20-F 1 y01330e20vf.htm FORM 20-F 20-F
Table of Contents

 
 
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
Form 20-F
     
o
  REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR (g) OF THE SECURITIES EXCHANGE ACT OF 1934
 
OR
 
þ
  ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
    For the fiscal year ended December 31, 2005
OR
 
o
  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
OR
 
o
  SHELL COMPANY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
Commission file number: 1-11130
ALCATEL
(Exact name of Registrant as specified in its charter)
ALCATEL
(Translation of Registrant’s name into English)
Republic of France
(Jurisdiction of incorporation or organization)
54, rue La Boétie
75008 Paris, France
(Address of principal executive offices)
     Securities registered pursuant to Section 12(b) of the Act:
     
    Name of each exchange
Title of each class   on which registered
     
American Depositary Shares, each representing
one ordinary share,
nominal value 2 per share*
  New York Stock Exchange
 
Listed, not for trading or quotation purposes, but only in connection with the registration of the American Depositary Shares pursuant to the requirements of the Securities and Exchange Commission.
     Securities registered or to be registered pursuant to Section 12(g) of the Act:
None
      Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act:
None
      Indicate the number of outstanding shares of each of the issuer’s classes of capital or common stock as of the close of the period covered by the annual report.
1,428,541,640 ordinary shares, nominal value 2 per share
      Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
Yes     þ               No     o
      If this report is an annual or transition report, indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.
Yes     o               No     þ
      Note — checking the box above will not relieve any registrant required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 from their obligations under those sections.
      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     þ               No     o
      Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer þ          Accelerated filer o          Non-accelerated filer o
      Indicate by check mark which financial statement item the registrant has elected to follow:
Item 17     o               Item 18     þ
      If this is an annual report, indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes     o               No     þ
 
 


 

TABLE OF CONTENTS
             
        Page
         
   Identity of Directors, Senior Management and Advisers     1  
   Offer Statistics and Expected Timetable     1  
   Key Information     1  
   Information on the Company     9  
   Unresolved Staff Comments     20  
   Operating and Financial Review and Prospects     20  
   Directors, Senior Management and Employees     46  
   Major Shareholders and Related Party Transactions     57  
   Financial Information     58  
   The Offer and the Listing     61  
   Additional Information     63  
   Quantitative and Qualitative Disclosures About Market Risk     79  
   Description of Securities Other than Equity Securities     79  
   Defaults, Dividend Arrearages and Delinquencies     79  
   Material Modifications to the Rights of Security Holders     79  
   Controls and Procedures     79  
   Reserved     79  
   Audit Committee Financial Expert     79  
   Code of Ethics     80  
   Principal Accounting Fees and Services     80  
   Exemptions from the Listing Standards for Audit Committee     81  
   Purchases of Equity Securities by the Issuer and Affiliated Purchasers     81  
   Financial Statements     81  
   Financial Statements     82  
   Exhibits     82  
 EX-10.1: CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
 EX-12.1: CERTIFICATION
 EX-12.2: CERTIFICATION
 EX-13.1: CERTIFICATION
 EX-13.2: CERTIFICATION

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PART I
Item 1. Identity of Directors, Senior Management and Advisers
      Not applicable.
Item 2. Offer Statistics and Expected Timetable
      Not applicable.
Item 3. Key Information
SELECTED FINANCIAL DATA
Alcatel Selected Consolidated Financial Data
      In accordance with a regulation adopted by the European Union, or EU, in July, 2002, all companies incorporated under the laws of one of the member states of the EU and whose securities are publicly traded within the EU are required to prepare their consolidated financial statements for the fiscal year starting on or after January 1, 2005 on the basis of accounting standards issued by the International Accounting Standards Board. Therefore, in accordance with these requirements, we converted from using French generally accepted accounting principles (“French GAAP”) to International Financial Reporting Standards (“IFRS”), as adopted by the EU. As used in this Form 20-F, unless the context otherwise indicates, the terms “we,” “us,” “our” or similar expressions, as well as references to “Alcatel” or the “Group,” mean Alcatel and its consolidated subsidiaries.
      As a first time adopter of IFRS at January 1, 2004, we have followed the specific requirements described in IFRS 1 “First Time Adoption of IFRS.” The options selected for the purpose of the transition to IFRS are described in the notes to our 2005 consolidated financial statements included elsewhere in this document. Impacts of the transition on the balance sheet at January 1, 2004, the income statement for the year ended December 31, 2004 and the balance sheet at December 31, 2004 are presented and discussed in Note 38 to our 2005 consolidated financial statements.
      In accordance with General Instruction G.(c) to Form 20-F, the table below represents selected consolidated financial data for Alcatel for the two-year period ended December 31, 2005 in IFRS, which have been derived from the audited consolidated financial statements of Alcatel and for the five-year period ended December 31, 2005 in accordance with accounting principles generally accepted in the United States (“U.S. GAAP”). The selected consolidated financial data are qualified by reference to, and should be read in conjunction with, Alcatel’s consolidated financial statements and the notes to those statements and Item 5 — “Operating and Financial Review and Prospects” appearing elsewhere in this annual report.
      IFRS differs from U.S. GAAP in certain significant respects. For a discussion of significant differences between U.S. GAAP and IFRS as they relate to Alcatel’s consolidated financial statements and a reconciliation to U.S. GAAP of net income and shareholders’ equity for 2005 and 2004, please refer to Notes 39 through 42 to our 2005 consolidated financial statements included elsewhere herein.

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    At December 31,
     
    2005(1)   2005   2004   2003   2002   2001
                         
    (in millions)
Income Statement Data Amounts in accordance with IFRS
                                               
Revenues
  $ 15,554       13,135       12,244                          
Operating profit (loss)(2)
    1,408       1,189       1,179                          
Restructuring costs
    (130 )     (110 )     (324 )                        
Income (loss) from operating activities
    1,349       1,139       707                          
Income(loss) from continuing operations
    1,165       984       503                          
Net income (loss)
    1,150       971       645                          
Net income (loss) attributable to equity holders of the parent
    1,101       930       576                          
Earnings per Ordinary Share
                                               
Net income (loss) attributable to the equity holders of the parent (before discontinued operations)
                                               
 
 — Basic(3)
    0.82       0.69       0.32                          
 
 — Diluted(4)
    0.82       0.69       0.31                          
Dividends per ordinary share(5)
    0.19       0.16        —                          
Dividend per ADS(5)
    0.19       0.16        —                          
Amounts in accordance with U.S. GAAP(6)
                                               
Net sales
  $ 15,547       13,129       12,663       12,528       16,549       25,627  
Income (loss) from operations
    1,113       940       550       (1,349 )     (8,300 )     (5,285 )
Net income (loss)
    904       763       550       (1,721 )     (11,511 )     (4,937 )
Basic earnings per ordinary share(3) (7):
                                               
 
Income (loss) before extraordinary items
    0.66       0.56       0.45       (1.46 )     (7.29 )     (4.05 )
 
Net income (loss)
    0.66       0.56       0.45       (1.42 )     (9.67 )     (4.26 )
Diluted earnings per ordinary share(4)(7) :
                                               
 
Income (loss) before extraordinary items
    0.66       0.55       0.43       (1.46 )     (7.29 )     (4.05 )
 
Net income (loss)
    0.66       0.55       0.42       (1.42 )     (9.67 )     (4.26 )
Basic earnings per ADS(7):
                                               
 
Income (loss) before extraordinary items
    0.66       0.56       0.45       (1.46 )     (7.29 )     (4.05 )
 
Net income (loss)
    0.66       0.56       0.45       (1.42 )     (9.67 )     (4.26 )
Diluted earnings per ADS(7):
                                               
 
Income (loss) before extraordinary items
    0.66       0.55       0.43       (1.46 )     (7.29 )     (4.05 )
 
Net income (loss)
    0.66       0.55       0.42       (1.42 )     (9.67 )     (4.26 )

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    For the Year Ended
    December 31,
     
    2005(1)   2005   2004
             
Balance Sheet Data Amounts in accordance with IFRS
                       
Total assets
  $ 24,656     20,821     20,342  
Marketable securities and cash and cash equivalents
    6,099       5,150       5,163  
Bonds, notes issued and other debt  — Long-term part
    3,259       2,752       3,491  
Current portion of long-term debt
    1,239       1,046       1,115  
Capital Stock
    3,383       2,857       2,852  
Shareholders’ equity attributable to the equity holders of the parent after appropriation
    7,111       6,005       4,920  
Minority interests
    565       477       373  
                                                 
    At December 31,
     
    2005(1)   2005   2004   2003   2002   2001
                         
    (In millions)
Amounts in accordance with U.S. GAAP(5)
                                               
Shareholders’ equity before appropriation
  $ 10,325     8,719     6,864     6,414     8,184     20,985  
Total assets(8)
    28,639       24,184       23,888       25,998       30,435       49,046  
Long-term debt
    3,450       2,913       3,628       4,713       5,070       6,202  
 
(1) Translated solely for convenience into dollars at the noon buying rate of 1.00 = U.S. $1.1842 on December 31, 2005.
 
(2) Operating profit (loss) corresponds to the income (loss) from operating activities before share-based payments, restructuring costs, impairment of capitalized development costs and gain/ (loss) on disposal of consolidated shares.
 
(3) Based on the weighted average number of shares issued after deduction of the weighted average number of shares owned by consolidated subsidiaries at December 31, without adjustment for any share equivalent:
  Ordinary shares: 1,367,994,653 in 2005 for IFRS earnings per share and 1,367,994,653 for U.S. GAAP earnings per share; 1,349,528,158 in 2004 for IFRS earnings per share (including 120,780,519 shares related to bonds mandatorily redeemable for ordinary shares) and 1,228,745,770 for U.S. GAAP earnings per share; 1,211,579,968 in 2003, 1,190,067,515 in 2002 and 1,158,143,038 in 2001 for U.S. GAAP earnings per share.
(4) Diluted earnings per share takes into account share equivalents having a dilutive effect after deduction of the weighted average number of share equivalents owned by our subsidiaries. Net income is adjusted for after-tax interest expense related to our convertible bonds. The dilutive effect of stock option plans is calculated using the treasury stock method. The number of shares taken into account is as follows:
  IFRS: ordinary shares: 1,376,576,909 in 2005 and 1,362,377,441 in 2004.
 
  U.S. GAAP: ordinary shares: 1,377,183,582 in 2005; 1,363,661,187 in 2004; 1,211,579,968 in 2003; 1,190,067,515 in 2002 and 1,158,143,038 in 2001.
(5) Under French company law, payment of annual dividends must be made within nine months following the end of the fiscal year to which they relate. Our board of directors has announced that it will propose at the annual shareholders’ meeting to be held in 2006 to pay a dividend of 0.16 per ordinary share and ADS for 2005.
 
(6) For information concerning the differences between IFRS and U.S. GAAP for years 2005 and 2004, see notes 39 to 42 to our 2005 consolidated financial statements included elsewhere herein. For information concerning the differences between French GAAP and U.S. GAAP for 2003 through 2001, see the notes to our prior consolidated financial statements filed as part of our Annual Reports on Form 20-F for the years ended December 31, 2004 and 2003.
 
(7) All ordinary share and per ordinary share data and all ADS and per ADS data for the years ended December 31, 2002 and 2001 have been adjusted to reflect the conversion on April 17, 2003 of all of our outstanding Class O shares and Class O ADSs into our ordinary shares and ADSs, as applicable, on a one-to-one basis. We no longer have Class O shares trading on the Euronext Paris or Class O ADSs trading on the NASDAQ National Market.
 
(8) Advance payments received from customers are not deducted from the amount of total assets. See note 39(k) to our consolidated financial statements included elsewhere herein.

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Exchange Rate Information
      The table below shows the average noon buying rate of euro from 2001 to 2005. As used in this document, the term “noon buying rate” refers to the rate of exchange for the euro, expressed in U.S. dollars per euro, as announced by the Federal Reserve Bank of New York for customs purposes as the rate in The City of New York for cable transfers in foreign currencies.
         
Year   Average rate(1)
     
2005
  $ 1.2400  
2004
  $ 1.2478  
2003
    1.1411  
2002
    1.0531  
2001
    0.8929  
                    
 
      (1) The average of the noon buying rate for euro on the last business day of each month during the year.
     The table below shows the high and low noon buying rates expressed in U.S. dollars per euro for the previous six months.
                 
Period   High   Low
         
February 2006
  $ 1.2100     $ 1.1860  
January 2006
    1.2287       1.1980  
December 2005
    1.2041       1.1699  
November 2005
    1.2067       1.1667  
October 2005
    1.2148       1.1914  
September 2005
    1.2538       1.2011  
      On March 30, 2006, the noon buying rate was 1.00 = U.S. $1.2132.
RISK FACTORS
Risks Relating to our Operations
      Our business, financial condition or results of operations could suffer material adverse effects due to any of the following risks. We have described the specific risks that we consider material to our business but the risks described below are not the only ones we face. We do not discuss risks that would generally be equally applicable to companies in other industries, due to the general state of the economy or the markets, or other factors. Additional risks not known to us or that we now consider immaterial may also impair our business operations.
Renewed weakness in the telecommunications market could once again have a material adverse effect on our business, operating results and financial condition, and cause us to incur net losses in the future.
      Our business is extremely sensitive to market conditions in the telecommunications industry. In the recent past, our operating results were adversely affected due to unfavorable economic conditions and reduced capital spending by carriers and businesses, particularly in the United States and Europe. While there has been some improvement in capital spending trends since 2003, it is difficult to know whether these trends will continue. Capital spending for telecommunications equipment and related services depends upon the extent of existing unused capacity and the growth rate in voice and data traffic levels, including growth in Internet and electronic commerce generated traffic. If this capital spending does not increase from current levels, or does not at least maintain its current level, the market for our products may decline or fail to develop as expected. This would result in reduced sales and the carrying of excess inventory and may result in our incurring net losses once again in the future.

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If we fail to keep pace with rapid changes in technology, our business could suffer.
      Technology in the telecommunications industry continues to advance at a rapid pace, particularly in the fields of mobile telecommunication networks and services, data processing and transmission. Failure to introduce or develop new products and technologies in a timely manner or failure to respond to changes in market demand may harm our business.
Our inability to compete effectively with existing or new competitors could result in reduced revenues, reduced margins and loss of market share.
      The telecommunications equipment manufacturing industry continues to have excess capacity and there has not been any significant consolidation. Additionally, new competitors continue to emerge and grow. Asian-based competitors are now providing fierce competition not only in Asia but in other markets as well. Accordingly, the industry remains highly competitive and pricing pressures are intense across a wide range of products and services. Some of our competitors have a stronger position than us with respect to certain products or in particular markets. Also, the continued strength of the euro against the U.S. dollar and the major Asian currencies may give a competitive advantage to those of our competitors that incur a great portion of their costs outside the euro area.
      Gross margins may be adversely affected by increased price competition, excess capacity, higher material or labor costs, obsolescence charges, additional inventory write-downs, introductions of new products, increased levels of customer services, changes in distribution channels, and changes in product and geographic mix.
      In order to maintain or increase market share and to acquire new clients we may need to enter into contracts on terms that are less advantageous to us than what has been our general practice and as a result, our gross margin may be adversely impacted.
Our business requires significant amounts of cash, and we may require additional sources of funds if our sources of liquidity are unavailable or insufficient to fund our operations.
      Our working capital requirements and cash flows historically have been, and are expected to continue to be, subject to quarterly and yearly fluctuations, depending on a number of factors. If we are unable to manage fluctuations in cash flow, our business, operating results and financial condition may be materially adversely affected. Factors which could lead us to suffer cash flow fluctuations include:
  the level of sales;
 
  the collection of receivables;
 
  the timing and size of capital expenditures; and
 
  customer financing obligations.
      In order to finance our business, we have entered into a syndicated credit facility allowing for the drawdown of significant levels of debt, but our ability to draw on this facility is conditioned upon our compliance with a financial covenant, and we can provide no assurance that we will be in compliance with such covenant at all times in the future.
      In the future, we may need to secure additional sources of funding if our existing facility and borrowings are not available or insufficient to finance our business. We can provide no assurance that such funding will be available on terms satisfactory to us. If we were to incur high levels of debt, this would require a larger portion of our operating cash flow to be used to pay principal and interest on our indebtedness. The increased use of cash to pay indebtedness could leave us with insufficient funds to finance our operating activities, such as research and development expenses and capital expenditures, which could have a material adverse effect on our business.
      Our short-term debt rating, though improved over the last two years, allows us a limited access to the commercial paper market, and the non-French commercial paper market is generally not available to us on

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terms and conditions that we find acceptable. Our ability to access the capital markets and our financing costs are, in part, dependent on Standard & Poor’s, Moody’s or similar agencies’ ratings with respect to our debt and corporate credit and their outlook with respect to our business. Our current short-term and long-term credit ratings as well as any possible future lowering of our ratings may result in higher financing costs and reduced access to the capital markets. We can provide no assurance that our credit ratings will not be reduced in the future by Standard & Poor’s, Moody’s or similar rating agencies.
Credit and commercial risks and exposures could increase if the financial condition of customers declines.
      A substantial portion of our sales are to customers in the telecommunications industry. These customers often require their suppliers to provide extended payment terms, direct loans or other forms of financial support as a condition to obtaining commercial contracts. As of December 31, 2005, net of provisions, we had provided customer financing of approximately 301 million, and we had outstanding commitments to provide further direct loans or financial guarantees of approximately 97 million. We expect to continue to provide or commit to financing where appropriate for our business. Our ability to arrange or provide financing for our customers will depend on a number of factors, including our credit rating, our level of available credit, and our ability to sell off commitments on acceptable terms.
      More generally, as part of our business we routinely enter into long-term contracts involving significant amounts to be paid by our customers over time. Pursuant to these contracts, we may deliver products and services representing an important portion of the contract price before receiving any payment from the customer.
      As a result of the financing provided to customers and our commercial risk exposure under long-term contracts, our business could be adversely affected if the financial condition of our customers erodes. Over the past few years certain of our customers have filed with the courts seeking protection under the bankruptcy or reorganization laws of the applicable jurisdiction or have experienced financial difficulties. Upon the financial failure of a customer, we have experienced, and in the future may experience, losses on credit extended and loans made to such customer, losses relating to our commercial risk exposure, as well as the loss of the customer’s ongoing business. Should additional customers fail to meet their obligations to us, we may experience reduced cash flows and losses in excess of reserves, which could materially adversely impact our results of operations and financial position.
Our sales are made to a relatively limited number of large customers. The loss of one of these customers or our inability to obtain new customers would result in lower sales.
      Historically, orders from a relatively limited number of customers have accounted for a substantial portion of our revenues and we expect that, for the foreseeable future, this will continue to be the case. For example, in 2005 our 10 largest customers accounted for 28% of our revenues. However, no single customer accounted for more than 10% of our revenues. In addition, even if we are successful in attracting new customers, new market entrants may not have access to sufficient financing to purchase our products and equipment.
An increasing amount of our sales, particularly in mobile networks, is made in emerging markets.
      We continue to experience strong sales in emerging markets in Asia, Africa and Latin America. This is particularly the case with respect to mobile infrastructure products and related services. In these markets we are faced with several risks that are more significant than in other countries. These risks include economies that may be dependent on only a few products and therefore subject to significant fluctuations, weak legal systems which may affect our ability to enforce contractual rights, possible exchange controls, unstable governments, privatization actions or other government actions affecting the flow of goods and currency.

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Our financial condition and results of operations may be harmed if we do not successfully reduce market risks through the use of derivative financial instruments.
      Since we conduct operations throughout the world, a substantial portion of our assets, liabilities, revenues and expenses are denominated in various currencies other than the euro, principally the U.S. dollar, and, to a lesser extent, the British pound. Because our financial statements are denominated in euros, fluctuations in currency exchange rates, especially the U.S. dollar against the euro, could continue to have a material impact on our reported results. From 2003 through 2005, the relative strength of the euro against the U.S. dollar had a significant negative impact on our revenues. The weakness of the dollar against the euro has meant that competition is particularly intense from competitors with a large part of their costs outside the euro area. This has put pressure on our margins and might continue to do so. If the dollar continues to be weak against the euro in 2006, this may have a further negative impact on our revenues and our margins. We also experience other market risks, including changes in interest rates and in prices of marketable equity securities that we own. We use derivative financial instruments to reduce certain of these risks. If our strategies to reduce market risks are not successful, our financial condition and operating results may be harmed.
Because of our significant international operations, we are exposed to a variety of risks, many of which are beyond our control.
      In addition to the currency risks described elsewhere in this section, our international operations are subject to a variety of risks arising out of the economy, the political outlook and the language and cultural barriers in countries where we have operations or do business, which is virtually every country in the world.
      We have significant operations and sales in many countries outside of Western Europe and North America, particularly in Asia. As such, our business activities are exposed to shifting government policies and legal systems that may not provide full protection of intellectual property rights or contractual commitments. Changes in government policies or an inability to protect our legal rights may have an adverse impact on our financial conditions.
      As a result of being active in many countries we are continually moving products from one country to another and we often provide services in one country from a base in another. Accordingly, we remain vulnerable to abrupt changes in customs and tax regimes that may have significant negative impacts on our financial condition and operating results.
We are involved in several significant joint ventures and are exposed to problems inherent to companies under joint management.
      We are involved in several significant joint venture companies, some of which are fully consolidated in our accounts. The related joint venture agreements may require unanimous consent or the affirmative vote of a qualified majority of the shareholders to take certain actions, thereby possibly slowing down the decision-making process.
Risks Relating to Ownership of our ADSs
The trading price of our ADSs may be affected by fluctuations in the exchange rate for converting euro into U.S. dollars.
      Fluctuations in the exchange rate for converting euro into U.S. dollars may affect the value of our ADSs.
If a holder of our ADSs fails to comply with the legal notification requirements upon reaching certain ownership thresholds under French law or our governing documents, the holder could be deprived of some or all of the holder’s voting rights and be subject to a fine.
      French law and our governing documents require any person who owns our outstanding shares or voting rights in excess of certain amounts specified in the law or our governing documents to file a report with us upon crossing this threshold percentage and, in certain circumstances, with the French stock exchange

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regulator (Autorité des marchés financiers). If any shareholder fails to comply with the notification requirements:
  the shares or voting rights in excess of the relevant notification threshold may be deprived of voting power on the demand of any shareholder;
 
  all or part of the shareholder’s voting rights may be suspended for up to five years by the relevant French commercial court; and
 
  the shareholder may be subject to a fine.
Holders of our ADSs will have limited recourse if we or the depositary fail to meet obligations under the deposit agreement between us and the depositary.
      The deposit agreement expressly limits our obligations and liability and the obligations and liability of the depositary. Neither we nor the depositary will be liable despite the fact that an ADS holder may have incurred losses if the depositary:
  is prevented or hindered in performing any obligation by circumstances beyond our control;
 
  exercises or fails to exercise discretion under the deposit agreement;
 
  performs its obligations without negligence or bad faith;
 
  takes any action based upon advice from legal counsel, accountants, any person presenting our ordinary shares for deposit, any holder or any other qualified person; or
 
  relies on any documents it believes in good faith to be genuine and properly executed.
      This means that there could be instances where you would not be able to recover losses that you may have suffered by reason of our actions or inactions or the actions or inactions of the depositary pursuant to the deposit agreement. In addition, the depositary has no obligation to participate in any action, suit or other proceeding in respect of our ADSs unless we provide the depositary with indemnification that it determines to be satisfactory.
We are subject to different corporate disclosure standards that may limit the information available to holders of our ADSs.
      As a foreign private issuer, we are not required to comply with the notice and disclosure requirements under the Securities Exchange Act of 1934, as amended, relating to the solicitation of proxies for shareholder meetings. Although we are subject to the periodic reporting requirement of the Exchange Act, the periodic disclosure required of non-U.S. issuers under the Exchange Act is more limited than the periodic disclosure required of U.S. issuers. Therefore, there may be less publicly available information about us than is regularly published by or about other public companies in the United States.
Judgments of U.S. courts may not be enforceable against us including those predicated on the civil liability provisions of the federal securities laws of the United States in French courts.
      An investor in the United States may find it difficult to:
  effect service of process within the United States against us and our non-U.S. resident directors and officers;
 
  enforce U.S. court judgments based upon the civil liability provisions of the U.S. federal securities laws against us and our non-U.S.  resident directors and officers in both the United States and France; and
 
  bring an original action in a French court to enforce liabilities based upon the U.S. federal securities laws against us and our non-U.S.  resident directors and officers.

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Preemptive rights may not be available for U.S. persons.
      Under French law, shareholders have preemptive rights to subscribe for cash issuances of new shares or other securities giving rights to acquire additional shares on a pro rata basis. U.S. holders of our ADSs or ordinary shares may not be able to exercise preemptive rights for their shares unless a registration statement under the Securities Act of 1933 is effective with respect to such rights or an exemption from the registration requirements imposed by the Securities Act is available. We may, from time to time, issue new shares or other securities giving rights to acquire additional shares at a time when no registration statement is in effect and no Securities Act exemption is available. If so, U.S. holders of our ADSs or ordinary shares will be unable to exercise their preemptive rights.
Item 4. Information on the Company
History and Development
      We are a leading, worldwide provider of a wide variety of telecommunications equipment and services. With revenues of 13.1 billion in 2005 and approximately 58,000 employees, we operate in more than 130 countries. Our telecommunications equipment and services enable our customers to send or receive virtually any type of voice or data transmission. Our customers include fixed line and wireless telecommunications operators, sometimes referred to as carriers, Internet service providers, governments and businesses.
      Alcatel is a French société anonyme, established in 1898, originally as a publicly owned company. Alcatel’s corporate existence will continue until June 30, 2086, which date may be extended by shareholder vote. We are subject to all laws governing business corporations in France, specifically the provisions of the commercial code, the financial and monetary code and decree No. 67-236 of March 23, 1967, as amended to date.
      Our registered office and principal place of business is 54, rue la Boétie, 75008 Paris, France, our telephone number is 33 (1) 40.76.10.10 and our website address is www.alcatel.com. The contents of our website are not incorporated into this Form 20-F. The address for Steven Sherman, our authorized representative in the United States, is Alcatel USA, Inc., 3400 West Plano Parkway, Plano, Texas 75075.
      Our total capital expenditures were 638 million for the year ended December 31, 2005 compared to 579 million in 2004. Our capital expenditures are incurred in the ordinary course of our business and operations and are generally funded out of our cash flow from operations. Further information with respect to capital expenditures and funding sources is set forth in Item 5 — “Operating and Financial Review and Prospects  — Liquidity and Capital Resources.”
Overview and Outlook
      The telecommunications market continued to recover in 2005, with a sustained demand for broadband services for data transmission and voice and data services on wireless infrastructures. The wireline market, in particular, grew during the second half of 2005, driven by the transformation of carrier networks to Internet protocol (sometimes referred to as IP) and the introduction of triple play (meaning voice, data and video) services in the network. The wireless market also continued to benefit from growth in emerging markets. The major telecommunications carriers increased their capital spending to meet this demand.
      As a result of this improved market environment, our revenues increased by 7.3% in 2005 as compared to 2004. Excluding the impact of the currency exchange rate between the euro and the U.S. dollar and other currencies linked to the U.S. dollar, our revenues would have increased by 8.0%. For 2005, our gross margin was 35.3%, a slight decrease from 2004 reflecting competitive pricing pressure in our key markets, and our operating margin was 9.1%.
      We anticipate that the carrier market will continue to grow in the mid-single digit range for the full year 2006. The wireline market should accelerate with the deployment of IP television services and the continued transformation of carrier networks towards IP. The wireless market growth rate will most probably slow down

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compared to last year and will be focused on emerging market needs and new applications across all geographical regions. Alcatel’s rate of growth in 2006 will depend on a favorable regulatory environment for fiber deployments, third generation wireless deployments in China, and the rate at which carrier networks transform their systems to IP. IP products and services primarily sold to non-carriers (that is, businesses and governmental and quasi-governmental entities) should continue to present opportunities, particularly those business and entities engaged in transport, energy and defense.
      With respect to our business, we expect that the good dynamics of year-end 2005 will continue into the first quarter of 2006, with year-over-year revenue growth above 10%. Overall, with the current limited visibility beyond mid-year, we expect a lower growth rate for the second half compared to the first half, but believe that our revenues should outpace the carrier market growth for the full year 2006.
      In terms of full year operating profitability, we anticipate a slight improvement in the operating margin for 2006, taking into account continuing competitive pressure in some markets.
Recent Events
      On March 24, 2006, we issued a press release confirming that we are engaged in discussions with Lucent about a potential merger of equals that is intended to be priced at market. We stated that there can be no assurances that any agreement will be reached or that a transaction will be consummated, and that we will have no further comment until an agreement is reached or the discussions are terminated.
Highlights of Transactions during 2005
     Acquisitions
      Acquisition of Native Networks. On March 17, 2005, we completed the acquisition of Native Networks, Inc., a provider of optical Ethernet goods and services, for U.S. $55 million in cash.
     Dispositions
      Sale of shareholding in Nexans. On March 16, 2005, we sold our shareholding in Nexans, representing 15.1% of Nexans’ share capital, through a private placement.
      Sale of electrical power systems business. On January 26, 2005, we completed the sale of our electrical power business to Ripplewood, a U.S. private equity firm.
     Other Transactions
      Amendment of credit facility. On March 15, 2005, we amended our existing syndicated revolving 1.3 billion credit facility by extending the maturity date from June 2007 to June 2009 with a possible extension until 2011, eliminating one of the two financial covenants, reducing the cost of the facility and reducing the overall amount to 1.0 billion.
      Moody’s upgrade of our long-term debt. On April 11, 2005, Moody’s upgraded to Bal from Ba3 the ratings for our long-term debt on the basis of cost savings achieved by us and our balance sheet strength.
      Merger of space activities. On July 1, 2005, we completed the merger of our space activities with those of Finmeccanica, S.p.A., an Italian aerospace and defense company, through the creation of two sister companies. We own approximately 67%, and Alenia Spazio, a unit of Finmeccanica, owns approximately 33%, of the first company, Alcatel Alenia Space, that combines our respective industrial space activities. Finmeccanica owns approximately 67%, and we own approximately 33%, of the second company, Telespazio Holding, which combines our respective satellite operations and service activities.
      Exchange of our interest in joint venture with TCL Communication. On July  18, 2005, we exchanged our 45% shareholding in our joint venture with TCL Communication Technology Holdings Limited (see “Highlights of Transactions during 2004 — Other Transactions — Creation of joint venture for mobile

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handset business” below) for shares of TCL Communication, which resulted in TCL Communication owning all of the joint venture company and our owning 141,375,000 shares of TCL Communication.
Highlights of Transactions during 2004
     Acquisitions
      Acquisition of Spatial Wireless. On December 16, 2004, we completed the acquisition of Spatial Communications Technologies, Inc. for consideration consisting of our American Depositary Shares, or ADSs, having a value of 223 million (based on the market value of our ADSs on the date of the acquisition). Spatial develops and markets mobile switching equipment that can operate using any of the major mobile technologies and related software. Through this acquisition we are able to offer next-generation mobile switching equipment and will facilitate our ability to provide carriers with systems that can be updated relatively easily in the future.
      Acquisition of eDial. On September 17, 2004, we acquired eDial for consideration consisting of cash and ADSs having an aggregate value of 22 million (based on the market value of our ADSs on the date of the acquisition). eDial provides conferencing and related services for businesses and carriers. This acquisition complements our communications software development strategy.
     Dispositions
      Sale of battery business. On January 14, 2004, we completed the sale of our battery business, Saft, to Doughty Hanson, a European private equity firm, for 390 million in cash.
     Other Transactions
      Sale of a portion of shareholding in Avanex. On December 14, 2004, we sold a portion of our shareholding in Avanex in a block trade market transaction, which reduced our shareholding in this company to 19.65% of its share capital.
      Creation of joint venture for mobile handset business. On August 31, 2004, our joint venture with TCL Communication Technology Holdings Limited commenced operations. This joint venture engaged in research and development, manufacturing, and sales and distribution of mobile handsets and peripheral devices. We contributed cash and our mobile handset business having an approximate aggregate value of 45 million in exchange for a 45% equity stake in the joint venture, and TCL Communications contributed cash of 55 million in exchange for a 55% equity stake in the joint venture.
      Creation of joint venture for optical fiber cable business. On July 1, 2004, we combined our global fiber and communication cable business with that of Draka Holding, N.V, a Dutch cable and cable systems producer, and created a new company, Draka Comteq B.V., owned 50.1% by Draka and 49.9% by us.
Highlights of Transactions during 2003
     Acquisitions
      Acquisition of iMagicTV. On April 30, 2003, we acquired, for 3.5 million of our ADSs having a market value on that date of 26 million, the 84% of the outstanding shares that we did not own of iMagicTV, a Canadian supplier of software products and services that enable service providers to create, deliver and manage digital television and media services over broadband networks. This acquisition, together with our acquisition of ThirdSpace and Packet Video, enabled us to add to our portfolio of content and systems integration products.
      Acquisition of TiMetra. On July 18, 2003, we acquired, for 18 million ADSs, having a market value on that date of 145 million, TiMetra, Inc., a privately held, Silicon Valley-based company that produces routers (devices that interconnect computer networks and move information from one network to another). The customers for our routers are generally carriers.

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     Dispositions
      Sale of optical components business. On August 1, 2003, we sold our optical components business to Avanex. Under the terms of the agreement, we received 28% of Avanex’s stock. We contributed cash in the transaction in the amount of U.S. $110 million, the majority of which related to the restructuring of the optical business.
      Sale of European factories. In 2003, we sold a number of manufacturing facilities in Europe. The principal transactions were: our Saintes, France factory that engaged in cutting, stamping and general sheet metal work was sold, and 300 employees were transferred, to GMD, a French industrial company; our Coutances, France factory that specialized in producing printed circuit boards used in telecommunications applications was sold in a leveraged management buyout and 220 employees were transferred; our Hoboken, Belgium factory that produced electro-mechanical devices was sold, and 241 employees were transferred, to Scanfil Oyi. These facilities comprised nearly 80,000 square meters.
      Sale of shareholding in Atlinks. On February 12, 2003, we exercised our option to sell our 50% shareholding in Atlinks to Thomson, our joint venture partner. Atlinks is a manufacturer of residential telephones. The sale price was 68 million.
     Other Transactions
      Conversion of Class O shares into our ordinary shares. On February 3, 2003, our board of directors decided to submit for approval a resolution at our annual shareholders’ meeting to convert all outstanding Class O shares and Class O ADSs into our ordinary shares and ADSs, as applicable, on a one-for-one basis. This decision was taken after our board analyzed the market conditions of the opto-electronic industry and noted that the conditions were very different than those that existed at the time the Class O shares were created and that the conditions in early 2003 negatively affected the Optronics division’s performance and appeared likely to continue to do so throughout 2003 and later. Our management believed that the elimination of the tracking stock would give us more flexibility as we addressed the future of the Optronics business and continued to explore strategic alternatives for this division. On April 17, 2003, our shareholders approved this resolution and, immediately thereafter, all Class O shares and Class O ADSs were converted into our ordinary shares and ADSs, as applicable.
Business Organization
      The organizational chart below sets forth our three business segments and their principal business activities:
                     
         
 Fixed Communications   Mobile Communications   Private Communications
         
• Access Networks
• Fixed Solutions
• Internet Protocol
• Optical Networks
  • Mobile Radio
• Mobile Solutions
• Wireless Transmission
  • Enterprise Solutions
• Space Solutions
• Transport Solutions
• Integration and Services
      For financial information by operating segment and geographic market, see Note 4 to our consolidated financial statements and Item 5 — “Operating and Financial Review and Prospects.”
Fixed Communications
General
      Our Fixed Communications segment is comprised of the following divisions: access networks, fixed solutions, internet protocol (IP), and optical networks. This segment supplies a broad portfolio of products and services used by carriers in all facets of their network operations, from the carriers’ central office to the end-user. In 2005, our Fixed Communications segment had revenues of 5,213 million (excluding inter-company sales), representing 39.7% of our total revenues.

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Access Networks
      We are the worldwide leader in (in terms of annual revenues) broadband access, including digital subscriber lines, or DSL. Our access products consist of equipment that transports information at high speeds, using a large bandwidth called “broadband,” over existing copper wire telephone lines. These broadband products enable carriers to generate additional revenues by providing advanced services to their residential and business customers. Our newest access Internet Protocol (or IP)-based product, introduced in 2004, is designed to accommodate expanding demand for new applications requiring greater bandwidth. It permits carriers to offer voice, data and video (triple play functionality), and to deliver to their customers virtually unlimited broadcast channels, video on demand, HDTV (high definition TV), VoIP (voice over IP), high speed Internet, and business access services. Our products permit carriers to serve the needs of their urban, suburban and rural customers.
      We believe that our large installed DSL base provides us with a competitive advantage, as most carriers enhance their networks with fiber-based services. Our fiber-based products enable the delivery of high quality voice, high-speed data and high definition interactive video, supporting hundreds of analog and digital channels. These products are complementary to our DSL products, depending on network configuration and the area of installation.
Fixed Solutions
      In addition to our broadband access infrastructure products described above, our Open Media Suite enables carriers to deliver broadband entertainment, permitting them to generate potential new revenues from their broadband networks. By offering carriers the ability to provide IPTV to their customers, we enable carriers to create and deliver entertainment services, such as broadcast TV, video on demand, personal video recorder and other services, which can be designed and customized for local markets.
      We have market-leading positions in many countries in access, signaling, switching and related equipment for voice transmission. We are upgrading our voice offerings from both a performance and a cost perspective. Moreover, we have worked with carriers over the years to migrate their networks to the latest technologies. Our next generation networking (NGN) program addresses carriers’ needs to enhance their service offerings, thereby generating new revenues, while lowering the carriers’ related costs.
Internet Protocol
      Our portfolio of data offerings is led by three products — our multiservice, multiprotocol switching platform, a service router and our Ethernet service switch. Our multiservice switching platform has been designed to provide flexibility to carriers when they build and expand their networks. This platform is based on a blend of technologies, which has integrated Internet protocol and multiprotocol switching functions, thereby allowing carriers to expand their service offerings at their option and to adapt their networks to meet the growth of traffic over the Internet. A service router is a device that interconnects computer networks and moves information from one network to another. Our Ethernet service switch, introduced in 2004, enables carriers to deliver virtual private networks, or VPNs, and triple play offerings (data, voice and video) using an Ethernet standard. Each of these products is designed to deliver high margin data services, including the full variety of network-based virtual private networks and other data services used for business applications. The service router features a new generation of processing power and many customized and scaleable applications designed to appeal to carriers. It provides high value, differentiated IP services to businesses. We believe our product provides services and applications that go well beyond what is possible with the single purpose routing products that are generally available today.
      We have developed an Internet protocol portfolio of products to meet our customers’ varying requirements. For instance, our multiservice switch platform can interface with our service router to deliver seamless networking services regardless of technology. Seamless interfacing between the two products allows carriers to combine their newer Internet protocol or Ethernet-based networking products with their older network or base of services to offer customers a smooth service migration to these more advanced technologies.

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Optical Networks
      Our optical networks division produces equipment to transport information for long distances over land (terrestrial) and undersea (submarine), as well as for short distances in metropolitan and regional areas. According to industry analyst OVUM/ RHK, we have had the largest optical networking market share since 2001.
      Terrestrial. Our terrestrial products are designed for long haul and metropolitan/regional applications. With our products, carriers can manage voice, data and video traffic patterns based on different applications or platforms and benefit from new competitive service offerings by introducing a wide variety of data-managed services, including different service quality capabilities, variable service rates and traffic congestion management. Most importantly, these products allow our customers to offer these new services without impacting their existing investment program for their current networks. Our metro WDM (wave division multiplexing) products address carriers’ requirements for cost-effective networks to meet their growing business and data networking needs. Our products are scaleable, in that they permit our customers to easily enlarge their networks as their business and data networking needs grow. These products provide cost-effective, managed platforms that support different services and are suitable for applications in diversified network configurations.
      Submarine. We are an industry leader in the development, manufacture, installation and management of undersea telecommunications cable networks. Our submarine network systems can connect continents (using regeneration due to the long distances), as well as span distances up to 400km (using no regeneration) to connect mainland and an island, or several islands together or many points along a coast.
Mobile Communications
General
      Our Mobile Communications segment serves the needs of wireless carriers throughout the world. We provide an extensive range of mobile communications products and services, including radio access and core network hardware and software, applications hardware and software and a wide range of services, including installation, maintenance and operation systems. In 2005, our Mobile Communications segment had revenues of 4,096 million (excluding inter-company sales), accounting for 31.2% of our total revenues.
Mobile Radio
      We develop Evolium mobile radio products for all major mobile technologies — GSM/ GPRS/ EDGE and UMTS. Our mobile radio products are designed to minimize total cost of ownership through a continuous re-engineering program and the use of a highly modular framework that facilitates rapid network deployment and expansion, flexible network evolution, including the easy introduction of new technologies and easier maintenance, and allows for the evolution to a third generation, or 3G, network without loss of operability.
      Global System for Global Communications/ General Packet Radio Service, or GSM/ GPRS, remains by far the world’s dominant mobile technology and is increasingly in demand in emerging countries. Enhanced Data rates for GSM Evolution, or EDGE, provides a relatively simple, cost-effective development step beyond GSM/ GPRS that can be an alternative to, or complement, the implementation of UMTS (described below). Compared to GSM/ GPRS, the main benefits of EDGE are higher data transmission speeds, better geographic coverage and improved operating characteristics. EDGE does not support the full range of services provided by UMTS such as video-telephony and cannot compete with UMTS data transmission speeds. However, EDGE can be faster and cheaper to deploy and has better coverage in rural areas deployments. All of our Evolium base stations have been shipped fully EDGE-ready since early 2001, enabling EDGE to be introduced through an easy software upgrade, with no need for site visits.
      UMTS. Universal Mobile Telephone Communications Systems, commonly referred to as UMTS or 3G, represents an important evolutionary step over GSM/ GPRS/ EDGE networks in terms of services, voice quality and data transmission speeds. Our joint venture with Fujitsu, launched in 2000, provides us with competitive and comprehensive UMTS mobile radio network products. Our existing customers that utilize Evolium GSM

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base stations and that wish to migrate to 3G systems can do so relatively easily and inexpensively by incorporating our 3G modules into their systems. Similarly, customers wishing to migrate their systems to the even more advanced HSDPA (High Speed Downlink Packet Access), followed next year by HSUPA (High Speed Uplink Packet Access), will be able to do so through a relatively simple software upgrade to their existing systems.
      In 2004, we formed an alliance with Intel for the development of end-to-end solutions using wiMAX standards (Worldwide Interoperability for Microwave Access) that provide broadband connectivity over wireless networks. We expect that these wiMAX products, based on our Evolium portfolio of products, will be available in 2006. These products will be especially important for emerging countries, which generally do not have an extensive existing network of installed landlines. We also have an alliance with Datang Mobile to foster the development of the 3G mobile standard, TD-SCDMA, in China. During 2005, we entered into a non-exclusive agreement with a Chinese equipment vendor, ZTE, under which they provide us with radio equipment for sale in China. In addition, we have a number of partnerships for the development of equipment and services based on Advanced Telecom Computing Architecture (ATCA), a standard that reduces the cost and complexity of our customers’ mobile infrastructure.
Mobile Solutions
      Our mobile solutions business consists of core network products and software applications. In software applications, our extensive range of platforms and software products enables mobile operators to deliver new value-added mobile services. End-user needs addressed by our products include personal multimedia communication, access to information and entertainment services, and mobile commerce. We are a leader in intelligent network platforms and services with over 110 customers worldwide, and we are recognized by industry analysts for our multimedia services (for instance, mobile music and mobile video) and convergent payment applications (voice/data, pre/post-paid).
      Pioneering a major industry shift, Alcatel is driving network transformation across all layers. With the introduction of IT-based platforms, Alcatel is providing higher capacity and scalability, built-in modularity to more quickly capture IT innovation, software-based evolution and simplified operation and maintenance.
      At the network level, we are helping operators evolve toward a services-enhanced, all-IP environment, thereby reducing network complexity and costs.
      Moreover, our Unlicensed Mobile Access (UMA) products enable roaming between cellular networks and WiFi and Bluetooth networks. These products offer both a standalone and combined NGN-UMA solution, which can be cost-effectively integrated into legacy and NGN core networks.
      At the services level, our next generation network architecture is IMS-ready, which is a new standard evolving in the wireless market referring to the IP Multimedia Subsystem. Providing real-time, IP multimedia communications for mobile networks, our IMS products can be deployed with minor modifications to the NGN core.
Wireless Transmission
      We offer a comprehensive point-to-point portfolio of microwave radio products meeting both European telecommunications standards (ETSI) and American standard-based (ANSI) requirements. These products include high, low and medium capacity microwave systems for carriers’ transmission systems, mobile backhauling applications, fixed broadband applications and private applications in vertical segments like digital television broadcasting, defence and security, energy and utilities. As a complement to optical fiber and other wireline systems, our portfolio of wireless equipment supports a full range of network/radio configurations, network interfaces and frequency bands with high spectrum efficiency. We market wireless transmission equipment that can be managed by our complementary software platforms in a fixed or mobile environment.

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Private Communications
General
      Our Private Communications segment develops communications products, applications and services, which we market to medium and large communication-intensive businesses and other organizations, particularly those involved in transportation, oil/gas and utilities, banking and finance and security, as well as governmental agencies. Our Private Communications segment also provides a broad range of satellite systems that include the high speed transport of voice, data and multimedia communications. In 2005, our Private Communications segment had revenues of 3,918 million (excluding intercompany sales), accounting for 29.8% of our total revenues.
Enterprise Solutions
      We produce hardware and software communications products that we market to enterprise users and that are designed to improve their communications systems. Our enterprise product portfolio includes voice and data applications, such as hybrid Internet protocol, or IP, telephone systems, call center software and applications, and IP networking products.
      Our enterprise communications products are based on open industry standards and protocols to support our customers’ current systems and future communications needs. We offer our customers equipment that can be easily upgraded, and we (through our business partners) provide on-premise installations, support and related services. Our call center products help businesses manage customer interactions and communications, as well as customer service operations and staffing, enabling businesses to intelligently route all incoming customer interactions in real time, including phone, email and Web contacts. We were recognized by several analyst firms, including Gartner and Forrester Research, as a leading supplier of enterprise voice and data products in 2005. According to industry analyst, Infonetics Research (published February 2006), in 2005, we had the highest revenues of any company for IP private branch exchanges, or PBXs, in Europe.
      We continue to work with our partners resulting from some significant partnerships we formed in 2004 to support our enterprise business. For the U.S. market, we work under a distribution agreement with a major U.S.-based carrier that permits it to sell the entire Alcatel portfolio of enterprise voice and data products. Our contact center software subsidiary has a strategic agreement with Microsoft to deliver products that link telephony and instant messaging applications to deliver real-time voice and data enterprise communications.
Space Solutions
      During 2005, we successfully merged our space activities with those of Finmeccanica, S.P.A., an Italian aerospace and defense company. We formed two companies as a result of this merger, one for the production of products for the industrial space sector, named Alcatel Alenia Space, of which we own 67%, and the second one named Telespazio Holding, to provide services related to satellite activities, of which we own 33%. Alcatel Alenia Space booked orders for four satellites in 2005. The space activities referred to below in this section are conducted through these two companies.
      We develop a broad range of satellites and related space-based technology for the private and public sectors for use in telecommunications, navigation, optical and radar observation, meteorology, and other scientific fields. We continue to develop satellite telecommunication products for broadband access, wireless local loop backhaul, and GSM/ GPRS backhaul. In addition, we have added satellite Internet protocol applications to our portfolio of products and services.
      For the public sector, we provide space-based products and services, including applications for telecommunications, navigation, radar and optical observation. We are also a strong contributor to the Galileo project (satellite navigation system), to the GMES project (Global Monitoring for Environment and Security) and to studies for the development of future communication satellites.

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Transport Solutions
      We provide control and signaling system products and services for trains and subways around the world. We have developed a new generation of train routing systems (electronic interlocking) and train control systems (European train control systems for main line and communications based train control for Automated Metro), that use computer platforms to execute complex safety related functions in order to improve the safety of rail networks and at the same time to increase efficiency (more trains on the same infrastructure), thus improving passenger service.
      We continue to develop strategic new products, such as radio-based train control (first commercial application commissioned in Las Vegas in the fourth quarter of 2004) and urban electronic interlocking (first commercial application in New York in 2005). We maintained our position as a leader in the European train control system (ETCS) market and successfully completed the first commercial, cross-border, interoperable ETCS solution on the rail corridor between Vienna and Budapest (which became fully operational in 2005). We have key roles in the supply of four high speed ETCS lines in Spain.
Integration and Services
      We plan, design, install, operate and maintain communication networks for our carrier and our non-carrier customers. We tailor these networks to our customers’ objectives and infrastructure requirements: voice or data, wireless or wireline, regional or national, or any combination thereof. The networks that we serve can consist entirely of our comprehensive portfolio of products and applications, or can integrate products or services produced or supplied by others. Through our network of Regional Support Centers that manage customer projects, we can deploy, manage and upgrade all aspects of our customers’ networks. The integration and services division provides the following: Network Design and Build — responsible for turnkey communication projects in wireline, wireless and vertical markets; Outsourcing — responsible for outsourcing and network support services, including operations and maintenance; and Software and Systems Integration — responsible for software and systems integration for the management of networks.
      In 2005, we continued our strategy to improve and expand our service portfolio to include network outsourcing for carriers and system integration of important communication networks for non-carriers. These two strategic directions are intended to improve and expand the services we offer. By outsourcing their network activities to us, our customers seek to shift their focus from managing infrastructure to developing new customer services and optimizing their processes to gain efficiency.
Marketing and Competition
Marketing and Distribution
      We sell substantially all of our products, other than our private branch exchange products which are sold by distributors, through our direct sales force worldwide, except in China where our products are also marketed through joint ventures that we have formed with Chinese companies.
Competition
      We have one of the broadest product and services offerings in the telecommunications service provider market, both for the carrier and non-carrier markets. Our addressable market segment is very broad and our competitors include large companies, such as Avaya, Cisco, Ericsson, Fujitsu, Huawei, Lucent, Motorola, Nokia, Nortel and Siemens. There are also a number of smaller companies that we consider to be competitors, in one segment or another.
      We believe that technological advancement, quality, reliable on-time delivery, product cost, flexible manufacturing capacities, local field presence and long-standing customer relationships are the main factors that distinguish competitors of each of our segments in their respective markets.

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Research and Development and Intellectual Property
Research and Development
      As of December 31, 2005, 15,600 of our employees occupied research and development positions, of which 19% were based in North America, 32% were based in Western Europe, 30% were based in Eastern Europe, Asia and India and the remainder were based elsewhere. In 2005, our research and development expenses were 1,443 million, representing 11.0% of our 2005 revenues after the impact of the capitalization of development expenses (1,544 million, or 11.8% of 2005 revenues, before capitalization of development expenses). For a detailed discussion of our research and development expenditures for the past three years and certain accounting policies relating to our research and development and acquired technologies, see Item 5 — “Operating and Financial Review and Prospects.”
      Research and development is one of our key priorities, particularly the development of key technologies for the carrier telecommunications market. We continue to reduce spending on mature technologies, discontinue non-competitive programs and non-core programs, slow down research and development in non-urgent programs, such as the development of advanced optical technologies, and reduce capital expenditures relating to investments in platforms, test tools, and certain development efforts. We also adopted measures intended to promote the reuse of existing technology, particularly among our business segments, the introduction of new processes to increase efficiency, especially in the area of software production; and to focus on mid-term customer requirements to develop products and services that will increase our customers’ revenues. Our research centers are now built around six centers worldwide: three in Europe (France, Belgium, Germany), two in North America (Canada and the United States), and one in Asia (China).
      In addition to our continued focus on cost efficiency, key priorities in 2005 included pursuing developments in broadband access, second and third generation technology in mobile communications, next generation transmission technologies, IP and converged fixed/mobile applications.
      Most of our research and development effort is under the direct control of our business groups and divisions in order to provide flexible and customer-oriented development and rapid utilization of innovations in new products and applications.
Intellectual Property
      We rely on patent, trademark, trade secret and copyright laws both to protect our proprietary technology and to protect us against claims from others. We believe that we have direct intellectual property rights or rights under licensing arrangements covering substantially all of our material technologies. However, there can be no assurance that claims of infringement will not be asserted against us or against our customers in connection with their use of our systems and products, nor can there be any assurance as to the outcome of any such claims, given the technological complexity of our systems and products.
      We consider patent protection to be particularly important to our businesses due to the emphasis on research and development and intense competition in our markets. We filed 700 patent applications in 2005 and have a patent portfolio of approximately 10,000 patent families. We do not believe that any single patent or group of related patents is material to our business as a whole.
Sources and Availability of Materials
      We make significant purchases of electronic components, aluminum, steel, precious metals, plastics and other materials and components from many domestic and foreign sources. We continue to develop and maintain alternative sources of supply for essential materials and components. We believe that we will be able to obtain sufficient materials and components from European and other world market sources to meet our production requirements.

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Properties
      We have administrative, production, manufacturing and research and development facilities worldwide. A substantial portion of our production and research activities in all business areas is conducted in France and China. We also have operating affiliates and production plants in many other countries, including Germany, Italy, Spain, Belgium, Denmark, the United Kingdom, India, the United States, Brazil and Mexico. As of December 31, 2005, our total global productive capacity was approximately 398,000 square meters (of which, approximately 80% is owned and the remainder is leased), as described below.
                                   
        North   Rest of    
Business Group   Europe   America   World   Total
                 
    (in thousands of square meters)
Fixed Communications
    141       5       24       170  
Mobile Communications
    37       34       31       102  
Private Communications
    124       2             126  
                         
 
Group Total
    302       41       55       398  
                         
      We believe that our current facilities are in good condition and adequate to meet the requirements of our present and foreseeable future operations.
      We have been largely outsourcing the manufacturing of many of our telecommunications products in an effort to obtain greater flexibility to adapt quickly to economic and market changes. In order to decrease our costs, we are focused on shifting our production to utilize contract manufacturers.
Our Activities in Certain Countries
      We operate in more than 130 countries, some of which have been accused of human rights violations, are subject to economic sanctions by the U.S. Treasury Department’s Office of Foreign Assets Control or have been identified by the U.S. State Department as state sponsors of terrorism. Some U.S.-based pension funds and endowments have announced their intention to divest the securities of companies doing business in some of these countries and some state and local governments have adopted, or are considering adopting, legislation that would require their state and local pension funds to divest their ownership of securities of companies doing business in those countries. Our net revenues attributable to these countries represented less than one percent of our total net revenues. We estimate that U.S.-based pension funds and endowments own approximately 1.4% of our outstanding stock, and most of these institutions have not indicated that they intend to effect such divestment.
Environmental Matters
      We are subject to national and local environmental and health and safety laws and regulations that affect our operations, facilities and products in each of the jurisdictions in which we operate. These laws and regulations impose limitations on the discharge of pollutants into the air and water, establish standards for the treatment, storage and disposal of solid and hazardous waste and may require us to clean up a site at significant cost. We have incurred significant costs to comply with these laws and regulations and we expect to continue to incur significant compliance costs in the future.
      It is our policy to comply with environmental requirements and to provide workplaces for employees that are safe and environmentally sound and that will not adversely affect the health or environment of communities in which we operate. Although we believe that we are in substantial compliance with all environmental and health safety laws and regulations and that we have obtained all material environmental permits required for our operations and all material environmental authorizations required for our products, there is a risk that we may have to incur expenditures significantly in excess of our expectations to cover environmental liabilities, to maintain compliance with current or future environmental and health and safety laws and regulations or to undertake any necessary remediation.

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Seasonality
      Our quarterly results reflect seasonality in the sale of our services and products. Sales are generally stable over the first three quarters of the year, with the strongest sales in the fourth quarter.
Item 4A. Unresolved Staff Comments
      Not applicable.
Item 5. Operating and Financial Review and Prospects
Forward-Looking Information
      This Form 20-F, including the discussion of our Operating and Financial Review and Prospects contains forward-looking statements based on beliefs of our management. We use the words “anticipate,” “believe,” “expect,” “may,” “intend,” “should,” “plan,” “project,” or similar expressions to identify forward-looking statements. Such statements reflect our current views with respect to future events and are subject to risks and uncertainties. Many factors could cause the actual results to be materially different, including, among others, changes in general economic and business conditions, changes in currency exchange rates and interest rates, introduction of competing products, lack of acceptance of new products or services and changes in business strategy. Such forward-looking statements include, but are not limited to, the forecasts and targets set forth in this Form 20-F, such as the discussion in Item 4 — “Information on the Company — History and Development — Overview” and below in this Item 5 under the heading “Overall Perspective” with respect to (i) our anticipation that the carrier market will continue to grow in the mid-single digit range for the full year 2006, (ii) our expectation that for the first quarter of 2006 we will have a year-over-year revenue growth above 10%, and that for the second half of the year we will have a lower growth rate than for the first half, (iii) our view that our revenues should outpace the carrier market growth for the full year 2006, and that our operating margin for such period will reflect a slight improvement, (iv) expected cash receipts, capital expenditures and other cash outlays in 2006 and (v) the amount we would be required to pay in the future pursuant to our existing contractual obligations and off-balance sheet contingent commitments, included below in this Item 5 in this discussion under the heading “Contractual obligations and off-balance sheet contingent commitments.”
Presentation of Financial Information
      The following discussion of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and the related notes presented elsewhere in this document. Our consolidated financial statements have been prepared in accordance with International Financial Reporting Standards (“IFRS”) as adopted by the European Union, which differ in certain significant ways from accounting principles generally accepted in the United States (“U.S. GAAP”). IFRS, as adopted by the European Union, differs in certain respects from the International Financial Reporting Standards issued by the International Accounting Standards Board. However, our consolidated financial statements for the year presented in this document in accordance with IFRS would be no different if we had applied International Financial Reporting Standards issued by the International Accounting Standards Board. References to “IFRS” in this Form 20-F refer to IFRS as adopted by the European Union. The most significant differences that affect the presentation of our financial results relate to the accounting treatment of business combinations before the date of transition to IFRS (January 1, 2004), capitalization of development costs, accounting of post-employment benefits, accounting for share-based payment transactions, accounting of compound financial instruments, accounting for sale and leaseback transactions and accounting for restructuring costs. For a discussion of the significant differences between IFRS and U.S. GAAP as they relate to our consolidated financial statements, and a reconciliation of our net income (loss) for the period ended December 31, 2005 and shareholders’ equity as of that date to U.S. GAAP, please refer to Notes 39 through 42 in our consolidated financial statements included elsewhere in this document.
      As permitted by release No. 33-8567 — First-time application of International Financial Reporting Standards — issued by the U.S. Securities and Exchange Commission (the “SEC”), we are filing for our first

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year of reporting under IFRS in this Annual Report on Form 20-F for the fiscal year ended December 31, 2005 two years rather than three years of statements of income, changes in shareholders’ equity and cash flows prepared in accordance with IFRS, with appropriate related disclosure required by this SEC release concerning exceptions to IFRS and reconciliation to previous generally accepted accounting principles applied by us.
Changes in Accounting Standards as of January 1, 2005
      Before January 1, 2005 our consolidated financial statements were prepared in accordance with French GAAP. Effective January 1, 2005 we adopted IFRS, along with other European listed companies, in accordance with European Union regulations. This requires us to present our 2005 consolidated financial statements, together with 2004 comparative information, in accordance with IFRS.
      As indicated in our consolidated financial statements included elsewhere in this document, our accounts for 2005 and comparative data for 2004 were prepared by applying IFRS, as adopted by the European Union. IFRS includes the International Accounting Standards (“IASs”) approved by the International Accounting Standards Board (“IASB”) and the accounting interpretations issued by the International Financial Reporting Interpretations Committee (“IFRIC”) or the former Standing Interpretations Committee (“SIC”).
      The principal areas that have been affected by the change from French GAAP to IFRS are described in the section “Main Areas Affected by the Change from French GAAP to IFRS,” on page 41 of this document, and the exemptions to IFRS that we elected as a first time adopter of IFRS are described in the section “Exemptions to IFRS” on page 45 of this document.
Critical Accounting Policies
      Our Operating and Financial Review and Prospects is based on our consolidated financial statements, which are prepared in accordance with IFRS as described in Note 1 to our consolidated financial statements. As noted above, the principal differences between IFRS and U.S. GAAP are detailed in the Notes to our consolidated financial statements. Some of the accounting methods and policies used in preparing our consolidated financial statements under IFRS and the reconciliation of our net income and shareholders’ equity to U.S. GAAP are based on complex and subjective assessments by our management or on estimates based on past experience and assumptions deemed realistic and reasonable based on the circumstances concerned. The actual value of our assets, liabilities and shareholders’ equity and of our earnings could differ from the value derived from these estimates if conditions changed and these changes had an impact on the assumptions adopted.
      We believe that the accounting methods and policies listed below are the most likely to be affected by these estimates and assessments:
Valuation allowance for inventories and work in progress
      Inventories and work in progress are measured at the lower of cost or net realizable value. Valuation allowances for inventories and work in progress are calculated based on an analysis of foreseeable changes in demand, technology or the market, in order to determine obsolete or excess inventories and work in progress.
      The valuation allowances are accounted for in cost of sales or in restructuring costs depending on the nature of the amounts concerned.
      Significant write-downs of inventories and work in progress were accounted for in the past because of difficult market conditions and the abandonment of certain product lines. The impact of these write-downs on our income before tax was a net charge of 18 million in 2005, representing new write-downs taken in 2005 which more than offset the reversal of existing provisions of 120 million due to asset sales that occurred in 2005, compared to a net gain of 20 million in 2004.
      Because of the revival in the telecommunications market, our future results could continue to be positively impacted by the reversal of valuation allowances previously made.

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Impairment of customer receivables and loans
      An impairment loss is recorded for customer receivables and loans if the present value of the future receipts is below the nominal value. The amount of the impairment loss reflects both the customers’ ability to honor their debts and the age of the debts in question. A higher default rate than estimated or the deterioration of our major customers’ creditworthiness could have an adverse impact on our future results. Impairment losses on customer receivables were 228 million at December 31, 2005 (284 million at December 31, 2004). The impact of impairment losses for customer receivables and loans on income before tax was a net gain of 19 million in 2005 (a net gain of 43 million in 2004).
      Impairment losses on customer loans and other financial assets (assets essentially relating to customer financing arrangements) were 897 million at December 31, 2005 (908 million at December 31, 2004). The impact of these impairment losses on income before tax was a net gain of 25 million in 2005 (a net gain of 77 million in 2004).
Capitalized development costs, goodwill and other intangible assets
      The criteria for capitalizing development costs are set out in Note 1f. Once capitalized, these costs are amortized over the estimated lives of the products concerned.
      We must therefore evaluate the commercial and technical feasibility of these projects and estimate the useful lives of the products resulting from the projects. Should a product fail to substantiate these assumptions, we may be required to impair or write off some of the capitalized development costs in the future.
      We also have intangible assets acquired for cash or through business combinations and the goodwill resulting from such combinations.
      As indicated in Note 1g to our consolidated financial statements included elsewhere herein, in addition to the annual goodwill impairment tests, timely impairment tests are carried out in the event of indications of reduction in value of intangible assets held. Possible impairments are based on discounted future cash flows and/or fair values of the assets concerned. A change in the market conditions or the cash flows initially estimated can therefore lead to a review and a change in the impairment loss previously recorded.
      Net goodwill was 3,772 million at December 31, 2005 (3,774 million at December 31, 2004). Other intangible assets, net were 819 million at December 31, 2005 (705 million at December 31, 2004).
Impairment of property, plant and equipment
      In accordance with IAS 36 “Impairment of Assets,” when events or changes in market conditions indicate that tangible or intangible assets may be impaired, such assets are reviewed in detail to determine whether their carrying value is lower than their recoverable value, which could lead to recording an impairment loss (recoverable value is the higher of its value in use and its fair value less costs to sell) (see Note 1g to our consolidated financial statements included elsewhere herein). Value in use is estimated by calculating the present value of the future cash flows expected to be derived from the asset. Fair value less costs to sell is based on the most reliable information available (market statistics, recent transactions, etc.).
      The planned closing of certain facilities, additional reductions in personnel and reductions in market outlooks have been considered impairment triggering events in prior years. No significant impairment losses were recorded in 2005 or 2004.
      When determining recoverable value of property, plant and equipment, assumptions and estimates are made, based primarily on market outlooks, obsolescence and sale or liquidation disposal values. Any change in these assumptions can have a significant effect on the recoverable amount and could lead to a revision of recorded impairment losses.

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Provision for warranty costs and other contractual obligations
      Provisions are recorded for warranties given to customers on our products or for expected losses and for penalties incurred in the event of failure to meet contractual obligations on construction contracts. These provisions are calculated based on historical return rates and warranty costs expensed as well as on estimates. These provisions and subsequent changes to the provisions are recorded in cost of sales either when revenue is recognized (provision for customer warranties) or, for construction contracts, when revenue and expenses are recognized by reference to the stage of completion of the contract activity. Costs and penalties that will be effectively paid can differ considerably from the amounts initially reserved and could therefore have a significant impact on future results.
      Provisions for contractual obligations represented 753 million at December 31, 2005, of which 173 million related to construction contracts (see Note 18 to our consolidated financial statements included elsewhere herein) (933 million and 271 million, respectively, at December 31, 2004). For further information on the impact on net income (loss) of the change in these provisions, see Notes 18 and 27 to our consolidated financial statements included elsewhere herein.
Deferred taxes
      Deferred tax assets relate primarily to tax loss carryforwards and to deductible temporary differences between reported amounts and the tax bases of assets and liabilities. The assets relating to the tax loss carryforwards are recognized if it is probable that the Group will dispose of future taxable profits against which these tax losses can be set off.
      At December 31, 2005, deferred tax assets were 1,606 million (of which 850 million related to the United States and 369 million to France). Evaluation of our capacity to utilize tax loss carryforwards relies on significant judgment. We analyze the positive and negative elements of certain economic factors that may affect our business in the foreseeable future and past events to conclude as to the probability of utilization in the future of these tax loss carry-forwards, which also consider the factors indicated in Note 1n to our consolidated financial statements included elsewhere herein. This analysis is carried out regularly in each tax jurisdiction where significant deferred tax assets are recorded.
      If future taxable results are considerably different from those forecast that support recording deferred tax assets, we will be obliged to revise downwards or upwards the amount of the deferred tax assets, which would have a significant impact on our balance sheet and net income (loss).
Pension and retirement obligations and other employee and post-employment benefit obligations
      As indicated in Note 1k to our consolidated financial statements included elsewhere herein, we participate in defined contribution and defined benefit plans for employees. Furthermore, certain other post-employment benefits, such as life insurance and health insurance (mainly in the United States), are also reserved. All these obligations are measured based on actuarial calculations relying upon assumptions, such as the discount rate, return on plan assets, future salary increases, employee turnover and mortality tables.
      These assumptions are generally updated annually. The assumptions adopted for 2005 and how they have been determined are detailed in Note 25 to our consolidated financial statements included elsewhere herein. Using the “corridor” method, only actuarial gains and losses in excess of the greater of 10% of the present value of the defined benefit obligation or 10% of the fair value of any plan assets are recognized over the expected average remaining working lives of the employees participating in the plan. In accordance with the option available under IFRS 1, cumulative actuarial gains and losses at the transition date have been recognized in shareholders’ equity. The corridor method is therefore only applied as from January 1, 2004.
      We consider that the actuarial assumptions used are appropriate and supportable but any future changes could, however, have a significant impact on the amount of such obligations and the Group’s net income (loss). An increase of 0.5% in the discount rate at December 31, 2004 (or a reduction of 0.5%) would have a positive impact on 2005 net income of 8 million (or a negative impact of 8 million on net income). An

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increase of 0.5% in the assumed rate of return on plan assets for 2005 (or a reduction of 0.5%) would have a positive impact on 2005 net income of 11 million (or a negative impact of 11 million on net income).
Revenue recognition
      As indicated in Note 1o to our consolidated financial statements included elsewhere herein, revenue is measured at the fair value of the consideration received or to be received when the company has transferred the significant risks and rewards of ownership of a product to the buyer.
      For revenues and expenses generated from construction contracts, we apply the percentage of completion method of accounting, provided certain specified conditions are met, based either on the achievement of contractually defined milestones or on costs incurred compared with total estimated costs. The determination of the stage of completion and the revenues to be recognized rely on numerous estimations based on costs incurred and acquired experience. Adjustments of initial estimates can, however, occur throughout the life of the contract, which can have significant impacts on net income (loss).
      For arrangements to sell software licenses with services, software license revenue is recognized separately from the related service revenue, provided the transaction adheres to certain criteria (as prescribed by the Statement of Practice (SOP) 97-2) of the American Institute of Certified Public Accountants, or the AICPA, such as the existence of sufficient vendor-specific objective evidence to determine the fair value of the various elements of the arrangement. Determination of the fair value of the various elements of the arrangement relies also on estimates, which, if they had to be corrected, would have an impact on revenues and net income (loss).
      For product sales made through distributors, product returns that are estimated according to contractual obligations and past sales statistics are recognized as a reduction of sales. Again, if the actual product returns were considerably different from those estimated, the resulting impact on the income statement could be significant.
      In the context of the present telecommunications market, it can be difficult to evaluate our capacity to recover receivables. Such evaluation is based on the customers’ creditworthiness and on our capacity to sell such receivables without recourse. If, subsequent to revenue recognition, the recoverability of a receivable that had been initially considered as likely becomes doubtful, a provision for an impairment loss is then recorded.
Derecognition of financial assets
      A financial asset, as defined under IAS 32 “Financial Instruments: Disclosure and Presentation,” is either totally or partially derecognized (removed from the balance sheet) when (i) we expect that no further cash flow will be generated by it, (ii) we transfer substantially all risks and rewards attached to the asset or (iii) we retain no control of the asset.
      With respect to trade receivables, a transfer without recourse in case of payment default by the debtor is regarded as a transfer of substantially all risks and rewards of ownership, thus making such receivables eligible for derecognition, on the basis that risk of late payment is considered marginal. Potential new interpretations in the future of the concept of “substantial transfer of risks and rewards” could lead us to modify our current accounting treatment.
OPERATING AND FINANCIAL REVIEW AND PROSPECTS
Overall Perspective
      Overview of 2005. The telecommunications market continued to recover in 2005, primarily as a result of an increased demand for broadband services for data transmission and voice and data services in wireless infrastructures. The wireline market, in particular, grew during the second half of 2005, driven by the transformation of carrier networks to IP and the introduction of triple play services in the network. The wireless market also continued to benefit from growth in emerging markets. The major telecommunications carriers increased their capital spending to meet this demand.

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      As a result of this improved market environment, our revenues increased by 7.3% in 2005 as compared to 2004. Excluding the impact of the currency exchange rate between the euro and the U.S. dollar and other currencies linked to the U.S. dollar, our revenues would have increased by 8.0%. For 2005, our gross margin was 35.3% and our operating margin was 9.1%, a slight decrease over 2004, reflecting competitive pricing pressure in our key markets.
      We had net income attributable to the equity holders of the parent of 930 million for 2005, even after taking into account 110 million in restructuring costs for continuing restructuring programs in France, Germany and Spain.
      For 2005 our revenues and profitability were at significantly improved levels and we ended the year with a strengthened net cash position of 1.5 billion, resulting from 0.2 billion in cash flow provided by operating activities less capital expenditures. By mid-year 2005, we had experienced a turnaround in our wireline business due to the success of our triple play strategy coupled with an acceptance by our customers of our IP carrier data products. In addition, we experienced continued expansion in our wireless business fueled by our radio multistandard product strategy and a very efficient research and development program. In 2005 our carrier business increased by over 10%, outpacing the market growth. In our private business, trends were mixed, with a weakness in our satellite business, but with momentum growing both in enterprise and in the vertical markets.
      As a result of our improved performance in 2005, our board of directors has announced that it will propose at the annual shareholders’ meeting to be held in 2006 to pay a dividend of 0.16 per ordinary share and ADS for 2005.
      Outlook for 2006. We anticipate that the carrier market will continue to grow in the mid-single digit range for the full year 2006. The wireline market should accelerate with the deployment of IP television services and the transformation of carrier networks towards IP. The wireless market growth rate will most probably slow down compared to last year and will be focused on emerging market needs and new applications across all geographical regions. Our growth rate in 2006 will depend on a favorable regulatory environment for fiber deployments, third generation deployments in China, and the rate that carrier networks transform their systems to IP. IP products and services primarily sold to non-carriers (that is, businesses and governmental and quasi-governmental entities) should continue to present opportunities, particularly those businesses and entities engaged in transport, energy and defense.
      With respect to our business, we expect that the good dynamics of year-end 2005 will continue into the first quarter of 2006, with year-over-year revenue growth above 10%. Overall, with the current limited visibility beyond mid-year, we expect a lower growth rate for the second half compared to the first half, but believe that our revenues should outpace the carrier market growth for the full year 2006.
      In terms of full year operating profitability, we anticipate a slight improvement in the operating margin for 2006, taking into account continuing competitive pressure in some markets.
Recent Events.
      On March 24, 2006, we issued a press release confirming that we are engaged in discussions with Lucent about a potential merger of equals that is intended to be priced at market. We stated that there can be no assurances that any agreement will be reached or that a transaction will be consummated, and that we will have no further comment until an agreement is reached or the discussions are terminated.
      Highlights of Transactions during 2005. On March 17, 2005, we completed the acquisition of Native Networks, Inc., a provider of optical Ethernet transport solutions, for U.S. $55 million in cash. On March 16, 2005 we sold our shareholding in Nexans, representing 15.1% of Nexans’ share capital, through a private placement. On January 26, 2005, we completed the sale of our electrical power business to Ripplewood, a U.S. private equity firm.
      On March 15, 2005, we amended our existing syndicated revolving 1.3 billion credit facility by extending the maturity date from June 2007 to June 2009 with a possible extension until 2011, eliminating

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one of the two financial covenants, reducing the cost of the facility and reducing the overall amount to 1.0 billion.
      On April 11, 2005, Moody’s upgraded to Bal from Ba3 the ratings for our long-term debt on the basis of cost savings achieved by us and our balance sheet strength.
      On July 1, 2005, we completed the merger with of our space activities with those of Finmeccanica, S.p.A., an Italian aerospace and defense company, through the creation of two sister companies. We own approximately 67%, and Alenia Spazio, a unit of Finmeccanica, owns approximately 33%, of the first company, Alcatel Alenia Space, that combines our respective industrial space activities. Finmeccanica owns approximately 67%, and we own approximately 33%, of the second company, Telespazio Holding, which combines our respective satellite operations and service activities.
      In July 2005, we exchanged our 45% shareholding in our joint venture with TCL Communication Technology Holdings Limited (see “Highlights of Transactions during 2004” below) for shares of TCL Communication, which resulted in TCL Communication owning all of the joint venture company and our owning 141,375,000 shares of TCL Communication.
      Highlights of Transactions during 2004. On December 16, 2004, we completed the acquisition of Spatial Communications Technologies, Inc. for consideration consisting of our ADSs having a value of 223 million (based on the market value of our ADSs on the date of the acquisition). Spatial develops and markets mobile switching equipment that can operate using any of the major mobile technologies and related software. Through this acquisition we can offer next-generation mobile switching equipment, thereby providing carriers with systems that can be updated relatively easily in the future. On September 17, 2004, we acquired eDial for consideration consisting of cash and ADSs having an aggregate value of 22 million (based on the market value of our ADSs on the date of the acquisition). eDial provides conferencing and related services for businesses and carriers.
      In January 2004 we completed the sale of Saft, our battery business, to Doughty Hanson, a European private equity firm, for 390 million in cash. On December 14, 2004, we sold a portion of our shareholding in Avanex in a block trade market transaction, which reduced our shareholding in this company to 19.65% of its share capital. From the date of this sale we do not treat Avanex as an equity affiliate, since we consider that we no longer exercise significant influence on the company.
      In August 2004, we formed a joint venture with TCL Communication, which was owned 55% by TCL Communication and 45% by us. We contributed cash and our mobile handset business having an approximate aggregate value of 45 million, to the joint venture and TCL contributed 55 million in cash. In July, 2004, we combined our global fiber and communication cable business with that of Draka Holding, N.V, a Dutch cable and cable systems producer, and created a new company, Draka Comteq B.V., owned 50.1% by Draka and 49.9% by us. Draka Comteq B.V. holds the global optical fiber and communication cable business previously owned by the parties.
Consolidated Results of Operations for the Year Ended December 31, 2005 Compared to the Year Ended December 31, 2004
      Revenues. Consolidated revenues increased by 7.3% to 13,135 million for 2005, primarily driven by the mobile communications segment, compared to 12,244 million for 2004. Approximately 40% of our consolidated revenues are denominated in or linked to the U.S. dollar. When we translate these revenues into euros for accounting purposes, there is an exchange rate impact based on the relative value of the U.S. dollar and the euro. During 2005, the decreases in the value of the U.S. dollar relative to the euro had a negative impact on our revenues. If there had been a constant euro/ U.S. dollar exchange rate in 2005 as compared to 2004, our consolidated revenues would have increased by approximately 8.0%. This is based on applying (i) to our sales made directly in U.S. dollars or currencies linked to U.S. dollars effected during 2005, the average exchange rate that applied in 2004, instead of the average exchange rate that applied in 2005, and (ii) to our exports (mainly from Europe) effected during 2005 which are denominated in U.S. dollars and for which we enter into hedging transactions, our average euro/ U.S. dollar hedging rate that applied in 2004. Our

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management believes that providing our investors with our consolidated net revenues in constant euro/ U.S. dollar exchange rates facilitates the comparison of the evolution of our revenues with that of the industry. The table below sets forth our revenues as reported, the conversion and hedging impact of the euro/ U.S. dollar and our revenues at a constant rate:
                         
    2005   2004   % of change
             
Revenues as reported
    13,135       12,244       7.3 %
Conversion impact euro/ U.S. dollar
    2             %
Hedging impact euro/ U.S. dollar
    78             0.7 %
Revenues at constant rate
    13,215       12,244       8.0 %
      Revenues (measured by location of subsidiary that recorded such revenues) in Europe increased to 8,784 million in 2005 from 8,125 million in 2004; revenues in North America increased to 1,930 million in 2005 from 1,814 million in 2004; revenues in Asia increased to 1,481 million in 2005 from 1,424 million in 2004; and revenues in the rest of the world increased to 940 million in 2005 from 881 million in 2004. In 2005, Europe, North America, Asia and the rest of the world accounted for 66.8%, 14.7%, 11.3% and 7.2%, respectively, of our total revenues compared with the following percentages of revenues for 2004: Europe 66.4%, North America 14.8%, Asia 11.6% and the rest of the world 7.2%.
      Gross Profit. Gross profit of 4,632 million in 2005 represented 35.3% of revenues compared to 37.7%, or 4,613 million, in 2004. The decrease in gross profit margin was primarily due to competitive pricing pressures in our carrier markets.
      Administrative and Selling Expenses. Administrative and selling expenses were 2,000 million for 2005 compared to 1,944 million in 2004. As a percentage of revenues, administrative and selling expenses were 15.2% of revenues in 2005 compared to 15.9% of revenues in 2004, decreasing despite the increase in revenues primarily due to the decrease in our fixed costs resulting from our restructuring efforts.
      Research and Development Costs. Research and development costs were 1,443 million in 2005 compared to 1,490 million in 2004. As a percentage of revenues, research and development costs amounted to 11.0% in 2005 as compared to 12.2% in 2004.
      Operating Profit (Loss). We recorded operating profit of 1,189 million for 2005 compared to 1,179 million for 2004. Operating profit as a percentage of revenues was 9.1% for 2005 compared to 9.6% in 2004. This decrease resulted from the competitive pricing environment that impacted our gross profit despite decreases in our fixed costs.
      Share-based Payments (Stock Option Plans). Share-based payments representing expensed employee stock options amounted to 69 million in 2005 compared to 60 million in 2004.
      Restructuring Costs. We recorded 110 million for restructuring costs in 2005 compared to 324 million in 2004. The restructuring costs for 2005 reflected new restructuring plans in 2004, attributable to continuing head count reductions in Germany, Spain and France. The decrease was as a result of the substantial completion of our earlier major restructurings.
      Impairment of Capitalized Development Costs. In 2005 we did not record any impairment of capitalized development costs. However, 88 million was recorded in 2004, primarily linked to our fixed communication segment.
      Gain (Loss) on Disposal of Consolidated Shares. We recorded a gain on the disposal of consolidated shares of 129 million related to the merger of our satellite activities with those of Finmecannica.
      Income (Loss) from Operating Activities. Income from operating activities amounted to 1,139 million in 2005 compared to 707 million in 2004. This increase was due primarily to a lower restructuring cost in 2005 compared to 2004, the gain in connection with the merger of our satellite activities and the absence of an impairment of capitalized development costs in 2005.

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      Finance Costs. Finance costs were 96 million in 2005 compared to 121 million in 2004 and included financial interest paid on gross financial debt of 218 million and financial interest received on cash and cash equivalents of 122 million. The decrease in financial costs was due to a decrease in our financial debt in 2005 compared to 2004 and an increase in our net cash position.
      Other Financial Income (Loss). Other financial income was 46 million in 2005 compared to 14 million in 2004. This increase was due primarily to capital gains resulting from the disposal of shares that we owned in Nexans (69 million) and Mobilrom (45 million), offset in part by the financial component of pensions, net exchange losses and impairment losses of financial assets.
      Share in Net Income (Losses) of Equity Affiliates. Share in net losses of equity affiliates was a loss of 14 million compared to a loss of 61 million in 2004. The main cause of the decrease reflected the fact that Avanex was no longer an equity affiliate in 2005 due to the sale of a portion of our shareholdings in Avanex in December 2004.
      Income Before Tax and Discontinued Operations. Income before tax and discontinued operations was 1,075 million in 2005 compared to 539 million in 2004.
      Income Tax Expense. Income tax expense was 91 million in 2005 compared to 36 million in 2004. The charge for 2005 resulted from a current income tax expense of 52 million (compared with a current income tax benefit of 82 million in 2004 mainly due to the favorable outcome of tax litigations) and from a deferred income tax charge of 39 million (compared with a deferred income tax charge of 118 million in 2004).
      Income (Loss) from Continuing Operations. Income from continuing operations was 984 million compared to 503 million in 2004.
      Income (Loss) from Discontinued Operations. Loss from discontinued operations was 13 million in 2005 principally as a result of the adjustment of the selling price of businesses sold during 2004 compared to an income of 142 million in 2004.
      Minority Interests. Minority interests were 41 million in 2005 compared to 69 million in 2004, due primarily to lower results from Alcatel Shanghai Bell.
      Net Income (Loss) Attributable to the Equity Holders of the Parent. As a result of the foregoing, we recorded net income (group share) of 930 million in 2005 compared to 576 million in 2004.
Results of Operations by Business Segment for the Year Ended December 31, 2005 Compared to the Year Ended December 31, 2004
      The table below sets forth the consolidated revenues (before elimination of inter-segment revenues, except for “Total Group” results and “Other and Eliminations”), operating profit (loss) and capital expenditures for tangible and intangible assets for each of our business segments for fiscal 2005 and for fiscal 2004.
                                           
    Fixed   Mobile   Private   Other and    
    Communications   Communications   Communications   Eliminations   Total Group
                     
Year ended December 31, 2005
                                       
 
Revenues
  5,213     4,096     3,918     (92 )   13,135  
 
Operating profit (loss)
    579       436       274       (100 )     1,189  
 
Capital expenditures for tangible and intangible assets
    160       269       140       69       638  
Year ended December 31, 2004
                                       
 
Revenues
  5,125     3,313     3,946     (140 )   12,244  
 
Operating profit (loss)
    576       418       267       (82 )     1,179  
 
Capital expenditures for tangible and intangible assets
    163       208       143       65       579  

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Fixed Communications
      Revenues of our fixed communications segment were 5,213 million for 2005, compared to 5,125 million for 2004, an increase of 1.7%. This increase was primarily due to an increase in revenues of our optical business, driven by new submarine projects, as well as sustained demand in the terrestrial metro sector coming from the preparation by our carrier customers for deployment of triple play (voice, data and video) services, and growth in our IP business that supplies products to transmit data through high bandwidth in the networks. Our fixed line voice switching business continued to decline as our customers transition to next generation networks and therefore reduce their capital expenditures for narrow band switching.
      Even though we continued to increase our line deliveries in our broadband access business (21.6 million in 2005, as compared to 19.6 million in 2004), our broadband revenues declined slightly due to substantial pricing pressures.
      Our fixed communications segment’s operating profit was 579 million for 2005, compared to 576 million in 2004. The increases in profitability from our optical and IP businesses were offset by the decline in our fixed line voice switching business, resulting in a stable level of operating profit compared to 2004.
Mobile Communications
      Revenues of our mobile communications segment were 4,096 million for 2005, compared to 3,313 million in 2004, an increase of 23.6%. This increase was primarily due to significant increases in all businesses, particularly as a result of the continuing growth of our presence in emerging countries with our 2/2.5G radio access products.
      The mobile communications segment’s operating profit was 436 million for 2005, compared to 418 million in 2004. The intensely competitive pricing environment impacted profitability in the mobile radio division.
Private Communications
      Revenues of our private communications segment were 3,918 million for 2005, compared to 3,946 million in 2004, a decrease of 0.7%. The decrease in our satellite business more than offset the growth in all other business divisions. The decline resulted from a low 2004 order backlog and some delays in the 2005 order intake in both commercial and institutional space programs.
      Our private communications segment’s operating profit was 274 million for 2005, compared to 267 million in 2004. This increase was primarily due to an increase in our transport and integration and services businesses, offset, in part, by a decline in the enterprise and satellite divisions.
Liquidity and Capital Resources
Liquidity
Cash Flow for the Years Ended December 31, 2005 and 2004.
Cash Flow Overview
      Cash and cash equivalents decreased by 101 million in 2005 to 4,510 million at December 31, 2005. This decrease was mainly due to the use of 887 million for financing activities, due primarily to the cash repayment of long term debt, including repurchased debt, that was largely offset by net cash provided by operating activities of 849 million.
      Net Cash Provided (Used) by Operating Activities. Net cash provided by operating activities before changes in working capital, interest and taxes was 984 million compared to 650 million for 2004. This increase was primarily due to our net income of 971 million in 2005 as compared with net income of 645 million in 2004. The 971 million of net income is adjusted for financial, tax and non-cash items, primarily depreciation and amortization, net gain on disposal of non-current assets, changes in fair values and

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share based payments, and adjusted further for cash outflows that had been previously reserved for (mainly for ongoing restructuring programs). The net gain on disposal of non-current assets was mainly due to a gain of 129 million related to the merger of 33% of Alcatel Space’s satellite industrial activity with that of Finmeccanica and to a gain of 114 million upon the disposal of our holdings in Nexans and Mobilrom. The cash outflows for restructuring amounted to 414 million in 2005 compared to 606 million in 2004. Net cash provided by operating activities was 849 million in 2005 compared to 58 million in 2004. These amounts take into account the cash used by the increase in operating working capital, which amounted to 198 million in 2005 and 414 million in 2004, reflecting our increased revenues as well as our expectations for revenue growth in the coming quarters.
      Net Cash Provided (Used) by Investing Activities. Net cash used by investing activities was 181 million in 2005 compared to 114 million in 2004. This increase in net cash used was mainly due to the increase in capital expenditures to 638 million in 2005 compared with 579 million in 2004. Cash proceeds from loan repayments from our customers decreased in 2005 with net proceeds of 108 million in 2005 compared with net proceeds of 569 million in 2004, due mainly to a decrease in our vendor financing activities. This decrease was more than offset by changes in shares of consolidated and non consolidated entities and marketable securities which represented net cash proceeds of 184 million in 2005 (due mainly to the merger of 33% of Alcatel Space’s satellite industrial activity with that of Finmeccanica) compared with net cash used of 321 million in 2004 (due mainly to our investments made in short term investments). Proceeds from disposal of fixed assets amounted to 165 million in 2005 compared to 217 million in 2004 due mainly to disposal of various real estate assets.
      Net Cash Provided (Used) by Financing Activities. Net cash used by financing activities amounted to 887 million in 2005 compared to net cash used of 1,251 million in 2004. The main reason for this change was the more limited use of cash to decrease our short-term and long-term debt (879 million in 2005 compared with 1,716 million in 2004), including by repurchasing debt, somewhat offset in 2004 by 462 million of proceeds from the issuance of long-term debt.
      Disposed of or discontinued operations. Disposed of or discontinued operations represented net cash used of 5 million in 2005 (mainly due to adjustments to the sale price of activities disposed of in 2004) compared with 67 million used in 2004 (of which, net proceeds of 390 million from the disposal of our battery business were more than offset by the capital contributed to the optical fiber division prior to the establishment of our joint venture with Draka and other cash payments made for discontinued operations).
Capital Resources
      Resources and Cash Flow Outlook. We derive our capital resources from a variety of sources, including the generation of positive cash flow from on-going operations, the issuance of debt and equity in various forms, and banking facilities including the revolving credit facility of 1,000 million maturing in June 2009 and on which we have not drawn (see “Syndicated Facility” below). Our ability to draw upon these resources is dependent upon a variety of factors, including our customers’ ability to make payments on outstanding accounts receivable, the perception of our credit quality by debtors and investors, our ability to meet the financial covenant for our revolving facility and debt and equity market conditions generally.
      Our short-term cash requirements are primarily related to funding our operations, including our restructuring program, capital expenditures and short-term debt repayments. We believe that our cash, cash equivalents and marketable securities, including short-term investments of 5,150 million as of December 31, 2005, are sufficient to fund our cash requirements for the next 12 months.
      During 2006 we expect to make cash outlays for our restructuring programs of approximately 250 million, and to make capital expenditures of approximately 700 million, including research and development capitalization. We also expect to repay short-term debt that will not be renewed, such as the 462 million principal amount of our 7.00% Notes due in December 2006 that were not repurchased in the exchange offer that closed in April 2005. (See “Long-term Debt” for a further discussion of the exchange offer.) In addition, our expected growth in revenues in 2006 compared to 2005 may result in additional cash requirements linked to an increase in our working capital needs. During 2006, depending upon market and

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other conditions, we intend to also continue our bond repurchase program in order to redeem our outstanding bonds with maturities within the next three years.
      We can provide no assurance that our actual cash requirements will not exceed the currently expected cash outlays. If we cannot generate sufficient cash from operations to meet cash requirements in excess of our current expectations, we might be required to obtain supplemental funds through additional operating improvements or through external sources, such as capital market proceeds (if conditions are considered favorable by us), assets sales or financing from third parties, the availability of which is dependent upon a variety of factors, as noted above.
      Credit Ratings. As of March 30, 2006, our credit ratings were as follows:
                         
Rating Agency   Long-term Debt   Short-term Debt   Outlook/Credit Watch   Last Update
                 
Standard & Poor’s
    BB       B     Negative credit watch   March 24, 2006
Moody’s
    Ba1       Not Prime     Positive outlook   April 11, 2005
      Standard & Poor’s. On March 10, 2006, Standard & Poor’s revised its outlook on us from stable to positive. However, on March 24, 2006, upon our confirming that we are engaged in discussions with Lucent about a potential merger, Standard & Poor’s removed its positive outlook on us and placed us on credit watch with negative implications, stating that if the merger goes forward, Standard & Poor’s may lower our long-term corporate credit and senior unsecured debt rating due to its view that the merged entities would present a weaker financial profile. On November 10, 2004, Standard & Poor’s upgraded our long-term corporate credit and senior unsecured debt rating to BB on the basis of our stabilized sales, adequate cost structure positioning and strong cash level, as well as healthier market conditions for the telecom equipment industry and our severe cost cutting. Standard & Poor’s outlook for us continues to be stable and it also affirmed our short-term B corporate credit rating. The rating grid of Standard & Poor’s ranges from AAA (the strongest rating) to D (the weakest rating). Our BB rating is in the BB category, which also includes BB+ and BB- ratings. Standard & Poor’s gives the following definition to the BB category: “[a]n obligation rated “BB” is less vulnerable to nonpayment than other speculative issues. However, it faces major ongoing uncertainties or exposure to adverse business, financial, or economic conditions, which could lead to the obligor’s inadequate capacity to meet its financial commitment on the obligation.”
      Moody’s. On March 24, 2006, Moody’s informed us that it had taken note of the current discussions between Lucent and us but that, given the preliminary nature of these discussions, it was not taking any rating action at this stage. On April 11, 2005, Moody’s upgraded to Bal from Ba3 the rating for our long-term debt on the basis of cost savings achieved by us and our balance sheet strength. Moody’s maintained its positive outlook. The “not prime” rating of our short-term debt was reaffirmed. The rating grid of Moody’s ranges from Aaa, which is considered to carry the smallest degree of investment risk, to C, which is the lowest rated class. Our Ba1 rating is in the Ba category, which also includes Ba2 and Ba3 ratings. Moody’s gives the following definition of its Ba category, “debt which is rated Ba is judged to have speculative elements and is subject to substantial credit risk.”
      We can provide no assurances that our credit ratings will not be lowered in the future by Standard & Poor’s, Moody’s or similar rating agencies. In addition, a security rating is not a recommendation to buy, sell or hold securities, and each rating should be evaluated separately of any other rating. Our current short-term and long-term credit ratings as well as any possible future lowering of our ratings may result in additional higher financing costs and in reduced access to the capital markets.
      Our short-term debt rating allows us a very limited access to commercial paper, and the non-French commercial paper market is generally not available to us on terms and conditions that we find acceptable.
      At December 31, 2005, our total financial debt, gross amounted to 3,798 million compared to 4,606 million at December 31, 2004.
      Short-term Debt. At December 31, 2005, we had 1,046 million of short-term financial debt outstanding, which included 462 million of 7.00% Notes due 2006 and 127 million in commercial paper,

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with the remainder representing other bank loans and lines of credit and other financial debt and accrued interest payable.
      Long-term Debt. At December 31, 2005 we had 2,752 million of long-term financial debt outstanding.
      On April 7, 2004, we closed an exchange offer for our 7.00% Notes due 2006, of which 995 million principal amount was then outstanding, for new notes of a longer maturity. The main objective of the exchange offer was to lengthen our average debt maturity. We issued 412 million principal amount of our new 6.375% Notes due 2014 in exchange for 366 million principal amount of our 7.00% Notes due 2006. We also issued and sold an additional 50 million principal amount of our new 6.375% Notes due 2014. Interest on the 6.375% Notes is payable annually.
      Rating Clauses Affecting our Debt. Our outstanding bonds do not contain clauses that would trigger an accelerated repayment in the event of a lowering of our credit ratings. However, the 1,200 million 7.00% Notes due in December 2006, of which only 462 million remains, includes a “step up rating change” clause, which provides that the interest rate will be increased by 150 basis points if our ratings fall below investment grade. This clause was triggered when our credit ratings were lowered to below investment grade status in July 2002. The 150 basis point increase in the interest rate from 7% to 8.5% became effective in December 2002, and applied to the payment of the December 2003, 2004 and 2005 coupons. This bond issue also contains a “step down rating change” clause that provides that the interest rate will be decreased by 150 basis points if our ratings move back to investment grade level. However, since the condition related to our ratings was not met before December 7, 2005, no step down ratings change will occur. Our new 6.375% Notes due 2014, which we exchanged for a portion of our 7.00% Notes due 2006, as described above, do not provide for a “step up rating change.”
      Syndicated Facility. On June 21, 2004, we closed a 1,300 million syndicated three-year revolving credit facility that replaced the then existing undrawn 1,375 million syndicated facility maturing in April 2005. On March  15, 2005, we amended this facility by extending its maturity to June 2009 (with a possible extension until 2011), reducing its amount to 1,000 million, and eliminating one of the two then applicable financial covenants.
      The availability of this syndicated revolving credit facility does not depend upon our credit ratings. At December 31, 2005, this facility had not been drawn and remained undrawn on February 1, 2006, the date our board of directors approved the 2005 financial statements. Our ability to draw on this facility is conditioned upon our compliance with certain financial covenants. Until its amendment on March 15, 2005, the facility contained two financial covenants: the first was a gearing ratio (net debt/equity including minority interests) and the second is a ratio linked to our capacity to generate cash to reimburse our debt. The March 15th amendment eliminated the gearing ratio covenant. We tested the cash-generation covenant every quarter. We were in compliance with this covenant at every quarter during 2005, including December 31, 2005 (the date of the last published financial statements); as we had cash and cash equivalents in excess of our gross financial debt at December 31, 2005, the ratio was actually not applicable at year-end. We will continue to test the cash-generation covenant quarterly. We can provide no assurance that we will remain compliant with such financial covenant in the future.

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Contractual obligations and off-balance sheet contingent commitments
      Contractual obligations. We have certain contractual obligations that extend beyond 2006. Among these obligations we have long-term debt and interest thereon, finance leases, operating leases, commitments to purchase fixed assets and other unconditional purchase obligations. Our total contractual cash obligations at December 31, 2005 for these items are presented below based upon the minimum payments we will have to make in the future under such contracts and firm commitments. Amounts related to financial debt and capital lease obligations are fully reflected in our consolidated balance sheet included in this document.
                                         
    Payment Deadline
     
    Before    
    December 31,       2011    
Contractual Payment Obligations   2006   2007-2008   2009-2010   and after   Total
                     
    (in millions)
Financial debt (excluding finance leases)
  986     468     887     1,397     3,738  
Finance lease obligations
    60                         60  
                               
Subtotal — included in our balance sheet
  1,046     468     887     1,397     3,798  
                               
Operating leases
  150       264       182       350       946  
Commitments to purchase fixed assets
    28                         28  
Finance costs on financial debt
    164       200       152       89       605  
Other unconditional purchase obligations(a)
    81       15       3             99  
                               
Subtotal — not included in our balance sheet
  423     479     337     439     1,678  
                               
Total contractual obligations
  1,469     947     1,224     1,836     5,476  
                               
 
(a)  Other unconditional purchase obligations result mainly from obligations related to multi-year equipment supply contracts linked to the sale of businesses or plants to third parties.
     Off-balance sheet commitments and contingencies. On December 31, 2005, our off-balance sheet commitments and contingencies amounted to 2,755 million, consisting primarily of 2,034 million in guarantees on long-term contracts for the supply of telecommunications equipment and services by our consolidated and un-consolidated subsidiaries. Generally we provide these guarantees to back performance bonds issued to customers through financial institutions. These performance bonds and counter-guarantees are standard industry practice and are routinely provided in long-term supply contracts. If certain events occur subsequent to our including these commitments within our off-balance sheet contingencies, such as the delay in promised delivery or claims related to an alleged failure by us to perform on our long-term contracts, or the failure by one of our customers to meet its payment obligations, we reserve the estimated risk on our consolidated balance sheet under the line items “Provisions” or “Amounts due to/from our customers on construction contracts”, or in inventory reserves. Not included in the 2,755 million of off-balance sheet commitments and contingencies is a 639 million guarantee granted to the bank implementing our cash pooling program. This guarantee covers any intraday debit position that could result from the daily transfers between our central treasury account and our subsidiaries’ accounts. Also not included in the 2,755 million is our contingent liability pursuant to the securitization of other accounts receivable and the sale of a carryback receivable described below.
      Only performance guarantees issued by us to financial institutions are presented in the table below.

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      Off-balance sheet contingent commitments (excluding our commitment to provide further customer financing, as described below) given in the normal course of business are as follows:
                 
    December 31,   December 31,
    2005   2004
         
    (In millions)
Guarantees given on contracts made by Group entities and by non-consolidated subsidiaries(1)
  2,034     1,742  
Discounted notes receivables(2)
      5  
             
Other contingent commitments(3)
  624     793  
             
Subtotal — Contingent commitments(4)
  2,658     2,540  
Secured borrowings(5)
  97     156  
             
Total off-balance sheet commitments and secured borrowings(4)
  2,755     2,696  
             
 
(1) This amount is not reduced by any amounts that may be recovered under recourse or similar provisions, guarantees received, or insurance proceeds, as explained more fully below. Of this amount, 216 million as of December 31, 2005 and 258 million as of December 31, 2004 represent undertakings we provided on contracts of non-consolidated companies.
 
(2) This contingent liability relates to our obligation pursuant to the applicable law of certain jurisdictions (mainly France) to repurchase discounted notes receivable in certain circumstances, such as if there is a payment default.
 
(3) Included in the 624 million are: 101 million of guarantees provided to tax authorities in connection with tax assessments contested by us, 3 million of commitments of our banking subsidiary, Electro Banque, to third parties providing financing to non-consolidated subsidiaries, 90 million of commitments related to leasing or sale and leaseback transactions, and 430 million of various guarantees given by certain subsidiaries in the Group. Included in the 793 million are: 90 million of guarantees provided to tax authorities in connection with tax assessments contested by us, 3 million of commitments of our banking subsidiary, Electro Banque, to third parties providing financing to non-consolidated subsidiaries, 90 million of commitments related to leasing or sale and leaseback transactions, and 610 million of various guarantees given by certain subsidiaries in the Group.
 
(4) Excluding our commitment to provide further customer financing, as described below.
 
(5) The amounts in this item represent borrowings and advance payments received which are secured through security interests or similar liens granted by us. The borrowings are reflected in the Contractual Payment Obligations table above in the line item “Financial debt (excluding capital leases).”
     The amounts of guarantees given on contracts reflected in the preceding table represent the maximum potential amounts of future payments (undiscounted) we could be required to make under current guarantees granted by us. These amounts do not reflect any amounts that may be recovered under recourse, collateralization provisions in the guarantees or guarantees given by customers for our benefit. In addition, most of the parent company guarantees and performance bonds given to our customers are insured; therefore, the estimated exposure related to the guarantees set forth in the preceding table may be reduced by insurance proceeds that we may receive in case of a claim.
      Commitments related to product warranties and pension and post-retirement benefits are not included in the preceding table. These commitments are fully reflected in our 2005 audited consolidated financial statements. Contingent liabilities arising out of litigation, arbitration or regulatory actions are not included in the preceding table either, with the exception of those linked to the guarantees given on our long-term contracts.
      Commitments related to contracts that have been cancelled or interrupted due to the default or bankruptcy of the customer are included in the above mentioned “Guarantees given on contracts made by Group entities and by non-consolidated subsidiaries” as long as the legal release of the guarantee is not obtained.
      Guarantees given on third-party long-term contracts could require us to make payments to the guaranteed party based on a non-consolidated company’s failure to perform under an agreement. The fair value of these contingent liabilities, corresponding to the premium to be received by the guarantor for issuing the guarantee, was 2 million as of December 31, 2005 (3 million as of December 31, 2004).

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      Customer Financing. Based on standard industry practice, from time to time we extend financing to our customers by granting extended payment terms, making direct loans, and providing guarantees to third-party financing sources. As of December 31, 2005, net of reserves we had provided customer financing of approximately 301 million. This amount includes 278 million of customer deferred payments and accounts receivable, and 19 million of other financial assets. In addition, we had outstanding commitments to make further direct loans or provide guarantees to financial institutions in an amount of approximately 97 million.
      More generally, as part of our business we routinely enter into long-term contracts involving significant amounts to be paid by our customers over time.
      SVF Trust Program. In 1999, we established a securitized customer financing (SVF) program arranged by Citibank, which was amended in June 2000, May 2002 and May 2003.
      In accordance with IFRS, the SVF trust was consolidated beginning January 1, 2004.
      In April 2004, as part of a reassessment of our financing requirements and credit facilities, and with a view to optimizing our financial costs, we decided to cancel this securitized program. As a result, the banks no longer have any financing commitments in this respect, and we bought back from the SVF trust all outstanding receivables at their nominal value during the second quarter of 2004. The cancellation of the program did not have a significant impact on our results and financial position.
      Sale of carryback receivable. In May 2002, we sold to a credit institution a carryback receivable with a face value of 200 million resulting from the choice to carry back tax losses from prior years. The cash received from this sale amounted to 149 million, corresponding to the discounted value of this receivable, which matures in five years. Under IFRS, the carryback receivable is not removed from the balance sheet but is reported on the asset side of the balance sheet as an “other non current asset,” at its discounted value using the discount rate applied in the sale transaction by the credit institution who purchased the receivable and as a “other long term debt” at its discounted value using the French state bonds’ discount rate, on the liability side of the balance sheet.
      We are required to indemnify the purchaser in case of any error or inaccuracy concerning the amount or nature of the carry-back receivable sold. The sale would be retroactively cancelled if future changes in law resulted in a substantial change in the rights attached to the carryback receivable sold.
      Securitization of accounts receivables. In December 2003, we entered into a further securitization program for the sale of customer receivables without recourse. Eligible receivables are sold to a special purpose vehicle, which benefits from a bank financing, and from a subordinated financing from us representing an over-collateralization determined on the basis of the risk profile of the portfolio of receivables sold. This special purpose vehicle is fully consolidated under IFRS. The receivables sold at December 31, 2005, which amounted to 61 million (82 million as of December 31, 2004), are therefore maintained in our consolidated balance sheet. At December 31, 2005, the maximum amount of bank financing that we could obtain through the sale of receivables was 150 million. The actual amount of such funding for each receivable is a percentage of the amount of the receivable and the percentage varies depending on the quality of the receivables sold. The purpose of this securitization program is to optimize the management and recovery of receivables, in addition to providing extra financing.
      Customer Credit Approval Process and Risks. We engage in a thorough credit approval process prior to providing financing to our customers or guarantees to financial institutions, which provide financing to our customers. Any significant undertakings have to be approved by a central Risk Assessment Committee, independent from our commercial departments. We continually monitor and manage the credit we have extended to our customers, and attempt to limit credit risks by, in some cases, obtaining security interests or by securitizing or transferring to banks or export credit agencies a portion of the risk associated with this financing.
      Although, as discussed above, we engage in a rigorous credit approval process and have taken actions to limit our exposure to customer credit risks, the global downturn and deterioration of the telecommunications industry through 2003 caused certain of our customers to experience financial difficulties and others to file for

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protection under the bankruptcy laws. Upon the financial failure of a customer, we realized losses on credit we extended and loans we made to our customers, on guarantees provided for our customers, losses relating to our commercial risk exposure under long-term contracts, as well as the loss of our customer’s ongoing business. If economic conditions and the telecommunications industry in particular deteriorate once again, we may in the future realize similar losses. In such a context, should additional customers fail to meet their obligations to us, we may experience reduced cash flows and losses in excess of reserves, which could materially adversely impact our results of operations and financial position.
      Capital Expenditures. We expect that our capital expenditures in 2006 will be approximately 700 million, including gross capitalization of research and development expenses. We believe that our current cash and cash equivalents, cash flows and funding arrangements provide us with adequate flexibility to meet our short-term and long-term financial obligations and to pursue our capital expenditure program as planned. We base this assessment on current and expected future economic and market conditions. Should economic and market conditions deteriorate, we may be required to engage in additional restructuring efforts and seek additional sources of capital, which may be difficult if there is no continued improvement in the market environment and given our limited ability to access the fixed income market at this point. In addition, as mentioned in “Capital Resources” above, if we do not meet the financial covenant contained in our syndicated facility, we may not be able to rely on this funding arrangement to meet our cash needs.
Qualitative and Quantitative Disclosures About Market Risk
Financial instruments
      We enter into derivative financial instruments primarily to manage our exposure to fluctuations in interest rates and foreign currency exchange rates. Our policy is not to take speculative positions. Our strategies to reduce exchange and interest rate risk have served to mitigate, but not eliminate, the positive or negative impact of exchange and interest rate fluctuations.
      Derivative financial instruments held by us at December 31, 2005 were mostly hedges of existing or future financial or commercial transactions or were related to issued debt.
      The most important part of our issued debt is in euro. Interest rate derivatives are used to convert the fixed rate debt into floating rate in order to cover the interest rate risk.
      Since we conduct commercial and industrial operations throughout the world, we are exposed to foreign currency risk, principally with respect to the U.S. dollar, but to a lesser extent with respect to the British pound and the Canadian dollar. We use derivative financial instruments to protect ourselves against fluctuations of foreign currencies which have an impact on our assets, liabilities, revenues and expenses.
      Future transactions mainly relate to firm commercial contracts and commercial bids. Firm commercial contracts and other firm commitments are hedged using forward exchange contracts, while commercial bids are hedged using mainly currency options. The duration of future transactions that are not firmly committed does not usually exceed 18 months.
Counterparty risk
      For our derivative financial instruments, we are exposed to credit risk if a counterparty defaults on its financial commitments to us. This risk is monitored on a daily basis, within strict limits based on the ratings of counterparties. The exposure of each market counterparty is calculated taking into account the nature and the duration of the transactions and the volatilities and fair value of the underlying market instruments. Counterparties are generally major international banks.
Foreign currency risk
      Derivative foreign exchange instruments are mainly used to hedge future sales denominated in non-euro currencies.

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      Since we are a net seller of non-euro currencies, the rise of the euro against these currencies would have a positive impact on the fair value of the hedges. However, most of the change in fair value of derivative financial instruments would be offset by a change in the fair value of the underlying exposure.
Interest rate risk
      In the event of an interest rate decrease, the fair value of our fixed-rate debt would increase and it would be more costly for us to repurchase it (not taking into account that an increased spread of credit reduces the value of the debt).
      In the table below, the potential change in fair value for interest rate sensitive instruments is based on a hypothetical and immediate one percent fall or rise for 2005 and 2004, in interest rates across all maturities and for all currencies. Interest rate sensitive instruments are fixed-rate, long-term debt or swaps.
                                                                 
    December 31, 2005   December 31, 2004
         
        Fair value   Fair value       Fair value   Fair value
        variation if   variation if       variation if   variation if
    Booked   Fair   rates fall   rates rise   Booked   Fair   rates fall   rates rise
    value   value   by 1%   by 1%   value   value   by 1%   by 1%
                                 
    (in millions of euros)
Assets
                                                               
Marketable securities
    641       641       0       0       549       549       0       0  
Cash and cash equivalents(1)
    4,509       4,509       0       0       4,611       4,611       0       0  
 
Liabilities(2)
                                                               
Convertible bonds
    (901 )     (1,099 )     (56 )     53       (886 )     (1,079 )     (64 )     60  
Other bonds and other financial debt
    (2,897 )     (3,042 )     (82 )     77       (3,720 )     (3,847 )     (108 )     102  
Interest rate derivative
    107       108       82       (77 )     178       178       122       (112 )
(Debt)/ Cash position
    1,459       1,117       (56 )     53       732       412       (50 )     50  
 
(1)  For bank overdrafts, the booked value is considered as a good estimation of the fair value.
 
(2)  Over 90% of our bonds have been issued with fixed rates. At year-end 2005 and 2004, the fair value of our long-term debt is higher than its booked value due to a fall in interest rates.
Assumptions and Calculations
      The fair value of the instruments in the table above is calculated with market standard financial software according to the market parameters prevailing on December 31, 2005.
Fair value hedge
      The ineffective portion of changes in fair value hedge was a loss of 9 million at December 31, 2005, compared with a loss of 2 million at December 31, 2004. We did not have any amount excluded from the measure of effectiveness. There was no impact of contract cancellation in the income statement at December 31, 2005 and 2004.
Net investment hedge
      We have stopped using investment hedges in foreign subsidiaries. At December 31, 2005 and 2004, there were no derivatives that qualified as investment hedges.
Equity risks
      We may use derivative instruments to manage the equity investments in listed companies that we hold in our portfolio. We may sell call options on shares held in our portfolio and any profit would be measured by the difference between our book value for such securities and the exercise price of the option, plus the premium received.

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      We may also use derivative instruments on Alcatel shares held in treasury. Such transactions are authorized as part of the stock buy back program approved at our shareholders’ general meeting held on May 20, 2005.
      Since April 2002, we have not had any derivative instruments in place on investments in listed companies or on Alcatel shares held in treasury.
      Additional information regarding market and credit risks, including the hedging instruments used, is provided in Note 28 to our consolidated financial statements included elsewhere herein.
Research and Development
      Expenditures. In 2005, our research and development expenditures before capitalization of development expenses totaled 1,544 million (11.8% of 2005 revenues) compared to expenditures of 1,620 million in 2004 (13.2% of 2004 revenues).
      Accounting policies. In accordance with IAS 38 “Intangible Assets,” research and development expenses are recorded as expenses in the year in which they are incurred, except for:
  development costs, which are capitalized as an intangible asset when they strictly comply with the following criteria:
  the project is clearly defined, and the costs are separately identified and reliably measured;
 
  the technical feasibility of the project is demonstrated;
 
  the intention exists to finish the project and use or sell the products created during the project;
 
  a potential market for the products created during the project exists or their usefulness, in case of internal use, is demonstrated; and
 
  adequate resources are available to complete the project.
      These development costs are amortized over the estimated useful lives of the projects concerned. Specifically for software, useful life is determined as follows:
  in case of internal use: over its probable service lifetime; and
 
  in case of external use: according to prospects for sale, rental or other forms of distribution.
      The amortization of capitalized development costs begins as soon as the product in question is released. Capitalized software development costs are those incurred during the programming, codification and testing phases. Costs incurred during the design and planning, product definition and product specification stages are accounted for as expenses.
  customer design engineering costs (recoverable amounts disbursed under the terms of contracts with customers) are included in work in progress on construction contracts.
      With regard to business combinations, we allocate a portion of the purchase price to in-process research and development projects that may be significant. As part of the process of analyzing these business combinations, we may make the decision to buy technology that has not yet been commercialized rather than develop the technology internally. Decisions of this nature consider existing opportunities for us to stay at the forefront of rapid technological advances in the telecommunications-data networking industry.
      The fair value of in-process research and development acquired in business combinations is based on present value calculations of income, an analysis of the project’s accomplishments and an evaluation of the overall contribution of the project, and the project’s risks.
      The revenue projection used to value in-process research and development is based on estimates of relevant market sizes and growth factors, expected trends in technology, and the nature and expected timing of new product introductions by us and our competitors. Future net cash flows from such projects are based on management’s estimates of such projects’ cost of sales, operating expenses and income taxes.

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      The value assigned to purchased in-process research and development is also adjusted to reflect the stage of completion, the complexity of the work completed to date, the difficulty of completing the remaining development, costs already incurred, and the projected cost to complete the projects.
      Such value is determined by discounting the net cash flows to their present value. The selection of the discount rate is based on our weighted average cost of capital, adjusted upward to reflect additional risks inherent in the development life cycle.
      Capitalized development costs considered as assets (either generated internally and capitalized or reflected in the purchase price of a business combination) are generally amortized over three to seven years.
      In accordance with IAS 36 “Impairment of Assets,” whenever events or changes in market conditions indicate a risk of impairment of intangible assets, a detailed review is carried out in order to determine whether the net carrying amount of such assets remains lower than their recoverable amount, which is defined as the greater of fair value (less costs to sell) and value in use. Value in use is measured by discounting the expected future cash flows from continuing use of the asset and its ultimate disposal.
      If the recoverable value is lower than the net carrying value, the difference between the two amounts is recorded as an impairment loss. Impairment losses for intangible assets with finite useful lives can be reversed if the recoverable value becomes higher than the net carrying value (but not exceeding the loss initially recorded).
      In August 2001, the Financial Accounting Standards Board issued SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” (“SFAS 144”). SFAS 144 supersedes SFAS No. 121, “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of,” and the accounting and reporting provisions of APB Opinion No. 30, “Reporting the Results of Operations—Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions,” for the disposal of a segment of a business. The provisions of SFAS 144 are required to be applied for fiscal years beginning after December 15, 2001.
      During the year ended December 31, 2002, we performed an assessment of the carrying values of acquired technology, booked in our consolidated statements reconciled to U.S. GAAP, pursuant to SFAS 144 in connection with the DSC Communications, Genesys, Kymata, Innovative Fibers and Newbridge acquisitions. The assessment was performed due to sustained negative economic conditions impacting our operations and expected future revenues. As a result, we recorded impairment charges of 553 million related to acquired technology to reflect, in our consolidated statements reconciled to U.S. GAAP, these assets at their current estimated fair values. The impairments represent the amount by which the carrying values of these assets exceeded their fair values.
      During the year ended December 31, 2005, no trigger events occurred that would require us to reassess the carrying values of acquired technology.
      Application of accounting policies to certain significant acquisitions. In accounting for, and reconciling under U.S. GAAP, our acquisitions of Spatial in 2004, Timetra in 2003 and Genesys and Newbridge in 2000, we allocated a significant portion of the purchase price of each acquisition to in-process research and development projects.
      Set forth below is a description of our methodology for estimating the fair value of the in-process research and development of Genesys, Newbridge, Timetra and Spatial at the time of their acquisition. We cannot give assurances that the underlying assumptions used to estimate expected project revenues, development costs or profitability, or the events associated with such projects, as described below, will take place as estimated.
      Genesys. At the acquisition date, Genesys was conducting design, development, engineering and testing activities associated with the completion of several projects related to Genesys release 6. The allocation of U.S. $100 million of the purchase price to the in-process research and development projects represented their estimated fair values using the methodology described above.

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      Newbridge. At the acquisition date, Newbridge was conducting design, development, engineering and testing activities associated with the completion of numerous projects aimed at developing next-generation technologies that were expected to address emerging market demands for the telecommunications equipment market. The allocation of U.S. $750 million of the purchase price to these in-process research and development projects represented their estimated fair value using the methodology described above. More specifically, the development, engineering and testing activities associated with the following technologies were allocated portions of the purchase price: switching and routing (U.S. $505 million) and access (U.S. $245 million).
      Timetra. At the acquisition date, Timetra was developing routers to handle data traffic at what is known as the network edge, the part of the data network that links offices, homes and other buildings to the long distance “core” network. In June 2003, Timetra introduced its first product, a family of service routers for next generation carrier networks. The allocation of U.S. $5.5 million of the purchase price to these in-process research and development projects represented their estimated fair values using the methodology described above.
      Approximately U.S. $42 million had been spent on research and development projects as the valuation date. Costs to complete the projects were estimated at approximately U.S. $9 million over 24 months following the acquisition. Management estimated that the aforementioned projects were in various stages of development and were approximately 80% complete, in the aggregate, based on development costs.
      Estimated total revenues from the acquired in-process technology are expected to peak in 2006 and 2007 and steadily decline thereafter as other new products and technologies were expected to be introduced by us.
      The estimated costs of goods sold as well as operating expenses as a percentage of revenues for Timetra were expect to be materially consistent with historical levels, primarily due to the extremely competitive nature of the industry and the need to continue to spend heavily on research and development.
      A discount rate of 35% was used for determining the value of the in-process research and development. This rate is higher than the implied weighted average cost of capital for the acquisition due to inherent uncertainties surrounding the successful development of the purchased in-process technology, the useful life of such technology, the profitability levels of such technology, and the uncertainty of technological advances that were unknown at that time. However, we believe that expenses incurred to date associated with the development and integration of the in-process research and development projects are consistent with our estimates at the time of acquisition.
      Spatial. We used the purchase method of accounting for Spatial, whereby the excess of cost over the net amounts assigned to assets acquired and liabilities assumed is allocated to goodwill and intangible assets based on their estimated fair values. Such intangible assets identified by us include U.S. $62.5 million allocated to developed technology and know how (“developed technology”) and U.S. $14.5 million allocated to in-process research and development.
      At the acquisition date, Spatial was selling its distributed mobile switching solution; a centralized call server that manages call/session control for mobile voice and data services, commonly referred to as a “softswitch.” In March 2002, Spatial introduced its Atriumtm product, the industry’s first next-generation mobile core switch that supports 2/2 5/3G GSM and CDMA networks. The allocation of U.S. $62.5 million of the purchase price to the developed technology encompassed the call server technology.
      In addition, at the time of acquisition, Spatial was developing new software functionalities that integrate UMTS (Universal Mobile Telecommunications System) and Wi-Fi technology into our wireless softswitch technology platform. It was estimated that this project had incurred approximately U.S. $4 million in costs as of the valuation date. Cost to complete the project was estimated at approximately U.S. $650,000 over four months following the acquisition. Management estimated that the project was approximately 80% complete, in the aggregate, based on development costs.

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      Estimated total revenues from the acquired developed technology and know how and in-process technology are expected to peak in 2006 and 2008, respectively, and steadily decline thereafter, as other new products and technologies are introduced by Spatial.
      The estimated costs of goods sold as well as operating expenses as a percentage of revenues for Spatial were expected to be materially consistent with historical levels, primarily due to the extremely competitive nature of the industry and the need to continue to spend heavily on research and development.
      A discount rate of 30% was used for determining the value of the in-process research and development, while a rate of 18% was employed for determining the value of the developed technology and know how. The in-process research and development rate is higher than the implied weighted average cost of capital for the acquisition due to inherent uncertainties surrounding the successful development of the purchased in-process technology, the useful life of such technology, the profitability levels of such technology, and the uncertainty of technological advances that were unknown at that time.
Main Areas affected by the Change from French GAAP to IFRS
      The principal areas that have been affected by the change from French GAAP to IFRS are described below.
Property, plant and equipment
      The application of IAS (International Accounting Standard) 16 (Property, Plant and Equipment) and IAS 36 (Impairment of Assets) did not have a significant impact on our financial statements prepared in accordance with IFRS. We elected not to choose the option provided by IFRS 1 (First-time Adoption of IFRS) that allows certain property, plant and equipment to be recorded at fair value in the opening balance sheet. Furthermore, the rules governing depreciation methods (determination of the estimated useful life of the asset, inclusion of residual values and related matters) are either already applied by us or did not have a major impact on our opening balance sheet. Marine vessels represent the main category of our property, plant and equipment that required restatement in order to comply with IFRS.
      The application of IAS 36 did not have a major impact on us with respect to impairment losses. We performed impairment tests of our property, plant and equipment in 2002, 2003 and 2004, using methods comparable to those required by IFRS, and, as a result, significant impairments had been recognized.
      Our fixed assets used in the context of financial leasing contracts were already recognized as assets in our consolidated financial statements prepared in accordance with French GAAP in accordance with the criteria defined in IAS 17 (Leases) and we do not own any significant property within the scope of IAS 40 (Investment Property).
      Fixed assets to be sold, as defined in IFRS 5 (Non-current Assets Held for Sale and Discontinued Operations), are recorded as non-current assets and are no longer depreciated. This change did not have a significant impact on our 2004 consolidated net income remeasured under IFRS and did not have a significant impact on our 2005 consolidated net income.
Construction contracts
      The principles of IAS 11 (Construction Contracts) are very close to those already used under French GAAP to account for construction contracts (or long-term contracts). In particular, the percentage of completion method of accounting that we applied to our French GAAP 2004 consolidated financial statements complies with IAS 11. Contract segmentation and combination rules under IFRS are also very close to the accounting principles we used under French GAAP. The methods for recognizing reserves for penalties (changes are recorded in contract revenues under IFRS but in contract costs in our French GAAP 2004 consolidated financial statements), and accounting for the financial impact on net sales of deferred payments when they are material, has a limited effect on the presentation of our income statement and no effect on either our gross profit or our opening shareholders’ equity using IFRS.

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      The presentation of assets and liabilities related to construction contracts under specific balance sheet captions, and the application of specific offset rules as required by IAS 11, reduced our working capital due to the fact that certain reserves for product sales were presented as a deduction of this amount under French GAAP.
Research and development costs
      Under French GAAP, research and development costs were generally expensed, with the exception of certain software development costs. The application of the principles defined in IAS 38 (Intangible Assets) required us to capitalize a part of the development costs. This increased significantly the intangible assets and shareholders’ equity in our January 1, 2004 opening balance sheet prepared in accordance with IFRS. However, full retroactive application of this standard was not possible due to the lack of prior period information; under IAS 38, availability of such information would have enabled us to meet the eligibility criteria for the capitalization of certain expenditures.
      Assuming a constant volume of research work, the capitalization of certain development costs in accordance with IAS 38 should not have a material impact on our net income. For two or three years starting in 2005, this capitalization will have a positive impact, which will gradually dissipate. The impact on our capitalization is presented in our IFRS consolidated financial statements under a specific income statement caption, “Impact of capitalization of development expenses,” to better isolate the ramp-up effect of the capitalization of development costs.
Convertible bonds or notes mandatorily redeemable for shares
      The convertible bonds (OCEANE) and notes mandatorily redeemable for shares (ORANE) issued by us in 2002 and 2003 are compound financial instruments (according to IAS 32) that include a debt component and an equity component. The first-time adoption of IFRS has the effect of recording all of these notes and a part of these convertible bonds as of January 1, 2004 in shareholders’ equity and part of the convertible bonds (OCEANE) in financial debt. Under French GAAP, the notes mandatorily redeemable for shares (ORANE) were recorded in other equity and the convertible bonds (OCEANE) were recorded primarily as financial debt, and a lesser portion was recorded in shareholders’ equity.
      The IFRS standard has both a positive and a negative effect on the future level of financial expense due, on the one hand, to accounting for prepaid expenses in shareholders’ equity as of January 1, 2004 (ORANE) and, on the other hand, to accreting the debt component and increasing financial expense (OCEANE).
Goodwill and business combinations
      In connection with major stock-for-stock acquisitions in the past, we used the special exemption provided by paragraph 215 of Regulation 99-02 adopted by the “Comité de la Réglementation Comptable,” which permits the difference between the purchase price of the business acquired and the corresponding share of net assets to be recorded directly in our shareholders’ equity.
      Insofar as we have elected to adopt the IFRS 1 option not to restate business combinations that do not comply with IFRS 3 (Business Combinations) and which occurred prior to January 1, 2004, first-time adoption of IFRS did not result in any changes to the accounting methods previously applied.
      In addition, for business combinations prior to January 1, 2004, regardless of the accounting method used, the review of assets and liabilities recorded in the context of these combinations and the analysis of their compliance with IFRS accounting principles had no material impact on our shareholders’ equity, with the exception of the accounting treatment of stock options existing in the acquired company on the date of acquisition. Provision was made under French GAAP based on the intrinsic value of these items, a treatment that does not comply with the IFRS 2 (Share-based Payment) and IFRS 3 rules.
      Other acquired assets and liabilities, in particular intangible assets recorded in our French GAAP 2004 consolidated financial statements resulting from business combinations, were generally in compliance with

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IFRS. We did not identify any significant unrecorded intangible assets that should have been recorded in accordance with IFRS, other than the goodwill in the business combinations.
      With respect to goodwill recorded as of December 31, 2003, the application of an impairment test based on the criteria defined in IAS 36 did not result in any significant impairment loss in the opening balance sheet. Starting January 1, 2004, goodwill is no longer amortized but is tested for impairment annually.
Financial instruments
      Under IFRS, financial assets available for sale (as defined in IAS 39) are recorded at fair value in the 2004 IFRS opening balance sheet. For listed securities, the restatement consisted of recording, in opening shareholders’ equity, the difference between the carrying value and the market value, net of any possible deferred tax impacts. Since we own some listed securities, and because we valued marketable securities at the lower of cost and market value in our French GAAP 2004 consolidated financial statements, the impact on shareholders’ equity in IFRS is positive.
      With respect to customer receivables sold without recourse (see Note 15 to our French GAAP 2004 consolidated financial statements), the “derecognition” (that is, the transfer) of these receivables from our balance sheet under French GAAP did not result in a significant restatement upon transition to IFRS, insofar as we considered that, for trade receivables sold without recourse, in case of non-payment, substantially all of the risks and rewards associated with the asset had been effectively transferred to the buyer.
      In accordance with the provisions of IAS 39 on financial instruments (which we have chosen to apply starting January 1, 2004), derivatives are recorded at fair value in the balance sheet.
      Most of our interest rate derivatives are fair value hedges, and the changes in their value were largely offset in income by revaluations of the underlying debt.
      We use currency derivatives to hedge future cash flows, firm commitments and commercial bids.
      Derivatives used to hedge firm commitments are treated as fair value hedges.
      In addition, from April 1, 2005 onwards, we identify and document highly probable future streams of revenue with respect to which we enter into hedge transactions. The corresponding derivatives are eligible for cash flow hedge accounting. Changes in fair value of the effective part of these financial instruments are recognized directly in equity and reclassified in profit or loss (cost of sales) in the same period during which the hedged revenue is accounted for; the ineffective part is recorded in financial income (expense).
      Derivatives related to commercial bids are not considered as eligible for hedge accounting and are accounted for as trading financial instruments. Changes in fair values of such instruments are therefore included in the income statement in the cost of sales (in the business segment “other”).
Retirement and other employee benefits
      The methods for determining pensions and other post-employment benefits, as described in Notes 1(i) and 24 to our French GAAP 2004 consolidated financial statements, were in compliance with IAS 19 (Employee Benefits), insofar as we have applied, starting January 1, 2004, recommendation 2003-R01 of the “Conseil National de la Comptabilité” (the “CNC”). The impact of applying this recommendation as of January 1, 2004, particularly on shareholders’ equity, was presented in Note 24 to our French GAAP 2004 consolidated financial statements.
Share-based payment
      The application of IFRS 2 (Share-based Payment) modifies the method of accounting for stock options granted to our employees. Only stock option plans established after November 2002, and whose stock options had not yet vested at December 31, 2004, have been restated. This affects our 2003 and 2004 plans and the plans resulting from business combinations completed after November 2002, under which the stock options had not yet vested at December 31, 2004. We decided not to adopt the full retroactive application option

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provided for in this standard, since the fair values of the stock options granted in the past had not been published and the method of valuing the stock options for determining the pro forma income per share in accordance with U.S. GAAP is not identical to that adopted for the application of IFRS 2.
      The impact on 2004 net income, restated in accordance with IFRS, corresponds to the allocation of the fair value over the vesting period of the stock options granted that fall within the scope of IFRS 2. This impact is presented under a specific income statement caption, “Share-based payment (Stock Option Plans”), in our IFRS income statement.
      Since the compensation expense does not result in an outflow of cash and since the counter-entry to the expense is recorded in consolidated reserves, the application of this standard had no impact on IFRS shareholders’ equity.
Off-balance sheet commitments and “derecognition” (that is, transfer) of financial assets and liabilities
      The accounting of our off-balance sheet commitments under French GAAP are described in Note 31 to our French GAAP 2004 consolidated financial statements. On December 31, 2003, we participated in two structured securitization programs (the SVF program and a customer receivable securitization program), described in Note 31 to our French GAAP 2004 consolidated financial statements. The special purpose vehicle used in the SVF program was consolidated as of January 1, 2004, following changes in French accounting regulations as indicated in Note 31 to our French GAAP 2004 consolidated financial statements. The impact on the IFRS 2004 opening balance sheet is described in Note 38 IV E of our 2005 consolidated financial statements. The special purpose entity used in the customer receivables securitization program was already consolidated at December 31, 2003 and the application of IFRS to this program, therefore, had no impact on our IFRS consolidated financial statements. In addition, the carryback receivable sold in 2002, as explained in Note 31 to our French GAAP 2004 consolidated financial statements, is recorded as an asset at discounted value in the IFRS opening balance sheet, as security for the corresponding financial liability that results from the consideration received.
Reserves for restructuring and other liabilities
      We applied CNC regulation 00-06 to liabilities since January 1, 2002 in our French GAAP consolidated financial statements. Since this regulation is very similar to IAS 37 (Provisions, Contingent Liabilities and Contingent Assets), IAS 37 did not have any material impact on our IFRS 2004 opening balance sheet.
Presentation of financial statements
      The application of IAS 1 (as revised in December 2003) and, to a lesser extent, the application of IAS 7 (Cash Flow Statements), IAS 14 (Segment Reporting) and IFRS 5 (Non-current Assets Held for Sale and Discontinued Operations) had significant consequences on the manner of presenting our financial information.
      IFRS requires a distinction to be made between current and non-current items in the balance sheet, which is different from the past French GAAP presentation that was based on the type and/or liquidity of assets and liabilities. In addition, certain specific rules governing the offsetting of assets and liabilities (for example, certain reserves for product sales relating to construction contracts that have to be deducted from contract assets) result in reclassifications compared to previous practice.
      The removal of the concept of extraordinary income or loss in IFRS resulted in the reclassification in income from operating activities and/or financial income of certain revenues and expenses recorded under French GAAP by us in other revenue/expense (see Notes 1m, n, o and Note 7 to our French GAAP 2004 consolidated financial statements). The extent of the changes in presentation is such that we have made specific comments in our reconciliation schedules (see Note 38 to our 2005 consolidated financial statements).
Other standards
      The other requirements of IFRS do not call for any specific comment, and we had no major impact on our IFRS opening balance sheet as a result of applying these other standards. This is the case for IAS 2

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(Inventories), IAS 12 (Income Taxes), IAS 18 (Revenue), IAS 20 (Accounting for Government Grants and Disclosure of Government Assistance), IAS 21 (Effects of Changes in Foreign Exchange Rates), IAS 23 (Borrowing Costs), IAS 27 (Consolidated and Separate Financial Statements), IAS 28 (Investments in Associates), IAS 29 (Financial Reporting in Hyperinflationary Economies), and IAS 31 (Interests in Joint Ventures). Moreover, we had previously applied some International Accounting Standards under French GAAP, notably IAS 19 (Employee Benefits), IAS 33 (Earnings Per Share), and IAS 24 (Related Party Disclosures).
      A more extensive description of our accounting policies applied is given in Note 1 to our 2005 consolidated financial statements, and the reconciliation between 2004 consolidated financial statements under IFRS and French GAAP is set forth in Note 38 to our 2005 consolidated financial statements.
Exemptions to IFRS
      As a first time adopter of IFRS, we have elected some exemptions to IFRS as permitted by IFRS 1, section 13. These exemptions are described below.
Business combinations
      We elected not to apply IFRS 3 (Business Combinations) retrospectively for all business combinations that occurred before the date of transition (January 1, 2004).
      As indicated in the section “Changes in Accounting Standards as of January 1, 2005 — Goodwill and business combinations” and in Note 12 to our 2005 consolidated financial statements, major past business combinations were accounted for using the French “pooling of interest method,” instead of the purchase accounting method as prescribed by IFRS 3. These business combinations were not restated in our IFRS consolidated financial statements.
      If we had restated past business combinations to comply with IFRS 3, shareholders’ equity and the amount of goodwill under IFRS as of January 1, 2004 would have been materially greater. We estimate that the impact would have been comparable to the adjustment between French GAAP and U.S. GAAP consolidated financial statements as of December 31, 2003 as described and valued in Notes 37(a) and 38(b) to our French GAAP 2004 consolidated financial statements.
Employee benefits
      We elected to recognize all cumulative actuarial gains and losses at the date of transition to IFRS (January 1, 2004) for all employee benefit plans, but we elected to use the “corridor” approach for actuarial gains and losses arising beginning January 1, 2004 in our IFRS consolidated financial statements. Taking into account that in the long term actuarial gains and losses may offset one another, the applicable IAS standard permits an entity to leave some actuarial gains and losses within a range (or “corridor”) around the best estimate of post-employment benefit obligations unrecognized.
      The impact of this election on our shareholders’ equity at the date of transition to IFRS, as indicated in Note 38 to our 2005 consolidated financial statements included elsewhere herein, was negative amount of approximately 200 million. The estimated impact on 2004 net income was comparable to the adjustment between French GAAP and U.S. GAAP consolidated financial statements as of December 31, 2004, as described and valued in Notes 37(d) and 38(a) to our French GAAP 2004 consolidated financial statements.
Cumulative translation differences
      We elected the exemption related to cumulative translation differences. As indicated in IFRS 1 paragraph 22:
      “If a first-time adopter uses this exemption:
  (a)  the cumulative translation differences for all foreign operations are deemed to be zero at the date of transition to IFRSs; and

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  (b)  the gain or loss on a subsequent disposal of any foreign operation shall exclude translation differences that arose before the date of transition to IFRSs and shall include later translation differences.”
This exemption had no impact on shareholders’ equity at the date of transition to IFRS and no material impact on 2004 net income as no material disposals of foreign operations were accounted for during the 2004 fiscal year.
Compound financial instruments
      We elected the exemption related to compound financial instruments as permitted by IFRS 1 paragraph 23. Therefore, the two portions in equity (the portion related to the cumulated interests accreted on the liability component, and the portion related to the original equity component) of our ORANE (notes mandatorily redeemable for shares) have not been separated, as the liability component was no longer outstanding at the transition date. A description of the IFRS accounting treatment of compound financial instruments is set forth in Note 38 — IV B to our 2005 consolidated financial statements included elsewhere herein.
      We did not elect any other exemption to IFRS.
Item 6. Directors, Senior Management and Employees
      In accordance with French company law governing a société anonyme, our business is managed by our board of directors and by our Chairman and Chief Executive Officer.
Board of Directors
      The following table sets forth, as of March 31, 2006, the following information for each of our directors: name, age, year of election to the board, year in which the term on the board expires, principal business activities performed outside of Alcatel (including other principal directorships) and the number of Alcatel securities owned.
                                 
        Year   Year        
        Initially   Term   Principal Business Activities   Number of
Name   Age   Appointed   Expires   Outside of Alcatel   Securities Held
                     
Serge Tchuruk
    68       1995       2007     Director of Thales and Total; Member of the Board of Directors of the Ecole Polytechnique, Chairman of Alcatel USA Holdings Corp., and Member of the Supervisory Board of Alcatel Deutschland GmbH   236,150 ordinary shares
209 FCP 3A(1)
 
Daniel Bernard
    60       1997       2007     Director of Saint-Gobain and Cap Gemini; Chairman of Provestis   141,125 ordinary shares
 
Philippe Bissara
    64       1997       2008     Honorary Managing Director of ANSA (National Association of Limited Liability Companies); Honorary instructing judge at the Conseil d’État (the highest administrative court of France); Member of the Académie de Comptabilité; Member of the Board of Directors of the French branch of the International Fiscal Association   53,645 ordinary shares
4,469 FCP 3A(1)
 
W. Frank Blount
    67       1999       2008     Chairman and CEO of JI Ventures Inc. and TTS Management Corp.; Director of Entergy Corporation, Caterpillar Inc., Adtran Inc. and Hanson Plc   1,000 ADSs
 
Jozef Cornu
    61       2000       2008     Chairman of Alcatel Bell NV and Tijd NV; Director of Alcatel CIT; Member of the Supervisory Board of Alcatel SEL AG; Director of Taiwan International Standard Electronics Ltd, Barco, KBC, Agfa Gevaert and Arinsa International; Chairman of the Information Society Technologies Group of the European Commission   20,500 ordinary shares
1,734 FCP 3A
 
Jean-Pierre Halbron
    69       1999       2008     Director of Electro Banque; Chairman of the Alcatel Ethics Committee   18,670 ordinary shares
1,969 FCP 3A

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        Year   Year        
        Initially   Term   Principal Business Activities   Number of
Name   Age   Appointed   Expires   Outside of Alcatel   Securities Held
                     
David Johnston
    64       2001       2009     President of the University of Waterloo (Canada); Director of CGI, Masco and Sustainable Development Technology Foundation   3,336 ordinary shares
 
Daniel Lebègue
    62       2003       2007     Director of Crédit Agricole SA, Scor and Technip; Member of the Supervisory Board of Areva; Chairman of the Institut Français des Administrateurs, Transparency International (France) and the Institut d’Études Politiques (Lyon)   500 ordinary shares
 
Pierre-Louis Lions
    49       1996       2009     Professor at the Collège de France and the Ecole Polytechnique; Chairman of the Conseil Scientifique d’EDF, the CEA-DAM and of France Telecom, Member of the Académie des technologies, the Académie des sciences, the Conseil Scientifique de la Défense, the Société de mathématique de France, and the Société de mathématiques appliquées et industrielles; consultant to EADS — Launch Vehicles, Paribas et CAI; Director of the Sark Fund; Member of the American Mathematical Society, the European Mathematical Society, the International Association in Mathematical Physics, the Istituto Lombardo, the Academia Europea and the Acad. Naz. Lincei   520 ordinary shares
 
Thierry de Loppinot
    62       1997       2006     Legal counsel at Alcatel’s Head Office; Chairman of the Supervisory Board of the “Actionnariat Alcatel” Unit Trust (FCP 3A); Chairman of Formalec   6,091 ordinary shares
4,901 FCP3A
 
Peter Mihatsch
    65       2002       2008     Chairman of the Supervisory Board of Giesecke and Devrient; Member of the Supervisory Board of Vodafone GmbH, Vodafone-Mobilfunk, ARCOR-Vodafone, and Rheinmetal AG; Board Member of 3i p.l.c.   1,200 ordinary shares
 
Bruno Vaillant
    62       1997       2006     Engineer at Alcatel Alenia Space (Information Systems Division); Member of the Supervisory Board of the “Actionnariat Alcatel” Unit Trust (FCP 3A); Expert at the Toulouse Court of Appeal; Vice President of the Compagnie des Experts-judiciaires près la Cour d’Appel et du Tribunal Administratif de Toulouse   1,850 ordinary shares
5,349 FCP 3A
 
Marc Viénot
    77       1987       2007     Honorary Chairman and Director of Société Générale; Member of the Supervisory Board of Groupe Barrière; Director of Société Générale Marocaine de Banque and of Ciments Français; Member of the Board of the Association Française des Entreprises Privées   4,950 ordinary shares
 
(1) FCP 3A is the unit trust of our employees governed by Article 20 of French law dated December 23, 1988. Our articles of association and bylaws require that two members of our board be employed by us, and that they participate in a FCP at the time of their appointment to our board and during their terms of office as directors.

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     The following table sets forth the amount of compensation paid by us during 2005 to each of the individuals who were, during 2005, members of our board of directors, in connection with such person’s service as a director and, if applicable, an executive of Alcatel.
         
Director   Amount
     
Daniel Bernard
  66,604  
Philippe Bissara
    40,884  
Frank Blount
    49,524  
Jozef Cornu
    44,606  
Jean-Pierre Halbron
    44,606  
David Johnston
    44,606  
Daniel Lebègue
    60,489  
Pierre-Louis Lions
    50,720  
Thierry de Loppinot(1)
    146,953  
Peter Mihatsch
    45,802  
Serge Tchuruk(2)
    2,848,483  
Bruno Vaillant(3)
    129,030  
Marc Viénot
    62,948  
Philippe Germond(4)
    5,066,206  
 
(1) 102,347 of this amount consisted of Mr. de Loppinot’s salary and the remainder consisted of director’s fees.
 
(2) 2,839,363 of this amount consisted of Mr. Tchuruk’s salary (of which 1,314,873 was a bonus) and the remainder consisted of benefits in kind.
 
(3) 84,425 of this amount consisted of Mr. Vaillant’s salary and the remainder consisted of director’s fees.
 
(4) 1,958,334 of this amount consisted of Mr. Germond’s salary (of which 1,543,750 was a bonus with respect to the fiscal years 2004 and (pro rata) 2005), 3,105,017 consisted of his termination payment and accrued vacation payable upon termination, and the remainder consisted of benefits in kind. Mr. Germond ceased to be President, Chief Operating Officer and a director on April 19, 2005.
     The amount of directors’ fees paid for 2005 totaled 600,000. A portion of the directors’ fees is distributed equally among all directors and a portion is distributed among the members of the board based on the number of board and committee meetings and on attendance at such meetings by the directors. Mr. Tchuruk does not receive directors’ fees from our company.
      In February 2003, in view of the corporate governance requirements or recommendations contained in the Sarbanes-Oxley Act of 2002, in The New York Stock Exchange’s then proposed revised listing standards and in the AFEP-MEDEF report (a French report relating to corporate governance standards), our board of directors modified its charter and adopted internal regulations governing our board of directors’ functions and the conduct of our directors. In accordance with the provisions of this charter and internal regulations, our board of directors regularly considers the functions of the board and the independence of its members.
      At its meeting held on March 30, 2006, our board of directors evaluated the independence of its members and determined that eight of its members (which represents more than half of the members of the board) are independent under the independence criteria set by the board and those set by The New York Stock Exchange. Such members are Messrs. Bernard, Bissara, Blount, Johnston, Lebègue, Lions, Mihatsch and Viénot.

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Senior Management
      The table below sets forth, as of March 31, 2006, the following information for each of our senior executives: name, age, current position with our company and the year in which such person was appointed a member of our Alcatel executive committee.
             
Name   Age   Current Position and Year Appointed to Executive Committee
         
Serge Tchuruk
    68     Chairman and Chief Executive Officer (1995)
Mike Quigley
    53     President and Chief Operating Officer (2001)
Jean-Pascal Beaufret
    55     Chief Financial Officer (2002)
Jacques Dunogué
    55     Executive Vice President of Alcatel and President of Alcatel Europe and South (2002)
Etienne Fouques
    57     Executive Vice President of Alcatel and President of Mobile Communications Group (2001)
Olivier Houssin
    53     Executive Vice President of Alcatel and President of Private Communications Group (2000)
Claire Pedini
    40     Senior Vice President of Alcatel and Corporate Human Resources (2005)
Christian Reinaudo
    51     Executive Vice President of Alcatel and President of Alcatel Asia-Pacific (2000)
      There are no family relationships between any director and senior executive. No director or senior executive was elected or appointed as a result of any arrangement or understanding with any third party. At December 31, 2005, none of our senior executives owned more than one percent of the total outstanding number of our ordinary shares.
Compensation
      For the year ended December 31, 2005, the aggregate amount of compensation, including benefits, that we paid to those persons who were senior executives on December 31, 2005 as a group, for services in all capacities, was 14 million. The compensation for senior executives consists of both a base salary and a bonus, which is determined based partly on our performance and partly on the executive’s performance, pursuant to criteria reviewed by the nominating and compensation committee. For 2005, the bonus was based on our revenues, our net income and our working capital needs for 2004. Of the total compensation paid to our senior executives in 2005, 7.2 million was paid in base salary and 6.8 million was paid in bonus, which represents 48.6% of their total salary. Non-recurring compensation paid to retiring or departing executives totaled 5.3 million in 2005. Directors’ fees that senior executives receive from various companies as a result of their employment with us are deducted from their salary. Our directors and senior executives exercised 37,186 stock options in 2005 at an average price of 6.77 per ordinary share.
      In 2005, Mr. Tchuruk was paid a base salary of 1,524,490. This amount has remained unchanged since 2000. A bonus of 1,314,873 was paid to Mr. Tchuruk in 2005 with respect to our 2004 fiscal year. Generally, Mr. Tchuruk’s bonus for each fiscal year is set by the board of directors upon a recommendation of the nomination and compensation committee. Such bonus is determined in accordance with a method that is reviewed each year by the board of directors and that takes into account the prospects of growth and prospective results of our Group for the following fiscal year. Mr. Tchuruk’s bonus is paid during the fiscal year following the fiscal year to which the bonus relates, after approval by the shareholders of the financial statements of our Group for the preceding fiscal year.
      At its meeting held on March 10, 2005, our board of directors decided that, in order to determine the amount of the bonus for fiscal year 2005, it would refer to the same criteria as those referred to in setting the amount of the bonus for fiscal year 2004: consolidated net income before goodwill amortization and minority interests.
      At its meeting held on March 30, 2006, our board of directors therefore set the amount of the bonus to be paid to Mr. Tchuruk in 2006 with respect to the 2005 fiscal year at 1,105,255, which represents 72.5% of

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the fixed compensation received by Mr. Tchuruk for the 2005 fiscal year. This is compared to his bonus of 1,314,873 for the 2004 fiscal year, which represented 86.25% of the fixed compensation received for that year.
      Our board of directors further decided that, in order to determine the amount of Mr. Tchuruk’s bonus for fiscal year 2006 to be paid in 2007, it will refer to the criteria to be applied to all of our executives, that is, 30% by reference to our consolidated revenues, 40% by reference to our net income attributable to the equity holders of the parent, and 30% by reference to our free cash flow, proportionately on the basis of the time spent as our Chief Executive Officer in 2006.
      Pursuant to his request, Mr. Tchuruk did not receive any options under the stock option plans approved by our board of directors in March 2005 and in March 2006. Mr. Tchuruk invested the full amount of the net bonus paid to him in 2005 for fiscal year 2004 in Alcatel ordinary shares, acquiring 130,700 shares in the stock market in June 2005 for total consideration of 1,201,050.
      Upon ceasing to be our Chairman and Chief Executive Officer, and consistent with the terms agreed upon his nomination, Mr. Tchuruk will be entitled to receive a termination payment equal to twice the average of his two highest total annual remunerations during the last five years and will be entitled to retirement benefits under the terms of a plan covering approximately 80 executives of the Group. Due to the benefits Mr. Tchuruk accrued pursuant to this plan, as well as the benefits he accrued prior to his employment with the Group, we will not need to make any payments pursuant to the guarantee that our board of directors gave Mr. Tchuruk that his retirement benefits would equal, on an annual basis, 40% of the average of his two highest total annual remunerations during the five years preceding his ceasing to be our Chairman and Chief Executive Officer.
      The board of directors met on April 19, 2005 and authorized, upon the recommendation of the nomination and compensation committee, the execution of an agreement between us and Mr. Germond concerning the cessation of his responsibilities as the Group’s President and Chief Operating Officer. The main provisions of this agreement clarified the contractual obligations of Mr. Germond and of the Group due to Mr. Germond’s departure in the first half of the year. It determined the actual amount of the termination payment owed to Mr. Germond, calculated pursuant to the terms of his employment contract as executed upon his joining the Group, such amount being 3,000,000. The agreement also reduced the notice period for termination to three months, and set his bonus compensation for the 2005 fiscal year, pro rata to his departure date, at 250,000.
      The aggregate amount of the benefit obligation related to pension, retirement or similar benefits for our directors listed in the table under the heading “Board of Directors” above and our senior executives listed in the table under the heading “Senior Management” above, as a group, as of December 31, 2005, was approximately 57.4 million. The corresponding amount of pension reserve accounted for, taking into account plan assets and unrecognized actuarial loss/gain amounted to 33.4 million as of December 31, 2005.
Committees of the Board
      In February 2003, in light of the corporate governance requirements or recommendations contained in the Sarbanes-Oxley Act of 2002, in The New York Stock Exchange proposed revised listing standards and in the French AFEP-MEDEF report, our board of directors adopted charters governing our audit committee, nomination and compensation committee and strategy planning committee.
Audit Committee
      Currently, the audit committee consists of three members: Daniel Lebègue, chairman of the committee (served since 2003), Marc Viénot (served since 1995) and Daniel Bernard (served since 1997). Our board has determined that each of the members of the audit committee is “independent” under the applicable rules promulgated by the Securities and Exchange Commission and by The New York Stock Exchange. The audit committee reviews all subjects of an accounting or financial nature (including closing of the financial statements, relevance of accounting methods and review of internal audit procedures and plans and external auditors’ independence and fees) and issues opinions on the renewal or appointment of auditors. For more

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information regarding the audit committee’s policies and procedures for the appointment of outside auditors, see Item 16C. — “Principal Accounting Fees and Services.”
Nomination and Compensation Committee
      The board of directors established the nomination and compensation committee on July 25, 2001. Currently, the nomination and compensation committee consists of three members: Daniel Bernard, chairman of the committee, Philippe Bissara and Frank Blount. Our board of directors has determined that each of the members of the nomination and compensation committee is “independent” as such term is defined under the applicable rules of The New York Stock Exchange. Serge Tchuruk may attend and participate in the meetings of the nomination and compensation committee, but may not be present at any deliberation of the committee that concern him. The nomination and compensation committee is responsible for studying issues related to the composition, organization, and operation of the board of directors and its committees. It also determines procedures governing the nomination of directors and the evaluation of their performance. In addition, the nomination and compensation committee advises the board of directors on issues related to the compensation of corporate officers, including compensation of the Chairman, stock purchase and stock option plans and capital increases reserved for employees.
Strategic Planning Committee
      The board of directors has a strategic planning committee that currently consists of three members: Serge Tchuruk, chairman of the committee, Pierre-Louis Lions and Peter Mihatsch. Our board of directors has determined that Mr. Lions and Mr. Mihatsch are “independent” as such term is defined under the applicable rules of The New York Stock Exchange. The strategic planning committee is responsible for considering our strategic orientation, identifying investment opportunities and monitoring our performance.
Statement on Business Practices, Ethics Committee, Code of Ethics and Chief Compliance Officer
      Our statement on business practices, adopted in 1997 and revised in 2003, is a code of conduct that defines our vision of appropriate business behavior. It covers many areas, from business ethics and corporate governance to human rights and environmental concerns. Our statement on business practices provides that our policy is to conduct our worldwide operations in accordance with the highest business ethical considerations, to comply with the laws of the countries in which we operate and to conform to locally accepted standards of good corporate citizenship.
      We have established an ethics committee to enforce our statement on business practices. The ethics committee is chaired by Jean-Pierre Halbron, and it includes members of our management. The ethics committee reports to our Chairman and Chief Executive Officer.
      In addition, in 2004, our board of directors adopted a code of ethics that applies to our Chief Executive Officer, President, Chief Operating Officer, Chief Financial Officer and Corporate Controller.
      In the beginning of 2006, we created the position of Chief Compliance Officer. The Chief Compliance Officer is charged with overseeing regulatory compliance according to international laws and standards and our corporate governance and business practices. The Chief Compliance Officer is a member of our Ethics Committee and reports to our Chairman and Chief Executive Officer.
Employees
      As reported, at December 31, 2005, we employed 57,699 people worldwide, primarily in Europe, compared with 55,718 at December 31, 2004 and 60,486 at December 31, 2003. The tables below show the geographic locations and the business segments in which our employees worked at December 31, 2003, 2004 and 2005 after taking into account the discontinuance in 2003 of our battery and optical components businesses and in 2004 of our optical fiber, mobile phones and electrical power systems businesses. As restated to exclude the employees of these discontinued businesses, we employed 56,690 people at December 31, 2003.

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      Total number of employees and the breakdown of this number by business segments is determined by taking into account all of the employees at year-end who work for fully consolidated companies and a percentage of those employees at year-end who work for subsidiaries consolidated using proportionate consolidation based on the percentage of interest in such companies (see Note 36 to our consolidated financial statements included elsewhere herein).
      The breakdown by geographical areas gives the headcount of employees who work for fully consolidated companies and companies in which we own 50% or more of the equity. The impact of taking into account headcount of subsidiaries consolidated using proportionate consolidation only for the percentage of interests in these entities is isolated in the “proportionate consolidation impact” column. This impact is related to the creation of two joint ventures with Finmeccanica in the space business as explained in Note 2 to our consolidated financial statements.
                                         
    Fixed   Mobile   Private       Total
    Communications   Communications   Communications   Other   Group
                     
2003
    23,461       13,355       19,282       592       56,690  
2004
    18,446       15,350       21,367       555       55,718  
2005
    17,311       17,700       22,138       550       57,699  
                                                                 
                            Proportionate    
                Asia           consolidation   Total
    France   Germany   Rest of Europe   Pacific   North America   Rest of World   impact   Group
                                 
2003
    17,206       6,736       12,502       8,110       8,811       3,325             56,690  
2004
    16,161       5,951       11,918       8,338       8,783       4,567             55,718  
2005
    16,037       5,288       14,108       9,109       9,009       6,094       (1,946 )(1)     57,699  
 
(1) This consolidation impact is a reduction of 1,362 in our employee headcount in France, and a reduction of 584 in the rest of Europe.
     Membership of our employees in trade unions varies from country to country. Although differing from country to country, we believe that relations with our employees are satisfactory. The number of temporary workers at December 31, 2005 was 1,568.
Share Ownership
Directors and Senior Executives
      Our articles of association and bylaws provide that each of our directors must own at least 500 shares. As of December 31, 2005, none of our directors or senior executives beneficially owned, or held options to purchase, 1% or more of our ordinary shares.
      Shares. As of March 31, 2006 our directors, including directors who were also senior executives, and other senior executives, as a group, beneficially held an aggregate of 494,919 ordinary shares (including ADSs) and 23,283 FCP 3A interests.
      Options. As of March 31, 2006 our directors listed in the table under the heading “Board of Directors” above and our senior executives listed in the table under the heading “Senior Management” above, as a group, beneficially owned the following options:
  for 1,005,000 ordinary shares granted pursuant to a share subscription plan approved by our board in March 2000 at an exercise price of 48 per share expiring on December 31, 2005 or 2007, depending on whether the beneficiary is an employee of a company with a registered office in France;
 
  for 1,344 ordinary shares pursuant to options awarded to participants in a share subscription plan in connection with a capital increase reserved for employees in March 2000, at an exercise price of 48 per share expiring on June 30, 2004 or 2006, depending on whether the beneficiary is an employee of a company with a registered office in France;

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  for 15,000 ordinary shares granted pursuant to a share subscription plan approved by our board in December 2000 at an exercise price of 65 per share expiring on December 31, 2005 or 2007, depending on whether the beneficiary is an employee of a company with a registered office in France;
 
  for 889,900 ordinary shares granted pursuant to a share subscription plan approved by our board in March 2001 at an exercise price of 50 per share expiring on March 6, 2009;
 
  for 1,074,300 ordinary shares granted pursuant to a share subscription plan approved by our board in December 2001 at an exercise price of 20.80 per share expiring on December 18, 2009;
 
  for 200 ordinary shares granted to those persons who participated in our March 2000 and March 2001 capital increases, pursuant to a share subscription plan approved by our board in December 2001 at an exercise price of 20.80 per share expiring on December 31, 2005 or 2006, depending on whether the beneficiary is an employee of a company with a registered office in France;
 
  for 956,200 ordinary shares granted pursuant to share subscription plans approved by our board in March 2003 at an exercise price of 6.70 per share expiring on or prior to March 6, 2011;
 
  for 56 ordinary shares granted to those persons who participated in our March 2000 and March 2001 capital increases, pursuant to a share subscription plan approved by our board in March 2003, at an exercise price of 6.70 per share expiring on June 30, 2007 or 2008, depending on whether the beneficiary is an employee of a company with a registered office in France;
 
  for 50,000 ordinary shares granted pursuant to a share subscription plan approved by our Chief Executive Officer in September 1, 2003 at an exercise price of 9.30 per share expiring on August 31, 2011;
 
  for 1,021,000 ordinary shares granted pursuant to share subscription plans approved by our board in March 2004 at an exercise price of 13.20 per share expiring on or prior to March 9, 2012;
 
  for 711,000 ordinary shares granted pursuant to share subscription plans approved by our board in March 2005 at an exercise price of 10 per share expiring on or prior to March 9, 2013; and
 
  for 750,000 ordinary shares granted pursuant to share subscription plans approved by our board in March 2006 at an exercise price of 11.70 per share expiring on or prior to March 7, 2014.
      During 2005, a total of 37,186 options were exercised by our directors or senior executives at an average price of 6.77.
Employee stock options
      At December 31, 2005, there were 131,953,837 options outstanding pursuant to existing share subscription plans and existing share purchase plans, each option giving a right to acquire one ordinary share.
      Our board of directors and Chief Executive Officer have granted stock options to specialists, high-potential employees and future executives as well as members of senior management pursuant to the share subscription plans and share purchase plans listed below. In order to maintain in all circumstances the stability of the activities of our Group and the personnel that is key to our development, our board of directors has the ability to render outstanding options under our share subscription plans immediately exercisable in the event of a merger pursuant to which Alcatel is merged into another company, a tender offer for our shares or a withdrawal of our shares from public listing (a “going private” transaction), regardless of any delay in the vesting of such options provided for in the initial terms of the plans. However, any such acceleration would not apply to stock options held by any member of our board of directors, our Chief Executive Officer or any deputy executive officer, that is, by a “mandataire social,” as such term is defined in French law, who was a “mandataire social” either at the date of the grant of the option or at the date of the decision of the board of directors to accelerate vesting.
      Share Subscription Plans. At our shareholders’ meeting held on May 20, 2005, our shareholders authorized our board of directors to grant options to our employees and executives to subscribe for a number of new shares not to exceed 6% of the total number of shares comprising the capital of the company.

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      The following table sets forth information as at December 31, 2005 with respect to share subscription plans approved by our board of directors:
                                                 
    Number of                
    options   Number of   Number of   Exercise period    
    authorized   options   recipients at       Exercise
Date of approval of plan   at grant date   outstanding   grant date   From   To   price
                         
12/097/1998
    11,602,500       9,884,750       2,025       12/09/2003       12/31/2005     20.52  
09/08/1999
    545,000       421,250       141       09/08/2004       12/31/2005     28.40  
03/29/2000
    15,239,250       12,862,305       3,887       04/01/2003 (1)     12/31/2005 (1)   48.00  
                              04/01/2005 (2)     12/31/2007 (2)        
03/29/2000
    3,317,808 (3)     3,258,704       58,957       07/01/2005 (2)     06/30/2006 (2)   48.00  
12/13/2000
    1,235,500       1,003,850       478       12/13/2003 (1)     12/31/2005 (1)   65.00  
                              12/13/2005 (2)     12/31/2007 (2)        
12/13/2000
    306,700       197,500       340       12/13/2001 (4)     12/12/2008     64.00  
                              12/13/2004 (2)(4)                
03/07/2001
    37,668,588       27,121,370       30,790       03/07/2002 (4)     03/06/2009     50.00  
                              03/07/2005 (2)(4)                
03/07/2001
    275,778 (5)     77,550       2,024       07/01/2005 (2)     06/30/2006 (2)   50.00  
12/19/2001
    27,871,925       18,983,365       25,192       12/19/2002 (4)     12/18/2009     20.80  
                              12/19/2005 (2)(4)                
12/19/2001
    565,800       336,905       521       12/19/2002 (4)     12/18/2009     9.30  
                              12/19/2005 (2)(4)                
12/19/2001
    935,660 (6)     893,990       45,575       01/01/2005 (1)     12/31/2005 (1)   20.80  
                              01/01/2006 (2)     12/31/2006 (2)        
03/07/2003
    25,626,865       19,627,155       23,650       03/07/2004 (1)(4)     03/06/2011 (1)   6.70  
                              03/07/2007 (2)(4)                
03/07/2003
    827,348 (6)     808,797       31,600       07/01/2006 (1)     06/30/2007 (1)   6.70  
                              07/01/2007 (2)     06/30/2008 (2)        
03/10/2004
    18,094,315       16,352,513       14,810       03/10/2005 (1)     03/09/2012 (1)   13.20  
                              05/10/2008 (2)                
03/10/2005
    16,756,690       16,049,480       9,470       03/10/2006 (1)     03/09/2013 (1)   10.00  
                              03/10/2009 (2)                
03/08/2006
    17,009,320       17,009,320       8,001       03/08/2007 (1)     03/07/2014 (1)   11.70  
                              03/08/2010 (2)                
 
(1) Options granted to employees of any of our subsidiaries with a registered office outside France.
 
(2) Options granted to employees of any of our subsidiaries with a registered office in France.
 
(3) On March 29, 2000, our board of directors approved a capital increase reserved for employees. In connection therewith, 2,226,451 ordinary shares were issued on June 29, 2000 at a price of 48 per share, and for each share subscribed, the participant received an option to purchase four additional shares.
 
(4) One quarter of these options vest upon the first anniversary of the grant date and the remaining options vest thereafter at a monthly rate of 1/48th of the total number of options initially granted.
 
(5) On March 7, 2001, our board of directors approved a capital increase reserved for employees In connection therewith, 91,926 ordinary shares were issued at a price of 50 per share, and for each share subscribed the participant received an option to purchase three additional shares.
 
(6) Options granted to recipients who subscribed to the capital increases of March 2000 and March 2001, and remain our employees.
     In 2001, 2002, 2003, 2004 and 2005, our Chief Executive Officer approved certain share subscription plans pursuant to authority delegated to him by our board of directors. Pursuant to this delegation of authority, our Chief Executive Officer may grant certain stock subscription options to our, or to our affiliates’ new employees or, under exceptional circumstances, to our or to our affiliates’ existing employees.

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      The following table sets forth information as at December 31, 2005 with respect to share subscription plans approved by our Chief Executive Officer:
                                                 
    Number of                
    options   Number of   Number of   Exercise period    
    authorized   options   recipients       Exercise
Date of approval of plan   at grant date   outstanding   at grant date   From   To   Price
                         
04/02/2001
    48,850       12,250       13       04/02/2002 (1)     04/01/2009     41.00  
04/02/2001
    2,500       2,500       1       04/02/2002 (1)     04/01/2009     39.00  
06/15/2001
    977,410       767,640       627       06/15/2002 (1)     06/14/2009     32.00  
                              06/15/2005 (1)(2)                
09/03/2001
    138,200       103,800       58       09/03/2002 (1)     09/02/2009     19.00  
                              09/03/2005 (1)(2)                
11/15/2001
    162,000       106,000       16       11/15/2002 (1)     11/14/2009     9.00  
                              11/15/2005 (1)(2)                
02/15/2002
    123,620       72,830       37       02/15/2003 (1)     02/14/2010     17.20  
                              02/15/2006 (1)(2)                
04/02 2002
    55,750       34,750       24       04/02/2003 (1)     04/01/2010     16.90  
05/13/2002
    54,300       41,300       23       05/13/2003 (1)     05/12/2010     14.40  
                              05/13/2006 (1)(2)                
06/03/2002
    281,000       231,979       176       06/03/2003 (1)     06/02/2010     13.30  
                              06/03/2006 (1)(2)                
09/02/2002
    1,181,050       410,401       226       09/02/2003 (1)     09/01/2010     5.20  
10/07/2002
    30,500       10,459       16       10/07/2003 (1)     10/06/2010     3.20  
11/14/2002
    111,750       51,224       26       11/14/2003 (1)     11/13/2010     4.60  
12/02/2002
    54,050       11,635       16       12/02/2003 (1)     12/01/2010     5.40  
06/18/2003
    338,200       278,478       193       06/18/2004 (1)     06/17/2011     7.60  
                              06/18/2007 (1)(2)                
07/01/2003
    53,950       22,250       19       07/01/2007 (1)(2)     06/30/2011     8.10  
09/01/2003
    149,400       137,929       77       09/01/2004 (1)     08/31/2011     9.30  
                              09/01/2007 (1)(2)                
10/01/2003
    101,350       61,683       37       10/01/2004 (1)     09/30/2011     10.90  
                              10/01/2007 (1)(2)                
11/14/2003
    63,600       60,100       9       11/14/2004 (1)     11/13/2011     11.20  
                              11/14/2007 (1)(2)                
12/01/2003
    201,850       134,487       64       12/01/2004 (1)     11/30/2011     11.10  
                              12/01/2007 (1)(2)                
04/01/2004
    48,100       29,458       19       04/01/2005 (1)     03/31/2012     13.10  
                              04/01/2008 (1)(2)                
05/17/2004
    65,100       56,500       26       05/17/2008 (1)     05/16/2012     12.80  
                              05/17/2005 (1)(2)                
07/01/2004
    313,450       277,500       187       07/01/2005 (1)     06/30/2012     11.70  
                              07/01/2008 (1)(2)                
09/01/2004
    38,450       37,150       21       09/01/2005 (1)     08/31/2012     9.90  
                              09/01/2008 (1)(2)                
10/01/2004
    221,300       193,300       85       10/01/2005 (1)     09/30/2012     9.80  

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    Number of                
    options   Number of   Number of   Exercise period    
    authorized   options   recipients       Exercise
Date of approval of plan   at grant date   outstanding   at grant date   From   To   Price
                         
                              10/01/2008 (1)(2)                
11/12/2004
    69,600       68,800       20       11/12/2005 (1)     11/11/2012     11.20  
                              11/12/2008 (1)(2)                
12/01/2004
    42,900       37,900       11       12/01/2005 (1)     11/30/2012     11.90  
                              12/01/2008 (1)(2)                
01/03/2005
    497,500       480,100       183       01/03/2006 (1)     01/02/2013     11.41  
06/01/2005
    223,900       215,100       96       06/01/2006 (1)     05/31/2013     8.80  
                              06/01/2009 (1)(2)                
09/01/2005
    72,150       72,150       39       09/01/2006 (1)     08/31/2013     9.80  
                              09/01/2009 (1)(2)                
11/14/2005
    54,700       54,700       23       11/14/2006 (1)     11/13/2013     10.20  
                              11/14/2009 (1)(2)                
 
(1) One quarter of these options vests upon the first anniversary of the grant date and the remaining options vest thereafter at a monthly rate of 1/48th of the total number of options initially granted.
 
(2) Options granted to employees of any of our subsidiaries with a registered office in France are not exercisable during the first four years after grant.
     Under certain of the share subscription plans described above, options granted to employees of our companies with a registered office in Belgium may become exercisable or vest, as applicable, over a longer period, as in France.
      Share Purchase Plans. Our share purchase plans are comprised of options to purchase existing, and not newly issued, ordinary shares. If the options are exercised, we will sell the optionees ordinary shares that we had acquired in connection with our buy-back program approved by our board of directors on September 21, 1998 and subject to the annual approval of our shareholders. Under a December 1998 plan, options to purchase up to 11,602,500 ordinary shares were granted with an exercise period from December 9, 2003 to December 31, 2005 at an exercise price of 20.52. As at December 31, 2005, there were options to purchase up to 9,884,750 ordinary shares outstanding under the December 1998 plan. Our board of directors also approved a share purchase plan in September 1999 and granted options to purchase up to 545,000 ordinary shares with an exercise period from September 8, 2004 to December 31, 2005 and at an exercise price of 28.40 per share. As at December 31, 2005, there were options to purchase up to 421,250 ordinary shares outstanding under the September 1999 plan. We currently have no share purchase plans, since the exercise period for all our share purchase plans expired on December 31, 2005.

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Option plans for acquired companies
      Option plans of companies that we acquired now provide for the issuance of ordinary shares or ADSs upon exercise of options granted under such plans, in lieu of the issuance of shares of the acquired companies. Except in the case of Astral Point, Telera, Imagic TV, TiMetra and Spatial, we will not issue new ordinary shares (or ADSs) to satisfy these options, but rather, will use outstanding ADSs held by us. In addition, Alcatel USA, Inc. has also adopted share purchase plans for executives and employees of our U.S. and Canadian subsidiaries. In total, options to purchase up to 10,058,615 ADSs or ordinary shares were outstanding as of December 31, 2005 under the assumed stock option plans and the share purchase plans of Alcatel USA, Inc. The following table sets forth information as of December 31, 2005 with respect to option plans of our acquired companies and the share purchase plans of Alcatel USA, Inc.
                                                 
    Outstanding Options    
        Exercisable Options
        Weighted        
    Exercise price   Number   remaining   Weighted   Amount   Weighted
    (giving right to   outstanding   exercise   average   exercisable   average
    one ordinary   at   period   exercise   at   exercise
Company   share or ADS)   12/31/2005   (years)   price   12/31/2005   price
                         
Packet Engines
    0.29-0.86 USD       10,372       2.10       0.59       10,372       0.59  
Xylan
    0.05-18.14 USD       1,393,928       2.21       9.08       1,393,928       9.08  
Internet Devices Inc. 
    0.26-1.17 USD       23,980       2.88       0.92       23,980       0.92  
DSC
    16.57-44.02 USD       45,690       1.25       20.40       45,690       20.40  
Genesys
    0.01-41.16 USD       3,018,403       3.25       20.70       3,018,403       20.70  
Newbridge
    11.72-52.48 USD       4,253       2.40       12.73       4,253       12.73  
Astral Point
    0.29-58.71 EUR       74,510       4.29       16.57       74,510       16.57  
Telera
    0.43-6.36 EUR       136,161       4.88       5.15       135,759       5.14  
Imagic TV
    2.84-64.68 EUR       78,506       1.74       18.69       78,069       18.77  
TiMetra
    0.53-7.97 EUR       1,703,423       4.96       5.91       1,152,000       5.10  
Spatial Communications Technologies Inc. 
    0.24-9.1 EUR       858,123       8.24       2.97       248,177       2.99  
Alcatel USA Inc. 
    21.40-84.88 USD       10,058,615       4.13       53.98       10,058,615       53.98  
                                     
Total number of options
            17,405,964                       16,243,756          
                                     
Item 7. Major Shareholders and Related Party Transactions
Major Shareholders
      At December 31, 2005, to our knowledge, no shareholder beneficially owned 5% or more of either our ordinary shares or ADSs.
      The table below lists our principal shareholders as of December 31, 2005:
                 
Principal Shareholders   Capital   Voting Rights
         
Caisse des Dépôts et Consignations
    4.12 %     4.22 %
Employee Investment Fund (FCP 3A)
    1.89 %     3.14 %
Société Générale Group
    0.75 %     1.28 %
Shares held by Alcatel subsidiaries
    1.77 %      
Treasury Stock
    2.35 %      
Public(1)
    89.12 %     91.36 %
             
Total
    100 %     100 %
             
 
(1) Includes shares owned by Brandes Investment Partners, L.P. as more fully described below.
     Each fully paid ordinary share that is held in registered form by the same holder for at least three years entitles the holder to double voting rights at any of our shareholder meetings. The dual voting right will automatically terminate for any share which has been subject to conversion into a bearer share or for which

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ownership has been transferred. Regardless of the number of ordinary shares held, the total voting rights per shareholder cannot exceed 8% of the total voting rights present or represented at any of our shareholder meetings (16% if double voting rights apply). For further details about voting rights of our shares please refer to Item 10 — “Additional Information — Description of Ordinary Shares.”
      The number of ordinary shares held by the Caisse des Dépôts et Consignations Group (the “CDC Group”) as of December 31, 2003, December 31, 2004 and December 31, 2005 was 74,340,807, 68,100,807 and 58,867,807 respectively.
      According to Amendment Number 5 to a Schedule 13G filed with the SEC on February 14, 2006, Brandes Investment Partners, L.P. was, as of December 31, 2005, the beneficial owner of 60,737,851 ADSs and 91,636,167 ordinary shares, representing 10.7% of our capital. Brandes Investment Partners, L.P. is an investment adviser registered under the Investment Advisers Act of 1940. The ordinary shares and ADSs owned by Brandes Investment Partners, L.P. are included in the line item “Public” in the table above.
      As of December 31, 2005, 128,314,387 ADSs were outstanding in the United States, representing approximately 9.0% of the total outstanding ordinary shares. At such date, the number of registered ADS holders in the United States was 3,157.
      We are not directly or indirectly owned or controlled by another corporation, by any foreign government or by any other natural or legal person. We are not aware of any arrangements that may result in a change of control of Alcatel.
Related Party Transactions
      In December 1999, we entered into an amended agreement (originally entered into in 1998) with Thales, a company in which Mr. Tchuruk serves as a director, pursuant to which we agreed to cooperate with Thales on strategic and operational matters. We currently have a 9.46% interest in Thales.
      The board of directors met on April 19, 2005 and authorized, upon the recommendation of the nomination and compensation committee, the execution of an agreement between us and Mr. Germond concerning the cessation of his responsibilities as the Group’s President and Chief Operating Office. The main provisions of this agreement clarified the contractual obligations of Mr. Germond and of the Group due to Mr. Germond’s departure in the first half of the year. It determined the actual amount of the termination payment owed to Mr. Germond, calculated pursuant to the terms of his employment contract as executed upon his joining the Group, such amount being 3,000,000. The agreement also reduced the notice period for termination to three months, and set his bonus compensation for the 2005 fiscal year, pro rata to his departure date, at 250,000.
Item 8. Financial Information
Consolidated statements and other financial information
      See our consolidated financial statements elsewhere in this annual report.
Legal matters
      In addition to legal proceedings incidental to the conduct of our business (including employment-related collective actions in France and the United States), which our management believes are adequately reserved against in our financial statements or will not result in any significant costs to us, we are involved in the following legal proceedings:
      France Telecom. Since 1993, a legal investigation has been ongoing concerning “overbillings” which are alleged to have been committed at Alcatel CIT to the detriment of its principal client, France Telecom, based on an audit of production costs conducted in 1989 in the transmission division and in 1992 in the switching division (which are now the part of the Fixed Communications segment).

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      We entered into two settlement agreements with France Telecom, one in 1993, in relation to the transmission division, and the other in May 2004, in relation to the switching activity and the financial impact of which has been fully reserved in our December 31, 2004 financial statements. In the context of the latter settlement, France Telecom acknowledged that the parties’ dispute on pricing did not involve fraud by Alcatel CIT.
      In April 1999, we learned that the criminal investigation had been extended to determine whether our corporate funds as well as those of Alcatel CIT had been misused. As a consequence, both Alcatel CIT and we have filed civil complaints to preserve our respective rights with respect to this investigation.
      In January 2000, the investigating magistrate declared his investigation closed on the alleged “overbillings.” Since then, there have been several procedural developments, including appeals relating to the closing of the investigation phase by an indicted defendants. At the end of November 2004, the investigating magistrate again declared his investigation closed. By a decision dated June 29, 2005, which has not become final, the division of the Paris Court of Appeals dealing with issues arising in the context of criminal investigation definitely rejected a final request for annulment. As a result, the investigating magistrate may now close his judicial inquiry at any time.
      Class A and Class O Shareholders. Several purported class action lawsuits were filed in the United States District Court for the Southern District of New York since May 2002 against us and certain of our officers and directors, asserting various claims under the federal securities laws. These actions have been consolidated. The consolidated action challenges the accuracy of certain public disclosures that were made in the prospectus for the initial public offering for Class O shares and other public statements regarding Alcatel, and in particular, our former Optronics division.
      The complaint purports to bring claims on behalf of the lead plaintiffs and a class of persons consisting of persons who (i) acquired Class O shares in or traceable to the initial public offering of ADSs conducted by us in October 2000, (ii) purchased Class A or Class O shares in the form of ADSs between October 20, 2000 and May 29, 2001, and (iii) purchased Class A shares in the form of ADSs between May 1, 2000 and May 29, 2001. The amount of damages sought has not been specified.
      We are defending this action vigorously and deny any liability or wrongdoing with respect to this litigation. We filed a motion to dismiss this action on January 31, 2003, and a decision on the motion was rendered on March 4, 2005. The judge rejected a certain number of the plaintiffs’ demands with prejudice. He also rejected all the remaining claims under the federal securities laws for lack of specificity in the pleadings, but with leave to file a further amended complaint. This was filed, and fully briefed as of August 5, 2005. The parties are now waiting for the judge’s decision.
      Costa Rica. Beginning in early October 2004, we learned that investigations had been launched in Costa Rica by the Costa Rican Attorney General and the National Congress regarding payments alleged to have been made by consultants on behalf of Alcatel de Costa Rica to various state and local officials in Costa Rica, two political parties in Costa Rica and representatives of ICE, the state owned telephone company, in connection with the procurement of one or more contracts for network equipment and services from ICE. Upon learning of these allegations, we immediately commenced and are continuing an investigation into this matter.
      In Costa Rica and other countries, we retain consultants to assist us with our local operations and contracts. Our contracts with persons through whom we deal locally strictly prohibit the provision of any pecuniary or other advantage in contravention of applicable laws. In addition, we have a strict Statement of Business Practice (a copy of which is available on our web site, www.alcatel.com, under the heading Sustainable Development — Values and Charters) that imposes the highest standards of legal and ethical conduct on our employees. We rigorously enforce this Statement of Business Practice across the entire company and, when violations occur, we take prompt and appropriate action against the persons involved.
      We have terminated the employment of the president of Alcatel de Costa Rica and a vice president-Latin America of a French subsidiary. We are also in the process of pursuing criminal actions against the former president of Alcatel de Costa Rica, the local consultants and the employee of the French subsidiary based on our suspicion of their complicity in an improper payment scheme and misappropriation

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of funds. The contracts with the local consultants were limited to the specific projects involved and are no longer in effect or have been terminated, and any payments due under those contracts have been suspended. Our internal investigation is continuing.
      We contacted the United States Securities and Exchange Commission and the United States Department of Justice and informed them that we will cooperate fully in any inquiry or investigation into these matters. The SEC is conducting an inquiry into the allegations. If the Department of Justice or the SEC determines that violations of law have occurred, it could seek civil or, in the case of the Department of Justice, criminal sanctions, including monetary penalties against us. Neither the Department of Justice nor the SEC has informed us what action, if any, it will take.
      Several investigations have been launched in Costa Rica concerning this matter by both the Costa Rican Attorney General and the Costa Rican National Congress. On November 25, 2004, the Costa Rican Attorney General’s Office commenced a civil lawsuit against Alcatel CIT to seek compensation for the pecuniary damage caused by the alleged payments described above to the people and the Treasury of Costa Rica, and for the loss of prestige suffered by the Nation of Costa Rica. On February 1, 2005, ICE commenced a lawsuit against Alcatel CIT to seek compensation for the pecuniary damage caused by the alleged payments described above to ICE and its customers, and for the harm to the reputation of ICE resulting from these events. The amount of damages sought by these lawsuits has not yet been specified. We intend to defend these actions vigorously and deny any liability or wrongdoing with respect to these litigations.
      We are unable to predict the outcome of these investigations and civil lawsuit and their effect on our business. If the Costa Rican authorities conclude criminal violations have occurred, we may be banned from participating in government procurement contracts in Costa Rica for a certain period and fines or penalties may be imposed on us in an amount which we are not able to determine at this time. We expect to generate approximately 10 million in revenue from Costa Rican contracts in 2006. Based on the amount of revenue received from these contracts, we do not believe a loss of business in Costa Rica would have a material adverse effect on us as a whole. However, these events may have a negative impact on the image of our company in Latin America.
      Taiwan. Certain employees of Taisel, a Taiwanese subsidiary of Alcatel, and Siemens Taiwan, along with a few suppliers and a legislative aide, have been the subject of an investigation by the Taipei Investigator’s Office of the Ministry of Justice relating to an axle counter supply contract awarded to Taisel by Taiwan Railways in 2003. It has been alleged that persons in Taisel and Siemens Taiwan and subcontractors hired by them were involved in a bid rigging and payment arrangement for the Taiwan Railways contract.
      Upon learning of these allegations, we immediately commenced and are continuing an investigation into this matter. We terminated the former president of Taisel. A director of international sales and marketing development of a German subsidiary who was involved in the Taiwan Railways contract has resigned.
      On November 15, 2005, the Taipei criminal district court found Taisel not guilty of the alleged violation of the Government Procurement Act. The former President of Taisel was not judged because he was not present or represented at the proceedings. The court found two Taiwanese businessmen involved in the matter guilty of violations of the Business Accounting Act.
      The prosecutor has filed an appeal with the Taipei court of appeal. Should the higher court find Taisel guilty of the bid-rigging allegations in the indictment, Taisel may be banned from participating in government procurement contracts within Taiwan for a certain period and fines or penalties may be imposed on us, in an amount not to exceed 25,000.
      Other allegations made in connection with this matter may still be under ongoing investigation by the Taiwanese authorities.
      We expect to generate approximately 126 million of revenue from Taiwanese contracts in 2006, of which only a part will be from governmental contracts. Based on the amount of revenue expected from these

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contracts, we do not believe a loss of business in Taiwan would have a material adverse effect on Alcatel as a whole.
      Effect of the investigations. Our policy is to conduct our business with transparency, and in compliance with all laws and regulations, both locally and internationally. We cooperate with all governmental authorities in connection with the investigation of any violation of those laws and regulations.
      Although it is not possible at this stage of these cases to predict their outcome with certainty, we do not believe that the ultimate outcome of these proceedings will have a material adverse effect on our consolidated financial position or results from our operations. We are not aware of any other proceedings that would or may have a significant effect on our activities, financial position or assets.
Dividend policy
      General. Under French law, our board of directors must first propose the distribution of any dividend to a general meeting of all our shareholders, voting together as a single class. A majority of the holders of our ordinary shares must then approve the distribution. Under French law, the aggregate amount of any dividends paid on our ordinary shares will, for any year, be limited to our distributable profits (bénéfice distribuable) for that year. In any fiscal year, our distributable profits will equal the sum of the following:
  our profits for the fiscal year, less
 
  our losses for the fiscal year, less
 
  any required contribution to our legal reserve fund under French law, plus
 
  any additional profits that we reported, but did not distribute in our prior fiscal year.
 
  In the future, we may offer our shareholders the option to receive any dividends in shares instead of cash.
      See “Item 10 — “Additional Information — Taxation” for a summary of certain U.S. federal and French tax consequences to holders of Alcatel shares or ADSs. Holders of Alcatel shares or ADSs should consult their own tax advisors with respect to the tax consequences of an investment in Alcatel shares or ADSs. Dividends paid to holders of ADSs will be subject to a charge by the Depositary for any expenses incurred by the Depositary in the conversion of euro to U.S. dollars. You should refer to Item 10 — “Additional Information — Description of ADSs” for a further discussion of the payment of dividends on the ADSs.
      Dividends in 2006. On February 2, 2006, we announced that our board of directors will propose a resolution at our annual shareholders’ meeting to be held in 2006 to pay a dividend of 0.16 per ordinary share and ADS for 2005.
Item 9. The Offer and the Listing
General
      In September 2000, the Paris Bourse (SBF) SA, or the “SBF,” the Amsterdam Exchange and the Brussels Exchange merged to create Euronext, the first Pan-European exchange. Securities quoted on exchanges participating in Euronext are traded over a common Euronext platform, with central clearinghouse, settlement and custody structures. However, these securities remain listed on their local exchanges. As part of Euronext, the SBF retains responsibility for the admission of shares to the Paris Bourse’s trading markets as well as the regulation of those markets.
      Since February 18, 2005, Premier, Second and Nouveau Marchés of Euronext Paris merged to create one market, Eurolist by Euronext. Prior to this change, our ordinary shares were traded on the Premier Marché. All shares and bonds are now traded on the same market and listed alphabetically.
      The principal trading market for our ordinary shares is the Eurolist. Our ordinary shares have been traded on the Euronext Paris SA since June 3, 1987. The ordinary shares are also listed on Euronext Amsterdam, Antwerp, Basle, Euronext Brussels, Frankfurt, Geneva, Tokyo and Zurich exchanges and are

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quoted on SEAQ International in London. In addition, our ADSs have been listed on The New York Stock Exchange since May 1992.
      The following table sets forth, for the periods indicated, the high and low prices on the Euronext Paris SA for our ordinary shares:
                     
    Price per share
     
    High   Low
         
2001
  72.35     11.34  
2002
    21.62       2.05  
2003
    11.89       4.16  
2004
    14.82       8.77  
 
First Quarter
    14.82       10.25  
 
Second Quarter
    14.10       10.88  
 
Third Quarter
    12.86       8.77  
 
Fourth Quarter
    12.38       9.49  
2005
    11.70       8.14  
 
First Quarter
    11.70       9.35  
 
Second Quarter
    9.69       8.14  
 
Third Quarter
    11.12       8.47  
 
Fourth Quarter
    11.35       9.45  
2005
    11.35       10.35  
 
September
    11.12       9.53  
 
October
    11.35       9.45  
 
November
    10.62       9.65  
 
December
    10.93       10.35  
2006
    12.01       10.38  
   
January
    11.59       10.38  
   
February
    12.01       10.98  
Trading in the United States
      The Bank of New York serves as the Depositary with respect to the ADSs traded on The New York Stock Exchange. Each ADS represents one ordinary share.

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      The following table sets forth, for the periods indicated, the high and low prices on The New York Stock Exchange for the ADSs:
                   
    ADS
    price per share
     
    High   Low
         
2001
  $ 66.94     $ 10.53  
2002
    19.14       2.02  
2003
    13.68       4.60  
2004
    18.32       10.76  
 
First Quarter
    18.32       13.06  
 
Second Quarter
    17.08       13.09  
 
Third Quarter
    15.30       10.76  
 
Fourth Quarter
    16.20       11.98  
2005
    15.75       10.44  
 
First Quarter
    15.75       12.06  
 
Second Quarter
    12.22       10.45  
 
Third Quarter
    13.42       10.44  
 
Fourth Quarter
    13.51       11.50  
2005
    13.51       12.17  
 
September
    13.42       11.91  
 
October
    13.51       11.51  
 
November
    12.49       11.50  
 
December
    13.09       12.17  
2006
    14.45       12.68  
 
January
    14.07       12.68  
 
February
    14.45       13.25  
Item 10. Additional Information
Memorandum and articles of association
      Our purpose. Our purposes can be found in Article 2 of our articles of association and bylaws. Generally, our purpose in all countries is to take any and all types of actions relating to electricity, telecommunications, computer, electronics, the space industry, nuclear power, metallurgy and generally to all types of energy and communications production and transmission systems. In addition, we may create companies regardless of activity, own stock in other companies and manage shares and securities. We are listed in the Paris Trade Register under number 542 019 096 and our APE code is 741 J.
Information Concerning Directors
      General. Our articles of association and bylaws stipulate that our directors shall be elected by our shareholders and that our board of directors shall consist of no fewer than six and no more than 18 directors. Our board of directors presently consists of 13 directors. Two directors are required to be our employees or employees of our subsidiaries and participants in a mutual fund for our employees that holds our shares (an “FCP”). Directors elected after May 2000 are elected for terms of up to four years, which term can only be renewed by the vote of our shareholders. However, directors may be elected to multiple, and consecutive, terms. Our board of directors appoints, and has the power to remove, the chairman and Chief Executive Officer. The chairman serves for the term determined by the board when the chairman is elected, which may

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not exceed the chairman’s term as a director. Our governing documents also provide for one or more vice-chairmen, who may be elected by the board.
      Directors can be individuals or entities, including corporations. If an entity is a director, it must appoint an individual to act as its permanent representative.
      Our articles of association and bylaws provide that the board of directors is responsible for managing the company. In accordance with article 17 of our articles of association and bylaws, the board of directors has the discretion to determine whether the management of the company will be performed by the chairman of the board of directors or by a Chief Executive Officer. On April 24, 2002 and on April 17, 2003, our board of directors determined that Mr. Tchuruk will exercise the functions of both the chairman of the board of directors and the Chief Executive Officer.
      In February 2003, our board of directors adopted internal rules requiring our directors to notify the board of any situation involving a potential conflict of interest between them and Alcatel. In addition, our directors are precluded from voting on matters relating to such conflicts of interest.
      Shareholdings. Each director must own at least 500 shares. Two directors must be our employees and must participate in an FCP at the time of appointment.
      Retirement. Generally, the maximum age for holding a directorship is 70. However, this age limit does not apply if less than one-third, rounded up to the nearest whole number, of serving directors has reached the age of 70. No director over 70 may be appointed if, as a result of the appointment, more than one-third of the directors would be over 70.
      If for any reason more than one-third of the number of serving directors are over 70, then the oldest director shall be deemed to have retired at the ordinary shareholders’ meeting called to approve our accounts for the fiscal year in which the one-third threshold was exceeded, unless the board proportion is reestablished prior to the meeting.
      If a company or other legal entity has the right to appoint a director and that director reaches 70, the company or legal entity must replace the director by the date of the ordinary shareholders’ meeting called to approve our accounts for the fiscal year in which such director reached 70.
      The retirement age for the Chief Executive Officer is 68. As noted above (see “Information Concerning Directors”), currently the Chief Executive Officer is also the chairman of the board of directors. In the event in the future our board of directors decides to separate the function of chairman of the board from that of Chief Executive Officer, then the maximum age for holding the chairmanship of the board will be 70.
Description of Ordinary Shares
      Form of shares. Under French company law, ownership of ordinary shares is not represented by share certificates. Bearer shares are recorded in the books of an accredited financial intermediary in an account opened in the name of the shareholder at EUROCLEAR France (formerly Sicovam SA) (an accredited financial intermediary is a French broker, bank or authorized financial institution registered as such in France). Upon our request, EUROCLEAR France will disclose to us the name, nationality, address and number of shares held by each shareholder who holds them in bearer form. This information may only be requested by us and may not be communicated to third parties.
      Ordinary shares that are fully paid-up may be held in registered or bearer form at the option of the holder, subject to the next paragraph. Ownership of ordinary shares in registered form is recorded in books maintained by us or our appointed agent. A holder of ordinary shares in registered form may manage its own ordinary shares or appoint an accredited financial intermediary. Ordinary shares held in bearer form by a person who is not a resident of France may, at the request of such holder, be physically delivered in the form of bearer certificates representing such ordinary shares, provided that the ordinary shares are held and traded outside France. In determining whether or not to issue physical certificates in these circumstances, the accredited financial intermediary considers certification practices in foreign markets and may consult with us.

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      Registration of shares. Any holder owning 3% of the total number of ordinary shares (including ADSs) must request, within five trading days of reaching that ownership level, registration of the shares in non-transferable form. In addition, this registration requirement will apply to all ordinary shares (including ADSs) that the holder may subsequently acquire each time a holder of 3% or more of the total number of shares increases its holding by 1%, up to and including 50%. The holder is required to notify us of any such subsequent acquisition within two weeks and such notice shall set forth the number of shares held, the acquisition date and a certification that all shares owned by such holder are reported. Compliance with this requirement is deemed to be in compliance with the notification requirements described below under “Holdings exceeding certain percentages.” Failure to comply with this requirement may, upon petition of one or more shareholders representing 3% or more of our share capital, result in the loss of the voting rights attached to the shares in excess of the relevant threshold.
      Transfer of shares. Ordinary shares held in registered form are transferred by means of an entry recorded in the transfer account maintained by us or on our behalf for this purpose. In order for ordinary shares in registered form to be traded on a stock exchange in France, the shares must first be converted into bearer form by a financial intermediary upon receipt of a selling order from the holder. Upon completion of the trade, the new holder is required to register the shares in its name within five trading days, only if such trade causes the holder to cross the 3% threshold specified by our articles of association and bylaws. Bearer shares are held and recorded in the securities account of the holder and may be traded without any further requirement. Ordinary shares held in bearer form by a person who is not a resident of France are transferable outside France by delivery of the bearer certificates representing the ordinary shares.
      Holdings exceeding certain percentages. Under French law, any individual or entity, acting alone or in concert with others, who becomes the owner of more than 5%, 10%, 15%, 20%, 331/3%, 50%, 662/3%, 90% or 95% of our outstanding share capital or voting rights (including through ADSs), or whose holding subsequently falls below any of these thresholds, must notify us of the number of ordinary shares it holds within five trading days of the date the relevant threshold was crossed. The individual or entity must also notify the French stock exchange and securities regulator (Autorité des marchés financiers) within five trading days of the date the threshold was crossed.
      In addition, our articles of association and bylaws provide that any individual or entity which at any time owns, directly or indirectly, a number of shares equal to or more than 2% of our issued share capital, or whose holding falls below any of these thresholds, must within five days of exceeding this threshold, notify us by letter, fax or telex of the total number of each class of shares owned. When this threshold is reached, every further increase of 1% must be reported. Failure to provide timely written notice to us may, upon petition of one or more shareholders representing 3% or more of our share capital, result in the loss of the voting rights attached to the shares in excess of the relevant threshold.
      French company law and the regulations of the French stock exchange and securities regulator impose additional reporting requirements on any person or persons acting alone or in concert who acquire more than 10% or 20% of our share capital or voting rights. An acquiror exceeding those thresholds must file a statement with us, the French securities regulator and stock exchange regulator. The notice must specify the acquirer’s intentions for the 12-month period following the acquisition of its 10% or 20% stake, including whether or not it intends to (1) increase its stake, (2) acquire a controlling interest in us or (3) seek the election of nominees to our board of directors. The statement must be filed within 10 trading days after the date either of these thresholds was crossed. The statement is published by the French stock exchange and securities regulator. Similar reporting requirements must be complied with if the acquiror’s intentions have changed due to material events.
      In addition, under French law and the regulations of the French stock exchange and securities regulator, any person or persons, acting alone or in concert, who enter into an agreement containing provisions granting preferential treatment, with respect to the sale of shares, voting rights, or otherwise, for shares representing 0.5% or more of our share capital or voting rights must file such provisions with the French stock exchange and securities regulator.

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      Under French law and the regulations of the French stock exchange and securities regulator, and subject to limited exemptions granted by it, any person or persons, acting alone or in concert, who acquires shares representing one-third or more of our share capital or voting rights must initiate a public tender offer for the balance of our share capital and all other outstanding securities (such as convertible bonds) that are convertible into or exchangeable for our share capital.
      If a shareholder (including a holder of ADSs) fails to comply with these notification requirements, the shareholder will be deprived of voting rights attached to the shares it holds in excess of the relevant threshold. The shareholder will be deprived of its voting rights at all shareholders’ meetings held until the end of a two-year period following the date on which the shareholder has complied with the notification requirements. Furthermore, any shareholder who fails to comply with these requirements, including the notification requirements of our articles of association and bylaws, may have all or part of its voting rights (and not only with respect to the shares in excess of the relevant threshold) suspended for up to five years by court decree at the request of our chairman, any of our shareholders or the French stock exchange and securities regulator. Such shareholder may also be subject to criminal penalties.
      In order to permit shareholders to give the notice required by law and our articles of association and bylaws, we are obligated to publish in the French official newspaper (Bulletin des annonces légales obligatoires, or BALO), not later than 15 calendar days after our annual ordinary shareholders’ meeting, information with respect to the total number of votes available as of the date of the meeting. In addition, if we are aware that the number of available votes has changed by at least five percent since the last publication of the number of available votes, we must publish the number of votes then available in the BALO within 15 calendar days of that change and provide the French stock exchange regulator with written notice.
      Shareholder Meetings. Annual ordinary and extraordinary meetings of our shareholders are convened and held in accordance with French law. Any shareholder may attend a properly convened meeting of shareholders in person or by proxy upon confirmation of such shareholder’s identity and ownership of shares at least three days before the shareholders’ meeting, which period may be reduced at the discretion of our board of directors.
      Voting rights. Each ordinary share entitles a holder to one vote at all meetings of our shareholders subject to the provisions concerning double voting rights described below. For each ordinary share fully paid and registered in the name of the same person for at least three years, the holder will be entitled to double voting rights with respect to such ordinary share at any of our meetings, whether ordinary or extraordinary. The double voting right will automatically terminate for any share which has been subject to conversion into a bearer share or for which ownership has been transferred. Any transfer of shares as a result of inheritance, division of community property by spouses or donation to a spouse or heir shall not affect a share’s double voting rights.
      Regardless of the number of ordinary shares held, the total voting rights per shareholder cannot exceed 8% of the total voting rights present or represented at any meeting of shareholders (16% if double voting rights apply). This limit applies whether or not the shares are voted directly or by proxy. However, this limit does not apply if a shareholder, acting alone or in concert, owns at least 662/3 % or more of our outstanding shares as a result of a public tender offer or exchange offer for all our shares. In addition, this limit does not apply to the votes cast by the chairman of the meeting pursuant to a blank proxy.
      Preemptive rights. Under French law, shareholders will have preemptive rights to subscribe on a pro rata basis for additional shares of any equity securities or other securities giving a right, directly or indirectly, to equity securities issued by us for cash. During the subscription period relating to a particular offering of shares, shareholders may transfer preferential subscription rights that they have not previously waived. In order to issue additional ordinary shares without preemptive rights, beyond issuances already approved, we must obtain the approval of two-thirds of the voting rights present or represented by proxy at an extraordinary meeting of our shareholders, voting together as a single class.

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      Liquidation. Upon our liquidation, after payment of all prior claims, holders of ordinary shares will be entitled to receive a pro rata amount of all our net assets. The pro rata amount will be calculated, first to repay the paid-up and non-liquidated capital and any surplus will be divided among all shareholders, subject to any applicable rights arising from the different classes of shares.
      Dividends. You should refer to Item 8 — “Dividend Policy” for a description of how dividends are calculated and paid on our ordinary shares.
Changes in Share Capital
      Capital increases. In accordance with French law and subject to the exceptions discussed below, our share capital may be increased only with the approval of a two-thirds vote of the shareholders present or represented by proxy voting together as a single class at an extraordinary meeting. The shareholders may delegate to our board of directors, which in turn may delegate to the chairman of the board of directors, the power required to effect, in one or more phases, certain increases in share capital previously approved by our shareholders.
      Our share capital may be increased by the issuance of additional shares or by an increase in the nominal value of our existing shares. Our share capital may also be increased through the capitalization of existing reserves, profits or premium, in which case we must obtain the approval of a majority of the shareholders present or represented by proxy voting together as a single class at an extraordinary meeting of our shareholders. In case of an increase in our share capital by capitalization of reserves, profits or premium, shares attributed to a shareholder will be allocated pro rata based on the respective total nominal value of the ordinary shares held by such shareholder. The shares received by a shareholder will be of the same class as those owned by such shareholder.
      Share dividends may be approved by the shareholders, in lieu of payment of cash dividends, at an ordinary meeting.
      Additional ordinary shares may be issued:
  for cash;
 
  in satisfaction of or set off against liabilities, including indebtedness;
 
  for assets contributed to us in kind; or
 
  upon the conversion, exchange or redemption of securities or upon exercise of warrants to purchase ordinary shares.
      Capital decreases. Our share capital may generally only be decreased with the approval of two-thirds of the shareholders present or represented by proxy voting together as a single class at an extraordinary meeting. Reductions in share capital may be made either by decreasing the nominal value of the shares or reducing the number of shares. The number of shares may be reduced if we either exchange or repurchase and cancel shares. As a general matter, reductions of capital occur pro rata among all shareholders, except (1) in the case of a share buyback program, or a public tender offer to repurchase shares (offre publique de rachat d’actions (OPRA)), where such a reduction occurs pro rata only among tendering shareholders; and (2) in the case where all shareholders unanimously consent to an unequal reduction.
      Cross shareholdings and holding of our shares by our subsidiaries. French law prohibits a company from holding our shares if we hold more than 10% of that company’s share capital. French law also prohibits us from owning any interest in a French company holding more than 10% of our share capital. In the event of a cross-shareholding that violates this rule, the company owning the smaller percentage of shares in the other company must sell its interest. Until sold, these shares are not entitled to voting rights. Failure by the officers or directors of a company to sell these shares is a criminal offense. In the event that one of our

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subsidiaries holds our shares, these shares are not entitled to voting rights. However, French law does not require the subsidiary to sell the shares.
Description of ADSs
      The following is a summary of certain provisions of the deposit agreement for the ADSs and is qualified in its entirety by reference to the deposit agreement among Alcatel, The Bank of New York as depositary, and the holders from time to time of ADRs and the form of ADR itself, copies of which are attached as an exhibit to the registration statement on Form F-6 that we filed with the Securities and Exchange Commission on March 19, 2003. Additional copies of the deposit agreement are also available for inspection at the principal office of The Bank of New York, which is located at 101 Barclay Street, New York, New York 10286, and at the principal office of the custodian, Société Générale, located at 32, rue du Champ de Tir, 44312 Nantes, France.
      American depositary receipts. Each ADS represents one ordinary share. An American depositary receipt (ADR) may evidence any whole number of ADSs. The ordinary shares underlying the ADRs will be deposited with the custodian or any successor custodian, under the terms of the deposit agreement. Under French law and our articles of association and bylaws, shareholders must disclose the amount of their shareholding in certain circumstances.
      Deposit and withdrawal of ordinary shares. As used in this discussion, “deposited securities” means the ordinary shares deposited under the deposit agreement and all other securities, property and cash received by The Bank of New York or the custodian in respect or in lieu of the ordinary shares.
      If ordinary shares are deposited with the custodian, or at The Bank of New York’s principal office for forwarding to the custodian, The Bank of New York will issue ADRs representing a whole number of ADSs. Upon the payment of required taxes, charges and fees and the receipt of all required certifications, The Bank of New York will register the ADRs in the name of the person or persons specified by the depositor of the ordinary shares. No ordinary shares will be accepted for deposit unless accompanied by evidence satisfactory to The Bank of New York that any necessary approval has been granted by (a) the French governmental agency, if any, that regulates currency exchange and (b) the French governmental authority, if any, that regulates foreign ownership of French companies. We will not, and will not permit any of our subsidiaries to, deposit ordinary shares for which any necessary approval has not been granted.
      Upon surrender of ADRs at The Bank of New York’s principal office, and upon payment of the fees provided for in the deposit agreement, the ADR holder is entitled to the whole number of deposited ordinary shares that underlie the ADSs evidenced by the surrendered ADRs. The Bank of New York will deliver the underlying deposited ordinary shares to an account designated by the ADR holder. At the ADR holder’s request, risk and expense, The Bank of New York will deliver at its principal office certificates or other documents of title for the deposited securities, as well as any other property represented by the ADSs.
      Pre-release of ADRs. The Bank of New York may, unless we instruct it not to, issue ADRs prior to the receipt of ordinary shares. This is called a “pre-release.” In addition, The Bank of New York may also deliver ordinary shares upon the receipt and cancellation of ADRs, even if the ADRs were issued as a pre-release for which ordinary shares have not been received. In addition, The Bank of New York may receive ADRs in lieu of ordinary shares in satisfaction of a pre-release. Before or at the time of such a transaction, the person to whom ADRs or ordinary shares are delivered must represent that it or its customer:
  owns the ordinary shares or ADRs to be delivered to The Bank of New York;
 
  assigns to The Bank of New York in trust all rights to the ordinary shares or ADRs; and
 
  will not take any action inconsistent with the transfer of ownership of the ordinary shares or ADRs.

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      In addition, each transaction must be:
  fully collateralized (marked to market daily) with cash, U.S. government securities or other collateral of comparable safety and liquidity;
 
  terminable by The Bank of New York on not more than five business days’ notice; and
 
  subject to further indemnities and credit regulations as The Bank of New York deems appropriate.
      The Bank of New York will generally limit the number of ordinary shares represented by pre-release ADRs to 30% of the ordinary shares on deposit with the custodian under the ordinary deposit agreement.
Dividends, Other Distributions and Rights
      The Bank of New York is responsible for making sure that it or the custodian, as the case may be, receives all dividends and distributions in respect of deposited ordinary shares.
      Amounts distributed to ADR holders will be reduced by any taxes or other governmental charges required to be withheld by the custodian or The Bank of New York. If The Bank of New York determines that any distribution in cash or property is subject to any tax or governmental charges that The Bank of New York or the custodian is obligated to withhold, The Bank of New York may use the cash or sell or otherwise dispose of all or a portion of that property to pay the taxes or governmental charges. The Bank of New York will then distribute the balance of the cash and/or property to the ADR holders entitled to the distribution, in proportion to their holdings.
      Cash dividends and cash distributions. The Bank of New York will convert into dollars all cash dividends and other cash distributions that it or the custodian receives, to the extent that it can do so on a reasonable basis, and transfer the resulting dollars to the United States within one day. The Bank of New York will distribute to the ADR holder the amount it receives, after deducting any currency conversion expenses. If The Bank of New York determines that any foreign currency it receives cannot be converted and transferred on a reasonable basis, it may distribute the foreign currency (or an appropriate document evidencing the right to receive the currency), or hold that foreign currency uninvested, without liability for interest, for the accounts of the ADR holders entitled to receive it.
      Distributions of ordinary shares. If we distribute ordinary shares as a dividend or free distribution, The Bank of New York may, with our approval, and will, at our request, distribute to ADR holders new ADRs representing the ordinary shares. The Bank of New York will distribute only whole ADRs. It will sell the ordinary shares that would have required it to use fractional ADRs and then distribute the proceeds in the same way it distributes cash. If The Bank of New York deposits the ordinary shares but does not distribute additional ADRs, the existing ADRs will also represent the new ordinary shares.
      If holders of ordinary shares have the option of receiving a dividend in cash or in ordinary shares, we may also grant that option to ADR holders.
      Other distributions. If The Bank of New York or the custodian receives a distribution of anything other than cash or ordinary shares, The Bank of New York will distribute the property or securities to the ADR holder, in proportion to such holder’s holdings. If The Bank of New York determines that it cannot distribute the property or securities in this manner or that it is not feasible to do so, then, after consultation with us, it may distribute the property or securities by any means it thinks is fair and practical, or it may sell the property or securities and distribute the net proceeds of the sale to the ADR holders.

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      Rights to subscribe for additional ordinary shares and other rights. If we offer our holders of shares any rights to subscribe for additional ordinary shares or any other rights, The Bank of New York will, if requested by us:
  make the rights available to all or certain holders of ADRs, by means of warrants or otherwise, if lawful and feasible; or
 
  if it is not lawful or feasible to make the rights available, attempt to sell those rights or warrants or other instruments.
      In that case, The Bank of New York will allocate the net proceeds of the sales to the account of the ADR holders entitled to the rights. The allocation will be made on an averaged or other practicable basis without regard to any distinctions among holders.
      If registration under the Securities Act of 1933, as amended, is required in order to offer or sell to the ADR holders the securities represented by any rights, The Bank of New York will not make the rights available to ADR holders unless a registration statement is in effect or such securities are exempt from registration. We do not, however, have any obligation to file a registration statement or to have a registration statement declared effective. If The Bank of New York cannot make any rights available to ADR holders and cannot dispose of the rights and make the net proceeds available to ADR holders, then it will allow the rights to lapse, and the ADR holders will not receive any value for them.
      Record dates. The Bank of New York will fix a record date any time:
  a dividend or distribution is to be made;
 
  rights are issued; or
 
  The Bank of New York receives notice of any meeting of holders of ordinary shares or other securities represented by the ADRs.
      The persons who are ADR holders on the record date will be entitled to receive the dividend, distribution or rights, or to exercise the right to vote.
      Notices and reports. When we give notice, by publication or otherwise, of a shareholders’ meeting or of the taking of any action regarding any dividend, distribution or offering of any rights, we will also transmit to the custodian a copy of the notice, in the form given or to be given to holders of deposited securities. The Bank of New York will arrange for the mailing to ADR holders of copies of those notices in English, as well as other reports and communications that are received by the custodian as the holder of deposited securities.
      Voting of the underlying ordinary shares. Under the deposit agreement, an ADR holder is entitled, subject to any applicable provisions of French law, our articles of association and bylaws and the deposited securities, to exercise voting rights pertaining to the ordinary shares represented by its ADSs. The Bank of New York will send to ADR holders English-language summaries of any materials or documents provided by us for the purpose of exercising voting rights. The Bank of New York will also send to ADR holders directions as to how to give it voting instructions, as well as a statement as to how the underlying ordinary shares will be voted if it receives blank or improperly completed voting instructions.
      The voting rights per holder of ADSs cannot exceed 8% of the total number of voting rights present or represented at a meeting of shareholders (16% if double voting rights apply). ADSs will represent ordinary shares in bearer form unless the ADR holder notifies The Bank of New York that it would like the ordinary shares to be held in registered form.
      If The Bank of New York receives properly completed voting instructions, on or before the date specified, it will either vote the deposited securities in accordance with the instructions or forward the instructions to the custodian. If the voting instructions are forwarded to the custodian, the custodian will endeavor, insofar as practicable and permitted under applicable provisions of French law, our articles of

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association and bylaws and the deposited securities, to vote, or cause to be voted, the deposited securities in accordance with any nondiscretionary instructions. The Bank of New York will only vote ordinary shares or other securities that the ADRs represent in accordance with the ADR holder’s instructions. If it receives a blank proxy or improperly completed voting instructions, it will vote in accordance with a default position that will be stated in the proxy materials.
      Inspection of transfer books. The Bank of New York will keep books at its principal office in New York City for the registration and transfer of ADRs. Those books are open for inspection by ADR holders at all reasonable times, except that inspection is not permitted for purposes of communicating with holders of ADRs on matters that are not related to our business, the deposit agreement or the ADRs.
      Changes affecting deposited securities. If there is any change in nominal value or any split-up, consolidation, cancellation or other reclassification of deposited securities, or any recapitalization, reorganization, merger or consolidation or sale of assets involving us, then any securities that The Bank of New York receives in respect of deposited securities will become new deposited securities. Each ADR will automatically represent its share of the new deposited securities, unless The Bank of New York delivers new ADRs as described in the following sentence. The Bank of New York may, with our approval, and will, at our request, distribute new ADRs or ask ADR holders to surrender their outstanding ADRs in exchange for new ADRs describing the new deposited securities.
      Charges of The Bank of New York. The Bank of New York will charge ADR holders the following fees and expenses:
  fees for the registration of ADRs, the transfer, splitting-up or combination of ADRs, and the delivery of dividends, distributions or rights;
 
  taxes and other governmental charges;
 
  cable, telex, facsimile transmission and delivery expenses;
 
  expenses of conversions of foreign currency into U.S. dollars; and
 
  a fee of U.S. $5.00 (or less) per each 100 ADSs (or portion thereof) for the execution and delivery of ADRs and for the surrender of ADRs and withdrawal of deposited securities.
      Amendment of the deposit agreement. The Bank of New York and we may agree to amend the form of the ADRs and the deposit agreement at any time, without the consent of the ADR holders. If the amendment adds or increases any fees or charges (other than taxes or other governmental charges) or prejudices an important right of ADR holders, it will not take effect as to outstanding ADRs until three months after The Bank of New York has sent the ADR holders a notice of the amendment. At the expiration of that three-month period, each ADR holder will be considered by continuing to hold its ADRs to agree to the amendment and to be bound by the deposit agreement as so amended. The Bank of New York and we may not amend the deposit agreement or the form of ADRs to impair the ADR holder’s right to surrender its ADRs and receive the ordinary shares and any other property represented by the ADRs, except to comply with mandatory provisions of applicable law.
      Termination of the deposit agreement. The Bank of New York will terminate the deposit agreement if we ask it to do so and will notify the ADR holders at least 30 days before the date of termination. The Bank of New York may likewise terminate the deposit agreement if it resigns and a successor depositary has not been appointed by us and accepted its appointment within 90 days after The Bank of New York has given us notice of its resignation. After termination of the deposit agreement, The Bank of New York will no longer register transfers of ADRs, distribute dividends to the ADR holders, accept deposits of ordinary shares, give

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any notices, or perform any other acts under the deposit agreement whatsoever, except that The Bank of New York will continue to:
  collect dividends and other distributions pertaining to deposited securities;
 
  sell rights as described under the heading “— Dividends, other distributions and rights — Rights to subscribe for additional ordinary shares and other rights” above; and
 
  deliver deposited securities, together with any dividends or other distributions received with respect thereto and the net proceeds of the sale of any rights or other property, in exchange for surrendered ADRs.
      One year after termination, The Bank of New York may sell the deposited securities and hold the proceeds of the sale, together with any other cash then held by it, for the pro rata benefit of ADR holders that have not surrendered their ADRs. The Bank of New York will not have liability for interest on the sale proceeds or any cash it holds.
      Transfer of ADRs. ADRs are transferable upon surrender by the ADR holder, if the ADRs are properly endorsed and accompanied by the proper instruments of transfer. The Bank of New York will execute and deliver a new ADR to the person entitled to it. The Bank of New York may not suspend the surrender of ADRs and withdrawal of deposited securities, except for:
  temporary delays caused by the closing of transfer books maintained by The Bank of New York, us or our transfer agent or registrar;
 
  temporary delays caused by the deposit of ordinary shares in connection with voting at a shareholders’ meeting or the payment of dividends;
 
  the payment of fees, taxes and similar charges; or
 
  compliance with laws or governmental regulations relating to the Class A ADRs or to the withdrawal of deposited securities.
      The Bank of New York may refuse to deliver ADRs or to register transfers of ADRs when the transfer books maintained by The Bank of New York or our transfer agent or registrar are closed, or at any time that The Bank of New York or we think it is advisable to do so.
      Governing Law. The deposit agreement and the ADRs are governed by the laws of the State of New York.
Ownership of shares by non-French persons
      Under French law and our articles of association and bylaws, no limitation exists on the right of non-French residents or non-French shareholders to own or vote our securities.
      Both E.U. and non-E.U. residents must file an administrative notice (“déclaration administrative”) with French authorities in connection with the acquisition of a controlling interest in any French company. Under existing administrative rulings, ownership of 20% or more of a listed company’s share capital or voting rights is regarded as a controlling interest; however, a lower percentage may be held to be a controlling interest in certain circumstances depending upon such factors as the acquiring party’s intentions, its ability to elect directors or financial reliance by the French company on the acquiring party.
      The payment of all dividends to foreign shareholders must be effected through an accredited intermediary. All registered banks and credit establishments in France are accredited intermediaries.
      You should refer to “Description of Ordinary Shares” above for a description of the filings required based on shareholdings.

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Material contracts
      We have not entered into any material contracts requiring disclosure under this heading.
Exchange controls
      Under current French exchange control regulations, no limits exist on the amount of payments that we may remit to residents of the United States. Laws and regulations concerning foreign exchange controls do require, however, that an accredited intermediary must handle all payments or transfer of funds made by a French resident to a non-resident.
Taxation
      The following is a general summary of the material U.S. federal income tax and French tax consequences to you if you acquire, hold and dispose of our ordinary shares or ADSs. It does not address all aspects of U.S. and French tax laws that may be relevant to you in light of your particular situation. It is based on the applicable tax laws, regulations and judicial decisions as of the date of this annual report, and on the Convention between the United States of America and the Republic of France for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with respect to Taxes on Income and Capital dated as of August 31, 1994 (the “Treaty”) entered into force on December 30, 1995, all of which are subject to change, possibly with retroactive effect, or different interpretations.
      This summary may only be relevant to you if all of the following five points apply to you:
  You own, directly or indirectly, less than 10% of our capital,
 
  You are any one of (a), (b), (c) or (d) below:
  (a) an individual who is a citizen or resident of the United States for U.S. federal income tax purposes,
 
  (b) a corporation, or other entity taxable as a corporation that is created in or organized under the laws of the United States or any political subdivision thereof,
 
  (c) an estate, the income of which is subject to U.S. federal income tax regardless of its source, or
 
  (d) a trust, if a court within the United States is able to exercise a primary supervision over its administration and one or more U.S. persons have the authority to control all of the substantial decisions of such trust,
  You are entitled to the benefits of the Treaty under the “limitations on benefits” article contained in the Treaty,
 
  You hold our ordinary shares or ADSs as capital assets, and
 
  Your functional currency is the U.S. dollar.
      You generally will not be eligible for the reduced withholding tax rates under the Treaty if you hold our ordinary shares in connection with the conduct of business through a permanent establishment or the performance of services through a fixed base in France, or you are a nonresident in the United States for U.S. tax purposes.
      The following description of tax consequences should be considered only as a summary and does not purport to be a complete analysis of all potential tax effects of the purchase or ownership of our ordinary shares or ADSs. Special rules may apply to U.S. expatriates, insurance companies, tax-exempt organizations, financial institutions, persons subject to the alternative minimum tax, securities broker-dealers, traders in securities that elect to use a mark-to-market method of accounting for the securities’ holdings and persons

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holding their ordinary shares or ADSs as part of a hedging, straddle or conversion transaction, among others. Those special rules are not discussed in this annual report. Because this summary does not address all potential tax implications, you should consult your tax advisor concerning the overall U.S. federal, state and local tax consequences, as well as the French tax consequences, of your ownership of our ordinary shares or ADRs and ADSs represented thereby.
      For purposes of the Treaty and the U.S. Internal Revenue Code of 1986, as amended (the “Code”), if you own ADSs evidenced by ADRs, you will be treated as the owner of the ordinary shares represented by such ADSs.
Taxation of Dividends
      Withholding Tax and Tax Credit. In France, companies may only pay dividends out of income remaining after tax has been paid. When shareholders resident in France receive dividends from French companies, they historically were entitled to a tax credit, known as the avoir fiscal tax credit. However, the French Finance Law of 2004 eliminated the avoir fiscal mechanism and the related précompte mechanism. The avoir fiscal tax credit is no longer available for dividends paid after January 1, 2004 to corporate shareholders and after January 1, 2005 to individual shareholders.
      To compensate for the abolition of the avoir fiscal, for dividends paid as from January 1, 2005, French resident individuals will be subject to taxation on only 50 percent of the dividends received by them from both French and foreign companies, which rate is increased to 60 percent for dividends paid on or after January 1, 2006. This exemption will apply to any dividend distributed by a company that is subject to corporation tax or an equivalent tax and that is located in an EU member state or a country that has signed a tax treaty with France.
      In addition, French resident individuals will receive a tax credit equal to 50 percent of the dividends (which we refer to as the Tax Credit), capped at 115 for single individuals or married persons subject to separate taxation and 230 for married couples and members of a union agreement subject to joint taxation.
      French companies normally must deduct a 25% French withholding tax from dividends paid to nonresidents of France. Under the Treaty, this withholding tax is reduced to 15% if your ownership of our ordinary shares or ADSs is not effectively connected with a permanent establishment or a fixed base that you have in France.
      If your ownership of the ordinary shares or ADSs is not effectively connected with a permanent establishment or a fixed base that you have in France, we will withhold tax from your dividend at the reduced rate of 15%, provided that you (i) complete the French Treasury Form entitled “Certificate of Residence” which establishes that you are a resident of the U.S. under the Treaty, (ii) have it certified either by the Internal Revenue Service or the financial institution that is in charge of the administration of the ordinary shares or ADSs, and (iii) send it to us before the date of payment of the dividend.
      If you have not completed and sent the “Certificate of Residence” before the dividend payment date, we will deduct French withholding tax at the rate of 25%. In that case, you may claim a refund from the French tax authorities of any excess withholding tax in accordance with the following procedures.
  1. If you are an “eligible” U.S. holder as defined below, you must complete French Treasury Form RF1 A EU-No. 5052, entitled “Application for Refund of French Taxes on Dividends Entitled to the Tax Credit,” and send it to us early enough to enable us to file it with the French tax authorities before December 31st of the year following the year during which the dividend is paid.
 
  2. If you are not an “eligible” U.S. holder but nonetheless qualify as a resident of the United States under the Treaty, you must complete French Treasury Form RF1 B EU-No. 5053, entitled “Application for Refund of French Taxes on Dividends where the Recipient is not Entitled to the

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  Tax Credit,” and send it to us early enough to enable us to file it with the French tax authorities before December 31st of the year following the year during which the dividend is paid.

      You are “eligible” if any one of the following four points applies to you:
  1. You are an individual or other noncorporate holder that is a resident of the United States for purposes of the Treaty;
 
  2. You are a U.S. corporation, other than a regulated investment company;
 
  3. You are a U.S. corporation which is a regulated investment company, provided that less than 20% of your ordinary shares or ADSs are beneficially owned by persons who are neither citizens nor residents of the United States; or
 
  4. You are a partnership or trust that is a resident of the U.S. for purposes of the Treaty, but only to the extent that your partners, beneficiaries or grantors would qualify as “eligible” under point 1 or point 2 above.
      You can obtain the certificate, the forms and their respective instructions from the Depositary, the Internal Revenue Service or the French Centre des Impôts des non-résidents the address of which is 9 rue d’Uzès, 75094 Paris Cedex 2, France. If you are a U.S. holder of ADSs, the Depositary will file your completed certificate or form as long as you deliver it to the Depositary within the time period specified in the distribution to registered U.S. holders of ADSs.
      Any French withholding tax refund is generally expected to be paid within 12 months after you file the relevant French Treasury Form. However, it will not be paid before January 15, following the end of the calendar year in which the related dividend is paid.
      Prior to the French tax reform described above, an “eligible” U.S. individual holder could also claim the avoir fiscal tax credit (net of applicable withholding tax) in addition to the reduced rate of withholding tax. Instead, qualifying nonresident individuals who were previously entitled to a refund of the avoir fiscal tax credit may benefit, under the same conditions as for the avoir fiscal tax credit, from a refund of the Tax Credit (net of applicable withholding tax). Thus, if you are an “eligible” U.S. individual holder, you may be entitled to a refund of the Tax Credit (less a 15% withholding tax), provided that you are subject to U.S. federal income tax on the Tax Credit and the related dividend.
      U.S. holders that are legal entities, pension fund or other tax-exempt holders are no longer entitled to tax credit payments from the French Treasury.
      For U.S. federal income tax purposes, the gross amount of any distribution (including any related Tax Credit) will be included in your gross income as dividend income to the extent paid or deemed paid out of our current or accumulated earnings and profits as calculated for U.S. federal income tax purposes. You must include this amount in income in the year payment is received by you, which, if you hold ADSs, will be the year payment is received by the Depositary. Dividends paid by us will not give rise to any dividends-received deduction allowed to a U.S. corporation under Section 243 of the Code. They will generally constitute foreign source “passive” income for foreign tax credit purposes (or, for some holders, foreign source “financial services” income for tax years beginning before January 1, 2007).
      For tax years beginning before January 1, 2009, a maximum U.S. federal income tax rate of 15% will apply to dividend income received by an individual (as well as certain trusts and estates) from a U.S. corporation or from a “qualified foreign corporation” provided certain holding period requirements are met. A non-U.S. corporation (other than a passive foreign investment company) generally will be considered to be a qualified foreign corporation if (i) the shares of the non-U.S. corporation are readily tradable on an established securities market in the United States, or (ii) the non-U.S. corporation is eligible for the benefits of a comprehensive U.S. income tax treaty determined to be satisfactory to the United States Department of the Treasury. The United States Department of the Treasury and the Internal Revenue Service have

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determined that the Treaty is satisfactory for this purpose. In addition, the United States Department of the Treasury and the Internal Revenue Service have determined that ordinary shares, or an American Depositary Receipt in respect of such shares (which would include the ADSs), is considered readily tradable on an established securities market if it is listed on an established securities market in the United States such as the New York Stock Exchange. Information returns reporting dividends paid to U.S. persons will identify the amount of dividends eligible for the reduced tax rates.
      Also, for U.S. federal income tax purposes, the amount of any dividend paid in a foreign currency such as euros, including any French withholding taxes, will be equal to the U.S. dollar value of the euros on the date the dividend is included in income, regardless of whether you convert the payment into U.S. dollars. If you hold ADSs, this date will be the date the payment is received by the Depositary. You will generally be required to recognize U.S. source ordinary income or loss when you sell or dispose of the euros. You may also be required to recognize foreign currency gain or loss if you receive a refund of tax withheld from a dividend in excess of the 15% rate provided for under the Treaty. This foreign currency gain or loss will generally be U.S. source ordinary income or loss.
      To the extent that any dividends paid exceed our current and accumulated earnings and profits as calculated for U.S. federal income tax purposes, the distribution will be treated as follows:
  First, as a tax-free return of capital to the extent of your basis in your ordinary shares or ADSs, which will reduce the adjusted basis of your ordinary shares or ADSs. This adjustment will increase the amount of gain, or decrease the amount of loss, which you will recognize if you later dispose of those ordinary shares or ADSs.
 
  Second, the balance of the distribution in excess of the adjusted basis will be taxed as capital gain.
      French withholding tax imposed on the dividends you receive on your ordinary shares or ADSs at 15% under the Treaty is treated as payment of a foreign income tax eligible for credit against your federal income tax liability. Under the Code, the limitation on foreign taxes eligible for credit is not calculated with respect to all worldwide income, but instead is calculated separately with respect to specific classes of income. For this purpose, the dividends you receive on your ordinary shares or ADSs generally will constitute “passive” income (or, for some holders, foreign source “financial services” income for tax years beginning before January 1, 2007). Foreign tax credits allowable with respect to each class of income cannot exceed the U.S. federal income tax otherwise payable with respect to such class of income. The consequences of the separate limitation calculation will depend in general on the nature and sources of your income and deductions. Alternatively, you may claim all foreign taxes paid as an itemized deduction in lieu of claiming a foreign tax credit. A deduction does not reduce U.S. tax on a dollar-for-dollar basis like a tax credit. The deduction, however, is not subject to the limitations described above.
      The Précompte Tax. For taxable years ending before January 1, 2005, a French company is required to pay an equalization tax known as the précompte tax to the French tax authorities if it distributes dividends out of:
  profits which have not been taxed at the ordinary corporate income tax rate, or
 
  profits which have been earned and taxed more than five years before the distribution.
      The amount of the précompte tax is equal to 50% of the net dividend before withholding tax.
      Under the French Finance Law of 2004, distributions made by French companies from 2005 on will no longer be subject to the précompte tax. However, an exceptional levy of 25% will be imposed on distributions of untaxed earnings paid in 2005. Although the base for the exceptional levy will be the same as that for the précompte tax, the levy will apply to all distributions of earnings, including exceptional distributions from company reserves. The exceptional levy will not be refundable to shareholders.
      Distributions made from 2006 on will not give rise to précompte tax or the exceptional levy.

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Taxation of Capital Gains
      If you are a resident of the United States for purposes of the Treaty, you will not be subject to French tax on any gain if you sell your ordinary shares or ADSs unless you have a permanent establishment or fixed base in France and such ordinary shares or ADSs were part of the business property of that permanent establishment or fixed base. Special rules apply to individuals who are residents of more than one country.
      In general, for U.S. federal income tax purposes, you will recognize capital gain or loss if you sell or otherwise dispose of your ordinary shares or ADSs based on the difference between the amount realized on the disposition and your tax basis in the ordinary shares or ADSs. Any gain or loss will generally be U.S. source gain or loss. If you are a noncorporate holder, any capital gain will generally be subject to U.S. federal income tax at preferential rates if you meet certain minimum holding periods. Long-term capital gains realized upon a sale or other disposition of the ordinary shares or ADSs before the end of a taxable year which begins before January 1, 2009 generally will be subject to a maximum U.S. federal income tax rate of 15%.
Transfer Tax on Sale of Ordinary Shares or ADSs
      A 1% transfer tax capped at 3,049 per transfer applies to certain transfers of ordinary shares or ADSs in French corporations. On January 1, 2006, the rate was increased to 1.10% and the cap was increased to 4,000. The transfer tax does not apply to transfers of ordinary shares or ADSs in French publicly-traded companies that are not evidenced by a written agreement, or where that agreement is executed outside France. Therefore, you should not be liable to pay the transfer tax on the sale or disposition of your ordinary shares or ADS provided such sale or disposition is not evidenced by a written agreement or such agreement is not executed in France.
French Estate and Gift Taxes
      Under “The Convention Between the United States of America and the French Republic for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Estates, Inheritance and Gifts of November 24, 1978,” if you transfer your ordinary shares or ADSs by gift, or if they are transferred by reason of your death, that transfer will be subject to French gift or inheritance tax only if one of the following applies:
  you are domiciled in France at the time of making the gift, or at the time of your death, or
 
  you used the ordinary shares or ADSs in conducting a business through a permanent establishment or fixed base in France, or you held the ordinary shares or ADS for that use.
French Wealth Tax
      The French wealth tax generally does not apply to you if you are a “resident” of the United States for purposes of the Treaty.
U.S. Information Reporting and Backup Withholding
      In general, if you are a non-corporate U.S. holder of our ordinary shares or ADSs (or do not come within certain other exempt categories), information reporting requirements will apply to distributions paid to you and proceeds from the sale, exchange, redemption or disposal of your ordinary shares or ADSs.
      Additionally, if you are a non-corporate U.S. holder of our ordinary shares or ADSs (or do not come within certain other exempt categories) you may be subject to backup withholding at a current rate of 28% (increased to 31% for taxable years 2011 and thereafter) with respect to such payments, unless you provide a correct taxpayer identification number (your social security number or employer identification number), certify

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that you are not subject to backup withholding and otherwise comply with applicable requirements of the backup withholding rules. Generally, you will provide such certification on Internal Revenue Service Form W-9 (“Request for Taxpayer Identification Number and Certification”) or a substitute Form W-9.
      If you do not provide your correct taxpayer identification number, you may be subject to penalties imposed by the Internal Revenue Service, as well as backup withholding. However, any amount withheld under the backup withholding rules may be allowable as a credit against your U.S. federal income tax liability (which might entitle you to a refund), provided that you furnish the required information to the Internal Revenue Service.
      A non-U.S. holder of our ordinary shares or ADSs generally will be exempt from information reporting requirements and backup withholding, but may be required to comply with certification and identification procedures in order to obtain an exemption from information reporting and backup withholding.
U.S. State and Local Taxes
      In addition to U.S. federal income tax, you may be subject to U.S. state and local taxes with respect to your ordinary shares or ADSs. You should consult your own tax advisor concerning the U.S. state and local tax consequences of holding your ordinary shares or ADSs.
Documents on display
      We file reports with the Securities and Exchange Commission that contain financial information about us and our results or operations. You may read or copy any document that we file with the Securities and Exchange Commission at the Securities and Exchange Commission’s Public Reference Room at 100 F Street, N.E., Washington, D.C. 20549. You may obtain information about the Public Reference Room by calling the Securities and Exchange Commission for more information at 1-800-SEC-0330. All of our Securities and Exchange Commission filings made after February 4, 2002 are available to the public at the SEC web site at http://www.sec.gov. Our web site at http://www.alcatel.com includes information about our business and also includes some of our Securities and Exchange Commission filings prior to February 4, 2002. The contents of our website are not incorporated by reference into this Form 20-F. You may also inspect any reports and other information we file with the Securities and Exchange Commission at the offices of the New York Stock Exchange, 20 Broad Street, New York, New York 10005.

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Item 11. Quantitative and Qualitative Disclosures About Market Risk
      See Item 5 under “Qualitative and Quantitative Disclosures About Market Risk.”
Item 12. Description of Securities Other than Equity Securities
      Not applicable.
PART II
Item 13. Defaults, Dividend Arrearages and Delinquencies
      Not applicable.
Item 14. Material Modifications to the Rights of Security Holders
      Not applicable.
Item 15. Controls and Procedures
      (a) We performed an evaluation of the effectiveness of our disclosure controls and procedures that are designed to ensure that the material financial and non-financial information required to be disclosed on Form 20-F and filed with the Securities and Exchange Commission is recorded, processed, summarized and reported timely. Based on our evaluation, our management, including our Chief Executive Officer and Chief Financial Officer, have concluded that our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended) as of the end of the period covered by this report are effective. Notwithstanding the foregoing, there can be no assurance that our disclosure controls and procedures will detect or uncover all failures of persons within Alcatel to disclose material information otherwise required to be set forth in our reports, although our management, including our Chief Executive Officer and Chief Financial Officer, have concluded that, as of the end of the period covered by this report, our disclosure controls and procedures provide reasonable assurance of achieving their objectives.
      (b) As disclosed in Item 8 of this report and Note 34 to our consolidated financial statements, we noted some weaknesses with respect to our internal controls over financial reporting in certain of our foreign operations, which may involve the U.S. Foreign Corrupt Practices Act. We believe these weaknesses do not have a material impact on our financial results. We have taken actions which our management believes will enhance our internal controls over financial reporting in these and other foreign operations.
      Other than as noted in the preceding paragraph, there have been no significant changes in our internal controls or in other factors that could significantly affect our internal controls over financial reporting subsequent to the date of the evaluation thereof.
Item 16. Reserved
Item 16A. Audit Committee Financial Expert
      Our board of directors has determined that Daniel Lebègue is an “audit committee financial expert” and that he is independent under the applicable rules promulgated by the Securities and Exchange Commission and the New York Stock Exchange.

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Item 16B. Code of Ethics
      On February 4, 2004, our board of directors adopted a Code of Ethics for Senior Financial Officers that applies to our Chief Executive Officer and President, Chief Operating Officer, Chief Financial Officer and corporate controller. A copy of our Code of Ethics for Senior Financial Officers has been posted on our Internet website, http://www.alcatel.com. This Code of Ethics is in addition to our statement on business practices which also applies to our senior financial officers (see Item 6 — “Directors, Senior Management and Employees — Statement on Business Practices, Ethics Committee, Code of Ethics and Chief Compliance Officer”).
Item 16C. Principal Accounting Fees and Services
Fees and Services.
      Under French law, we are required to have two auditors, and we have appointed Barbier Frinault & Autres (Ernst & Young) and Deloitte & Associés to act in that capacity. These firms received approximately 89% of the total audit fees that we and our consolidated subsidiaries paid during 2005.
      The table below summarizes the audit fees paid by us and our consolidated subsidiaries during each of 2005 and 2004. Fees paid by our subsidiaries in the space business and consolidated using proportionate consolidation are taken into account only as to the percentage interest we hold in these companies. Fees paid by our non-consolidated subsidiaries are not reflected in this table and represent less than 5% of our total audit fees.
                                                                 
    2005   2004
         
        Barbier Frinault       Barbier Frinault
        & Autres       & Autres
    Deloitte & Associés   (Ernst & Young)   Deloitte & Associés   (Ernst & Young)
                 
    Amount   %   Amount   %   Amount   %   Amount   %
                                 
            (in thousands of euros)            
Audit Fees(1)
                                                               
Audit Fees
  6,875       87.3 %   4,454       88.4 %   5,162       70.4 %   3,506       58.3 %
Audit-Related Fees(2)
    689       8.8 %     525       10.4 %     1,041       14.2 %     2,090       34.7 %
                                                 
Subtotal
    7,564       96.1 %     4,979       98.8 %     6,203       84.5 %     5,597       93.0 %
Other Services
                                                               
Tax Fees(3)
    303       3.8 %     35       0.7 %     967       13.2 %     342       5.7 %
All Other Fees(4)
    7       0.1 %     26       0.5 %     167       2.3 %     77       1.3 %
                                                 
Subtotal
    310       3.9 %     61       1.2 %     1,134       15.5 %     419       7.0 %
                                                 
Total
    7,874       100.0 %     5,040       100.0 %     7,337       100.0 %     6,015       100.0 %
                                                 
 
(1) “Audit fees” are fees related to (a) statutory audits using applicable sets of accounting standards, (b) audits of the implementation of IFRS, (c) services associated with AMF and SEC reports, (d) attestations of management reports on internal controls or other services as required by law to be provided by the independent auditors and (e) accounting or disclosure treatment consultations.
 
(2) “Audit-related fees” are fees generally related to (a) due diligence investigations, (b) audits of combined financial statements prepared for purposes of the contemplated disposal of certain of our activities or of combined financial statements of companies that we acquired, (c) assignments relating to IFRS, (d) the Sarbanes-Oxley Act management review and (e) internal accounting functions and procedures.
 
(3) “Tax fees” are fees for professional services rendered by our auditors for tax compliance, tax advice on actual or contemplated transactions, tax consulting associated with international transfer prices and employee tax services.
 
(4) “All other fees” are principally fees related to environmental report review, information technology and training and support services.

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Audit Committee’s pre-approval policies and procedures.
      The audit committee of our board of directors chooses and engages our independent auditors to audit our financial statements, subject to the approval of our shareholders.
      According to the audit and non-audit pre-approval policy implemented in 2003, the audit committee gives its approval before engaging our auditors to provide any other audit or permitted non-audit services to us or our subsidiaries. This policy, which is designed to assure that such engagements do not impair the independence of our auditors, requires the audit committee to pre-approve various audit and non-audit services that may be performed by our auditors. In addition, the audit committee limited the aggregate amount of fees our auditors may receive under the pre-approval policy for 2005 for non-audit services in certain categories; fees in excess of such aggregate amount require specific approval.
      On a quarterly basis, we inform the audit committee of the pre-approved services actually provided by our auditors. Services of a type that are not pre-approved by the audit committee require pre-approval by the audit committee’s chairman on a case-by-case basis. The chairman of our audit committee is not permitted to approve any engagement of our auditors if the services to be performed either fall into a category of services that are not permitted by applicable law or the services would be inconsistent with maintaining the auditors’ independence.
Item 16D. Exemptions from the Listing Standards for Audit Committee
      Not Applicable.
Item 16E. Purchases of Equity Securities by the Issuer and Affiliated Purchasers
      At our annual meeting of shareholders held on May 20, 2005, our shareholders approved a resolution authorizing us, prior to the annual shareholders’ meeting to be held in 2006 and at the discretion of our board of directors, to purchase our shares and to hold up to 10% of our share capital. This resolution superseded a similar resolution approved by our shareholders at the annual shareholders’ meeting held in 2004. Although such authorizations were in place, during 2005 neither we nor any of our subsidiaries purchased any of our shares. As of December 31, 2005, we held directly 25,343,255 of our ordinary shares, and our subsidiaries held a total of 33,601,350 of our ordinary shares.
PART III
Item 17. Financial Statements
      See Item 18.

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Item 18. Financial Statements
      The following consolidated financial statements of Alcatel, together with the report of Deloitte & Associés for the years ended December 31, 2004 and 2005, are filed as part of this annual report.
         
    Page
     
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    F-2  
    F-3  
    F-5  
    F-7  
Notes to Consolidated Financial Statements:
       
      All schedules have been omitted since they are not required under the applicable instructions or the substance of the required information is shown in the financial statements.
Item 19. Exhibits
      1.1   Statuts (Articles of Association and By-Laws) of Alcatel (English translation) (incorporated by reference to Alcatel’s Report of Foreign Issuer on Form 6-K filed September 27, 2005).
      2.1   Form of Amended and Restated Deposit Agreement, as further amended and restated as of March 19, 2003, among Alcatel, The Bank of New York, as Depositary, and the holders from time to time of the ADRs issued thereunder, including the form of ADR (incorporated by reference to Exhibit A to Alcatel’s Registration Statement on Form F-6) (File No. 333-103885).
      8.    List of subsidiaries (see Note 36 to our consolidated financial statements included elsewhere herein).
      10.1 Consent of Independent Registered Public Accounting Firm.
      12.1 Certification of the Chief Executive Officer pursuant to §302 of the Sarbanes-Oxley Act of 2002.
      12.2 Certification of the Chief Financial Officer pursuant to §302 of the Sarbanes-Oxley Act of 2002.
      13.1 Certification of the Chief Executive Officer pursuant to 18 U.S.C. Section 1350.
      13.2 Certification of the Chief Financial Officer pursuant to 18 U.S.C. Section 1350.

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SIGNATURE
      The registrant hereby certifies that it meets all of the requirements for filing on Form 20-F and that it has duly caused and authorized the undersigned to sign this annual report on its behalf.
  ALCATEL
  By:  /s/ Jean-Pascal Beaufret
 
 
  Name: Jean-Pascal Beaufret
  Title: Chief Financial Officer
March 31, 2006

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ALCATEL AND SUBSIDIARIES
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Shareholders and the Board of Directors of Alcatel:
      We have audited the accompanying consolidated balance sheets of Alcatel and subsidiaries (the “Group”) as of December 31, 2005 and 2004, and the related consolidated statements of income, changes in equity, and cash flows for each of the two years in the period ended December 31, 2005 (all expressed in euros). These consolidated financial statements are the responsibility of the Group’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
      We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. The Group is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances but not for the purpose of expressing an opinion on the effectiveness of the Group’s internal control over financial reporting. Accordingly, we express no such opinion. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
      In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Alcatel and its subsidiaries as of December 31, 2005 and 2004, and the results of their operations and their cash flows for each of the two years in the period ended December 31, 2005, in conformity with International Financial Reporting Standards (“IFRS”) as adopted by the European Union.
      IFRS as adopted by the European Union vary in certain significant respects from accounting principles generally accepted in the United States of America. The application of the latter would have affected the determination of net income for each of the two years in the period ended December 31, 2005 and the determination of equity and financial position at December 31, 2005 and 2004, to the extent summarized in Notes 39 to 42.
Deloitte & Associés
Neuilly-sur-Seine, France
March 30, 2006

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ALCATEL AND SUBSIDIARIES
CONSOLIDATED INCOME STATEMENTS
                                   
    Note   2005(a)   2005   2004
                 
        (in millions except per share
        information)
Revenues
    (4) & (5)     $ 15,554     13,135     12,244  
Cost of sales
            (10,069 )     (8,503 )     (7,631 )
                         
Gross profit
            5,485       4,632       4,613  
Administrative and selling expenses
            (2,368 )     (2,000 )     (1,944 )
 
Research and development expenses before capitalization of development expenses
            (1,828 )     (1,544 )     (1,620 )
 
Impact of capitalization of development expenses
            120       101       130  
R&D costs
    (6)       (1,709 )     (1,443 )     (1,490 )
                         
Operating profit (loss)
    (4)       1,408       1,189       1,179  
Share-based payments (stock option plans)
    (23)       (82 )     (69 )     (60 )
Restructuring costs
    (27)       (130 )     (110 )     (324 )
Impairment of capitalized development costs
    (7)                   (88 )
Gain/(loss) on disposal of consolidated shares
            153       129        
                         
Income (loss) from operating activities
            1,349       1,139       707  
 
Financial interest on gross financial debt
            (258 )     (218 )     (226 )
 
Financial interest on cash and cash equivalents
            144       122       105  
Finance costs
    (8)       (114 )     (96 )     (121 )
Other financial income (loss)
    (8)       54       46       14  
Share in net income (losses) of equity affiliates
    (16)       (17 )     (14 )     (61 )
                         
Income before tax and discontinued operations
            1,273       1,075       539  
Income tax expense
    (9)       (108 )     (91 )     (36 )
                         
Income (loss) from continuing operations
            1,165       984       503  
Income (loss) from discontinued operations
    (10)       (15 )     (13 )     142  
                         
NET INCOME (LOSS)
          $ 1,150     971     645  
                         
Attributable to:
                               
— Equity holders of the parent
            1,101       930       576  
— Minority interests
            49       41       69  
Net income (loss) attributable to the equity holders of the parent per share (in euros)
                               
— Basic earnings per share
    (11)       0.81       0.68       0.43  
— Diluted earnings per share
    (11)       0.81       0.68       0.42  
Net income (loss) (before discontinued operations) attributable to the equity holders of the parent per share (in euros)
                               
— Basic earnings per share
            0.82       0.69       0.32  
— Diluted earnings per share
            0.82       0.69       0.31  
Net income (loss) of discontinued operations per share (in euros)
                               
— Basic earnings per share
            (0.01 )     (0.01 )     0.11  
— Diluted earnings per share
            (0.01 )     (0.01 )     0.11  
 
(a) Translation of amounts from into U.S. $ has been made merely for the convenience of the reader at the Noon Buying Rate of  1 = U.S. $1.1842 on December 31, 2005.
The accompanying Notes are an integral part of these Consolidated Financial Statements

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ALCATEL AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS AT DECEMBER 31
ASSETS
                                 
    Note   2005(a)   2005   2004
                 
    (in millions)
Goodwill, net
    (12)     $ 4,467     3,772     3,774  
Intangible assets, net
    (13)       970       819       705  
                         
Goodwill and intangible assets, net
            5,437       4,591       4,479  
                         
Property, plant and equipment
    (14)       5,396       4,557       4,674  
Depreciation
    (14)       (4,081 )     (3,446 )     (3,579 )
                         
Property, plant and equipment, net
            1,316       1,111       1,095  
                         
Share in net assets of equity affiliates
    (16)       718       606       604  
Other non-current financial assets, net
    (17)       362       306       554  
Deferred tax assets
    (9)       2,094       1,768       1,638  
Prepaid pension costs
    (25)       348       294       287  
Other non-current assets
    (21)       554       468       332  
                         
TOTAL NON-CURRENT ASSETS
            10,828       9,144       8,989  
                         
Inventories and work in progress, net
    (18) & (19)       1,703       1,438       1,273  
Amounts due from customers on construction contracts
    (18)       1,086       917       729  
Trade receivables and related accounts, net
    (18) & (20)       4,050       3,420       2,693  
Advances and progress payments
    (18)       147       124       90  
Other current assets
    (21)       979       827       1,418  
Assets held for sale
    (10)       59       50       196  
Current income taxes
            53       45       78  
Marketable securities, net
    (17) & (26)       758       640       552  
Cash and cash equivalents
    (26)       5,341       4,510       4,611  
                         
TOTAL CURRENT ASSETS
            14,176       11,971       11,640  
                         
TOTAL ASSETS
          $ 25,004     21,115     20,629  
                         
 
(a) Translation of amounts from into U.S. $ has been made merely for the convenience of the reader at the Noon Buying Rate of 1 = U.S. $1.1842 on December 31, 2005.
The accompanying Notes are an integral part of these Consolidated Financial Statements

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ALCATEL AND SUBSIDIARIES
LIABILITIES AND SHAREHOLDERS’ EQUITY
                                 
    Note   2005(a)   2005   2004
                 
    (in millions)
Capital stock (2 nominal value: 1,428,541,640 ordinary shares issued at December 31, 2005 and 1,305,455,461 ordinary shares issued and 120,780,519 shares to be issued related to Orane at December 31, 2004)
    (23)     $ 3,383     2,857     2,852  
Additional paid-in capital
            9,838       8,308       8,226  
Less treasury stock at cost
            (1,865 )     (1,575 )     (1,607 )
Retained earnings, fair value and other reserves
            (5,282 )     (4,460 )     (4,944 )
Cumulative translation adjustments
            206       174       (183 )
Net income (loss) — attributable to the equity holders of the parent
    (11) & (22)       1,101       930       576  
                         
Shareholders’ equity — attributable to the equity holders of the parent
    (23)       7,382       6,234       4,920  
                         
Minority interests
    (23)       565       477       373  
                         
TOTAL SHAREHOLDERS’ EQUITY
    (23) & (24)       7,947       6,711       5,293  
                         
Pensions, retirement indemnities and other post-retirement benefits
    (25)       1,730       1,461       1,459  
Bonds and notes issued, long-term
    (26)       2,834       2,393       3,089  
Other long-term debt
    (26)       425       359       402  
Deferred tax liabilities
    (9)       192       162       132  
Other non-current liabilities
    (21)       349       295       201  
                         
TOTAL NON-CURRENT LIABILITIES
            5,530       4,670       5,283  
                         
Provisions
    (27)       1,920       1,621       2,049  
Current portion of long-term debt
    (26)       1,239       1,046       1,115  
Customers’ deposits and advances
    (18) & (29)       1,355       1,144       973  
Amounts due to customers on construction contracts
    (18)       163       138       133  
Trade payables and related accounts
    (18)       4,447       3,755       3,350  
Liabilities related to disposal groups held for sale
    (10)                   97  
Current income tax liabilities
            117       99       179  
Other current liabilities
    (21)       2,287       1,931       2,157  
                         
TOTAL CURRENT LIABILITIES
            11,527       9,734       10,053  
                         
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY
          $ 25,004     21,115     20,629  
                         
 
(a) Translation of amounts from into U.S. $ has been made merely for the convenience of the reader at the Noon Buying Rate of 1 = U.S. $1.1842 on December 31, 2005.
The accompanying Notes are an integral part of these Consolidated Financial Statements

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ALCATEL AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
                           
    2005(a)   2005   2004
             
    (millions)
Cash flows from operating activities
                       
Net income (loss) — attributable to the equity holders of the parent
  $ 1,101     930     576  
Minority interests
    49       41       69  
Adjustments
    15       13       5  
                   
Net cash provided (used) by operating activities before changes in working capital, interest and taxes
    1,165       984       650  
                   
Net change in current assets and liabilities (excluding financing):
                       
— Decrease (increase) in inventories and work in progress
    (8 )     (7 )     (154 )
— Decrease (increase) in trade receivables and related accounts
    (589 )     (497 )     (231 )
— Decrease (increase) in advances and progress payments
    (37 )     (31 )     8  
— Increase (decrease) in trade payables and related accounts
    213       180       90  
— Increase (decrease) in customers’ deposits and advances
    186       157       (127 )
— Other current assets and liabilities (excluding financing)
    122       103       (139 )
                   
Cash provided (used) by operating activities before interest and taxes
    1,053       889       97  
                   
— Interest received
    137       116       113  
— Interest paid
    (169 )     (143 )     (175 )
— Taxes (paid)/received
    (15 )     (13 )     23  
                   
Net cash provided (used) by operating activities
    1,005       849       58  
                   
Cash flows from investing activities:
                       
Proceeds from disposal of tangible and intangible assets
    195       165       217  
Capital expenditures
    (756 )     (638 )     (579 )
 
Of which impact of capitalization of development costs
    (413 )     (349 )     (326 )
Decrease (increase) in loans and other non-current financial assets
    128       108       569  
Cash expenditures for acquisition of consolidated and non-consolidated companies
    (81 )     (68 )     (120 )
Cash proceeds from sale of previously consolidated and non-consolidated companies
    334       282       64  
(Increase) in marketable securities
    (36 )     (30 )     (265 )
                   
Net cash provided (used) by investing activities
    (214 )     (181 )     (114 )
                   

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    2005(a)   2005   2004
             
    (millions)
Cash flows from financing activities:
                       
Issuance/(repayment) of short-term debt
    (88 )     (74 )     (733 )
Issuance of long-term debt
                462  
Repayment/repurchase of long-term debt
    (953 )     (805 )     (983 )
Proceeds from issuance of shares
    15       13       12  
Proceeds from disposal/(acquisition) of treasury stock
    6       5        
Dividends paid
    (31 )     (26 )     (9 )
                   
Net cash provided (used) by financing activities
    (1,050 )     (887 )     (1,251 )
                   
Cash provided (used) by operating activities of discontinued operations
    (22 )     (19 )     (247 )
Cash provided (used) by investing activities of discontinued operations
    17       14       210  
Cash provided (used) by financing activities of discontinued operations
                (30 )
Net effect of exchange rate changes
    146       123       (50 )
                   
Net increase (decrease) in cash and cash equivalents
    (120 )     (101 )     (1,424 )
                   
Cash and cash equivalents at beginning of period/ year
    5,460       4,611       6,035  
                   
Cash and cash equivalents at end of period/ year
  $ 5,341     4,510 *   4,611  
                   
 
  * This amount includes 337 million of cash and cash equivalents held in countries subject to exchange control restrictions. Such restrictions can limit the use of such cash and cash equivalents by other group subsidiaries.
(a) Translation of amounts from into U.S. $ has been made merely for the convenience of the reader at the Noon Buying Rate of 1 = U.S. $1.1842 on December 31, 2005.
 
(b) The consolidated statements of cash flows are presented so as to isolate cash flows relating to disposed of or discontinued operations (see note 10).
 
(c) The corporate tax paid for 2004 amounted to 40 million (14 million for 2003 and 30 million for 2002) and the gross financial charges amounted to 179 million (294 million for 2003 and 674 million for 2002).
The accompanying Notes are an integral part of these Consolidated Financial Statements

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ALCATEL AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS’ EQUITY
                                                                                             
                                        Total        
                                        attributable        
                Additional       Changes in fair       Cumulative   Net   to the equity        
        Number of   Capital   paid-in   Retained   value and   Treasury   translation   income   holders of   Minority    
    Note   shares   stock   capital   earnings   other reserves   stock   adjustments   (loss)   the parent   interests   TOTAL
                                                 
    (in millions of euros except for number of shares outstanding)
Balance at January 1, 2004
        1,342,622,184       2,810       7,966       (4,951 )     50       (1,730 )                 4,145       388       4,533  
                                                                       
Financial assets available for sale
                                        32                               32               32  
Cumulative translation adjustments
                                                        (183 )             (183 )     (34 )     (217 )
Cash flow hedging
                                                                                       
Other adjustments
                                                                                       
                                                                       
Net income (loss) changes directly recognized in equity
                                        32               (183 )             (151 )     (34 )     (185 )
                                                                       
Net income (loss)
                                                                576       576       69       645  
                                                                       
Total of accounted expenses and revenues
                                        32               (183 )     576