20-F 1 alcatel20f.htm ALCATEL-LUCENT FORM 20-F Alcatel-Lucent Form 20F

2008
ANNUAL REPORT
ON FORM 20-F











SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

________________

Form 20-F


REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR (g) OF THE SECURITIES EXCHANGE ACT OF 1934

 

OR

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

 

For the fiscal year ended December 31, 2008

OR

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

 

OR

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


Commission file number: 1-11130

ALCATEL LUCENT

 (Exact name of Registrant as specified in its charter)


 N/A

(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)

Rémi Thomas

Telephone Number 33 (1) 40 76 10 10

Facsimile Number 33 (1) 40 76 14 00

54, rue La Boétie

75008 Paris, France

(Name, Telephone, E-mail and/or Facsimile Number and Address of Company Contact Person)


Securities registered pursuant to Section 12(b) of the Act:



Title of each class

Name of each exchange

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.

2,318,041,761 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

No

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

No

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

No

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

Accelerated filer

Non-accelerated filer

Indicate by check mark which basis of accounting the registrant has used to prepare the financial statements included in this filing:

U.S. GAAP International Financial Reporting Standards as issued by the International Accounting Standards Board Other

If “Other” has been checked in response to the previous question, indicate by check mark which financial statement item the registrant has elected to follow:

Item 17

Item 18

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

No










Table of Contents

1

Selected financial data

5

1.1

Condensed consolidated income statement and balance sheet data

6

1.2

Exchange rate information

7

2

Activity overview

9

2.1

Carrier Segment

9

2.2

Enterprise Segment

10

2.3

Services Segment

10

3

Risk factors

11

3.1

Risks relating to the business

11

3.2

Legal risks

16

3.3

Risks relating to ownership of our ADSs

17

4

Information about the Group

19

4.1

General

19

4.2

History and development

20

4.3

Structure of the principal companies consolidated in the Group as of December 31, 2008

24

4.4

Real estate and equipment

25

5

Description of the Group’s activities

29

5.1

Business organization

29

5.2

Carrier Segment

30

5.3

Enterprise Segment

34

5.4

Services Segment

35

5.5

Marketing and distribution of our products

36

5.6

Competition

36

5.7

Technology, Research and Development

37

5.8

Intellectual Property

38

5.9

Sources and availability of materials

39

5.10

Seasonality

39

5.11

Our activities in certain countries

39

5.12

Environmental matters

39

5.13

Human Resources

40

6

Operating and financial review and prospects

47

6.1

Overview of 2008

54

6.2

Consolidated results of operations for the year ended December 31, 2008 compared to the year ended December 31, 2007

56

6.3

Results of operations by business segment for the year ended December 31, 2008 compared to the year ended December 31, 2007

59

6.4

Consolidated results of operations for the year ended December 31, 2007 compared to the year ended December 31, 2006

62

6.5

Results of operations by business segment for the year ended December 31, 2007 compared to the year ended December 31, 2006

65

6.6

Liquidity and capital resources

67

6.7

Contractual obligations and off-balance sheet contingent commitments

70

6.8

Outlook for 2009

74

6.9

Qualitative and quantitative disclosures about market risk

75

6.10

Legal matters

76

6.11

Research and Development – expenditures

80

7

Corporate governance

83

7.1

Governance code

83

7.2

Management

86

7.3

Powers of the Board of Directors

93

7.4

Committees of the Board

95

7.5

Compensation

98

7.6

Statement of business principles and Code of ethics

109

7.7

Regulated agreements, commitments and related party transactions

109

7.8

Major Differences between our Corporate Governance Practices and NYSE Requirements

111

7.9

Operating Rules of the Board of Directors

111



Alcatel-Lucent - 2008 annual report on form 20-F - 2






8

Information concerning our capital

115

8.1

Share capital and voting rights

115

8.2

Diluted capital at December 31, 2008

115

8.3

Delegations of authority and authorizations

116

8.4

Use of authorizations

117

8.5

Changes in our capital over the last five years

118

8.6

Purchase of Alcatel-Lucent shares by the company

119

8.7

Outstanding Instruments giving right to shares

120

9

Stock exchange and shareholding

123

9.1

Listing

123

9.2

Trading over the last five years

124

9.3

Shareholder profile

126

9.4

Breakdown of capital and voting rights

126

9.5

Changes of shareholdings

129

9.6

Shareholders’ General Meeting

130

9.7

Trend of dividend per share over 5 years

131

10

Additional information

133

10.1

Legal information

133

10.2

Specific provisions of the by-laws and of law

133

10.3

American Depositary Shares, taxation and certain other matters

138

10.4

Documents on display

142

11

Controls and procedures, statutory Auditors’ fees and other matters

143

11.1

Controls and procedures

143

11.2

Report of independent registered public accounting firms

144

11.3

Statutory auditors

145

11.4

Statutory auditors’ fees

145

11.5

Audit Committee financial expert

146

11.6

Code of Ethics

147

11.7

Financial Statements

147

11.8

Exhibits

147

11.9

Cross-reference table between Form 20-F and this document

148

12

Consolidated financial statements at December 31, 2008

151

Report of independent registered public accounting firms

152

Consolidated income statements

153

Consolidated balance Sheets

154

Consolidated statements of cash flows

155

Consolidated statements of recognized income and expense

156

Consolidated statements of changes in shareholders’ equity

157

Notes to Consolidated Financial Statements

158




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Alcatel-Lucent - 2008 annual report on form 20-F - 4




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1

SELECTED FINANCIAL DATA

Our consolidated financial statements have been prepared in accordance with International Financial Reporting Standards (“IFRS”) as adopted by the European Union. 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 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. As permitted by U.S. securities laws, we no longer provide a reconciliation of our net income and shareholders’ equity as reflected in our consolidated financial statements that are prepared in accordance with IFRS, as adopted by the European Union and that are also in conformity with IFRS as issued by the International Accounting Standards Board, to U.S. GAAP.

On November 30, 2006, historical Alcatel and Lucent Technologies Inc., since renamed Alcatel-Lucent USA Inc. (“Lucent”), completed a business combination pursuant to which Lucent became a wholly owned subsidiary of Alcatel. On December 1, 2006, we and Thales signed a definitive agreement for the acquisition by Thales of our ownership interests in two joint ventures in the space sector created with Finmeccanica and our railway signaling business and integration and services activities for mission-critical systems not dedicated to operators or suppliers of telecommunications services. In January 2007, the transportation and security activities were contributed to Thales, and in April 2007, we completed the sale of our ownership interests in the two joint ventures in the space sector.

As a result of the Lucent transaction, our 2006 consolidated financial results include (i) 11 months of results of only historical Alcatel and (ii) one month of results of the combined company. As a result of the Thales transaction, our 2004, 2005 and 2006 financial results pertaining to the businesses transferred to Thales are treated as discontinued operations. Further, our 2005 and 2006 financial results take into account the effect of the change in accounting policies on employee benefits with retroactive effect from January 1, 2005 and our 2006 and 2007 financial results take into account the effect of the application of the interpretation IFRIC 14 with retroactive effect from January 1, 2006, as described in the section “Changes in accounting standards as of January 1, 2008” and in Note 4 of our consolidated financial statements included elsewhere in this document.

As a result of the purchase accounting treatment of the Lucent business combination required by IFRS, our results for 2008, 2007 and 2006 included several negative, non-cash impacts of purchase accounting entries.



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1.1

CONDENSED CONSOLIDATED INCOME STATEMENT AND BALANCE SHEET DATA

 

For the year ended December 31,

(in millions, except per share data)

2008 (1)

2008

2007

2006

2005

2004

Income Statement Data

      

Revenues

23,640

€ 16,984

€ 17,792

€ 12,282

€ 11,219

€ 10,263

Income (loss) from operating activities before restructuring costs, impairment of assets, gain/(loss) on disposal of consolidated entities and post-retirement plan amendments

(77)

(56)

(707)

687

1,016

1,003

Restructuring costs

(782)

(562)

(856)

(707)

(79)

(313)

Income (loss) from operating activities

(7,381)

(5,303)

(4,249)

(146)

1,066

602

Income (loss) from continuing operations

(7,246)

(5,206)

(4,087)

(219)

855

431

Net income (loss)

(7,200)

(5,173)

(3,477)

(61)

963

645

Net income (loss) attributable to equity holders of the parent

(7,259)

(5,215)

(3,518)

(106)

922

576

Earnings per Ordinary Share

      

Net income (loss) (before discontinued operations) attributable to the equity holders of the parent per share

      

basic (2)

$(3.23)

(2.32)

(1.83)

(0.18)

0.59

0.27

diluted (3)

$(3.23)

(2.32)

(1.83)

(0.18)

0.59

0.26

Dividend per ordinary share (4)

-

-

-

0.16

0.16

-

Dividend per ADS (4)

-

-

-

0.16

0.16

-


 

At December 31,

(in millions)

2008 (1)

2008

2007

2006

2005

2004

Balance Sheet Data

      

Total assets

U.S. $ 38,015

€ 27,311

€ 33,830

€ 41,890

€ 21,346

€ 20,629

Marketable securities and cash and cash equivalents

6,393

4,593

5,271

5,994

5,150

5,163

Bonds, notes issued and other debt – Long-term part

5,565

3,998

4,565

5,048

2,752

3,491

Current portion of long-term debt

1,527

1,097

483

1,161

1,046

1,115

Capital stock

6,453

4,636

4,635

4,619

2,857

2,852

Shareholders’ equity attributable to the equity holders of the parent after appropriation (5)

6,448

4,633

11,187

15,467

5,911

4,913

Minority interests

823

591

515

495

475

373

(1)

Translated solely for convenience into dollars at the noon buying rate of € 1.00 = U.S. $ 1.3919 on December 31, 2008.

(2)

Based on the weighted average number of shares issued after deduction of the weighted average number of shares owned by our consolidated subsidiaries at December 31, without adjustment for any share equivalent:

– ordinary shares: 2,259,174,970 in 2008; 2,255,890,753 in 2007; 1,449,000,656 in 2006; 1,367,994,653 in 2005 and 1,349,528,158 in 2004 (including 120,780,519 shares related to bonds mandatorily redeemable for ordinary shares).

(3)

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 consolidated 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:

– ordinary shares: 2,259,174,970 in 2008; 2,255,890,753 in 2007; 1,449,000,656 in 2006; 1,376,576,909 in 2005 and 1,362,377,441 in 2004.

(4)

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 to not pay a dividend for 2008 at our Annual Shareholders’ Meeting to be held on May 29, 2009.

(5)

Amounts presented are net of dividends distributed. Shareholders’ equity attributable to holders of the parent before appropriation are € 4,633 million, € 11,187 million, € 15,828 million, € 6,130 million and € 4,913 million as of December 31, 2008, 2007, 2006, 2005 and 2004 respectively and dividends proposed or distributed amounted to € 0 million, € 0 million, € 370 million, € 219 million and € 0 million as of December 31, 2008, 2007, 2006, 2005 and 2004 respectively.




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1.2

EXCHANGE RATE INFORMATION

The table below shows the average noon buying rate of euro from 2004 to 2008. 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 certified by the Federal Reserve Bank of New York for customs purposes.

Year

Average rate (1)

2008

$ 1.4726

2007

$ 1.3797

2006

$ 1.2728

2005

$ 1.2400

2004

$ 1.2478

(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

March 2009 (through March 27)

$ 1.3730

$ 1.2549

February 2009

$ 1.3064

$ 1.2547

January 2009

$ 1.3946

$ 1.2804

December 2008

$ 1.4358

$ 1.2634

November 2008

$ 1.3039

$ 1.2525

October 2008

$ 1.4058

$ 1.2446

September 2008

$ 1.4737

$ 1.3939


On March 27, 2009, the noon buying rate was € 1.00 = $ 1.3306.



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Alcatel-Lucent - 2008 annual report on form 20-F - 8




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2

ACTIVITY OVERVIEW

The charts below set forth the three business segments that comprised our organization in 2008: Carrier, Enterprise and Services. In 2008, our Carrier segment was organized into seven business divisions: IP, Fixed Access, Optics, Mobile Access, CDMA Networks, Multicore and Applications. Effective January 1, 2009, we reorganized our business into four groups: Carrier Product Group, Enterprise Product Group, Services Group, and Applications Software Group. The Carrier Product Group is now organized in four divisions: IP, Optics, Wireless and Wireline.

2.1

CARRIER SEGMENT

IP, FIXED ACCESS AND OPTICS

Position

Activities

Market positions

A world leader and privileged partner of telecom operators, enterprises and governments in transforming wireline networks toward an all-IP (internet Protocol) architecture – using broadband access, traffic aggregation to the optical transport network – with central focus on the IP intelligent router market. Our technology allows service providers to enrich the end-user experience which creates sustainable value.

Activities focus on the three main wireline market segments: access, optics and IP (internet Protocol). The portfolio of products we offer may be deployed anywhere in legacy and next-generation networks from the core to the access, facilitating the delivery of voice, data and video services (Triple Play) over broadband.

#1 in Broadband Access with 40.6% of DSL market share in 2008 (in revenues) (1)

#1 in optics (Terrestrial and Submarine) with 22.2% of market share in 2008 (in revenues) (2)

#2 in IP/MPLS Service Provider edge routers with 19% of market share in 2008 (in revenues) (3)

(1)

Dell’Oro.

(2)

Ovum.

(3)

Ovum.


MOBILE ACCESS AND CDMA NETWORKS

Position

Activities

Market positions

One of the world’s leading suppliers of wireless communications product offerings across a variety of wireless technologies; designing and supplying mobile telecommunications infrastructure for telecommunications operators.

Activities focus on wireless product offerings for 2G (GSM/GPRS/EDGE, CDMA), 3G (UMTS/HSPA/EV-DO) and 4G networks (WiMAX, LTE) from access to core switching.

#3 in GSM/GPRS/EDGE Radio Access Networks with 10.8% of market share in 2008 (in revenues) (4)

#3 in W-CDMA Radio Access Networks with 14.6% of market share in 2008 (in revenues) (5)

#1 in CDMA with 42.4% of market share in 2008 (in revenues) (6)

# 1 in WiMAX 802.16e with 30.2% of market share in 2008 (in base stations revenues) (7)

(4)

Dell’Oro.

(5)

Dell’Oro.

(6)

Dell’Oro.

(7)

Infonetic Research.




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MULTICORE AND APPLICATIONS

Position

Activities

Market positions

A leading supplier of communications product offerings that enable the delivery of innovative voice and multimedia services across a variety of devices and converged networks to serve some of the world’s largest fixed and mobile service providers.

Develop IP multimedia subsystems (IMS), and create advanced multimedia applications, including TV over IP, fixed and mobile video, music services, IP communication applications, and billable end-user services (charging and billing with converged payment, subscriber data management).

We have deployed IP/NGN products in more than 275 fixed and mobile networks, and we are involved in (various stages of deployment, trials and commercial roll out) more than 30 full IMS network transformation projects. In addition, there are more than 60 customers using our IMS application servers and services, and more than 190 networks using our subscriber data management applications.


2.2

ENTERPRISE SEGMENT

Position

Activities

Market positions

A world leader in the delivery of secure, dynamic communication product offerings for enterprises and government agencies, with emphasis on the education, finance, healthcare and hospitality industries and the public sector.

Supply end to end IP communication product offerings that interconnect networks, people, business processes and knowledge with real time communications (secure networking, telephony, unified communications, Genesys contact center and mobile applications) for small, medium, large and extra-large companies and public agencies.

#1 in Western Europe Enterprise Telephony with 17% of market share (in revenues) (8)

#1 in Contact Center agent revenue, Western Europe 2007 (Alcatel & Genesys combined) (9)

(8)

Gartner Dataquest, Market Share Enterprise Telephony Western Europe July 2008.

(9)

Gartner Market Share: Contact Centers, Western Europe, 2007, 27 June 2008.


2.3

SERVICES SEGMENT

Position

Activities

Market positions

A world leader in supplying services for telecom service providers and companies in selected verticals, with particular expertise in integrating complete telecommunication end-to-end product offerings.

Activities focus on supplying complete offerings for networks’ entire life cycle – consultation and conception, integration and deployment, exploitation and maintenance, as well as various partnership models to facilitate a total or partial outsourcing of operations.

#1 in worldwide Service Delivery Platform integration services (10)

Since many of our competitors define the overall services market differently, we are unable to provide overall services market positions.

(10)

Infonetics Research.



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3

RISK FACTORS

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.

3.1

RISKS RELATING TO THE BUSINESS

We have adopted a new strategic focus and we are shifting our resources to support that new focus. If our new strategic plan is not aligned with the direction our customers take as they invest in the evolution of their networks, customers may not buy our products or use our services.

We have adopted a new strategic plan as of January 1, 2009, and we are undergoing a strategic transformation and realignment of our operations in support of that new plan. The transformation we are undergoing includes reduced spending on research and development as we accelerate the shift in our investments from mature technologies that previously generated significant revenue for us toward certain next-generation technologies. Our choices of specific technologies to pursue and those to de-emphasize may prove to be inconsistent with our customers’ investment spending.

The telecommunications industry fluctuates and is affected by many factors, including the economic environment, decisions by service providers regarding their deployment of technology and their timing of purchases, as well as demand and spending for communications services by businesses and consumers.

Spending trends in the global telecommunications industry were negatively impacted by the deteriorating global macroeconomic environment in 2008, and we expect the global economy to deteriorate further in 2009. We expect the global telecommunications equipment and related services market to decline between 8% and 12% at constant currency in 2009, but in the context of the global economic environment, the degree of volatility and subsequent lack of visibility is at a historically high level and actual market conditions could be very different from what we expect and are planning for. Moreover, market conditions could vary geographically and across different technologies, and are subject to substantial fluctuations. Conditions in the specific industry segments in which we participate may be weaker than in other segments. In that case, the results of our operations may be adversely affected.

If capital investment by service providers is weaker than the 8% to 12% decline at constant currency rates that we anticipate, our revenues and profitability may be adversely affected. The level of demand by service providers can change quickly and can vary over short periods of time, including from month to month. As a result of the uncertainty and variations in the telecommunications industry, accurately forecasting revenues, results and cash flow remains difficult.

In addition, our sales volume and product mix will affect our gross margin. Therefore, if reduced demand for our products results in lower than expected sales volume, or if we have an unfavorable product mix, we may not achieve the expected gross margin rate, resulting in lower than expected profitability. These factors may fluctuate from quarter to quarter.

Our business requires a significant amount 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 have historically been, and they 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;

costs associated with potential restructuring actions; and

customer financing obligations.



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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 our revolving credit facility of € 1.4 billion maturing in April 2012 (with an extension until April 5, 2013 for an amount of € 837 million) and on which we have not drawn. 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 lenders and investors, our ability to meet the financial covenant for our revolving facility and debt and equity market conditions generally. Given current conditions, access to the debt and equity markets may not be relied upon at this time. Based on our current view of our business and capital resources and the overall market environment, we believe we have sufficient resources to fund our operations. If, however, the business environment were to materially worsen, the credit markets were to limit our access to bid and performance bonds, or our customers were to dramatically pull back on their spending plans, our liquidity situation could deteriorate. 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, assets sales or financing from third parties. We cannot provide any 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 ability to have access to the capital markets and our financing costs will be, 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 cannot provide any assurance that our credit ratings will be sufficient to give us access to the capital markets on acceptable terms, or that once obtained, such credit ratings will not be reduced by Standard & Poor’s, Moody’s or similar rating agencies.

Credit and commercial risks and exposures could increase if the financial condition of our customers declines.

A substantial portion of our sales are to customers in the telecommunications industry. These customers may require their suppliers to provide extended payment terms, direct loans or other forms of financial support as a condition to obtaining commercial contracts. We expect that we may 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, we expect to 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 significant payment from the customer. As a result of the financing that may be 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. As a result of the more challenging economic environment, we saw some increase in the number of our customers experiencing such difficulties in 2008, and we expect that trend to intensify as the global economy deteriorates further in 2009. That trend may be exacerbated in many emerging markets, where our customers are being affected not only by recession, but by deteriorating local currencies and a lack of credit. Upon the financial failure of a customer, we may experience losses on credit extended and loans made to such customer, losses relating to our commercial risk exposure, and the loss of the customer’s ongoing business. If 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.

The Group’s U. S. pension and post-retirement benefit plans are large and have funding requirements that fluctuate based on how their assets are invested, the performance of the financial markets world-wide, the level of interest rates, and changes in legal requirements. These plans are also costly, and our efforts to fund or control those costs may be ineffective.

In particular, many former and current employees and retirees of the Group in the U.S. participate in one or more of the following benefit plans:

management pension plan;

occupational pension plans;

post-retirement health care benefit plan for former management employees; and

post-retirement health care benefit plan for formerly represented employees.

The performance of the financial markets and the level of interest rates impact the funding obligations for the Group’s U.S. pension plans. Both of those factors contributed to a deterioration in the funded status of our pension plans in 2008. Specifically, the deterioration in equity markets contributed to a large decline in pension plan assets late in the year, while lower interest rates were reflected in lower discount rates that contributed to an increase in our pension obligations. A continuation of those trends could have a negative impact on the funded status and funding obligations of our pension plans.

As of January 1, 2009, we estimate that all of our U.S. pension plans meet the current funding requirements of the Internal Revenue Code of 1986 (the “Code”), as amended, and the Employee Retirement Income Security Act of 1974, as amended, each as further amended by the Pension Protection Act of 2006 (the “PPA”) and the Worker, Retiree, and Employer Recovery Act of 2008 (the “WRERA”), and we believe it is unlikely that the Group will make any material contributions to these plans through 2010. We are unable to provide an estimate of future funding requirements beyond fiscal year 2010 for the Group’s U.S. pension plans.



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Although we estimate that all of our material U.S. pension plans are overfunded under the requirements of ERISA and the Code (each as amended by PPA and WRERA), based on IFRS accounting standards to which the Group is subject, the management pension plan was underfunded by € 551 million as of December 31, 2008. For more details regarding this underfunding, see Note 25g to our consolidated financial statements included elsewhere in this annual report.

Section 420 of the Code, as amended by PPA and the U.S. Troop Readiness, Veterans’ Care, Katrina Recovery, and Iraq Accountability Appropriations Act, 2007, provides for the “qualified” transfer of pension plan assets--either for a single year or for two or more years--whereby pension plan assets in excess of 125% (for a “single-year” transfer) or 120% (for a “multi-year” transfer) of a pension plan’s funding obligations would be available to fund retiree health care costs.

As of the January 1, 2009 valuation date, the occupational pension plan had approximately € 2.1 billion of pension plan assets that would be eligible for transfer to fund retiree health care costs for a single year for Lucent’s formerly represented retirees. As of the same valuation date, € 2.5 billion would be available to fund such retiree health care costs for multiple years.

In December 2008 we made a multi-year “collectively bargained” Section 420 transfer of excess pension assets from the occupational pension plan for former Lucent employees in the amount of $ 653 million to fund healthcare benefits for Lucent’s formerly represented retirees for the period beginning January 1, 2008 through about September 30, 2009. We expect to make another multi-year “collectively bargained transfer” during 2009 to cover Lucent’s formerly represented retiree health care costs for the remainder of 2009 through the first nine months of 2010. Based on current actuarial assumptions we believe it is likely that all of the healthcare funding required for Lucent’s formerly represented retirees (assuming the present level and structure of benefits) could be addressed through Section 420 transfers. However, a deterioration in the funded status of our occupational pension plan could negatively impact our ability to make future Section 420 transfers.

The Group has also taken some steps, and we may take additional actions over time, to reduce the overall cost of our U.S. retiree health care benefit plans and the share of these costs borne by us, consistent with legal requirements and any collective bargaining obligations.

However, the cost increases may exceed our ability to reduce these costs. In addition, the reduction or elimination of U.S. retiree health care benefits by the Group has led to lawsuits against us. Any other initiatives that we undertake to control or reduce costs may lead to additional claims against us.

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 and the U.S. dollar. Because our financial statements are denominated in euros, fluctuations in currency exchange rates, especially the U.S. dollar against the euro, could have a material impact on our reported results.

We also experience other market risks, including changes in interest rates and in prices of marketable equity securities that we own. We may 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.

An impairment of other intangible assets or goodwill would adversely affect our financial condition or results of operations.

We have a significant amount of goodwill and intangible assets, including acquired intangibles, development costs for software to be sold, leased or otherwise marketed and internal use software development costs as of December 31, 2008. In connection with the combination between Alcatel and Lucent, a significant amount of additional goodwill and acquired intangible assets were recorded as a result of the purchase price allocation.

Goodwill and intangible assets with indefinite useful lives are not amortized but are tested for impairment annually, or more often, if an event or circumstance indicates that an impairment loss may have been incurred. Other intangible assets are amortized on a straight-line basis over their estimated useful lives and reviewed for impairment whenever events such as product discontinuances, plant closures, product dispositions or other changes in circumstances indicate that the carrying amount may not be wholly recoverable.

Historically, we have recognized significant impairment charges due to various reasons, including some of those noted above as well as potential restructuring actions or adverse market conditions that are either specific to us or the broader telecommunications industry or more general in nature. For instance, we accounted for an impairment loss of € 4.7 billion in 2008 related to a re-assessment of our near-term outlook, our decision to streamline our portfolio and our weaker than expected CDMA business. Additional impairment charges may be incurred in the future that could be significant and that could have an adverse effect on our results of operations or financial condition.



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We operate in a highly competitive industry with many participants. Our failure to compete effectively would harm our business.

We operate in a highly competitive environment in each of our businesses, competing on the basis of product offerings, technical capabilities, quality, service and pricing. Competition for new service provider and enterprise customers as well as for new infrastructure deployments is particularly intense and increasingly focused on price. We offer customers and prospective customers many benefits in addition to competitive pricing, including strong support and integrated services for quality, technologically-advanced products; however, in some situations, we may not be able to compete effectively if purchasing decisions are based solely on the lowest price.

We have a number of competitors, many of which currently compete with us and some of which are very large, with substantial technological and financial resources and established relationships with global service providers. Some of these competitors have very low cost structures. In addition, new competitors may enter the industry as a result of acquisitions or shifts in technology. These new competitors, as well as existing competitors, may include entrants from the telecommunications, computer software, computer services and data networking industries. We cannot assure you that we will be able to compete successfully with these companies. Competitors may be able to offer lower prices, additional products or services or a more attractive mix of products or services, or services or other incentives that we cannot or will not match or offer. These competitors may be in a stronger position to respond quickly to new or emerging technologies and may be able to undertake more extensive marketing campaigns, adopt more aggressive pricing policies and make more attractive offers to customers, prospective customers, employees and strategic partners.

Technology drives our products and services. If we fail to keep pace with technological advances in the industry, or if we pursue technologies that do not become commercially accepted, customers may not buy our products or use our services.

The telecommunications industry uses numerous and varied technologies and large service providers often invest in several and, sometimes, incompatible technologies. The industry also demands frequent and, at times, significant technology upgrades. Furthermore, enhancing our services revenues requires that we develop and maintain leading tools. We will not have the resources to invest in all of these existing and potential technologies. As a result, we concentrate our resources on those technologies that we believe have or will achieve substantial customer acceptance and in which we will have appropriate technical expertise. However, existing products often have short product life cycles characterized by declining prices over their lives. In addition, our choices for developing technologies may prove incorrect if customers do not adopt the products that we develop or if those technologies ultimately prove to be unviable. Our revenues and operating results will depend to a significant extent on our ability to maintain a product portfolio and service capability that is attractive to our customers, to enhance our existing products, to continue to introduce new products successfully and on a timely basis and to develop new or enhance existing tools for our services offerings.

The development of new technologies remains a significant risk to us, due to the efforts that we still need to make to achieve technological feasibility; due – as mentioned above – to rapidly changing customer markets; and due to significant competitive threats.

Our failure to bring these products to market in a timely manner could result in a loss of market share or a lost opportunity to capitalize on emerging markets, and could have a material adverse impact on our business and operating results.

Many of our current and planned products are highly complex and may contain defects or errors that are detected only after deployment in telecommunications networks. If that occurs, our reputation may be harmed.

Our products are highly complex, and there is no assurance that our extensive product development, manufacturing and integration testing is, or will be, adequate to detect all defects, errors, failures and quality issues that could affect customer satisfaction or result in claims against us. As a result, we might have to replace certain components and/or provide remediation in response to the discovery of defects in products that have been shipped.

The occurrence of any defects, errors, failures or quality issues could result in cancellation of orders, product returns, diversion of our resources, legal actions by customers or customers’ end users and other losses to us or to our customers or end users. These occurrences could also result in the loss of or delay in market acceptance of our products and loss of sales, which would harm our business and adversely affect our revenues and profitability.

Rapid changes to existing regulations or technical standards or the implementation of new ones for products and services not previously regulated could be disruptive, time-consuming and costly to us.

We develop many of our products and services based on existing regulations and technical standards, our interpretation of unfinished technical standards or the lack of such regulations and standards. Changes to existing regulations and technical standards, or the implementation of new regulations and technical standards relating to products and services not previously regulated, could adversely affect our development efforts by increasing compliance costs and causing delay. Demand for those products and services could also decline.



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Our ten largest customers accounted for 40% of our revenues in 2008, and most of our revenues come from telecommunications service providers. The loss of one or more key customers or reduced spending of these service providers could significantly reduce our revenues, profitability and cash flow.

Our ten largest customers accounted for 40% of our revenues in 2008. As service providers increase in size, it is possible that an even greater portion of our revenues will be attributable to a smaller number of large service providers going forward. Our existing customers are typically not obligated to purchase a certain amount of products or services over any period of time from us and may have the right to reduce, delay or even cancel previous orders. We, therefore, have difficulty projecting future revenues from existing customers with certainty. Although historically our customers have not made sudden supplier changes, our customers could vary their purchases from period to period, even significantly. Combined with our reliance on a small number of large customers, this could have an adverse effect on our revenues, profitability and cash flow. In addition, our concentration of business in the telecommunications service provider industry makes us extremely vulnerable to a downturn in spending in that industry, like the one that is developing in today’s increasingly challenging economic environment. Service providers are planning cuts in their 2009 capital expenditure budgets, and their reduced spending will have adverse effects on our results of operations.

We have long-term sales agreements with a number of our customers. Some of these agreements may prove unprofitable as our costs and product mix shift over the lives of the agreements.

We have entered into long-term sales agreements with a number of our large customers, and we expect that we will continue to enter into long-term sales agreements in the future. Some of these existing sales agreements require us to sell products and services at fixed prices over the lives of the agreements, and some require, or may in the future require, us to sell products and services that we would otherwise discontinue, thereby diverting our resources from developing more profitable or strategically important products. Since our new strategic plan entails a streamlined set of product offerings, it may increase the likelihood that we may have to sell products that we would otherwise discontinue. The costs incurred in fulfilling some of these sales agreements may vary substantially from our initial cost estimates. Any cost overruns that cannot be passed on to customers could adversely affect our results of operations.

We have significant international operations and a significant amount of our revenues are made in emerging markets and regions.

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. We expect to continue to focus on expanding business in emerging markets in Asia, Africa and Latin America. In many of these emerging markets, we may be 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 are 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. We are required to move products from one country to another and provide services in one country from a base in another. Accordingly, we are vulnerable to abrupt changes in customs and tax regimes that may have significant negative impacts on our financial condition and operating results.



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3.2

LEGAL RISKS

We are involved in lawsuits and investigations which, if determined against us, could require us to pay substantial damages, fines and/or penalties.

We are defendants in various lawsuits. These lawsuits against us include such matters as commercial disputes, claims regarding intellectual property, customer financing, product discontinuance, asbestos claims, labor, employment and benefit claims and others. We are also involved in certain investigations by government authorities. For a discussion of some of these legal proceedings and investigations, you should read “Legal Matters” in Section 6.10 of this annual report and Note 34 to our consolidated financial statements included elsewhere in this document. We cannot predict the extent to which any of the pending or future actions will be resolved in our favor, or whether significant monetary judgments will be rendered against us. Any material losses resulting from these claims and investigations could adversely affect our profitability and cash flow.

If we fail to protect our intellectual property rights, our business and prospects may be harmed.

Intellectual property rights, such as patents, are vital to our business and developing new products and technologies that are unique is critical to our success.

We have numerous French, U.S. and foreign patents and numerous pending patents.

However, we cannot predict whether any patents, issued or pending, will provide us with any competitive advantage or whether such patents will be challenged by third parties.

Moreover, our competitors may already have applied for patents that, once issued, could prevail over our patent rights or otherwise limit our ability to sell our products.

Our competitors also may attempt to design around our patents or copy or otherwise obtain and use our proprietary technology.

In addition, patent applications currently pending may not be granted.

If we do not receive the patents that we seek or if other problems arise with our intellectual property, our competitiveness could be significantly impaired, which would limit our future revenues and harm our prospects.

We are subject to intellectual property litigation and infringement claims, which could cause us to incur significant expenses or prevent us from selling certain products.

From time to time, we receive notices or claims from third parties of potential infringement in connection with products or services.

We also may receive such notices or claims when we attempt to license our intellectual property to others. Intellectual property litigation can be costly and time-consuming and can divert the attention of management and key personnel from other business issues.

The complexity of the technology involved and the uncertainty of intellectual property litigation increase these risks.

A successful claim by a third party of patent or other intellectual property infringement by us could compel us to enter into costly royalty or license agreements or force us to pay significant damages and could even require us to stop selling certain products.

Further, if one of our important patents or other intellectual property rights is invalidated, we may suffer losses of licensing revenues and be prevented from attempting to block others, including competitors, from using the related technology.

We are involved in significant joint ventures and are exposed to problems inherent to companies under joint management.

We are involved in significant joint venture companies. 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.

Our largest joint venture, Alcatel-Lucent Shanghai Bell, has this type of requirement.

We own 50% plus one share of Alcatel-Lucent Shanghai Bell, the remainder being owned by the Chinese government.

We are subject to environmental, health and safety laws that restrict our operations.

Our operations are subject to a wide range of environmental, health and safety laws, including laws relating to the use, disposal and clean up of, and human exposure to, hazardous substances. In the United States, these laws often require parties to fund remedial action regardless of fault. Although we believe our aggregate reserves are adequate to cover our environmental liabilities, factors such as the discovery of additional contaminants, the extent of required remediation and the imposition of additional cleanup obligations could cause our capital expenditures and other expenses relating to remediation activities to exceed the amount reflected in our environmental reserves and adversely affect our results of operations and cash flows. Compliance with existing or future environmental, health and safety laws could subject us to future liabilities, cause the suspension of production, restrict our ability to utilize facilities or require us to acquire costly pollution control equipment or incur other significant expenses.



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3.3

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 market price 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 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 requirements 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 most other public companies in the United States.

Judgments of U.S. courts, including those predicated on the civil liability provisions of the federal securities laws of the United States in French courts, may not be enforceable against us.

An investor located 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.

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.



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4

INFORMATION ABOUT THE GROUP

4.1

GENERAL

We provide product offerings that enable service providers, enterprises and governments worldwide, to deliver voice, data and video communication services to end-users. As a leader in fixed, mobile and converged broadband networking, IP technologies, applications and services, we leverage the technical and scientific expertise of Bell Labs, one of the largest innovation powerhouses in the communications industry. With operations in more than 130 countries, we are a local partner with global reach. We also have one of the most experienced global services teams in the industry.

Alcatel-Lucent is a French société anonyme, established in 1898, originally as a listed company named Compagnie Générale d’Électricité. Our 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 and the financial and monetary code.

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-lucent.com. The contents of our website are not incorporated into this document.

The address for Stephen R. Reynolds, our authorized representative in the United States, is Alcatel-Lucent USA Inc., 600 Mountain Avenue, Murray Hill, New Jersey 07974.



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4.2

HISTORY AND DEVELOPMENT

Set forth below is an outline of certain significant events of Alcatel-Lucent from formation until 2005:

May 31, 1898

French engineer Pierre Azaria forms the Compagnie Générale d’Électricité (CGE) with the aim of taking on the likes of AEG, Siemens and General Electric

1925

Acquisition by CGE of Compagnie Générale des Câbles de Lyon

1928

Formation of Alsthom by Société Alsacienne de Constructions Mécaniques and Compagnie Française Thomson-Houston

1946

Formation of Compagnie Industrielle des Téléphones (CIT)

1966

Acquisition by CGE of the Société Alsacienne de Constructions Atomiques, de Télécommunications et d’Électronique (Alcatel)

1970

Ambroise Roux becomes CGE’s Chairman. At the end of his term (1982), he remains Honorary Chairman until his death in 1999

1982

Jean-Pierre Brunet becomes CGE’s Chairman

1984

Georges Pebereau becomes CGE’s Chairman

Thomson CSF’s public telecommunication and business communication operations are merged into a holding company Thomson Télécommunications, which is acquired by the CGE group

1985

Alsthom Atlantique changes its name to Alsthom

Merger between CIT-Alcatel and Thomson Télécommunications. The new entity adopts the name Alcatel

1986

Formation of Alcatel NV following an agreement with ITT Corporation, which sells its European telecommunications activities to CGE

Pierre Suard becomes CGE’s Chairman. CGE acquires an interest in Framatome (40%). Câbles de Lyon becomes a subsidiary of Alcatel NV

1987

Privatization of CGE

Alsthom wins an order to supply equipment for the TGV Atlantique network and leads the consortium of French, Belgian and British companies involved in the building of the northern TGV network

1988

Alliance of Alsthom and General Electric Company (UK)

Merger of Alsthom’s activities and GEC’s Power Systems division into a joint venture

1989

Agreement between CGE and General Electric Company and setting up of GEC Alsthom

GEC acquires an equity interest in CGEE Alsthom (a company of CGE)

CGEE-Alsthom changes its name to Cegelec

1990

CGE-Fiat agreement. Alcatel acquires Telettra and Fiat acquires a majority stake in CEAC

Acquisition by Câbles de Lyon of Câbleries de Dour (Belgium) and Ericsson’s U.S. cable operations

Agreement on Framatome’s capital structure, with CGE holding a 44.12% stake

1991

Compagnie Générale d’Électricité changes its name to Alcatel Alsthom

Purchase of the transmission systems division of the American group Rockwell Technologies

Câbles de Lyon becomes Alcatel Cable and takes over AEG Kabel

1993

Acquisition by Alcatel Alsthom of STC Submarine Systems, a division of Northern Telecom Europe (today Nortel Networks)

1995

Serge Tchuruk becomes chairman and CEO of Alcatel Alsthom. He restructures the company focusing on telecommunications

1998

Alcatel Alsthom is renamed Alcatel

Acquisition of 16.36% in Thomson-CSF (now Thales)

Acquisition of DSC, a U.S. company, which has a solid position in the U.S. access market

Initial public offering of GEC ALSTHOM which becomes Alstom. Alcatel retains 24% in the newly-formed company

Alcatel sells Cegelec to Alstom

1999

Acquisition of the American companies Xylan, Packet Engines, Assured Access and Internet Devices, specializing in Internet network and solutions

Alcatel raises its ownership in Thomson-CSF (now Thales) to 25.3% and reduces its ownership in Framatome to 8.6%

2000

Acquisition of Newbridge Networks, a Canadian company and worldwide leader in ATM technology networks

Acquisition of the American company Genesys, worldwide leader in contact centers

The Cable and Components activities are subsidiarized and renamed Nexans

2001

Sale of its 24% share in Alstom

IPO of a significant part of Cables & Components business (Nexans activity). Alcatel retains 20% of Nexans shares

Acquisition of the remaining 48.83% stake held in Alcatel Space by Thales, bringing Alcatel’s ownership of Alcatel Space to 100%. After this transaction, Alcatel’s stake in Thales decreases to 20%

Sale of DSL modems activity to Thomson Multimedia

2002

Sale of its remaining interest in Thomson (formerly TMM)

Alcatel acquires control of Alcatel Shanghai Bell

Sale of 10.3 million Thales shares (Alcatel’s shareholding in Thales decreases from 15.83% to 9.7%)

2003

Acquisition of TiMetra Inc., a privately held, U.S.-based company that produces routers

Sale of Alcatel’s optical components business to Avanex

Sale of SAFT Batteries subsidiary to Doughty Hanson



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2004

Alcatel and TCL Communication Technology Holdings Limited form a joint venture mobile handset company. The joint venture company is 55% owned by TCL and 45% owned by Alcatel

Alcatel and Draka Holding NV (“Draka”) combine their respective global optical fiber and communication cable businesses. Draka owns 50.1% and Alcatel owns 49.9% of the new company, Draka Comteq BV

Acquisition of privately held, U.S.-based eDial Inc., a leading provider of conferencing and collaboration services for businesses and telephone companies

Acquisition of privately held, U.S.-based Spatial Communications (known as Spatial Wireless), a leading provider of software-based and multi-standard distributed mobile switching products

2005

Acquisition of Native Networks, a UK-based company providing of optical Ethernet goods and services

Sale of shareholding in Nexans, representing 15.1% of Nexans’ share capital, through a private placement

Merger of Alcatel space activities with those of Finmeccanica, S.p.A completed through the creation of Alcatel Alenia Space (Alcatel owned 67%, and Alenia Spazio, a unit of Finmeccanica, owned 33%) and Telespazio Holding (Finmeccanica owned 67%, and Alcatel owned 33%).

Exchange of Alcatel 45% interest in joint venture with TCL Communication for TCL Communication Shares (TCL owning all of the joint venture company and Alcatel owning 141,375,000 shares of TCL).


Recent events

No 2008 dividend. Our Board has determined that it is not prudent to pay a dividend on our ordinary shares and ADSs based on 2008 results. Our Board will present this proposal at our Annual Shareholders’ Meeting on May 29, 2009.

Change in credit rating. On March 3, 2009, Standard & Poor’s lowered to B+ from BB- its long-term corporate credit ratings and senior unsecured ratings on Alcatel-Lucent and on Lucent. The ratings on the trust preferred notes of Lucent Technologies Capital Trust were lowered to CCC+. The B short-term rating on Alcatel-Lucent was affirmed. The B1 short-term credit rating on Lucent was withdrawn and a negative outlook was issued.

On February 18, 2009, Moody’s lowered the Alcatel-Lucent Corporate Family Rating, as well as the rating for senior debt of the Group, from Ba3 to B1. The trust preferred notes of Lucent Technologies Capital Trust were downgraded from B2 to B3. The Not-Prime rating for the Group’s short-term debt was confirmed. The negative outlook of the ratings was maintained.

Thales. On February 4, 2009, we confirmed that our divestiture of our interest in Thales for € 1.6 billion was proceeding on plan (see “Highlights of transactions during 2008”).

Highlights of transactions during 2008

Acquisitions

Acquisition of Motive Networks. On October 7, 2008, we completed the acquisition of Motive, Inc., a U.S.-based company, through a tender offer for an aggregate purchase price of U.S. $ 67.8 million. The acquisition solidified the existing three-year relationship between the two companies, which had jointly developed and sold remote management software solutions for automating the deployment, configuration and support of advanced home networking devices called residential gateways (RGs). As a result of this combination, more than 70 service providers worldwide can now rely on a single solution to deliver a seamless, consistent, converged customer experience across a range of services, networks and devices, both fixed and mobile.

Dispositions

Thales. On December 19, 2008, we announced the signature of a definitive agreement regarding the acquisition by Dassault Aviation of our interest in Thales (41,262,481 shares).The total purchase price is based on a price of € 38 per Thales share, representing approximately € 1.57 billion. The closing of the transaction, expected to take place in the second quarter of 2009, is subject to certain governmental approvals, including with respect to antitrust.

Other matters

Moody’s. On April 3, 2008, Moody’s affirmed the Alcatel-Lucent Corporate Family Rating as well as that of the debt instruments originally issued by historical Alcatel and Lucent. The outlook was changed from stable to negative.

Update on joint venture with NEC. In February 2008, we and NEC announced the execution of a memorandum of understanding concerning the formation of a R&D joint venture focusing on the development of Long Term Evolution (LTE) wireless broadband access product offerings to support the network evolution of some of the leading carriers around the world. Leveraging the common LTE product strategy and platform of the joint venture, we and NEC each planned to manage delivery, project execution and dedicated support to our respective customers. Since then, the roadmaps as well as the technical and business requirements of key operators around the world have significantly evolved. Recognizing the diversity of the market, we and NEC agreed that a full-fledged R&D joint venture was an inappropriate option. We have further optimized and focused the scope and format of our technical collaboration in the LTE radio access space, and we are currently working on a Joint Development Agreement to share some key radio technologies between the two companies.



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Developments in Microsoft cases. On September 25, 2008, the Court of Appeals for the Federal Circuit in Washington D.C. affirmed the ruling of the lower court in San Diego, California, reversing the earlier jury verdict that had awarded us U.S. $ 1.5 billion in damages for patent infringement (see Section 6.10 “Legal Matters”). In a second phase of this litigation with Microsoft Corporation, which also involves Dell, on April 4, 2008, a jury awarded us approximately U.S. $ 368 million in damages on additional patents, and the judge granted prejudgment interest on that award on April 28, 2008. On December 15, 2008, we and Microsoft executed a settlement and license agreement whereby the parties agreed to settle the majority of their outstanding litigations. This settlement included dismissing all pending patent claims in which we are a defendant and provided us with licenses to all Microsoft patents-in-suit in these cases. Only the appeal of the April 2008 judgment against Microsoft and Dell remains currently pending in the Court of Appeals for the Federal Circuit.

Highlights of transactions during 2007

Acquisitions

Acquisition of Informiam. On December 11, 2007, we acquired Informiam LLC, a privately-held U.S.-based company and a pioneer in software that optimizes customer service operations through real-time business performance management. Informiam is now a business unit within Genesys.

Acquisition of NetDevices. On May 24, 2007, we acquired privately-held NetDevices, based in California. NetDevices sells enterprise networking technology designed to facilitate the management of branch office networks.

Acquisition of Tropic Networks. On April 13, 2007, we acquired substantially all the assets, including all intellectual property, of privately-held Tropic Networks. Canada-based Tropic Networks designs, develops and markets regional and metro-area optical networking equipment for use in telephony, data, and cable applications. We and Tropic Networks have been cooperating since July 2004, when historical Alcatel invested in the Canadian start-up.

The financial terms of these all-cash transactions were not disclosed, but were not material to the Group.

Dispositions

Sale of interest in Draka Comteq. In December 2007, we sold our 49.9% interest in Draka Comteq to Draka Holding, N.V., our joint venture partner in this company, for € 209 million in cash. Historical Alcatel formed this joint venture with Draka Holding in 2004 by combining its optical fiber and communication cable business with that of Draka Holding.

Sale of interest in Avanex. In October 2007, we sold our 12.4% interest in Avanex to Pirelli and entered into supply agreements with both Pirelli and Avanex for related components. We had acquired these shares in July 2003 when historical Alcatel sold its optronics business to Avanex.

Completion of transactions with Thales. On April 6, 2007, following the authorization of the European Commission on April 4, 2007, we sold our 67% interest in the capital of Alcatel Alenia Space (a joint venture company, created in 2005 with the space assets from Finmeccanica and historical Alcatel) and our 33% interest in the capital of Telespazio (a worldwide leader in satellite services) to Thales for € 670 million in cash, subject to an adjustment, the calculation of which is being performed. We had previously completed, on January 5, 2007, the contribution to Thales of our railway signaling business and our integration and services activities for mission-critical systems not dedicated to operators or suppliers of telecommunications services in exchange for 25 million newly issued Thales shares and € 50 million in cash, including purchase price adjustments.

Other matters

Conclusion of Class A and Class O litigation. Beginning in May 2002, several purported Class Action lawsuits were filed against us and certain of our officers and Directors challenging the accuracy of certain public disclosures that were made in the prospectus for the initial public offering of historical Alcatel’s Class O shares (which are no longer outstanding) and the accuracy of other public statements regarding the market for our former Optronics division’s products. The actions were consolidated in the U.S. District Court for the Southern District of New York. In June 2007, the court dismissed the plaintiff’s amended complaint and the time to appeal has expired.

Microsoft case update. On August 6, 2007, the U.S. District Court judge in San Diego, California presiding over our digital music patent infringement litigation with Microsoft Corporation issued his ruling on the post-trial hearings in which Microsoft argued for the reversal of the earlier jury verdict that had awarded us U.S. $ 1.5 billion in damages. The judge agreed with Microsoft and reversed the jury verdict.

Change in credit rating. On September 13, 2007, Standard & Poor’s revised our outlook, together with Lucent’s, from Positive to Stable. At the same time, our BB- long-term corporate rating, which had been set on December 5, 2006, was affirmed. Our B short-term corporate credit rating and Lucent’s B1 short-term credit rating, both of which had been affirmed on December 5, 2006, were also affirmed.

On November 7, 2007, Moody’s lowered the Alcatel-Lucent Corporate Family Rating as well as the rating of the senior debt of the Group, from Ba2 to Ba3. The Not-Prime rating was confirmed for the short-term debt. The stable outlook was maintained. The trust preferred notes of Lucent Technologies Capital Trust were downgraded from B1 to B2.

Highlights of transactions during 2006

Acquisitions

Acquisition of UMTS business from Nortel. On December 4, 2006, we signed an agreement with Nortel Networks Corporation (or Nortel) to acquire Nortel’s UMTS (Universal Mobile Telecommunications System) radio access business (including the technology and product portfolio), associated patents and tangible assets, as well as customer contracts and other related assets, for U.S. $ 320 million. The acquisition was completed on December 31, 2006.

Business combination with Lucent. On April 2, 2006, historical Alcatel and Lucent announced that they had entered into a definitive agreement. Completion of the business combination took place on November 30, 2006.

As a result of the business combination, each share of Lucent common stock issued and outstanding immediately prior to the effective time of the business combination was converted into the right to receive 0.1952 (the “Exchange Ratio”) of an ADS representing one ordinary share, nominal value € 2.00 per share, of Alcatel-Lucent. Outstanding options to purchase shares of Lucent common stock granted under Lucent’s option plans were converted into the right to acquire our ordinary shares, with the exercise price and the number of ordinary shares adjusted to reflect the Exchange Ratio. Lucent’s warrants and convertible debt securities outstanding at the effective time of the business combination also became exercisable for or convertible into our ADSs and ordinary shares with the strike price and number of ADSs or ordinary shares adjusted to reflect the Exchange Ratio.



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Acquisition of VoiceGenie. During the second quarter of 2006, we acquired privately-held VoiceGenie for € 30 million in cash. Founded in 2000, VoiceGenie is a leader in voice self-service solutions, with a software platform based on Voice XML, an open standard used for developing self-service applications by both enterprises and carriers.

Acquisition of 2Wire. On January 27, 2006, we acquired a 27.5% stake in 2Wire, a pioneer in home broadband network product offerings, for a purchase price of U.S. $ 122 million in cash.

Dispositions

Thales. On December 1, 2006, we signed an agreement with Thales for the transfer of our interests in two joint ventures in the space sector created with Finmeccanica and of our railway signaling business and our integration and services activities for mission-critical systems not dedicated to operators or suppliers of telecommunications services (see “Highlights of transactions during 2007 – Dispositions” above).

Other Transactions

Buy-out of Fujitsu joint venture. In August 2006, we acquired Fujitsu’s share in Evolium 3G, our wireless infrastructure joint venture with Fujitsu.



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4.3

STRUCTURE OF THE PRINCIPAL COMPANIES CONSOLIDATED IN THE GROUP AS OF DECEMBER 31, 2008

By percentage of share capital held.



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4.4

REAL ESTATE AND EQUIPMENT

We occupy, as an owner or tenant, a large number of buildings, production sites, laboratories and service sites around the world. There are two distinct types of sites with different sizes and features:

production and assembly sites dedicated to our various businesses;

sites that house research and innovation activities and support functions, which cover a specific region and all businesses.

A significant portion of assembly and research activities are carried out in Europe and China for all of our businesses. We also have operating subsidiaries and production and assembly sites in Canada, the United States, Mexico, Brazil and India.

At December 31, 2008, our total production capacity was equal to approximately 305,000 sq. meters and the table below shows the geographic region by business segment for 2008 of such production capacity.

We believe that these properties are in good condition and meet the needs and requirements of the Group’s current and future activity and do not present an exposure to major environmental risks that could impact the Group’s earnings.

The environmental issues that could affect how these properties are used are mentioned in Section 5.12 of this annual report.

Alcatel-Lucent, production capacity at December 31, 2008

(in thousands of m2)

Europe

North America

Asia-Pacific

Total

Carrier

162

33

89

284

Enterprise

21

0

0

21

Services

0

0

0

0

TOTAL

183

33

89

305


We are present in 130 countries and have approximately 800 sites, the most important of which are as follows:

Production/assembly sites

Country

Site

Ownership

China

Shanghai

Full ownership

France

Calais

Full ownership

France

Eu

Full ownership

United Kingdom

Greenwich

Full ownership

Italy

Battipaglia

Full ownership

Germany

Hannover

Full ownership

United States

Meriden

Full ownership



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Research and innovation and support sites

Country

Site

Ownership

Germany

Stuttgart

Lease

Germany

Nuremberg

Lease

Austria

Vienna

Full ownership

Belgium

Anvers

Lease

Brazil

São Paulo

Full ownership

Canada

Ottawa

Full ownership

China

Shanghai (Pudong)

Full ownership

Spain

Madrid

Lease

United States

Daly City

Lease

United States

Plano

Full ownership

United States

Whippany

Full ownership

United States

Naperville

Full ownership

United States

Murray Hill

Full ownership

France

Villarceaux

Lease

France

Vélizy

Lease

France

Lannion

Full ownership

France

Paris Headquarters

Lease

France

Orvault

Full ownership

India

Bangalore

Lease

India

Chennai

Lease

Italy

Vimercate

Lease

Mexico

Cuautitlan Izcalli

Full ownership

Netherlands

Hilversum

Lease

United Kingdom

Swindon

Lease

Singapore

Singapore

Lease



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4.5

MATERIAL CONTRACTS

Thales agreements

Overview. On December 1, 2006, we signed an agreement with Thales for the transfer of our transportation, security and space activities to Thales and on the future industrial cooperation of the two groups. This agreement follows the execution in 2006 of an agreement among Thales, Finmeccanica S.p.A., an Italian aerospace and defense company, and us, in which Finmeccanica agreed to the transfer to Thales of our 67% interest in Alcatel Alenia Space and our 33% interest in Telespazio Holding, our two joint ventures with Finmeccanica.

On January 5, 2007, our transportation and security activities were contributed to Thales and we received 25 million new Thales shares and a cash payment of € 50 million, including purchase price adjustments. The transfer of our space activities to Thales for a cash payment of € 670 million was finalized on April 6, 2007.

On December 19, 2008, we announced the signature of a definitive agreement regarding the acquisition by Dassault Aviation of our Thales shares. The closing of the transaction is expected to take place in the second quarter of 2009. For more detail about this sale, please refer to Section 4.2, “History and Development – Highlights of transactions during 2008 – Dispositions.” Until the closing, the cooperation agreement, shareholders’ agreement and the agreement regarding the strategic interest of the French State described below remain in full force and effect.

Cooperation Agreement. In connection with the transfer of certain of our transportation, security and space activities to Thales, we entered into a cooperation agreement on December 1, 2006 with Thales and the French government (the “French State”) governing the relationship between Thales and us after completion of the transaction. The cooperation agreement requires that Thales give preference to the equipment and solutions developed by us, in consideration for our agreement not to submit offers to military clients in certain countries, subject to certain exceptions protecting, in particular, the continuation of Lucent’s business with U.S. defense agencies. The agreement also includes non compete commitments by us with respect to our businesses being contributed to Thales, and by Thales with respect to our other businesses, in each case, subject to limited exceptions. The agreement also provides for cooperation between Thales and us in certain areas relating to Research and Development.

In connection with the Thales transaction, we entered into an amended shareholders agreement on December 28, 2006 with TSA, a French company wholly owned by the French State, which governs the relationship of the shareholders in Thales. The key elements of this relationship are described below.

Board of Directors of Thales. The Thales Board of Directors is comprised of 16 persons and includes (i) five Directors, proposed by the French State, represented by TSA; (ii) four Directors proposed by us, each of whom must be a citizen of the European Union, unless otherwise agreed by the French State; (iii) two Thales employee representatives; (iv) one representative of the employee shareholders of Thales; and (v) four independent Directors. The French State and we must consult with each other on the appointment of independent Directors. At least one Director appointed by the French State and one Director appointed by us sit on each of the board committees.

The French State and we each have the right to replace members of the Thales Board of Directors, such that the number of Directors appointed by each of the French State and us is equal to the greater of:

the total number of Directors (excluding employee representatives and independent Directors), multiplied by a fraction, the numerator of which is the percentage of shares held by the French State or us, as the case may be, and the denominator of which is the total shares held by the French State and us; and

the number of employee representatives and representatives of employee shareholders on the Thales Board of Directors.

Joint Decision-Making. The following decisions of the Thales Board of Directors require the approval of a majority of the Directors appointed by us:

the election and dismissal of the chairman/chief executive officer of Thales (or of the chairman and of the chief executive officer, if the functions are split) and the splitting of the functions of the chairman/chief executive officer;

the adoption of the annual budget and strategic plan of Thales;

any decision threatening the cooperation between us and Thales; and

significant acquisitions and sales of shares or assets (with any transaction representing € 150 million in revenues or commitments deemed significant).

If the French State and we disagree on (i) major strategic decisions deemed by the French State to negatively affect its strategic interests or (ii) the nomination of a chairman/chief executive officer in which we exercised our veto power, the French State and we must consult in an effort to resolve the disagreement. If the parties cannot reach a joint agreement within 12 months (reduced to three months in the case of a veto exercised on the nomination of the chairman/chief executive officer), either the French State or we may unilaterally terminate the shareholders agreement.

Shareholding in Thales. We will lose our rights under the shareholders agreement unless we hold at least 15% of the capital and voting rights of Thales. The shareholders agreement provides that the participation of the French State in Thales will not exceed 49.9% of the share capital and voting rights of Thales, including the French State’s golden share in Thales (described below under “Agreement Regarding the Strategic Interests of the French State”).

Duration of Shareholders Agreement. The amended shareholders agreement took effect on January 5, 2007 and will remain in force until December 31, 2011. The agreement provides that, unless one of the parties makes a non-renewal request at least six months before the expiration date, the agreement will be automatically renewed for five years. If the French State’s or our equity ownership drops below 15% of the then outstanding share capital of Thales, the following provisions apply:

the party whose ownership decreases below 15% of Thales’ share capital will, one year following the date on which such shareholding falls below 15%, no longer have rights under the shareholders agreement unless such party has acquired during that one-year period Thales shares so that it again owns in excess of 15% of the Thales share capital. If a party’s ownership decreases below 15%, the party will take the necessary actions to cause the resignation of the board members it has appointed so that their number reflects the proportion of Thales’ share capital and voting rights that such party maintains;



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the party whose shareholding has not decreased below the 15% threshold has a right of first refusal to acquire any shares the other party offers for sale to a third party in excess of 1% of the then outstanding share capital of Thales.

Breach of Our Obligations. In the case of a material breach by us of our obligations under the agreement relating to the strategic interests of the French State, which is defined as a breach that the French State determines may jeopardize substantially the protection of its strategic interests, the French State has the power to enjoin us to cure the breach immediately. If we do not promptly cure the breach or if the French State determines that foreign rules of extra territorial application that are applicable to us impose constraints on Thales likely to substantially jeopardize the strategic interests of the French State, the French State is entitled to exercise its termination remedies as described below.

If any natural person’s or entity’s equity ownership of us increases above the 20%; 33.33%, 40% or 50% thresholds, in capital or voting rights, we and the French State must consult as to the consequences of this event and the appropriateness of the agreement respecting the strategic interests of the French State to the new situation. If, after a period of six months following the crossing of the threshold, the French State determines that the share ownership of us is no longer compatible with its strategic interests and that the situation cannot be remedied through an amendment to the shareholders agreement, the French State is entitled to exercise its termination remedies as described below.

Termination Remedies. Upon a breach of our obligations described above or if a third party acquires significant ownership in us as described above and an amendment to the shareholders agreement will not remedy the concerns of the French State, the French State may:

terminate the shareholders agreement immediately;

if the French State deems necessary, require us to immediately suspend the exercise of our voting rights that exceed 10% of the total voting rights in Thales; or

if the French State deems necessary, require us to reduce our shareholding in Thales below 10% of the total share capital of Thales by selling our shares of Thales in the marketplace. If, after a period of six months, we have not reduced our shareholding, the French State may force us to sell all of our Thales shares to the French State or a third party chosen by the French State.

Agreement Regarding the Strategic Interests of the French State. On December 28, 2006, we entered into a revised agreement with the French State in order to strengthen the protection of the strategic interests of the French State in Thales. The terms of this agreement include, either as an amendment to, or as a separate agreement supplementing the shareholders agreement, the following:

we will maintain our executive offices in France;

Thales board members appointed by us must be citizens of the European Union, unless otherwise agreed by the French State, and one of our executives or board members who is a French citizen must be the principal liaison between us and Thales;

access to classified or sensitive information with respect to Thales is limited to our executives who are citizens of the European Union, and we are required to maintain procedures (including the maintenance of a list of all individuals having access to such information) to ensure appropriate limitations to such access;

normal business and financial information with respect to Thales is available to our executives and Directors (regardless of nationality);

the French State will continue to hold a golden share in Thales, giving it veto rights over certain transactions that might otherwise be approved by the Thales Board of Directors, including permitting a third party to own more than a specified percentage of the shares of certain subsidiaries or affiliates holding certain sensitive assets of Thales, and preventing Thales from disposing of certain sensitive assets;

the French State has the ability to restrict access to the Research and Development operations of Thales, and to other sensitive information; and

we must use our best efforts to avoid any intervention or influence of foreign state interests in the governance or activities of Thales.

National Security Agreement and Specialty Security Agreement

On November 17, 2006, the Committee on Foreign Investment in the United States (“CFIUS”), approved our business combination with Lucent. In the final phase of the approval process CFIUS recommended to the President of the United States that he not suspend or prohibit our business combination with Lucent, provided that we execute a National Security Agreement (“NSA”) and Specialty Security Agreement (“SSA”) with certain U.S. Government agencies within a specified time period. As part of the CFIUS approval process, we entered into a NSA with the Department of Justice, the Department of Homeland Security, the Department of Defense and the Department of Commerce (collectively, the “USG Parties”) effective on November 30, 2006. The NSA provides for, among other things, certain undertakings with respect to our U.S. businesses relating to the work done by Bell Labs and to the communications infrastructure in the United States. Under the NSA, in the event that we materially fail to comply with any of its terms, and the failure to comply threatens to impair the national security of the United States, the parties to the NSA have agreed that CFIUS, at the request of the USG Parties at the cabinet level and the Chairman of CFIUS, may reopen review of the business combination with Lucent and revise any recommendations submitted to the President. In addition, we agreed to establish a separate subsidiary to perform certain work for the U.S. government, and hold government contracts and certain sensitive assets associated with Bell Labs. This separate subsidiary has a Board of Directors including at least three independent Directors who are resident citizens of the United States who have or are eligible to possess personnel security clearances from the Department of Defense. These Directors are former U.S. Secretary of Defense William Perry, former National Security Agency Director Lt. Gen. Kenneth A. Minihan, USAF (Ret.) and former Assistant Secretary of the U.S Navy Dr. H. Lee Buchanan. The SSA, effective December 20, 2006, that governs this subsidiary contains provisions with respect to the separation of certain employees, operations and facilities, as well as limitations on control and influence by the parent company and restrictions on the flow of certain information.


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5

DESCRIPTION OF THE GROUP’S ACTIVITIES

5.1

BUSINESS ORGANIZATION

We announced several changes to our leadership team, organization, business model and strategic focus over the course of 2008. In September, we announced two key leadership changes: Philippe Camus became non-executive Chairman of the Board of Directors and Ben Verwaayen became Chief Executive Officer. In November, we announced that Paul Tufano became Chief Financial Officer. In addition, our Board of Directors initiated a process that ultimately resulted in a smaller Board – with 10 directors instead of 14 – consisting largely of new members. In November, we also announced our new organization and business model (effective January 1, 2009) which steps are part of a realignment of our operations in support of our new strategic focus that we announced in December 2008 and which is discussed below. All of these changes are intended to improve our profitability as they strengthen our focus on customers, simplify the organization, clarify accountability and responsibility, and improve the cost structure of our business.

Strategic Focus. Our new strategic vision for 2009 and beyond is to improve the internet or “web” experience of service providers, enterprises and end-users while improving our customers’ return on their investments. To do that, we intend to combine the creative innovation that is delivered on a best-efforts basis over the internet via so-called “over-the-top” services, like social networking, video sharing, etc. that treat the network as transport only, with the “trusted” services (security, quality of service, privacy, reliability, etc.) that leverage unique capabilities of the network-based service providers. The resulting combination will be more end-users who are willing to pay for more web-based services offered within a trusted environment. We believe the result is a sustainable business model that is beneficial for both network operators and web application creators; one that will fuel innovation and the capital investment required to expand the overall web experience to more people and businesses. In order to achieve this strategy, we will undergo a major strategic transformation and are taking significant steps to realign our operations. We will be focusing on three markets: service providers, enterprises, and selected verticals and on four key areas of investment: IP (internet protocol), optics, mobile and fixed broadband and applications enablement. Applications enablement is a key focus area because it includes all aspects of an “open” network architecture that need to be accessible to “over-the-top” application providers so they can develop more compelling, high value services for delivery over service provider networks.

Organization. The new organization structure effective January 1, 2009 includes:

four groups responsible for emphasizing our strengths in R&D in the design, development and overall product management of the products and services we offer our customers. One of the four groups is the Applications Software group (ASG), a new group that consolidates the various software businesses that were previously spread throughout the company, and is designed to increase our focus on and support for our software applications business. This new Applications software group is an integral part of our new strategic focus on new services and applications that combine the trusted capabilities of the network with the creative services delivered over the internet. ASG consists of the Applications Software business division that had previously been part of the Carrier group, the Genesys contact center software business that had previously been part of the Enterprise group, and the Operations Support Systems and Business Support Systems (OSS/BSS) software businesses that had previously been part of the Services group. The Carrier Product group has been simplified from six to four divisions: IP, Optics, Wireless and Wireline. The Enterprise Product group remains focused on small, medium and large enterprises and now also includes selected verticals – where customers in transportation, energy, health, defense and the public sector need large, complex communications networks. The Services group is focused on managed services, professional services, and network integration. It no longer includes OSS/BSS (operations support systems/business support systems) software activities that are now part of ASG, or the select verticals that are now part of the Enterprise Product group;

three regional organizations – one for the Americas, one for Asia Pacific, and one that includes Europe, the Middle East and Africa – to replace the two geographic structures that existed previously. The regions are accountable for serving customers and growing the business profitably. The regions’ primary mission is to sell and insure the highest customer satisfaction. The three regions will each have complete responsibility for all customer-focused activities except for the Enterprise market and the selected verticals included in the industry and public sector market;

three new organizations designed to sharpen our customer focus and reinforce our focus on operations. The Solutions and Marketing organization will focus on bringing together the right products and services to create the complex solutions required by customers to address new opportunities. The Quality Assurance and Customer Care organization will work with the regional organizations and the Groups to insure that our solutions, products and services are of the highest quality and will work seamlessly in our customer environments. A global Operations function will focus on our IT and procurement infrastructure, including manufacturing, logistics, supply chain and underlying processes, systems and IT;

an expanded management committee that reports to our CEO, with 14 members, including our CEO. The role of this committee is to oversee our strategy, organization, corporate policy matters, long term financial planning and human resources.

As a result, starting in 2009, we no longer organize our business according to the three former business segments – Carrier, Enterprise and Services – and we no longer organize the Carrier business around seven business divisions. However, in this annual report, we discuss the Carrier, Enterprise and Services segments that were in place for 2008.



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The 2008 organization is shown in the table below, which is followed by a table that shows how the 2008 organization was changed to create the 2009 organization:

 

CARRIER

ENTERPRISE

SERVICES

Fixed Access

Mobile Access

Multicore

Enterprise Solutions

Network Integration

IP

CDMA Networks

Applications

Genesys

Professional Services

Optics

  

Industrial Components

Maintenance

    

Network Operations


For financial information by operating segment and geographic market, see Note 5 to our consolidated financial statements and Chapter 6 – “Operating and financial review and prospects”, included elsewhere in this document.

5.2

CARRIER SEGMENT

The Carrier segment supplies a broad portfolio of products and solutions used by fixed, wireless and convergent service providers, as well as enterprises and governments, for their business critical communications. A key development that began in the wireline carrier market and is now taking place in the wireless carrier market is the transformation of networks to a high bandwidth, full Internet Protocol (or IP) architecture. This architecture enables service providers to provide enhanced, triple play services (internet, telephony and TV) to end users over any kind of broadband access (copper, fiber or wireless). For 2009 and beyond, as part of our strategic transformation, the Carrier Product group will shift its investment towards next-generation platforms:

by reinforcing those areas where we are market leaders (IP, Optics, broadband access, IMS core, CDMA EV-DO);

by boosting investment in focus areas such as LTE, W-CDMA, evolved packet core, open application enablers; and

by streamlining product offerings in mature portfolios such as CDMA 1x, GSM, ATM, ADSL, DLC and legacy applications.

In addition we expect to partner, co-source and participate in the consolidation of the industry to reduce spending for WiMAX, CPE, classic core, non-IMS based fixed next generation networks (or NGN) portfolio and some legacy applications, and during 2009 we expect to complete platform rationalization programs for W-CDMA and NGN.

In 2008, our carrier segment revenues were € 11,540 million including inter-company sales and € 11,514 million excluding inter-company sales, representing 68% of our total revenues.



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Fixed Access

We are the largest digital subscriber line (or DSL) vendor worldwide, and we also lead the Gigabit Passive Optical Networking (or GPON) market, with 41% of DSL revenues, and 46% of GPON Optical Line Termination (or GPON OLT) revenues in 2008 according to industry analyst firm Dell’Oro. This confirms our long-standing position as the worldwide leader in broadband access.

The Fixed access market is driven, on one hand, by the increased penetration of broadband in fast growing economies such as China and, on the other hand, by the introduction by service providers of triple play offerings (internet, telephony and TV). These enhanced services require increased bandwidth delivered over classical copper telephone lines, using DSL, and optical fiber that our customers are deploying in their access networks, closer to the end-user.

Our family of fixed access products, which are IP-based, provides support for both DSL and fiber. It enables service providers to optimize the combination of these technologies, depending on the network configuration and the area of installation. Our products allow carriers to offer voice, data and video (triple play functionality) over a single access line, and to deliver to their customers virtually unlimited broadcast channels, video on demand, HDTV (or high definition TV), VoIP (or voice over IP), high speed Internet, and business access services. The functionality of our products serves the needs of the carriers’ urban, suburban and rural customers.

Internet Protocol

Our portfolio of third generation IP routers and switches is designed to support the next wave of internet applications and services while helping service providers monetize their network investment and reduce customer churn. The portfolio consists of three product families that deliver multiple services – including triple play, Ethernet, Frame Relay, Asynchronous Transfer Mode (or ATM) and IP Virtual Private Networks (or VPN) business services – over different networks, including next-generation voice; IP-based core, radio access and mobile backhaul networks; and converged fixed/mobile networks. The three product families of switches and routers are:

Multi-service wide-area-network (or MS WAN) switches enable fixed line and wireless carriers to transition their existing networks to support newer technologies and services. They are based on a blend of technologies, which has integrated ATM and multi-protocol switching functions;

Internet Protocol/Multiprotocol Label Switching (or IP/MPLS) service routers were designed for internet-based services. They direct traffic within and between carriers’ networks to enable delivery of internet access, internet TV, mobile phone and text messaging and managed VPNs on a single common network infrastructure with superior performance and scale;

Carrier Ethernet service switches enable carriers to deliver residential, business and mobility services more cost-effectively than traditional methods due to higher capacity and performance.

The IP/MPLS and Carrier Ethernet products are designed to facilitate the development and availability of applications for the more participatory and more interactive Web 2.0 business and consumer services that offer carriers the opportunity to increase the profitability of their fixed and mobile networks and services without relying on subscriber growth alone. The products make it possible for service providers to offer and deliver services that are set forth in service level agreements between business enterprises and operators.

Our service routers and Ethernet service switches share a single operating system and network management that provides consistency of features, quality of service and operations, administration and maintenance capabilities from the network core to the customer edge – which is unique, cost-effective, and critical as carriers transform their networks to support new internet-based services. Our service routers are particularly well suited to deliver complex services to business, residential and mobile end-users, ensuring the high capacity, reliability and quality of service required to support HDTV channels, voice calls and high bandwidth internet access. Our IP/MPLS service routers and Ethernet service switches are often used in conjunction with our DSL and GPON access products to deliver these newer triple-play services.

Optics

Our Optics division designs and markets equipment to transport information over fiber optic connections 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 share of the optical networking market (measured in revenues) since 2001. The division also includes our microwave wireless transmission activities.

Terrestrial

Our terrestrial optical products offer a portfolio designed to seamlessly support service growth from the metro to the core parts of the network. With our products, carriers can manage voice, data and video traffic patterns based on different applications or platforms and can introduce a wide variety of competitive data-managed services, including multiple service quality capabilities, variable service rates and traffic congestion management. Most importantly, these products allow carriers to leverage their existing network infrastructure to offer these new services.

As the market leader in optical networking, we have played a key role in the transformation of optical transport networks. Our wavelength-division multiplexing (WDM) products address a variety of markets, from the enterprise to the ultra-long-haul, to meet service provider requirements for cost-effective, scalable networks that can handle their increased data networking needs. In 2008, our WDM product portfolio was enhanced with the launch of our “Zero Touch Photonics” approach which eliminates the need for frequent on-site interventions, allowing operators to solve bandwidth bottlenecks while offering the lowest cost per transported bit. This new approach facilitates the design and installation of a more flexible WDM network that is also easier to operate, manage and monitor. Our innovation in optics is also apparent in traffic aggregation, where our new packet optical transport technology allows for a virtually seamless migration to new IP-based services, and in optical switching, where our increasingly intelligent switches maximize the efficient utilization of network resources. All these products provide cost-effective, managed platforms that support different services and are suitable for applications in diversified network configurations.



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Submarine

We are an industry leader in the development, manufacturing, installation and management of undersea telecommunications cable networks. Our submarine cable networks can connect continents (using optical amplification due to the long distances), as well as a mainland and an island, or several islands together or many points along a coast. This market is characterized by relatively few large contracts that often require more than one year to complete, and current projects are concentrated on links between Europe and India, networks to connect West and East Africa, Mediterranean and South East Asia systems, as well as around the Indian sub-continent. In addition to new cable systems, this market also includes significant activity upgrading existing submarine networks as our customers respond to surging broadband traffic volumes.

 Wireless Transmission

We offer a comprehensive point-to-point portfolio of microwave radio products meeting both European telecommunications standards (or ETSI) and American standards-based (or 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, defense and security, energy and utilities. As a complement to optical fiber and other wireline systems, our portfolio of wireless transmission equipment supports a full range of network/radio configurations, network interfaces and frequency bands with high spectrum efficiency. Our next-generation packet microwave radio links enable operators to quickly and efficiently adapt their networks in line with traffic and service growth. We are the market leader in the long haul microwave market segment where microwave radio is used to transport signals over long distances.

Mobile Access

GSM

We develop mobile radio products for the second generation (or 2G) GSM (or Global System for Mobile communications) standard, including GPRS/EDGE (or General Packet Radio Service/Enhanced Data Rates for GSM Evolution) technology upgrades to that standard. Beginning in 2006, the GSM infrastructure market has experienced heightened competition, while remaining the world’s leading 2G mobile technology in terms of the number of subscribers. Subscriber growth has been particularly strong in emerging markets, such as China and India.

In 2008, our GSM product strategy focused on providing operators with total cost of ownership savings (i.e., savings that apply to capital expenditures and operating expenses) without compromising performance, scalability or future evolution, based on a renovated portfolio that we introduced at the end of 2006 and that is now fully field proven. This portfolio includes the Advanced Telecom Computing Architecture (or ATCA) Base Station Controller (or BSC) together with a new generation of transceiver that doubles the capacity of sites (or Twin TRX). We provide a full range of tailored GSM/EDGE products to satisfy all type of operators’ needs and challenges, including products for emerging markets, fast expansion, greenfield deployment or full network renovation.

As part of our innovation program, we developed products to address remote site constraints, where external power supplies are limited or not available. We are active in the “Green BTS (base station)” market with products maximizing renewable energy thanks to the significant power reductions offered by our Twin TRX technology. We have already deployed more than 400 solar powered BTSs worldwide. As a result, our GSM product line strategy allows us to take advantage of GSM growth opportunities in emerging markets.

Since 1999, our product strategy has focused on the ability to evolve our technology in order to deliver future capabilities while maintaining compatibility with earlier versions of the technology. To that end, we have delivered more than 500,000 multi-standard indoor and outdoor GSM base stations which are able to host 2G, 3G and 4G Long Term Evolution (or LTE) modules, allowing our customers to evolve smoothly from second generation GSM to third generation W-CDMA and fourth generation LTE technologies.

WiMAX

As part of the new strategic focus we announced in December 2008, our WiMAX activities for 2009 will be specifically focused on addressing the “enhanced Wireless DSL” market opportunity, which includes data-centric mobility usage on small laptop computers (or netbooks) and other mobile internet devices as well as residential and limited mobility PC use. This market segment positions WiMAX as a lower-cost alternative to building out a new landline network. As early as 2004, we announced a partnership with Intel – a key WiMAX proponent for the development of end-to-end product offerings to provide broadband connectivity over wireless networks, and we continue to work with them to drive the WiMAX market.

We believe that a broad, widely-inclusive ecosystem of WiMAX vendors (of infrastructure, handsets, etc.) will foster widespread development of the technology. Accordingly, in 2008, we marketed our Open Customer Premises Equipment Program, one of the industry’s premiere showcases and test-beds for WiMAX devices, and we continued to participate in the Open Patent Alliance (OPA), whose primary objective is to foster widespread access to WiMAX patent licenses. Finally, to further enrich the ecosystem, we announced in September 2008 that we had developed a new Seal of Interoperability Acceptance for Commercial Services (SIACS), designed to help ensure interoperability between WiMAX products.

In 2008, we entered into approximately 34 commercial contracts of which 10 are already in operation. These include OneMax in the Dominican Republic (the first commercial network operating in the 3.5 gigahertz spectrum band in Central and Latin America), Nuevatel and Entel in Bolivia, Packet One in Malaysia, WorldMax in The Netherlands (the first commercial network in Amsterdam, launched in June 2008), Mobilink in Pakistan, V-TEL in Georgia and WiMAX Telecom in Croatia.

W-CDMA

Wideband Code Division Multiple Access, referred to as W-CDMA or Universal Mobile Telephone Communications Systems, or UMTS, is the third generation (or 3G) wireless technology derived from the GSM standard deployed worldwide. The focus on W-CDMA and other 3G wireless technologies has increased as competition among operators has reduced the average revenue per user (or ARPU) that wireless operators recognize from their voice services. This competition has driven increased investment in 3G networks so that our customers can offer new mobile high-speed data capabilities to their customers in order to increase ARPU. 2008 has been a very important year for W-CDMA, as a growing subscriber base, new applications and increased market penetration have driven strong traffic growth. One specific aspect of that traffic growth is in the use of wireless data and of the mobile internet, with both operators and users citing the financial and social benefits of this technology.



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The iPhone® phenomenon has shown that there is strong end-user demand for W-CDMA’s mobile broadband capabilities, especially when they are offered via a user-friendly device. This, combined with the capability to deliver email to handheld devices like the Blackberry® or Ultra Mobile PCs, is at the heart of current 3G successes. The recent support of HSDPA and HSUPA (High Speed Downlink Packet Access and High Speed Uplink Packet Access – the latest evolution of W-CDMA technology) on networks and devices has led to significant increases in data speeds and the volume of data traffic. The demand for 3G services delivered over W-CDMA networks has also been driven by increasingly common flat-rate offers, at least for the data part of the end user subscription.

Our position in the W-CDMA market is the result of the rationalization of the product portfolios from our acquisition of Nortel’s 3G assets and the integration of the historical Alcatel and Lucent technologies into a single portfolio. In 2008 we delivered a new, converged software release for all of our customers. During 2009, we expect to complete the platform rationalization of W-CDMA.

TD-SCDMA

We have an alliance with Datang Mobile to foster the development of the TD-SCDMA (or Time Division-Synchronized Code Division Multiple Access) 3G mobile standard in China, where we deployed trial TD-SCDMA networks in 2006. In 2008, we were awarded the phase II trial of the TD-SCDMA network for China Mobile, leveraging our experience accumulated in the first phase that started in early 2007. In addition, we have a number of partnerships for the development of equipment and services based on Advanced Telecom Computing Architecture (or ATCA), a standard that reduces the cost and complexity of our customers’ mobile infrastructure.

LTE (Long-Term Evolution)

2008 saw a rapid surge of mobile data traffic fuelled by the success and proliferation of 3G-enabled devices. As mobile operators move to offer more flat-rate pricing plans, mobile traffic levels will continue to increase, putting additional pressure on existing network capacity. As user demand continues to evolve and the next generation of users gain access to personalised services, the need to evolve networks to support these increasing traffic levels while minimizing operating expenses and capital expenditures is leading operators to look forward to deploying fourth-generation LTE.

LTE offers service providers a highly compelling evolution path from existing networks (GSM, W-CDMA, CDMA or WiMAX) by simplifying the network and harmonizing on a common IP base, leading to better network performance and a lower cost per bit, thus lowering the total cost of ownership for network operators. It creates an environment in which consumers will be able to use wireless networks to access high-bandwidth content at optimal cost, enabling a new generation of services and affordability for mobile users. LTE is expected to become the technology of choice for wireless operators.

CDMA

CDMA2000 is the world’s leading 3G (third generation) wireless technology with over 463 million subscribers worldwide in 2008 according to the CDG (CDMA Development Group). It is deployed in spectrum ranging from 450 Mhz to 2,100 Mhz, with each carrier network deployed in smaller increments of spectrum than competing wireless product offerings. CDMA2000 provides operators with a path to increase capacity and coverage with minimum hardware and software upgrades. The most current technology, known as 1XEV-DO (Evolution Data Only) Revision A (“Rev A”), enables operators to offer high speed data supporting two-way, real-time data applications such as VoIP (voice over Internet Protocol), mobile video, push-to-talk and push-to multimedia. The next enhancement, Revision B, is expected to provide improvements significantly increasing throughput performance with minimal upgrades.

Despite increases in both CDMA subscribers and traffic volumes, we believe the market for CDMA infrastructure is mature and declining. We have revised our long-term outlook for this market, taking into account recent changes in market conditions as well as the potential negative impact of future technology evolutions. As with any product or technology that reaches a mature point in its life cycle, we are moderating our R&D investments in the current generation of CDMA to reflect the declines that will naturally take place in this market over time. We have been focusing our investments to sustain our CDMA revenue while we position to win in 4G. In addition, during 2009 we will emphasize improving our customers’ total cost of ownership through capital expenditure and operating expense improvements. Our CDMA Product Unit is also aggressively positioning LTE-ready High Efficiency products and assets for voice and data applications while it supports EVDO growth through enhancements in system capacity, reliability and performance and introduces EVDO VOIP for enhanced applications. These enhancements provide an elegant evolution to LTE, minimize footprint and improve power efficiency, thereby reinforcing our commitment to eco-sustainability and broadband data.

Applications

Our Applications business includes multimedia and communications related services such as web information, video and music, as well as payment and messaging products organized around the following portfolios:

IPTV (internet Protocol Television – the delivery of broadcast-like television over an IP network) and Multi-screen (multi-play services on the TV, PC, handheld devices, etc.): interactive, multimedia applications that can be delivered over fixed and mobile networks for residential use and personal entertainment;

mobile TV: the Alcatel-Lucent 5910 Mobile interactive TV solutions are ready-to-deploy, end-to-end solutions for delivering mobile interactive television service over various types of networks, including packet switched networks such as GPRS, 3G, and HSDPA (Unicast). Other network types include broadcast and multicast networks, such as Digital Video Broadcast Satellite services to Handheld (or DVB-(S)H) and Anycast, a network with many receiver endpoints, only one of which is chosen at any given time to receive information from the sender. We are a provider of the world’s first commercial trial of mobile TV service based on the Open Mobile Alliance’s BCAST Smartcard Profile in Singapore, with the Alcatel-Lucent 5910 MiTV platform.

In September 2008, at the International Broadcasting Convention in Amsterdam, we, together with other major players from the DVB-SH ecosystem delivered the world-first live demonstration of full end-to-end DVB-SH mobile TV, as well as the world-first implementation of the DVB-SH standard in the UHF band;

payment: we have a portfolio of end-to-end rating and billing offerings. We have long-standing field experience in bridging legacy and IP environments, including a range of solutions for the converged payment market, customer interactions market (800 toll-free numbers, gaming and premium numbers), deregulation market (number portability, carrier selection) and “smart metering” for utilities. Our convergent charging payment products are deployed in more than 200 networks and serve over 450 million subscribers;



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messaging: voice, data and next generation messaging services for mobile, fixed and convergent service providers.

The division also develops subscriber data management products, applications and convergent services for networks that are based on the IP-based IMS architecture. Although customer spending in this market has materialized more slowly than we had expected, we believe this sector offers strong growth potential, so we have increased resources and streamlined the portfolio to better address the specific areas where we see the most market opportunity. Our IMS services are available over any kind of access network, on any device, and may be blended with other IMS or non-IMS traditional services. Our complete IMS package (application and core network) is in more than 30 deployments or advanced trials, and more than 60 operators are using our IMS application servers and services.

Our subscriber data management portfolio is a suite of software applications that can be used by all types of service providers (fixed, wireless, converged) to manage subscriber data (subscription, authentication, mobility, etc.) that comes from multiple sources. Our subscriber data management applications have been deployed in more than 200 networks with over 775 million subscribers.

Multicore

The Multicore division offers core networking products that extend from classic switching systems, where we have a leading market position supporting approximately one quarter of the world’s installed lines, to IP next-generation core offerings (the IP Multimedia Subsystem, IMS) for fixed, mobile and convergent operators. We have deployed our IP/NGN products in more than 275 fixed and mobile networks, and we are involved in more than 30 full IMS network transformation projects. Carriers have expressed a strong desire to migrate their embedded base with products that are scalable, beginning with basic voice services and growing into enriched multimedia services enabled by IMS. Based on these market needs, in 2008 we released a new version of our market leading IMS software, running on standards-based hardware, which incorporates innovations from Bell Laboratories, that enables carriers to deploy a less complex, greener, IMS solution and provides both NGN and IMS functionality. Using our IMS service architecture, operators can differentiate their products and services with quality of service controls and deliver new services that go beyond simple voice and internet usage.

5.3

ENTERPRISE SEGMENT

Our enterprise segment provides end to end offerings including software, hardware and services that interconnect networks, people, processes and knowledge. The division addresses the enterprise and government markets via indirect channels and a dedicated sales and marketing force that leverages our innovation, integration and unique engagement capabilities to address small to extra large and multinational businesses and government agencies. A network of over 2100 alliance partners, business partners and system integrators support our global customer base.

The group’s traditional portfolio includes:

secure converged communication infrastructure offering total continuous service for voice, local, wide and wireless area networks;

personalized tools for collaboration, customer service (including contact center) and mobility;

communication-enabled business process solutions designed to improve execution and service delivery;

product offerings that provide context-aware, content-driven knowledge sharing across any access;

carrier grade solutions and a comprehensive services offering.

Following our repositioning of the Enterprise segment into high growth sectors in 2007, including security and services, efforts in 2008 were directed toward deepening our customer relationships through improved engagement models, including additional investments in our direct sales channel, our channel management capabilities and our relationships with our carrier customers.

We continued to enhance our Unified Communications (UC) portfolio through the release of our 2008 editions of Corporate and Office Communications Solutions. The My Instant Communicator unified communications solution, that we integrated with IBM Sametime during 2008 received industry recognition in independent tests for its delivery of state-of-the art UC functionality and performance. Our Office Communications release in 2008 leveraged the trend towards open source with its support for open API (application program interface) development, allowing partners and customers to rapidly and cost effectively introduce new services for small and medium businesses.

The data networking business contributed significantly to our growth in 2008. The OmniSwitch evolution reinforced our market leading capabilities in terms of availability, security, convergence and eco-sustainability for Ethernet core, aggregation and edge networking. In addition, we launched new products specifically tailored for medium-sized businesses and specific industries. The OmniAccess WLAN (wireless local area network) portfolio was enriched with the support of the 802.11n set of standards for WLANs and other wireless networks.

Our Genesys contact center business continued to gain market share in a difficult economic climate, and it broadened its portfolio beyond the contact center with the acquisitions of Conseros and SDE Software Development Engineering. Conseros brings business applications that allow enterprises to manage and distribute high volumes of work anywhere in the enterprise. SDE is the developer of the Genesys Customer Interaction Portal, a Web-based capability that allows our service provider customers to offer contact center capabilities with on-demand or as-needed licensing to their enterprise customers.



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We market and sell our enterprise segment solutions to enterprises and government agencies under our own vision of what we call the Dynamic Enterprise, where interconnection of network, people, processes and knowledge differentiates a company’s competitiveness and efficiency.

In 2008, our enterprise segment revenues were € 1,590 million including inter-company sales and € 1,551 million excluding inter-company sales, representing 9% of our total revenues.

5.4

SERVICES SEGMENT

Our services business segment uses a combination of IT experience and network expertise to integrate clients’ networks to enable faster, more reliable and cost-effective communications. Our offerings are centered on five areas where we believe we can enhance value by designing, integrating, implementing and running complex projects in a changing environment. Across these five areas, we are focused on high value-added services – including network transformation and other professional services – across multiple technologies and vendors in order to provide our customers with a complete and high quality offering.

The five service areas on which we are focused are:

IP Network Transformation;

Multivendor Maintenance;

Systems & Applications Integration;

Managed Services & Network Operations;

Selected Verticals.

IP network transformation services (including network planning, design, consulting, project management, and optimization services) help our customers choose a migration plan to a new technology, which will allow our clients to effectively seize new revenue opportunities, optimize performance, reduce operating expenses, and plan an evolution of their network to capitalize on their investment and drive bottom-line results. Our project management services help our customers meet their time to market needs and budgetary targets by identifying, analyzing and mitigating risks.

We are a global player in the delivery of multi-vendor maintenance services. Multi-vendor maintenance services create operational efficiencies for customers by restructuring and streamlining traditional maintenance functions and delivering improved service levels at a lower total cost. Our global reach, multi-vendor technology skills, integrated delivery capability, and delivery track record characterize our offerings. Multi-vendor services include technical support to diagnose, restore, and resolve network problems, and spare parts management to improve asset utilization. They include remote and on-site technical support services for both proactive and reactive maintenance services.

Systems and applications integration services consist of specialized consulting services that help carriers leverage their network assets to introduce new and innovative services. These professional services help our customers significantly reduce the time required to bring new applications to market, streamline and enhance their current operational processes, and integrate their new service delivery environment with their operational and business support systems. We offer a powerful combination of network and IT expertise, and we continue to invest in our IT expertise. In 2008, for example, we purchased ReachView, an IT assurance integrator company in North America to enhance our breadth of IT competences. Some of the new integration contracts we signed in 2008 were with Belgacom of Belgium to design and integrate IMS applications and a core network solution, with Vodacom South Africa for integrating its new 3G network, and with eircom of Ireland for integration services associated with its IP network transformation project.

Managed services & network operations services consist of a wide range of outsourced network operations and network transformation services that help our clients reduce their operating expenses while enhancing network reliability. Managed services provide a seamless transition to an outsourced environment utilizing state-of-the-art tools and technology plus highly skilled technicians to provide ongoing network management of our customers’ networks. These functions can be performed at our 10 network operations centers, at our 4 IP transformation centers, or at the customer’s network operations center. We believe that the market for managed services offers significant growth opportunities on a stand alone basis as well as offering a significant opportunity to build long lasting relationships with our customers. Managed services and network operations services also offer a way to capitalize on an emerging industry trend for operators to share network infrastructure. Since these services often require an up-front investment by us in both resources and the tools required to manage and operate the networks, we are disciplined and selective in our approach when pursuing new managed services opportunities. We currently provide network operation services to more than 70 networks with more than 140 million subscribers around the world, including new 2008 customers such as BT Global Services.

Selected Verticals are an area of increasing focus where we have significantly increased resources. The target markets within Verticals are transportation, energy and the public sector. In these markets, customers require complex private communications networks to support their mission-critical operations. Whether providing internet access to passengers in high-speed trains, enabling power utilities enhanced control over their transmission grids, monitoring the transport of several million barrels of oil per day in real-time over thousands of kilometers, offering innovative e-government services and very high speed broadband to citizens, or enhancing large administrations’ and enterprises’ efficiency, all of these missions require reliable, future-proof, and multi-service communication networks. We use our carrier-grade equipment and services to meet the mission-critical requirements in these markets: from design, integration and deployment to operations and maintenance. In 2008, some of our new Verticals customers were Poland’s A2 motorway, the Public Security Secretary for the state of Sao Paulo in Brazil, RTE (a subsidiary of French utility EDF Group) for its integrated fiber-optic network and King Shaka International Airport (South Africa).



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In 2008, our services segment revenues were € 3,452 million including inter-company sales and € 3,441 million excluding inter-company sales, representing 20% of our total revenues.

5.5

MARKETING AND DISTRIBUTION OF OUR PRODUCTS

We sell substantially all of our products and services to the world’s largest telecommunications service providers through our direct sales force, except in China where our products are also marketed through indirect channels and joint ventures that we have formed with Chinese partners. For sales to Tier 2 and Tier 3 service providers, we use our direct sales force and value-added resellers. Under the organization structure that became effective January 1, 2009, our three regional organizations each have complete responsibility for all customer-focused activities, except for the Enterprise market. Our enterprise communications products are sold through business partners and distributors that are supported by our direct sales force.

In order to strengthen our customer focus, we decided at the beginning of 2009 to discontinue the use of third party sales agents. This decision will be implemented over the course of a transition period. Furthermore, we have created two new organizations to (i) improve solutions that are designed for customers and (ii) ensure that the mix of products and services that are delivered to customers have been appropriately tested and have the required quality assurance. The Solutions and Marketing organization will focus on pre-sales activities and bring together the right products and services to create the solutions required by customers to address new opportunities. It will provide the link between the business groups’ experts and the regions’ knowledge of their customers’ needs. The Quality Assurance and Customer Care organization will insure that our solutions, products, and services are of the highest quality and will work seamlessly and reliably in our customers’ networks.

5.6

COMPETITION

We have one of the broadest portfolios of 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 Systems, Ericsson, Fujitsu, Huawei, ZTE, Motorola, Nokia Siemens Networks (NSN) and Nortel Networks Corporation. Some of our competitors, such as Ericsson, NSN, Huawei and Nortel, compete across many of our product lines while others – including a number of smaller companies – compete in one segment or another. The list of our competitors may change as a result of the difficult economic environment – for example, Nortel’s recent decision to file for bankruptcy protection – but it is too early to predict the changes that may occur.

We believe that technological advancement, product and service 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. In today’s difficult economic environment another factor that may serve to differentiate competitors, particularly in emerging markets, is the ability and willingness to offer some form of financing.

We expect that the level of competition in the global telecommunications networking industry will remain intense, for several reasons. First, although consolidation among vendors results in a smaller set of competitors, it also triggers competitive attacks to increase established positions and market share, pressuring margins.

Consolidation also allows some vendors to enter new markets with acquired technology and capabilities, effectively backed by their size, relationships and resources. In addition, carrier consolidation is continuing in both developed and emerging markets, resulting in fewer customers overall. In today’s economic environment, Capex spending cuts are compounding the competitive impact of a smaller set of customers. Most vendors are also targeting the same set of the world’s largest service providers because they account for the bulk of carrier spending for new equipment. Competition is also accelerating around IP network technologies as carriers continue to shift capital to areas that support the migration to next-generation networks. Furthermore, competitors providing low-priced products and services from Asia are gaining significant market share worldwide. They have been gaining share both in developed markets and in emerging markets, which account for a growing share of the overall market and which are particularly well-suited for those vendors’ low-cost, basic communications offerings. As a result, we continue to operate in an environment of intensely competitive pricing.


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5.7

TECHNOLOGY, RESEARCH AND DEVELOPMENT

Overview

Research and development remains one of our main priorities, as we believe the creation of new technologies for the carrier and enterprise telecommunications market can substantially differentiate us in the marketplace. However, we are enhancing the efficiency of our R&D spending by focusing on four key segments – optical, IP, broadband and applications enablement – while we partner or rationalize spending in other areas. We also have plans under way to consolidate global R&D centers and have taken actions to transfer people from Chateaufort en Yvelines to Velizy and Villarceaux in France, and from Lisle to Naperville, Illinois and from Whippany to Murray Hill, New Jersey in the U.S. Some of the specific technologies and scientific fields that we view as central to our business strategy and our research and development priorities are:

broadband wired access (VDSL, GPON);

broadband wireless access and indoor coverage (multi-standard radio access, CDMA EV-DO, W-CDMA, WiMAX, innovative antenna technologies such as MIMO, Femto technology that provides in-home cell phone coverage, and LTE);

optics (100 Gbit/s transport, Flexible optics, photonic networking);

intelligent IP (IP and optical);

new service delivery architecture and platforms (IMS, end-to-end provisioning, fault management);

multimedia and mobile/fixed services and applications (wireline video networking, mobile TV);

network security and optimization;

mathematics, physical sciences, computer and software sciences; and

e-Health (in partnership with University of Pittsburgh Medical Center, for example)

Our new strategic plan has directly affected our research and development efforts and led to specific initiatives to sharpen focus and achieve greater operational and cost efficiencies such as:

increasing our own, internal R&D emphasis on Long-Term Evolution (LTE) in order to bring our own solution to market as momentum continues to grow behind this preferred technology for “4G” cellular mobile services. As we accelerated our internal LTE development program, we have stopped our LTE joint venture project with NEC.

focusing our R&D efforts in WiMAX on the “enhanced wireless DSL” segment of the market.

Placing additional emphasis on developing differentiating solutions in support of our growing IMS business

In 2008, we spent € 2.5 billion, representing 14.8% of our revenues, on innovation and the support of our various product lines. The € 2.5 billion amount is actual euros spent before taking into account capitalization of development costs and the impact of the purchase price allocation entries of the business combination with Lucent, as disclosed in Note 3 to our consolidated financial statements included elsewhere in this document.

Advanced Research

Advanced research is conducted across many of our organizations, including Bell Labs. These initiatives create new growth opportunities though disruptive innovation and provide us with a competitive market advantage. Bell Labs has research locations in nine countries: USA, Canada, France, Germany, Belgium, UK, Ireland, India and China. Bell Labs continues to conduct fundamental and applied research in the areas that we view as central to our business strategy and our research and development priorities.

Bell Labs has achieved break-through innovations in areas such as 100 Gigabit Ethernet and Long Term Evolution (LTE) as well as green technology, thermal management and Web 2.0. In 2008, Bell Labs developed a novel heatsink device that has the potential to significantly reduce energy consumption in a broad range of telecommunications equipment.

In 2008, Bell Labs developed applications that foster collaboration in a virtual environment among colleagues who may be in geographically diverse locations, which increases productivity while decreasing administrative and travel expense.

Quality, security and reliability

Quality

In 2008, our goal was to continue to execute on the goal we set in 2007 to improve quality, security and reliability of our portfolio.

One of our objectives in 2008 was to improve our customer satisfaction survey in order to achieve a higher degree of assurance that we meet customer expectations. We also integrated over 50 separate TL. 9000 certificates into a single, multi-site certification, to improve business agility and establish a consistent approach to resolving customer critical issues.

Security

Telecom services and network infrastructures continue to maintain a sharp focus on security. In response, we continue to improve our offering so that security and reliability are a more integral part of our overall portfolio – what we call “security designed-in”. The release in 2008 of our new security specific technologies for both the enterprise and the service provider space improve our offerings. The security framework that Bell Labs developed is part of our product lifecycle permitting the tightening of security for our products, systems and services.

In the security and reliability program framework, in 2008 we continued to promote a study called the Availability and Robustness of Electronic Communications Infrastructure that involved government and industry participants across Europe and which was formally accepted by the European Commission’s Information Science and Media Directorate-General with high praise for this significant contribution. The aim of the study was to develop a forward-looking analysis of the factors influencing the availability of electronic communication networks and of the adverse factors that could act as potential barriers to the development of global networked economies. The study has been used as a framework and the basis for security roadmaps and strategies that further strengthen European telecommunications availability.



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Reliability

To anticipate future technology reliability needs, in 2008 we pursued ongoing study of the implications that result from introducing emerging technologies. Our network modeling experts continued to develop methods for network design with quality of service and reliability while migrating large numbers of users to all-IP networks. In addition, business modeling experts created models for new services such as IPTV, for decision support during critical technology choices, and for evaluation of outsourcing options. These models are used in our customer engagements.

R&D Efficiency

In the area of R&D efficiency, in 2008 we continued and improved upon a number of major initiatives begun in 2007 that were designed to improve the cost and efficiency of research and development activities in 2008. We initiated within the Carrier business group, an R&D transformation program whose goal is to modernize and improve overall R&D efficiency. The first phase of this program was completed in 2008. The second phase began in 2008 and expects to be completed in 2009.

By defining and validating a common hardware library and set of tools, we have completed the first step in achieving the rationalization of our hardware development environment across all of the company’s hardware development centers. This initiative will be generalized to all hardware lab sites in 2009 with the goal of providing the Group with an optimal, flexible and cost effective hardware development program.

Leveraging a strong compliance program and expertise in central office structure and thermal technology, in 2008 we developed an innovative solution for data centers and central offices that will significantly reduce the amount of energy required to cool IT or telecom equipment. Today, half of a data center’s energy expenditure is applied to cooling alone. This thermal management solution was demonstrated successfully at two of our sites (one in Europe and one in the U.S.) in 2008 and is expected to be commercialized in 2009 as a key service within our portfolio of eco-sustainability and energy reduction solutions. All of our product groups maintain energy reduction targets within their roadmaps. We also take an active role in shaping and defining energy consumption metrics for the telecommunication industry and we believe we comply with industry standards.

Standardization, technology partnerships and acquisitions

Standardization

In 2008, more than 500 employees from across all of our business groups were engaged in standardization efforts. They participated in a total of more than 200 working groups in approximately 100 standards organizations. Building on our position as a leading contributor in the areas of Access, Packet, Optics and Wireless technologies, we have reinforced our efforts in areas such as 4G Mobility, IMS and Applications enablement. During the course of 2008, we reaffirmed or secured significant leadership positions in organizations such as the 3GPP, 3GPP2, ATIS, Broadband Forum, ETSI, IEEE, IETF, OMA, TIA and the WiMAX Forum.

Technology partnerships and acquisitions

To strengthen our technology leadership we entered into a number of partnerships and made strategic acquisitions in 2008. We developed strategic relationships with a number of companies in the sector including Edgeware (Sweden) to expand video server ecosystem, Convergys (U.S.) to provide operators with a pre-integrated and converged billing and customer care solution, Airvana (U.S.) for CDMA Femto cells and GENBAND (U.S.) for Media Gateway solutions. We have also maintained ongoing global partner engagements with companies such as IBM, Accenture, Sun Microsystems, Hewlett Packard and Cap Gemini. We completed a number of acquisitions to complement our Genesys contact center offering. For example, we acquired a German software development and engineering company that was previously owned by partner VoicInt Telecommunications. We also acquired U.S. based Conseros, a pioneer in the area of integrating customer interactions and business processes as well as Motive (also U.S.-based) to enhance our home networking management solution.

5.8

INTELLECTUAL PROPERTY

In 2008 we obtained more than 2,700 patents worldwide, resulting in a portfolio of more than 26,000 active patents worldwide across a vast array of technologies. We also actively pursue a strategy of licensing selected technologies in order to expand the reach of our technologies and to generate licensing revenues.

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.

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.


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5.9

SOURCES AND AVAILABILITY OF MATERIALS

We make significant purchases of electronic components and other materials from many sources. While we have experienced some shortages in components and other commodities commonly used across the industry, we have generally been able to obtain sufficient materials and components from various sources around the world to meet our needs. We continue to develop and maintain alternative sources of supply for essential materials and components.

We do not have a concentration of sources of supply of materials, labor or services that, if suddenly eliminated, could severely impact our operations, and we believe that we will be able to obtain sufficient materials and components from U.S., European and other world market sources to meet our production requirements.

5.10

SEASONALITY

The quarterly pattern in our 2008 revenues – a weak first quarter, a very strong fourth quarter and second and third quarter results that fell between those two extremes – generally reflects the underlying pattern of service providers’ capital expenditures. That same general pattern is likely to be present in service providers’ capital expenditures in 2009, although the global recession is very likely to have an impact on that pattern. Specifically, first quarter weakness may be magnified as service providers enter the year with very cautious capital expenditure plans, reflecting their uncertainty about the ultimate severity of the recession. The global economy will continue to have an impact on seasonality beyond the first quarter, but that impact will ultimately depend on how the recession unfolds in 2009.

5.11

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 in 2008 attributable to these countries represented less than one percent of our total net revenues. Although U.S.-based pension funds and endowments own a significant amount of our outstanding stock, most of these institutions have not indicated that they intend to effect such divestment.

5.12

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. In the U.S., these laws often require parties to fund remedial action regardless of fault. 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.

Remedial and investigatory activities are under way at numerous current and former facilities owned or operated by the respective historical Alcatel and Lucent entities. In addition, Lucent was named a successor to AT&T as a potentially responsible party at numerous Superfund sites pursuant to the U.S. Comprehensive Environmental Response, Compensation and Liability Act of 1980 (“CERCLA”) or comparable state statutes in the United States. Under a Separation and Distribution Agreement with AT&T and NCR Corp. (a former subsidiary of AT&T), Lucent is responsible for all liabilities primarily resulting from or relating to its assets and the operation of its business as conducted at any time prior to or after the separation from AT&T, including related businesses discontinued or disposed of prior to its separation from AT&T. Furthermore, under that Separation and Distribution Agreement, Lucent is required to pay a portion of contingent liabilities in excess of certain amounts paid out by AT&T and NCR, including environmental liabilities. In Lucent’s separation agreements with Agere and Avaya, those companies have agreed, subject to certain exceptions, to assume all environmental liabilities related to their respective businesses.



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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 and 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. The future impact of environmental matters, including potential liabilities, is often difficult to estimate. Although it is not possible at this stage to predict the outcome of the remedial and investigatory activities with any degree of certainty, we believe that the ultimate financial impact of these activities, net of applicable reserves, will not have a material adverse effect on our consolidated financial position or our income (loss) from operating activities.

5.13

HUMAN RESOURCES

Our approach

Human capital is critical: it can significantly impact a company’s long-term growth strategy. Our human resources teams forecast talent needs for current and future requirements to shape our business strategy but also to ensure that we have the associated skills/competency sets. In 2008, our main missions were to:

provide expertise and leadership support in all functional areas of human resources;

define and deploy human capital strategies that support and align with business initiatives at corporate, organizational and local levels;

develop and enhance individual and organizational capabilities to achieve performance excellence.

Supporting diversity and equal opportunities

In today’s global environment we believe it is crucial to understand the cultures, customs and needs of employees, customers and regional markets. As a global enterprise, we actively seek to ensure that our employee body reflects the diversity of our business environment.

We are committed to recognizing and respecting the diversity of people and ideas, and to ensuring equal opportunities for all.

With a presence in 130 countries, we offer employees the opportunity to gain exposure to very different cultures and ways of working. At the end of 2008, we launched a “Talent Diversity” review in each organization aimed at renewing teams and fostering cultural diversity as a key competency.

Promoting the development of talents as a tool for retention

We focus our attention on attracting and keeping the people with the greatest ability and potential to deliver our business strategy. We have launched a large set of HR programs and tools – like the Global Performance Management Process (GPMP) and the Organization and People Reviews (OPRs) – to ensure we continue to improve our ability to identify talents, enhance our employees’ experience and provide appropriate development opportunities and prospects to progress our employees’ career with us. Through the GPMP, employees receive concrete, constructive feedback on their individual performance and have the opportunity to review their professional development plans. In 2008, 85% of managers and professionals set performance goals based on the GPMP. The OPRs help us to identify and nurture internal talents for strategic roles or succession plans.

With 20 centers worldwide accredited through a combined internal and external process, the Alcatel-Lucent University helps employees succeed in their current jobs and adapt to future requirements. The University offers qualification programs in key areas, such as project management, sales, services, leadership development and IP transformation, complemented by structured learning solutions developed to strengthen key business competencies. In 2008, our employees averaged 18 hours of training. Overall, nearly 55,000 employees received formal training in 2008.

Encouraging mobility

We actively encourage mobility across borders – whether geographical, organizational or functional – to develop diversity and teamwork and express our international culture. As a cornerstone of our social policy, this is a powerful tool in our employee’s professional evolution, and at December 31, 2008, we had 766 employees engaged in such rotations. In 2009, we will implement a new HR objective to rotate 80% of our high-potential employees through such an assignment within three years.

Implementing a competitive and harmonized compensation policy

We are committed to providing our employees with a total compensation package that, in each country, is competitive with those of major companies in the technology sector. Our compensation structure reflects both individual and company performance. Our policy is for all employees to be fairly paid regardless of gender, ethnic origin or disability. Beginning in 2008, we have been engaging in a single, unified review process throughout the entire company.

We also have a long-term remuneration policy involving equity ownership. In December 2008, our Board decided that, in 2009, in an effort to give our employees a stake in our future, all employees will be eligible to receive a grant of 400 options, to the extent legally possible.

Managing workforce reduction

In December 2008, we announced that we would institute cost reductions designed to reduce our break-even point by € 1 billion per year in both 2009 and 2010. As a part of these initiatives, we analyzed the Group’s organizational structure and decided to reduce approximately 1,000 managers and approximately 5,000 contractors (as defined in “Contractors”, below) worldwide in order to simplify our reporting structure and ensure better operational controls. We carry out all workforce reductions in accordance with local rules and regulations, both in terms of the method and the measures.



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Fostering a dialogue with employees

We are committed to fostering an open dialogue with employees on important decisions directly affecting them. The objective of our European Committee (ECID) is to provide information and facilitate an exchange of views between senior management and European employee representatives. The committee is composed of 30 members including representatives from the various European countries where we operate and meets at least twice a year depending on company business. In 2008, the European Committee met three times and various interim meetings were also held. In 2009, members from Eastern European countries will join the ECID

Accompanying the transformation

Our human resources teams are playing a key role in supporting our strategic transformation. Related initiatives include a strong emphasis on people and organizational aspects with specific attention to instilling emphasis on customer care, speed, accountability, innovation, trust and empowerment in our day-to-day business activities.

Employees

At December 31, 2008, we employed 77,717 people worldwide, compared with 76,410 at December 31, 2007 and 89,370 at December 31, 2006.

The tables below show the geographic locations and the business segments in which our employees worked on December 31, 2006 through 2008.

Total number of employees and the breakdown of this number by business segment is determined by taking into account all of the employees at year-end who worked for fully consolidated companies and a percentage of those employees at year-end who worked for subsidiaries consolidated using proportionate consolidation based on the percentage of interest in such companies.

 

Carrier

Enterprise

Services

Other

Total Group

2006 (1)

45,444

6,026

28,080

9,819

89,370

2007

39,428

6,779

29,033

1,170

76,410

2007 Restated (2)

39,011

7,427

28,902

1,070

76,410

2008

36,646

7,832

32,099

1,140

77,717

(1)

Including 1,631 employees that were part of the acquisition of UMTS technologies from Nortel as of December 31, 2006; 29,861 employees from Lucent in connection with the business combination of Lucent as of November 30, 2006, and 8,862 employees related to discontinued businesses transferred to Thales as described in Note 3 to our consolidated financial statements included elsewhere in this document.

(2)

In 2008, certain shared support staff in the Carrier and Services segments were transferred to Enterprise with a corresponding decrease in the support staff of the other segments, mainly Carrier. In 2008, employees from Other were transferred to other segments as part of the reduction of the corporate headquarters activities of Lucent.


The breakdown by geographical areas below gives the headcount of employees who worked for fully consolidated companies and companies in which we own 50% or more of the equity. The impact of taking into account the headcount of subsidiaries consolidated using proportionate consolidation only for the percentage of interests in these entities is isolated in the “proportionate consolidation impact” column. The impact is related to the joint ventures with Finmeccanica in the space business, which were transferred to Thales as explained in Note 3 to our 2008 consolidated financial statements included elsewhere in this document.

 

France

Other Western Europe

Rest of Europe

Asia Pacific

USA

Rest of the World

Proportionate consolidation impact

Total Group

2006

17,071

20,632

3,108

14,589

23,647

12,219

(1,896) (1)

89,370

2007

12,109

14,382

3,168

14,083

21,946

10,722

 

76,410

2008

10,942

13,958

3,664

15,210

20,360

13,583

 

77,717

(1)

This consolidation impact is a reduction of 1,411 in our employee headcount in France, and a reduction of 485 in the rest of Europe.


Membership of our employees in trade unions varies from country to country. In general, relations with our employees are satisfactory.

Temporary workers and contrators

Separate from our employees, we resort to temporary workers and contractors.

Temporary Workers

The average number of temporary workers (that is, in general, employees of third parties seconded to perform work at our premises due, for example, to a short-term shortfall in our employees or in the availability of a certain expertise) in January and February 2008 was 2,442.

Contractors

Starting in March 2008, we have placed our focus on the notion of “contractors,“ which includes not only temporary workers, but also the number of individuals at third parties performing work subcontracted by us on a “Time & Materials“ basis, when such third parties’ cost to us is almost exclusively a function of the time spent by their employees in performing this work. At December 31, 2008, we had 11,265 contractors.


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Employee share ownership, stock option plans and performance shares

Profit-sharing agreements

The companies of the Group have set up profit-sharing agreements and employee savings plans based on the recommendations of senior management.

Our foreign subsidiaries establish profit-sharing plans for their employees in accordance with local laws applicable to them, when such laws allow them to do so.

Capital increases reserved for employees

Since 2001, we have not effected any capital increases reserved for employees.

Performance shares and stock option grant policy

Our policy in this area is to remain competitive worldwide in light of our competitors’ practices. Upon recommendation of the Compensation Committee, our Board determines the number of options or shares to be granted and the conditions applicable to the grants based on a review of the equity compensation policies of companies in the same business sector, the practices in each country and the level of responsibility of the beneficiary.

Our stock option plans were created to give those senior executives and employees who, either directly or indirectly, actively participate in generating the Group’s earnings, a stake in the Group’s increased profitability. The options are therefore a way of giving beneficiaries a long-term interest in the Group’s earnings.

Moreover, to ensure that the Group’s activities and the employees who are most essential to its development remain stable under all circumstances, in the event a third party tries to launch a takeover of Alcatel-Lucent, a tender offer for our shares or a procedure to de-list our shares, our Board of Directors may decide to immediately vest all outstanding options (excluding those held by individuals who were Directors on the option grant date or on the date of the Board’s decision) regardless of any restricted period.

The group of beneficiaries of stock options grew considerably following the business combination with Lucent, changing from 8,001 beneficiaries in 2006 to 14,415 in 2008, with the major portion of the options being granted to employees of our U.S. subsidiaries, in accordance with the compensation policies prevailing in the United States.

Stock options

The main policies regarding the grant of stock options established in 2000 and 2001 are retained.

Our Board of Directors received an authorization at the Shareholder’s Meeting held on May 30, 2008 to grant Alcatel Lucent stock options representing up to 4% of the company’s capital for a period of 38 months. The exercise price for option grants does not include any discount or reduction from the average opening share price for Alcatel-Lucent shares on the Euronext™ market for the 20 trading days preceding the Board meeting at which the options are granted, but such price cannot be lower than the € 2 nominal share value.

Under our annual stock option plans, one-fourth of the number of options granted to beneficiaries vest on the first anniversary of the date of grant and 1/48 of the options granted vest at the end of each subsequent month.

Options can only be exercised when vested (subject to the existence of holding periods that may be imposed by local laws). Therefore beneficiaries who are employees of a subsidiary with its registered office in France cannot exercise their options before the end of the holding period set by Article 163 bis C of the French tax code, which is currently four years from the date of grant. All vested options must be exercised no later than the eighth anniversary of the date of grant.

Performance conditions for option grants applicable to members of our Management Committee

Options granted to members of our Management Committee are subject to the same conditions as those governing all other beneficiaries, as well as the following conditions.

In compliance with the commitment made by our Board of Directors at the Annual Shareholders’ Meeting held on May 30, 2008, options granted to Management Committee members are also subject to an additional exercisability condition linked to the performance of Alcatel-Lucent shares.

The share price of Alcatel-Lucent shares will be measured yearly in relation to a representative sample of 14 peer group companies that are solution and service providers in the telecommunications equipment sector (this figure may be revised in line with market changes).

The number of vested stock options that will be exercisable will be measured annually in proportion to our stock price’s performance as compared to our peer group. This annual measurement will occur over a four year period, beginning from the grant date. At the meeting closest to the end of each twelve month period, our Board, after consultation with the Compensation Committee, will determine whether or not the stock performance target has been met for the prior year, based on an annual study conducted by a third party consulting firm.

Performance shares

Our Board of Directors received an authorization at the Shareholders’ Meeting held on May 30, 2008, to grant up to 1% of the company’s capital in Alcatel-Lucent performance shares for a period of 38 months.

At the time of the grant, our Board must set the vesting criteria, including the service conditions applicable to the beneficiary and the Group performance targets applicable to the Group throughout the vesting period.

A beneficiary who is an employee and/or Executive Officer of a company within the Group with its registered office in France will vest in his/her performance shares at the end of a two-year vesting period. Such performance shares will be available following the expiration of a two year holding period. For a beneficiary who is an employee and/or Executive Officer of a company within the Group with its registered office outside of France, the vesting period is four years, with no additional holding period.

Evaluation of the Group’s performance must be based on the same criteria as those used for the Global Annual Incentive Plan. For each of the criteria, quantified targets will be fixed at the start of each year for the current fiscal year.

At the end of the two or four year vesting period, so long as the beneficiary has been an employee of the Group for two years (with limited exceptions) the number of performance shares that will vest will depend on the achievement, based on an average, of the annual Group performance targets set by our Board for the two or four year period.



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2009 grants

The Board of Directors has decided to extend its performance share grant policy in 2009, by proceeding with a mixed grant of performance shares and stock options in favor of the beneficiaries.

In this context, the Board of Directors has also decided to make an exceptional grant of 400 stock options to each employee of the Group.

Performance shares

On March 18, 2009, our Board of Directors authorized the grant of  up to 6,982,956 Alcatel Lucent Performance shares to 11,076 employees and managers of the Group, subject to the satisfaction of the service and performance conditions described above. This grant includes the grant of a maximum of 866,658 performance shares to 13 members of the Management Commitee, representing 12.4% of the annual grant, and a maximum of 200,000 Performance shares granted to our Chaiman of the Board of Directors as further described in Section 7.5 – “Compensation”.

The Board of Directors fixed the performance targets on the basis of the criteria used for the Global Incentive Annual Incentive Plan (AIP) applicable to approximately 43,000 employees in the Group, namely the evolution of Revenues, Operating income and Operating cash flow minus restructuring cash outlays and capital expenditures.

The earliest date on which these shares will be available to the beneficiaries is March 18, 2013.

Exceptional plan for Group employees

On March 18, 2009, our Board of Directors authorized the grant of 400 stock options to all of our employees, subject to compliance with the relevant laws of the countries where the beneficiaries work. This exceptional plan represents 30,646,400 stock options to 76,641 employees in the Group. The employees will be able to subscribe for shares at the price of € 2 per share, which is equal to the nominal share value.

These options will vest, subject to the service conditions, in two successive tranches, at 50% per year over two years.

After the end of a holding period, which varies depending on the country in which the employer of the beneficiary has its registered office (four years for beneficiaries who are employees of a company that has its registered office in France) these options are exercisable  until March 17, 2017.

Annual stock option plan

On March 18, 2009, our Board of Directors authorized under our annual stock option plan, the grant of 21,731,110 stock options to 11,112 Group employees and managers at an exercise price of € 2 per share, which is equal to the nominal share value.

After the end of holding period, which varies depending on the country in which the employer of the beneficiary has its registered office (four years for beneficiaries who are employees of a company that has its registered office in France), these options are exercisable until March 17, 2017.

This grant includes a total of 3,600,000 options granted to the 14 members of the Management Committee including the CEO, representing 6.9% of the annual stock option plan, and 3.9% of the total of options granted in March 2009 (52 million). These options were granted at the same exercise price of € 2 per share and are subject to the general conditions of the annual plan in addition to the specific condition applicable to the members of the Management Committee, namely  the share performance condition described above.

2008 grants

Performance shares

At meetings held on September 17 and October 29, 2008, our Board of Directors authorized the grant of a maximum of 100,000 Alcatel-Lucent performance shares to Mr. Camus and 250,000 Alcatel-Lucent performance shares to Mr. Verwaayen, subject to the vesting service and Group performance conditions as described in Section 7.5 “Compensation”.

Stock option plans

On March 25 and April 4, 2008, our Board of Directors authorized under our annual stock option plan, the grant of 48,787,716 stock options to 14,415 Group employees and managers at an exercise price of € 3.80, which corresponds to the average opening share price for the 20 trading days preceding the Board meeting held on March 25, 2008.

A total of 2,850,000 of these options were granted to the members of the Management Committee at the time, representing 5.8% the total number of options granted. These options are subject to the general conditions of the annual plan.

After the end of holding period, which varies depending on the country in which the employer of the beneficiary has its registered office (four years for beneficiaries who are employees of a company that has its registered office in France), the options are exercisable until March 24, 2016.

Our Board of Directors, meeting on September 17, 2008, granted Mr. Verwaayen 250,000 stock options, subject to Group performance targets, at an exercise price of € 3.90 which corresponds to the average opening share price for the 20 trading days preceding the Board meeting. The performance conditions are the same as those applicable to the members of Management Committee as described above and only are applicable to 125,000 of the options granted (see Section 7.5 “Compensation” for further details.)

During the course of 2008, our CEO, exercising the power delegated to him, granted 2,276,100 stock options to certain newly hired Group employees. The exercise conditions are consistent with those applicable to the annual stock option plan, including performance conditions for the beneficiaries who are members of the Management Committee. The employees will be able to subscribe shares at the price of € 4.40 per share under the July 1, 2008 plan and € 2 per share under the December 31, 2008 plan.



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Information concerning the largest grants or exercises

In compliance with the provisions of Article L. 225-184 of the French Commercial Code, the table below provides information for fiscal year 2008 relating to the employees of the Group (other than the Chairman or the CEO) who received the 10 largest amounts of option grants and were issued the 10 largest numbers of shares upon exercise of options.

10 largest numbers of options

Number of stock options granted/issued

Weighted average price

Plan

Specific provisions

10 largest stock option grants

7,100,000

3.48

March 25, 2008

April 2, 2008

Dec 31, 2008

Performance conditions for Management Committee members

10 largest option exercises

31,205

1.08

Between 11/November  1, 2000

and March 25, 2008

 


Summary of outstanding options

On December 31, 2008, before the expiration of the stock option plan adopted on March 7, 2001, 177,898,780 stock options were outstanding, representing 7.7% of our existing share capital, each option giving the right to one Alcatel-Lucent share. On December 31, 2008, the March 7, 2001 plan represented 25.1 million outstanding stock options.

Taking into account the stock option grants on March 18, 2009 mentioned above, the total number of outstanding options is 204.8 million, representing 8.85% of our existing share capital (before taking into account the issuance of shares corresponding to these options). In fiscal year 2009, stock options granted under seven plans will expire, representing 13.5 million options. These options were granted in 2001 at exercise prices between € 9 and € 41. At March 18, 2009, the situation is as follows:

Grant year (1)

Exercise price

Outstanding options

2001

from € 9 to € 41

13,549,181

2002

from € 3.2 to € 17.2

508,745

2003

from € 6.7 to € 11.2

12,702,330

2004

from € 9.8 to € 13.2

13,662,806

2005

from € 8.8 to € 11.41

13,697,445

2006

from € 9.3 to € 12

14,655,635

2007

from € 6.3 to € 10

35,588,202

2008

from € 2 to € 4.40

48,448,834

2009

€ 2

52,377,510

TOTAL FOR PLANS

 

205,190,688

(1)

This summary does not take into account options cancelled from January 1, 2009 until March 18, 2009.



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History of stock option plans

The main characteristics of stock options granted and not yet exercised at December 31, 2008 are described hereunder.


ALCATEL-LUCENT STOCK OPTION PLANS

Creation of the plan (1)

Number of recipients

Number of options granted

Number of options exercised

Number of options cancelled

Number of options outstanding

Option exercise period (3)

Exercise price (in euros)

Options exercised in 2008

Held by all employees

Number held by senior executives (2)

From

To

12/13/2000

340

306,700

0

306,700

0

 

12/13/2001/12/13/2004

12/12/2008

64,00

 

03/07/2001

30,790

37,668,588

0

12,582,986

25,085,602

127,500

03/07/2002/03/07/2005

03/06/2009

50,00

 

04/02/2001

13

48,850

0

42,850

6,000

 

04/02/2002

04/01/2009

41,00

 

04/02/2001

1

2,500

0

0

2,500

 

04/02/2002

04/01/2009

39,00

 

06/15/2001

627

977,410

0

273,970

703,440

 

06/15/2002/06/15/2005

06/14/2009

32,00

 

09/03/2001

58

138,200

0

44,150

94,050

 

09/03/2002/09/03/2005

09/02/2009

19,00

 

11/15/2001

16

162,000

27,000

53,000

82,000

 

11/15/2002

11/14/2009

9,00

 

12/19/2001

25,192

27,871,925

0

15,303,035

12,568,890

137,500

12/19/2002/12/19/2005

12/18/2009

20,80

 

12/19/2001

521

565,800

265,985

207,514

92,301

 

12/19/2002/12/19/2005

12/18/2009

9,30

 

02/15/2002

37

123,620

0

86,040

37,580

 

02/15/2003/02/15/2006

02/14/2010

17,20

 

04/02/2002

24

55,750

0

28,500

27,250

 

04/02/2003

04/01/2010

16,90

 

05/13/2002

23

54,300

0

26,000

28,300

 

05/13/2003/05/13/2006

05/12/2010

14,40

 

06/03/2002

176

281,000

0

88,500

192,500

 

06/03/2003/06/03/2006

06/02/2010

13,30

 

09/02/2002

226

1,181,050

656,190

339,172

185,688

 

09/02/2003

09/01/2010

5,20

 

10/07/2002

16

30,500

9,517

13,274

7,709

 

10/07/2003

10/06/2010

3,20

850

11/14/2002

26

111,750

80,424

11,408

19,918

 

11/14/2003

11/13/2010

4,60

 

12/02/2002

16

54,050

20,602

23,648

9,800

 

12/02/2003

12/01/2010

5,40

 

03/07/2003

23,650

25,626,865

7,240,272

6,144,835

12,241,658

200,000

03/07/2004/03/07/2007

03/06/2011

6,70

100

03/07/2003Plan AL

31,600

827,348

190,978

636,370

0

 

07/01/2007

06/30/2008

6,70

150

06/18/2003

193

338,200

59,361

65,387

213,452

 

06/18/2004/06/18/2007

06/17/2011

7,60

 

07/01/2003

19

53,950

15,868

33,081

5,001

 

07/01/2004

06/30/2011

8,10

 

09/01/2003

77

149,400

4,498

23,539

121,363

20,000

09/01/2004/09/01/2007

08/31/2011

9,30

 

10/01/2003

37

101,350

906

52,126

48,318

 

10/01/2004/10/01/2007

09/30/2011

10,90

 

11/14/2003

9

63,600

0

56,300

7,300

 

11/14/2004/11/14/2007

11/13/2011

11,20

 

12/01/2003

64

201,850

8,222

128,390

65,238

 

12/01/2004/12/01/2007

11/30/2011

11,10

 

03/10/2004

14,810

18,094,315

700

4,870,799

13,222,816

180,000

03/10/2005/03/10/2008

03/09/2012

13,20

 

04/01/2004

19

48,100

0

30,300

17,800

 

04/01/2005/04/01/2008

03/31/2012

13,10

 

05/17/2004

26

65,100

0

20,199

44,901

 

05/17/2005/05/17/2008

05/16/2012

12,80

 

07/01/2004

187

313,450

2,399

113,101

197,950

 

07/01/2005/07/01/2008

06/30/2012

11,70

 

09/01/2004

21

38,450

822

8,578

29,050

 

09/01/2005

08/31/2012

9,90

 

10/01/2004

85

221,300

18,778

112,733

89,789

 

10/01/2005/10/01/2008

09/30/2012

9,80

 

11/12/2004

20

69,600

0

42,900,

26,700

 

11/12/2005

11/11/2012

11,20

 

12/01/2004

11

42,900

0

9,100

33,800

 

12/01/2005

11/30/2012

11,90

 

01/03/2005

183

497,500

7,558

129,585

360,357

 

01/03/2006

01/02/2013

11,41

 

03/10/2005

9,470

16,756,690

292,370

3,354,325

13,109,995

242,333

03/10/2006/03/10/2009

03/09/2013

10,00

 

06/01/2005

96

223,900

7,576

77,243

139,081

 

06/01/2006/06/01/2009

05/31/2013

8,80

 

09/01/2005

39

72,150

0,

15,638

56,512

 

09/01/2006

08/31/2013

9,80

 

11/14/2005

23

54,700

1,250

21,950

31,500

 

11/14/2006

11/13/2013

10,20

 

03/08/2006

8,001

17,009,320

0

2,837,529

14,171,791

321,145

03/08/2007/03/08/2010

03/07/2014

11,70

 

05/15/2006

53

122,850

0

21,856

100,994

 

05/15/2007

05/14/2014

12,00

 

08/16/2006

217

337,200

0

50,950

286,250

 

08/16/2007/08/16/2010

08/15/2014

9,30

 

11/08/2006

26

121,100

0

24,500

96,600

 

11/08/2007/11/08/2010

11/07/2014

10,40

 

03/01/2007

42

204,584

0

34,873

169,711

 

03/01/2008/03/01/2011

02/28/2015

10,00

 

03/28/2007

15,779

40,078,421

0

5,171,383

34,907,038

1,180,749

03/28/2008/03/28/2011

03/27/2015

9,10

 

08/16/2007

119

339,570

0

42,417

297,153

 

08/16/2008/08/16/2011

08/15/2015

9,00

 

11/15/2007

33

294,300

0

80,000

214,300

130,000

11/15/2008/11/15/2011

11/14/2015

6,30

 

03/25/2008

14,414

47,987,716

5,000

2,543,315

45,439,401

1,000,000

03/25/2009/03/25/2012

03/24/2016

3,80

5,000

04/04/2008

1

800,000

0

316,667

483,333

483,333

04/04/2009/04/04/2012

04/03/2016

3,80

 

07/01/2008

64

223,700

0

0

223,700

 

07/01/2009/07/01/2012

06/30/2016

4,40

 

09/17/2009

1

250,000

0

0

250,000

250,000

09/17/2009/09/17/2012

09/16/2016

3,90

 

12/31/2008

88

2,052,400

0

0

2,052,000

1,700,000

12/31/2009/21/31/2012

12/30/2016

2,00

 

TOTAL

177,579

243,315,872

8,916,376

56,500,716

177,898,780,

5,972,560

   

6,100

(1)

Vesting rules as of December 2000: options are vested over four years, in successive tranches, at a rate of 25% following a one-year period from the date of the Board meeting granting the options and 1/48 at the end of each subsequent month.

(2)

For purposes of this table, “senior executives” are members of the Management Committee in office during 2008.

(3)

Restricted period: four years for recipients who are employees of a company that has its registered office in France; one year for all other recipients.



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Stock options granted by foreign subsidiaries

Until 2000, Alcatel-Lucent Holding Inc., formerly Alcatel USA Inc., had established its own option plans for executives of our U.S. and Canadian companies which options were exercisable for Alcatel-Lucent ADSs. Under these plans, at December 31, 2008, 7,641,471 options remain outstanding.

Option plans of foreign companies acquired by Alcatel-Lucent are exercisable for Alcatel-Lucent shares or ADSs, in an amount adjusted for the exchange ratio used during the acquisition.

The details at December 31, 2008 of the outstanding options granted by U.S. and Canadian companies are set forth in Note 23 of the consolidated financial statements.

When the options are exercised, we use treasury shares (for the Packet Engines, Xylan, Internet Devices Inc., DSC and Genesys acquisitions), or we issue new ADSs (for the Lucent Technologies Inc., Astral Point Communications Inc., Telera, iMagic TV, TiMetra Inc. and Spatial Wireless acquisitions).


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6

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 Chapter 4 – “Information about the Group” and below in this Chapter 6 under the heading “Outlook for 2009” with respect to (i) our projection that the 2009 global telecommunications equipment and related services market should decline between 8% and 12% at a constant €/U.S. $ exchange rate, (ii) our expectation that we will maintain a stable share of that market, (iii) our plan to reduce our break-even point by € 1 billion per year for each of 2009 and 2010 by improving gross margin, enhancing R&D efficiency and materially reducing SG&A expenses, and (iv) our expectation that we will achieve an operating profit before restructuring costs, impairment of assets, gain/loss on disposal of consolidated entities and post-retirement benefit plan amendments (excluding the negative non-cash impacts of Lucent’s purchase price allocation) around break-even in 2009, under the heading “Liquidity and Capital Resources” with respect to (v) the expected level of  restructuring costs and capital expenditures in 2009, and under the heading “Contractual obligations and off-balance sheet contingent commitments” with respect to (vi) the amount we would be required to pay in the future pursuant to our existing 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. 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 years 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.

On November 30, 2006, historical Alcatel and Lucent Technologies Inc., since renamed Alcatel-Lucent USA, Inc. (“Lucent”) completed a business combination pursuant to which Lucent became a wholly owned subsidiary of Alcatel. On December 1, 2006, we and Thales signed a definitive agreement for the acquisition by Thales of our ownership interests in two joint ventures in the space sector created with Finmeccanica and our railway signaling business and integration and services activities for mission-critical systems not dedicated to operators or suppliers of telecommunications services. In January 2007, the transportation and security activities were contributed to Thales, and in April 2007, we completed the sale of our ownership interests in the two joint ventures in the space sector.

As a result of the Lucent transaction, our 2006 consolidated financial results include (i) 11 months of results of only historical Alcatel and (ii) one month of results of the combined company. As a result of Thales transaction, our 2006 financial results pertaining to the businesses transferred to Thales are treated as discontinued operations.

In addition, our 2006 and 2007 financial results take into account the effect of the change in accounting policies on employee benefits, due to the application of the interpretation IFRIC 14, with retroactive effect from January 1, 2006 as described in the following section.

As a result of the purchase accounting treatment of the Lucent business combination required by IFRS, our results for 2008, 2007 and 2006 included several negative, non-cash impacts of purchase accounting entries.


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CHANGES IN ACCOUNTING STANDARDS AS OF JANUARY 1, 2008

As of January 1, 2008, Alcatel-Lucent applied (with retroactive effect as of January 1, 2006) IFRIC 14, which is an interpretation of IAS19, ”The Limit on a Defined Benefit Asset, Minimum Funding Requirements and their Interaction.”

The “asset ceiling” rule of IAS 19 limits the measurement of a defined benefit asset to ‘the present value of economic benefits available in the form of refunds from the plan or reductions in future contributions to the plan plus unrecognized gains and losses’. Questions have arisen about when refunds or reductions in future contributions should be considered available, particularly when a minimum funding requirement exists.

In the United Kingdom, for example, minimum funding requirements exist to improve the security of the post-employment benefit obligations to participants of an employee benefit plan. Such requirements normally stipulate a minimum amount or level of contributions that must be made to a plan over a given period. Therefore, a minimum funding requirement may limit the ability of the entity to reduce future contributions.

Further, the limit on the measurement of the value of a defined benefit asset may cause the minimum funding requirement to be onerous. Normally, a requirement to make contributions to a plan would not affect the value of the defined benefit asset or liability. This is because the contributions, once paid, will become plan assets and so the additional net liability is nil. However, a minimum funding requirement may give rise to a liability if the required contributions will not be available to the entity once they have been paid.

The first application of this new interpretation had a negative impact on our shareholder’s equity as of December 31, 2008 of € 91 million € 45 million as of December 31, 2007 and € 82 million as of December 31, 2006) in connection with our pension plans in the United Kingdom.

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 those consolidated financial statements. Some of the accounting methods and policies used in preparing our consolidated financial statements under IFRS 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.



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The valuation allowances are accounted for in cost of sales or in restructuring costs depending on the nature of the amounts concerned.

(in millions of euros)

December 31, 2008

December 31, 2007

December 31, 2006

Valuation allowance for inventories and work in progress on construction contracts

(654)

(514)

(378)

 

2008

2007

2006

Impact of inventory and work in progress write-downs in income (loss) before income tax, related reduction of goodwill and discontinued operations

(285)

(186)

(77)


Impairment of customer receivables

An impairment loss is recorded for customer receivables 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.

(in millions of euros)

December 31, 2008

December 31, 2007

December 31, 2006

Accumulated impairment losses on customer receivables (excluding construction contracts)

(207)

(187)

(192)

 

2008

2007

2006

Impact of impairment losses in income (loss) before income tax, related reduction of goodwill and discontinued operations

(17)

(3)

(18)


Capitalized development costs, other intangible assets and goodwill

Capitalized development costs

(in millions of euros)

December 31, 2008

December 31, 2007

December 31, 2006

Capitalized development costs, net

578

596

501


The criteria for capitalizing development costs are set out in Note 1f to our consolidated financial statements included elsewhere in this annual report. Once capitalized, these costs are amortized over the estimated useful lives of the products concerned (3 to 10 years).

We must therefore evaluate the commercial and technical feasibility of these development 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.

Impairment losses for capitalized development costs of € 135 million were accounted for in the fourth quarter of 2008 mainly related to a change in our WiMAX strategy, by focusing our WiMAX efforts on supporting fixed and nomadic broadband access applications for providers. This impairment is presented on the specific line item “Impairment of assets” in the income statement.

Impairment losses for capitalized development costs of € 41 million were accounted for in 2007 mainly related to the UMTS (Universal Mobile Telecommunications Systems) business.

Impairment losses of € 104 million and write-offs amounting to € 197 million were accounted for in capitalized development costs in 2006, and were mainly related to the discontinuance of product lines following the acquisition of UMTS technologies from Nortel and the business combination with Lucent.

Other intangible assets and Goodwill

(in millions of euros)

December 31, 2008

December 31, 2007

December 31, 2006

Goodwill, net

4,215

7,328

10,891

Intangible assets, net (1)

2,567

4,230

5,441

TOTAL

6,782

11,558

16,332

(1)

Including capitalized development costs, net.


Goodwill amounting to € 8,051 million and intangible assets amounting to € 4,813 million were accounted for in 2006 as a result of the Lucent business combination as described in Note 3 to our consolidated financial statements. Using market-related information, estimates (primarily based on risk-adjusted discounted cash flows derived from Lucent’s management) available at the time and judgment, an independent appraiser determined the fair values of the net assets acquired from Lucent, and in particular those relating to the intangible assets acquired.



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As discussed in more detail in Notes 7, 12 and 13 to our consolidated financial statements, impairment losses of € 4,545 million were accounted for in 2008 mainly related to the CDMA (€ 2,533 million), Optics (€ 1,019 million), Multicore (€ 300 million) and Applications (€ 339 million) business divisions, each of which are considered to be groups of Cash Generating Units (“CGU”) at which level impairment tests of goodwill are performed.

An impairment loss of € 2,832 million was accounted for in 2007, of which € 2,657 million was charged to goodwill and € 175 million was charged to other intangible assets, mainly for the CDMA, IMS business divisions and UMTS business.

An impairment loss of € 40 million on intangible assets and € 233 million in write-offs were accounted for in 2006 on the UMTS business.

The recoverable values of our goodwill and intangible assets, as determined for the impairment tests performed by the Group, are based on key assumptions which could have a significant impact on the consolidated financial statements. These key assumptions include, among other things, the following elements:

discount rate; and

projected cash-flows; which are based on the successful implementation of the strategic plan publicly announced on December 12, 2008 and a nominal rate of growth of our revenues in 2010.

The discount rate used for the additional impairment test performed during the fourth quarter of 2008 was the Group’s weighted average cost of capital (“WACC”) of 12.0%. For the annual impairment tests of 2008 and 2007, the rate used was 10% and 9.5% for 2006. The same rate of 10% was used for the additional impairment test performed in December 2007. These discount rates are after-tax rates applied to after-tax cash flows. The use of such rates results in recoverable values that are identical to those that would be obtained by using, as required by IAS 36, pre-tax rates applied to pre-tax cash flows. Given the absence of comparable “pure player” listed companies for each group of Cash Generating Units, we do not believe that the assessment of a specific WACC for each product or market is feasible. A single discount rate has therefore been used on the basis that risks specific to certain products or markets have been reflected in determining the cash flows.

Holding all other assumptions constant, a 0.5% increase or decrease in the discount rate would have decreased or increased the 2008 impairment loss € 100 million and € 93 million, respectively.

As indicated in Note 1g to our consolidated financial statements, in addition to the annual goodwill impairment tests, impairment tests are carried out if we have indications of a potential reduction in the value of our intangible assets. Possible impairments are based on discounted future cash flows and/or fair values of the assets concerned. Changes in the market conditions or the cash flows initially estimated can therefore lead to a review and a change in the impairment losses previously recorded.

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 value in use and fair value less costs to sell) (see Note 1g to our consolidated financial statements). 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.).

When determining recoverable values 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.

The planned closing of certain facilities, additional reductions in personnel and unfavorable market conditions have been considered impairment triggering events in prior years. Impairment losses of € 34 million have been recorded on property, plant and equipment in 2008. Impairment losses of € 94 million were accounted for during 2007 mainly related to the UMTS business and the planned disposal of real estate (no significant impairment losses were recorded in 2006).

Provision for warranty costs and other product sales reserves

Provisions are recorded for (i) warranties given to customers on our products, (ii) expected losses at completion and (iii) penalties incurred in the event of failure to meet contractual obligations. 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 ultimately paid can differ considerably from the amounts initially reserved and could therefore have a significant impact on future results.



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Product sales reserves

(in millions of euros)

December 31, 2008

December 31, 2007

December 31, 2006

Related to construction contracts (1)

186

147

70

Related to other contracts (2)

575

557

599

TOTAL

761

704

669

(1)

See Note 18 to our consolidated financial statements, included in the amounts due to/from customers.

(2)

See Note 27 to our consolidated financial statements.


For further information on the impact on 2008 income statement of the change in these provisions, see Notes 18 and 27 to our consolidated financial statements.

Deferred taxes

Deferred tax assets relate primarily to tax loss carry-forwards and to deductible temporary differences between reported amounts and the tax bases of assets and liabilities. The assets relating to the tax loss carry-forwards are recognized if it is probable that the Group will generate future taxable profits against which these tax losses can be set off.

Deferred tax assets recognized

(in millions of euros)

December 31, 2008

December 31, 2007

December 31, 2006

Related to the United States (including Lucent)

339 (2)

675 (1)

746

Related to France

339 (2)

404 (1)

372

Related to other tax jurisdictions

174

153 (1)

574

TOTAL

852

1,232

1,692

(1)

Following the performance by the Group of the 2007 annual goodwill impairment test, a reassessment of deferred taxes resulted in the reduction of deferred tax assets recorded compared to the situation as of December 31, 2006.

(2)

Following the performance by the Group of an additional impairment test of goodwill during the fourth quarter of 2008, a reassessment of deferred taxes resulted in the reduction of deferred tax assets recorded in the United States and in France compared to the situation as of December 31, 2007.


Evaluation of the Group’s capacity to utilize tax loss carry-forwards relies on significant judgment. We analyze past events and the positive and negative elements of certain economic factors that may affect our business in the foreseeable future to determine the probability of our future utilization of these tax loss carry-forwards, which also consider the factors indicated in Note 1n to our consolidated financial statements. 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).

As a result of the business combination with Lucent, € 2,395 million of net deferred tax liabilities were recorded as of December 31, 2006, resulting from the temporary differences generated by the differences between the fair value of assets and liabilities acquired (mainly intangible assets such as acquired technologies) and their corresponding tax bases. These deferred tax liabilities will be reduced in our future income statements as and when such differences are amortized. The remaining deferred tax liabilities related to the purchase price allocation of Lucent as of December 31, 2008 are € 957 million (€ 1,629 million as of December 31, 2007).

As prescribed by IFRSs, we had a twelve-month period to complete the purchase price allocation and to determine whether certain deferred tax assets related to the carry-forward of Lucent’s unused tax losses that had not been recognized in Lucent’s historical financial statements should be recognized in our financial statements. If any additional deferred tax assets attributed to the combined company’s unrecognized tax losses existing as of the transaction date are recognized in our future financial statements, the tax benefit will be included in our income statement. Goodwill will also be reduced, resulting in an expense, for that part of the deferred tax assets recognized relating to Lucent’s tax losses.

On the other hand, as a result of the business combination, a historical Alcatel entity may consider that it becomes probable that it will recover its own tax losses not recognized as a deferred tax asset before the business combination. For example, an entity may be able to utilize the benefit of its own unused tax losses against the future taxable profit of the Lucent business. In such cases, we would recognize a deferred tax asset but would not include it as part of the accounting for the business combination. It could therefore have a positive impact on our future net results.

Pension and retirement obligations and other employee and post-employment benefit obligations

Our results of operations include the impact of significant pension and post-retirement benefits that are measured using actuarial valuations. Inherent in these valuations are key assumptions, including assumptions about discount rates, expected return on plan assets, healthcare cost trend rates and expected participation rates in retirement healthcare plans. These assumptions are updated on an annual basis at the beginning of each fiscal year or more frequently upon the occurrence of significant events. In addition, discount rates are updated quarterly for those plans for which changes in this assumption would have a material impact on Alcatel-Lucent’s results or shareholders’ equity.



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2008

2007

2006

Weighted average expected rates of return on pension and post-retirement plan assets

7.04%

7.39%

7.35%

Weighted average discount rates used to determine the pension and post-retirement obligations

6.44%

5.54%

3.95%


The net effect of pension and post-retirement costs included in “income (loss) before tax, related reduction of goodwill and discontinued operations”, was a € 246 million increase in pre-tax income during 2008 (€ 628 million increase in pre-tax income during 2007 and a € 50 million reduction in pre-tax income during fiscal 2006). Included in the € 246 million increase in 2008 is € 65 million booked as a result of certain changes to management retiree healthcare benefit plans (refer to Note 25f). Included in the € 628 million increase in 2007 was € 258 million booked as a result of certain changes to management retiree healthcare benefit plans (refer to Note 25f).

The weighted average expected rates of return on pension and post-retirement plan assets used to determine our pension and post-retirement credits are established at the beginning of each fiscal year. The decrease in the weighted average expected rates of return on pension and post-retirement plan assets between 2007 and 2008 is mainly due to the more conservative asset allocation at the end of 2007 (the Group reduced the exposure of its defined benefit pension plans to the equity markets in November 2007). Changes in the rates were generally due to adjustments in expected future returns based on studies performed by the Group’s external investment advisors or/and to a change in the asset allocation. Even if the actual financial markets are very volatile, this assumption is required to be a long-term expected rate of return rather than a prediction of the immediate next period performance and is not reviewed every quarter. In addition, the rates that are used to determine the pension expense or income are applied on the opening fair value. For Alcatel-Lucent’s U.S. plans, the pension expense or income is updated every quarter. Therefore, the fourth quarters 2008 expected return on plan assets (accounted for in financial income) for Alcatel-Lucent’s U.S. plans is based on the fair value of plan assets at September 30, 2008, whereas the expected return on plan assets for Alcatel-Lucent’s non U.S. plans is based on December 31, 2007 plan assets fair values. The interest cost associated with the plan liabilities is also impacted by the change in discount rates used to value the plan liabilities. The Group recognized a U.S. $ 72 million decrease between the third and fourth quarter of 2008 of the net pension credit accounted for in “other financial income (loss)“ (expected return on plan assets for Alcatel-Lucent’s U.S. plans due to the decline of the plan assets fair values and expected change of the interest cost in relation with the decrease of the liability). We do not expect any significant change of the net pension credit accounted for in “other financial income (loss)“ between the fourth quarter 2008 and the first quarter 2009.

Plans assets are invested in many different asset categories (such as cash, equities, bonds, real estate, private equity, etc…). In the quarterly update of plan asset fair values, approximately 80% are based on closing date fair values and 20% have a one to three month delay as the fair value of private equity, venture capital, real estate and absolute return investments are not available in a short period. This is standard practice in the investment management industry. Assuming that the December 31, 2008 actual fair value of private equity, venture capital, real estate and absolute return investments were 10% lower than the ones retained for accounting purposes as of December 31, 2008, this would result in a negative impact in equity of roughly € 250 million.

For the purposes of recognizing the net pension and post-retirement credit, the discount rates are determined at the beginning of each quarterly period (for significant plans). For the purposes of determining the plan obligations, these rates are determined at the end of each period. The Group plans to use a discount rate of 6.08% during fiscal 2009. Changes in the discount rate in 2007 and 2008 were due to increasing long-term interest rates. The discount rates also are somewhat volatile because they are set based upon the prevailing rates as of the measurement date. The discount rate used to determine the post-retirement benefit costs is slightly lower due to a shorter expected duration of post-retirement plan obligations as compared to pension plan obligations. A lower discount rate increases the plan obligations and the Alcatel-Lucent net pension and post-retirement credit and profitability, whereas a higher discount rate reduces the plan obligations and the Alcatel-Lucent net pension and post-retirement credit and profitability.

The expected rate of return on pension and post-retirement plan assets and the discount rate were determined in accordance with consistent methodologies, as described in Note 25 to our consolidated financial statements.

Holding all other assumptions constant, a 0.5% increase or decrease in the discount rate would have decreased or increased the 2008 net pension and post-retirement result by approximately € 28 million and € 34 million, respectively. A 0.5% increase or decrease in the expected return on plan assets would have increased or decreased the 2008 net pension and post-retirement result by approximately € 133 million.

The Group’s U.S. companies have taken various actions to reduce their share of retiree health care costs, including the shifting or increases of certain costs to their retirees. The retiree health care obligations are determined using the terms of the current plans. Health care benefits for employees who retired from Lucent’s predecessor prior to March 1, 1990 are not subject to annual dollar caps on Lucent’s share of future benefit costs. The benefit obligation associated with this retiree group approximated 59% of the total U.S. retiree health care obligation as of December 31, 2008. Management employees who retired on or after March 1, 1990 have paid amounts above the applicable annual dollar caps on Lucent’s share of future benefit costs since 2001.

Lucent’s collective bargaining agreements were ratified during December 2004 and address retiree health care benefits, among other items. Lucent agreed to continue to subsidize these benefits up to the established cap level consistent with current actuarial assumptions. Except for costs attributable to an implementation period that ended on February 1, 2005, costs that are in excess of this capped level are being borne by the retirees in the form of premiums and plan design changes. Lucent also agreed to establish a U.S. $ 400 million trust that is being funded by Lucent over eight years and managed jointly by trustees appointed by Lucent and the unions. This trust is currently being funded by Section 420 transfers from the overfunded Occupational Pension Plan. The trust is being used to mitigate the cost impact on retirees of premiums or plan design changes. The agreements also acknowledge that retiree health care benefits will no longer be a required subject of bargaining between Lucent and the unions.



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The amount of prepaid pension costs that can be recognized in our consolidated financial statements is limited to the sum of (i) the cumulative unrecognized net actuarial losses and past service cost, (ii) the present value of any available refunds from the plan, and (iii) any reduction in future contributions to the plan. As Lucent currently has the ability and intent to use eligible excess pension assets applicable to formerly represented retirees to fund certain retiree healthcare benefits for such retirees, such use has been considered as a reimbursement from the pension plan. The funded status of the formerly represented retiree health care obligation of € 1,479 million as of December 31, 2008 (€ 1,775 million as of December 31, 2007), the present value of Medicare Part D subsidies of approximately € 272 million as of December 31, 2008 (as this amount is currently netted in the retiree health care obligation – € 299 million as of December 31, 2007) and the present value of future service costs of € 61 million as of December 31, 2008 (€ 644 million as of December 31, 2007) have been considered in determining the asset ceiling limitation for Lucent’s pension plans as of December 31, 2008.

The impact of expected future economic benefits on the pension plan asset ceiling is a complex matter. Based on preliminary estimates, as of the January 1, 2009 valuation date, there were approximately € 2.1 billion of pension plan assets that would be eligible for “collectively bargained” transfers to fund retiree health care costs for Lucent’s formerly represented retirees (alternatively, € 2.5 billion would be available for “multi-year” transfers, which also require the plan to remain 120% funded during the transfer period). This amount should be sufficient to address the obligation arising from the healthcare being provided to Lucent’s formerly represented retirees and as a result the Group should be able to utilize pension plan assets for Section 420 “collectively bargained” or “multi-year” transfers to fund all its health care obligations for Lucent’s formerly represented retirees.

In December 2008, a Section 420 transfer of U.S. $ 653 million occurred to cover 2008 and nine months of 2009 health care costs for Lucent’s formerly represented retirees. This had an U.S. $ 270 million positive impact in the consolidated statement of cash flows in the fourth quarter of 2008.

The impact of the different actuarial assumptions on the level of the funded status could have consequences on the Group’s funding requirements and the determination of the asset ceiling, which would affect our ability to make Section 420 transfers in the future and use the overfunding of some pension plans to fund underfunded healthcare plans related to the same beneficiaries.

Revenue recognition

As indicated in Note 1o to our consolidated financial statements, revenue is measured at the fair value of the consideration received or to be received when the Group 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 our future net income (loss).

Although estimates inherent in construction contracts are subject to uncertainty, certain situations exist whereby management is unable to reliably estimate the outcome of a construction contract. These situations can occur during the early stages of a contract due to a lack of historical experience or throughout the contract as significant uncertainties develop related to additional costs, claims and performance obligations, particularly with new technologies. During the fourth quarter of 2007, as a result of cost overruns and major technical problems that we experienced in implementing a large W-CDMA contract, we determined that we could no longer estimate with sufficient reliability the final revenue and associated costs of such contract. As a result, we expensed all the contract costs incurred to that date, but we only recognized revenues to the extent that the contract costs incurred were recoverable. Consequently, revenues of € 72 million and cost of sales of € 298 million were recognized in 2007 in connection with this construction contract. The negative impact on income (loss) before tax, related reduction of goodwill and discontinued operations of changing from the percentage of completion method to this basis of accounting was € 98 million for 2007. No change in the accounting treatment occured in 2008. If and when reliable estimates become available, revenue and costs associated with the construction contract will then be recognized respectively by reference to the stage of completion of the contract activity at the balance sheet date. Future results of operations may therefore be impacted.

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 Position SOP 97-2 of the American Institute of Certified Accountants or AICPA, such as the existence of sufficient vendor-specific objective evidence (“VSOE”) to determine the fair value of the various elements of the arrangement.

Some of our products include software that is embedded in the hardware at delivery. In those cases, where indications are that software is more than incidental, such as where the transaction includes software upgrades or enhancements, more prescriptive software revenue recognition rules are applied to determine the amount and timing of revenue recognition. As products with embedded software are continually evolving, as well as the features and functionality of the products driven by software components that are becoming more critical to their operation and success in the market, the Group is continually assessing the applicability of some of the guidance of the SOP 97-2 including whether software is more than incidental. Several factors are considered in making this determination including (i) whether the software is a significant focus of the marketing effort or is sold separately, (ii) whether updates, upgrades and other support services are provided on the software component and (iii) whether the cost to develop the software component of the product is significant in relation to the costs to develop the product as a whole. The determination of whether the evolution of our products and marketing efforts should result in the application of some of the SOP 97-2 guidance requires the use of significant professional judgment. Further, we believe that reasonable people evaluating similar facts and circumstances may come to different conclusions regarding the most appropriate accounting model to apply in this environment. Our future results of operations may be significantly impacted, particularly due to the timing of revenue recognition, if we change our assessment as to whether software is incidental, particularly if VSOE or similar fair value cannot be obtained with respect to one or more of the undelivered elements.



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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 our future net income (loss) could be significant.

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 (see Note 2b to our consolidated financial statements).

Alcatel-Lucent had a fire in a newly-built factory containing new machinery. The non recoverables assets having a net book value of € 4 million were written off as of September 30, 2008 representing an equivalent negative impact on cost of sales in 2008. The cost of the physical damage and business interruption are insured and will give right to an indemnity claim, the amount of which is currently being assessed by our insurers. This indemnity will be accounted for as other revenue once virtually certain and a reliable estimates are available which could take up to one to two years to determine.

Purchase price allocation of a business combination

In a business combination, the acquirer must allocate the cost of the business combination at the acquisition date by recognizing the acquiree’s identifiable assets, liabilities and contingent liabilities at fair value at that date. The allocation is based upon certain valuations and other studies performed with the assistance of outside valuation specialists. Due to the underlying assumptions made in the valuation process, the determination of those fair values requires estimations of the effects of uncertain future events at the acquisition date and the carrying amounts of some assets, such as fixed assets, acquired through a business combination could therefore differ significantly in the future.

As prescribed by IFRS 3, if the initial accounting for a business combination can be determined only provisionally by the end of the reporting period in which the combination is effected, the acquirer must account for the business combination using those provisional values and has a twelve-month period to complete the purchase price allocation. Any adjustment of the carrying amount of an identifiable asset or liability made as a result of completing the initial accounting is accounted for as if its fair value at the acquisition date had been recognized from that date. Detailed adjustments accounted for in the allocation period are disclosed in Note 3 to our consolidated financial statements.

Once the initial accounting of a business combination is complete, further adjustments are accounted for only to correct errors.

6.1

OVERVIEW OF 2008

In 2008, service providers continued to focus their equipment spending on next-generation technologies that will allow them to offer new services and/or reduce their operating expenses. At the same time, the economic environment grew considerably more challenging in the latter part of 2008 as the recession in the U.S. deepened and spread elsewhere around the world. In addition to overall market and negative economic forces, our business was also affected by internal developments, including key changes to our senior leadership team, adoption of a new strategic focus and a realignment of our operations.

The transformation of carrier networks to all-IP (internet Protocol) architecture remains a key objective of service provider spending on next-generation technology, as the new architecture allows carriers to consolidate multiple networks while delivering new multimedia and triple play services to their end users. Strong carrier spending for IP equipment continued to reflect that ongoing transformation in 2008, and helped drive our own IP service router revenues to a record quarterly high at year-end. The ongoing transformation of service provider networks to all-IP also resulted in healthy demand for network integration and other professional services offered by us and other vendors.

Expanding broadband access capabilities remained a focus area for wireline carriers, with an emphasis on offering enhanced capabilities over optical fiber deployed deeper into access networks. However, the number of new subscribers to broadband access delivered over older, copper-based DSL (digital subscriber line) technology fell in 2008, and our own DSL shipments dropped 19%. That decline reflects a shift by some users to fiber-based and cable-based services, an increasingly saturated DSL market and deteriorating economic conditions. The deteriorating economy is also one of the factors, along with equal access regulatory issues, that resulted in a slower than expected deployment of fiber-based access networks in 2008. Despite those issues, the increasingly widespread availability of broadband access has facilitated marked growth in bandwidth-intensive traffic like video, and that drove very strong spending for additional capacity in optical networks earlier in the year. As added capacity came on-line and economic conditions deteriorated, growth in optical spending softened considerably later in the year, particularly for terrestrial-based networks. Spending on undersea optical networks – for additional capacity on existing networks and for new cable systems – remained strong throughout the year. Elsewhere in wireline, spending for legacy core switching equipment continued to decline, and spending for next-generation equipment increased.



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In wireless, the number of subscribers and traffic volume continued to increase globally, and wireless operators continued to invest in the mobile broadband capabilities offered by third-generation networks. However, some very disparate technology-specific spending trends have developed. Specifically, spending for CDMA (Code Division Multiple Access) wireless networks was much weaker than expected, while demand has been stronger than expected for GSM (Global System for Mobile Communications) and W-CDMA (Wideband CDMA) in emerging markets, especially in Asia. Meanwhile, the industry continued to work on the standards and technologies that will underlie fourth-generation wireless networks. In the market for professional services – which includes services that are attached to a product sold, as well as those which are offered independent of any equipment sale – growing demand has been led by the network integration and network operations (outsourcing) sectors. The deteriorating economy has affected the enterprise market more than the service provider market, especially in North America. However, our own enterprise data networking business has posted gains throughout the year, as has our contact center business.

As has been noted above, the deteriorating global macroeconomic environment in 2008 negatively impacted many of these broad spending trends. So far, the magnitude of those impacts has been mixed, with more projects being delayed and stretched out as opposed to being cancelled. However, the sharp year-end deterioration of the U.S. economy in 2008 suggests that the global recession may be deepening, which would mean service provider spending in the future may be seriously impacted. Economic issues are magnifying what already were intense competitive pressures, resulting in market-wide prices and margins that remain under significant pressure. In developed markets, the pressure on profitability reflects aggressive pricing by incumbents who are consolidating their existing market positions and defending those positions against other vendors who are trying to establish market share with their own aggressive pricing. Vendors are also battling to establish market share in emerging markets, which account for a growing portion of global spending for carrier telecommunications equipment and related applications and services. There, the pressure on profitability is compounded by a focus on providing low-cost basic communications services.

In addition to overall market and economic forces, internal developments in 2008 affected our business. Starting in September, we announced several changes to our leadership team, organization, business model and strategic focus. These changes are intended to improve our profitability as they strengthen our focus on customers, simplify the organization, clarify accountability and responsibility, and improve the cost structure of the business. For a more detailed discussion of these changes, see Chapter 5 “Business Organization”.

We also booked impairment charges totalling € 4.7 billion during the year related to our CDMA, Optics, Multicore, Applications, Mobile Access and Fixed Access business divisions. Included in the € 4.7 billion is an € 810 million charge related to our CDMA business that was taken at mid-year following the 2008 annual impairment test, and charges of € 3.9 billion were booked at year-end. The mid-year CDMA impairment was due to the fact that in the second quarter of 2008, revenues from our CDMA business declined at a higher pace than planned. The unexpected, large reduction in the capital expenditures of one of our key customers in North America primarily affected this business. Although other geographic areas offer new opportunities, the uncertainty regarding spending in North America has led us to make more cautious mid-term assumptions about the results of this business. We performed an additional impairment test during the fourth quarter of 2008 in light of the difficult financial and economic environment, the continuing material decrease in our market capitalization and the new 2009 outlook, taking into account estimated consequences of our strategic decisions we disclosed in December 2008. The re-assessment of our near-term outlook, taking into account more conservative growth assumptions for the telecommunications equipment and related services market in 2009, coupled with the decision to streamline our portfolio, and with the use of a higher discount rate, led to an additional loss at year-end of € 3,910 million, including a € 2,429 million charge to goodwill and other impairment losses on other assets.


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6.2

CONSOLIDATED RESULTS OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 2008 COMPARED TO THE YEAR ENDED DECEMBER 31, 2007

Introduction. As mentioned earlier, in January 2007, we contributed our transportation and security activities to Thales, and in April 2007, we completed the sale of our ownership interests in two joint ventures in the space sector to Thales. Consequently, our results for 2007 exclude the businesses transferred in January and April 2007 to Thales.

Revenues. Revenues were € 16,984 million in 2008, a decline of 4.5% from € 17,792 million in 2007. Approximately 52% of our revenues are denominated in or linked to the U.S. dollar. When we translate these sales into euros for accounting purposes, there is an exchange rate impact based on the relative value of the U.S. dollar and the euro. The value of the U.S. dollar relative to the euro increased significantly in the second half of 2008, but for the year as a whole compared with 2007, the value of the U.S. dollar declined relative to the euro. The decrease in the value of the U.S. dollar relative to the euro from 2007 to 2008 had a negative impact on our revenues. If there had been a constant euro/U.S. dollar exchange rate in 2008 as compared to 2007, our consolidated revenues would have decreased by approximately 1.1% instead of the 4.5% decrease actually experienced. This is based on applying (i) to our sales made directly in U.S. dollars or in currencies linked to U.S. dollars during 2008, the average exchange rate that applied for 2007, instead of the average exchange rate that applied in 2008, and (ii) to our exports (mainly from Europe) during 2008 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 for 2007. Our management believes that providing our investors with our revenues for 2008 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:

(in millions of euros)

Year ended December 31, 2008

Year ended December 31, 2007

% Change

Revenues as reported

16,984

17,792

(4.5%)

Conversion impact euro/U.S. dollar

519

2.9%

Hedging impact euro/U.S. dollar

90

0.5%

Revenues at constant rate

17,593

17,792

(1.1%)


Revenues in 2008 and in 2007 by geographical market (calculated based upon the location of the customer) are as shown in the table below:

Revenues by geographical market

(in millions of euros)

France

Other Western Europe

Rest
of Europe

Asia Pacific

U.S.

Other Americas

Rest
of world

Consolidated

2008

1,419

3,537

944

3,192

4,812

1,538

1,542

16,984

2007

1,219

3,657

954

3,386

5,438

1,534

1,604

17,792

% Change 2008 vs. 2007

16.4%

(3.3%)

(1.0%)

(5.7%)

(11.5%)

0.3%

(3.9%)

(4.5%)


In 2008, the United States accounted for 28.3% of revenues by geographical market, down from 30.6% in 2007 as revenues fell 11.5% in that market. The decline in the United States reflected particular weakness in CDMA and DSL revenues, which were not fully offset by increased sales in W-CDMA, Enterprise and Services. Europe accounted for 34.7% of revenues in 2008 (8.4% in France, 20.8% in Other Western Europe and 5.6% in Rest of Europe), up from 32.8% in 2007 (6.9% in France, 20.6% in Other Western Europe and 5.4% in Rest of Europe). Within Europe, revenue increased 16.4% year-over-year in France due in part to gains in W-CDMA, while revenue fell 3.3% in Other Western Europe and 1.0% in Rest of Europe. Revenues in the Asia Pacific market fell 5.7% in 2008, but they were little changed as a percent of total revenue (18.8% in 2008 and 19.0% in 2007). Services revenues were particularly strong in the Asia Pacific market in 2008. Revenues in Other Americas were flat in 2008 (up 0.3% from 2007) as widespread gains offset lower CDMA revenues, although share of total revenue increased slightly – from 8.6% in 2007 to 9.1% in 2008. Rest of World revenues fell 3.9% from 2007 to 2008 but were little changed as a percent of total revenue (9.1% in 2008 and 9.0% in 2007). Around the world, growth in our Services business was solid in 2008. We capitalized on new opportunities for our wireless business in emerging markets in 2008. Our IP routing business developed strong momentum in North America, Europe and China in 2008. Our legacy fixed access business (DSL) was weak in North America and Europe as spending shifted to highly price competitive emerging markets.

Gross Profit. Despite the decline in revenue in 2008, gross profit increased to 34.1% of revenue, or € 5,794 million, compared to 32.1% of revenue or € 5,709 million in 2007. The increase in gross profit is due to enhanced pricing discipline, which improves our ability to retain the benefits of our product cost reduction programs, and which reflects our ongoing commercial selectivity as we balance our intent to grow share with our focus on profitable growth. In addition, gross profit was minimally impacted in 2008 from purchase accounting for the Lucent business combination whereas in 2007, there was a negative, non-cash impact of € 253 million. Gross profit in 2008 included a € 13 million net gain from currency hedging; a € 21 million capital gain from the sale of real estate; and € 34 million from a litigation settlement, which were more than offset by (i) a net charge of € 275 million for write-downs of inventory and work in progress; (ii) a net charge of € 24 million for reserves on customer receivables; and (iii) a € 48 million provision for a contract loss. Gross profit in 2007 included € 34 million from a litigation settlement related to business arrangements with a company in Columbia which was subsequently liquidated; and a net reversal of € 10 million of reserves on customer receivables as the reversal of historical reserves exceeded the amount of new reserves, which were more than offset by (i) a negative impact of € 130 million related to investments in current products and platforms that we will eventually discontinue, but that we continue to enhance in order to meet our commitment to our customers while preparing to converge them into a common platform; (ii) a € 98 million one-time charge resulting from the difficulties we encountered in fulfilling a large W-CDMA contract; and (iii) a net charge of € 178 million for write-downs of inventory and work in progress.



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Administrative and selling expenses. In 2008, administrative and selling expenses were € 3,093 million or 18.2% of revenues compared to € 3,462 million or 19.5% of revenues in 2007. The 10.7% decline in administration and selling expenses reflects the progress we have made executing on our programs to reduce operating expenses, as well as a favorable currency impact on our U.S. dollar denominated expenses. Also contributing to the decrease in administrative and selling expenses was a decline in purchase accounting entries resulting from the Lucent business combination, from € 295 million in 2007 to € 122 million in 2008. The purchase accounting entries have a negative, non-cash impact, and they primarily relate to the amortization of purchased intangible assets of Lucent, such as customer relationships.

Research and development costs. Research and development costs were € 2,757 million or 16.2% of revenues in 2008, after the capitalization of € 101 million of development expense, compared to € 2,954 million or 16.6% of revenues after the capitalization of € 153 million of development expense in 2007. The 6.7% decline in research and development costs is due, as was the case for administrative and selling expenses, to the progress we have made executing on our programs to reduce operating expenses, as well as a favorable currency impact on our U.S. dollar denominated expenses. The reported decline in research and development costs would have been 12.0%, except for an increase in 2008 in purchase accounting entries relating to R&D resulting from the Lucent business combination, from € 269 million in 2007 to € 394 million in 2008. The increase in purchase accounting entries relating to R&D in 2008 is largely due to a non-recurring adjustment for the disposal of patents and an increase in the amortization of in-progress R&D reflecting the completion and initial amortization of various development projects acquired from Lucent. The purchase accounting entries have a negative, non-cash impact, and they primarily relate to the amortization of purchased intangible assets of Lucent, such as acquired technologies and in-process research and development. Research and development costs in 2008 included € 58 million in capital gains on the sale of intellectual property which was booked against our research and development expense.

Two contributors to our reduced operating expenses (including both administrative and selling expenses and research and development costs) in 2008, compared with 2007, have been headcount reductions and a shift of manpower from high cost to low cost countries. Company-wide headcount reductions, net totaled 2,775 in 2008, excluding the impact of acquisitions, managed services contracts and new consolidations of previously non-fully-consolidated entities. In 2007, headcount reductions, net totaled 6,324 excluding the impact of acquisitions, managed services contracts and new consolidations of previously non-fully-consolidated entities.

Income (loss) from operating activities before restructuring costs, impairment of assets, gain/(loss) on disposal of consolidated entities and post-retirement benefit plan amendments. We recorded a loss from operating activities before restructuring costs, impairment of assets, gain/(loss) on disposal of consolidated entities and post-retirement benefit plan amendments of € 56 million in 2008 compared to a loss of € 707 million in 2007. This smaller loss reflects improved pricing discipline, the benefits of our product cost and operating expense reduction programs and a decline in the purchase accounting entries booked in 2008, all of which more than offset the impact of lower revenues in 2008. The purchase accounting entries had a negative, non-cash impact of € 522 million in 2008 as compared to € 817 million in 2007.

Changes in provisions adversely impacted income (loss) from operating activities before restructuring costs, impairment of assets, gain/(loss) on disposal of consolidated entities and post-retirement benefit plan amendments in 2008 by € 235 million (of which € 443 million were additional provisions and € 208 million were reversals). Additional product sales reserves (excluding construction contracts) created during 2008 were € 354 million, while reversals of product sales reserves were € 135 million during the same period. Of the € 135 million in reversals, € 59 million related to reversals of reserves made in respect of warranties due to the revision of our original estimates for these reserves regarding warranty period and costs. This revision was due mainly to (i) the earlier than expected replacement of products under warranty by our customers with more recent technologies and (ii) the product’s actual performance leading to fewer warranty claims than anticipated and for which we had made a reserve. In addition, € 30 million of the € 135 million reversal of product sales reserves was mainly related to reductions in probable penalties due to contract delays or other contractual issues or in estimated amounts based upon statistical and historical evidence. The remaining reversals (€ 46 million) were mainly related to new estimates of losses at completion. Changes in provisions adversely impacted income (loss) from operating activities before restructuring costs, impairment of intangible assets, gain/(loss) on disposal of consolidated entities and post-retirement benefit plan amendments by € 429 million in 2007, of which additional provisions were € 642 million and reversals were € 213 million. Additional product sales reserves created in 2007 were € 500 million while reversals of product sales reserves were € 145 million.



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Restructuring Costs. Restructuring costs were € 562 million in 2008, representing (i) an asset write-off of € 35 million; (ii) € 489 million of new restructuring plans, and adjustments to previous plans and (iii) € 38 million of other monetary costs. New restructuring plans cover costs related to the elimination of jobs and to product rationalization and facilities closing decisions. Restructuring costs were € 856 million in 2007, representing (i) an asset write-off of € 47 million, (ii) € 623 million of new restructuring plans or adjustments to previous plans; and (iii) € 186 million of other monetary costs. Our restructuring reserves of € 595 million at December 31, 2008 covered jobs identified for elimination and notified in the course of 2008, as well as jobs eliminated in previous years for which total or partial settlement is still due, costs of replacing rationalized products, and other monetary costs linked to decisions to reduce the number of our facilities.

Impairment of Assets. In 2008 we booked an impairment of assets charge of € 4,725 million, including € 3,272 million for goodwill; € 135 million for capitalized development costs; € 1,276 million for other intangible assets; € 39 million for property, plant and equipment; and € 14 million for financial assets. € 810 million of the € 4,725 million is a charge taken at mid-year arising from our yearly impairment test related to our CDMA business, and charges of € 3,910 million were booked at year-end related to our CDMA, Optics, Multicore, Applications, Mobile Access and Fixed Access business divisions. The mid-year CDMA impairment was due to the fact that in the second quarter of 2008, revenues from our CDMA business declined at a higher pace than we had planned. The unexpected, large reduction in the capital expenditures of one of our key CDMA customers in North America and the uncertainty regarding spending CDMA in North America were the main drivers of the decline. We performed an additional impairment test during the fourth quarter of 2008 in light of the difficult financial and economic environment, the continuing material decrease in our market capitalization and the new 2009 outlook, taking into account estimated consequences of our strategic decisions disclosed in December 2008. In 2007 we took an impairment of assets charge of € 2,944 million mainly related to our CDMA, W-CDMA and IMS businesses. Of the € 2,944 million, € 2,657 million is related to goodwill; € 39 million to capitalized development costs; € 174 million to other intangible assets; and € 74 million to property, plant and equipment.

Post-retirement benefit plan amendment. In 2008 we booked a € 47 million net credit related to post-retirement benefit plan amendments. It consists of an € 18 million reserve related to ongoing litigation that concerns a previous Lucent healthcare plan amendment (see 6.10 “Legal Matters – Lucent’s Employment and Benefits Related Cases,” in this annual report for more detail) and a € 65 million credit related to a € 148 million benefit obligation decrease for the Lucent management retiree healthcare plan. The benefit obligation decrease is a result of our adoption of a Medicare Advantage Private Fee-For-Service Plan. € 83 million of the € 148 million decrease is a result of a change in actuarial assumptions and is recognized in the Statement of Recognized Income and Expense, while € 65 million of the decrease is a result of a plan amendment and is recognized in this specific line item of our income statement. In 2007 we booked a € 258 million credit resulting from certain changes to Lucent management retiree healthcare benefit plans. Effective January 1, 2008, prescription drug coverage offered to former Lucent management retirees was changed to a drug plan similar to the Medicare Part D program. This change reduced the benefit obligation projected in the first half of 2007 by € 258 million, net of a € 205 million elimination of the previously expected Medicare Part D subsidies.

Income (loss) from operating activities. Income (loss) from operating activities was a loss of € 5,303 million in 2008, compared to a loss of € 4,249 million in 2007. The bigger loss in 2008 is due primarily to a significantly larger impairment charge in 2008 as compared with 2007, which more than offset the combined positive impacts of our improved pricing discipline, our product cost and operating expense reduction programs, lower restructuring costs and a decline in the total purchase accounting entries booked in 2008 as compared with 2007. The bigger loss in 2008 is also partially due to a smaller credit booked for post-retirement benefit plan amendments than was the case in 2007.

Finance costs. Net finance costs in 2008 were € 212 million and included € 391 million of interest paid on our gross financial debt, offset by € 179 million in interest earned on our cash, cash equivalents and marketable securities. In 2007 net finance costs of € 173 million resulted from € 403 million of interest paid on our gross financial debt, offset by € 230 million in interest earned on cash, cash equivalents and marketable securities. The decline in interest paid in 2008 compared to 2007 is due largely to a lower level of gross financial debt, while the decline in interest earned is due largely to a lower level of cash, cash equivalents and marketable securities.

Other financial income (loss). Other financial income was € 366 million in 2008, compared to financial income of € 541 million in 2007. Other financial income consists largely of the difference between the expected financial return on the assets and the interest cost on the obligations of the pension and post-retirement benefit plans, mainly related to the Lucent plans’ assets and obligations. The decline from 2007 to 2008 is due to a November 2007 re-allocation of the plans’ assets which reduced their exposure to equity markets, as well as the decline in the fair value of the plans’ assets.

Share in net income (losses) of equity affiliates. Share in net income of equity affiliates was € 96 million in 2008, compared with € 110 million in 2007. While our share of equity affiliates’ earnings included positive contributions from both Thales and Draka in 2007, our share in 2008 included a contribution from Thales only, since we sold our interest in Draka in the fourth quarter of 2007. In 2008, the contribution from Thales also reflected the reclassification of our Thales shares from net assets in equity affiliates to assets held for sale as of the announcement on December 19, 2008 of a definitive agreement to sell our stake in Thales to Dassault Aviation.

Income (loss) before income tax, related reduction of goodwill and discontinued operations. Income (loss) before income tax, related reduction of goodwill and discontinued operations was a loss of € 5,053 million in 2008 compared to a loss of € 3,771 million in 2007.

Reduction of goodwill related to deferred tax assets initially unrecognized. In 2008 there was no reduction of goodwill related to deferred tax assets that were initially unrecognized. In 2007, there was a € 256 million reduction of goodwill that was due largely to the post-retirement benefit plan amendment described above.



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Income tax (expense) benefit. We had an income tax expense of € 153 million in 2008, compared to an income tax expense of € 60 million in 2007. The income tax expense for 2008 resulted from a current income tax charge of € 99 million and a net deferred income tax charge of € 54 million. The € 54 million net deferred tax charge included deferred income tax benefits of € 740 million (related to the reversal of deferred tax liabilities accounted for in the purchase price allocation of the Lucent combination), that were more than offset by (i) a € 476 million charge from changes in deferred tax mainly due to the reassessment of the recoverability of deferred tax assets in connection with the goodwill impairment tests performed in 2008; (ii) a € 293 million deferred tax charge related to Lucent’s post-retirement benefit plans; and (iii) a € 25 million deferred tax charge related to the post-retirement benefit plan amendment associated with our adoption of a Medicare Advantage Private Fee-For-Service Plan. The € 60 million income tax expense for 2007 resulted from a current income tax charge of € 111 million and a net deferred income tax benefit of € 51 million. The € 51 million net deferred tax benefit included deferred income tax benefits of € 652 million (related to the reversal of deferred tax liabilities accounted for in the purchase price allocation of the Lucent combination and the recognition of deferred tax assets initially unrecognized at the time of the Lucent combination), that were not fully offset by a € 420 million charge from changes in deferred tax mainly due to the reassessment of the recoverability of deferred tax assets in connection with the goodwill impairment and a € 181 million deferred tax charge related primarily to the post-retirement benefit plan amendment.

Income (loss) from continuing operations. We had a loss from continuing operations of € 5,206 million in 2008 compared to a loss of € 4,087 million in 2007 due to the factors noted above.

Income (loss) from discontinued operations. There was income of € 33 million from discontinued operations in 2008, mainly related to adjustments on initial capital gain (loss) on discontinued operations that were sold or contributed in previous periods (mainly related to activities that were contributed to Thales). That compares with income of € 610 million in 2007, which consisted primarily of a € 615 million net capital gain after tax on the contribution of our railway signaling business and our integration and services activities to Thales.

Minority Interests. Minority interests were € 42 million in 2008, compared with € 41 million in 2007, largely reflecting our operations in China with Alcatel-Lucent Shanghai Bell.

Net income (loss) attributable to equity holders of the parent. A net loss of € 5,215 million was attributable to equity holders of the parent in 2008, compared with a loss of € 3,518 million attributable to equity holders of the parent in 2007.

A summary of new financial reporting standards, amendments and interpretations published but not yet applied by the Group is presented in Note 1 to the consolidated financial statements (See Section 12).

6.3

RESULTS OF OPERATIONS BY BUSINESS SEGMENT FOR THE YEAR ENDED DECEMBER 31, 2008 COMPARED TO THE YEAR ENDED DECEMBER 31, 2007

As mentioned earlier, in January 2007, we contributed our transportation and security activities to Thales, and in April 2007, we completed the sale of our ownership interests in two joint ventures in the space sector to Thales. The table immediately below shows how we organized our business through December 31, 2008, which is also the basis for the segment results presented and discussed further below. Effective January 1, 2009, this organization structure was superseded by the new organization that is discussed in further detail in Item 5.1 “Business Organization” found elsewhere in this document.

Carrier

Enterprise

Services

Fixed Access

Mobile Access

Multicore

Enterprise Solutions

Network Integration

IP

CDMA Networks

Applications

Genesys

Professional Services

Optics

  

Industrial Components

Maintenance

    

Network Operations




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The table below sets forth certain financial information on a segment basis for 2008 and 2007. Segment operating income (loss) is the measure of operating segment profit or loss that is used by our Management Committee to perform its chief operating decision making function, assess performance and allocate resources. It consists of segment income (loss) from operating activities before restructuring costs, impairment of intangible assets, gain/(loss) on disposal of consolidated entities and post-retirement benefit plan amendments, excluding the main non-cash impacts of the purchase price allocation (PPA) entries relating to the Lucent business combination. Adding “PPA Adjustments (excluding restructuring costs and impairment of assets)” to segment operating income (loss), as shown in the table below, reconciles segment operating income (loss) with income (loss) from operating activities before restructuring costs, impairment of assets, gain/(loss) on disposal of consolidated entities and post-retirement benefit plan amendments, as shown in the table below and in our 2008 consolidated financial statements.

2008

(in millions of euros)

Carrier

Enterprise

Services

Other & Elimination

Total Group

REVENUES

11,540

1,590

3,452

402

16,984

Segment Operating Income (Loss)

(68)

128

268

138

466

PPA Adjustments (excluding restructuring costs and impairment of assets)

    

(522)

Income (loss) from operating activities before restructuring costs, impairment of assets, gain/(loss) on disposal of consolidated entities and post-retirement benefit plan amendments

    

(56)

Capital expenditures

680

96

73

52

901



2007

(in millions of euros)

Carrier

Enterprise

Services

Other & Elimination

Total Group

REVENUES

12,819

1,562

3,173

238

17,792

Segment Operating Income (Loss)

(152)

126

147

(11)

110

PPA Adjustments (excluding restructuring costs and impairment of assets)

    

(817)

Income (loss) from operating activities before restructuring costs, impairment of assets, gain/(loss) on disposal of consolidated entities and post-retirement benefit plan amendments

    

(707)

Capital expenditures

673

93

40

36

842


PPA Adjustments (excluding restructuring costs and impairment of assets). In 2008, PPA adjustments (excluding restructuring costs and impairment of assets) were € (522) million, compared with € (817) million in 2007. The decline in PPA adjustments in 2008 is due largely to the fact that PPA adjustments included € (258) million for an inventory reversal in 2007 which was not repeated in 2008.

Income (loss) from operating activities before restructuring costs, impairment of assets, gain/(loss) on disposal of consolidated entities and post-retirement benefit plan amendment. In 2008, segment operating income of € 466 million for the Group, adjusted for € (522) million in PPA yields a loss from operating activities before restructuring costs, impairment of assets, gain/(loss) on disposal of consolidated entities and post-retirement benefit plan amendment of € 56 million, as shown in the consolidated financial statements. In 2007, segment operating income of € 110 million for the Group adjusted for € (817) million in PPA yields a loss from operating activities before restructuring costs, impairment of assets, gain/(loss) on disposal of consolidated entities and post-retirement benefit plan amendment of € 707 million, as shown in the consolidated financial statements.

Carrier Segment

Revenues in our carrier business segment were € 11,540 million in 2008, a decline of 10.0% from € 12,819 million in 2007, using current exchange rates. When we translate these sales into euros for accounting purposes, there is an exchange rate impact based on the relative value of the U.S. dollar and the euro. The decrease in the value of the U.S. dollar relative to the euro since 2007 had a significant negative impact on our revenues. If there had been a constant euro/U.S. dollar exchange rate in 2008 as compared to 2007 our carrier segment revenues would have decreased by approximately 6.9% instead of the 10.0% decline actually experienced.

Within the carrier segment, activity in our divisions that are focused on fixed line technologies exhibited varied trends in 2008, ranging from growth in Optics and IP routing to a decline in Fixed Access. Our Optics and Fixed Access businesses also reflected the sharper second-half deterioration in the economic environment, as the growth in Optics slowed and the decline in Fixed Access accelerated in the latter part of the year. In Optics, the increasingly widespread availability of broadband access facilitated strong growth in bandwidth-intensive traffic like video, driving solid spending for added capacity in optical networks. That growth slowed considerably in the latter part of the year, especially in the terrestrial segment, reflecting the new capacity that came on-line earlier in the year as well as the increasingly difficult economic environment. Spending on undersea optical networks – for additional capacity on existing networks and for new cable systems – was particularly strong in 2008. Our Fixed Access revenues weakened in 2008 as we shipped 19% fewer DSL lines than in 2007. That decline reflected fewer new subscribers to carriers’ broadband access services, particularly in the increasingly saturated developed markets. DSL activity in North America and Western Europe was also impacted by the recession. Initial mass deployments of GPON – the next-generation fixed access technology – were launched in 2008, but growth was slower than expected due to regulatory uncertainty and the economy. Operators still consider GPON as the preferred technology for extending optical fiber deeper into their access networks, but it is a new technology and has not yet scaled to the point where it can offset declines in our legacy DSL business. Our IP routing business increased in 2008, with an upgrade portfolio and increased customer diversification helping to drive record revenues in the fourth quarter. Our mature ATM (Asynchronous Transfer Mode) switching business, which is included in our IP division, continued on its structural decline path.



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Elsewhere in our carrier segment, our Mobile Access division was paced by 50% growth in our W-CDMA business, as revenues ramped higher at several key customers. The increase in revenues, along with lower costs, helped us to reduce, by more than half, operating losses in our W-CDMA business in 2008. Elsewhere in Mobile Access, our growth in our GSM business was strong in the first half, driven by network expansions in China, India, the Middle East and Africa, but slowed considerably in the second half and was more in line with what is a mature, declining market. Our CDMA business declined sharply in 2008, reflecting particular weakness in North America that was not fully offset by shipments to a new customer in China.

Our legacy voice switching business continued its decreasing trend, reflecting lower carrier spending on that technology. At the same time, growth in our next-generation core networking business continued, and our revenues in that business surpassed, for the first time, those in our legacy switching business at year-end. There were mixed trends in our Applications business in 2008, including weakness in legacy payment systems and strong growth in subscriber data management.

Enterprise Segment

Revenues in our enterprise business segment were € 1,590 million in 2008, an increase of 1.8% over revenues of € 1,562 million in 2007, using current exchange rates. If there had been a constant euro/U.S. dollar exchange rate in the 2008 as compared to 2007 our enterprise segment revenues would have increased by 4.8% instead of the 1.8% increase actually experienced. We have refocused our enterprise channel management and reorganized and added resources to our enterprise sales force, and those initiatives helped to drive growth in data networking, IP telephony and our Genesys contact center business in 2008. Growth in North America was particularly strong in 2008, although as the year progressed signs increased in North America and elsewhere that the deteriorating economy was affecting the enterprise market, particularly small-to-medium sized businesses. Enterprise segment operating income was € 128 million or 8.1% of revenue in 2008, little changed from € 126 million or 8.1% of revenue in 2007. The ongoing investments we are making in this part of our business have been largely offset by higher volumes and the progress we are making in our product cost reduction programs.

Services Segment

Revenues in our services business segment were € 3,452 million in 2008, an increase of 8.8% over revenues of € 3,173 million in 2007, using current exchange rates. If there had been a constant euro/U.S. dollar exchange rate in the first half of 2008 as compared to the first half of 2007 our services segment revenues would have increased by 11.6% instead of the 8.8% increase actually experienced. Growth in services was particularly strong in network operations, network integration and multivendor maintenance. Services segment operating income was € 268 million or 7.8% of revenue in 2008, compared with € 147 million or 4.6% of revenue in 2007. The increase in segment operating income is due to higher volumes, a favorable mix of services and higher margins across our services portfolio.


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6.4

CONSOLIDATED RESULTS OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 2007 COMPARED TO THE YEAR ENDED DECEMBER 31, 2006

Introduction. As noted earlier, on November 30, 2006, pursuant to a merger agreement that historical Alcatel and Lucent entered into on April 2, 2006, Lucent became a wholly owned subsidiary of Alcatel. On December 1, 2006, we and Thales signed a definitive agreement for the acquisition by Thales of our ownership interests in two joint ventures in the space sector, our railway signaling business and our integration and services activities for mission-critical systems not dedicated to operators or suppliers of telecommunications services. In January 2007, the transportation and security activities were contributed to Thales, and in April 2007, the sale of our ownership interests in the two joint ventures in the space sector was completed.

Consequently, the following discussion takes into account our results of operations under IFRS for the year ended December 31, 2007 which includes twelve months of Lucent’s results of operations, while our 2006 results include only one month of Lucent’s results. Our results for the year ended December 31, 2007 also include the UMTS radio access business acquired from Nortel on December 31, 2006 and exclude the businesses transferred in January and April 2007 to Thales. Our results for 2006 have been re-presented to exclude the businesses transferred to Thales in 2007 and to take into account the effect of the change in accounting policies on employee benefits.

Revenues. Revenues were € 17,792 million for 2007, an increase of 44.9% as compared to € 12,282 million for 2006. The increase was largely due to the inclusion of twelve months of Lucent’s results of operations for 2007, while our 2006 results included only one month of Lucent’s results. Approximately 56.4% of our revenues were denominated in or linked to the U.S. dollar. When we translate these sales 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 2007, the decrease 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 during 2007 as compared to 2006 our consolidated revenues would have increased by approximately 51.7% instead of the 44.9% actually experienced. This is based on applying (i) to our sales made directly in U.S. dollars or currencies linked to U.S. dollars effected during 2007, the average exchange rate that applied for 2006, instead of the average exchange rate that applied for 2007, and (ii) to our exports (mainly from Europe) effected during 2007 which are denominated in U.S. dollars and for which we entered into hedging transactions, our average euro/U.S. dollar hedging rate that applied for 2006. Our management believes that providing our investors with our revenues for 2007 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:

(in millions of euros)

Year ended December 31, 2007

Year ended December 31, 2006

% Change

Revenues as reported

17,792

12,282

44.9%

Conversion impact euro/U.S. dollar

740

6.0%

Hedging impact euro/U.S. dollar

98

0.8%

Revenues at constant rate

18,630

12,282

51.7%


Revenues increased across the business – in the carrier, enterprise and services segments. The revenue increase in each part of the business, except for the enterprise segment, is largely due to the inclusion of twelve months of Lucent’s results of operations for 2007, while our 2006 results include only one month of Lucent’s results.

Revenues for 2007 and 2006 by geographical market (calculated based upon the location of the customer) are as shown in the table below:

Revenues by geographical market

(in millions of euros)

France

Other Western Europe

Rest
of Europe

Asia Pacific

U.S.

Other Americas

Rest
of world

Consolidated

2007

1,219

3,657

954

3,386

5,438

1,534

1,604

17,792

2006

1,096

2,879

946

2,116

2,323

1,128

1,794

12,282

% Change 2007 vs. 2006

11%

27%

1%

60%

134%

36%

(11%)

45%




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The revenue increase in individual geographic markets was largely due to the inclusion of twelve months of Lucent’s results of operations for 2007, while our 2006 results included only one month of Lucent’s results. However, in the Rest of World segment the inclusion of twelve months of Lucent’s results in 2007 was more than offset by a reclassification of certain countries, including India, out of the Rest of World segment and into the Asia Pacific segment. Without the reclassification, Rest of World revenue would have shown an increase in 2007 instead of the 11% decline shown in the table, and Asia Pacific revenue would have shown a smaller increase than the 60% shown in the table. In 2007, the United States accounted for 30.6% of revenues by geographical market, while France, Other Western Europe, the Rest of Europe, Asia Pacific, Other Americas and the Rest of the World accounted for 6.9%, 20.6%, 5.4%, 19.0%, 8.6% and 9.0%, respectively. This compares with the following percentages of revenues by geographical market for 2006: France – 8.9%, Other Western Europe – 23.4%, the Rest of Europe – 7.7%, Asia Pacific – 17.2%, United States – 18.9%, Other Americas – 9.1% and the Rest of the World – 14.6%. The increase in United States revenue as a percentage of total revenue was largely due to the inclusion of twelve months of Lucent’s results of operations for 2007, while our 2006 results included only one month of Lucent’s results, and to the fact that Lucent’s revenues were concentrated in the United States.

Gross profit. During 2007, gross profit was 32.1% of revenues or € 5,709 million, compared to 33.1% of revenues or € 4,068 million in 2006. The increase in gross profit in absolute terms was largely due to the inclusion of twelve months of Lucent’s results of operations for 2007, while our 2006 results include only one month of Lucent’s results. The decrease in gross profit as a percentage of revenues was due to competitive pricing pressures in our carrier markets and the non-recurring negative, non-cash impact of € 247 million upon the sale of a portion of Lucent’s inventory in 2007. As a result of purchase accounting for the Lucent business combination, Lucent’s inventory was revalued to its fair value and such “step-up” in valuation was reversed once the inventory was sold. The reversal of the inventory step-up related to the Lucent business combination began in 2006, with a negative non-cash impact on gross profit of € 167 million, and it was completed in 2007. Gross profit in 2007 also included (i) the negative impact of € 130 million related to investments in current products and platforms that we will eventually discontinue, but that we continue to enhance in order to meet our commitment to our customers while preparing to converge them into a common platform; (ii) the negative impact of a € 98 million one-time charge resulting from the difficulties we encountered in fulfilling a large W-CDMA contract; (iii) the positive impact of € 34 million from a litigation settlement related to business arrangements with a company in Colombia which was subsequently liquidated; (iv) the negative impact of a net charge of € 178 million for write-downs of inventory and work in progress; and (v) the positive impact of a net reversal of € 10 million of reserves on customer receivables as the reversal of historical reserves exceeded the amount of new reserves.

In addition to the negative non-cash impacts from purchase accounting discussed above, gross profit in 2006 also included (i) the negative impact of a net charge of € 59 million for write-downs of inventory and work in progress, (ii) the negative impact of a net charge of € 8 million on customer receivables, and (iii) the negative impact of € 87 million of sales incentive amounts paid to employees which are now included in administrative and selling expenses effective January 1, 2007.

Administrative and selling expenses. For 2007, administrative and selling expenses were € 3,462 million or 19.5% of revenues compared to € 1,911 million or 15.6% of revenues in 2006. The primary reason for the increase in administrative and selling expenses in 2007 compared with 2006 is the inclusion of twelve months of Lucent’s results of operations for 2007, while our 2006 results included only one month of Lucent’s results. The increase in administrative and selling expenses as a percentage of revenues included the negative, non-cash impact of purchase accounting entries of € 295 million in 2007 and € 30 million in 2006 resulting from the Lucent business combination and primarily related to the amortization of purchased intangible assets of Lucent, such as customer relationships. Administrative and selling expenses in 2007 also include sales incentive amounts paid to employees, whereas prior to January 1, 2007, historical Alcatel classified these costs as cost of sales. Other operations that are included in 2007 results but not in 2006, including the UMTS radio access business acquired from Nortel and activities acquired through other acquisitions, also contributed to the 2007 increase in administrative and selling expenses.

Research and Development costs. Research and Development costs were € 2,954 million in 2007, after the capitalization of € 153 million of development expense, compared to € 1,470 million in 2006, after the capitalization of € 109 million of development expense. As a percentage of revenues, Research and Development costs for 2007 were 16.6%, compared to 12.0% in 2006. Research and Development costs included the negative, non-cash impact of purchase accounting entries of € 269 million in 2007 and € 30 million in 2006 resulting from the Lucent business combination primarily related to the amortization of purchased intangible assets of Lucent, such as acquired technologies and in process Research and Development. The primary reason for the increase in Research and Development expenses in 2007 compared with 2006 was the inclusion of twelve months of Lucent’s results of operations for 2007, while our 2006 results included only one month of Lucent’s results. Acquisitions that occurred in 2007 or that occurred during 2006 but were included for a full year in 2007 also contributed to the 2007 increase in Research and Development costs.

Income (loss) from operating activities before restructuring costs, impairment of assets, gain/(loss) on disposal of consolidated entities and post-retirement benefit plan amendment. We recorded a loss from operating activities before restructuring costs, impairment of assets, gain/(loss) on disposal of consolidated entities and post-retirement benefit plan amendment of € 707 million for 2007 compared to income of € 687 million in 2006, which represented 5.6% of revenues. This decrease resulted from the competitive pricing environment that impacted our gross profit, and from the negative, non-cash impact of purchase accounting entries of € 817 million in 2007 as compared to € 227 million in 2006 resulting from the Lucent business combination, which more than offset Lucent’s contribution to revenues and gross margin.

Changes in provisions adversely impacted income (loss) from operating activities before restructuring costs, impairment of assets, gain/(loss) on disposal of consolidated entities and post-retirement benefit plan amendment for 2007 by € 429 million (of which € 642 million were additional provisions and € 213 million were reversals). Additional product sales reserves (excluding construction contracts) created during 2007 were € 500 million, while product sales reserves reversals during 2007 were € 145 million. Of the € 145 million in reversals, € 85 million related to reversals of warranty provisions due to the revision of our original estimates for warranty provisions regarding warranty period and costs. This revision was due mainly to (i) the earlier than expected replacement of products under warranty by our customers with more recent technologies and (ii) the product’s actual performance leading to fewer warranty claims than anticipated and for which we had made a reserve. In addition, € 21 million of the € 145 million reversal of product sales reserves were mainly related to reductions in probable penalties due to contract delays or other contractual issues or in estimated amounts based upon statistical and historical evidence. The remaining reversals (€ 39 million) were mainly related to new estimates of losses at completion. Changes in provisions adversely impacted income (loss) from operating activities before restructuring costs, impairment of intangible assets and gain/(loss) on disposal of consolidated entities by € 252 million for 2006, of which € 195 million related to product sales reserves (excluding construction contracts). Additional product sales reserves created during 2006 were € 376 million while provision reversals during 2006 were € 181 million.



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Restructuring costs. Restructuring costs were € 856 million for 2007, representing € 623 million of new restructuring plans and adjustments to previous plans, € 186 million of other monetary costs, and a valuation allowance or write-off of assets of € 47 million. New restructuring plans covered costs related to the elimination of jobs and to product rationalization and facilities closing decisions following the acquisition of UMTS technologies from Nortel and the business combination with Lucent. Restructuring costs were € 707 million in 2006, representing € 100 million of new restructuring plans or adjustments to previous plans, € 137 million of other monetary costs, and € 470 million of valuation allowances or write-offs of assets mainly associated with the discontinuance of certain product lines. Our restructuring reserves of € 698 million at December 31, 2007 covered more than 2,380 eliminated jobs, costs of replacing rationalized products, and other monetary costs linked to decisions to reduce the number of our facilities.

Impairment of assets. In 2007 we took an impairment of assets charge of € 2,944 million. Of the € 2,944 million, € 2,657 million was related to goodwill, € 39 million to capitalized development costs, € 174 million to other intangible assets and € 74 million to property, plant and equipment. Due to the delay in revenue generation from our 3G W-CDMA assets as compared to our initial expectations and to a reduction in margin estimates, we booked a € 426 million impairment charge. Also included in the € 2,944 million of 2007 impairment charges were impairment losses related to goodwill of € 2,109 million booked against our CDMA and EVDO (Code Division Multiple Access & Evolution Data Only) assets, € 396 million related to our IMS (internet Protocol Multimedia Subsystem) business and the balance was related to our Network Integration business. The CDMA and EVDO impairment charge related to goodwill was due to a revision in the long-term outlook for this activity, taking into account the 2007 change in market conditions as well as potential future technology evolutions. In 2006, we had € 141 million of impairment charges against intangible assets, primarily linked to our carrier segment.

Post-retirement benefit plan amendment. In 2007 we booked a € 258 million credit resulting from certain changes to management retiree healthcare benefit plans. Effective January 1, 2008, prescription drug coverage offered to former Lucent management retirees was changed to a drug plan similar to the Medicare Part D program. The future change reduced the current projected benefit obligation by € 258 million, net of a € 205 million elimination of the previously expected Medicare Part D subsidies. There was no corresponding amount for 2006.

Income (loss) from operating activities. Income (loss) from operating activities was a loss of € 4,249 million in 2007 compared to a loss of € 146 million in 2006. This larger loss was in great part due to major asset impairment charges and restructuring costs, a reduced gross margin, higher administrative and selling expenses and Research and Development costs, and the negative, non-cash impact of purchase accounting entries resulting from the Lucent business combination.

Finance costs. Finance costs were € 173 million in 2007 and included € 403 million of interest paid on our gross financial debt, offset by € 230 million in interest earned on our cash, cash equivalents and marketable securities. The 2006 net finance costs of € 98 million resulted from € 241 million of interest paid on our gross financial debt, offset by € 143 million in interest earned on cash, cash equivalents and marketable securities. The 2007 increase over 2006 in both interest paid and interest earned was largely due to the inclusion of twelve months of Lucent-related interest paid and interest earned for 2007, while our 2006 results included only one month of Lucent-related interest paid and interest earned.

Other financial income (loss). Other financial income was € 541 million in 2007 compared to financial expense of € 34 million in 2006. This increase was due primarily to the financial component of pension and post-retirement benefits, mainly related to the Lucent pension credit that was included in twelve months of 2007 results but in only one month of 2006 results.

Share in net income (losses) of equity affiliates. Share in net income of equity affiliates was € 110 million during 2007, with our 20.8% share in Thales and our 49.9% ownership interest in Draka (that we sold in the fourth quarter of 2007) contributing positively, compared to € 22 million in 2006. The increase in the Thales contribution was primarily due to our larger ownership interest in Thales (from 9.5% in 2006 to 20.80% in 2007) resulting from the receipt of 25 million Thales shares in January 2007 in connection with our contribution to Thales of our railway signaling business and our integration and services activities for mission-critical systems not dedicated to operators or suppliers of telecommunications services.

Income (loss) before tax, related reduction of goodwill and discontinued operations. Income (loss) before tax, related reduction of goodwill and discontinued operations was a loss of € 3,771 million compared to a loss of € 256 million in 2006.

Reduction of goodwill related to deferred tax assets initially unrecognized. Due to the inability to demonstrate when deferred tax assets related to Lucent’s pensions and other post-retirement benefits would be reversed and whether tax loss carry forwards would be available at the time of the reversal to offset such assets, our management decided to recognize only such amount of deferred tax assets as was equal to the amount of deferred tax liabilities accounted for in connection with these temporary differences. Deferred tax assets identified after the completion of a business combination and not initially recognized are accounted for in the income statement, as an income tax benefit (see discussion below) and a corresponding charge is accounted for as a reduction of goodwill. As the deferred tax liabilities related to pension assets increased in 2007 to € 256 million, a corresponding amount of deferred tax assets related to pensions that had not been recognized at the date of the business combination with Lucent were booked, which resulted in a corresponding reduction of goodwill. Of the € 256 million deferred tax liabilities recognized in 2007 relating to Lucent’s pension obligations, € 181 million represented the post-retirement benefit plan amendment described above.



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Income tax (expense) benefit. We had an income tax expense of € 60 million for 2007, compared to an income tax benefit of € 42 million for 2006. The net income tax expense for 2007 resulted from a current income tax charge of € 111 million and a net deferred income tax benefit of € 51 million. The € 51 million net deferred tax benefit included deferred income tax benefits of € 652 million (related to the reversal of deferred tax liabilities accounted for in the purchase price allocation of the Lucent combination and the recognition of deferred tax assets initially unrecognized at the time of the Lucent combination – see the explanation provided in the preceding paragraph), that were not fully offset by a € 420 million charge from changes in deferred tax mainly due to the reassessment of the recoverability of deferred tax assets in connection with the goodwill impairment described above and a € 181 million deferred tax charge related primarily to the post-retirement benefit plan amendment described above.

Income (loss) from continuing operations. We had a loss from continuing operations of € 4,087 million in 2007 compared to a loss of € 219 million in 2006.

Income (loss) from discontinued operations. Income from discontinued operations was € 610 million during 2007, consisting primarily of a € 615 million net capital gain after tax on the contribution of our railway signaling business and our integration and services activities to Thales. That compares with income of € 158 million generated primarily by those businesses in 2006.

Minority Interest. Minority interests were € 41 million during 2007 compared with € 45 million during 2006.

Net income (loss) attributable to equity holders of parent. A net loss of € 3,518 million was attributable to equity holders of the parent during 2007. In 2006, a net loss of € 106 million was attributable to equity holders of the parent.

6.5

RESULTS OF OPERATIONS BY BUSINESS SEGMENT FOR THE YEAR ENDED DECEMBER 31, 2007 COMPARED TO THE YEAR ENDED DECEMBER 31, 2006

The following discussion takes into account our results of operations under IFRS for the year ended December 31, 2007, (i) including Lucent’s results of operations starting on December 1, 2006, (ii) excluding the businesses transferred to Thales, and (iii) treating the business segments established after the business combination with Lucent as if they were effective on January 1, 2006.

The table below sets certain financial information on a segment basis for 2007 and 2006. Segment operating income (loss) is the measure of operating segment profit or loss that is used by our Management Committee to perform its chief operating decision making function, assess performance and allocate resources. It consists of segment (loss) from operating activities before restructuring costs, impairment of intangible assets, gain/(loss) on disposal of consolidated entities and post-retirement benefit plan amendments, excluding the main non-cash impacts of the purchase price allocation (PPA) entries relating to the Lucent business combination. Adding “PPA Adjustments (excluding restructuring costs and impairment of assets)” to segment operating income (loss), as shown in the table below, reconciles segment operating income (loss) with income (loss) from operating activities before restructuring costs, impairment of assets, gain/(loss) on disposal of consolidated entities and post-retirement benefit plan amendments, as shown in the table below and the consolidated financial statements.



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2007

(in millions of euros)

Carrier

Enterprise

Services

Other & Elimination

Total Group

REVENUES

12,819

1,562

3,173

238

17,792

Segment Operating Income (Loss)

(152)

126

147

(11)

110

PPA Adjustments (excluding restructuring costs and impairment of assets)

    

(817)

Income (loss) from operating activities before restructuring costs, impairment of assets, gain/(loss) on disposal of consolidated entities and post-retirement benefit plan amendment

    

(707)

Capital expenditures

673

93

40

36

842



2006

(in millions of euros)

Carrier

Enterprise

Services

Other & Elimination

Total Group

REVENUES

9,000

1,439

1,761

82

12,282

Segment Operating Income (Loss)

613

120

211

(31)

913

PPA Adjustments (excluding restructuring costs and impairment of assets)

    

(226)

Income (loss) from operating activities before restructuring costs, impairment of assets, gain/(loss) on disposal of consolidated entities and post-retirement benefit plan amendment

    

687

Capital expenditures

473

84

29

98

684


PPA Adjustments (excluding restructuring costs and impairment of assets). In 2007, PPA adjustments (excluding restructuring costs and impairment of assets) were € (817) million, compared with € (226) million in 2006. The increase in PPA adjustments in 2007 was due largely to the inclusion of twelve months of PPA entries relating to the Lucent business combination, while our 2006 results included only one month of PPA entries.

Income (loss) from operating activities before restructuring costs, impairment of assets, gain/(loss) on disposal of consolidated entities and post-retirement benefit plan amendment. In 2007, segment operating income of € 110 million for the Group, adjusted for € (817) million in PPA yielded a loss from operating activities before restructuring costs, impairment of assets, gain/(loss) on disposal of consolidated entities and post-retirement benefit plan amendment of € 707 million, as shown in our consolidated financial statements. In 2006, segment operating income of € 913 million for the Group adjusted for € (226) million in PPA yielded income from operating activities before restructuring costs, impairment of assets, gain/(loss) on disposal of consolidated entities and post-retirement benefit plan amendment of € 687 million, as shown in our consolidated financial statements.

Carrier Segment

Carrier segment revenues were € 12,819 million for 2007 compared with € 9,000 million for 2006. The increase was due to the inclusion of twelve months of Lucent, and to a lesser degree the UMTS business acquired from Nortel, in results of operations for 2007, while our 2006 results included only one month of Lucent’s results. A key development within the carrier market is the transformation of networks to a high-bandwidth, full IP architecture. While that IP transformation has had positive impacts across our carrier business, those impacts were more pronounced in wireline than in wireless in 2007. For example, increased shipments of our IP-based products helped drive our broadband access business in 2007, when we shipped 33 million DSL lines and counted more than 170 customers for our IP-based products. However, growth in that market slowed as 2007 progressed, reflecting high market penetration rates and the somewhat slower than expected transition to new GPON technology. The demand for metro and long haul DWDM optical networks to support high-bandwidth requirements for IP video services, including IPTV, was a key contributor to growth in 2007 in both our terrestrial and submarine optics business. Our IP service routing business was up 33% in 2007, excluding reseller sales, and reached a milestone of U.S. $ 1 billion in revenues for the year, while our multi-service wide-area-network switching business continued its long-term decline. In our multicore business in 2007 our core circuit switch business reflected the ongoing long-term decline that dominates carrier spending for that legacy technology. While that legacy market continued its decline in 2007, revenues in our next-generation core networking business remained too small to offset the declining legacy business. A growing number of subscribers on CDMA and GSM networks continued to drive higher traffic volumes, spending for capacity, and, in some cases, additional footprint. However, both of these businesses operate in mature markets that have started to decline, although revenues in our GSM business grew considerably as 2007 progressed, due to a refreshed product portfolio. 2007 was a year of investment for our W-CDMA business as we took three portfolios – one from historical Alcatel, one from Lucent and one from our acquisition of Nortel’s UMTS radio access assets – and converged them into one portfolio. We completed the convergence from three platforms to two, and we are working to complete the move to one converged platform.

Carrier segment operating income was a loss of € 152 million in 2007 compared with income of € 613 million in 2006. This decrease resulted from competitive pricing pressures that impacted our gross profit, from investments in current products and platforms that we will eventually discontinue, from € 98 million that we recognized in cost of sales due to the problems we experienced on a large W-CDMA construction contract and from the negative, non-cash impact of purchase accounting entries resulting from the Lucent business combination which more than offset Lucent’s contribution to revenues and gross margin.



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Enterprise Segment

Enterprise segment revenues were € 1,562 million for 2007, an increase of 9% over revenues of € 1,439 million for 2006. Part of the increase was due to the inclusion of twelve months of Lucent’s results of operations for 2007, while our 2006 results included only one month of Lucent’s results, but the impact of Lucent’s results on this segment was much smaller than it was on either the carrier or services segments. 2007 revenues showed strength across all parts of the enterprise business, with particularly strong gains in our data business and our contact center business, where we added more than 200 new customers during the year. There was also continued good momentum in the migration to IP-based telephony systems. Key growth regions were Europe and Asia.

Enterprise segment operating income was € 126 million in 2007, compared with € 120 million in the same period last year. The increase was largely due to higher revenues in 2007.

Services Segment

Revenues in the services segment were € 3,173 million in 2007, compared with € 1,761 million in 2006. Nearly all of the increase was attributable to the inclusion of twelve months of Lucent’s results of operations for 2007, while our 2006 results included only one month of Lucent’s results. Additionally, the transformation of networks to an all-IP architecture has increased carrier spending for our network integration and transformation capabilities. Also, growth in our outsourced network operations services and professional services reflected an ongoing shift in the services market from traditional product-attached deployment and maintenance-type services to integration, network operations and other managed services.

Services segment operating income was € 147 million in 2007 compared with income of € 211 million in 2006. The decline reflects increased costs associated with new network operations contracts, a shift in the mix of services revenues and the negative, non-cash impact of purchase accounting entries resulting from the Lucent business combination.

6.6

LIQUIDITY AND CAPITAL RESOURCES

Liquidity

Cash flow for the years ended December 31, 2008 and 2007

Cash flow overview

Cash and cash equivalents decreased by € 690 million in 2008 to € 3,687 million at December 31, 2008. This decrease was mainly due to the cash used by investing activities of € 726 million (mainly due to capital expenditures), the net cash provided by operating activities of € 207 million being more than offset by cash of € 257 million used by financing activities, due primarily to the repayment or repurchase of long-term debt.

Net cash provided (used) by operating activities. Net cash provided by operating activities before changes in working capital, interest and taxes was € 653 million compared to € 413 million for 2007. This increase was primarily due to the effect of non-cash items (mainly impairment losses which amounted to € (4,725) million) that contributed to our net loss (group share) of € 5,215 million in 2008, as compared with net loss of € 3,518 million in 2007, which included an impairment of assets of € (2,944) million. In order to calculate net cash provided by operating activities before changes in working capital, interest and taxes, the € 5,215 million net loss for 2008 must be adjusted for financial, tax and non-cash items (primarily restructuring reserves, depreciation, amortization, impairments and provisions), net gain on disposal of non-current assets and changes in fair values and share based payments, and adjusted further for cash outflows that had been previously reserved (mainly for ongoing restructuring programs). Impairment of assets and changes in pension and other post-retirement benefit obligations represented a non-cash net positive adjustment of € 4,273 million in 2008, mainly related to the impairment recorded in connection with the Optics and CDMA businesses, as compared with € 2,265 million in 2007 related to the impairment recorded in connection with the CDMA and UMTS businesses. The positive impact of adjustments related to depreciation and amortization of tangible and intangible assets, finance costs and share-based payments decreased from € 1,731 million in 2007 to € 1,538 million in 2008 due mainly to the lower depreciation allowances in 2008 following the impairment of assets accounted for in 2007. Income taxes and related reduction of goodwill represented a positive adjustment of the net result for an amount of € 153 million in 2008 as compared to a positive adjustment of € 316 million in 2007 (the decrease corresponding mainly to deferred taxes, as current income taxes remained stable). On the other hand, the negative adjustment on net income to exclude income from discontinued activities represented € 33 million in 2008 and corresponds mainly to the adjustment of the capital gain on businesses disposed of to Thales in 2007 (compared to € 610 million in 2007, mainly due to the capital gain on the disposal of the two joint ventures in the space sector to Thales).



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Net cash provided by operating activities was € 207 million in 2008 compared to net cash used by operating activities of € 24 million in 2007. These amounts take into account the net cash used by operating working capital, vendor financing and other current assets and liabilities, which amounted to € 131 million in 2008 and € 212 million in 2007, which represents € 81 million of less cash used in 2008 compared to 2007. The change between the two periods related to the decrease in cash used by working capital, representing € 30 million in 2008 compared to € 234 million in 2007 and was partially offset by the cash used related to other current assets and liabilities of € 101 million in 2008 to be compared with cash provided by other current assets and liabilities of € 22 million in 2007.

Net cash provided (used) by investing activities. Net cash provided (used) by investing activities was € 726 million of net cash used in 2008 compared to € 539 million of net cash provided by investing activities in 2007. The difference is mainly due to the fact that the net cash provided by the disposal of marketable securities in 2008 was only € 12 million, compared to € 1,050 million in 2007. Capital expenditures were relatively stable in 2008 compared to 2007. On the other hand, the cash proceeds from the sale of previously consolidated and non-consolidated investments decreased materially from € 293 million in 2007 (of which € 209 million related to the disposal of our stake in Draka Comteq) to € 22 million in 2008.

Net cash provided (used) by financing activities. Net cash used by financing activities amounted to €Ê257 million in 2008 compared to net cash used of €Ê1,106 million in 2007. The primary changes were the decrease in the amount of repayment of short-term and long-term debt (€Ê250 million in 2008 compared with €Ê760 million in 2007) and the dividend payment of €Ê366 million we made on our ordinary shares and ADSs in 2007 based on the results of the 2006 fiscal year.

Disposed of or discontinued operations. Disposed of or discontinued operations represented net cash provided of € 21 million in 2008 (adjustment of the selling price of businesses disposed of to Thales in 2007) compared to € 223 million in 2007 (including the proceeds of € 670 million related to the disposal of our ownership interest in two joint ventures in the space sector to Thales offset by the cash used by operating activities and financing activities of the discontinued activities during the period).

Capital resources

Resources and cash flow outlook. Our capital resources may be derived 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 € 1.4 billion maturing in April 2012 (with an extension until April 5, 2013 for an amount of € 837 million) and on which we have not drawn (see “Syndicated facility” below). Our ability to draw upon these resources at any time 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 lenders and investors, our ability to meet the financial covenant for our revolving facility and debt and equity market conditions generally. Given current conditions, access to the debt and equity markets may not be relied upon at this time.

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, aggregating € 4,593 million as of December 31, 2008, are sufficient to fund our cash requirements for the next 12 months, taking into account the anticipated sale of our stake in Thales for € 1.6 billion. Approximately € 826 million of our cash, cash equivalents and market securities are held in countries, primarily China, which are subject to exchange control restrictions. These restrictions can limit the use of such funds by our subsidiaries outside of the local jurisdiction. Repatriation efforts are underway to reduce that amount. We do not expect that such restrictions will have an impact on our ability to meet our cash obligations.

During 2009 the projected amount of cash outlays pursuant to our previously announced restructuring programs is expected to be in the same order of magnitude as for 2008, that is, approximately € 570 million. On the other hand, we expect a material reduction in capital expenditures compared to 2008 which amounted to € 901  million including capitalization of development expenditures. We repaid € 777 million in aggregate principal amount of our 4.375% bond that matured on February 2009. In February 2009 Lucent repurchased at a substantial discount U.S. $ 99 million in aggregate principal amount of our 7.75% bond maturing March 2017. Later in 2009, depending upon market and other conditions, we may continue our bond repurchase program in order to redeem certain of our outstanding bonds.

Based on our current view of our business and capital resources and the overall market environment, we believe we have sufficient resources to fund our operations. If, however, the business environment were to materially worsen, the credit markets were to limit our access to bid and performance bonds, or our customers were to dramatically pull back on their spending plans, our liquidity situation could deteriorate. 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, assets sales or financing from third parties, the availability of which is dependent upon a variety of factors, as noted  above.



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At March 18, 2009, our credit ratings were as follows:

Rating Agency

Long-term debt

Short-term debt

Outlook

Last update of the rating

Last update of the outlook

Moody’s

B1

Not Prime

Negative

February 18, 2009

April 3, 2008

Standard & Poor’s

B+

B

Negative

March 3, 2009

March 3, 2009


At March 18, 2009, Lucent’s credit ratings were as follows:

Rating Agency

Long-term debt

Short-term debt

Outlook

Last update of the rating

Last update of the outlook

Moody’s

Corporate Family Rating withdrawn (1)

n.a

n.a

December 11, 2006

n.a

Standard & Poor’s

B+

withdrawn

Negative

March 3, 2009

March 3, 2009

(1)

Except for preferred notes and bonds that continue to be rated (last update February 18, 2009).


Moody’s: on February 18, 2009, Moody’s had lowered the Alcatel-Lucent Corporate Family Rating, as well as the rating for senior debt of the Group, from Ba3 to B1. The trust preferred notes of Lucent Technologies Capital Trust were downgraded from B2 to B3. The Not-Prime rating for the short-term debt was confirmed. The negative outlook of the ratings was maintained.

On April 3, 2008, Moody’s had affirmed the Alcatel-Lucent Corporate Family Rating as well as that of the debt instruments originally issued by historical Alcatel and Lucent. The outlook was changed from stable to negative.

On November 7, 2007, Moody’s had lowered the Alcatel-Lucent Corporate Family Rating, as well as the rating of the senior debt of the Group, from Ba2 to Ba3. The Not-Prime rating was confirmed for the short-term debt. The stable outlook was maintained. The trust preferred notes of Lucent Technologies Capital Trust were downgraded from B1 to B2.

On March 29, 2007, the rating for senior, unsecured debt of Lucent was upgraded to Ba2, thus aligning Lucent’s rating with Alcatel-Lucent at the time. The subordinated debt and trust preferred notes of Lucent Technologies Capital Trust were rated at B1. On December 11, 2006, Lucent Corporate Family Rating was withdrawn based upon the premise that the management of the two entities would be fully integrated over the following several months. Lucent’s obligations were upgraded to a range of B3 to Ba3.

The rating grid of Moody’s ranges from AAA, to C, which is the lowest rated class. Our B1 rating is in the B category, which also includes B2 and B3 ratings. Moody’s gives the following definition of its B1 category: “obligations rated B are considered speculative and are subject to high credit risk”.

Standard & Poor’s: on March 3, 2009, Standard & Poor’s lowered to B+ from BB- its long-term corporate credit ratings and senior unsecured ratings on Alcatel-Lucent and on Lucent. The ratings on the trust preferred notes of Lucent Technologies Capital Trust were lowered to CCC+. The B short-term rating on Alcatel-Lucent was affirmed. The B1 rating on Lucent was withdrawn. The outlook is negative.

On December 12, 2008, Standard & Poor’s placed on Credit Watch with negative implications the long-term corporate credit ratings of Alcatel-Lucent and Lucent, as well as all issue ratings on both companies. At the same time, the long-term credit ratings were affirmed.

On July 31, 2008, Standard & Poor’s revised to negative from stable its outlook on Alcatel-Lucent and Lucent long-term corporate credit ratings. At the same time, the long and short-term debt ratings of Alcatel-Lucent and of Lucent were affirmed.

On March 19, 2008, the remainder of Lucent’s senior unsecured debt was raised to BB-. The trust preferred notes of Lucent Technologies Capital Trust were rated B-.

On September 13, 2007, Standard & Poor’s reset the outlook of the long-term corporate credit rating of Alcatel-Lucent and of Lucent. Both outlooks were revised from Positive to Stable. At the same time, Alcatel-Lucent’s BB-long term corporate rating, which had been set on December 5, 2006, was affirmed. The Alcatel-Lucent B short-term corporate credit rating and the Lucent B-1 short-term credit rating, both of which had been affirmed on December 5, 2006, were also confirmed.

On June 4, 2007, the ratings of Lucent’s Series A and Series B 2.875% senior unsecured debt were raised to BB- from B+ and the B+ rating of Lucent’s remaining senior unsecured debt was affirmed.

On December 5, 2006, Lucent’s long-term corporate credit rating was equalized with that of Alcatel-Lucent to BB-.

The rating grid of Standard & Poor’s ranges from AAA (the strongest rating) to D (the weakest rating). Our B+ rating is in the B category, which also includes B+ and B- ratings. Standard & Poor’s gives the following definition to the B category: “An obligation rated “B” is more vulnerable to non-payment than obligations rated “BB” but the obligor currently has the capacity to meet its financial commitment on the obligation. Adverse business, financial or economic condition likely will impair the obligator’s capacity or willingness to meet its financial commitment on the obligation.”

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 higher financing costs and in reduced or no access to the capital markets.

Alcatel-Lucent’s short-term debt rating allows a limited access to the French commercial paper market for short periods of time.

At December 31, 2008, our total financial debt, gross amounted to € 5,095 million compared to € 5,048 million at December 31, 2007.

Short-term Debt. At December 31, 2008, we had € 1,097 million of short-term financial debt outstanding, which included € 777 million of 4.375% Notes due February 2009 (which were repaid in 2009, as noted earlier) and € 134 million of accrued interest payable, with the remainder representing other bank loans and lines of credit and other financial debt.



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Long-term Debt. At December 31, 2008 we had € 3,998 million of long-term financial debt outstanding.

Rating Clauses Affecting our Debt. Alcatel-Lucent’s and Lucent’s outstanding bonds do not contain clauses that could trigger an accelerated repayment in the event of a lowering of their respective credit ratings.

Alcatel-Lucent syndicated bank credit facility. On April 5, 2007, Alcatel-Lucent obtained a € 1.4 billion multi-currency syndicated five-year revolving bank credit facility (with two one-year extension options). This facility replaced the undrawn € 1.0 billion syndicated facility, maturing in June 2009. On March 21, 2008, € 837 million of availability under the facility was extended until April 5, 2013.

The availability of this syndicated credit facility of € 1.4 billion is not dependent upon Alcatel-Lucent’s credit ratings. Alcatel-Lucent’s ability to draw on this facility is conditioned upon its compliance with a financial covenant linked to the capacity of Alcatel-Lucent to generate sufficient cash to repay its net debt, and compliance is tested quarterly when we release our consolidated financial statements. Since the € 1.4 billion facility was established, we have complied every quarter with the financial covenant that is included in the facility. The facility was undrawn at the date of approval by our Board of Directors of our 2008 consolidated financial statements.

6.7

CONTRACTUAL OBLIGATIONS AND OFF-BALANCE SHEET CONTINGENT COMMITMENTS

Contractual obligations. We have certain contractual obligations that extend beyond 2009. 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, 2008 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, finance lease obligations and the equity component of our convertible bonds are fully reflected in our consolidated balance sheet included in this document.

(in millions of euros)

Payment Deadline

Contractual Payment Obligations

Before December 31, 2009

2010-2011

2012-2013

2014 and after

Total

Financial debt (excluding finance leases)

1,097

1,397

398

2,203

5,095

Finance lease obligations

Equity component of convertible bonds

264

272

110

646

SUBTOTAL – INCLUDED IN OUR BALANCE SHEET

1,097

1,661

670

2,313

5,741

Finance costs on financial debt (1)

259

431

364

1,190

2,244

Operating leases

238

419

288

351

1,296

Commitments to purchase fixed assets

38

38

Other unconditional purchase obligations (2)

144

37

181

SUBTOTAL – NOT INCLUDED IN OUR BALANCE SHEET

679

887

652

1,541

3,759

TOTAL CONTRACTUAL OBLIGATIONS (3)

1,776

2,548

1,322

3,854

9,500

(1)

To compute finance costs on financial debt, all put dates have been considered as redemption dates. For debentures with calls but no puts, call dates have not been considered as redemption dates. Further details on put and call dates are given in Note 24 of our consolidated financial statements included elsewhere in this document. If all outstanding debentures at December 31, 2008 were not redeemed at their respective put dates, we would incur an additional finance cost of approximately € 420 million until redemption at their respective contractual maturities (of which € 39 million in 2010-2011 and the remaining part in 2012 or later).

(2)

Other unconditional purchase obligations result mainly from obligations under multi-year supply contracts linked to the sale of businesses to third parties.

(3)

Obligations related to pensions, post-retirement health and welfare benefits and postemployment benefit obligations are excluded from the table. Refer to Note 25 to our consolidated financial statements for a summary of our expected contributions to these plans.


Off-balance sheet commitments and contingencies. On December 31, 2008, our off-balance sheet commitments and contingencies amounted to € 2,504 million, consisting primarily of € 1,232 million in guarantees on long-term contracts for the supply of telecommunications equipment and services by our consolidated and non-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 € 2,504 million is approximately € 425 million in customer financing provided by us.



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With respect to guarantees given for contract performance, only those issued by us to back guarantees granted by financial institutions are presented in the table below.

Off-balance sheet contingent commitments given in the normal course of business are as follows:

(in millions of euros)

December 31, 2008

December 31, 2007

Guarantees given on contracts made by Group entities and by non-consolidated subsidiaries (1)

1,232

1,172

Discounted notes receivables (2)

5

3

Other contingent commitments (3)

770

797

Commitments of discontinued activities (4)

-

54

SUBTOTAL – CONTINGENT COMMITMENTS (5)

2,007

2,026

Secured borrowings (6)

24

25

Guarantee in cash pooling (7)

473

522

TOTAL OFF-BALANCE SHEET COMMITMENTS, GUARANTEE IN CASH POOLING AND SECURED BORROWINGS (5)

2,504

2,573

(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, € 236 million as of December 31, 2008 and € 220 million as of December 31, 2007 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 € 770 million are: € 117 million of guarantees provided to tax authorities in connection with tax assessments contested by us, € 83 million of commitments of our banking subsidiary, Electro Banque, to third parties providing financing to non-consolidated subsidiaries, € 101 million of commitments related to leasing or sale and leaseback transactions, € 109 million primarily related to secondary lease obligations resulting from leases that were assigned to businesses Lucent spun-off or disposed of and € 360 million of various guarantees given by certain subsidiaries in the Group. Included in the € 797 million are: € 111 million of guarantees provided to tax authorities in connection with tax assessments contested by us, € 83 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, € 123 million primarily related to secondary lease obligations resulting from leases that were assigned to businesses Lucent spun-off or disposed of and € 390 million of various guarantees given by certain subsidiaries in the Group.

(4)

Commitments of discontinued activities correspond to guarantees on third party contracts related to the businesses sold or contributed to Thales (see “Highlights of transactions during 2007” in Section 4.2 of this document), which guarantees amounted to € 54 million as of December 31, 2007. There were no other contingent commitments as of December 31, 2007 held by entities disposed of or contributed to Thales (see Note 3 of our consolidated financial statements included elsewhere in this document). Commitments that were still in the process of being transferred to Thales as of December 31, 2007 in the context of the sale of businesses and contribution of assets to Thales, were counter-guaranteed by Thales. As of December 31, 2008, all such guarantees had been formally transferred to Thales.

(5)

Excluding our commitment to provide further customer financing, as described below.

(6)

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).”

(7)

This guarantee covers any intraday debit position that could result from the daily transfers between our central treasury account and our subsidiaries’ accounts.


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 2008 consolidated financial statements included elsewhere in this document. 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, 2008 (€ 2 million as of December 31, 2007).

In connection with our consent solicitation to amend the indenture pursuant to which Lucent’s 2 ¾ Series A Convertible Senior Debentures due 2023 and 2 ¾ Series B Convertible Senior Debentures due 2025 were issued, on December 29, 2006 we issued a full and unconditional guaranty of these debentures. The guaranty is unsecured and is subordinated to the prior payment in full of our senior debt and is pari passu with our other general unsecured obligations, other than those that expressly provide that they are senior to the guaranty obligations.



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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. 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.

As of December 31, 2008, net of reserves, there was an exposure of approximately € 308 million under drawn customer financing arrangements, representing approximately € 305 million of deferred payments and loans, and € 3 million of guarantees. In addition, as of December 31, 2008, we had further commitments to provide customer financing for approximately € 86 million. It is possible that these further commitments will expire without our having to actually provide the committed financing.

Outstanding customer financing and undrawn commitments are monitored by assessing, among other things, each customer’s short-term and long-term liquidity positions, the customer’s current operating performance versus plan, the execution challenges faced by the customer, changes in the competitive landscape, and the customer’s management experience and depth. When we detect potential problems we take mitigating actions, which may include the cancellation of undrawn commitments. Although by taking such actions we may be able to limit the total amount of our exposure, we still may suffer losses to the extent of the drawn and guaranteed amounts.

Lucent’s Separation Agreements. Lucent is party to various agreements that were entered into in connection with the separation of Lucent and former affiliates, including AT&T, Avaya, LSI Corporation (formerly Agere Systems, before its merger with LSI corporation in April 2007) and NCR Corporation. Pursuant to these agreements, Lucent and the former affiliates have agreed to allocate certain liabilities related to each other’s business, and have agreed to share liabilities based on certain allocations and thresholds. We are not aware of any material liabilities to Lucent’s former affiliates as a result of the separation agreements that are not otherwise reflected in our consolidated financial statements included elsewhere in this document. Nevertheless, it is possible that potential liabilities for which the former affiliates bear primary responsibility may lead to contributions by Lucent.

Lucent’s Other Commitments – Contract Manufacturers. Lucent outsources most of its manufacturing operation to electronic manufacturing service (EMS) providers. Until 2008, two EMS providers, Celestica and Solectron (acquired by Flextronics in October 2007), had exclusive arrangements with Lucent to supply most of Lucent-designed wireless and wireline products. Although no longer exclusive suppliers, Celestica continues to manufacture most of Lucent’s existing wireless products and Solectron continues to consolidate the outsourced manufacturing of Lucent’s portfolio of wireline products. Lucent generally does not have minimum purchase obligations in its contract-manufacturing relationships with EMS providers and therefore the contractual obligations schedule, presented above under the heading “Contractual Obligations”, does not include any commitments related to contract manufacturers.

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

Lucent remains secondarily liable for approximately U.S. $ 105 million of lease obligations as of December 31, 2008 (U.S. $ 131 million of lease obligations as of December 31, 2007), that were assigned to Avaya, LSI Corporation (formerly Agere) and purchasers of other businesses that were divested. The remaining terms of these assigned leases and the corresponding guarantees range from one month to 10 years. The primary obligor under assigned leases may terminate or restructure the lease obligation before its original maturity and thereby relieve Lucent of its secondary liability. Lucent generally has the right to receive indemnity or reimbursement from the assignees and we have not reserved for losses on this form of guarantee.

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

Lucent guaranty of Alcatel-Lucent public bonds. On March 27, 2007, Lucent issued full and unconditional guaranties of our 6.375% notes due 2014 (the principal amount of which was € 462 million on December 31, 2008) and our 4.750% Convertible and/or Exchangeable Bonds due 2011 (the principal amount of which was € 1,022 million on December 31, 2008). Each guaranty is unsecured and is subordinated to the prior payment in full of Lucent’s senior debt and is pari passu with Lucent’s other general unsecured obligations, other than those that expressly provide that they are senior to the guaranty obligations.



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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 Trade and Project Finance group and by a central Risk Assessment Committee, each 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, if economic conditions and the telecommunications industry in particular were to deteriorate, leading to the financial failure of our customers, we may realize losses on credit we extended and loans we made to our customers, on guarantees provided for our customers and losses relating to our commercial risk exposure under long-term contracts, as well as the loss of our customer’s ongoing business. In such a context, should 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 a material reduction in capital expenditures compared to 2008 which amounted to €Ê901 million including capitalization of development expenditures. We believe that our current cash and cash equivalents, cash flows, including the proceeds from the agreed sale of our shares in Thales 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. To the extent that the business environment materially deteriorates or our customers reduce their spending plans, we will reevaluate our capital expenditure priorities appropriately. We may be also 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.


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6.8

OUTLOOK FOR 2009

Positive fundamentals continue to influence the market for telecommunications equipment and related services. The number of mobile subscribers is increasing, video and data traffic volumes are growing, telephony penetration is increasing as operators in emerging markets build out their communications infrastructure, and service providers everywhere are spending to transform their networks to an all IP-based architecture. There are also some region-specific pockets of strength. In China, government officials expect mobile operators to spend U.S. $ 25 billion in 2009 as they build out their new 3G networks, and India is likely to follow suit shortly thereafter. Finally, economic stimulus packages in the U.S. and elsewhere are likely to include funding and/or other incentives for an expansion of broadband access capabilities. Overall, however, the positive fundamentals and pockets of strength are very likely to be outweighed by the deteriorating global economy in 2009. Many service providers are already seeing weakness in spending by their business customers and continued declines in their fixed access lines. Consequently, service providers are planning cuts in their 2009 capital expenditure budgets that are generally expected to affect wireline spending more than wireless. Carriers are emphasizing the need for flexible spending plans to allow them to quickly react to any additional deterioration they expect to see in end-user spending as 2009 unfolds. In many emerging markets, service provider spending is being affected not only by recession, but by deteriorating local currencies and a lack of credit. And in the emerging markets where spending may remain strong, like China and India, vendor margins will be pressured. As a result, we expect that competitive pressures will remain intense as the global telecommunications equipment and related services market declines in 2009 between 8% and 12% at constant currency rates. We expect to maintain a stable share of that market.

Against that backdrop, we are aiming to reduce our break-even point by € 1 billion per year for each of 2009 and 2010. Specifically, we aim to:

improve gross margin by reducing manufacturing, supply chain and procurement costs, introducing stricter pricing discipline and improving the product mix;

enhance R&D efficiency by focusing on four key segments – IP, optics, broadband and applications – while we accelerate the shift of our investments towards next-generation platforms;

materially reduce SG&A expenses through the de-layering of our organization and the elimination of sales duplication between product groups and regions.

As a part of these initiatives, our goal is to reduce the number of managers by approximately 1,000 and the number of third-party contractors by approximately 5,000. We aim to complete our existing restructuring initiatives as well as to seek savings in real estate, support functions and discretionary spending. Our objective is that, by the fourth quarter of 2009 on an annual run rate basis, we should achieve total savings of € 750 million at a constant exchange rate, of which approximately one-third will be in cost of goods sold and two-thirds in R&D and SG&A expenses. As a result of the expected decline in volumes and given that the improvement in gross margin may only materialize towards the end of the year, our initial forecast is to achieve an operating profit before restructuring costs, impairment of assets, gain/loss on disposal of consolidated entities and post-retirement benefit plan amendments (excluding the negative non-cash impacts of Lucent’s purchase price allocation) around break-even in 2009.


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6.9

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, 2008 were mostly hedges of existing or future financial or commercial transactions or were related to issued debt.

The largest position part of our issued debt is in euro and U.S. dollar. We use interest rate derivatives to convert a part of the fixed rate debt into floating rate in order to cover the interest rate risk.

Counterparty risk

For our marketable securities, cash, cash equivalents and financial derivative instruments, we are exposed to credit risk if a counterparty defaults on its financial commitments to us. This risk is monitored daily, with strict limits based on the counterparties’ rating. All of our counterparties were classified in the investment grade category as of December 31, 2008. 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.

Foreign currency risk

Since we conduct commercial and industrial operations throughout the world, we are exposed to foreign currency risk. 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 commercial bids are hedged by forward foreign exchange transactions or currency options. The duration of future transactions that are not firmly committed does not usually exceed 18 months.

Interest rate risk on financial debt, net

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 credit spread 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 2008 and 2007, in interest rates across all maturities and for all currencies. Interest rate sensitive instruments are fixed-rate, long-term debt or swaps and marketable securities.

 

December 31, 2008

December 31, 2007

(in millions of euros)

Booked value

Fair value

Fair value variation if rates fall by 1%

Fair value variation if rates rise by 1%

Booked value

Fair value

Fair value variation if rates fall by 1%

Fair value variation if rates rise by 1%

Assets

        

Marketable securities

906

906

7

(7)

894

894

10

(10)

Cash and cash equivalents (1)

3,687

3,687

-

-

4,377

4,377

-

-

Liabilities (2)

        

Convertible bonds

(2,387)

(1,779)

(47)

44

(2,273)

(2,051)

(136)

123

Non convertible bonds

(2,320)

(1,555)

(42)

42

(2,381)

(2,234)

(134)

118

Other financial debt

(388)

(388)

-

-

(394)

(394)

-

-

Interest rate derivatives

71

71

40

(37)

3

3

34

(32)

Loan to co-venturer

42

42

-

-

45

45

-

-

DEBT/CASH POSITION

(389)

984

(42)

42

271

640

(226)

199

(1)

For cash and cash equivalents, the booked value is considered as a good estimation of the fair value.

(2)

Over 99% of our bonds have been issued with fixed rates. At year-end 2008, the fair value of our long-term debt was lower than its booked value due to increasing credit spread. At year-end 2007, the fair value of our long-term debt was lower than its booked value due to increasing interest rates


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, 2008.


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Fair value hedge and cash flow hedge

The ineffective portion of changes in fair value hedges and cash flow hedges was a profit of € 13 million at December 31, 2008, compared to a loss of € 19 million at December 31, 2007 and a loss of € 11 million at December 31, 2006. We did not have any amount excluded from the measure of effectiveness. These was no impact of contract cancellation in the income statement at December 31, 2008, 2007 and 2006 .

Net investment hedge

We have stopped using investment hedges in foreign subsidiaries. At December 31, 2008, 2007 and 2006, 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.

We may also use derivative instruments on our shares held in treasury. Such transactions are authorized as part of the stock repurchase program approved at our shareholders’ general meeting held on June 1, 2007.

Since April 2002, we have not had any derivative instruments in place on investments in listed companies or on our 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.

6.10

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 management believes are adequately reserved against in the financial statements or will not result in any significant costs to the Group, we are involved in the following legal proceedings.

Costa Rica

Beginning in early October 2004, we learned that investigations had been launched in Costa Rica by the Costa Rican prosecutors and the National Congress, regarding payments alleged to have been made by consultants on behalf of Alcatel CIT, a French subsidiary now called Alcatel-Lucent France (“CIT”), or other Alcatel subsidiaries to various public officials in Costa Rica, two political parties in Costa Rica and representatives of ICE, the state-owned telephone company, in connection with the procurement by CIT of several contracts for network equipment and services from ICE. Upon learning of these allegations, we commenced an investigation into this matter, which is ongoing.

We terminated the employment of the then-president of Alcatel de Costa Rica in October 2004 and of a vice president Latin America of CIT. CIT is also pursuing criminal actions in France against the latter and in Costa Rica against these two former employees and certain local consultants, based on CIT’s suspicion of their complicity in a bribery scheme and misappropriation of funds. The United States Securities and Exchange Commission (“SEC”) and the United States Department of Justice (“DOJ”) are aware of the allegations and we have stated we will cooperate fully in any inquiry or investigation into these matters. The SEC and the DOJ are conducting an investigation into possible violations of the Foreign Corrupt Practices Act (“FCPA”) and the federal securities laws. In connection with that investigation, the DOJ and the SEC also have requested information regarding Alcatel’s operations in other countries. If the DOJ or the SEC determine that violations of law have occurred, they could seek civil or, in the case of the DOJ, criminal sanctions, including monetary penalties against us.

In connection with these allegations, on December 19, 2006, the DOJ indicted the former CIT employee on charges of violations of the FCPA, money laundering, and conspiracy. On March 20, 2007, a grand jury returned a superseding indictment against the same former employee and the former president of Alcatel de Costa Rica, based on the same allegations contained in the previous indictment. On June 11, 2007, the former CIT employee entered into a Plea Agreement in the U.S. District Court for the Southern District of Florida and pleaded guilty to violations of the FCPA. On September 23, 2008, the former CIT employee was sentenced to 30 months’ imprisonment, three years’ supervised release, the forfeiture of U.S. $ 261,500, and a U.S. $ 200 special assessment.

French authorities are also conducting an investigation of CIT’s payments to consultants in the Costa Rica matter.

We are cooperating with the U.S., French and Costa Rican authorities in the respective investigations described above.

Neither the DOJ, the SEC nor the French authorities have informed us what action, if any, they will take against us and our subsidiaries.

In connection with the aforementioned allegations, on July 27, 2007, the Costa Rican Prosecutor’s Office indicted eleven individuals, including the former president of Alcatel de Costa Rica, on charges of aggravated corruption, unlawful enrichment, simulation, fraud and others. Two of those individuals have since pled guilty. Shortly thereafter, the Costa Rican Attorney General’s Office and ICE, acting as victims of this criminal case, each filed amended civil claims against the eleven criminal defendants, as well as five additional civil defendants (one individual and four corporations, including CIT) seeking compensation for damages in the amounts of U.S. $ 52 million (in the case of the Attorney General’s Office) and U.S. $ 20 million (in the case of ICE). The Attorney General’s claim supersedes two prior claims, of November 25, 2004 and August 31, 2006. On November 25, 2004, the Costa Rican Attorney General’s Office commenced a civil lawsuit against CIT to seek pecuniary compensation for the 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 (social damages). The ICE claim, which supersedes its prior claim of February 1, 2005, seeks pecuniary compensation for the damage caused by the alleged payments described above to ICE and its customers, for the harm to the reputation of ICE resulting from these events (moral damages), and for damages resulting from an alleged overpricing it was forced to pay under its contract with CIT. During preliminary court hearings held in San José during September 2008, ICE filed a report in which the damages allegedly caused by CIT are valued at U.S. $ 71.6 million. No formal notice of a revised civil claim has so far been received by CIT.



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We intend to defend these actions vigorously and deny any liability or wrongdoing with respect to these claims.

Additionally, in August 2007, ICE notified CIT of the commencement of an administrative proceeding to terminate the 2001 contract for CIT to install 400,000 GSM cellular telephone lines (the “400KL GSM Contract”), in connection with which ICE is claiming compensation of U.S. $ 59.8 million for damages and loss of income. By March 2008, CIT and ICE concluded negotiations of a draft settlement agreement for the implementation of a “Get Well Plan,” in full and final settlement of the above-mentioned claim. This settlement agreement was not approved by ICE’s Board of Directors that resolved, instead, to resume the aforementioned administrative proceedings to terminate the operations and maintenance portion of the 400KL GSM Contract, claim penalties and damages in the amount of U.S. $ 59.8 million and call the performance bond. CIT was notified of this ICE resolution on June 23, 2008. ICE has made additional damages claims and penalty assessments related to the 400KL GSM Contract that bring the overall exposure under the contract to U.S. $ 64.7 million in the aggregate.

In June 2008, CIT filed an administrative appeal against the resolution mentioned above. ICE called the performance bond in August 2008, and on September 16, 2008 CIT was served notice of ICE’s request for payment of the remainder amount of damages claimed, U.S. $ 44.7 million. On September 17, 2008, the Costa Rican Supreme Court ruled on the appeal filed by CIT stating that: (i) the U.S. $ 15.1 million performance bond amount is to be reimbursed to CIT and (ii) the U.S. $ 44.7 million claim is to remain suspended until final resolution by the competent Court of the case. Following a clarification request filed by ICE, the Court finally decided that the U.S. $ 15.1 million performance bond amount is to remain deposited in an escrow account held by the Court, until final resolution of the case. On October 8, 2008 CIT filed a claim against ICE requesting the court to overrule ICE’s contractual resolution regarding the 400KL GSM Contract and claiming compensation for the damages caused to CIT. In January 2009, ICE filed its response to CIT’s claim. At a Court hearing on March 25, 2009, ICE ruled out entering into settlement discussions with CIT. The next Court hearing regarding these legal proceedings is scheduled for June 1, 2009.

On October 14, 2008, the Costa Rican authorities notified CIT of the commencement of an administrative proceeding to ban CIT from government procurement contracts in Costa Rica for up to 5 years.

We are unable to predict the outcome of these investigations and civil lawsuits and their effect on CIT’s business. If the Costa Rican authorities conclude criminal violations have occurred, CIT may be banned from participating in government procurement contracts within Costa Rica for a certain period. We expect to generate approximately € 3 million in revenue from Costa Rican contracts in 2009. Based on the amount of revenue expected from these contracts, we do not believe a loss of business in Costa Rica would have a material adverse effect on our group as a whole. However, these events may have a negative impact on our reputation in Latin America.

We have recognized a provision in connection with the various ongoing legal proceedings in Costa Rica.

Taiwan

Certain employees of Taisel, a Taiwanese affiliate of Alcatel-Lucent, and Siemens’s Taiwanese distributor, 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, Alcatel-Lucent Deutschland AG (our German subsidiary involved in the Taiwan Railway contract), Siemens Taiwan, and subcontractors hired by them were involved in a bid-rigging and illicit payment arrangement for the Taiwan Railways contract.

Upon learning of these allegations, we commenced and are continuing an investigation into this matter. As a result of the investigation, we terminated the former president of Taisel. A director of international sales and marketing development of the German subsidiary resigned during the investigation.

On February 21, 2005, Taisel, the former president of Taisel, and others were indicted in Taiwan for violation of the Taiwanese Government Procurement Act.

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 not guilty verdict for Taisel was upheld by the Taiwan High Court and the Taiwan Prosecutor Office has stated that it will not appeal the ruling any further.

Other allegations made in connection with this matter may still be under ongoing investigation by the Taiwanese authorities.

The SEC and the DOJ are also looking into these allegations.

As a Group, we expect to generate approximately € 99 million of revenue from Taiwanese contracts in 2009, of which only a part is generated from governmental contracts. Based on the amount of revenue expected from these contracts, we do not believe a loss of business in Taiwan would have a material adverse effect on our Group as a whole.

Kenya

The SEC and the DOJ have asked us to look into payments made in 2000 by CIT to a consultant arising out of a supply contract between CIT and a privately-owned company in Kenya. We understand that the French authorities are also conducting an investigation to ascertain whether inappropriate payments were received by foreign public officials in connection with such project. We are cooperating with the U.S. and French authorities and have submitted to these authorities our findings regarding those payments.


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Government investigations related to Lucent

China

In April 2004, Lucent reported to the DOJ and the SEC that an internal FCPA compliance audit and an outside counsel investigation found incidents and internal control deficiencies in Lucent’s operations in China that potentially involve FCPA violations. Lucent cooperated with those agencies. On December 21, 2007, Lucent entered into agreements with the DOJ and the SEC to settle their respective investigations. Lucent signed a non-prosecution agreement with the DOJ. Pursuant to that agreement, the DOJ agreed not to charge Lucent with any crime in connection with the allegations in China. Lucent agreed to pay a U.S. $ 1 million monetary penalty and adopt or modify its existing internal controls, policies, and procedures.

On December 21, 2007, the SEC filed civil charges against Lucent in the United States District Court for the District of Columbia alleging violations of the books and records and internal controls provisions of the FCPA. That same day, Lucent and the SEC entered into a consent agreement, resolving those charges. Pursuant to that consent agreement, Lucent, without admitting or denying the allegations in the SEC’s complaint, agreed to a permanent injunction enjoining Lucent from any future violations of the internal controls and books and records provisions of the FCPA. Lucent further agreed to pay a civil penalty of U.S. $ 1.5 million.

If Lucent abides by the terms of its agreements with the DOJ and the SEC, Lucent does not anticipate any further actions by the DOJ and the SEC with respect to allegations regarding Lucent’s conduct in China.

Lucent’s employment and benefits related cases

Lucent has implemented various actions to address the rising costs of providing retiree health care benefits and the funding of Lucent pension plans. These actions have led to the filing of cases against Lucent and may lead to the filing of additional cases. Purported class action lawsuits have been filed against Lucent in connection with the elimination of the death benefit from its U.S. management pension plan in early 2003. Three such cases have been consolidated into a single action pending in the U.S. District Court in New Jersey, captioned In Re Lucent Death Benefits ERISA Litigation. The elimination of this benefit reduced Lucent future pension obligations by U.S. $ 400 million. The benefit was paid out of the pension plan assets to certain qualified surviving dependents, such as spouses or dependent children of management retirees. The case alleges that Lucent wrongfully terminated this death benefit and requests that it be reinstated, along with other remedies. This case has been dismissed by the court and the appellate court. The time for the plaintiffs to have filed an appeal with the U.S. Supreme Court has expired. Another such case, Chastain, et al. v. AT&T, was filed in the U.S. District Court in the Western District of Oklahoma. The Chastain case also involves claims related to changes to retiree health care benefits. That case has also been dismissed by the court and appellate court, but an appeal to the U.S. Supreme Court is possible.

In October 2005, a purported class action was filed by Peter A. Raetsch, Geraldine Raetsch and Curtis Shiflett, on behalf of themselves and all others similarly situated, in the U.S. District Court for the District of New Jersey. The plaintiffs in this case allege that Lucent failed to maintain health care benefits for retired management employees for each year from 2001 through 2006 as required by the Internal Revenue Code, the Employee Retirement Income Security Act, and the Lucent pension and medical plans. Upon motion by Lucent, the court remanded the claims to Lucent’s claims review process. A Special Committee was appointed and reviewed the claims of the plaintiffs and Lucent filed a report with the court on December 28, 2006. The Special Committee denied the plaintiffs’ claims and the case has returned to the court, where limited discovery has been completed.

By Opinion and Order, each dated June 11, 2008, the court granted in part and denied in part the plaintiffs’ motion for summary judgment (as to liability) and denied Lucent’s cross-motion for summary judgment (also as to liability). Specifically, the court found that Lucent had violated the Plan’s maintenance of benefits requirement with respect to the 2003 plan year but that the record before the court contained insufficient facts from which to conclude whether those provisions were violated for years prior to 2003. The court also “tentatively” ruled that Lucent had not violated the Plan’s maintenance of cost provisions for the years 2004 through 2006. The court ordered the parties to engage in further discovery proceedings. Finally, the Court denied, without prejudice, the plaintiff’s motion for class certification. On June 26, 2008, Lucent requested the Court to certify the case for appeal to the Third Circuit Court of Appeals in its discretion. This request was denied.

Lucent believes it has meritorious defenses to the claims for each year and intends to continue to defend this case vigorously. However, as a result of the court’s findings for 2003, Lucent established a provision for U.S. $ 27 million during the second quarter of 2008. The amount was determined based on internal estimates from 2002 of the potential impact of the benefit plan changes for the 2003 plan year. Based upon a review of claims data, Lucent now believes that the impact of the 2003 benefit plan changes, during fiscal year ending September 30, 2003, is U.S. $ 29.4 million, an increase of U.S. $ 2.4 million over the current provision. Lucent is currently unable to determine the actual impact of the related benefit plan changes for the 2003 plan year because, even if Lucent is finally determined to be liable, the method of determining damages to participants has not been determined. Although the plaintiffs have alleged damages in excess of the amount provided for by Lucent, Lucent believes that those amounts are without merit. Because of the court’s directions with respect to years other than 2003, Lucent has not reflected any provision for years other than 2003.

In September 2004, the Equal Employment Opportunity Commission (EEOC) filed a purported class action lawsuit against Lucent, EEOC v. Lucent Technologies Inc., in the U.S. District Court in California. The case alleges gender discrimination in connection with the provision of service credit to a class  of present and former Lucent employees who were on maternity leave prior to 1980 and seeks the restoration of lost service credit prior to April 29, 1979, together with retroactive pension payment adjustments, corrections of service records, back pay and recovery of other damages and attorne ys fees and costs. The case is stayed pending the disposition of another case raising similar issues. In the related case, the U.S. Ninth Circuit Court of Appeals recently found against the defendant employer. The defendant employer in the related case has filed an appeal to the U.S. Supreme Court. The Supreme Court heard argument of this case on December 10, 2008. The Supreme Court has requested additional briefings based on the enactment of the Lilly Ledbetter Fair Pay Act.


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Intellectual property cases

Each of Alcatel-Lucent, Lucent and certain other entities of the Group is a defendant in various cases in which third parties claim infringement of their patents, including certain cases where infringement claims have been made against its customers in connection with products the applicable Alcatel-Lucent entity has provided to them, or challenging the validity of certain patents.

Microsoft

On February 22, 2007, after a three-week trial in the U.S. District Court in San Diego, California, a jury returned a verdict in favor of Lucent against Microsoft in the first of a number of scheduled patent trials. In this first trial involving two of Lucent’s “Audio Patents”, the jury found all the asserted claims of the patents valid and infringed, and awarded Lucent damages in an amount exceeding U.S. $ 1.5 billion. On August 6, 2007, the U.S. District Court in San Diego issued a judgment as a matter of law reversing the jury verdict and entering judgment in favor of Microsoft. On September 25, 2008, the Court of Appeals for the Federal Circuit in Washington, D.C. affirmed the lower court’s ruling.

Lucent, Microsoft and Dell have been involved in a number of patent lawsuits in various jurisdictions. In the summer of 2003, certain Dell and Microsoft lawsuits in San Diego, California, were consolidated in federal court in the Southern District of California. The court scheduled a number of trials for groups of the Lucent patents, including the trial described above. Additional trials in this case against Microsoft and Dell were held in 2008. In one of the additional San Diego trials, on April 4, 2008, a jury awarded us approximately U.S. $ 368 million in damages on additional patents and the judge granted prejudgment interest on that award on April 28, 2008.

On December 15, 2008, we and Microsoft executed a settlement and license agreement whereby the parties agreed to settle the majority of their outstanding litigations. This settlement included dismissing all pending patent claims in which we are a defendant and provided us with licenses to all Microsoft patents-in-suit in these cases. Only the appeal relating to two patents involved in the February-April, 2008 trial against Microsoft and Dell remains currently pending in the Court of Appeals for the Federal Circuit. A decision on this appeal is expected in the third or fourth quarter of this year.

Other Lucent litigation

Winstar

Lucent is a defendant in an adversary proceeding originally filed in U.S. Bankruptcy Court in Delaware by Winstar and Winstar Wireless, Inc. in connection with the bankruptcy of Winstar and various related entities. The trial for this matter concluded in June 2005. The trial pertained to breach of contract and other claims against Lucent, for which the trustee for Winstar was seeking compensatory damages of approximately U.S. $ 60 million, as well as costs and expenses associated with litigation. The trustee was also seeking recovery of a payment Winstar made to Lucent in December 2000 of approximately U.S. $ 190 million plus interest. The Trustee also sought to invalidate Lucent’s priority claim to an escrow account currently worth approximately U.S. $ 23 million. On December 21, 2005, the judge rendered his decision and the verdict resulted in a judgment against Lucent for approximately U.S. $ 244 million, plus statutory interest and other costs. The court also ruled against Lucent’s priority claim to the escrow account. As a result, Lucent has recognized a U.S. $ 315 million provision (including related interest and other costs of approximately U.S. $ 71 million) as of December 31, 2008. In addition, U.S. $ 328 million of cash is collateralizing a letter of credit that was issued in connection with this matter. On April 26, 2007, the U.S. District Court for the District of Delaware affirmed the decision of the Bankruptcy Court. Lucent appealed this decision with the United States Court of Appeals. On February 3, 2009, the Court issued its opinion affirming the District Court’s Order with a modification to the lower courts’ subordination of Lucent’s security interest in the escrow account which has no financial consequence. On February 20, 2009, Lucent and the Trustee entered into a settlement agreement, which the Court approved on March 25, 2009. Pursuant to this settlement, the Trustee received U.S. $ 320 million, consisting of the proceeds of the letter of credit and a portion of the escrow account. The balance of the escrow was released to Lucent and the excess restricted cash securing the letter of credit was released from such restriction. This settlement resolves this matter.

Effect of the various investigations and procedures

We reiterate that our policy is to conduct our business with transparency, and in compliance with all laws and regulations, both locally and internationally. We will cooperate with all governmental authorities in connection with the investigation of any violation of those laws and regulations.

Governmental investigations and legal proceedings are subject to uncertainties and the outcomes thereof are difficult to predict. Consequently, we are unable to estimate the ultimate aggregate amount of monetary liability or financial impact with respect to these matters. Because of the uncertainties of government investigations and legal proceedings, one or more of these matters could ultimately result in material monetary payments by us.


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6.11

RESEARCH AND DEVELOPMENT – EXPENDITURES

Expenditures

In 2008, in absolute value 14.8% of revenues was spent in innovation and in supporting our various product lines. These expenditures amounted to € 2.5 billion before capitalization of development expenses and capital gain (loss) on disposal of fixed assets, and excluding the impact of the purchase price allocation entries of the business combination with Lucent, as disclosed in Note 3 of the consolidated financial statements included elsewhere in this document.

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;

the ability to 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, leading to believe that the project will generate probable future economic benefits; and

adequate resources are available to complete the project.

These development costs are amortized over the estimated useful life of the projects concerned or the products they are incorporated within. The amortization of capitalized development costs begins as soon as the related product is released.

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.

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. The amortization of capitalized software costs during a reporting period is the greater of the amount computed using (a) the ratio that current gross revenues of a product bear to the total of current and anticipated further gross revenues for that product and (b) the straight-line method over the remaining estimated economic life of the software or the product they are incorporated within.

The amortization of internal use software capitalized development costs is accounted for by function depending on the beneficiary function.

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 usually 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.

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 ten 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).

During the year ended December 31, 2008, impairment losses of € 1,125 million were accounted for related to acquired technologies coming from the business combination with Lucent completed in December 2006, and are mainly related to the CDMA business. In 2007, impairment losses of € 159 million ware accounted for related to the acquired technologies from Nortel’s UMTS business acquired on December 2006.



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Impairment losses for capitalized development costs of € 135 million were accounted for in 2008, mainly related to the adaptation of our WiMAX strategy, by focusing our WiMAX efforts on supporting fixed and nomadic broadband access applications for providers. Impairment losses for capitalized development costs of € 41 million were accounted for in 2007 mainly related to the UMTS business. In 2006, impairment losses of € 104 million and write-offs of € 197 million were accounted for in capitalized development costs, and were mainly related to the discontinuance of product lines following the acquisition of UMTS technologies from Nortel and the business combination with Lucent.

Application of accounting policies to certain significant acquisitions

In accounting for our business combination with Lucent and our acquisition of the UMTS business of Nortel in 2006, we allocated a significant portion of the purchase price of each transaction to in-process Research and Development projects and to acquired technologies.

Set forth below is a description of our methodology for estimating the fair value of the in-process research and development of the UMTS business of Nortel at the time of their acquisition, and of Lucent at the time of the business combination. 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.

Lucent. At the date of the business combination, Lucent was conducting design, development, engineering and testing activities associated with the completion of numerous projects aimed at developing next-generation technologies for the telecommunications equipment market. The nature of the additional efforts required to develop these technologies into commercially viable products consists primarily of planning, designing, experimenting, and further testing activities necessary to determine whether the technologies can meet market expectations, including functionality and technical requirements.

The methodology we used to allocate the purchase price to in-process research and development involved established valuation techniques. The income approach was the primary valuation method employed. This approach discounts expected future cash flows related to the projects to present value. The discount rates used in the present value calculations are typically based on a weighted-average cost of capital analysis, venture capital surveys and other sources, where appropriate. We made adjustments to reflect the inherent risk of the developmental assets. We also employed the cost approach in certain cases, which entails estimating the cost to recreate the asset. We consider the pricing models related to the combination to be standard within the telecommunications industry.

The key assumptions employed in both approaches consist primarily of an expected completion date for the in-process projects, estimated costs to complete the projects, revenue and expense projections, and discount rates based on the risks associated with such development of the in-process technology acquired. 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.

In the context of the combination with Lucent, we allocated approximately U.S. $ 581 million of the purchase price to in-process research and development. An impairment charge of U.S. $ 123 million was accounted for as restructuring costs in December 2006 in connection with the discontinuance of certain product lines. An additionnal impairment loss of U.S. $ 50 milllion was accounted for in the context of the 2008 impairment tests of goodwill mainly in CDMA.

UMTS business of Nortel. Nortel had spent over U.S. $ 1.0 billion in the five years immediately prior to our acquisition of the UMTS business on the development of the UMTS technology assets. The technology is based on current standards and architectures and is designed to allow for future enhancements. In order to proceed with the valuation of this technology asset upon the acquisition of the UMTS business, we reviewed royalty rate data for contemporary transactions in the telecommunications transmission technology market and wireless-related protocol market. The relevant range of royalty rate was 4.0% to 6.0%.

We considered it appropriate to use a royalty rate of 6.0%, to reflect the specific characteristics of the acquired UMTS technology. Certain of the comparable transactions reviewed involved restricted licensing arrangements (limited geography, markets, etc.), which, if treated as fully comparable to our acquisition, would result in underestimating the value of our unrestricted ownership for UMTS. Additionally, we and Nortel’s management both considered the Nortel UMTS technology as more mature and superior to our existing products. The majority of our UMTS technology platform going forward will be comprised of Nortel UMTS assets. The acquired UMTS-developed technology was expected to contribute meaningfully to revenue generation for approximately seven years. The technology may contribute to the forthcoming long term evolution (4G) products beyond seven years, but it was unclear at the valuation date what role, if any, the acquired assets will play. The resulting cash flows were discounted to present value using a rate of 18.0% based on the UMTS technology’s relative risk profile and position in its technology cycle. The present value associated with UMTS technology assets (including in-process research and development) was € 127 million.

In order to allocate this aggregate value to developed technology and in-process  research and development, the expected contribution to cash flows for the in-process  research and development was estimated and used as a factor for determining its share of the total UMTS value. The remaining value was ascribed to the acquired developed technology and know how. The contribution of in-process  research and development was estimated based on the relative  research and development costs incurred on the identified projects to the total  research and development spent on the overall UMTS platform while in development at Nortel. UA 5.0 and UA 6.0 UMTS projects were identified as in-process at the valuation date. Nortel had spent approximately U.S. $ 130 million on these projects until our acquisition of the UMTS business. In 2005, Nortel incurred U.S. $ 24.4 million and U.S. $ 0.2 million in development expenses for the UA 5.0 and the UA 6.0 in-process  research and development projects, respectively, and U.S. $ 102.7 million and U.S. $ 2.1 million in 2006. Expense incurred by Alcatel-Lucent in 2007 was € 45 million for UA 5.0 and € 106 million for UA 6.0.



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UMTS development efforts from 2001 through 2006 can be characterized by a period of three years of development of base UMTS technology, followed by two years of higher value, differentiating product technology (including UA 5.0 and UA 6.0 technologies). Consequently, UA 5.0 and UA 6.0 development expenses were adjusted upwards in value to reflect their higher contribution to the overall technology platform than the base technology components. The combined value-adjusted  research and development amount spent as of the valuation date was estimated at approximately U.S. $ 188 million. Given an estimate of U.S. $ 1.0 billion incurred on the UMTS technology platform since its inception through 2006, the in-process  research and development represented 18.8% of the total amount spent. In-process  research and development has therefore been valued at € 24 million (representing 18.8% of the € 127 million of the UMTS technology assets present value mentioned above).

During the second quarter of 2007, we accounted for impairment losses on tangible assets for an amount of € 81 million, on capitalized development costs and other intangible assets for an amount of € 208 million and on goodwill for an amount of € 137 million.

These impairment losses of € 426 million were related to the group of cash generating units (CGUs) corresponding to the business division UMTS/ W-CDMA. The impairment charge was due to the delay in revenue generation from this division’s solutions versus its initial expectations, and to a reduction in margin estimates for this business.



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7

CORPORATE GOVERNANCE

7.1

GOVERNANCE CODE

We uphold the AFEP-MEDEF Code of corporate governance for listed companies (sometimes referred to as “the Code” – see the MEDEF website: www.medef.fr). The Code results from the consolidation of the reports of 1995, 1999 and 2002 and the Recommendations of October 2008 regarding the compensation of chief executive officers. The AFEP (“Association française des entreprises privées”) and the MEDEF (“Mouvement des entreprises de France”) are French associations gathering companies in private sector. Our Board of Directors, at its meetings on October 29 and December 11, 2008, confirmed, and then published its adherence to the AFEP and MEDEF recommendations. The principles of the Code govern, among other things, the operating rules of our Board of Directors and its Committees, as described in the Board of Directors’ Operating Rules.

In addition, since our securities are listed on the New York Stock Exchange, we make every effort to reconcile the principles referred to above with the rules of the NYSE concerning corporate governance that apply to us, as well as with the provisions of the U.S. Sarbanes-Oxley Act, which came into force in 2002. In this respect, we note, throughout this Chapter 7, the main ways in which our corporate governance practices are aligned with, or differ from, the NYSE’s corporate governance rules applicable to U.S. “domestic issuers” listed on that exchange.

The AFEP-MEDEF code is based on specific principles which our policy in terms of corporate governance largely mirrors, as outlined in this Chapter 7; we explain in the chapter our alignment with the Code, and, when applicable, the particular position of our company.

Operating Rules

Our company operates according to the “monist” system (meaning that it has a Board of Directors, as opposed to a Supervisory Board and a Management Board).

Our Board of Directors consists of 10 Directors: two elected by the shareholders’ meeting of September 7, 2006, two co-opted Directors, such co-optation having been ratified by the shareholders’ meeting of June 1, 2007, and six Directors co-opted in 2008, subject to ratification at the shareholders’ meeting of May 29, 2009.

The duties of the Chairman of the Board of Directors, performed by Mr. Camus, co-opted as a director on September 1, 2008, and elected Chairman effective on October 1, 2008, and those of the CEO, performed by Mr. Verwaayen, co-opted as a director on September 1, 2008 and appointed CEO effective on September 15, 2008, have been separated.

The term of office of Directors as established in our Articles of Association is four years.

According to our Articles of Association, our Board of Directors must also include two observers the nomination of which must be proposed at the shareholders’ meeting and who must, at the time of their appointment, be both employees of Alcatel-Lucent or a company belonging to our Group and participants in an Alcatel-Lucent fonds commun de placement (mutual fund).



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The membership of our Board of Directors changed fundamentally during 2008. At December 31, 2008 the Board consisted of Directors representing five different nationalities and the average age of its members was 61.

Under the Articles of Association, each Director must own at least 500 shares in the company and undertake to comply with the ethics rules of the Director’s Charter. The Director’s Charter invites the Directors to own a significant number of shares, and stipulates that each Director must comply with applicable securities laws concerning trading as well as the rules contained in our “Alcatel-Lucent Insider Trading Policy” designed to prevent insider trading. Under French regulatory requirements, a Director must notify the Autorité des Marchés Financiers, the French securities regulator, of any transactions he or she executes involving Alcatel-Lucent shares.

Information concerning the Directors and observers is found in Section 7.2, “Management”.

The operation of our Board is governed by Operating Rules which are transcribed in full in Section 7.9 “Operating Rules of the Board of Directors”.

Chairman of the Board of Directors and Chief Executive Officer

At a meeting on September 1, 2008, our Board of Directors appointed Mr. Camus as Chairman of the board, effective on October 1, 2008, replacing Mr. Tchuruk, and Mr. Verwaayen as Chief Executive Officer, effective on September 15, 2008, replacing Ms. Russo.

Our Articles of Association provide that, until November 20, 2009, any decision to change the corporate governance system of separate management and to combine the functions of Chairman and CEO must be approved by a two-third majority of Directors present and represented.

The removal and replacement of either the Chairman or the CEO may now be decided by a simple majority vote of the Directors present or represented. The Board meeting of October 29, 2008 revised the Board of Directors’ Operating Rules, which set forth, among other things, the distribution of powers between the Board of Directors and the CEO in the context of the general principles defined by law. These Rules differ only slightly from the preceding version adopted on November 30, 2006, and define broadly the Board’s powers, confirming the existing limits to the new CEO, who must therefore submit the following decisions to the Board of Directors for prior approval:

the update of the Group’s annual strategic plans, and any significant strategic operation not envisaged by these plans;

the Group’s annual budget and annual capital expenditure plan;

acquisitions or divestitures in an amount per transaction higher than € 300 million (enterprise value);

capital expenditures in an amount per transaction higher than € 300 million;

offers and commercial contracts of strategic importance in an amount higher than € 1 billion;

any significant strategic alliances and industrial and financial cooperation agreements with annual projected revenues in excess of € 200 million, particularly if they involve a significant shareholding by a third party in the capital of our company;

financial transactions having a significant impact on the accounts of the Group, in particular the issuance of securities in excess of € 400 million;

any amendments to the National Security Agreement (“NSA”) among Alcatel, Lucent Technologies Inc. and certain United States governmental entities.

In addition, the existing specific delegations of power have been renewed in favor of Mr. Verwaayen, in his capacity as CEO, concerning the issuance of debt securities, for up to € 1 billion (which is a temporary exception to the € 400 level concerning financial transactions), stock option grants, trading in our shares and guarantees and security granted by our company.

The Board of Directors has also renewed in favor of Mr. Camus a delegation of power giving the Chairman the authority to represent the Group in its high-level relations, particularly vis-à-vis government representatives.

Selection criteria and independence of the Directors

The appointment of new Directors must comply with selection rules which are applied by our Corporate Governance and Nominating Committee. Members of the Board must be competent in the Group’s high-technology businesses, have sufficient financial expertise to make informed, independent decisions about financial statements and compliance with accounting standards, and be entirely independent of the company’s management based on the criteria set out below.

The independence criteria applied by the Board of Directors are specified in Article 4 of the Board of Directors’ Operating Rules discussed below. They comply with the definition provided in the AFEP-MEDEF Code and are based on the general principle that Directors are independent so long as they have no direct or indirect relationship of any kind with our company, its subsidiaries or senior management that could prevent them from exercising free judgment.

Our Board of Directors also includes at least one independent Director who has financial expertise, as recommended in Article 5 of its Operating Rules.




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In February 2009, our Board of Directors conducted a detailed review of its independence criteria. Based on all of these criteria, the Board determined that Lady Jay, Mr. Bernard, Mr. Blount, Mr. Eizenstat, Mr. Hughes, Mr. Monty, Mr. Piou and Mr. Spinetta, that is, eight of its 10 members, are independent.

The company also complies with the rules of the NYSE and the provisions of the Sarbanes-Oxley Act on this subject. These rules stipulate that the majority of members of the Board of Directors in a U.S. listed company must be independent and that the Board must determine whether the independence criteria are met. Our Board did this at its meeting of February 3, 2009.

Conflicts of interest

To our knowledge, there are no potential conflicts of interest between our Directors’ fiduciary duties and their private interests. In accordance with the Director’s Charter, a Director must notify the Board of any conflict of interest, even potential.

There are no family relationships between the members of our Board of Directors and the other senior executives of our company.

There are no service agreements between a member of the Board of Directors and our company or any of its affiliates.

To our knowledge, there is no arrangement or agreement with a shareholder, client, supplier or any third party pursuant to which a member of our Board of Directors or of our Management Committee has been nominated to their respective position or as CEO.

To our knowledge, no member of the Board of Directors of our company has been convicted of fraud during the last five years; has been charged and/or received an official public sanction pronounced by a statutory or regulatory authority; or has been banned by a court from holding office as a member of an administrative, management or supervisory body of an issuer, or from being involved in the management or conduct of the business of an issuer in the last five years.

To our knowledge, no member of the Board of Directors of our company has been a Director or executive officer of a company involved in a bankruptcy, court escrow or liquidation in the last five years, with the exception of Mr. Hughes, in his capacity as non-executive chairman of the American company Outperformance Inc., which was wound up voluntarily (“Chapter 7” of the U.S. Bankruptcy Code) in October 2008; and Mr. Monty, in his capacity as director of the Canadian company Teleglobe Inc., which was liquidated in 2002, with respect to which liquidation there are legal proceedings still in progress.


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7.2

MANAGEMENT

As of March 31, 2009

BOARD OF DIRECTORS

Philippe Camus

Chairman of the Board of Directors

Louis R. Hughes

Independent director

Chairman and Chief Executive Officer

of GBS Laboratories Inc.

Jean-Pierre Desbois

Board observer

President of the supervisory board of FCP

“Actionnariat Alcatel-Lucent”

Ben Verwaayen

Chief Executive Officer and director

Sylvia Jay

Independent director

Vice-Chairman of L’Oréal UK Ltd

Patrick Hauptmann

Board observer

Member of the supervisory board of FCP “Actionnariat Alcatel-Lucent”

Daniel Bernard

Independent director

Chairman of Provestis

Jean C. Monty

Independent director

 

W. Frank Blount

Independent director

Chairman and Chief Executive Officer

of JI Ventures Inc.

Olivier Piou

Independent director

Chief Executive Officer of Gemalto

Pascal Durand-Barthez

Secretary to the Board of Directors

Stuart E. Eizenstat

Independent director

Jean-Cyril Spinetta

Independent director

President of the Board of Directors of Air France-KLM

Nathalie Trolez-Mazurier

Deputy Secretary to the Board of Directors


AUDIT AND FINANCE COMMITTEE

Jean Monty, President

Daniel Bernard

W. Frank Blount

Jean-Cyril Spinetta

Jean-Pierre Desbois (Board observer)

CORPORATE GOVERNANCE AND NOMINATING COMMITTEE

Daniel Bernard, President

W. Frank Blount

Stuart E. Eizenstat

Sylvia Jay

COMPENSATION COMMITTEE

Jean-Cyril Spinetta, President

Sylvia Jay

Olivier Piou

Stuart E. Eizenstat

TECHNOLOGY COMMITTEE

Louis R. Hughes, President

Olivier Piou

Jeong Kim

Philippe Keryer

Jean-Pierre Desbois (Board observer)

Patrick Hauptmann (Board observer)

STATUTORY AUDITORS

Deloitte & Associés

Represented by Antoine de Riedmatten

Ernst & Young et Autres

Represented by Jean-Yves Jégourel

MANAGEMENT COMMITTEE

Ben Verwaayen

Chief Executive Officer

Tom Burns

President Enterprise Products Group

Janet Davidson

President Quality and Customer Care

Sean Dolan

President Asia Pacific Region

Kenneth Frank

President Solutions and Marketing

Adolfo Hernandez

President Europe, Middle East and Africa Region

Philippe Keryer

President Carrier Products Group

Jeong Kim

President Bell Labs

Claire Pedini

Executive Vice President Human Resources

Michel Rahier

President Operations

Paul Segre

President Applications Software Group

Paul Tufano

Chief Financial Officer

Robert Vrij

President Americas Region

Andy Williams

President Services Group


Outgoing members of management committee in 2008 and 2009

F. Rose was a member until August 2008

P. Russo and C. Christy were members until September 2008

H. de Pesquidoux was a member until December 2008

E. Fouques was a member until January 2009

Appointment as member of management committee 2008 and 2009

B. Verwaayen became member in September 2008

P. Tufano became member in December 2008

T. Burns, J. Davidson, S. Dolan, K. Frank, A. Hernandez, Ph. Keryer, J. Kim, P. Segre and R. Vrij became members in January 2009



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Information on the current Directors and board observers

Philippe CAMUS

Chairman of the Board of Directors

Born on June 28, 1948, French citizen

Appointed October 2008, to 2010

Business address:

Alcatel-Lucent

54, rue La Boétie – 75008 Paris

France

Career

Philippe Camus graduated from the École normale supérieure and the Institut d’études politiques of Paris. He began his career in the Finance Department of Caisse des Dépôts et Consignations. In 1982, he joined the General Management team of Lagardère Group and in 1993 was appointed CEO and Chairman of the Finance Committee. He controlled the preparatory work that led to the founding of EADS, where he served as President and Chief Executive Officer from 2000 to 2005. He has been co-managing Partner of Lagardère Group since 1998 and Senior Managing Director of Evercore Partners Inc. since 2006. On October 1, 2008, he was appointed Chairman of the Board of Directors of Alcatel-Lucent.

Expertise: 30 years in banking, finance, insurance and 8 years in the industrial sector.

Current Directorships and professional positions

In France: Chairman of the Board of Directors of Alcatel-Lucent, co-managing Partner of Lagardère Group, Director, Chairman of the Compensation Committee and member of the Audit Committee of Crédit Agricole, Director and member of the Audit and Finance Committees of Schlumberger, Director of Éditions P. Amaury, Honorary Chairman of Groupement des Industries Françaises Aéronautiques et Spatiales (GIFAS), Permanent Representative of Lagardère SCA to the Board of Directors of Hachette SA, Permanent Representative of Hachette SA to the Board of Directors of Lagardère Services, member of the Supervisory Board of Lagardère Active.

Abroad: Chairman and CEO of Lagardère North America, Inc., Senior Managing Director of Evercore Partners Inc., Director of Cellfish Media, LLC.

Directorships over the last 5 years

In France: Chairman of EADS France and of GIFAS, Director of: Accor*, Dassault Avation, La Provence, Nice Matin and Hachette Filipacchi Médias, Permanent Representative of Lagardère Active to the Board of Directors of Lagardère Active BroadCast (Monaco), member of the Compensation Committee, member of the Airbus Partners Committee and member of the Supervisory Board of Hachette Holding.

Abroad: Joint Executive President of EADS NV (The Netherlands) and of EADS Participations BV (The Netherlands).

Company shareholding

50,000 ordinary shares of Alcatel-Lucent.


*

Term of office expired in 2008.



Ben VERWAAYEN

CEO and Director

Born on February 11, 1952, Dutch citizen

Appointed September 2008, to 2010

Business address:

Alcatel-Lucent

54 rue La Boétie – 75008 Paris

France

Career

Ben Verwaayen graduated from the State University of Utrecht, the Netherlands, where he received a Master’s degree in law and international politics. Ben Verwaayen held several positions in business development, HR and public relations, before being appointed General Manager of ITT Nederland BV where he worked from 1975 to 1988. Ben Verwaayen was then President and General Manager of PTT Telecom, a KNP subsidiary in the Netherlands, from 1988 to 1997. International Vice-President, Executive Vice-President and Chief Operating Officer of Lucent Technologies from 1997 to 2002, Ben Verwaayen was also Vice-Chairman of the Management Board. He was President General Manager of BT from 2002 to June 2008. In 2006, Ben Verwaayen was made an officer of the Order of Orange-Nassau and an Honorary Knight of the British Empire by the Queen and Chevalier de la Légion d’honneur in France. Ben Verwaayen was appointed CEO of Alcatel-Lucent on September 1, 2008, with effect on September 15, 2008.

Expertise: 33 years in the industry sector.

Current Directorships and professional positions

In France: CEO of Alcatel-Lucent, Director of Alcatel-Lucent.

Abroad: Non-executive Director of UPS.

Directorships over the last 5 years

Abroad: CEO and Director of BT Group Plc*.

Company shareholding

50,000 ordinary shares of Alcatel-Lucent.


*

Term of office expired in 2008.




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Daniel BERNARD

Independent Director

Born on February 18, 1946, French citizen

Appointed November 2006 (1), to 2010

Business address:

Provestis

14, rue de Marignan – 75008 Paris

France

Career

A graduate of the École des hautes études commerciales, Mr. Bernard worked with Delcev Industries (1969-1971), Socam Miniprix (1971-1975) and La Ruche Picarde (1975-1980) and was CEO of the Metro France group (1981-1989), member of the Management Board with responsibility for the commercial activities of Metro International AG (1989-1992), Chairman of the Management Board (1992-1998) and later Chairman and CEO of Carrefour (1998-2005). He is currently Deputy Chairman of Kingfisher Plc London and Chairman of Provestis.

Expertise: 39 years in industry, retail and services.

Current Directorships and professional positions

In France: Independent Director of Alcatel-Lucent, Chairman of Provestis, Director of Cap Gemini.

Abroad: Deputy Chairman of the Board of Directors of Kingfisher Plc (UK).

Directorships over the last 5 years

In France: Chairman and CEO of Carrefour, Director of Saint-Gobain and of Erteco, Manager of SISP.

Abroad: Vice-Chairman of DIA SA (Spain) and of Vicour (Hong Kong), Director of: Carrefour Commercio e Industria (Brazil), Grandes Superficies de Colombia (Colombia), Carrefour Argentina (Argentina), Centros Comerciales Carrefour (Spain), Finiper (Italy), GS (Italy) and Presicarre (Taiwan).

Company shareholding

141,125 ordinary shares of Alcatel-Lucent.


(1)

Originally appointed to the Alcatel Board of Directors in 1997.



W. Frank BLOUNT

Independent Director

Born on July 26, 1938, U.S. citizen

Appointed November 2006 (1), to 2010

Business address:

1040 Stovall Boulevard N.E. – Atlanta, Georgia 30319

USA

Career

Master of Science in Management at the Massachusetts Institute of Technology (MIT) Sloan School, management MBA at Georgia State University and Bachelor of Science in Electrical Engineering at the Georgia Institute of Technology. Between 1986 and 1992, he was group President at AT&T Corp., in charge of the Group’s network operations and communications products. He then became Chief Executive from 1992 to 1999 of Telstra Corporation in Australia. Director of FOXTEL Corp. (Australia) (1995-1999), of IBM-GSA Inc. (Australia) (1996-1999), of the Australian Coalition of Service Industries (1993-1999) and the Australian Business Higher Education Roundtable (1993-1999); he was also Chairman and Chief Executive Officer of Cypress Communications Inc. (2000-2002). In 1991 he was interim Chief Executive of the New American Schools Development Corporation at the request of President George Bush. He is member of the Advisory Board of China Telecom. From 2004 through 2007, he was Chairman and CEO of TTS Management Corp. He is currently Chairman and CEO of JI Ventures Inc.

Expertise: 48 years in industry and telecommunications.

Current Directorships and professional positions

In France: Independent Director of Alcatel-Lucent.

Abroad: Chairman of JI Ventures Inc., Director of Entergy Corporation USA, of Caterpillar Inc. USA and of KBR Inc.

Directorships over the last 5 years

Abroad: Chairman and CEO of TTS Management Corp., Director of Adtran Inc. and of Hanson Plc. UK.

Company shareholding

3,668 American Depositary Shares of Alcatel-Lucent.


(1)

Originally appointed to the Alcatel Board of Directors in 1999.





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Stuart E. EIZENSTAT

Independent Director

Born on January 15, 1943, U.S. citizen

Appointed December 2008, to 2010

Business address:

Covington & Burling

1201 Pennsylvania Avenue, N.W., Suite 1117C

Washington, DC 20004

USA

Career

Stuart E. Eizenstat graduated in political science from the University of North Carolina and later graduated from Harvard University’s Law School. He holds seven honorary doctorate degrees from various universities and academic institutions. During his college years, he served as a White House staff aid. He then served as Chief Domestic Policy Advisor (1976) and Executive Director of the White House Domestic Policy Staff (1977-1981) under President Jimmy Carter’s term of office. Stuart E. Eizenstat was nominated U.S. Ambassador to the European Union (1993-1996) while a Partner and Vice Chairman of Powell, Goldstein, Frazer & Murphy law firm. At the time, he was also Adjunct Lecturer at the John F. Kennedy School of Government of Harvard University and a Guest Scholar at the Brookings Institution in Washington. He served as Under Secretary of Commerce for International Trade (1996-1997), Under Secretary of State for Economic, Business and Agricultural Affairs (1997-1999) and Deputy Secretary of the Treasury (1993-2001) while continuing to work as the Special Envoy for Property Claims in Central and Eastern Europe. During the Clinton Administration, he had a prominent role in the development of key international initiatives. He is Partner and Head of International Trade and Finance Practice at Covington & Burling LLP law firm. Moreover, he is a member of the Boards of Directors of United Parcel Service, BlackRock Funds, Chicago Climate Exchange and Globe Specialty Metals. Stuart E. Eizenstat is the author of several publications, which have been translated into German, French, Czech and Hebrew.

Expertise: 28 years in law and 13 years in governmental affairs.

Current Directorships and professional positions

In France: Independent Director of Alcatel-Lucent.

Abroad: Independent Director of United Parcel Service, of BlackRock Funds, of Chicago Climate Exchange and of Globe Specialty Metals.

Company shareholding

500 American Depositary Shares of Alcatel-Lucent.



Louis R. HUGHES

Independent Director

Born on February 10, 1949, U.S. citizen

Appointed December 2008, to 2010

Business address:

GBS Laboratories

2325 Dulles Corner Blvd, Suite 500

Herndon, VA 20171

USA

Career

Louis R. Hughes graduated from Harvard Business School (MBA, 1973) and from Kettering University, B.S. (Mechanical Engineering, 1971). He received his Bachelor of Mechanical Engineering from the General Motors Institute. Louis R. Hughes has been Chairman Chief Executive Officer and Chairman of GBS Laboratories LLC since 2005. Louis R. Hughes is also Executive Advisor Partner of Wind Point Partners and a member of the British Telecom U.S. Advisory Board. Moreover, Mr Hughes has been a member of the Boards of Directors of ABB (since 2003), Akzo Nobel (The Netherlands), and Sulzer (Switzerland). He served as President and Chief Operating Officer of Lockheed Martin Corp. His prior experiences also include positions of Chief of Staff Afghanistan Reconstruction Group, U.S. Department of State, from 2004 to 2005, Executive Vice President of General Motors Corporation from 1992 to 2000, President of General Motors International Operations from 1994 to 1999, President of General Motors Europe from 1992 to 1994 and Managing Director of Adam Opel AG from 1989 to 1992. He was non-executive Chairman of Maxager (renamed Outperformance in 2008) from 2000 to 2008. He has also served on several Boards, including: British Telecom (United Kingdom) from 2000 to 2006, Electrolux AB (Sweden) from 1996 to 2008, MTUAero Engines GmbH (Germany) from 2006 to 2008, Deutsche Bank from 1993 to 2000, Saab Automobile AB from 1992 to 2000 and Adam Opel AG from 1989 to 1992.

Expertise: 35 years in the industry sector.

Current Directorships and professional positions

In France: Independent Director of Alcatel-Lucent.

Abroad: Chairman and Chief Executive Officer of GBS Laboratories (USA). Independent Director of ABB (Switzerland), Akzo Nobel (Netherland), Sulzer (Switzerland).

Directorships over the last 5 years

Abroad: Independent Director of Electrolux* (Sweden), MTU Aero Engines GmbH* (Germany), Non-executive Chairman of Maxager* (USA). Member of the Advisory Board of Directors of British Te