe our cash and cash equivalents of $1.4 billion and marketable
securities of $2.6 billion as of March 31, 2006 are sufficient to fund our cash
requirements for fiscal 2006 as well as the following few years. However, we
cannot provide assurance that our actual cash requirements will not be greater
than we currently expect. If sources of liquidity are not available or if we
cannot generate sufficient cash flow from operations, we might be required to
obtain additional sources of funds through additional operating improvements,
capital market transactions, asset sales or financing from third parties, or a
combination thereof. We cannot provide assurance that these additional sources
of funds will be available or, if available, would have reasonable terms.

On April 27, 2006, certain net assets of Riverstone
  Networks, a maker of carrier-grade Ethernet routers for the telecommunications
  industry, were acquired for $207 million in cash.

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|          |                   
|--------- | ------------------
|<PAGE> 35 | Form 10-Q - Part I

Item 2. Managements Discussion and Analysis of Financial Condition and
Results of Operations

The remaining cash requirements for our restructuring program are
expected to be $126 million, primarily for lease obligations over the remaining
lease terms, net of expected sublease rental income of $119 million. The cash
requirements could increase in the future if the expected sublease income is
not realized.

We currently do not expect to make contributions to
  our qualified U.S. pension plans through fiscal 2007. We are unable to provide
  an estimate of future funding requirements beyond fiscal 2007 for our U.S. pension
  plans. Based on our actuarial projections and current law, we believe it is
  unlikely that any required contributions would have a material effect on our
  liquidity during fiscal 2008 through fiscal 2010. Several legislative changes
  were recently proposed that would impact U.S. pension plans, if adopted. The
  U.S. Senate passed its pension reform bill, The Pension Security and Transparency
  Act (S. 1783) on November 16, 2005. The U.S. House of Representatives passed
  the Pension Protection Act (H.R. 2830) on December 15, 2005. The Senate bill
  currently contains the Section 420 Amendments that we are pursuing as discussed
  in more detail below. These proposals would alter the manner in which liabilities
  and asset values are determined for the purpose of calculating required pension
  contributions and the timing and manner in which required contributions to under-funded
  pension plans would be made. The House and Senate bills will need to be reconciled
  in conference before being sent to the President for consideration and signed
  into law. The funding requirements for our U.S. pension plans could be significantly
  affected by these proposed changes, if they are adopted.

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

We were required to fund an additional $49 million
  of deferred compensation and non-qualified pension benefits related to certain
  current and retired officers during the third quarter of fiscal 2006 as a result
  of the announcement of the merger with Alcatel.

We currently provide retiree health care benefits for our retirees in
the United States, including 46,000 management retirees and 68,000 formerly
represented retirees as well as an additional 68,000 dependents of retirees.
The obligations and plan assets for management and formerly represented
retirees are accounted for separately. Historically, retiree health care
benefits were funded through plan assets set aside in trusts and transfers of
excess pension assets. There are currently no plan assets available in these
trusts to fund the obligations of the management retirees. There are
approximately $327 million of assets in trusts that are available to fund the
obligations of the formerly represented retirees as of March 31, 2006.

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

Together with our unions, we are seeking legislative changes to allow
an employer to fund more than one years retiree health care benefits through a
Section 420 transfer and permit the terms of an enforceable collective
bargaining agreement to serve as an alternative to the maintenance of cost
requirements described above. There were approximately $2.2 billion of pension
plan assets that would be eligible for Section 420 transfers in our formerly
represented retiree plan as of the most recent valuation (January 1, 2006). The
funding levels for our management retiree pension plans were below the required
thresholds that would allow for Section 420 transfers. If we are successful in
obtaining the legislative changes, we believe that a majority of our funding
requirements for formerly represented retirees could be addressed through
Section 420 transfers based on current actuarial assumptions. However, no
assurances can be given that we will be successful in these efforts or that
other legislative changes will not be adopted that will adversely affect the
amount of pension plan assets that would be available for Section 420
transfers.

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|          |                   
|--------- | ------------------
|<PAGE> 36 | Form 10-Q - Part I

Item 2. Managements Discussion and Analysis of Financial Condition and
Results of Operations

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

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

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

Customer financing commitments

We may provide or commit to additional
customer financings on a limited basis. We carefully review requests for
customer financing on a case-by-case basis. Such review assesses the credit
quality of the individual borrowers and the structure of the transactions. We
also assess our ability to sell or transfer the undrawn commitments and drawn
borrowings to unrelated third parties. Our net exposure for customer financing
commitments was not material as of March 31, 2006.

Credit
ratings

Our credit ratings are below investment grade. Any credit downgrade
affects our ability to enter into and maintain certain contracts on favorable
terms and increases our cost of borrowing. Our credit ratings as of May 9,
2006, are as follows:

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

|    |                                                                    
|--- | -------------------------------------------------------------------
|   
|(a) | Outlook changed to
  Watch Positive on March 24, 2006.             
|(b) | Rating placed
  under review for possible upgrade on April 3, 2006.
|(c) | Outlook changed to
  Watch Positive on April 3, 2006.              

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|          |                   
|--------- | ------------------
|<PAGE> 37 | Form 10-Q - Part I

Item 3. Quantitative and Qualitative
Disclosures About Market Risk

RISK MANAGEMENT

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

Foreign currency risk

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

Interest rate risk

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

As of March 31, 2006, we had interest rate swaps where we received
fixed interest rates (5.5% and 7.25%) and paid floating rates based upon the
three-month LIBOR rate plus agreed upon spreads (ranging from 1.72% to 2.89%)
on notional amounts aggregating $400 million. As of March 31, 2006, the
three-month LIBOR rate was 5.00%. We do not foresee any significant changes in
our interest rate risk management strategy or in our exposure to interest rate
fluctuations.

Equity price risk

Our investment portfolio includes equity investments in publicly held
companies that are classified as available-for-sale and other strategic equity
holdings in privately held companies and venture funds. These securities are
exposed to price fluctuations and are generally concentrated in high-technology
industries. The carrying values of our available-for-sale equity securities and
privately held securities were $2 million and $63 million as of March 31, 2006,
respectively. We generally do not hedge our equity price risk due to hedging
restrictions imposed by the issuers, illiquid capital markets or our inability
to hedge non-marketable equity securities in privately held companies.

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|          |                   
|--------- | ------------------
|<PAGE> 38 | Form 10-Q - Part I

Item 4. Controls and Procedures

We periodically review the design and effectiveness of our disclosure
controls and internal control over financial reporting worldwide, including
compliance with various laws and regulations that apply to our operations both
inside and outside the United States. We make modifications to improve the
design and effectiveness of our disclosure controls and internal control
structure, and may take other corrective action, if our reviews identify a need
for such modifications or actions. In designing and evaluating the disclosure
controls and procedures and internal control of financial reporting, we
recognize that any controls and procedures, no matter how well designed and
operated, can provide only reasonable assurance of achieving the desired
control objectives.

An evaluation was
carried out under the supervision and with the participation of our management,
including the Chief Executive Officer (CEO) and Chief Financial Officer (CFO),
of the effectiveness of our disclosure controls and procedures. Based on that
evaluation, the CEO and CFO have concluded that as of the end of the period
covered by this report, our disclosure controls and procedures are effective to
provide reasonable assurance that information required to be disclosed by us in
reports that we file or submit under the Securities Exchange Act of 1934 is
recorded, processed, summarized and timely reported as provided in the
Securities and Exchange Commission rules and forms. No changes occurred during
the three months ended March 31, 2006 in our internal control over financial
reporting that have materially affected, or are reasonably likely to materially
affect, our internal control over financial reporting.

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|          |                   
|--------- | ------------------
|<PAGE> 39 | Form 10-Q - Part I

Part II  Other Information

Item 1. Legal Proceedings

Information about legal proceedings is set forth in Note 12 to the
unaudited consolidated financial statements included in this report.

Item 4. Submission of Matters to a Vote of
Security Holders

We held our 2006 Annual Meeting of Shareowners on February 15, 2006. At
that meeting, shareowners elected Linnet F. Deily, Robert E. Denham, Daniel S.
Goldin, Edward E. Hagenlocker, Karl J. Krapek, Richard C. Levin, Patricia F.
Russo, Henry B. Schacht, Franklin A. Thomas and Ronald A. Williams as Directors
of the company. The terms of these directors will expire at the 2007 Annual
Meeting. In addition, shareowners approved two company proposals, two
shareowner proposals and rejected two shareowner proposals. The persons elected
and the results of the voting are as follows:

|                        |  |               |  |                | 
|----------------------- |  | ------------- |  | -------------- | 
|                        |  | Votes For     |  | Votes Withheld | 
|                        |  |               |  |                | 
|Linnet F. Deily         |  | 3,491,523,345 |  | 218,887,993    | 
|Robert E. Denham        |  | 3,494,678,343 |  | 215,732,995    | 
|Daniel S. Goldin        |  | 3,473,691,790 |  | 236,719,548    | 
|Edward E.
  Hagenlocker |  | 3,469,883,396 |  | 240,527,941    | 
|Karl J. Krapek          |  | 3,492,653,853 |  | 217,757,485    | 
|Richard C. Levin        |  | 3,493,271,137 |  | 217,140,201    | 
|Patricia F. Russo       |  | 3,462,537,972 |  | 247,873,365    | 
|Henry B. Schacht        |  | 3,472,970,741 |  | 237,440,596    | 
|Franklin A. Thomas      |  | 3,518,218,491 |  | 192,192,847    | 
|Ronald A. Williams      |  | 3,442,001,080 |  | 268,410,257    | 

|                                                                                                                                                                   |  |               |  |               |  |             |  |                 | 
|------------------------------------------------------------------------------------------------------------------------------------------------------------------ |  | ------------- |  | ------------- |  | ----------- |  | --------------- | 
|                                                                                                                                                                   |  | Votes For     |  | Votes Against |  | Abstain     |  | Broker Non-Vote | 
|                                                                                                                                                                   |  |               |  |               |  |             |  |                 | 
|Company proposal
  to ratify PricewaterhouseCoopers LLP as independent accountants                                                                                 |  | 3,569,670,542 |  | 86,182,979    |  | 54,557,814  |  |                 | 
|                                                                                                                                                                   |  |               |  |               |  |             |  |                 | 
|Company proposal
  to approve amendment to the restated certificate of incorporation to effect a
  reverse stock split at the discretion of the board of directors |  | 2,746,068,286 |  | 906,863,460   |  | 57,479,286  |  |                 | 
|                                                                                                                                                                   |  |               |  |               |  |             |  |                 | 
|Shareowner proposal regarding disclosure of political contributions                                                                                                |  | 349,722,933   |  | 1,071,499,455 |  | 242,892,461 |  | 2,046,296,486   | 
|                                                                                                                                                                   |  |               |  |               |  |             |  |                 | 
|Shareowner
  proposal requesting future cash bonus or incentive compensation be contingent
  upon restoration of retiree benefits                                  |  | 324,096,459   |  | 1,269,434,502 |  | 70,583,888  |  | 2,046,296,486   | 
|                                                                                                                                                                   |  |               |  |               |  |             |  |                 | 
|Shareowner
  proposal regarding performance-based equity compensation                                                                                              |  | 931,729,381   |  | 676,887,411   |  | 55,497,755  |  | 2,046,296,788   | 
|                                                                                                                                                                   |  |               |  |               |  |             |  |                 | 
|Shareowner
  proposal to exclude non-cash pension credit from earnings used to determine
  incentive compensation for executive officers                           |  | 851,402,116   |  | 747,884,534   |  | 64,826,533  |  | 2,046,298,152   | 

Item 6. Exhibits

See Exhibit Index on page 41 for a
description of the documents that are filed as Exhibits to this report on Form
10-Q or incorporated by reference herein.

---



|          |                   
|--------- | ------------------
|<PAGE> 40 | Form 10-Q - Part I

SIGNATURES

Pursuant to the requirements of the
Securities Exchange Act of 1934, the registrant has duly caused this report to
be signed on its behalf by the undersigned thereunto duly authorized.

| |                         
| | ------------------------
| | Lucent Technologies Inc.
| | Registrant              

Date: May 9, 2006

| |                                 
| | --------------------------------
| | /s/
  David W. Hitchcock        
| |                                 
| | David
  W. Hitchcock            
| | Corporate
  Controller          
| | (Principal
  Accounting Officer)

---



|          |                   
|--------- | ------------------
|<PAGE> 41 | Form 10-Q - Part I

Exhibit
Index

|        |                                                                                                                                                                         
|------- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|31(i).1 | Certification of Patricia F. Russo required by Rule 13a-14(a) (17
  C.F.R. 240.13a-14(a)).                                                                              
|        |                                                                                                                                                                         
|31(i).2 | Certification of
  John A. Kritzmacher required by Rule 13a-14(a) (17 C.F.R. 240.13a-14(a)).                                                                            
|        |                                                                                                                                                                         
|32      | Certification of
  Patricia F. Russo and John A. Kritzmacher pursuant to 18 U.S.C. Section 1350,
  as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

---