---

---

AS FILED WITH THE SEC ON FEBRUARY 8, 2006

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

For the quarterly period ended December 31, 2005

OR

oTRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OFTHE 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 x   No o

Indicate
by check mark whether the registrant is an accelerated filer (as defined in
Rule 12b-2 of the Exchange Act). Yes x   No o

At January 31, 2006, 4,469,189,442 common shares
were outstanding.

---

---



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

INDEX

|                                |                                                                                                         |    | 
|------------------------------- | ------------------------------------------------------------------------------------------------------- | -- | 
|Part I  Financial Information: |                                                                                                         |   
|                                |                                                                                                         |    | 
|Item 1.                         | Financial Statements                                                                                    |    | 
|                                |                                                                                                         |    | 
|                                | Consolidated Statements of
  Operations for the Three Months Ended December 31, 2005 and 2004           | 3  | 
|                                |                                                                                                         |    | 
|                                | Consolidated Balance Sheets as of
  December 31, 2005 and September 30, 2005                            | 4  | 
|                                |                                                                                                         |    | 
|                                | Consolidated Statement of Changes
  in Shareowners Equity for the Three Months Ended December 31, 2005 | 5  | 
|                                |                                                                                                         |    | 
|                                | Consolidated Statements of Cash
  Flows for the Three Months Ended December 31, 2005 and 2004           | 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                                            | 36 | 
|                                |                                                                                                         |    | 
|Item 4.                         | Controls and Procedures                                                                                 | 37 | 
|                                |                                                                                                         |    | 
|Part II  Other Information:    |                                                                                                         |   
|                                |                                                                                                         |    | 
|Item 1.                         | Legal Proceedings                                                                                       | 38 | 
|                                |                                                                                                         |    | 
|Item 6.                         | Exhibits                                                                                                | 38 | 

---



|         |                   
|-------- | ------------------
|<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 ended December 31, |      
|                                              |  | 2005                              |       | 2004 |  
|                                              |  |                                   |       |      |  
|Revenues:                                     |  |                                   |       |      |   |       |  
|Products                                      |  | $                                 | 1,507 |      | $ | 1,787 |  
|Services                                      |  |                                   | 540   |      |   | 548   |  
|                                              |  |                                   |       |      |   |       |  
|Total revenues                                |  |                                   | 2,047 |      |   | 2,335 |  
|                                              |  |                                   |       |      |   |       |  
|Costs:                                        |  |                                   |       |      |   |       |  
|Products                                      |  |                                   | 804   |      |   | 950   |  
|Services                                      |  |                                   | 392   |      |   | 401   |  
|                                              |  |                                   |       |      |   |       |  
|Total costs                                   |  |                                   | 1,196 |      |   | 1,351 |  
|                                              |  |                                   |       |      |   |       |  
|Gross margin                                  |  |                                   | 851   |      |   | 984   |  
|Operating expenses:                           |  |                                   |       |      |   |       |  
|Selling, general and administrative           |  |                                   | 656   |      |   | 385   |  
|Research and development                      |  |                                   | 283   |      |   | 279   |  
|Business restructuring                        |  |                                   | 1     |      |   | 1     |  
|                                              |  |                                   |       |      |   |       |  
|Total operating expenses                      |  |                                   | 940   |      |   | 665   |  
|                                              |  |                                   |       |      |   |       |  
|Operating income (loss)                       |  |                                   | (89   | )    |   | 319   |  
|Other income (expense), net                   |  |                                   | 84    |      |   | (46   | )
|Interest expense                              |  |                                   | 83    |      |   | 89    |  
|                                              |  |                                   |       |      |   |       |  
|Income (loss) before income taxes             |  |                                   | (88   | )    |   | 184   |  
|Income taxes                                  |  |                                   | 16    |      |   | 10    |  
|                                              |  |                                   |       |      |   |       |  
|Net income (loss)                             |  | $                                 | (104  | )    | $ | 174   |  
|                                              |  |                                   |       |      |   |       |  
|                                              |  |                                   |       |      |   |       |  
|Net income (loss) per
  share:                |  |                                   |       |      |   |       |  
|Basic                                         |  | $                                 | (0.02 | )    | $ | 0.04  |  
|Diluted                                       |  | $                                 | (0.02 | )    | $ | 0.04  |  
|Weighted
  average common shares outstanding: |  |                                   |       |      |   |       |  
|Basic                                         |  |                                   | 4,452 |      |   | 4,403 |  
|Diluted                                       |  |                                   | 4,452 |      |   | 4,998 |  

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)

|                                                                                                                                                                                                                 |  |                     |         |                      |   |         |  
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------------- | ------- | -------------------- | - | ------- | -
|                                                                                                                                                                                                                 |  | December 31,
  2005 |         | September 30,
  2005 |  
|                                                                                                                                                                                                                 |  |                     |         |                      |  
|                                                                                                                                                                                                                
|ASSETS                                                                                                                                                                                                           |  |                     |         |                      |   |         |  
|Cash and cash equivalents                                                                                                                                                                                        |  | $                   | 1,504   |                      | $ | 2,410   |  
|Marketable securities                                                                                                                                                                                            |  |                     | 650     |                      |   | 357     |  
|Receivables, net                                                                                                                                                                                                 |  |                     | 1,430   |                      |   | 1,395   |  
|Inventories                                                                                                                                                                                                      |  |                     | 766     |                      |   | 731     |  
|Other current assets                                                                                                                                                                                             |  |                     | 630     |                      |   | 690     |  
|                                                                                                                                                                                                                 |  |                     |         |                      |   |         |  
|Total current assets                                                                                                                                                                                             |  |                     | 4,980   |                      |   | 5,583   |  
|Marketable securities                                                                                                                                                                                            |  |                     | 2,226   |                      |   | 2,163   |  
|Property, plant and equipment, net                                                                                                                                                                               |  |                     | 1,256   |                      |   | 1,295   |  
|Prepaid pension costs                                                                                                                                                                                            |  |                     | 6,168   |                      |   | 6,010   |  
|Goodwill and other acquired intangibles, net                                                                                                                                                                     |  |                     | 415     |                      |   | 419     |  
|Other assets                                                                                                                                                                                                     |  |                     | 912     |                      |   | 930     |  
|                                                                                                                                                                                                                 |  |                     |         |                      |   |         |  
|Total assets                                                                                                                                                                                                     |  | $                   | 15,957  |                      | $ | 16,400  |  
|                                                                                                                                                                                                                 |  |                     |         |                      |   |         |  
|                                                                                                                                                                                                                
|LIABILITIES                                                                                                                                                                                                      |  |                     |         |                      |   |         |  
|Accounts payable                                                                                                                                                                                                 |  | $                   | 772     |                      | $ | 769     |  
|Payroll and benefit-related liabilities                                                                                                                                                                          |  |                     | 776     |                      |   | 1,095   |  
|Debt maturing within one year                                                                                                                                                                                    |  |                     | 368     |                      |   | 368     |  
|Other current liabilities                                                                                                                                                                                        |  |                     | 1,687   |                      |   | 1,588   |  
|                                                                                                                                                                                                                 |  |                     |         |                      |   |         |  
|Total current liabilities                                                                                                                                                                                        |  |                     | 3,603   |                      |   | 3,820   |  
|Postretirement and postemployment benefit liabilities                                                                                                                                                            |  |                     | 4,749   |                      |   | 4,751   |  
|Pension liabilities                                                                                                                                                                                              |  |                     | 1,402   |                      |   | 1,423   |  
|Long-term debt                                                                                                                                                                                                   |  |                     | 5,049   |                      |   | 5,066   |  
|Other liabilities                                                                                                                                                                                                |  |                     | 859     |                      |   | 965     |  
|                                                                                                                                                                                                                 |  |                     |         |                      |   |         |  
|Total liabilities                                                                                                                                                                                                |  |                     | 15,662  |                      |   | 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;
  4,469 issued and 4,459 outstanding shares as of December 31, 2005, and 4,457
  issued and 4,447 outstanding shares as of September 30, 2005 |  |                     | 45      |                      |   | 45      |  
|Additional paid-in capital                                                                                                                                                                                       |  |                     | 23,556  |                      |   | 23,513  |  
|Accumulated deficit                                                                                                                                                                                              |  |                     | (19,712 | )                    |   | (19,608 | )
|Accumulated other comprehensive loss                                                                                                                                                                             |  |                     | (3,594  | )                    |   | (3,575  | )
|                                                                                                                                                                                                                 |  |                     |         |                      |   |         |  
|Total shareowners equity                                                                                                                                                                                        |  |                     | 295     |                      |   | 375     |  
|                                                                                                                                                                                                                 |  |                     |         |                      |   |         |  
|Total liabilities and shareowners
equity                                                                                                                                                                        |  | $                   | 15,957  |                      | $ | 16,400  |  
|                                                                                                                                                                                                                 |  |                     |         |                      |   |         |  

See Notes to Unaudited Consolidated Financial
Statements.

---



|         |                   
|-------- | ------------------
|<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 (loss)                                          |  |                            |       |                |   |                                |  |                       |        |                                            |   | (104                          | ) |   |        |   |   | (104 | )
|Foreign currency translation adjustments                   |  |                            |       |                |   |                                |  |                       |        |                                            |   |                               |   |   | (17    | ) |   | (17  | )
|Unrealized holding losses on investments                   |  |                            |       |                |   |                                |  |                       |        |                                            |   |                               |   |   | (2     | ) |   | (2   | )
|Issuance of common stock related to employee benefit plans |  |                            | 11    |                |   |                                |  |                       | 20     |                                            |   |                               |   |   |        |   |   | 20   |  
|Stock-based compensation                                   |  |                            | 1     |                |   |                                |  |                       | 24     |                                            |   |                               |   |   |        |   |   | 24   |  
|Other                                                      |  |                            |       |                |   |                                |  |                       | (1     | )                                          |   |                               |   |   |        |   |   | (1   | )
|                                                           |  |                            |       |                |   |                                |  |                       |        |                                            |   |                               |   |   |        |   |   |      |  
|Balance as of December 31, 2005                            |  |                            | 4,459 |                | $ | 45                             |  | $                     | 23,556 |                                            | $ | (19,712                       | ) | $ | (3,594 | ) | $ | 295  |  
|                                                           |  |                            |       |                |   |                                |  |                       |        |                                            |   |                               |   |   |        |   |   |      |  

See Notes to Unaudited Consolidated Financial
Statements.

---



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

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

|                                                                                       |  |                                   |       |      |   |       |  
|-------------------------------------------------------------------------------------- |  | --------------------------------- | ----- | ---- | - | ----- | -
|                                                                                       |  | Three Months ended
  December 31, |      
|                                                                                       |  | 2005                              |       | 2004 |  
|                                                                                       |  |                                   |       |      |  
|Operating activities:                                                                  |  |                                   |       |      |   |       |  
|Net income (loss)                                                                      |  | $                                 | (104  | )    | $ | 174   |  
|Adjustments to reconcile net income (loss) to net
  cash used in operating activities: |  |                                   |       |      |   |       |  
|Depreciation and amortization                                                          |  |                                   | 127   |      |   | 165   |  
|Pension credit                                                                         |  |                                   | (167  | )    |   | (242  | )
|Stock-based compensation expense                                                       |  |                                   | 24    |      |   | 9     |  
|Other adjustments for non-cash items                                                   |  |                                   | (44   | )    |   | 75    |  
|Changes in operating assets and liabilities:                                           |  |                                   |       |      |   |       |  
|Receivables                                                                            |  |                                   | 41    |      |   | 86    |  
|Inventories and contracts in process                                                   |  |                                   | (15   | )    |   | 1     |  
|Accounts payable                                                                       |  |                                   | (80   | )    |   | (93   | )
|Deferred revenue                                                                       |  |                                   | (136  | )    |   | (107  | )
|Other operating assets and liabilities                                                 |  |                                   | (169  | )    |   | (392  | )
|                                                                                       |  |                                   |       |      |   |       |  
|Net cash used in operating activities                                                  |  |                                   | (523  | )    |   | (324  | )
|                                                                                       |  |                                   |       |      |   |       |  
|                                                                                       |  |                                   |       |      |   |       |  
|Investing activities:                                                                  |  |                                   |       |      |   |       |  
|Capital expenditures                                                                   |  |                                   | (30   | )    |   | (34   | )
|Net purchases of marketable securities                                                 |  |                                   | (357  | )    |   | (695  | )
|                                                                                       |  |                                   |       |      |   |       |  
|Net cash used in investing activities                                                  |  |                                   | (387  | )    |   | (729  | )
|                                                                                       |  |                                   |       |      |   |       |  
|                                                                                       |  |                                   |       |      |   |       |  
|Financing activities:                                                                  |  |                                   |       |      |   |       |  
|Repayment of long-term debt                                                            |  |                                   | (15   | )    |   | (21   | )
|Issuance of common stock                                                               |  |                                   | 20    |      |   | 55    |  
|Other financing activities                                                             |  |                                   |      |      |   | (2    | )
|                                                                                       |  |                                   |       |      |   |       |  
|Net cash provided by financing activities                                              |  |                                   | 5     |      |   | 32    |  
|Effect of exchange rate changes on cash and cash
  equivalents                         |  |                                   | (1    | )    |   | 23    |  
|                                                                                       |  |                                   |       |      |   |       |  
|Net decrease in cash and cash equivalents                                              |  |                                   | (906  | )    |   | (998  | )
|Cash and cash equivalents at beginning of year                                         |  |                                   | 2,410 |      |   | 3,379 |  
|                                                                                       |  |                                   |       |      |   |       |  
|Cash and cash equivalents at end of period                                             |  | $                                 | 1,504 |      | $ | 2,381 |  
|                                                                                       |  |                                   |       |      |   |       |  
|                                                                                       |  |                                   |       |      |   |       |  
|Income tax refunds (payments), net                                                     |  | $                                 | 21    |      | $ | (21   | )
|Interest payments                                                                      |  | $                                 | (51   | )    | $ | (52   | )

See Notes to Unaudited Consolidated Financial
Statements.

---



|         |                   
|-------- | ------------------
|<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.

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 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,
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.

2. PENSION AND POSTRETIREMENT BENEFITS

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

|                                     |  |                                                    |      |                                                           |   |      |   |      |     |   |   |     |  
|------------------------------------ |  | -------------------------------------------------- | ---- | --------------------------------------------------------- | - | ---- | - | ---- | --- | - | - | --- | -
|                                     |  | Pension benefits
  Three months ended December 31, |      | Postretirement benefits
  Three months ended December 31, |  
|(in
  millions)                      |  | 2005                                               |      | 2004                                                      |   | 2005 |   | 2004 |    
|                                     |  |                                                    |      |                                                           |   |      |   |      |    
|Service
  cost                       |  | $                                                  | 39   |                                                           | $ | 39   |   | $    | 2   |   | $ | 2   |  
|Interest
  cost                      |  |                                                    | 410  |                                                           |   | 414  |   |      | 79  |   |   | 85  |  
|Expected
  return on plan assets     |  |                                                    | (684 | )                                                         |   | (722 | ) |      | (16 | ) |   | (25 | )
|Amortization
  of prior service cost |  |                                                    | 14   |                                                           |   | 19   |   |      | (18 | ) |   | (2  | )
|Amortization
  of actuarial losses   |  |                                                    | 54   |                                                           |   | 5    |   |      | 16  |   |   | 7   |  
|                                     |  |                                                    |      |                                                           |   |      |   |      |     |   |   |     |  
|Subtotal                             |  |                                                    | (167 | )                                                         |   | (245 | ) |      | 63  |   |   | 67  |  
|Settlements                          |  |                                                    |     |                                                           |   | 3    |   |      |    |   |   |    |  
|                                     |  |                                                    |      |                                                           |   |      |   |      |     |   |   |     |  
|Benefit (credit) cost                |  | $                                                  | (167 | )                                                         | $ | (242 | ) | $    | 63  |   | $ | 67  |  
|                                     |  |                                                    |      |                                                           |   |      |   |      |     |   |   |     |  

3. 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.

---



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

Notes to Consolidated Financial Statements
(Unaudited)



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.

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 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.

---



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

Notes to Consolidated Financial Statements
(Unaudited)

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                              |  |                        | (3  | )                                             |   | 1.68  | 
|Forfeited/expired                      |  |                        | (16 | )                                             |   | 13.27 | 
|                                       |  |                        |     |                                               |   |       | 
|Outstanding
  as of December 31, 2005  |  |                        | 425 |                                               |   | 9.98  | 
|                                       |  |                        |     |                                               |   |       | 
|Exercisable
  as of December 31, 2005  |  |                        | 328 |                                               | $ | 11.97 | 
|                                       |  |                        |     |                                               |   |       | 

The weighted average remaining term for outstanding
  stock options was three years at December 31, 2005. The aggregate intrinsic
  value at December 31, 2005 was $107 million for stock options outstanding and
  $92 million for stock options exercisable. The intrinsic value for stock options
  is calculated based on the exercise price of the underlying awards and the market
  price of our common stock as of the reporting date.

The following table
summarizes non-vested restricted stock unit activity.

|                                    |  |                        |    |                                          |   |      | 
|----------------------------------- |  | ---------------------- | -- | ---------------------------------------- | - | ---- | 
|                                    |  | Shares
  (in millions) |    | Weighted average
  grant date fair value |  
|                                    |  |                        |    |                                          |  
|Unvested
  as of September 30, 2005 |  |                        | 3  |                                          | $ | 4.36 | 
|Granted                             |  |                        | 11 |                                          |   | 2.82 | 
|Vested                              |  |                        | (1 | )                                        |   | 3.69 | 
|Forfeited                           |  |                        |   |                                          |   | 4.32 | 
|                                    |  |                        |    |                                          |   |      | 
|Unvested
  as of December 31, 2005  |  |                        | 13 |                                          | $ | 3.13 | 
|                                    |  |                        |    |                                          |   |      | 

Proceeds received from the
exercise of stock options were $5 million during the first quarter of fiscal
2006 and 2005.  The intrinsic value
related to the exercise of stock options was $4 million and $6 million during
the first quarter of fiscal 2006 and 2005, respectively, which 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.

|                                                                                                       |  |                                        |      |  
|------------------------------------------------------------------------------------------------------ |  | -------------------------------------- | ---- | -
|(in millions, except per share amounts)                                                                |  | Three months ended 
  December 31,2004 |     
|                                                                                                       |  |                                        |     
|Net
  income, as reported                                                                              |  | $                                      | 174  |  
|Add: Stock-based employee compensation
  expense included in as
  reported net income                  |  |                                        | 9    |  
|Deduct: Total stock-based employee compensation
expense determined
  under the fair value based method |  |                                        | (84  | )
|                                                                                                       |  |                                        |      |  
|Pro
  forma net income                                                                                 |  | $                                      | 99   |  
|                                                                                                       |  |                                        |      |  
|Income per share
  applicable to common shareowners:                                                   |  |                                        |      |  
|As reported:                                                                                           |  |                                        |      |  
|Basic                                                                                                  |  | $                                      | 0.04 |  
|Diluted                                                                                                |  | $                                      | 0.04 |  
|Pro forma:                                                                                             |  |                                        |      |  
|Basic                                                                                                  |  | $                                      | 0.02 |  
|Diluted                                                                                                |  | $                                      | 0.02 |  

---



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

Notes to Consolidated Financial Statements
(Unaudited)

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.

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

|                                         |  |                                 |    |      |   |   | 
|---------------------------------------- |  | ------------------------------- | -- | ---- | - | - | 
|                                         |  | Three months ended December 31, |   
|                                         |  | 2005                            |    | 2004 |  
|                                         |  |                                 |    |      |  
|Stock
  options                          |  | $                               | 20 |      | $ |  | 
|Restricted
  stock units                 |  |                                 | 3  |      |   | 4 | 
|Other                                    |  |                                 | 1  |      |   | 5 | 
|                                         |  |                                 |    |      |   |   | 
|Total
  stock-based compensation expense |  | $                               | 24 |      | $ | 9 | 
|                                         |  |                                 |    |      |   |   | 
|                                         |  |                                 |    |      |   |   | 
|Costs                                    |  | $                               | 3  |      | $ |  | 
|Selling,
  general and administrative    |  |                                 | 13 |      |   | 8 | 
|Research
  and development               |  |                                 | 8  |      |   | 1 | 
|                                         |  |                                 |    |      |   |   | 
|Total
  stock-based compensation expense |  | $                               | 24 |      | $ | 9 | 
|                                         |  |                                 |    |      |   |   | 

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 December 31, |     
|                                                 |  | 2005                            |      | 2004 |  
|                                                 |  |                                 |      |      |  
|Dividend
  yield                                 |  |                                 | 0.0  | %    |   | 0.0  | %
|Weighted
  average volatility                    |  |                                 | 54.6 | %    |   | 82.1 | %
|Risk-free
  interest rate                        |  |                                 | 4.4  | %    |   | 3.5  | %
|Expected
  holding period (in years)             |  |                                 | 4.8  |      |   | 3.8  |  
|Weighted
  average fair value of options granted |  | $                               | 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.                                                                                                                                                                                                                                                                                                                

---



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

Notes to Consolidated Financial Statements
(Unaudited)

|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | 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.

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 December 31, 2005,
approximately $140 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.

4. 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                  |  |                         |  |                         |   |                    |  |   | 1     |   |   | 1   |  
|Utilization of reserves                          |  |                         |  |                         |   |                    |  |   | (10   | ) |   | (10 | )
|                                                 |  |                         |   |                         |   |                     |  |   |       |   |   |     |  
|Restructuring reserve as
  of December 31, 2005  |  | $                       | 1 |                         | $ | 1                   |  | $ | 136   |   | $ | 138 |  
|                                                 |  |                         |   |                         |   |                     |  |   |       |   |   |     |  

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.

---



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

Notes to Consolidated Financial Statements
(Unaudited)

5. SUPPLEMENTARY BALANCE SHEET INFORMATION

|                                                                                                    |  |                       |       |                        |   |       |  
|--------------------------------------------------------------------------------------------------- |  | --------------------- | ----- | ---------------------- | - | ----- | -
|(in millions)                                                                                       |  | December
  31,
  2005 |       | September
  30,
  2005 |  
|                                                                                                    |  |                       |       |                        |  
|Completed goods                                                                                     |  | $                     | 561   |                        | $ | 580   |  
|Work in process                                                                                     |  |                       | 49    |                        |   | 39    |  
|Raw materials                                                                                       |  |                       | 156   |                        |   | 112   |  
|                                                                                                    |  |                       |       |                        |   |       |  
|Inventories, net of reserves of $703 as of
  December 31, 2005 and  $712 as of
  September 30, 2005 |  | $                     | 766   |                        | $ | 731   |  
|                                                                                                    |  |                       |       |                        |   |       |  
|                                                                                                    |  |                       |       |                        |   |       |  
|Costs and recognized income not yet billed                                                          |  | $                     | 181   |                        | $ | 208   |  
|Billings in excess of costs and recognized
  income                                                 |  |                       | (216  | )                      |   | (220  | )
|                                                                                                    |  |                       |       |                        |   |       |  
|Contracts in process reflected in other
  current liabilities                                       |  | $                     | (35   | )                      | $ | (12   | )
|                                                                                                    |  |                       |       |                        |   |       |  
|                                                                                                    |  |                       |       |                        |   |       |  
|Deferred income taxes                                                                               |  | $                     | 243   |                        | $ | 237   |  
|Prepaid expenses                                                                                    |  |                       | 215   |                        |   | 206   |  
|Non-trade receivables                                                                               |  |                       | 90    |                        |   | 117   |  
|Income tax receivables, including related
  interest                                                |  |                       | 44    |                        |   | 85    |  
|Restricted cash                                                                                     |  |                       | 38    |                        |   | 41    |  
|Other                                                                                               |  |                       |      |                        |   | 4     |  
|                                                                                                    |  |                       |       |                        |   |       |  
|Other current assets                                                                                |  | $                     | 630   |                        | $ | 690   |  
|                                                                                                    |  |                       |       |                        |   |       |  
|                                                                                                    |  |                       |       |                        |   |       |  
|Marketed software                                                                                   |  | $                     | 265   |                        | $ | 254   |  
|Internal use software                                                                               |  |                       | 112   |                        |   | 120   |  
|Restricted cash                                                                                     |  |                       | 139   |                        |   | 137   |  
|Deferred income taxes                                                                               |  |                       | 75    |                        |   | 78    |  
|Investments                                                                                         |  |                       | 64    |                        |   | 65    |  
|Non-trade receivables                                                                               |  |                       | 20    |                        |   | 20    |  
|Retainage receivables                                                                               |  |                       | 8     |                        |   | 8     |  
|Other                                                                                               |  |                       | 229   |                        |   | 248   |  
|                                                                                                    |  |                       |       |                        |   |       |  
|Other assets                                                                                        |  | $                     | 912   |                        | $ | 930   |  
|                                                                                                    |  |                       |       |                        |   |       |  
|                                                                                                    |  |                       |       |                        |   |       |  
|Deferred revenue                                                                                    |  | $                     | 394   |                        | $ | 529   |  
|Winstar litigation reserve                                                                          |  |                       | 278   |                        |   |      |  
|Warranty                                                                                            |  |                       | 179   |                        |   | 188   |  
|Contracts in process                                                                                |  |                       | 35    |                        |   | 12    |  
|Business restructuring                                                                              |  |                       | 38    |                        |   | 44    |  
|Other                                                                                               |  |                       | 763   |                        |   | 815   |  
|                                                                                                    |  |                       |       |                        |   |       |  
|Other current liabilities                                                                           |  | $                     | 1,687 |                        | $ | 1,588 |  
|                                                                                                    |  |                       |       |                        |   |       |  
|                                                                                                    |  |                       |       |                        |   |       |  
|Deferred income taxes                                                                               |  | $                     | 207   |                        | $ | 205   |  
|Deferred compensation                                                                               |  |                       | 50    |                        |   | 112   |  
|Business restructuring                                                                              |  |                       | 99    |                        |   | 102   |  
|Environmental                                                                                       |  |                       | 72    |                        |   | 72    |  
|Warranty                                                                                            |  |                       | 69    |                        |   | 69    |  
|Minority interests                                                                                  |  |                       | 31    |                        |   | 63    |  
|Other, including contingencies                                                                      |  |                       | 331   |                        |   | 342   |  
|                                                                                                    |  |                       |       |                        |   |       |  
|Other liabilities                                                                                   |  | $                     | 859   |                        | $ | 965   |  
|                                                                                                    |  |                       |       |                        |   |       |  

---



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

Notes to Consolidated Financial Statements 
(Unaudited)

6. GOODWILL AND OTHER ACQUIRED
INTANGIBLE ASSETS

The following table
summarizes the changes in the carrying value of goodwill and other acquired
intangible assets.  Goodwill attributed
to the Network Operations Software reporting unit was transferred to Services
to conform with our new reporting structure discussed in Note 9.

|                         |  |                                                  |    |                                  |   |                              |   |          |     |       |   |                                        |  |   |     |  |   |    |  
|------------------------ |  | ------------------------------------------------ | -- | -------------------------------- | - | ---------------------------- | - | -------- | --- | ----- | - | -------------------------------------- |  | - | --- |  | - | -- | -
|                         |  | 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 |                                  | $ | 96                           |   | $        | 154 |       | $ | 92                                     |  | $ | 374 |  | $ | 45 |  
|Transfers                |  |                                                  |   |                                  |   | (10                          | ) |          |    |       |   | 10                                     |  |   |    |  |   |   |  
|Amortization             |  |                                                  |   |                                  |   |                             |   |          |    |       |   |                                       |  |   |    |  |   | (4 | )
|                         |  |                                                  |    |                                  |   |                              |   |          |     |       |   |                                        |  |   |     |  |   |    |  
|As of December 31, 2005  |  | $                                                | 32 |                                  | $ | 86                           |   | $        | 154 |       | $ | 102                                    |  | $ | 374 |  | $ | 41 |  
|                         |  |                                                  |    |                                  |   |                              |   |          |     |       |   |                                        |  |   |     |  |   |    |  

7. COMPREHENSIVE INCOME
(LOSS)

The components of other
comprehensive income (loss) 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 December 31, |     
|(in millions)                                   |  | 2005                              |      | 2004 |  
|                                                |  |                                   |      |      |  
|Net income (loss)                               |  | $                                 | (104 | )    | $ | 174 |  
|Minimum pension liability adjustment            |  |                                   |     |      |   | (4  | )
|Foreign currency translation adjustments        |  |                                   | (17  | )    |   | 99  |  
|Unrealized holding losses on investments,
  net |  |                                   | (2   | )    |   | (2  | )
|                                                |  |                                   |      |      |   |     |  
|Comprehensive income (loss)                     |  | $                                 | (123 | )    | $ | 267 |  
|                                                |  |                                   |      |      |   |     |  

8. EARNINGS (LOSS) PER COMMON
SHARE (EPS)

Basic EPS is calculated by
dividing net income (loss) by the weighted average number of common shares
outstanding during the period.  Diluted
EPS is calculated by dividing net income (loss), 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.
Due to the net loss incurred during the first quarter of fiscal 2006,
the diluted loss per share is the same as basic, because any potentially
dilutive securities would reduce the loss per share.

---



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

Notes to Consolidated Financial Statements 
(Unaudited)

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

|                                                           |  |                                   |       |      |   |       | 
|---------------------------------------------------------- |  | --------------------------------- | ----- | ---- | - | ----- | 
|                                                           |  | Three
  months ended December 31, |      
|(in millions, except per share amounts)                    |  | 2005                              |       | 2004 |  
|                                                           |  |                                   |       |      |  
|Net income (loss)                                          |  | $                                 | (104  | )    | $ | 174   | 
|Adjustment for dilutive securities on net
  income (loss): |  |                                   |       |      |   |       | 
|2.75% convertible securities                               |  |                                   |      |      |   | 11    | 
|                                                           |  |                                   |       |      |   |       | 
|Net income (loss)  diluted                                |  | $                                 | (104  | )    | $ | 185   | 
|                                                           |  |                                   |       |      |   |       | 
|                                                           |  |                                   |       |      |   |       | 
|Weighted average shares outstanding  basic                |  |                                   | 4,452 |      |   | 4,403 | 
|Effect of dilutive securities:                             |  |                                   |       |      |   |       | 
|Stock options                                              |  |                                   |      |      |   | 77    | 
|Warrants                                                   |  |                                   |      |      |   | 11    | 
|2.75% convertible securities                               |  |                                   |      |      |   | 507   | 
|                                                           |  |                                   |       |      |   |       | 
|Weighted average shares outstanding 
  diluted            |  |                                   | 4,452 |      |   | 4,998 | 
|                                                           |  |                                   |       |      |   |       | 
|                                                           |  |                                   |       |      |   |       | 
|EPS:                                                       |  |                                   |       |      |   |       | 
|Basic                                                      |  | $                                 | (0.02 | )    | $ | 0.04  | 
|Diluted                                                    |  | $                                 | (0.02 | )    | $ | 0.04  | 

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 December 31, |      
|(in millions)                                                                                                                                       |  | 2005                              |       | 2004 | 
|                                                                                                                                                    |  |                                   |       |      | 
|Stock options                                                                                                                                       |  |                                   | 47    |      |  |    | 
|Warrants                                                                                                                                            |  |                                   | 10    |      |  |    | 
|2.75% convertible securities                                                                                                                        |  |                                   | 593   |      |  |    | 
|8.00% convertible securities                                                                                                                        |  |                                   | 182   |      |  | 234 | 
|7.75% convertible securities                                                                                                                        |  |                                   | 228   |      |  | 238 | 
|                                                                                                                                                    |  |                                   |       |      |  |     | 
|Total potentially dilutive shares                                                                                                                   |  |                                   | 1,060 |      |  | 472 | 
|                                                                                                                                                    |  |                                   |       |      |  |     | 
|Stock options excluded from diluted
  earnings per share because the exercise price  was greater than the average market price of the common shares |  |                                   | 304   |      |  | 244 | 
|                                                                                                                                                    |  |                                   |       |      |  |     | 

9.  OPERATING SEGMENTS

Our mobility and wireline
businesses were recently combined into a single unit, the Network Solutions
Group (NSG). NSG consists of the following operating segments: Mobility Access
Solutions, Applications Solutions, Converged Core Solutions and Multimedia
Network 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
reported with our wireless business in prior years.  Converged Core Solutions consists primarily of voice networking
products, including circuit switching, personal handyphone systems and
next-generation switching products.
Multimedia Network Solutions consists primarily of optical, data and
access 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.

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. The accounting policies of
the reportable segments are the same as those applied in the unaudited
consolidated financial statements.

---



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

Notes to Consolidated Financial Statements 
(Unaudited)

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 December 31, |      
|(in
  millions)                                       |  | 2005                            |       | 2004 |  
|                                                      |  |                                 |       |      |  
|Revenues:                                             |  |                                 |       |      |   |       |  
|Mobility
  Access and Applications Solutions          |  | $                               | 945   |      | $ | 1,170 |  
|Multimedia
  Network Solutions                        |  |                                 | 395   |      |   | 366   |  
|Converged
  Core Solutions                            |  |                                 | 145   |      |   | 233   |  
|Services                                              |  |                                 | 540   |      |   | 548   |  
|                                                      |  |                                 |       |      |   |       |  
|Reportable
  segments                                 |  |                                 | 2,025 |      |   | 2,317 |  
|Intellectual
  property                               |  |                                 | 18    |      |   | 8     |  
|Other                                                 |  |                                 | 4     |      |   | 10    |  
|                                                      |  |                                 |       |      |   |       |  
|Revenues                                              |  | $                               | 2,047 |      | $ | 2,335 |  
|                                                      |  |                                 |       |      |   |       |  
|Operating
  income:                                   |  |                                 |       |      |   |       |  
|Mobility
  Access and Applications Solutions          |  | $                               | 317   |      | $ | 422   |  
|Multimedia
  Network Solutions                        |  |                                 | 45    |      |   | 20    |  
|Converged
  Core Solutions                            |  |                                 |      |      |   | (9    | )
|Services                                              |  |                                 | 89    |      |   | 76    |  
|                                                      |  |                                 |       |      |   |       |  
|Reportable
  segments                                 |  |                                 | 451   |      |   | 509   |  
|Global sales
  organization                           |  |                                 | (118  | )    |   | (131  | )
|Shared
  services such as general corporate functions |  |                                 | (275  | )    |   | (265  | )
|Unallocated
  compensation and benefits               |  |                                 | 139   |      |   | 233   |  
|Recovery of
  bad debts and customer financings       |  |                                 | 7     |      |   | 11    |  
|Business
  restructuring                              |  |                                 | (1    | )    |   | (1    | )
|Winstar
  litigation charge                           |  |                                 | (278  | )    |   |      |  
|Other                                                 |  |                                 | (14   | )    |   | (37   | )
|                                                      |  |                                 |       |      |   |       |  
|Operating
  income (loss)                             |  | $                               | (89   | )    | $ | 319   |  
|                                                      |  |                                 |       |      |   |       |  

Revenues from Verizon,
including Verizon Wireless, accounted for 26% and 24% of consolidated revenues
during the three months ended December 31, 2005 and 2004, respectively.  Revenues from Sprint accounted for 15% and
17% of consolidated revenues during the three months ended December 31, 2005
and 2004, respectively.

---



|          |                                              |                   
|--------- | -------------------------------------------- | ------------------
|<PAGE> 16 |                                              | Form 10-Q - Part I
|         
|          | Notes to Consolidated
  Financial Statements |                   
|          | (Unaudited)                                  |                   

10. 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 December 31, 2005. The
resolution of these matters could have a material impact on our consolidated results
of operations, financial position and cash flows. Charges of $283 million were
recognized during the three months ended December 31, 2005, almost exclusively
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. In addition, approximately $300 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 being appealed to 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.

Securities and Related Cases

The majority of the
assorted securities, ERISA and derivative class action and other related
lawsuits against us and certain of our current and former directors, officers
and employees have been settled. The net charges related to our global
securities and related cases were $71 million during the three months ended
December 31, 2004. We currently do not have any material opt out or related
securities cases pending.

Government Investigations

During August 2003, the
U.S. Department of Justice (the 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> 17 |                                              | 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. 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 are actively investigating and
evaluating the claims asserted.

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

Intellectual Property Cases

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

Other Matters

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

---



|          |                                              |                   
|--------- | -------------------------------------------- | ------------------
|<PAGE> 18 |                                              | Form 10-Q - Part I
|         
|          | Notes to Consolidated
  Financial Statements |                   
|          | (Unaudited)                                  |                   

A lawsuit involving
investors in Actel Integrated Communications was filed against us seeking $60
million in damages and punitive damages, claiming we misled these investors as
to certain technology, which influenced their decision to invest in Actel. This
case, Sandler Capital Partners IV, L.P. et
al. v. Lucent Technologies, filed in New York State Court, was
settled during our first quarter of fiscal 2006. Charges related to the
settlement were recorded in our fourth quarter of 2005. During fiscal 2004, we
settled cases filed against us by Actel. In addition, two other cases were
filed against us alleging that we failed to deliver working products related to
the same technology: Maxcess, Inc. v. Lucent
Technologies Inc. et al.,
filed in the U.S. District Court for the Middle District of Florida, and Official Plan Committee of Omniplex, Inc. v. Lucent
Technologies Inc., filed in Missouri State Court. The claims against
us in Maxcess, Inc. v. Lucent Technologies
Inc. et al have been dismissed. On December 27, 2005, the United
States Court of Appeals for the Eleventh Circuit affirmed the dismissal of the
litigation. Maxcess has filed a petition for a rehearing en bancby the entire panel of the Circuit
Court of Appeals. We settled the Omniplex
case during the first quarter of fiscal 2006. The costs related to these
settlements were accrued in prior periods.

During the first quarter of
fiscal 2006, we settled Pf.Net Supply Corp.
v. Lucent Technologies, which was pending in the U.S. District Court
in New Jersey. The plaintiff claimed that we breached an alleged purchase
commitment and sought to compel us to meet this purchase commitment or pay
damages. The cost related to this settlement was accrued in prior periods.

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 $173 million of lease obligations as of December 31,
2005, 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 one month to 14 years. The primary obligor
under assigned leases may terminate or restructure the lease obligation before
its original maturity and thereby relieve us of our secondary liability. We
generally have the right to receive indemnity or reimbursement from the
assignees and have not reserved for losses on this form of guarantee.

---



|          |                                              |                   
|--------- | -------------------------------------------- | ------------------
|<PAGE> 19 |                                              | Form 10-Q - Part I
|         
|          | Notes to Consolidated
  Financial Statements |                   
|          | (Unaudited)                                  |                   

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 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)                  |  | 2005 |     | 2004 |  
|                               |  |      |     |      |  
|Reserve as of September
  30   |  | $    | 257 |      | $ | 297 |  
|Accruals for warranties,
  net |  |      | 20  |      |   | 13  |  
|Payments                       |  |      | (29 | )    |   | (13 | )
|                               |  |      |     |      |   |     |  
|Reserve as of December 31      |  | $    | 248 |      | $ | 297 |  
|                               |  |      |     |      |   |     |  

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
$98 million have been established for environmental liabilities that can be
reasonably estimated as of December 31, 2005. These reserves are not discounted
to present value. We have receivables of $20 million with respect to
environmental matters due from third-party indemnitors as of December 31, 2005.
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.

---



|          |                                              |                   
|--------- | -------------------------------------------- | ------------------
|<PAGE> 20 |                                              | Form 10-Q - Part I
|         
|          | Notes to Consolidated
  Financial Statements |                   
|          | (Unaudited)                                  |                   

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 December 31, 2005 cannot be reasonably estimated.

11. SUBSEQUENT EVENT

On February 7, 2006, we agreed to acquire certain
  net assets of Riverstone Networks, a provider of carrier grade Ethernet routers
  for the telecommunications industry, for $170 million in cash. The transaction
  is subject to completion of a bankruptcy court administered process under Riverstone
  Networks impending reorganization proceeding and other closing conditions,
  which could occur in fiscal 2006.

---



|          |  |                   
|--------- |  | ------------------
|<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 forward-looking statements that are
based on current expectations, estimates, forecasts and projections about us,
our future performance and the industries in which we operate as well as on our
managements assumptions. Words such as expects, anticipates, targets,
goals, projects, intends, plans, believes, seeks,
estimates,
variations of such words and similar expressions are intended to identify such
forward-looking statements. These statements are not guarantees of future
performance and involve certain risks, uncertainties and assumptions that are
difficult to assess. Therefore, actual outcomes and results may differ
materially from what is expressed or forecasted in such forward-looking
statements. These risks and uncertainties include: fluctuations in the
telecommunications market; the pricing, cost and other risks inherent in our
long-term sales agreements; exposure to the credit risk of our customers; our
reliance on two contract manufacturers to supply most of the products we sell;
the social, political and economic risks of our foreign operations; the costs
and risks associated with our pension and postretirement benefit obligations;
the complexity of our products; changes to existing regulations or technical
standards; existing and future litigation; our ability to protect our
intellectual property rights and exposure to infringement claims by others; and
compliance with environmental, health and safety laws. For a more
complete list and description of such risks and uncertainties, refer to our
Form 10-K for the year ended September 30, 2005. Except as required under the federal securities laws and the rules and
regulations of the SEC, we do not have any intention or obligation to update
publicly any forward-looking statements after the distribution of this
quarterly report, whether as a result of new information, future events, changes in
assumptions or otherwise.

EXECUTIVE SUMMARY

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

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

---



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

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

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
quarter of fiscal 2006 were lower than recent quarters, primarily due to lower
sales to our large customers in the U.S. and China.  We believe that the revenue decline is temporary and that
quarterly revenues will be higher during the remaining quarters of the year.

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.

The following
table includes certain financial information.

|                                           |  |                                 |       |      |   |        |   |   |           |   
|------------------------------------------ |  | ------------------------------- | ----- | ---- | - | ------ | - | - | --------- | --
|                                           |  | Three months ended December 31, |      
|(in
  millions)                            |  | 2005                            |       | 2004 |   | change |  
|                                           |  |                                 |       |      |   |        |  
|Mobility Access and Applications Solutions |  | $                               | 945   |      | $ | 1,170  |   |   | (19       | %)
|Multimedia Network Solutions               |  |                                 | 395   |      |   | 366    |   |   | 8         | % 
|Converged Core Solutions                   |  |                                 | 145   |      |   | 233    |   |   | (38       | %)
|Services                                   |  |                                 | 540   |      |   | 548    |   |   | (1        | %)
|Intellectual property                      |  |                                 | 18    |      |   | 8      |   |   |           |   
|Other                                      |  |                                 | 4     |      |   | 10     |   |   |           |   
|                                           |  |                                 |       |      |   |        |   |   |           |   
|Revenues                                   |  | $                               | 2,047 |      | $ | 2,335  |   |   | (12       | %)
|                                           |  |                                 |       |      |   |        |   |   |           |   
|Gross margin                               |  | $                               | 851   |      | $ | 984    |   | $ | (133      | ) 
|Gross margin rate                          |  |                                 | 42    | %    |   | 42     | % |   |          |   
|                                           |  |                                 |       |      |   |        |   |   |           |   
|                                          
|Operating expenses                         |  | $                               | 940   |      | $ | 665    |   | $ | 275       |   
|Percentage of revenue                      |  |                                 | 46    | %    |   | 28     | % |   | 18 points |   
|                                           |  |                                 |       |      |   |        |   |   |           |   
|Operating income (loss)                    |  | $                               | (89   | )    | $ | 319    |   | $ | (408      | ) 
|Other income (expense), net                |  |                                 | 84    |      |   | (46    | ) |   |           |   
|Interest expense                           |  |                                 | 83    |      |   | 89     |   |   |           |   
|Income taxes                               |  |                                 | 16    |      |   | 10     |   |   |           |   
|                                           |  |                                 |       |      |   |        |   |   |           |   
|Net income (loss)                          |  | $                               | (104  | )    | $ | 174    |   | $ | (278      | ) 
|                                           |  |                                 |       |      |   |        |   |   |           |   

---



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

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

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
  data and access 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
  decreased due to lower professional services.
|                                                                                                                                             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|                                                                                                                                            | The gross
  margin rate remained consistent with the comparable prior year period.  The favorable impact of product and
  geographic mix and cost reductions, offset the unfavorable impact of lower
  revenues, a lower net pension and postretirement benefit credit (net pension credit) and the prior
  period effect of favorable revised estimates on long-term contracts.                                                                                                                                                                          
|                                                                                                                                             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|                                                                                                                                            | Operating
  expenses increased primarily due to the Winstar litigation charge of $278
  million.                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|                                                                                                                                             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|                                                                                                                                            | The net pension credit was $104 million and $175
        million during the first quarter of fiscal 2006 and 2005, 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 primarily attributed to non-U.S. earnings.  U.S. deferred income taxes were not recognized during the first
  quarter of fiscal 2006 due to the U.S. pretax loss.  We
  expect to recognize approximately $170 million of income taxes during fiscal
  2006, including non-cash impacting U.S. deferred taxes of approximately $100
  million.  The balance is attributable
  to non-U.S. income taxes.                                                                                                                               
|                                                                                                                                             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|                                                                                                                                            | Cash and
  cash equivalents and marketable securities decreased $550 million to $4.4
  billion during the three months ended December 31, 2005, primarily due to the
  payment of annual and long-term employee incentive awards and to a lesser
  extent, additional use of working capital.                                                                                                                                                                                                                                                             
|                                                                                                                                             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|Our
  expectations regarding fiscal 2006 results are as follows:                                                                            
|                                                                                                                                             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|                                                                                                                                            | Annual revenues to be essentially flat or increase on a percentage
  basis in the low-single digits for the year, with significantly higher
  revenues in the second half of the fiscal year than the first half of the
  fiscal year.                                                                                                                                                                                                                                                                                                                    
|                                                                                                                                             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|                                                                                                                                            | Annual revenues for the Mobility Access and Applications Solutions
  segment to be essentially flat for the fiscal year.                                                                                                                                                                                                                                                                                                                                                                                                                                  
|                                                                                                                                             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|                                                                                                                                            | Annual revenues for the combined Multimedia Network Solutions and
  Converged Core Solutions segments to be down somewhat year over year.                                                                                                                                                                                                                                                                                                                                                                                                                 
|                                                                                                                                             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|                                                                                                                                            | Annual revenues for Services segment to grow at or slightly below 10%
  year over year.                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|                                                                                                                                             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|                                                                                                                                            | Annual gross margin rate on a percentage basis in the 41% to 43%
  range. Quarterly gross margin rates may be subject to fluctuations.                                                                                                                                                                                                                                                                                                                                                                                                                    
|                                                                                                                                             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|                                                                                                                                            | Annual operating expenses as a percentage of revenues of about 33%,
  including a $278 million charge for a bankruptcy court judgment related
  to litigation between the Company and the trustee for Winstar Communications.                                                                                                                                                                                                                                                                                                                             
|                                                                                                                                             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|The above
  items are forward-looking statements about our expectations for future
  performance.  Actual results could
  differ materially.

---



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

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

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 10-K
for the year ended September 30, 2005.

SFAS 123R was adopted on October 1, 2005. Refer
  to Note 3 to our unaudited consolidated financial statements for further information.
  There were no other accounting policies adopted during the first quarter of
  fiscal 2006 that had a material effect on our financial condition and results
  of operations.

CONSOLIDATED RESULTS OF
OPERATIONS - THREE MONTHS ENDED DECEMBER 31,
2005 VERSUS THREE MONTHS ENDED DECEMBER 31, 2004

Revenues

|                                                   |  |                                 |       |  |  |      |   |   |       |  |  |     |  
|-------------------------------------------------- |  | ------------------------------- | ----- |  |  | ---- | - | - | ----- |  |  | --- | -
|                                                   |  | Three months ended December 31, |       |  |  |     
|(in millions)                                      |  | 2005                            |       |  |  | 2004 |   |   |      
|                                                   |  |                                 |       |  |  |      |   |   |      
|                                                   |  |                                 |       |  |  |      |   |   |       |  |  |     |  
|Mobility Access and Applications Solutions         |  | $                               | 945   |  |  | 46   | % | $ | 1,170 |  |  | 50  | %
|Multimedia Network Solutions                       |  |                                 | 395   |  |  | 19   | % |   | 366   |  |  | 16  | %
|Converged Core Solutions                           |  |                                 | 145   |  |  | 7    | % |   | 233   |  |  | 10  | %
|Services                                           |  |                                 | 540   |  |  | 27   | % |   | 548   |  |  | 24  | %
|Intellectual property                              |  |                                 | 18    |  |  | 1    | % |   | 8     |  |  |    |  
|Other                                              |  |                                 | 4     |  |  |     |   |   | 10    |  |  |    |  
|                                                   |  |                                 |       |  |  |      |   |   |       |  |  |     |  
|Revenues                                           |  | $                               | 2,047 |  |  | 100  | % | $ | 2,335 |  |  | 100 | %
|                                                   |  |                                 |       |  |  |      |   |   |       |  |  |     |  
|                                                   |  |                                 |       |  |  |      |   |   |       |  |  |     |  
|U.S.                                               |  | $                               | 1,343 |  |  | 66   | % | $ | 1,450 |  |  | 62  | %
|Other Americas (Canada, Caribbean & Latin America) |  |                                 | 186   |  |  | 9    | % |   | 181   |  |  | 8   | %
|EMEA (Europe, Middle East & Africa)                |  |                                 | 301   |  |  | 15   | % |   | 320   |  |  | 14  | %
|APaC (Asia Pacific & China)                        |  |                                 | 217   |  |  | 10   | % |   | 384   |  |  | 16  | %
|                                                   |  |                                 |       |  |  |      |   |   |       |  |  |     |  
|Revenues                                           |  | $                               | 2,047 |  |  | 100  | % | $ | 2,335 |  |  | 100 | %
|                                                   |  |                                 |       |  |  |      |   |   |       |  |  |     |  

Revenues
decreased by 12% during the first quarter of fiscal 2006.  Refer to the segment discussion later in
this MD&A for information on changes in revenues by segment and
product.

The decrease in the U.S. was primarily due to lower CDMA sales to our
two largest customers.  The decrease in
APaC was primarily due to lower CDMA sales in China driven by further delays in
the issuance of 3G licenses and the continuing reduction in PHS sales in
China.  The increase in Other Americas
was due to higher CDMA sales in Venezuela.
The decrease in EMEA was primarily due to changes in foreign currency
rates.

Changes in foreign currency rates unfavorably impacted our consolidated
revenues by approximately 1% during the first quarter of fiscal 2006.

---



|          |                     
|--------- | --------------------
|<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 December 31, |  
|(in millions)     |  | 2005                            |   | 2004 |  
|                  |  |                                 |   |      |  
|Gross margin      |  |                                 | $ | 851  |   |  |  | $ | 984 |   | 
|Gross margin rate |  |                                 |   | 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 period.                                                                                                                                                                                                                                                                                                                                                                                                                          
|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
| | Historically,
  our gross margin rates are generally higher in our wireless business than in
  our wireline and services businesses, and higher in the U.S. 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
  pricing, product mix and revised estimates related to long-term contracts in
  certain periods.  The net effect of
  these items increased the gross margin rate by approximately one percentage
  point from the comparable prior year period.
|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
| | Reductions
  in fixed costs offset the impact of lower revenues.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 

Operating Expenses

|                                                                                              |  |                                 |     |      |   |        |   |   |     |  
|--------------------------------------------------------------------------------------------- |  | ------------------------------- | --- | ---- | - | ------ | - | - | --- | -
|                                                                                              |  | Three months ended December 31, |    
|(in millions)                                                                                 |  | 2005                            |     | 2004 |   | Change |  
|                                                                                              |  |                                 |     |      |   |        |  
|Marketing
  and sales (M&S)                                                                 |  | $                               | 220 |      | $ | 231    |   | $ | (11 | )
|General and
  administration (G&A)                                                          |  |                                 | 161 |      |   | 161    |   |   |    |  
|                                                                                              |  |                                 |     |      |   |        |   |   |     |  
|Selling,
  general and administrative (SG&A) expenses, excluding the following three items: |  |                                 | 381 |      |   | 392    |   |   | (11 | )
|Winstar litigation                                                                            |  |                                 | 278 |      |   |       |   |   | 278 |  
|Recovery of bad debt and customer financing                                                   |  |                                 | (7  | )    |   | (11    | ) |   | 4   |  
|Amortization of other acquired intangible assets                                              |  |                                 | 4   |      |   | 4      |   |   |    |  
|                                                                                              |  |                                 |     |      |   |        |   |   |     |  
|SG&A                                                                                          |  |                                 | 656 |      |   | 385    |   |   | 271 |  
|Research and
  development (R&D)                                                            |  |                                 | 283 |      |   | 279    |   |   | 4   |  
|Business
  restructuring                                                                      |  |                                 | 1   |      |   | 1      |   |   |    |  
|                                                                                              |  |                                 |     |      |   |        |   |   |     |  
|Operating expenses                                                                            |  | $                               | 940 |      | $ | 665    |   | $ | 275 |  
|                                                                                              |  |                                 |     |      |   |        |   |   |     |  

---



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

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

Operating
expenses increased during the first quarter of fiscal 2006, primarily due to
Winstar litigation charge. Refer to Note 10 to our unaudited consolidated
financial statements for further discussion on this matter.

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.  A $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 the Winstar
litigation charge and recoveries of bad debt and customer financing, SG&A
decreased by $11 million during the first quarter of fiscal 2006.  Reductions of $36 million were primarily
attributed to lower average workforce levels and discretionary spending.  Lower accruals for fiscal 2006 employee
incentive awards of $9 million also contributed to the decrease.

The impact of these items more than offset a
$22 million lower net pension credit, $5 million of higher stock-based
compensation expense and the $7 million net impact of payroll and benefit-related
liability reversals discussed above.

Recovery of bad debt
and customer financing

The net
recovery was primarily due to the release of a customer financing guarantee
during the first quarter of fiscal 2006.
Further recoveries or charges may occur in the future.

Amortization of
other acquired intangible assets

Amortization
of other acquired intangible assets was related to the acquisition of Telica in
September of 2004.

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 December 31,
|(in
  millions)     |  | 2005                            |   | 2004
|                    |  |                                 |   |     
|Costs
  capitalized |  |                                 | $ | 62   |  |  |  | $ | 59 | 
|Amortization        |  |                                 |   | 51   |  |  |  |   | 73 | 

---



|                                                                                                |                   
|----------------------------------------------------------------------------------------------- | ------------------
|<PAGE> 27                                                                                       | Form 10-Q - Part I
|                                                                                                |                   
|Item 2. Managements
  Discussion and Analysis of Financial Condition and Results of Operations

R&D remained
essentially unchanged from the comparable prior year period. Reductions of $36
million were primarily attributed to lower average workforce levels and less
discretionary spending as well as $7 million of lower accruals for fiscal 2006
employee incentive awards. These spending reductions offset the impact of a $27
million lower net pension credit, $7 million of higher stock-based compensation
expense and the $13 million net impact of payroll and benefit-related liability
reversals previously discussed above.

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 4 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 2 to our unaudited consolidated financial
statements for further information.

|                                                |  |                                 |      |      |   |      |  
|----------------------------------------------- |  | ------------------------------- | ---- | ---- | - | ---- | -
|                                                |  | Three months ended December 31, |     
|(in millions)                                   |  | 2005                            |      | 2004 |  
|                                                |  |                                 |      |      |  
|Pension
  benefit credit                        |  | $                               | (167 | )    | $ | (242 | )
|Postretirement benefit
  cost                   |  |                                 | 63   |      |   | 67   |  
|                                                |  |                                 |      |      |   |      |  
|Net
  pension and postretirement benefit credit |  | $                               | (104 | )    | $ | (175 | )
|                                                |  |                                 |      |      |   |      |  
|                                                |  |                                 |      |      |   |      |  
|Postemployment
  benefit cost                   |  | $                               | 23   |      | $ | 18   |  
|                                                |  |                                 |      |      |   |      |  

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 $24 million and $9 million
during the three months ended December 31, 2005 and 2004, 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 first quarter of
fiscal 2006 was $60 million lower than the proforma amount determined
under the fair value-based method and disclosed in accordance with SFAS
123 for the comparable prior year period. 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 first quarter of fiscal 2006.

Refer to Note 3 to our
unaudited consolidated financial statements for more information on stock-based
compensation.

Other Income (Expense), net

|                                                  |  |                                 |    |      |   |     |  
|------------------------------------------------- |  | ------------------------------- | -- | ---- | - | --- | -
|                                                  |  | Three months ended December 31, |   
|(in millions)                                     |  | 2005                            |    | 2004 |  
|                                                  |  |                                 |    |      |  
|Legal
  settlements                               |  | $                               |   |      | $ | (71 | )
|Interest
  income                                 |  |                                 | 45 |      |   | 25  |  
|Minority
  interest                               |  |                                 | 33 |      |   | (2  | )
|Other-than-temporary
  write-downs of investments |  |                                 | (2 | )    |   | (6  | )
|Interest
  on tax matters                         |  |                                 | 2  |      |   | 5   |  
|Miscellaneous,
  net                              |  |                                 | 6  |      |   | 3   |  
|                                                  |  |                                 |    |      |   |     |  
|Other income (expense), net                       |  | $                               | 84 |      | $ | (46 | )
|                                                  |  |                                 |    |      |   |     |  

The expense attributed to
legal settlements during the first quarter of fiscal 2005 was primarily related
to the changes in fair market value of warrants issued in connection with the
global settlement of our shareowner lawsuit.

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

One of our joint ventures
recognized a loss in the first quarter of fiscal 2006 resulting in a minority
interest share of the losses. The loss recognized by the joint venture included
internal pricing adjustments related to certain prior periods.

Interest Expense

Interest expense was $83
million and $89 million during the three months ended December 31, 2005 and
2004, respectively. The decrease was primarily due to the early extinguishment
of convertible securities and other debt obligations.

Income Taxes

|                                                               |  |                                 |    |      |   |    | 
|-------------------------------------------------------------- |  | ------------------------------- | -- | ---- | - | -- | 
|                                                               |  | Three months ended December 31, |   
|(in millions)                                                  |  | 2005                            |    | 2004 |  
|                                                               |  |                                 |    |      |  
|Non-U.S.
  and state income taxes attributed to pre-tax income |  | $                               | 18 |      | $ | 10 | 
|Favorable resolution of
  tax matters                          |  |                                 | (2 | )    |   |   | 
|                                                               |  |                                 |    |      |   |    | 
|Income
  tax                                                   |  | $                               | 16 |      | $ | 10 | 
|                                                               |  |                                 |    |      |   |    | 
|                                                               |  |                                 |    |      |   |    | 
|Interest
  on tax matters                                      |  | $                               | 2  |      | $ | 5  | 
|                                                               |  |                                 |    |      |   |    | 

---



|                                                                                                |                   
|----------------------------------------------------------------------------------------------- | ------------------
|<PAGE> 29                                                                                       | Form 10-Q - Part I
|                                                                                                |                   
|Item 2. Managements
  Discussion and Analysis of Financial Condition and Results of Operations

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

Mobility Access and Applications Solutions

|                 |  |                                 |     |      |   |        |  |   |      |    | 
|---------------- |  | ------------------------------- | --- | ---- | - | ------ |  | - | ---- | -- | 
|                 |  | Three months ended December 31, |    
|(in millions)    |  | 2005                            |     | 2004 |   | change | 
|                 |  |                                 |     |      |   |        | 
|U.S.             |  | $                               | 763 |      | $ | 874    |  |   | (13  | %) | 
|NonU.S.         |  |                                 | 182 |      |   | 296    |  |   | (39  | %) | 
|                 |  |                                 |     |      |   |        |  |   |      |    | 
|Total revenues   |  | $                               | 945 |      | $ | 1,170  |  |   | (19  | %) | 
|                 |  |                                 |     |      |   |        |  |   |      |    | 
|                 |  |                                 |     |      |   |        |  |   |      |    | 
|Segment
  income |  | $                               | 317 |      | $ | 422    |  | $ | (105 | )  | 
|                 |  |                                 |     |      |   |        |  |   |      |    | 

Mobility Access and Applications Solutions revenues
decreased due to a $217 million decrease in Mobility Access Solutions and $8
million decrease in Applications
Solutions. U.S. revenues decreased primarily due to lower
CDMA sales to our two largest customers. Although initial large high-speed data
network build outs for our two largest customers are nearing completion, we
expect that further expansion and upgrades will continue to drive our revenue
levels in the U.S. These two customers accounted for 65% and 62% of total
Mobility Access and Applications Solutions revenues during the first quarter of
fiscal 2006 and 2005, respectively. Including these two customers, the five
largest Mobility Access and Applications Solutions customers accounted for 79%
and 78% of Mobility Access and Applications Solutions revenues during the first
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.

---



|                                                                                                |                   
|----------------------------------------------------------------------------------------------- | ------------------
|<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 $109 million decrease in gross margin offset by a $4 million decrease
in operating expenses. The decrease in gross margin was primarily due to lower
sales volume.

Multimedia Network Solutions (MNS)

|                     |  |                                 |     |      |   |        |  |   |    |    | 
|-------------------- |  | ------------------------------- | --- | ---- | - | ------ |  | - | -- | -- | 
|                     |  | Three months ended December 31, |    
|(in millions)        |  | 2005                            |     | 2004 |   | change | 
|                     |  |                                 |     |      |   |        | 
|Data
  and access    |  | $                               | 194 |      | $ | 160    |  |   | 21 | %  | 
|Optical
  networking |  |                                 | 201 |      |   | 206    |  |   | (2 | %) | 
|                     |  |                                 |     |      |   |        |  |   |    |    | 
|Total
  revenues     |  | $                               | 395 |      | $ | 366    |  |   | 8  | %  | 
|                     |  |                                 |     |      |   |        |  |   |    |    | 
|                     |  |                                 |     |      |   |        |  |   |    |    | 
|U.S.                 |  | $                               | 166 |      | $ | 139    |  |   | 19 | %  | 
|NonU.S.             |  |                                 | 229 |      |   | 227    |  |   | 1  | %  | 
|                     |  |                                 |     |      |   |        |  |   |    |    | 
|Total
  revenues     |  | $                               | 395 |      | $ | 366    |  |   | 8  | %  | 
|                     |  |                                 |     |      |   |        |  |   |    |    | 
|                     |  |                                 |     |      |   |        |  |   |    |    | 
|Segment
  income     |  | $                               | 45  |      | $ | 20     |  | $ | 25 |    | 
|                     |  |                                 |     |      |   |        |  |   |    |    | 

MNS revenues increased by
$29 million. U.S. revenues increased primarily due to higher optical networking
sales. Non-U.S. revenues increased slightly primarily from higher data and
access sales in EMEA and APaC, which were essentially offset by lower optical
networking sales in APaC. Five customers accounted for 40% and 39% of MNS
revenues during the first 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 $1 million increase in gross margin and $24 million decrease in operating expenses.
The decrease in operating expenses was primarily due to lower R&D
spending attributed to lower average employee workforce levels and
discretionary expenses.

---



|                                                                                                |                   
|----------------------------------------------------------------------------------------------- | ------------------
|<PAGE> 31                                                                                       | Form 10-Q - Part I
|                                                                                                |                   
|Item 2. Managements
  Discussion and Analysis of Financial Condition and Results of Operations

Converged Core Solutions (CCS)

|                        |  |                                 |     |      |   |        |   |   |     |    | 
|----------------------- |  | ------------------------------- | --- | ---- | - | ------ | - | - | --- | -- | 
|                        |  | Three months ended December 31, |    
|(in millions)           |  | 2005                            |     | 2004 |   | change |  
|                        |  |                                 |     |      |   |        |  
|U.S.                    |  | $                               | 70  |      | $ | 111    |   |   | (37 | %) | 
|NonU.S.                |  |                                 | 75  |      |   | 122    |   |   | (39 | %) | 
|                        |  |                                 |     |      |   |        |   |   |     |    | 
|Total revenues          |  | $                               | 145 |      | $ | 233    |   |   | (38 | %) | 
|                        |  |                                 |     |      |   |        |   |   |     |    | 
|                        |  |                                 |     |      |   |        |   |   |     |    | 
|Segment
  income (loss) |  | $                               |    |      | $ | (9     | ) | $ | 9   |    | 
|                        |  |                                 |     |      |   |        |   |   |     |    | 

CCS revenues declined by
$88 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 46% and 56% of CCS revenues during the first
quarter of fiscal 2006 and 2005, respectively.

Circuit switching revenues
declined by $38 million to $68 million. PHS revenues declined by $44 million to
$27 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 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 as
customers transition to next generation networks.

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

Segment income increased due to a $7 million increase in gross margin and $2 million decrease in
operating expense. The increase in gross margin was due to an
increase in the gross margin rate attributed to a more favorable product mix
and lower software amortization costs, warranty and inventory charges.

Services

|                 |  |                                 |     |      |   |        |  |   |    |    | 
|---------------- |  | ------------------------------- | --- | ---- | - | ------ |  | - | -- | -- | 
|                 |  | Three months ended December 31, |    
|(in millions)    |  | 2005                            |     | 2004 |   | change | 
|                 |  |                                 |     |      |   |        | 
|U.S.             |  | $                               | 322 |      | $ | 308    |  |   | 5  | %  | 
|NonU.S.         |  |                                 | 218 |      |   | 240    |  |   | (9 | %) | 
|                 |  |                                 |     |      |   |        |  |   |    |    | 
|Total revenues   |  | $                               | 540 |      | $ | 548    |  |   | (1 | %) | 
|                 |  |                                 |     |      |   |        |  |   |    |    | 
|                 |  |                                 |     |      |   |        |  |   |    |    | 
|Segment
  income |  | $                               | 89  |      | $ | 76     |  | $ | 13 |    | 
|                 |  |                                 |     |      |   |        |  |   |    |    | 

Services revenues decreased
by $8 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 and
EMEA regions. Five customers accounted
for 49% and 47% of Services revenues during the first quarter of fiscal 2006
and 2005, respectively.

Professional services
revenues decreased by $12 million primarily due to delayed funding in
government contracts and lower services for Non-U.S. customers.

Segment income increased
due to a $1 million increase in gross margin and a $12 million decrease in
operating expenses that was primarily attributed to lower average workforce
levels.

---



|                                                                                                |                   
|----------------------------------------------------------------------------------------------- | ------------------
|<PAGE> 32                                                                                       | 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 $550 million to $4.4 billion during the
three months ended December 31, 2005 primarily due to the payment of employee
incentive awards and to a lesser extent, additional use of working capital.
Summarized quarterly cash flow information and key working capital metrics are
as follows:

|                                                |  |                                   |      |      |   |        |   |   |      |   | 
|----------------------------------------------- |  | --------------------------------- | ---- | ---- | - | ------ | - | - | ---- | - | 
|                                                |  | Three
  Months ended December 31, |     
|(in millions)                                   |  | 2005                              |      | 2004 |   | change |  
|                                                |  |                                   |      |      |   |        |  
|Net income (loss)                               |  | $                                 | (104 | )    | $ | 174    |   | $ | (278 | )
|Non-cash items                                  |  |                                   | (60  | )    |   | 7      |   |   | (67  | )
|Changes in working
  capital                    |  |                                   | (190 | )    |   | (113   | ) |   | (77  | )
|Other changes                                   |  |                                   | (169 | )    |   | (392   | ) |   | 223  |  
|                                                |  |                                   |      |      |   |        |   |   |      |  
|Operating activities                            |  | $                                 | (523 | )    | $ | (324   | ) | $ | (199 | )
|                                                |  |                                   |      |      |   |        |   |   |      |  
|                                                |  |                                   |      |      |   |        |   |   |      |  
|Investing activities                            |  | $                                 | (387 | )    | $ | (729   | ) | $ | 342  |  
|                                                |  |                                   |      |      |   |        |   |   |      |  
|                                                |  |                                   |      |      |   |        |   |   |      |  
|Financing activities                            |  | $                                 | 5    |      | $ | 32     |   | $ | (27  | )
|                                                |  |                                   |      |      |   |        |   |   |      |  
|                                                |  |                                   |      |      |   |        |   |   |      |  
|Days sales outstanding in
  accounts receivable |  |                                   | 63   |      |   | 55     |   |   | 8    |  
|Inventory turnover                              |  |                                   | 6.2  |      |   | 6.1    |   |   | 0.1  |  
|Days sales outstanding in
  working capital     |  |                                   | 44   |      |   | 30     |   |   | 14   |  

Operating Activities

Our operating results and
resulting cash flows have generally improved during the past few years due to
higher revenues, 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 the
first quarter of fiscal 2005.

Changes in working capital
requirements include changes in receivables, inventories and contracts in
process, accounts payable and deferred revenue. Working capital requirements
increased due to 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 $41 million
and $84 million of receivables during the three months ended December 31, 2005
and 2004, respectively. This impact is reflected in the changes in receivables.
Receivables with extended billing terms were $245 million and $225 million as
of December 31, 2005 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.

---



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

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

Changes in other operating
assets and liabilities during the three months ended December 31, 2005 included
the payment of fiscal 2005 incentive awards and the impact of $278 million of
reserves 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 $600 million and $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 $28 million and net tax payments of $21 million (including related
interest) during the three months ended December 31, 2005 and 2004,
respectively.

Investing Activities

Investing
activities included net purchases of marketable securities of $357 million and
$695 million during the three months ended December 31, 2005 and 2004,
respectively. We may
continue to purchase marketable securities in an attempt to improve our
investment returns. 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
$21 million during the three months ended December 31, 2005 and 2004,
respectively. Cash provided from the issuance of common shares for certain employee benefit plans was $20 million and $55
million during the three months ended December 31, 2005 and 2004, respectively.

We are currently authorized
by our board of directors to issue shares of our common stock or use cash in
exchange for certain of our convertible securities and other debt obligations.
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 use cash or
issue more of our common shares in similar transactions in the future. If our
common stock is issued, it would result in additional dilution to our common
shareowners.

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 $167 million during fiscal 2005 and
  the first quarter of fiscal 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. Our 8%
  convertible securities of $486 million 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 also have the right to redeem
  the 8% convertible securities for cash after August 14, 2006.

We believe our cash and cash equivalents of $1.5
billion and marketable securities of $2.9 billion as of December 31, 2005 are
sufficient to fund our cash requirements for fiscal 2006 as well as the
following few years. However, we cannot provide assurance that our actual cash
requirements will not be greater than we currently expect. If sources of
liquidity are not available or if we cannot generate sufficient cash flow from
operations, we might be required to obtain additional sources of funds through
additional operating improvements, capital market transactions, asset sales or
financing from third parties, or a combination thereof. We cannot provide
assurance that these additional sources of funds will be available or, if
available, would have reasonable terms.

---



|          |                   
|--------- | ------------------
|<PAGE> 34 | 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 $138 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.

As a result of the U.S.
Bankruptcy Court judgment regarding Winstar and Winstar Wireless Inc., we used
approximately $300 million of cash to collateralize a letter of credit that was
issued during January 2006. This judgment is being appealed to the U.S.
District Court for the District of Delaware.

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
were 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 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 $430 million of assets in trusts that are available to fund the
obligations of the formerly represented retirees as of December 31, 2005.

We are permitted to transfer pension plan assets
  that are in excess of 125% of pension plan obligations under Section 420 of
  the Internal Revenue Code to fund annual retiree health care benefits. Our cumulative
  Section 420 transfers during the past several years were $1.9 billion, although
  no transfers were made within the management retiree plan since fiscal 2002
  or within the formerly represented retiree plan since fiscal 2003. If a Section
  420 transfer is made, we are required to maintain a certain level of cost per
  participant for a period of five years beginning with the year of transfer.
  As a result, although these excess pension asset transfers can help fund retiree
  health care benefits, they limit 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 $1.6 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, 2005). 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.

---



|          |                   
|--------- | ------------------
|<PAGE> 35 | 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 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 December 31, 2005.

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 February 8, 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
|Moodys (a)           |  |                  | B1  |                                  |  | B3                                                                 |  |               | B3 
|Fitch (b)             |  |                  | BB- |                                  |  | B                                                                  |  |               | B  



---

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

---



|          |                   
|--------- | ------------------
|<PAGE> 36 | 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 transactions will reduce our
overall cost of borrowing and increase investment returns.

As of December 31, 2005, 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 December 31, 2005, the three-month LIBOR rate was 4.54%. 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 December 31, 2005, 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.

---



|          |                   
|--------- | ------------------
|<PAGE> 37 | 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 December 31, 2005 in our internal control over
financial reporting that have materially affected, or are reasonably likely to
materially affect, our internal control over financial reporting.

---



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

Part II  Other Information

Item
1. Legal Proceedings

Information about legal
proceedings is set forth in Note 10 to the unaudited consolidated financial
statements included in this report.

Item 6. Exhibits

See
Exhibit Index on page 40 for a description of the documents that are filed as
Exhibits to this report on Form 10-Q or incorporated by reference herein.

---



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

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: February 8, 2006 |                         
|                       |                          | /s/
  John A. Kritzmacher                                                                    
|                       |                          |                                                                                               | 
|                       |                          | John
  A. Kritzmacher
  Senior Vice President and Controller
  (Principal Accounting Officer)

---



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

Exhibit Index

|        |                                                                                                                                                                                               
|------- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|10(i)   | Amendment No. 2 to Rights
  Agreement between Lucent Technologies Inc. and The Bank of New York
  (successor to First Chicago Trust Company of New York), effective as of
  December 21, 2005.
|        |                                                                                                                                                                                               
|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 Frank A.
  DAmelio required by Rule 13a-14(a) (17 C.F.R. 240.13a-14(a)).                                                                                                    
|        |                                                                                                                                                                                               
|32      | Certification of Patricia
  F. Russo and Frank A. DAmelio pursuant to 18 U.S.C. Section 1350, as adopted
  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                        

---