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Alcatel Lucent · 20-F · For 12/31/07

Filed On 4/8/08, 2:54pm ET   ·   Accession Number 1308179-8-39   ·   SEC File 1-11130

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  As Of                Filer                Filing    For/On/As Docs:Size              Issuer               Agent

 4/08/08  Alcatel Lucent                    20-F       12/31/07    7:4.4M                                   Labrador/FA

Annual Report of a Foreign Private Issuer   —   Form 20-F
Filing Table of Contents

Document/Exhibit                   Description                      Pages   Size 

 1: 20-F        Alcatel-Lucent Form 20-F                            HTML   2.48M 
 2: EX-10.1     Material Contract -- exhibit101                     HTML     19K 
 3: EX-10.2     Material Contract -- exhibit102                     HTML     19K 
 4: EX-12.1     Statement re: Computation of Ratios -- exhibit121   HTML     11K 
 5: EX-12.2     Statement re: Computation of Ratios -- exhibit122   HTML     11K 
 6: EX-13.1     Annual or Quarterly Report to Security Holders --   HTML      8K 
                          exhibit131                                             
 7: EX-13.2     Annual or Quarterly Report to Security Holders --   HTML      8K 
                          exhibit132                                             


20-F   —   Alcatel-Lucent Form 20-F
Document Table of Contents

Page (sequential) | (alphabetic) Top
 
11st Page   -   Filing Submission
"Back to Contents
"Selected financial data
"1.1
"Condensed consolidated income statement and balance sheet data
"1.2
"Exchange rate information
"Activity overview
"2.1
"Carrier Segment
"2.2
"Enterprise Segment
"2.3
"Services Segment
"Risk factors
"3.1
"Risks relating to the business combination between Alcatel and Lucent
"3.2
"Risks relating to the business
"3.3
"Legal risks
"3.4
"Risks relating to the market
"3.5
"Risks relating to ownership of our ADSs
"Information about the Group
"4.1
"General
"4.2
"History and development
"4.3
"Structure of the principal companies consolidated in the Group as of December 31, 2007
"4.4
"Real estate and equipment
"4.5
"Material contracts
"Description of the Group's activities
"5.1
"Business organization
"5.2
"5.3
"5.4
"5.5
"Marketing and distribution of our products
"5.6
"Competition
"5.7
"Technology, Research and Development
"5.8
"Intellectual property
"5.9
"Sources and availability of materials
"5.10
"Seasonality
"5.11
"Our activities in certain countries
"5.12
"Environmental matters
"5.13
"Human resources
"Operating and financial review and prospects
"6.1
"Overview of 2007
"6.2
"Consolidated results of operations for the year ended December 31, 2007 compared to the year ended December 31, 2006
"6.3
"Results of operations by business segment for the year ended December 31, 2007 compared to the year ended December 31, 2006
"6.4
"Consolidated results of operations for the year ended December 31, 2006 compared to the year ended December 31, 2005
"6.5
"Results of operations by business segment for the year ended December 31, 2006 compared to the year ended December 31, 2005
"6.6
"Liquidity and capital resources
"6.7
"Contractual obligations and off-balance sheet contingent commitments
"6.8
"Outlook for 2008
"6.9
"Qualitative and quantitative disclosures about market risk
"6.10
"Legal matters
"6.11
"Research and Development expenditures
"Corporate governance
"7.1
"Management
"7.2
"Board of directors
"7.4
"Compensation
"102
"7.6
"Statement of Business Principles
"108
"Information concerning our capital
"110
"8.1
"Share capital and voting rights
"8.2
"Diluted capital
"8.3
"Authorizations concerning our capital
"111
"8.4
"Changes in our capital over the last five years
"112
"8.6
"Outstanding Instruments giving right to shares
"114
"Stock exchange and shareholding
"117
"9.1
"Listing
"9.2
"Trading over the last five years
"118
"9.3
"Shareholder profile
"119
"9.4
"Breakdown of capital and voting rights
"120
"9.5
"Changes in shareholding over the last three years
"121
"9.7
"Evolution of the dividend over the last five years
"123
"10 Additional information
"124
"10.1
"Legal information
"Specific provisions of the Articles of Association and of law
"125
"10.3
"American Depositary Shares, taxation and certain other matters
"130
"10.4
"Documents on display
"136
"Controls and procedures, Statutory Auditors' fees and other matters
"137
"Report of independent registered public accounting firms
"138
"11.3
"Appointment of Statutory Auditors
"139
"Statutory Auditors' fees
"11.6
"Code of ethics
"141
"Financial statements
"Exhibits
"Cross-reference table between Form 20-F and this document
"142
"Consolidated financial statements at December 31, 2007
"148
"150
"2007-2006 Report of Independent Registered Public Accounting Firms
"151
"2005 Report of Independent Registered Public Accounting Firm
"Consolidated income statements
"152
"Consolidated Income Statements for the years ended December 31, 2007, 2006 and 2005
"Consolidated balance sheets
"153
"Consolidated Balance Sheets at December 31, 2007, 2006 and 2005
"Consolidated statements of cash flows
"155
"Consolidated Statements of Cash Flows for the years ended December 31, 2007, 2006 and 2005
"Consolidated statements of recognized income and expense
"156
"Consolidated statements of recognized income and expense for the years ended December 31, 2007, 2006 and 2005
"Consolidated statements of changes in shareholders' equity
"157
"Consolidated Statements of Changes in Shareholders' Equity for the years ended December 31, 2007, 2006 and 2005
"Notes to Consolidated Financial Statements
"158
"Note 1
"Summary of accounting policies
"Note 2
"Principal uncertainties regarding the use of estimates
"167
"Note 3
"Changes in consolidated companies
"171
"Note 4
"Change in accounting policy and presentation
"176
"Note 5
"Information by business segment and by geographical segment
"Note 6
"Revenues
"179
"Note 7
"Impairment losses on assets recognized in the income statement
"180
"Note 8
"Financial income (loss)
"181
"183
"232
"Note 9
"Income tax and related reduction of goodwill
"Note 10
"Discontinued operations, assets held for sale and liabilities related to disposal groups held for sale
"Note 11
"Earnings per Share
"184
"Note 12
"Goodwill
"186
"Note 13
"Intangible assets
"188
"Note 14
"Property, plant and equipment
"190
"Note 15
"Finance leases and operating leases
"191
"Note 16
"Share in net assets of equity affiliates and joint ventures
"192
"Note 17
"Financial assets
"194
"Note 18
"Operating working capital
"196
"Note 19
"Inventories and work in progress
"197
"Note 20
"Trade receivables and related accounts
"Note 21
"Other assets and liabilities
"198
"Note 22
"Allocation of 2007 net income (loss)
"Note 23
"Shareholders' equity
"Note 24
"Compound financial instruments
"209
"Note 25
"Pensions, retirement indemnities and other post-retirement benefits
"211
"Note 26
"Financial debt
"220
"Note 27
"Provisions
"225
"Note 28
"Market-related exposures
"226
"Note 29
"Customers' deposits and advances
"Note 30
"Net cash provided (used) by operating activities before changes in working capital, interest and taxes
"Note 31
"Contractual obligations and disclosures related to off balance sheet commitments
"233
"Note 32
"Related party transactions
"237
"Note 33
"Employee benefit expenses and staff training rights
"238
"Note 34
"Contingencies
"Note 35
"Events after the balance sheet date
"242
"Note 36
"Main consolidated companies
"Note 37
"Quaterly information (unaudited)
"244

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  Alcatel-Lucent 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, 2007

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.

2,317,441,420 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









Back to Contents




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

8

2.1

Carrier Segment

8

2.2

Enterprise Segment

9

2.3

Services Segment

9

3

Risk factors

10

3.1

Risks relating to the business combination between Alcatel and Lucent

10

3.2

Risks relating to the business

11

3.3

Legal risks

13

3.4

Risks relating to the market

14

3.5

Risks relating to ownership of our ADSs

16

4

Information about the Group

18

4.1

General

18

4.2

History and development

18

4.3

Structure of the principal companies consolidated in the Group as of December 31, 2007

22

4.4

Real estate and equipment

23

4.5

Material contracts

24

5

Description of the Group’s activities

27

5.1

Business organization

27

5.2

Carrier Segment

28

5.3

Enterprise Segment

32

5.4

Services Segment

33

5.5

Marketing and distribution of our products

34

5.6

Competition

34

5.7

Technology, Research and Development

35

5.8

Intellectual property

36

5.9

Sources and availability of materials

37

5.10

Seasonality

37

5.11

Our activities in certain countries

37

5.12

Environmental matters

37

5.13

Human resources

38


2 - 2007 ANNUAL REPORT ON FORM 20-F



Back to Contents




6

Operating and financial review and prospects

45

6.1

Overview of 2007

50

6.2

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

51

6.3

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

54

6.4

Consolidated results of operations for the year ended December 31, 2006 compared to the year ended December 31, 2005

56

6.5

Results of operations by business segment for the year ended December 31, 2006 compared to the year ended December 31, 2005

58

6.6

Liquidity and capital resources

60

6.7

Contractual obligations and off-balance sheet contingent commitments

63

6.8

Outlook for 2008

66

6.9

Qualitative and quantitative disclosures about market risk

67

6.10

Legal matters

69

6.11

Research and Development expenditures

73

7

Corporate governance

76

7.1

Management

76

7.2

Board of directors

93

7.3

Committees of the Board

98

7.4

Compensation

102

7.5

Stock Options and other securities held by Directors and senior executives

106

7.6

Statement of Business Principles

108

7.7

Regulated agreements and commitments, and related party transactions

108

8

Information concerning our capital

110

8.1

Share capital and voting rights

110

8.2

Diluted capital

110

8.3

Authorizations concerning our capital

111

8.4

Changes in our capital over the last five years

112

8.5

Purchases of Alcatel-Lucent shares by the company

113

8.6

Outstanding Instruments giving right to shares

114

9

Stock exchange and shareholding

117

9.1

Listing

117

9.2

Trading over the last five years

118

9.3

Shareholder profile

119

9.4

Breakdown of capital and voting rights

120

9.5

Changes in shareholding over the last three years

121

9.6

Shareholders’ General Meeting

122

9.7

Evolution of the dividend over the last five years

123


2007 ANNUAL REPORT ON FORM 20-F - 3



Back to Contents




10 Additional information

124

10.1

Legal information

124

10.2

Specific provisions of the Articles of Association and of law

125

10.3

American Depositary Shares, taxation and certain other matters

130

10.4

Documents on display

136

11

Controls and procedures, Statutory Auditors’ fees and other matters

137

11.1

Controls and procedures

137

11.2

Report of independent registered public accounting firms

138

11.3

Appointment of Statutory Auditors

139

11.4

Statutory Auditors’ fees

139

11.5

Audit Committee financial expert

140

11.6

Code of ethics

141

11.7

Financial statements

141

11.8

Exhibits

141

11.9

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

142

12

Consolidated financial statements at December 31, 2007

148

2007-2006 report of independent registered public accounting firms

150

2005 report of independent registered public accounting firm

151

Consolidated income statements

152

Consolidated balance sheets

153

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




4 - 2007 ANNUAL REPORT ON FORM 20-F



Back to Contents




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.

We did not prepare financial statements in accordance with IFRS prior to 2004 as we were only required to present our financial statements in accordance with French Generally Accepted Accounting Principles. Accordingly, we have not provided selected financial data for 2003.

Also, as permitted by recent changes in U.S. securities laws, we no longer provide a reconciliation of our net income and shareholders’ equity as reflected in our 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. (“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 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 as described in the section “Changes in Accounting Standards as of January 1, 2007 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 2007 and 2006 included several negative, non-cash impacts of purchase accounting entries.




2007 ANNUAL REPORT ON FORM 20-F - 5



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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)

2007 (1)

2007

2006

2005

2004

Income Statement Data

     

Revenues

$25,892

€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 amendment

(1,033)

(707)

687

1,016

1,003

Restructuring costs

(1,250)

(856)

(707)

(79)

(313)

Income (loss) from operating activities

(6,205)

(4,249)

(146)

1,066

602

Income (loss) from continuing operations

(5,969)

(4,087)

(219)

855

431

Net income (loss)

(5,078)

(3,477)

(61)

963

645

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

(5,138)

(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)

(2.67)

(1.83)

(0.18)

0.59

0.27

Diluted (3)

(2.67)

(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)

2007(1)

2007

2006

2005

2004

Balance Sheet Data

     

Total assets

$49,402

€33,830

€41,890

€21,346

€20,629

Marketable securities and cash and cash equivalents

7,698

5,271

5,994

5,150

5,163

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

6,666

4,565

5,048

2,752

3,491

Current portion of long-term debt

705

483

1,161

1,046

1,115

Capital stock

6,768

4,635

4,619

2,857

2,852

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

16,402

11,232

15,910

6,130

4,913

Minority interests

752

515

495

475

373

(1)

Translated solely for convenience into dollars at the noon buying rate of €1.00 = U.S.$1.4603 on December 31, 2007.

(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: 2,255,890,753 in 2007; 1,449,000,656 in 2006; 1,367,994,653 in 2005; 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: 2,255,890,753 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 2007 at our Annual Shareholders’ Meeting to be held on May 30, 2008.

(5)

Amounts presented are net of dividends distributed. Shareholders’ equity attributable to holders of the parent before appropriation are €11,232 million, €16,280 million, €6,349 million and €4,913 million as of December 31, 2007, 2006, 2005 and 2004 respectively and dividends proposed or distributed amounted to €0 million, €370 million, €219 million and €0 million as of December 31, 2007, 2006, 2005 and 2004 respectively.




6 - 2007 ANNUAL REPORT ON FORM 20-F



Back to Contents




1.2

EXCHANGE RATE INFORMATION

The table below shows the average noon buying rate of euro from 2003 to 2007. 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)

2007

$1.3797

2006

$1.2728

2005

$1.2400

2004

$1.2478

2003

$1.1411

(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 2008

$1.5805

$1.5195

February 2008

$1.5187

$1.4495

January 2008

$1.4877

$1.4574

December 2007

$1.4759

$1.4344

November 2007

$1.4862

$1.4435

October 2007

$1.4468

$1.4092

September 2007

$1.4219

$1.3606


On April 4, 2008, the noon buying rate was €1.00 = $1.5735.




2007 ANNUAL REPORT ON FORM 20-F - 7



Back to Contents




2

ACTIVITY OVERVIEW

The chart below sets forth our three current business segments: Carrier, Enterprise and Services.

However, since our announcement on October 31, 2007 of the changes in management of our three segments and the restructuring of our business groups within the Carrier segment, we no longer organize our Carrier segment according to three business groups (Wireline, Wireless and Convergence). Currently, our Carrier segment is organized into seven business divisions: IP, Fixed Access, Optics, Multicore, Applications, CDMA networks and Mobile Access. The following discussion regarding the Carrier segment is therefore provided for the continuity of analysis for full year 2007 and may not be provided as such in future reports.

All market positions are based on 2007 full-year published reports. We did not include unpublished ones.



2.1

CARRIER SEGMENT

Wireline

  

Position

Activities

Market positions

A world leader and privileged partner of telecom operators, enterprises and governments in transforming 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 market segments: access, optics and IP (Internet Protocol). The portfolio of products offered by the wireline group 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 44% of DSL market share (in revenues) (1)

#1 in optics (Terrestrial and Submarine) with 23.5% of market share (in revenues) (2)

#2 in IP/MPLS service EDGE Routers with 18% of market share (in revenues) (3)

(1)

Dell’Oro.

(2)

Ovum RHK.

(3)

Ovum RHK.


Wireless

  

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 10.1% of market share (in revenues) (4)

#3 in W-CDMA with 10.5% of market share (in revenues) (5)

#1 in CDMA with 47.4% of market share (in revenues) (6)

Included in 1st tier WiMAX vendors (7)

(4)

Dell’Oro.

(5)

Dell’Oro.

(6)

Dell’Oro.

(7)

Current Analysis Inc.




8 - 2007 ANNUAL REPORT ON FORM 20-F



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Convergence

  

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).

A leader in IMS with broad field experience, including 25 deployments or advanced trials and a leader in subscriber data management applications that have been deployed in more than 190 networks.




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 education, finance, healthcare and hospitality industries.

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

#1 in Western Europe Enterprise Telephony with 21.2% of market share (in revenues) (8)

(8)

Synergy Research Group.

2.3

SERVICES SEGMENT



Position

Activities

Market positions

A world leader in supplying services for operators, companies, industry and the public sector, with particular expertise in integrating complete telecommunication end-to-end product offerings.

Activities focus on supplying complete product 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.

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





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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 COMBINATION
BETWEEN ALCATEL AND LUCENT

We may fail to realize the anticipated cost savings, revenue enhancements and other benefits expected from the business combination.

As part of the integration of historical Alcatel and Lucent following the business combination, we are executing plans to consolidate support functions, optimize our supply chain and procurement structure, leverage our Research and Development and services across a larger base, and reduce our worldwide workforce by approximately 16,500 positions (before the impact of acquisitions and insourcing contracts). These actions are expected to result in significant cost savings, opportunities for revenue synergies and other synergistic benefits.

However, in the course of 2007, we experienced delays in the execution of our integration and cost reduction plans. In addition, the challenges inherent in the combination of global business enterprises of the size and scope of historical Alcatel and Lucent have been more complex than expected. These two factors, coupled with the continuing consolidation among both service providers and telecommunications equipment makers in 2007, have created disruptions in market conditions.

Looking forward, we cannot give assurance that pricing conditions will improve in our industry and that we will not be affected by further delays in the execution of our integration and cost reduction plans. These two factors could therefore negatively impact both our operations and our financial results.

Uncertainties associated with our integration and cost reduction plans may cause a loss of employees and may otherwise materially adver­sely affect our future business and operations.

Our success depends in part upon our ability to retain our key employees. Competition for qualified personnel can be intense. Our current and prospective employees may continue to experience uncertainty about their roles with us as we work through our integration and cost reduction plans. This may materially adversely affect our ability to attract and retain key management, sales, marketing, technical and other personnel. We have already experienced some limited retention issues in 2007. We can give no assurance that in the future, we will be able to attract or retain our key employees to the same extent that we have been able to attract or retain our employees prior to the business combination.

Technological innovation is important to our success and depends, to a significant degree, on the work of technically skilled employees. Competition for the services of these types of employees is vigorous. We cannot provide assurance that we will be able to attract and retain these employees in the future. If we are unable to attract and retain technically skilled employees, our competitive position could be materially adversely affected.



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The Group’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 pension plans.

The Group’s qualified U.S. pension plans meet ERISA’s current funding requirements, and we do not expect the Group will make any contributions to these plans through 2009. We are unable to provide an estimate of future funding requirements beyond fiscal year 2009 for the Group’s U.S. pension plans. However, based on actuarial projections and stochastic projections (that is simulations based on random variation of selected inputs), we believe it is unlikely that any required contributions through fiscal year 2012 would have a material adverse effect on our liquidity.

As of January 1, 2008 we estimate that all of our material U.S. pension plans are overfunded under the newly effective rules of the Pension Protection Act of 2006 (the “PPA”), assuming such rules were fully effective. The PPA impacts the funding requirements for the Group’s U.S. pension plans by altering the manner in which liabilities and asset values are determined for the purpose of calculating required pension contributions and the timing and manner in which required contributions to under-funded pension plans would be made. These changes resulting from the PPA remain subject to final regulations. When compared to prior law, the PPA rules could significantly increase the funding requirements for the Group’s U.S. management pension plan and reduce excess pension assets that could be available to fund retiree health care benefits for the Group’s formerly represented employees. Accordingly, the amounts we might contribute to these benefit plans are subject to uncertainty.

The fair market value of assets held in the Group’s U.S. pension trust was approximately €24.6 billion as of December 31, 2007.

The PPA, as amended by the U.S. Troop Readiness, Veterans’ Care, Katrina Recovery, and Iraq Accountability Appropriations Act, 2007, provides for “collectively bargained” transfers and “multi-year” transfers under Section 420 of the Internal Revenue Code, under which pension assets in excess of 125% (for collectively bargained transfers) and 120% (for multi-year transfers) of pension plan funding obligations would be available to fund health care costs for Lucent’s formerly represented retirees.

As of the January 1, 2008 valuation date, there were approximately €2.3 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. Under a “multi-year” Section 420 transfer, as of the same valuation date, €2.7 billion would be available to fund retiree health care. The Group expects to make a “collectively bargained” transfer during 2008 to cover the formerly represented retiree health care costs for 2008. Based on current actuarial assumptions we believe it is likely that almost all of the healthcare funding required for the Group’s formerly represented retirees (assuming the present level and structure of benefits) could be addressed through 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.



3.2

RISKS RELATING TO THE BUSINESS

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.



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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, support from governments in their home countries, or both. 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, data networking and semiconductor 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.

A small number of our customers account for a substantial portion of our revenues, 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.

A few large telecommunications service providers account for a substantial portion of our revenues. 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 will make us extremely vulnerable to downturns or slowdowns in spending in that industry.

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. 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.



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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.

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.

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 Shanghai Bell, has this type of requirement. We own 50% plus one share of Alcatel Shanghai Bell, the remainder being owned by the Chinese government. On February 12, 2008 we also announced a memorandum of understanding with NEC to create a joint venture that will focus on the development of Long Term Evolution (LTE) wireless broadband access product offerings. This joint venture may also be subject to similar governance provisions.



3.3

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 could adversely affect our profitability and cash flow.



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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 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.



3.4

RISKS RELATING TO THE MARKET

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.

Growth in the global telecommunications industry slowed in 2007, largely reflecting slightly negative growth in the global market for carrier telecommunications equipment and related applications and services at actual exchange rates. Although we believe the demand for telecommunications services will continue to grow in 2008, the equipment side of the industry is more likely to see a continuation of 2007’s slightly negative growth, at current exchange rates. Moreover, the rate of growth could vary geographically and across different technologies, and is subject to substantial fluctuations. The specific industry segments in which we participate may not experience the growth of other segments. In that case, the results of our operations may be adversely affected.

If capital investment by service providers grows at a slower pace than anticipated, 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.



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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.

In order to finance our business, we expect to use available cash and investments and to continue to have access to a syndicated credit facility allowing for the drawdown of significant levels of debt if required. However, we expect that the ability to draw on this facility will be conditioned upon our compliance with the financial covenant and other conditions included in the loan documents. We can give no assurance  that we will be in compliance with the financial covenant and other conditions required by our lenders at all times in the future.

We may need to secure additional sources of funding if our cash, syndicated credit facility and borrowings are not available or are insufficient to finance our business. 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 current short-term debt rating allows us limited access to the commercial paper market. 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. 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.

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.



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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, 2007. 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 the telecommunications industry or general in nature. For instance, we accounted for an impairment loss of €2.9 billion in 2007. 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.



3.5

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.



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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 offer the end-to-end product offerings that enable communications services for residential, business customers and customers on the move. With operations in more than 130 countries, we are a local partner with global reach. We have one of the most experienced global services teams in the industry, and one of the largest research, technology and innovation organizations in the telecommunications industry.

Alcatel-Lucent is a French société anonyme, established in 1898, originally as a listed company. 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 Lucent Technologies Inc., 600 Mountain Avenue, Murray Hill, New Jersey 07974.



4.2

HISTORY AND DEVELOPMENT

Set forth below is an outline of certain significant events of Alcatel-Lucent from formation until 2004:

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



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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 US 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 US company, which has a solid position in the US 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, US-based company that produces routers

Sale of Alcatel’s optical components business to Avanex

Sale of SAFT Batteries subsidiary to Doughty Hanson

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, US-based eDial Inc., a leading provider of conferencing and collaboration services for businesses and telephone companies

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


Recent events

No 2007 dividend. In light of 2007 results and of a more uncertain market outlook, our Board determined that it is prudent to suspend the payment of a dividend based on 2007 results on our ordinary shares and ADSs. Our Board will present this proposal at our Annual Shareholders’ Meeting on May 30, 2008.

Joint venture with NEC. On February 12, 2008, we and NEC announced the execution of a memorandum of understanding concerning the formation of a joint venture that will focus on the development of Long Term Evolution (LTE) wireless broadband access product offerings. These solutions will support the network evolution of some of the leading carriers around the world. Through this joint development effort, the two companies intend to accelerate the availability of next-generation wireless product offerings. Leveraging the common LTE product strategy and platform of the joint venture, we and NEC will each manage delivery, project execution and dedicated support to our respective customers.

Action by 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.

Development in Microsoft case. In a second phase of the San Diego patent infringement litigation with Microsoft Corporation mentioned in “Highlights of transactions during 2007 – Other Matters,” below, on April 4, 2008, a jury awarded Alcatel-Lucent approximately U.S.$ 368 million in damages on additional patents.




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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 that will occur in 2009. 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. We have appealed this ruling to the Federal Circuit Court of Appeals in Washington D.C.

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 and Lucent became a wholly owned subsidiary. As a result, Alcatel, the parent company, changed its name to Alcatel-Lucent.



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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.

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. The contribution of this company to our 2006 financial results was not significant.

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. This company is consolidated under the equity method and its contribution to our 2006 financial results was not significant.

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.



Highlights of Transactions during 2005

Acquisitions

Acquisition of Native Networks. On March 17, 2005, we completed the acquisition of Native Networks, Inc., a provider of optical Ethernet goods and services, for U.S.$ 55 million in cash.

Dispositions

Sale of shareholding in Nexans. On March 16, 2005, we sold our shareholding in Nexans, representing 15.1% of Nexans’ share capital, through a private placement.

Sale of electrical power systems business. On January 26, 2005, we completed the sale of our electrical power business to Ripplewood, a U.S. private equity firm.

Other Transactions

Amendment of credit facility. On March 15, 2005, we amended our existing syndicated revolving €1.3 billion credit facility by extending the maturity date from June 2007 to June 2009, with a possible extension until 2011, eliminating one of the two financial covenants, reducing the cost of the facility and reducing the overall amount to €1.0 billion.

Merger of space activities. On July 1, 2005, we completed the merger of our space activities with those of Finmeccanica, S.p.A., an Italian aerospace and defense company, through the creation of two sister companies. We owned 67%, and Alenia Spazio, a unit of Finmeccanica, owned 33%, of the first company, Alcatel Alenia Space, that combined our respective industrial space activities. Finmeccanica owned 67%, and we owned 33%, of the second company, Telespazio Holding, which combined our respective satellite operations and service activities.

Exchange of our interest in joint venture with TCL Communication. On July 18, 2005, we exchanged our 45% shareholding in our joint venture with TCL Communication Technology Holdings Limited for shares of TCL Communication, which resulted in TCL Communication owning all of the joint venture company and our owning 141,375,000 shares of TCL Communication.




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4.3

STRUCTURE OF THE PRINCIPAL COMPANIES CONSOLIDATED IN THE GROUP AS OF DECEMBER 31, 2007

 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, 2007, our total production capacity was equal to approximately 361,000 sq. meters and the table below shows the geographic region by business segment 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, 2007

In thousands of m2

Europe

North America

Asia-Pacific

Total

Carrier

195

69

78

342

Enterprise

15

0

0

15

Services

4

0

0

4

TOTAL

214

69

78

361


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

Poland

Bydgoszcz

Full ownership

United States

North Andover

Lease

United States

Columbus

Lease




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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

Lease

China

Shanghai Pudong

Full ownership

Spain

Madrid

Lease

United States

San Francisco Daly City

Lease

United States

Dallas Plano

Full ownership

United States

Whippany

Full ownership

United States

Naperville

Full ownership

United States

Lisle

Full ownership

United States

Murray Hill

Full ownership

France

Villarceaux

Lease

France

Vélizy

Lease

France

Lannion

Full ownership

France

Paris-La Boétie

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

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.

Cooperation Agreement. In connection with the Thales transaction, 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 Thales 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.



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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;

·

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.



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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 Director of the Central Intelligence Agency R. James Woolsey, 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.

The provisions contained in both the NSA and the SSA have not impacted the projected synergies to be realized from the business transaction with Lucent or materially impacted the integration of the businesses of historical Alcatel and Lucent.




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5

DESCRIPTION OF THE GROUP’S ACTIVITIES



5.1

BUSINESS ORGANIZATION

We believe that our strategy, our product portfolio and our expertise align with the long-term market drivers that will underpin the industry for the next several years, as networks migrate to all-IP based architecture. During the first year of operations as a single company, we strengthened our position in key strategic markets and technologies such as IP and mobile broadband, which we believe are required to position the company for long-term sustained growth. Having said that, and in spite of what we believe to be the promise of this industry and the long term benefits of the historical Alcatel and Lucent business combination, we recognize that market conditions remain difficult, with continued pressure on revenues and margins due to intensified competition and some slowdown of spending in North America. These market conditions along with our commitment to transform the company for the long term led us, on October 31, 2007, to announce a plan to improve profitability and reposition the business. Some parts of the plan are specific to our individual business segments, and they are discussed in the appropriate sections below. Other parts of the plan include changes that extend across the organization. They include:

·

the creation of two regional structures – one for the Americas and one that includes Asia Pacific, Europe, Africa and the Middle East – to replace our four regional structures. Two regions streamline our organization, improve our operational efficiency and allow us to eliminate overlapping functions and reduce overall expenses;

·

the combination of all our research and innovation capabilities into Bell Labs. This affords us the opportunity to eliminate duplicate functions while also gaining greater efficiencies and productivity;

·

a change in our sales channel, or go-to-market strategy, in certain countries where our margins are poor. Currently we operate in about 130 countries. In a small number of those countries, about 10 to 20, the level of our business hampers their profitability. To reduce costs and improve our profitability in those countries we will use an alternate “go-to-market” approach and will continue to support our customers. In addition, as we see lower volumes in some markets, we will adjust our resources geographically to reflect the volume fluctuations;

·

the creation of a new seven person Management Committee, reporting to our CEO, to strengthen clear accountability and ownership for the quick execution of our plans. Specifically, the role of this committee is to oversee our strategy, organization, corporate policy matters, long term financial planning and human resources;

·

the restructuring of our business groups within the Carrier segment. We no longer organize our Carrier segment according to three business groups (Wireline, Wireless and Convergence). Currently, our Carrier segment is organized into seven business divisions: IP, Fixed Access, Optics, Multicore, Applications, CDMA Networks and Mobile Access. The following discussion regarding the Carrier segment, based on the three business groups that were in place up to October 31, 2007, is provided for the continuity of analysis for full year 2007 and may not be provided as such in future publications of our Group.


Carrier

 

Enterprise

 

Services

WIRELINE

WIRELESS

CONVERGENCE

  

Access

GSM/WiMAX

Multicore

Enterprise Solutions

Network Integration

Internet Protocol

W-CDMA

Multimedia & Payment

Genesys

Professional Services

Optics

CDMA/EVDO

IMS Applications & Services

Industrial Components

Maintenance

 

Wireless Transmission

  

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.




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5.2

CARRIER SEGMENT

For substantially all of 2007, our carrier business segment was comprised of the wireline, wireless and convergence business groups. The carrier segment supplies a broad portfolio of products used by fixed, wireless and convergent service providers, as well as enterprises and governments, for their business critical communications. A key development currently ongoing within the carrier market – which 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 (voice, data and video) to end users over any kind of broadband access (copper, fiber, wireless). We are streamlining our core carrier business with an increased portfolio focus on the IP transformation of wireless and wireline networks, as evidenced by our investments in next-generation technologies like IP Service Routing, next-generation optical networking, IP Multimedia Subsystem (or IMS) applications, third generation mobile networks and wireline broadband access.

We extensively reviewed our carrier portfolio in 2007 and we believe that it aligns with the current direction of the market. Following this review, we made the decision not to exit any major areas of our carrier portfolio because we believe that its breadth is an asset. However, as part of the plan we announced on October 31, 2007 to improve profitability and reposition the business, we instituted a plan to reduce product costs by refocusing our R&D and by making a focused effort to use common platforms across the carrier portfolio. We are also streamlining operations in the supply chain for carrier products, and within the Carrier segment we created seven business divisions.

In 2007, our carrier segment revenues were €12,819 million (excluding inter-company sales), representing 72% of our total revenues.



Wireline

General

For substantially all of 2007, the wireline business group had three business divisions: access, optics and Internet Protocol (or IP), each of which included operations and products from both historical Alcatel and Lucent. The portfolio of products supplied by the wireline group is deployed anywhere from the core to the access networks, in legacy and next-generation networks, facilitating the delivery of voice, data and video services over broadband. While we believe we are well positioned in wireline, at the end of 2007 we instituted a product cost improvement program to generate additional savings as part of the plan we announced on October 31, 2007 to improve profitability and reposition the business. In 2007, our wireline business group revenues were €6,003 million (excluding inter-company sales), representing 47% of the carrier segment revenues and 34% of our total revenues.

Access

We are the worldwide leader in broadband access, with 44% of digital subscriber line (or DSL) revenues in 2007 according to industry analyst firm Dell’Oro. The access market is evolving with the recent introduction of Gigabit optical fiber-based Passive Optical Networking (or GPON) technology. In 2007, we were awarded GPON contracts by several carriers including Verizon, AT&T and France Telecom. The fixed access market is driven on one hand by the increasing penetration of broadband in fast growing economies such as China and on the other by the introduction by carriers of advanced services that combine triple play services. Our newest family of access products, which is IP-based, provides support for both DSL and GPON and allows carriers to optimize the combination of these technologies, depending on the network configuration and the area of installation. These products are designed to accommodate expanding demand for new applications requiring greater bandwidth and higher availability. For example, our products permit 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 (high definition TV), VoIP (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.

We believe that our large installed DSL base provides us with a competitive advantage as many of our DSL customers build optical fiber deeper into their access networks, which is closer to the end-user, in order to enhance their broadband service offerings with fiber-based services.



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Internet Protocol

Our portfolio of service provider IP switching/routing offerings are led by three product families – multi-service multi-protocol switches, service routers and Ethernet service switches:

·

our 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 Asynchronous Transfer Mode (or ATM) and multi-protocol switching functions;

·

our Internet Protocol/Multiprotocol Label Switching (or IP/MPLS) service routers direct traffic within and between carriers’ networks to enable delivery of Internet access, Internet TV, mobile phone and text messaging and managed Virtual Private Networks (or VPNs) on a single common network infrastructure;

·

our Ethernet service switches enable carriers to deliver triple play offerings (voice, data and video) and business VPN services more cost-effectively than traditional methods. Although pervasive in home and business networks, global carrier networks are using Ethernet to support IP-based services due to recent enhancements to Ethernet scalability, reliability and quality of service.

Each of these products is designed to deliver high margin multimedia services, including the full variety of network-based VPNs and other data services used for business computing and communication applications. Our service routers and Ethernet service switches feature state-of-the-art custom processing hardware and software to provide the reliability, global scalability and complex traffic management required by today’s global service providers. Our service routers are particularly well suited for complex triple play services for 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 residential 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, historical Alcatel has had the largest optical networking market share since 2001 and has continued to hold this position following the combination with Lucent.

Terrestrial

Our terrestrial products are designed for long haul and metropolitan/regional applications. With our products, carriers can manage voice, data and video traffic patterns based on different applications or platforms and can benefit from new competitive service offerings by introducing a wide variety of data-managed services, including different service quality capabilities, variable service rates and traffic congestion management. Most importantly, these products allow carriers to offer these new services without impacting their existing investment program for their current networks. Our metro wave division multiplexing (or WDM) products address carriers’ requirements for cost-effective networks to meet their growing business and multimedia networking needs. Both our metro and long haul WDM products offer the added capacity required to support video services, and they are scaleable, in that they permit our customers to easily expand their networks as their business and data networking needs grow. These products provide cost-effective, managed platforms that support different services and are suitable for applications in diversified network configurations.

Submarine

We are an industry leader in the development, manufacturing, installation and management of undersea telecommunications cable networks. This market is characterized by a few large contracts that often require more than one year to complete. These massive investments are currently concentrated on trans-Pacific links, around Africa, across the Mediterranean and in Southeast Asia as well as around the Indian sub-continent. Our submarine network systems can connect continents (using optical amplification due to the long distances), as well as span distances up to 400 km (using no optical amplification) to connect mainland and an island, or several islands together or many points along a coast.




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Wireless

General

Our wireless business group serves the needs of wireless carriers throughout the world as they transform their existing infrastructures to more flexible, competitive, end-to-end IP-based networks that can support existing voice as well as new data and video traffic. We provide an extensive range of mobile communications products across all the major established technology standards, including GSM/GPRS/EDGE, W-CDMA (Wideband Code Division Multiple Access, also referred to as Universal Mobile Telephone Communications Systems, or UMTS) and CDMA, as well as nascent technologies like WiMAX (Worldwide Interoperability for Microwave Access). Our mobile radio products are designed to minimize total cost of ownership through a continuous re-engineering program and the use of a highly modular framework that facilitates rapid network deployment and expansion, flexible network evolution, and allows for the evolution of second generation networks to third generation (or 3G), without loss of operability. Our GSM/GPRS/EDGE business is based upon products from historical Alcatel, our market-leading CDMA business is based upon products from Lucent, and our W-CDMA business is a combination of assets and customers from both companies and also includes the UMTS radio business that we acquired from Nortel on December 31, 2006. In 2007, our wireless business group revenues were €5,287 million (excluding inter-company sales), representing 41% of our carrier segment revenues and 30% of our total revenues.

GSM/WiMAX

We develop mobile radio products for the second generation (or 2G) GSM (Global System for Mobile communications) standard, including the GPRS/EDGE (General Packet Radio Service/Enhanced Data Rates for GSM Evolution) technology upgrades to that standard. In 2006 and continuing in 2007, the GSM infrastructure market experienced heightened competition, but remained the world’s leading 2G mobile technology in terms of the number of subscribers. Subscriber growth has been particularly strong in emerging countries. In 2007, we introduced a “state-of-the-art” base station controller based on Advanced Telecom Computing Architecture (or ATCA) with support of the Internet Protocol (or IP) into our GSM portfolio, and enhanced our entire line of GSM/EDGE radio systems to meet the needs of operators for increased capacity and flexibility by optimizing the portfolio to support existing and new data-based applications. The enhancements also increase coverage while reducing power consumption and space requirements, for a lower cost of ownership without compromising functionality, scalability and future evolution.

In 2004, we formed an alliance with Intel for the development of end-to-end product offerings using WiMAX standards that provide broadband connectivity over wireless networks. Since 2006, we have offered a full end-to-end WiMAX solution (based on the 802.16e standard). WiMAX can be a lower-cost alternative in emerging countries that generally do not have an extensive landline network already in place. In 2007, we also launched the OneMAX network in the Dominican Republic, which is the first commercial network in 3.5 gigahertz spectrum band in the Central and Latin America region.

W-CDMA

Wideband Code Division Multiple Access, commonly referred to as W-CDMA and also referred to as Universal Mobile Telephone Communications Systems, or UMTS, is the third generation (or 3G) wireless technology derived from the GSM standard deployed worldwide. Our 2G wireless customers worldwide continue to add voice subscribers and minutes of use to their networks, so voice capacity continues to be a very important driver in their network investment. At the same time, their average revenue per user (or ARPU) of voice services is under pressure from increased competition, and this is driving investment in 3G network products that bring new mobile high-speed data capabilities to our customers’ networks. Thus, one of the areas in which our customers are focusing relates to 3G mobile high-speed data network deployments. Such deployments consist of upgrading existing base stations and – in some cases – providing new base stations and other equipment that enable operators to introduce mobile high-speed data services at rates comparable to wireline connections.

W-CDMA represents an important evolutionary step over GSM/GPRS/EDGE networks in terms of voice quality, data transmission speeds and the new services they enable. Our customers that utilize our GSM base stations and wish to migrate to 3G systems can do so relatively easily and inexpensively by incorporating our 3G modules into their systems. Similarly, our customers who wish to upgrade their third generation W-CDMA systems with the more advanced HSDPA (High Speed Downlink Packet Access) and HSUPA (High Speed Uplink Packet Access) technology will be able to do so through relatively simple software upgrades to their existing W-CDMA systems.

Although we believe that the W-CDMA market offers better growth prospects than the mature GSM and CDMA markets, there have been delays in revenue generation versus our initial expectations. Moreover, as our competitors attempt to build scale, the market has experienced an extremely competitive pricing environment, which has led to a reduction in our margin estimates for the business. In the future, we will selectively pursue W-CDMA opportunities, balancing our intent to grow our market share with our focus on profitable growth.

2007 was a year of significant investment in W-CDMA as we worked to merge three portfolios, one from historical Alcatel, one from Lucent, and one from our acquisition of Nortel’s UMTS radio access assets into one. In 2007 we completed the convergence of three platforms into two, and we anticipate that we will have a single, converged platform available by the third quarter of 2008, at least with respect to the base station controller. Another aspect of our investment in W-CDMA is a portfolio that is differentiated by new technologies that will allow operators to offer enhanced in-building coverage and to deploy “flat IP architecture” that simplifies and collapses radio access networks.



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TD-SCDMA

We have an alliance with Datang Mobile to foster the development of the TD-SCDMA (Time Division-Synchronized Code Division Multiple Access) 3G mobile standard in China, where we deployed trial TD-SCDMA networks in 2006. 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.

CDMA2000/EV-DO

CDMA2000 is the world’s leading 3G (third generation) wireless technology with over 400 million subscribers worldwide according to the CDG (CDMA Development Group). It is deployed in spectrum ranging from 450 Mhz to 2100 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 bandwidth with minimal hardware and software upgrades.

Despite increases in both CDMA subscribers and traffic volumes, we believe the market for CDMA infrastructure is mature and starting to decline. We have revised our long-term outlook for this market, taking into account recent changes in market conditons 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 will moderate 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 also expect some new opportunities to arise within the overall CDMA market, such as VoIP and the next version of the CDMA standard, and we will continue to invest to support our customers’ plans to incorporate those capabilities. As a mature technology, CDMA is also proving attractive to emerging markets as a cost-effective way to deliver both high capacity voice and data with an evolution path to next generation capabilities.

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. We market wireless transmission equipment that can be managed by our complementary software platforms in a fixed or mobile environment.

In 2007 we implemented trials of a new generation of microwave packet radio systems, designed to enable the IP transformation in the mobile backhauling networks, with key customers. We anticipate that this new product will be commercially available in the first half of 2008.



Convergence

General

Our convergence business group offers a portfolio of applications and core network hardware and software designed to support the transformation of carriers and service providers to IP-based networks. Our convergence portfolio supports voice, multimedia, entertainment and converged services. Converged services are a combination or “blending” of what were previously standalone services, like a combination of voice, video and Internet data on a conference call. They are designed to be accessible over any kind of access network (wireline, wireless, etc.) and on any kind of communications device. As such, they require an entirely new set of network elements and capabilities. Our convergence group includes products from both historical Alcatel and Lucent, organized around three business divisions: Multimedia and Payment, IMS Applications & Services, and Multicore. In 2007, our convergence business group revenues were €1,529 million, (excluding inter-company sales), representing 12% of carrier segment revenues and 9% of our total revenues.

Multimedia & Payment

This division offers 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 MultiPlay (multi-player services): interactive, multimedia applications that can be delivered over fixed and mobile networks for residential use and personal entertainment;

·

payment: real time rating, charging and billing capabilities for networks and service providers to manage their voice, data and video (triple-play) services;

·

messaging: voice and multimedia messaging services for mobile, fixed and convergent service providers.

We are a world leader in TV, video and music services over telecom networks, with more than 140 fixed and mobile customers around the world, including more than 40 triple-play projects, and are a leader in real-time billing and payment with more than 210 fixed and mobile customers.



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IMS Applications & Services

This division develops applications and convergent services for networks that are based on the IP-based IMS architecture, and also develops subscriber data management products. Applications for the carrier market are one of the areas where we have increased our focus as part of our plan to improve profitability and reposition the business. Although 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 subscriber data management products include software tools that manage a user’s subscription, authentication and location information over a wide range of fixed and mobile network types. Our complete IMS package (application and core network) is in more than 25 deployments or advanced trials, and our subscriber data management applications have been deployed in more than 190 networks.

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 for fixed, mobile and convergent operators. We have deployed our IP/NGN products in more than 260 fixed and mobile networks, and we are involved in more than 25 IMS network transformation projects. However, carrier migration to these IMS-based next-generation networks has been slower than expected and growth in our next-generation core networking business has not been sufficient to offset the secular decline in classic switching. Consequently, we are making additional refinements that will further narrow our core NGN portfolio and allow us to leverage common multimedia capabilities and IP-based infrastructure for both fixed and mobile next-generation networks.



5.3

ENTERPRISE SEGMENT

Our enterprise business segment provides software, hardware and services that interconnect networks, people, processes and knowledge. The portfolio includes:

·

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

·

personalized tools for collaboration, customer service 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.

The enterprise business is a segment where we believe we can stimulate growth. We created a plan to improve profitability and reposition this business as part of the October initiative. Specifically, we are reorganizing and adding resources to our sales force in order to increase our share of the enterprise market.

In 2007 the enterprise segment repositioned itself to better align its resources with market opportunities and enhanced its portfolio through two acquisitions and organic growth. In May, we acquired NetDevices, a developer of services gateway products for enterprise branch networks, based in California. NetDevices has a market recognized, innovative and flexible enterprise networking platform known as a Unified Service Gateway (USG) which is designed to reduce the cost and complexity of managing branch office networks. In December 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.

Throughout 2007 we added to our security product offerings. In April we introduced the OmniAccess 3500 Nonstop Laptop Guardian, the first in a series of enterprise security products developed by Bell Labs for mobile networks. Also in April, we introduced the OmniAccess SafeGuard, an access control device. In December, we introduced the second Bell Labs enterprise security product – the OmniAccess 8550 WebServices Gateway, a network appliance that enforces policies in real-time, provides the ability to create the audit trail necessary to meet corporate governance obligations and supports effective business process automation (including on-line business-to-business web services deployed on a services oriented architecture).

We also enhanced our voice and data infrastructure products by scaling the OmniPCX Enterprise to support 100,000 users, launching MyInstant Communicator, and providing clients on the move with dual-mode Nokia handsets.

We enhanced our customer care capabilities by launching the OmniTouch premium edition for the North American mid-market – the offer combines the advanced technology of the Genesys solution with the simplicity of OmniTouch. In December Genesys acquired Informiam LLC, a broader reporting and analytical offering for the entire customer service chain.



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We market our products to enterprises and government agencies worldwide, with emphasis on education, finance, government, healthcare and hospitality industries. We address our customers through three partnership channels:

·

direct partnerships with large and extra large global customers,

·

indirect with a global network of independent distributors and resellers, and

·

through carriers and alternative service providers.

In 2007, our enterprise segment revenues were €1,562 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 better, more effective communications. Our offerings are centered around 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 – that are not product-attached and that are generally more profitable than many of the traditional product-attached services, like deployment services.

The five service areas on which we are focused are:

·

IP and Network Transformation;

·

Multivendor Maintenance;

·

Applications Integration;

·

Managed Services & Network Operations;

·

Industry and Public Sector.

IP and Network Transformation (including network planning, design, consulting, project management, and optimization services) help our customers identify network areas where they can capitalize on high-margin opportunities, optimize performance and reduce operating expenses, and plan evolution to protect their network investment and increase profits. Enhanced engineering and maintenance services help our customers determine the best configuration for maximizing traffic capacity and for achieving other operational efficiencies.

Multi-vendor maintenance services help our customers improve the performance of their multi-vendor networks and maintain network reliability and availability to ensure quality of service. Remote technical support services provide remote support capabilities to diagnose, resolve and restore the network. On-site technical support services provide technical specialists to deliver on-site maintenance services as our customers expand into new territories, develop new service offers, or face regional technical labor shortages.

Applications Integration are specialized consulting services that help carriers maintain a high-performing network by identifying and correcting network performance issues, balancing traffic loads and integrating new multi-vendor equipment and software into a live system. These professional services help our customers improve network quality by troubleshooting, reporting and resolving problems and providing on-the-job training to their staff. We draw on our Bell Labs members to bring new innovations, methodologies and tools to solve complex customer challenges in the areas of security, IPTV, service delivery, communications applications and IMS. We continue to invest in our IT expertise; in 2007, we purchased TAG, an IT company that gives us access to customers and IT experience.

Repair and exchange services manage inventory and operating expenses with repair and replacement of critical network hardware. Preventive maintenance services identify, analyze and recommend products and services that help service providers keep networks operating at peak performance.

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 preserving and enhancing network reliability. Managed services help 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 providing an opportunity to market and sell other products and services. 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 the resources 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 65 networks and more than 100 million subscribers around the world.



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The Industry and Public sector is a new area of focus for this segment and one where we have significantly increased resources and created a special customer focus as part of the October 2007 plan. We include in this sector transportation, government and energy, which are customers that need large, complex communications networks. We draw on our capabilities across the services business and leverage the capabilities we have across enterprise and carrier networks to provide the mission critical communications required by these customers. We are also providing industry-specific, turnkey services that require technology skills, local presence and vertical business knowledge.

By relying on our global multi-vendor expertise and field-proven processes, our customers can leverage their installed base of assets across multiple technologies and vendors, quickly implement new technologies and applications to expand presence in target markets, and simplify operations through customized support to design, build, and manage communication networks.

In 2007, our services segment revenues were €3,173 million (excluding inter-company sales), representing 18% 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, approved agents 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. Our enterprise communications products are sold through business partners and distributors that are supported by our direct sales force.



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.

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.

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

Consolidation has also allowed some large vendors to enter new markets with acquired technology and capabilities, effectively backed by their size, relationships and resources. In addition, carrier consolidation, which initially started in developed markets, is now extending to emerging markets, resulting in fewer customers overall. Most vendors are also seeking to strengthen their relationships with large service providers because they account for the bulk of carrier spending for new equipment (the 15 largest telecom service providers represented approximately 50% of global carrier spending at June 30, 2007). Competition is also accelerating around IP network technologies as carriers are shifting capital to areas that support the migration to next-generation networks. Furthermore, competitors providing low-priced products and services from Asia are gaining 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



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 our company in the marketplace and lead to significant future revenues for the Group.

Our Research and Development investment priorities focus on both current and future key technologies we view as central to our business strategy in areas such as:

·

broadband wired access (ADSL, VDSL, GPON);

·

broadband wireless access and indoor coverage (multi-standard radio access, CDMA, 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; and

·

mathematics, physical sciences, nanotechnology, computer and software sciences.

The Group’s 2007 plan to improve profitability and reposition the business also had impacts designed to improve the efficiency of our Research and Development efforts, such as:

·

rationalizing the Research and Development investment focused on W-CDMA, in line with the ongoing rationalization of our W-CDMA portfolio;

·

moderating our Research and Development investment in the current generation of CDMA to reflect the decline in that market;

·

increasing the emphasis on Research and Development projects which support the IP transformation that is driving carrier spending for new equipment.

Despite these changes, we continue to devote very significant resources to our Research and Development efforts. In 2007, we spent €2.7 billion, representing 15% of our revenues, on innovation and the support of our various product lines. The €2.7 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

Our innovation teams, which encompass many organizations within the Group, including Bell Labs, provide technical and scientific skills and expertise to anticipate tomorrow’s advanced technologies. For example, Bell Labs researchers and scientists focus on fundamental and applied research, and deliver innovative product ideas, components, technologies, and architectures for our business. Bell Labs has research locations in nine countries: USA, Canada, France, Germany, Belgium, UK, Ireland, India and China. In 2007, Bell Labs’ efforts led to breakthroughs in technology and products such as: a world record in optical transmission (25.6 terabits per second of information transmitted over a single strand of fiber); proof of the “Femto Base Station Router” which will improve indoor coverage  and reduce operating and capital expenditures by simplifying network architectures and easing installation; and the commercialization of the OmniAccess 3500 Non-stop Laptop Guardian which is a laptop security and management system developed to secure, monitor, and locate a mobile computer and to destroy its data if it is lost or stolen. Our innovation teams also include development engineers and technical experts across the world to improve the efficiency, quality, and security of our product portfolio.



Quality, security and reliability

In 2007, our goal was to improve quality, security and reliability of our portfolio; therefore, we invested in improvement programs.

One of our objectives is to improve the quality of our products and services in a manner that has a visible impact on the end-users, thereby creating customer satisfaction and loyalty.

Today telecom services and network infrastructures are focused on security. In response, we improved our offering so that security and reliability become a part of our overall portfolio. Our security framework is already implemented in guidelines/standards in our product lifecycle permitting the tightening of security for our products, systems and services. It will ensure that these systems meet customer and industry regulatory requirements. In the security program framework, we also launched a six-month study called the Availability and Robustness of Electronic Communications Infrastructure (“ARECI”) involving government and industry participants across Europe, 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 led to key recommendations that form the basis of our improvement plans.



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To anticipate future technology reliability needs, we studied the implications of introducing emerging technologies. Our network modeling experts created methods to design networks 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 customer engagements.



R&D efficiency

We made major efforts to improve the cost and efficiency of Research and Development activities in 2007. For example, we continued to reduce spending on mature technologies, discontinued non-competitive and non-core programs, and reduced capital expenditures in platforms, test tools, and certain development efforts without losing sight of our strategic initiatives. We also adopted measures to facilitate the reuse of existing technology and open source software, tools and processes across our business segments to increase efficiency, especially in the area of software usage and production. We have continued to share engineering best practices for the development and maintenance of products and services across their life cycles. Use of these models led to a significant increase in quality and reliability in our product and service developments in a cost-effective way. Compliance testing, both preliminary and final, have been improved to ensure flexibility and time-to-market. As an example of the result of such efficiency improvement programs the overall cost of product certification has been reduced. Another example of efficiency and cost reduction is the OneDoc program: a unique documentation system which will rationalize customer documentation production and distribution throughout our company in 2008.



Standardization, technology partnerships and acquisitions

In 2007, more than 600 of our employees participated in approximately 100 standards organizations and contributed to more than 220 different working groups to provide technical contribution, as well as leadership, in creating and developing standards through key management positions. We have reinforced our presence in organizations such as 3GPP, 3GPP2, ATIS, CCSA, DSL Forum, ETSI, IEEE, IETF, OMA, TIA, and the WiMAX Forum.

To reinforce our technology leadership we have also developed technology partnerships and have made acquisitions. In 2007 we developed strategic relationships with many companies, among them Bridgewater Systems (in Canada) for Subscriber Service Management, Sagem (in France) for Femto cells solutions, Zyxel (in Taiwan) for Wimax CPE products, and General Bandwidth (in the US) for Media Gateway solutions. We have also expanded strategic partner engagements with large companies such as IBM, Accenture, Sun Microsystems, Hewlett Packard, Cap Gemini and Ariscent; and, for an important program, we have developed a partnership for Unlimited Mobile TV (DVB-SH) with DIBcom, Udcast and Thales Alenia Space. In 2007 we performed a pilot test with SFR that validated fundamental assumptions for the deployment of a DVB-SH network co-localized, for its terrestrial part, with an existing commercial 3G+ network.



5.8

INTELLECTUAL PROPERTY

In 2007 we obtained more than 3,000 patents worldwide, resulting in a portfolio of more than 25,000 active patents worldwide across a vast array of technologies. We also actively pursue a strategy of licensing selected technologies through the Alcatel-Lucent program 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 there have been some shortages in components and some other materials in technology commodities common 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 2007 revenues – a weak first quarter, a 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. However, the magnitude of the swings in our first and fourth quarter revenues in 2007 also reflects the significant impact of other non-seasonal factors. They include, for example, business combination-related uncertainty on the part of our customers early in the year and progress integrating the operations of historical Alcatel and Lucent later in the year. We expect the impact of seasonality in our 2008 revenues to be more in line with the traditional pattern described above.



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 2007 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.



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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.

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

In the context of the business combination between historical Alcatel and Lucent, we began a process aimed at harmonizing our Human Resources policies and updating each of these companies’ tools and practices. Four objectives particularly guided our actions in 2007:

·

implementing a harmonized compensation policy for our Group;

·

developing common policies for performance management, identifying high-potential employees and encouraging career development;

·

launching a unified information system;

·

supporting integration programs by helping managers and employees in the distribution of the workforce, the establishment of organizations and the management of synergies.

Once again this year, our Group was more than ever committed to promoting diversity, equal opportunity and the respect of differences.

Compensation policy

To remain competitive with the compensation packages proposed by major companies in the technology sector, Alcatel-Lucent carried out a global compensation review process in 2007. The more global the nature of our company, where more and more managers have people reporting to them from different countries, called for this unified system. All business groups and countries carried out the review at the same time, using the same framework and the same tools while taking into account the local market conditions.

Talent Development and Training

We try to ensure that employees are placed in positions corresponding to their profiled skills and experience. Through “Organization and People Reviews” (“OPRs”), we identify high-potential employees for strategic roles and define personalized career plans for these individuals. OPRs are also important succession and development planning tools for all key jobs in our organization. In 2007, 70 OPRs were conducted, covering thousands of employees.

With 21 centers worldwide accredited through a combined internal and external process, Alcatel-Lucent University helps employees succeed in their current jobs and adapt to future requirements. Last year, the University initiated global qualification and development programs for business-critical functions such as project management, sales, leadership, IP transformation, product line management, and purchasing. In 2007, almost 75 percent of our employees received formal training.



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Mobility

We strongly encourage our employees to broaden their experience through geographic and functional mobility. Thus, in 2007 we implemented a worldwide mobility and online recruitment platform through which several hundreds of positions are offered first to our employees, before being published externally.  In September 2007 we also launched a widespread “Go Australia – New Zealand” mobility campaign aimed at recruiting some 300 people from around the world in order to respond to the very strong growth of our activities in Australasia. At December 31, 2007, we had nearly 800 expatriates within our Group.

Workforce reduction

Within the framework of our global cost reduction plan of €1.7 billion in annual pre-tax cost savings over three years, we announced in February  2007 an initial restructuring plan that will result in a workforce reduction of 12,500 positions by 2009. This is a necessary step to remove duplications of effort generated by the business combination between Alcatel and Lucent and by the acquisition of Nortel’s UMTS activities.

The restructuring is also an adaptive strategy to align the company’s investments with market conditions to create a more competitive enterprise over the long term. Due to intensified competition and some slow down in spending in North America, we have announced, in October 2007, a new plan resulting in additional reductions of 4,000 positions by the end of 2009.

We pay particular attention to the manner in which workforce reductions are carried out, both in terms of the method and the measures, making support available to these employees, in accordance with local rules and regulations. To date, more than half of our original 3-year target for a workforce reduction of 12,500 has been realized.



Headcount

At December 31, 2007, we employed 76,410 people worldwide, compared with 89,370 at December 31, 2006 and 57,699 at December 31, 2005 for historical Alcatel. The tables below show the geographic locations and the business segments in which our employees worked (i) at December 31, 2007 and 2006 based on the business segment that we instituted on December 1, 2006 and (ii) at December 31, 2005, based upon historical Alcatel’s business segments prior to December 1, 2006. Employees related to the businesses transferred to Thales in 2007 are included in the tables below for 2006 and 2005 figures, as these businesses had not yet been transferred as of December 31, 2006.

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.



 

Fixed
Communications

Mobile
Communications

Private
Communications

Other

Total
Group

2005

17,311

17,700

22,138

550

57,699


 

Carrier

Enterprise

Services

Other*

Total
Group

2006

45,444

6,026

28,080

9,819

89,370 (1)

2007

39,428

6,779

29,033

1,170

76,410

(1)

Including 1,631 employees from Nortel in connection with the acquisition of Nortel’s UMTS technologies 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* that are part of the businesses that were to be transferred to Thales as described in Note 3 to our 2007 consolidated financial statements.




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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 2007 consolidated financial statements included elsewhere in this document.



 

France

Other
Western
Europe

Rest of
Europe

Asia
Pacific

USA

Rest of
World

Proportionate Consolidation Impact

Total
Group

2005

16,037

17,114

2,037

9,109

6,181

9,167

(1,946) (1)

57,699

2006

17,071

20,632

3,108

14,589

23,647

12,219

(1,896) (2)

89,370

2007

12,109

14,382

3,168

14,083

21,946

10,722

 -

76,410

(1)

This proportionate consolidation impact is a reduction of 1,362 in our employee headcount in France and of 584 in the rest of Europe.

(2)

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


The average number of temporary workers during 2007 was approximately 2,620 (2,680 including the temporary workers that were part of the businesses during the first quarter of that year which were then transferred to Thales).

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



Employee share ownership and stock option plans

In addition to the stock option plans described below, the companies of the Group have set up profit-sharing agreements and employee savings plans based on the recommendations of senior management. Our non-French 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

We effected capital increases in favor of all of the employees of historical Alcatel and its subsidiaries in 2000 and 2001.

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

Option grant policy

The main policies regarding the grant of stock options were established by our Board of directors at its meetings of March 29 and December 13, 2000, and of December 19, 2001.

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

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 to be granted and the conditions for their exercise based on an analysis of the plans implemented by companies in the same business sector, the practices in each country and the level of responsibility of the recipients.

The option exercise price does not include any discount or reduction from the average opening share price for the 20 trading days preceding the grant date. Under our annual stock option plans one-fourth of the number of options granted to recipients 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.

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) and this notwithstanding any restricted period.

Subject to the provisions above, options granted to our Chairman, our CEO and other senior executives are granted on the same terms as those governing options granted to all other recipients.

Stock options granted by Alcatel-Lucent

2008 plans

On March 25, 2008, the Board of directors decided to grant 47,987,716 stock options to 14,414 Group employees and senior executives, at an exercise price of €3.80, which corresponds to the average opening share price for the 20 trading days preceding this Board meeting.

These options may be exercised at the end of a restricted period, which varies depending on the country in which the employer of the recipients has its registered office (four years for recipients who are employees of a company that has its registered office in France). Such restrictions apply to all our option plans.



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2,050,000 of these options were granted to members of the Management Committee (other than the Chief Executive Officer) representing 4.3% of the total number of options granted from the March 25, 2008 plan by the Board of directors. These options were granted under the same terms and conditions, including their exercise price, that is, €3.80.

On April 4, 2008, the Board of directors granted 800,000 options to our Chief Executive Officer, at an exercise price of €3.80 under the terms and conditions described above.

2007 plans

On March 28, 2007, our Board of directors granted 40,078,421 stock options to 15,779 Group employees and senior executives at an exercise price of €9.10.

On October 30, 2007, the Board renewed the CEO’s power to grant stock options, under strictly defined conditions, in order to honor promises made at the time of recruitment of new talent or to acknowledge exceptional situations.

During the fiscal year 2007, our CEO, exercising the powers that the Board had delegated to her, granted 838,454 stock options to certain Group employees with exercise prices ranging from €6.30 to €10.00.

During the course of 2007, the senior executives and employees of the Group (other than the Chairman and the CEO who received the 10 largest option grants), received in the aggregate 4,340,000 options. These options may be exercised at a weighted average price of €9.10. During this same period, the senior executives and employees of the Group (other than the Chairman and the CEO) who exercised options representing the 10 largest amounts of options, exercised an aggregate of 596,194 options, for a corresponding number of shares. These stock options were exercised at a weighted average price of €6.86.

Summary of the Alcatel-Lucent plans

At December 31, 2007, before the expiration of options mentioned in the next sentence, 148,618,289 stock options were outstanding, each of which entitles the holder to one Alcatel-Lucent share. At December 31, 2007, options granted under plans adopted on March 29, 2000 and December 13, 2000 (representing in the aggregate 8.1 million options) expired.

Taking into account the stock option plans approved by our Board of directors on March 25 and April 4, 2008 as mentioned above, the total number of outstanding options is 189.3 million, which represents 8.2% of our existing share capital (before increase of the shares corresponding to these options; all references to percentages of our share capital in this Section shall be read as being on the same basis).

Of this total number of options outstanding, 52% are vested and may be immediately exercised, except for any applicable restriction period as noted in the table below. More than half of these options (corresponding to 29% of the total number of outstanding stock options)  have an exercise price between €12 and €64  with an exercise period  expiring in 2012 at the latest.

The exercise price has been set for all these plans without any discount.

SUMMARY AT APRIL 4, 2008 (1)

Grant year

Exercise price

Outstanding options

2000

€48 to €64

196,000

2001

€9 to €50

39,999,548

2002

€3.2 to €17.2

553,275

2003

€6.7 to €11.2

15,220,893

2004

€9.8 to €13.2

14,622,426

2005

€8.8 to €11.41

14,641,032

2006

€9.3 to €12

15,756,220

2007

€6.3 to €10

39,550,240

2008

€3.80

48,787,716

TOTAL PLANS

 

189,327,350

(1)

This summary takes into account stock option grants beetween January 1 and April 4, 2008, but does not take into account any options eventually cancelled during the same period as a result of the loss of the right to such options by their beneficiaries due, for example, to a departure from the Group.

Use of authorization to grant options to subscribe for or purchase shares

The Board of directors currently has an authorization given by the Shareholders' Meeting of May 20, 2005 to grant options to subscribe for or purchase shares up to a 6% of our company's share capital.

The total number of options granted pursuant to this authorization at April 4, 2008 is 107.6 million, representing 4.6% of our company's share capital.



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The group of beneficiaries of stock options grew considerably following the business combination with Lucent, changing from 8,001 beneficiaries in 2006 to 15,779 beneficiaries in 2007 and 14,415 in 2008, with the major portion of the options being granted to employees in our U.S. subsidiaries, in accordance with the compensation policies prevailing in the United States.

The Board of Directors has proposed to submit at the Shareholders’ Meeting to be held on May 30, 2008 the renewal of the authorization to the Board of directors to grant options to subscribe for or purchase up to 4% of the share capital of the company over a period of 38 months, which would represent an average of 1.33% of the share capital per year.

The graph below shows the breakdown at April 4, 2008 of stock options granted to employees by historical Alcatel (between January 1, 2000 and November 30, 2006) and by Alcatel-Lucent (after December 1, 2006) to employees of the Group between 2000 and 2008.

*

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.

The main characteristics of our current option plans at December 31, 2007 are described below.



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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 2007

Held by all employees

Number held by senior executives (2)

From

To

03.29.2000

3,887

15,239,250

13,000

7,692,945

7,533,305

105,000

04.01.2005

12.31.2007

48,00

 

12.13.2000

478

1,235,500

0

690,150

545,350

30,000

12.13.2005

12.31.2007

65,00

 

12.13.2000

340

306,700

0

110,700

196,000

 

12.13.2001/12.13.2004

12.12.2008

64,00

 

03.07.2001

30,790

37,668,588

0

12,157,826

25,510,762

222,500

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

259,960

717,450

 

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

14,380,340

13,491,585

252,500

12.19.2002/12.19.2005

12.18.2009

20,80

 

12.19.2001

521

565,800

265,985

204,614

95,201

 

12.19.2002/12.19.2005

12.18.2009

9,30

6,500

02.15.2002

37

123,620

0

74,040

49,580

 

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

18,500

35,800

 

05.13.2003/05.13.2006

05.12.2010

14,40

 

06.03.2002

176

281,000

0

84,500

196,500

 

06.03.2003/06.03.2006

06.02.2010

13,30

 

09.02.2002

226

1,181,050

656,190

318,992

205,868

 

09.02.2003

09.01.2010

5,20

32,400

10.07.2002

16

30,500

8,667

13,274

8,559

 

10.07.2003

10.06.2010

3,20

 

11.14.2002

26

111,750

80,424

11,408

19,918

 

11.14.2003

11.13.2010

4,60

6,814

12.02.2002

16

54,050

20,602

23,648

9,800

 

12.02.2003

12.01.2010

5,40

1,355

03.07.2003

23,650

25,626,865

7,240,272

3,983,935

14,402,658

329,200

03.07.2004/03.07.2007

03.06.2011

6,70

2,335,784

03.07.2003
Plan AL

31,600

827,348

179,636

321,335

326,377

28

07.01.2007

06.30.2008

6,70

175,884

06.18.2003

193

338,200

59,361

50,574

228,265

 

06.18.2004/06.18.2007

06.17.2011

7,60

17,098

07.01.2003

19

53,950

15,868

33,081

5,001

 

07.01.2004

06.30.2011

8,10

4,399

09.01.2003

77

149,400

4,498

21,439

123,463

70,000

09.01.2004/09.01.2007

08.31.2011

9,30

 

10.01.2003

37

101,350

906

49,126

51,318

 

10.01.2004/10.01.2007

09.30.2011

10,90

 

11.14.2003

9

63,600

0

55,000

8,600

 

11.14.2004/11.14.2007

11.13.2011

11,20

 

12.01.2003

64

201,850

8,222

118,417

75,211

 

12.01.2004/12.01.2007

11.30.2011

11,10

 

03.10.2004

14,810

18,094,315

700

3,943,058

14,150,557

475,000

03.10.2005/03.10.2008

03.09.2012

13,20

 

04.01.2004

19

48,100

0

27,300

20,800

 

04.01.2005/04.01.2008

03.31.2012

13,10

 

05.17.2004

26

65,100

0

15,850

49,250

 

05.17.2005/05.17.2008

05.16.2012

12,80

 

07.01.2004

187

313,450

2,399

107,050

204,001

 

07.01.2005/07.01.2008

06.30.2012

11,70

 

09.01.2004

21

38,450

822

8,078

29,550

 

09.01.2005

08.31.2012

9,90

 

10.01.2004

85

221,300

18,778

100,754

101,768

 

10.01.2005/10.01.2008

09.30.2012

9,80

7,148

11.12.2004

20

69,600

0

36,900

32,700

 

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

118,914

371,028

 

01.03.2006

01.02.2013

11,41

 

03.10.2005

9,470

16,756,690

292,370

2,441,767

14,022,553

417,000

03.10.2006/03.10.2009

03.09.2013

10,00

133,932

06.01.2005

96

223,900

7,576

68,523

147,801

 

06.01.2006/06.01.2009

05.31.2013

8,80

6,611

09.01.2005

39

72,150

0

13,000

59,150

 

09.01.2006

08.31.2013

9,80

 

11.14.2005

23

54,700

0

14,200

40,500

 

11.14.2006

11.13.2013

10,20

 

03.08.2006

8,001

17,009,320

0

1,754,182

15,255,138

510,000

03.08.2007/03.08.2010

03.07.2014

11,70

 

05.15.2006

53

122,850

0

18,388

104,462

 

05.15.2007

05.14.2014

12,00

 

08.16.2006

217

337,200

0

42,180

295,020

 

08.16.2007/08.16.2010

08.15.2014

9,30

 

11.08.2006

26

121,100

0

19,500

101,600

 

11.08.2007/11.08.2010

11.07.2014

10,40

 

03.01.2007

42

204,584

0

17,500

187,084

 

03.01.2008/03.01.2011

02.28.2015

10,00

 

03.28.2007

15,779

40,078,421

0

1,349,135

38,729,286

3,330,000

03.28.2008/03.28.2011

03.27.2015

9,10

 

08.16.2007

119

339,570

0

0

339,570

 

08.16.2008/08.16.2011

08.15.2015

9,00

 

11.15.2007

33

294,300

0

0

294,300

210,000

11.15.2008/11.15.2011

11.14.2015

6,30

 

TOTAL

167,376

208,476,806

8,910,834

50,947,683

148,618,289,

5,951,228

    

(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 2007.

(3)

Restricted period: for recipients who are employees of a company that has its registered office in France, five years for options granted prior to April 27, 2000 and four years thereafter; for all other recipients, one year.




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Stock options granted by foreign subsidiaries

Until 2000 Alcatel USA Inc. (which later became Alcatel-Lucent Holding Inc.) had established its own option plans for executives of our U.S. and Canadian companies which options were exercisable for ADSs. Under these plans, at December 31, 2007 8,229,477 options remain outstanding.

In addition, option plans of U.S. and Canadian companies acquired by Alcatel-Lucent are exercisable for Alcatel-Lucent shares or ADSs. There remain outstanding 4,572,274 unexercised options as of December 31, 2007, pursuant to these option plans.

The details at December 31, 2007 of the outstanding options granted by U.S. companies (including those issued by Lucent before the business combination between Alcatel and Lucent) and Canadian companies are set forth in Note 23d of the consolidated financial statements included elsewhere in this document.

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




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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 2008” with respect to (i) our projection that the 2008 global telecommunications equipment and related services market should be flat to slightly up at a constant €/U.S.$ exchange rate and slightly down at current exchange rates, (ii) the implementation of a more selective pricing approach and our product cost reduction program that would enable us to improve our gross margin, (iii) our ability to progress our fixed costs reduction program, (iv) our expectation that we will incur a loss from operating activities before restructuring costs, impairment of assets, gain/(loss) on disposal of consolidated entities and post-retirement benefit plan amendment (excluding the negative, non-cash impacts of Lucent’s purchase price allocation which are expected to be approximately €(125) million in the first quarter of 2008, and (v) under the heading “Contractual obligations and off-balance sheet contingent commitments” with respect to the amount we would be required to pay in the future pursuant to our existing contractual obligations and off-balance sheet contingent commitments, and (vi) the level of capital expenditures in 2008.



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. (“Lucent”) completed a business combination pursuant to which Lucent became a wholly owned subsidiary. 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 financial results include (i) 11 months of operations of only historical Alcatel and (ii) one month of results of the combined company. As a result of the Thales transaction, our 2005 and 2006 financial results pertaining to the businesses transferred to Thales are treated as discontinued operations. Furthermore, 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 as described in the following section.

As a result of purchase accounting treatment of the Lucent business combination required by IFRS, our results for 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, 2007

On January 1, 2007, we adopted (with retroactive effect from January 1, 2005) the option offered by the amendment to IAS 19 – “Employee benefits – Actuarial gains and losses, group plans and disclosures”, to immediately recognize all actuarial gains and losses and any adjustment arising from an asset ceiling, net of deferred tax effects, in the period in which they occur outside the income statement in the Statements Of Recognized Income and Expense (SORIE) disclosed in the consolidated financial statements included elsewhere in this document. Management believes that the change will more fairly present the fair value of assets and liabilities related to retiree benefits in the company’s balance sheet and will eliminate significant volatility in its results of operations resulting from certain plans, the participants of which are all, or almost all, fully eligible to receive benefits.

Previously, we applied the corridor method, under which actuarial gains and losses exceeding 10% of the greater of (i) the benefit obligation or (ii) the fair value of plan assets, were recognized in the company’s income statement over the expected remaining working lives of the employees participating in the plans. The impact of the limitation in the value of plan assets to the lower of: (i) the value resulting from applying IAS 19 – Employee Benefits prior to our adoption of the option provided by the amendment to IAS 19, and (ii) the net total present value of any available refund from the plan or reduction in future contributions to the plan (arising from asset ceilings) was accounted for in the company’s income statement.

The impact of the change due to our adoption of the option offered by IAS 19 – Employee Benefits is presented in Note 4 – Change in accounting policies and presentation, in our consolidated financial statements included elsewhere in this annual report.



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.

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

Accumulated valuation allowances on inventories and work in progress were €514 million at December 31, 2007 (€378 million at December 31, 2006 and €423 million at December 31, 2005).

The impact of inventory and work in progress write-downs on income (loss) before tax, related reduction of goodwill and discontinued operations was a net charge of €186 million in 2007 (a net charge of €77 million in 2006 and a net charge of €18 million in 2005).

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. Accumulated impairment losses on customer receivables were €187 million at December 31, 2007 (€192 million at December 31, 2006 and €228 million at December 31, 2005). The impact of impairment losses on customer receivables (excluding construction contracts) on income (loss) before tax, related reduction of goodwill and discontinued operations, was a net charge of €3 million in 2007 (a net charge of €18 million in 2006 and a net gain of €19 million in 2005).

Capitalized development costs, other intangible assets and goodwill

Capitalized development costs

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



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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 €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 of €197 million were accounted for in capitalized development costs in 2006, and are 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

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) 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. If the expected results of the acquired business in the future do not support such fair values and the goodwill resulting from the business combination, impairment charges against such intangible assets and goodwill may be required in future financial statements. The amount of goodwill and intangible assets related to the Lucent transaction that we reported for the year ended December 31, 2006 were preliminary and subject to change from December 1, 2006 to December 1, 2007. Adjustments recognized during this period are described in Note 3 to our consolidated financial statements.

As discussed in more detail in Notes 7, 12 and 13 to our consolidated financial statements, impairment losses of €2,832 million (€2,657 million on goodwill and €175 million on other intangible assets) have been accounted for in 2007 mainly related to the CDMA and EVDO, IMS and UMTS businesses. An impairment loss of €40 million and write-offs of €233 million were accounted for against intangible assets in 2006 on the UMTS business.

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. Due to the continuing decrease in the market value of our shares during the fourth quarter of 2007 and our revised 2007 revenue outlook, we performed an additional impairment test of goodwill for year-end reporting purposes. Since that test indicated that the carrying amount of three of our business divisions may not be wholly recoverable, we recognized an impairment loss on goodwill as described above.

Net goodwill was €7,328 million at December 31, 2007 (€10,891 million at December 31, 2006 and €3,772 million at December 31, 2005). Other intangible assets, net were €4,230 million at December 31, 2007 (€5,441 million at December 31, 2006 and €819 million at December 31, 2005).

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.).

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 €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 and 2005).

When determining recoverable value of property, plant and equipment, assumptions and estimates are made based primarily on market outlooks, obsolescence and sale or liquidation disposal values. Any change in these assumptions can have a significant effect on the recoverable amount and could lead to a revision of recorded impairment losses.

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 on construction contracts. These provisions are calculated based on historical return rates and warranty costs expensed as well as on estimates. These provisions and subsequent changes to the provisions are recorded in cost of sales either when revenue is recognized (provision for customer warranties) or, for construction contracts, when revenue and expenses are recognized by reference to the stage of completion of the contract activity. Costs and penalties ultimately paid can differ considerably from the amounts initially reserved and could therefore have a significant impact on future results.

Product sales reserves were €704 million at December 31, 2007, of which €147 million related to construction contracts (see Note 18 to our consolidated financial statements) and €557 million related to other contracts (see Note 27 to our consolidated financial statements) (€669 million at December 31, 2006, of which €70 million related to construction contracts and €599 million related to other contracts and €753 million at December 31, 2005, of which €173 million related to construction contracts and €580 million related to other contracts). For further information on the impact on the 2007 income statement of the change in these provisions, see Notes 18 and 27 to our consolidated financial statements.



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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.

At December 31, 2007, recognized deferred tax assets were €1,232 million, of which €675 million related to the United States and €404 million to France (€1,692 million at December 31, 2006 of which €746 million related to the United States and €372 million to France and €1,768 million at December 31, 2005, of which €850 million related to the United States and €369 million to France). Evaluation of the Group’s capacity to utilize tax loss carry forwards relies on significant judgment. We analyze the positive and negative elements of certain economic factors that may affect our business in the foreseeable future and past events to conclude as to the probability of utilization in the future of these tax loss carry forwards, which also consider the factors indicated in Note 1n to our consolidated financial statements. 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 valuation of assets and liabilities acquired (mainly intangible assets such as acquired technologies) and their corresponding tax bases. These deferred tax liabilities will be reversed in our future income statements as and when such differences are amortized. The remaining deferred tax liabilities as of December 31, 2007 are €1,629 million.

As prescribed by IFRSs, we had a twelve-month period to complete the purchase price allocation resulting from the Lucent transaction and to determine the amount of deferred tax assets related to the carry-forward of Lucent’s unused tax losses that should be recognized in the financial statements of the combined company. 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 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, health care cost trend rates and expected participation rates in retiree 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 our results or shareholders’ equity.

The weighted average expected rates of return on pension and post-retirement plan assets used to determine our pension and post-retirement credits were 7.39%, 7.35% and 4.28% for 2007, 2006 and 2005, corresponding respectively, and were determined at the beginning of each period. We plan to use an expected rate of return of 7.05% during 2008. The decrease between 2008 and 2007 is mainly due to the more conservative asset allocation at the end of 2007 (we reduced the exposure of our U.S. 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 external investment advisors or to a change in the asset allocation.

The weighted average discount rates used to determine the pension and post-retirement credit were 5.54%, 3.95% and 4.46% for 2007, 2006 and 2005, respectively. For the purpose of recognition of the net pension and post-retirment credit, the discount rates are determined at the beginning of each quarterly period (for significant plans). For the purpose of determining the plan obligations, these rates are determined at the end of each period. We plan to use a discount rate of 6.04% for 2008. The change in the discount rates in 2007 and 2008, was 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 our net pension and post-retirement credit and profitability; a higher discount rate reduces the plan obligations and our 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 the consolidated financial statements included elsewhere in this document.

Holding all other assumptions constant, a 0.5% increase or decrease in the discount rate would have decreased or increased the 2007 net pension and post-retirement result by approximately €35 million and €53 million, respectively. A 0.5% increase or decrease in the expected return on plan assets would have increased or decreased the 2007 net pension and post-retirement result by approximately €151 million.



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The net effect of pension and post-retirement cost included in our income (loss) before tax, related reduction of goodwill and discontinued operations was a €628 million increase in pre-tax income during 2007 (a €50 million reduction in pre-tax income during 2006 and a €99 million reduction in pre-tax income during 2005). Included in the €628 million increase is €258 million booked as a result of certain changes to management retiree healthcare benefit plans. Effective January 1, 2008, prescription drug coverage offered to former Lucent U.S. management retirees will be changed to a drug plan design similar to the Medicare Part D program. The change reduces the projected benefit obligation by €258 million, net of a €205 million elimination of the previously expected Medicare Part D subsidies.

In the United States, there have been several developments related to retiree health care benefits, including changes in benefits, cost sharing and legislation, such as Medicare Part D of the Medicare Prescription Drug Improvement and Modernization Act of 2003.

The Group’s U.S. companies have taken various actions recently to reduce their share of retiree health care costs during recent periods, including the shifting of certain costs to its 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 60% of the total U.S. retiree health care obligation as of December 31, 2007. 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. 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.

The amount of prepaid pension costs that can be recognized in our 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 €1,775 million, the present value of Medicare Part D subsidies of approximately €299 million (as this amount is currently netted in the retiree health care obligation) and the present value of future service costs of €644 million have been considered in determining the asset ceiling limitation for Lucent’s pension plans as of December 31, 2007.

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, 2008 valuation date, there were approximately €2.3 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, €2.7 billion would be available for “multi-year” transfers which also require the plan to remain 120% funded during the transfer period). Lucent has assumed that the eligible plan assets will increase over time through the 2013 expiration date of the current legislation and as a result Lucent will be able to utilize pension plan assets for Section 420 “collectively bargained” or “multi-year” transfers to fund all its health care obligations for formerly represented retirees. Changes in plan asset values, funding levels or new legislation could result in significant changes in the asset ceiling that will impact our shareholders’ equity as well as the ultimate amount of plan assets eligible for Section 420 transfers.

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 revenue and associated costs 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. In 2007, revenues of €72 million and cost of sales of €298 million were recognized in connection with this construction contract. The negative impact on income (loss) before tax, related reduction of goodwill and discontinued operations of changing from our usual revenue recognition methodology to this basis of accounting was €98 million. 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. Our future results of operations may therefore be impacted.



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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 the 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 the Group’s 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 product 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 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.

For product sales made through distributors, product returns that are estimated according to contractual obligations and past sales history are recognized as a reduction of sales. If actual product returns are 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.

Purchase price allocation of a business combination

In business combinations, 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 service of outside valuation specialists. Due to the underlying assumptions taken in the valuation process, the determination of those fair values requires estimations of the effects of uncertain future events at the acquisition date and, therefore, 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 shall be accounted for only to correct errors.



6.1

OVERVIEW OF 2007

In 2007, carrier spending for new equipment was driven by many of the same broad trends that shaped spending in 2006.  Carriers continued to transform their networks to an all-IP (Internet Protocol) architecture delivering multimedia and triple play services to end-users. Expanding broadband access capabilities remained a key focus area for wire-line carriers, with an increasing emphasis on delivering enhanced capabilities over optical fiber deployed deeper into access networks. Growth in bandwidth-intensive traffic like video drove new spending for added capacity in metro and long haul optical networks. Wireless operators continued to invest in third generation networks.

At the same time, other forces negatively affected carrier demand for new equipment. Carrier consolidation and the sharing of network capacity reduced spending. Growth slowed in the number of new subscribers to copper-based broadband access services in developed markets. Competitive attacks designed to capture footprint and increase market share pressured prices and margins.  One result of these sometimes conflicting forces was slight positive growth in the global market for carrier telecommunications equipment and related applications and services in 2007 at constant Euro/U.S.$ exchange rate – and therefore a slight decline when measured in euros – compared to the mid-single digit growth posted in 2006. There was some growth in 2007 in certain segments of the market, including IP routing, optical networking and next-generation core networks. However, even in those sectors growth in 2007 was slower than it was in 2006, and it was offset by declines in areas like wireless and legacy core networking, both fixed and mobile. Finally, the challenging pricing environment squeezed profitability.



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In addition to overall market forces, our business was also affected by other developments that had significant impacts on our results. Most importantly, 2007 was a year of transition for Alcatel-Lucent as the combined company rationalized the portfolio; reduced costs, expenses and headcount; and reorganized the business as we executed integration plans in a very challenging and competitive environment. Early in the year, immediately after the business combination was completed, some customers reduced spending as a result of their uncertainty about which products the combined company would maintain and which would be phased out or delayed. In October 2007, we implemented a plan to improve profitability and reposition the business.  We also booked significant impairment charges during the year, totaling €2.9 billion in our reported accounts, including €2.52 billion in the last quarter of 2007 related to goodwill in the CDMA (Code Division Multiple Access) and IMS (IP Multimedia Subsystem) business divisions. In the case of CDMA (a wireless infrastructure standard designed in North America, where it remains a key technology) this impairment was due to a revision in the long term outlook for this activity, taking into account the recent changes in market conditions as well as potential future technology evolutions. In the case of IMS (a set of elements designed to enable the delivery of advanced IP-based services such as Fixed/wireless convergence), this impairment was due to a slower-than-expected take-off of this market segment. The business division W-CDMA (the third generation wireless standard that is gaining growing acceptance around the world) reported a €426 million impairment loss due to a delay in revenue generation versus initial expectations, and to a reduction in margin estimates for this business.



6.2

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 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. Approximately 56.4% 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. 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 enter 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.



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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

963

2,943

5,438

1,534

2,038

17,792

2006

1,096

2,879

946

2,116

2,323

1,128

1,794

12,282

% Change 2007 vs. 2006

11%

27%

2%

39%

134%

36%

14%

45%

The revenue increase in individual geographic markets 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. 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%, 16.5%, 8.6% and 11.5%, 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 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, and to the fact that Lucent’s revenues are 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 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. 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 have encountered in fulfilling a large wireless construction 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 €25 million negative impact for compensation expense recognized for share-based payments (stock options); (v) the negative impact of a net charge of €178 million for write-downs of inventory and work in progress; and (vi) 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 €19 million negative impact for compensation expense recognized for share-based payments (stock options), (ii) the negative impact of a net charge of €59 million for write-downs of inventory and work in progress, (iii) the negative impact of a net charge of €8 million on customer receivables, and (iv) 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 include 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 also included the compensation expense recognized for share-based payments (stock options) of €47 million in 2007 as compared to €28 million in 2006, with the increase primarily due to the inclusion of Lucent in the Group. 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. Research and Development costs also included the compensation expense recognized for share-based payments (stock options) of €27 million in 2007 and €16 million in 2006. The primary reason for the increase in Research and Development expenses in 2007 compared with 2006 is 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. Acquisitions that occurred in 2007 or that occurred during 2006 but are included for a full year in 2007 also contributed to the 2007 increase in Research and Development costs.



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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 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 (€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.

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 cover 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 cover 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 is 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 is related to our Network Integration business. The CDMA and EVDO impairment charge related to goodwill is due to a revision in the long-term outlook for this activity, taking into account the recent 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 will be changed to a drug plan similar to the Medicare Part D program. The future change reduces 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 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 €404 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 is largely due to the inclusion of twelve months of Lucent-related interest paid and interest earned for 2007, while our 2006 results include 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 is due primarily to the financial component of pension and post-retirement benefits, mainly related to the Lucent pension credit that is 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.



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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 is 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.  

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.



6.3

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. Since October 31, 2007 and the announcement of the reorganisation of our Carrier segment, we no longer manage this segment according to three business groups (Wireline, Wireless and Convergence). The following comments are therefore provided for the continuity of analysis for full year 2007 and may not be provided as such in future reports.

The table below sets forth the consolidated revenues (before elimination of inter-segment revenues, except for “Other” and “Total Group” results), income (loss) from operating activities before restructuring costs, impairment of intangible assets and gain/(loss) on disposal of consolidated entities and capital expenditures for tangible and intangible assets for each of our business segments for 2007 and 2006.

(In millions of euros)

2007

Carrier

Enterprise

Services

Other

Total Group

TOTAL – REVENUES

12,819

1,562

3,173

238

17,792

Of which:

- Wireline

6,003

    

- Wireless

5,287

    

- Convergence

1,529

    

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

(752)

131

122

(208)

(707)

Capital expenditures

673

93

40

36

842



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2006

Carrier

Enterprise

Services

Other

Total Group

TOTAL – REVENUES

8,989

1,420

1,721

152

12,282

Of which:

- Wireline

4,463

    

- Wireless

3,049

    

- Convergence

1,477

    

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

393

109

195

(10)

687

Capital expenditures

473

84

29

98

684

Carrier Segment

Carrier segment revenues were €12,819 million for 2007 compared with €8,989 million for 2006. The increase is 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 include 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 have been more pronounced in wireline than in wireless. 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 the year 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 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 total, our wireline revenues were €6,003 million in 2007 compared with €4,463 million in 2006. The increase 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. In our convergence 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, revenues in our next-generation core networking business remained too small to offset the declining legacy business. Our convergence revenues were €1,529 million in 2007 compared with €1,477 million in 2006. All of the increase was 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. On the wireless side, 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 have completed the convergence from three platforms to two, and will complete the move to one converged platform, at least for the radio network controller, in 2008. In total, our wireless revenues were €5,287 million in 2007 compared with €3,049 million in 2006. The increase is due to the inclusion of twelve months of Lucent’s results of operations in 2007, while our 2006 results included only one month of Lucent’s results.

The carrier segment had 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 €752 million in 2007 compared with income of €393 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.

Enterprise Segment

Enterprise segment revenues were €1,562 million for 2007, an increase of 10% over revenues of €1,420 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 include 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 income from operating activities before restructuring costs, impairment of assets, gain/(loss) on disposal of consolidated entities and post-retirement benefit plan amendment was €131 million in 2007, compared with €109 million in the same period last year. The increase was largely due to higher revenues in 2007.



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Services Segment

Revenues in the services segment were €3,173 million in 2007, compared with €1,721 million in 2006. Nearly all of the increase is attributable 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. 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.

The services segment had income from operating activities before restructuring costs, impairment of assets, gain/(loss) on disposal of consolidated entities and post-retirement benefit plan amendment of €122 million in 2007 compared with income of €195 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.



6.4

CONSOLIDATED RESULTS OF OPERATIONS
FOR THE YEAR ENDED DECEMBER 31, 2006
COMPARED TO THE YEAR ENDED DECEMBER 31, 2005

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 relating to the sale of our two space joint ventures and our railway signalling business and integration and services activities for mission-critical systems not dedicated to operators or suppliers of telecommunications services.

The following discussion takes into account our results of operations for the year ended December 31, 2006, (i) including Lucent’s results of operations starting on December 1, 2006, (ii) excluding the businesses to be transferred to Thales and (iii) taking into account the effect of the change in accounting policies on employee benefits with retroactive effect from January 1, 2005. As a result of purchase accounting treatment of the Lucent business combination required by IFRS, our results for 2006 included several negative, non-cash adjustments. In addition, the following discussion takes into account our results of operations for the year ended December 31, 2005 which have been re-presented as required by IFRS, to exclude the businesses to be transferred to Thales, which are shown as discontinued operations and to take into account the effect of the change in accounting policies on employee benefits.

Revenues. Consolidated revenues increased by 9.5% to €12,282 million for 2006, primarily driven by the services and enterprise business segments as well as the wireline group, compared to €11,219 million for 2005. Of the 9.5% increase, a significant portion is attributable to Lucent’s results in December 2006. The difference between the 9.5% increase and the percentage change in our revenues based on a constant euro/U.S. dollar exchange rate is marginal since the average exchange rate was €1.26 = U.S.$ 1 in 2006 versus €1.24 = U.S.$ 1 in 2005.

Revenues (by geographical market of customer) in Europe decreased to €4,921 million in 2006 from €4,927 million in 2005; revenues in the United States increased to €2,323 million in 2006 from €1,572 million in 2005; revenues in Asia Pacific increased to €2,116 million in 2006 from €1,779 million in 2005; revenues in Other Americas (Canada, Central and South Americas) increased to €1,113 million in 2006 from €978 million in 2005 and revenues in the rest of the world decreased to €1,863 million in 2006 from €1,963 million in 2005. In 2006, Europe, U.S., Asia Pacific, Other Americas and the rest of the world accounted for 39.6%, 18.9%, 17.2%, 9.1% and 15.2%, respectively, of our total revenues compared with the following percentages of revenues for 2005: Europe 43.9%, U.S. 14.0%, Asia Pacific 15.9%, Other Americas 8.7% and the rest of the world 17.5%.

Gross Profit. Gross profit of €4,068 million in 2006 represented 33.1% of revenues compared to 36.8%, or €4,133 million, in 2005. The decrease in gross profit margin was primarily due to competitive pricing pressures in our carrier markets. Gross profit also included the non-recurring negative, non-cash impact of €167 million upon the sale of a portion of Lucent’s inventory during December 2006. As a result of purchase accounting for the Lucent business combination, Lucent’s inventory was revalued to its net realizable value and such “step-up” in valuation was reversed once the inventory was sold. Gross profit for 2006 was also adversely affected by (i) a net impairment charge on customer receivables of €18 million in 2006 as compared with a net gain of €19 million in 2005, as the amount of new reserves in 2006 exceeded the amount generated from the reversal of historical reserves and (ii) a net charge of €59 million for write-downs of inventory and work in progress compared with a charge of €18 million in 2005, due to fewer reversals of reserves during 2006 compared with 2005.



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Administrative and Selling Expenses. Administrative and selling expenses were €1,911 million for 2006 compared to €1,816 million in 2005. As a percentage of revenues, administrative and selling expenses were 15.6% of revenues in 2006 compared to 16.2% of revenues in 2005, decreasing despite the increase in revenues primarily due to the decrease in certain costs resulting from our restructuring efforts. Administrative and selling expenses in 2006 included a negative, non-cash impact of purchase accounting entries resulting from the Lucent business combination of €30 million, primarily related to the amortization for one month of purchased intangible assets of Lucent, such as customer relationships.

Research and Development Costs. Research and Development costs were €1,470 million in 2006 compared to €1,301 million in 2005. As a percentage of revenues, Research and Development costs amounted to 11.9% in 2006 as compared to 11.6% in 2005. Research and Development costs in 2006 included a negative, non-cash impact of purchase accounting entries resulting from the Lucent business combination of €30 million, primarily related to the amortization for one month of purchased intangible assets of Lucent, such as acquired technologies and in process Research and Development.

Income (loss) from operating activities before restructuring costs, impairment of intangible assets and gain/(loss) on disposal of consolidated entities. We recorded income from operating activities before restructuring costs, impairment of intangible assets and gain/(loss) on disposal of consolidated entities of €687 million for 2006 compared to €1,016 million for 2005. Income from operating activities before restructuring costs, impairment of intangible assets and gain/(loss) on disposal of consolidated entities as a percentage of revenues was 5.6% for 2006 compared to 9.1% in 2005. This decrease resulted from the competitive pricing environment that impacted our gross profit despite decreases in our fixed cost structure, and from the negative, non-cash impact of purchase accounting entries resulting from the Lucent business combination of €227 million, which more than offset Lucent’s one-month contribution to revenues and gross margin.

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 €237 million. Additional provisions created during 2006 were €478 million while provision reversals during 2006 were €226 million, of which €181 million related to product sales reserves. Of the €181 million, €94 million related to reversals of warranty provisions due to the revision of our original estimate 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 €33 million of the €181 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 were mainly related to new estimations of losses at completion. Due to the re-presentation of our 2005 financial results as required by IFRS to present the businesses to be transferred to Thales as discontinued operations, we are unable to determine the amount of changes in provisions for 2005 for the businesses re-presented for such years.

Restructuring Costs. We recorded €707 million for restructuring costs in 2006 compared to €79 million in 2005. Restructuring costs in 2006 are primarily based on an impairment loss recorded as a result of streamlining and phasing out technologies of historical Alcatel in light of the UMTS radio access business acquired from Nortel in December 2006 and the Lucent business combination. The corresponding write-off and the estimated associated future costs for which we have already committed at December 31, 2006 represented €494 million, which has been accounted for in our 2006 restructuring costs. In addition, pursuant to the business combination with Lucent, some of Lucent’s product lines and businesses have been discontinued and the corresponding restructuring costs, of €120 million at December 31, 2006 have been recorded in the income statement.

Impairment of Intangible Assets. In 2006, we had €141 million of impairment charges against intangible assets, primarily linked to our carrier segment. There was no impairment charge in 2005.

Gain (Loss) on Disposal of Consolidated Entities. In 2005, we recorded a gain on the disposal of consolidated entities of €129 million related to the merger of our satellite activities with those of Finmeccanica. An additional gain of €15 million was recorded in 2006 due to a positive adjustment to that sales price.

Income (Loss) from Operating Activities. Income (loss) from operating activities was a loss of €146 million in 2006 compared to income of €1,066 million in 2005. This decrease was due primarily to major restructuring costs in 2006, impairment charges on intangible assets booked in 2006 (as compared to no charge in 2005) and the reduced gain from the disposal of consolidated entities in 2006.

Finance Costs. Finance costs were €98 million in 2006 compared to €93 million in 2005 and included financial interest paid on gross financial debt of €241 million which was partly offset by financial interest received on cash and cash equivalents of €143 million. This evolution is consistent with the average net (debt) cash position of the Group during 2005 and 2006.

Other Financial Income (Loss). Other financial loss was €34 million in 2006 compared to income of €42 million in 2005. In 2006, Alcatel-Lucent’s pension assets and liabilities created a net financial income of €31 million, although this amount was offset by an €18 million charge related to the adjustment of the conversion ratio of Lucent’s Series A and Series B convertible debentures following a consent solicitation completed in the fourth quarter of 2006, a €15 million interest charge due to the late payment of an amount relating to a tax dispute and €32 million of other net charges.  In 2005, net financial loss from historical Alcatel’s pension assets and liabilities was €45 million, offset primarily by capital gains resulting from the disposal of shares that we owned in Nexans (€69 million) and Mobilrom (€45 million) in 2005.

Share in Net Income (Losses) of Equity Affiliates. Share in net income (loss) of equity affiliates was income of €22 million compared to a loss of €14 million in 2005. The change was primarily due to a loss in 2005 in connection with our share in TAMP (the joint venture for mobile handsets we had created with TCL Communication Technology Holding Limited in August 2004) for €32 million. TAMP was no longer an equity affiliate in 2006 due to the swap of our 45% interest in the joint venture we owned for 4.8% in TCL Communication Holding Limited during 2005. The 2006 share in net income of equity affiliates is mainly related to our stake in Thales.



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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 €256 million in 2006 compared to income of €1,001 million in 2005.

Income Tax (Expense) Benefit. Income tax (expense) benefit was a net benefit of €42 million in 2006 compared to a net expense of €146 million in 2005. The net income tax benefit for 2006 resulted from a current income tax expense of €71 million (compared with a current income tax expense of €48 million in 2005) more than offset by a deferred income tax benefit of €113 million mainly due to the amortization for one month of Lucent’s intangible assets resulting from the purchase price accounting entries made in connection with the Lucent business combination that are not deductible for tax purposes (compared with a deferred income tax charge of €98 million in 2005).

Income (Loss) from Continuing Operations. Loss from continuing operations was €219 million compared to income of €855 million in 2005.

Income (Loss) from Discontinued Operations. Income from discontinued operations was €158 million in 2006 corresponding mainly to the businesses that will be transferred to Thales in 2007 (as discussed above and in Note 3 of our consolidated financial statements) compared to income generated primarily by those businesses of €108 million in 2005.

Minority Interests. Minority interests were €45 million in 2006 compared to €41 million in 2005, due primarily to higher results from Alcatel Shanghai Bell.

Net Income (Loss) Attributable to the Equity Holders of the Parent. As a result of the foregoing, we recorded a net loss (Group share) of €106 million in 2006 compared to a net income of €922 million in 2005.



6.5

RESULTS OF OPERATIONS BY BUSINESS
SEGMENT FOR THE YEAR ENDED DECEMBER 
31, 2006
COMPARED TO THE YEAR ENDED DECEMBER 31, 2005

Introduction. The following discussion takes into account our results of operations under IFRS for the year ended December 31, 2006, (i) including Lucent’s results of operation starting on December 1, 2006, (ii) excluding the businesses to be transferred to Thales, (iii) treating the business segments established after the business combination with Lucent as if they were effective on January 1, 2006 and (iv) taking into account the effect of the change in accounting policies on employee benefits with retroactive effect from January 1, 2005. In addition, the following discussion takes into account our results of operations for the year ended December 31, 2005 which have been re-presented, (i) treating the business segments established after the business combination with Lucent as if they were effective on January 1, 2005, (ii) excluding the businesses to be transferred to Thales, which are presented as discontinued activities and (iii) taking into account the effect of the change in accounting policies on employee benefits with retroactive effect from January 1, 2005.

The table below sets forth the consolidated revenues (before elimination of inter-segment revenues, except for “Other” and “Total Group” results), income (loss) from operating activities before restructuring costs, impairment of intangible assets and gain/(loss) on disposal of consolidated entities and capital expenditures for tangible and intangible assets for each of our business segments for 2006 and 2005.


(In millions of euros)

2006

Carrier

Enterprise

Service

Other

Total Group

TOTAL - REVENUES

8,989

1,420

1,721

152

12,282

Of which :

- Wireline

4,463

-

-

-

 

- Wireless

3,049

-

-

-

 

- Convergence

1,477

-

-

-

 

Income (loss) from operating activities before restructuring costs, impairment of intangible assets and gain/(loss) on disposal of consolidated entities

393

109

195

(10)

687

Capital expenditures for tangible and intangible assets

473

84

29

98

684




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(In millions of euros)

2005

Carrier

Enterprise

Service

Other

Total Group

TOTAL - REVENUES

8,463

1,248

1,378

130

11,219

Of which :

- Wireline

3,876

-

-

-

 

- Wireless

2,806

-

-

-

 

- Convergence

1,781

-

-

-

 

Income (loss) from operating activities before restructuring costs, impairment of intangible assets and gain/(loss) on disposal of consolidated entities

778

111

212

(85)

1,016

Capital expenditures for tangible and intangible assets

407

80

45

61

593


Carrier segment

Revenues of the carrier segment were €8,989 million in 2006, an increase of 6.2% over revenues of €8,463 million in 2005. Most of the increase was attributable to Lucent’s activity in December 2006. Within the carrier segment, demand for the wireline group’s products was particularly strong, driven by the continued migration to all-IP networks in carriers’ core as well as their access networks, and continued spending to enhance broadband access capabilities. There was also an acceleration in carrier spending to deploy video and voice-over IP (or VoIP) services as part of their new offer of triple-play services, enabled by their upgraded access networks. The increased volume of high-bandwidth traffic – like video – also added to carrier spending for additional capacity in both their metro area and long-haul optical networks. Revenues of our wireline business group were €4,463 million for 2006, compared to €3,876 million for 2005, an increase of 15.1%. Lucent’s activity in December 2006 did not contribute materially to such increase.

Our wireless business group was impacted by a number of developments. Carriers continued to introduce and enhance their high-speed data capabilities, continuing to add capacity to their networks as subscribers and traffic volumes increased. However, we experienced certain adverse developments in 2006, including (i) the diminishing number of 2G greenfield deployment projects in emerging countries, (ii) our selective commercial policy to deliberately abstain from large contracts where risks are high in the medium term and (iii) customers’ hesitation to make investments in 3G projects with us pending completion of the Nortel UMTS radio access transaction. Revenues of our wireless business group were €3,049 million for 2006, compared to €2,806 million for 2005, an increase of 8.7% that was primarily attribuable to Lucent’s activity in December 2006

Our convergence business group revenues were primarily impacted by the decline in our fixed and mobile line voice circuit-based switching businesses as our customers transition to next generation networks and therefore reduce their capital expenditures for legacy, narrow band switching. At the same time, there has been increasing interest in next-generation network architecture – like IMS – and the new service capabilities of that architecture. However, the evolution of carrier networks to that architecture is a long-term cycle, and spending for next-generation IMS products and capabilities is not yet sufficient to offset the decline in spending for core legacy equipment. Revenues of our convergence business group were €1,477 million for 2006, compared to €1,781 million for 2005, a decrease of 17.1%, which was partially offset by the inclusion of Lucent’s results in December 2006.

Income from operating activities before restructuring costs, impairment of intangible assets and gain/(loss) on disposal of consolidated entities was €393 million for 2006 compared with €778 million in 2005, a decrease of 49.5%. The decrease resulted from a competitive pricing environment; from our significant investments in next generation technologies such as NGN, IMS, and WiMAX, aimed at securing leading positions in future network builds; and from the negative impact of purchase accounting entries resulting from the Lucent business combination.

Enterprise segment

Enterprise segment revenues were €1,420 million in 2006, an increase of 13.8% over revenues of €1,248 million in 2005. The inclusion of Lucent’s activity in December 2006 had no significant impact on this increase. The segment posted steady gains throughout the year, driven by the ongoing migration to IP telephony, strong demand in IP networking and the segment’s strong position in contact center product offerings.

Income from operating activities before restructuring costs, impairment of intangible assets and gain/(loss) on disposal of consolidated entities was €109 million for 2006 compared to €111 million in 2005, a decrease of 1.8%. This decrease was primarily due to the competitive pricing pressure in our business communication activity, while the profitability of our contact center business remained fairly stable.



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Services segment

Services segment revenues were €1,721 million in 2006, an increase of 24.9% over revenues of €1,378 million in 2005; more than half of this increase was attribuable to Lucent’s results in December 2006. The transformation to an all-IP infrastructure is driving an increasing need for network integration services to address the complex end-to-end services our customers are deploying. Our services business is also seeing increased opportunities associated with the evolution to converged or blended services, network optimization and the outsourcing of network operations. Income from operating activities before restructuring costs, impairment of intangible assets and gain/(loss) on disposal of consolidated entities was €195 million for 2006 compared with €212 million in 2005, a decrease of 8.0%. The decrease reflected a competitive pricing environment and our investment in a new IP network integration and test facility, which is a part of our strategy to support operators worldwide in their IP transformation projects.



6.6

LIQUIDITY AND CAPITAL RESOURCES



Liquidity

Cash flow for the years ended December 31, 2007 and 2006

Cash flow overview

Cash and cash equivalents decreased by €493 million in 2007 to €4,377 million at December 31, 2007. This decrease was mainly due to the cash used by financing activities of €1,106 million (mainly due to repayment of short-term and long-term debt and dividend paid), which was partially offset by cash provided by investing activities of €539 million, due primarily to the cash proceeds from the sale of marketable securities and previously consolidated entities, less capital expenditures.

Net cash provided (used) by operating activities. Net cash provided by operating activities before changes in working capital, interest and taxes was €413 million compared to €929 million for 2006. This decrease was primarily due to the effect of non-cash items (mainly impairment losses which amounted to €(2,944) million) that contributed to our net loss (group share) of €3,518 million in 2007, as compared with net loss of €106 million in 2006, which included an impairment of assets of €(141) million. In order to calculate net cash provided by operating activities before changes in working capital, interest and taxes, the €3,518 million net loss for 2007 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 €2,265 million in 2007, mainly related to the impairment recorded in connection with the CDMA-EVDO and the UMTS businesses, as compared with €19 million in 2006. The positive impact of adjustments related to depreciation and amortization of tangible and intangible assets, finance costs and share-based payments increased from €792 million in 2006 to €1,731 million in 2007 due mainly to the impact of the consolidation of Lucent for the entire year 2007, compared to one month only in 2006. Income taxes and related reduction of goodwill represented also a positive adjustment of the net result for an amount of €316 million in 2007 (corresponding mainly to deferred taxes and, to a lesser extent, to current income taxes), to be compared to a negative adjustment of €37 million in 2006. On the other hand, the negative adjustment of the net income to exclude income from discontinued activities represented €610 million in 2007 (mainly due to the capital gain on the disposal of the two joint ventures in the space sector to Thales) compared to €158 million in 2006, corresponding mainly to the net result of the discontinued activities.

Net cash used by operating activities was €24 million in 2007 compared to net cash provided by operating activities of €351 million in 2006. These amounts take into account the net cash used by the increase in operating working capital, vendor financing and other current assets and liabilities, which amounted to €212 million in 2007 and €409 million in 2006, which represents €197 million of less cash used in 2007 compared to 2006. The change between the two periods related to the decrease in cash used by other assets and liabilities (€302 million of less cash used in 2007 compared to 2006), and was partially offset by the increase in cash used related to working capital due to a bigger increase of working capital in 2007 than in 2006, as result of the inclusion of twelve months of the activity of Lucent in 2007 compared to one month in 2006 (€105 million of more cash used in 2007 compared to 2006).



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Net cash provided (used) by investing activities. Net cash provided by investing activities was €539 million in 2007 compared to €761 million in 2006. Excluding the impact of the cash and cash equivalents held by Lucent at acquisition date, equal to €1,391 million, net cash used by investing activities would have been €630 million in 2006. This increase in 2007 in net cash provided (excluding the impact of the Lucent transaction) was mainly due to the disposal of marketable securities that amounted to €1,050 million in 2007, compared to €144 million in 2006, and to the cash used for the acquisition of Nortel’s UMTS business in 2006 for €240 million. The cash proceeds from disposal of fixed assets (tangible and intangible assets and previously consolidated entities) was relatively stable in 2007 compared to 2006. On the other hand capital expenditures increased from €684 million in 2006 to €842 million in 2007 mainly due to the inclusion of twelve months of Lucent activity in 2007 compared to one month in 2006.

Net Cash Provided (Used) by Financing Activities. Net cash used by financing activities amounted to €1,106 million in 2007 compared to net cash used of €699 million in 2006. The primary changes were the increase in the amount of repayment of short-term and long term debt (€760 million in 2007 compared with €505 million in 2006) and the dividend payment of €366 million we made on our ordinary shares and ADSs in 2007 compared with a dividend of €219 million in 2006.

Disposed of or discontinued operations. Disposed of or discontinued operations represented net cash provided of €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 and the cash used by operating activities and financing activities of the discontinued activities during the period) compared with net cash used of €11 million used in 2006.



Capital resources

Resources and cash flow outlook. We derive our capital resources from a variety of sources, including the generation of positive cash flow from on-going operations (although this was not the case this year), 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 and on which we have not drawn (see “Syndicated facility” below). Our ability to draw upon these resources is dependent upon a variety of factors, including our customers’ ability to make payments on outstanding accounts receivable, the perception of our credit quality by lenders and investors, our ability to meet the financial covenant for our revolving facility and debt and equity market conditions generally.

Our short-term cash requirements are primarily related to funding our operations, including our restructuring program, capital expenditures and short-term debt repayments. We believe that our cash, cash equivalents and marketable securities, including short-term investments, aggregating €5,271 million as of December 31, 2007, are sufficient to fund our cash requirements for the next 12 months. Approximately €415 million of our cash and cash equivalents 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. We do not expect that such restrictions will have an impact on our ability to meet our cash obligations.

During 2008 we expect to make cash outlays for our restructuring programs of approximately €800 million and to make capital expenditures of approximately €800 million, including development expenditures that are capitalized. We will repay approximately €137 million in aggregate principal amount of our 5.50% bonds that mature on November 2008. During 2008, depending upon market and other conditions, we may also continue our bond repurchase program in order to redeem certain of our outstanding bonds.

We can provide no assurance that the currently estimated cash resources will be sufficient to cover our actual cash requirements. 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.

Credit ratings. As of April 3, 2008, our credit ratings were as follows:

Rating Agency

Long-term debt

Short-term debt

Last update
of the rating

Outlook

Last update
of the outlook

Moody’s

Ba3

Not Prime

November 7, 2007

Negative

April 3, 2008

Standard & Poor’s

BB-

B

December 5, 2006

Stable

September 13, 2007

As of April 3, 2008, Lucent’s credit ratings were as follows:

Rating Agency

Long-term debt

Short-term debt

Last update
of the rating

Outlook

Last update of the outlook

Moody’s

Corporate Family Rating withdrawn

n.a.

December 11, 2006

n.a.

n.a.

Standard & Poor’s

BB-

B-1

December 5, 2006

Stable

September 13, 2007




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See below for ratings information on Lucent’s subordinated debt and trust securities.

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 Technologies Inc. The outlook was changed from stable to negative.

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.

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

The rating grid of Moody’s ranges from Aaa, which is considered to carry the smallest degree of investment risk, to C, which is the lowest rated class. Our Ba3 rating is in the Ba category, which also includes Ba1 and Ba2 ratings. Moody’s gives the following definition of its Ba category, “debt which is rated Ba is judged to have speculative elements and is subject to substantial credit risk.”

Standard & Poor’s: 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, our 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+ ratings of Lucent’s remaining senior unsecured debt was 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 are rated B-.

On December 5, 2006, Lucent’s long-term corporate credit rating had been 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 BB- rating is in the BB category, which also includes BB+ and BB ratings. Standard & Poor’s gives the following definition to the BB category: “[a]n obligation rated “BB” is less vulnerable to non-payment than other speculative issues. However, it faces major ongoing uncertainties or exposure to adverse business, financial or economic conditions, which could lead to the obligor’s inadequate capacity to meet its financial commitment on the obligation.”

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 access to the capital markets.

Our short-term debt rating allows us limited access to commercial paper market.

At December 31, 2007, our total financial debt, gross amounted to €5,048 million compared to €6,209 million at December 31, 2006.

Short-term debt. At December 31, 2007, we had €483 million of short-term financial debt outstanding, which included €137 million of 5.50% notes due November 2008 issued by Lucent and €139 million of accrued interest payable, with the remainder representing other bank loans and lines of credit and other financial debt and commercial papers.

Long-term debt. At December 31, 2007 we had €4,565 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.

Syndicated facility. On April 5, 2007, we signed 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, which was to mature 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 is not dependent upon Alcatel-Lucent’s credit ratings. Our ability to draw on this facility is conditioned upon our compliance with a financial covenant linked to our capacity to generate sufficient cash to repay our net debt. Since the €1.4 billion facility was established, we have complied every quarter with the financial covenant that is included in the facility.

The new facility was undrawn at the date of approval by our Board of directors of the financial statements for the year 2007.

Lucent letter of credit agreements. Lucent had two primary letter of credit agreements, a letter of credit issuance and reimbursement agreement and an external sharing debt agreement. The aggregate outstanding obligations under these agreements was €119 million as of December 31, 2006. The agreements terminated effective March 28, 2007. Outstanding letters of credit previously governed by these agreements remain outstanding under bilateral arrangements with the issuing banks.





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6.7

CONTRACTUAL OBLIGATIONS AND OFF-BALANCE SHEET CONTINGENT COMMITMENTS

Contractual obligations. We have certain contractual obligations that extend beyond 2008. 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, 2007 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.


 

Payment Deadline

Contractual Payment Obligations

Before December
31, 2008

2009-2010

2011-2012

2013 and after

Total

In millions of euros

     

Financial debt (excluding finance leases)

483

1,134

959

2,472

5,048

Finance lease obligations

Equity component of convertible bonds

205

81

385

671

Subtotal – included in our balance sheet

483

1,339

1,040

2,857

5,719

Finance costs on financial debt (1)

231

481

353

1,500

2,565

Operating leases

242

361

331

374

1,308

Commitments to purchase fixed assets

63

63

Other unconditional purchase obligations (2)

398

110

2

510

Subtotal – not included in our balance sheet

934

952

686

1,874

4,446

TOTAL CONTRACTUAL OBLIGATIONS (3)

1,417

2,291

1,726

4,731

10,165

(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 herein. If all outstanding debentures at December 31, 2007 were not redeemed at their respective put dates, we would incur an additional finance cost of approximately €397 million until redemption at their respective contractual maturities (of which €29 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, 2007, our off-balance sheet commitments and contingencies amounted to €2,573 million, consisting primarily of €1,972 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 €2,573 million is approximately €605 million in customer financing provided by us.

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:




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In millions of euros

December 31, 2007

December 31, 2006

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

1,172

1,454

Discounted notes receivables (2)

3

8

Other contingent commitments (3)

797

782

Commitments of discontinued activities (4)

54

794

Subtotal – Contingent commitments (5)

2,026

3,038

Secured borrowings (6)

25

60

Guarantee in cash pooling (7)

522

579

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

2,573

3,677

(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, €220 million as of December 31, 2007 and €191 million as of December 31, 2006 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 €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. Included in the €782 million are: €100 million of guarantees provided to tax authorities in connection with tax assessments contested by us, €3 million of commitments of our banking subsidiary, Electro Banque, to third parties providing financing to non-consolidated subsidiaries, €90 million of commitments related to leasing or sale and leaseback transactions,, €163 million primarily related to secondary lease obligations resulting from leases that were assigned to businesses Lucent spun-off or disposed of and €426 million of various guarantees given by certain subsidiaries in the Group.

(4)

Commitments of discontinued activities correspond to guarantees on third party contracts of €54 million as of December 31, 2007 (€780 million as of December 31, 2006). There were no other contingent commitments as of December 31, 2007; other contingent commitments amounted to €14 million as of December 31, 2006 held by entities disposed of or contributed to Thales (see Note 3 of our consolidated financial statements included elsewhere herein). 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 described earlier in this document (see “Highlights of transactions during 2007” in Section 4.2 of this document), are now counter-guaranteed by 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 2007 consolidated financial statements included elsewhere herein. 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, 2007 (€2 million as of December 31, 2006).

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.

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, 2007, net of reserves, there was a drawn outstanding exposure of approximately €345 million under such customer financing arrangements, representing approximately €343 million of deferred payments and loans, and €2 million of guarantees. In addition, as of December 31, 2007, we had further commitments to provide customer financing for approximately €217 million. It is possible that these further commitments will expire without our having to actually provide the committed financing.



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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.

Drawn 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 facing the customer, changes in the competitive landscape and the customer’s management experience and depth. When potential problems are evident, certain mitigating actions are taken, including cancellation of commitments. Although these actions can limit the extent of our losses, we remain exposed on account of drawn and guaranteed amounts.

Sale of carryback receivable. In May 2002, historic Alcatel sold to a credit institution a carry-back receivable with a face value of €200 million resulting from Alcatel’s decision to carry back 2001 tax losses. Until its maturity in May 2007, this receivable was maintained in the consolidated balance sheet with a financial debt as counterpart due to the ability of the Group to recover it before its maturity date.

Alcatel was required to indemnify the purchaser in case of any error or inaccuracy concerning the amount or nature of the receivable sold. The sale will be retroactively cancelled in the event of a modification to the law or regulations that substantially changes the rights attached to the receivable sold.

Securitization of Accounts Receivable. In December 2003, historic Alcatel entered into a securitization program for the sale of customer receivables without recourse. Eligible receivables are sold to a special purpose vehicle, which benefits from a subordinated financing from the Group representing an over-collateralization determined on the basis of the portfolio of receivables sold. This special purpose vehicle is fully consolidated in accordance with SIC 12 under IFRS. This program was temporarily frozen in December 2006, and the balance of receivables sold at December 31, 2007 and December 31, 2006 was therefore zero. Receivables sold in previous year (€61 million at December 31, 2005) were maintained in the consolidated balance sheet. The December 2006 freeze therefore had no impact on the Group’s balance sheet.

At December 31, 2007, the maximum amount of receivables that could be sold amounted to €150 million (the same as at December 31, 2006 and 2005), representing a credit line available to the Group. This amount can be increased to €250 million. The purpose of this securitization program is to optimize the management and recovery of receivables in addition to providing extra financing.

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 herein. 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 has outsourced most of its manufacturing operations to electronics manufacturing services (EMS) providers Celestica and Solectron (acquired by Flextronics in October 2007). Under a 2005 supply agreement between Celestica and Lucent, Celestica is Lucent’s exclusive EMS provider for Lucent-designed wireless products. Celestica’s exclusive rights to manufacture these wireless products ends June 30, 2008. Under a 2005 supply agreement between Solectron and Lucent, Solectron is Lucent’s exclusive EMS provider for Lucent-designed wireline products. Solectron’s exclusive rights to manufacture these wireline products ends  July 18, 2008. Lucent is generally not committed to unconditional purchase obligations in these contract-manufacturing relationships. However, there is exposure to short-term purchase commitments when they occur within the contract manufacturers’ lead-time for specific products or raw materials. These commitments were U.S.$ 211 million as of December 31, 2007 (U.S.$ 309 million as of December 31, 2006). Sudden and significant changes in forecasted demand requirements within the lead-time of those products or raw materials could adversely affect our results of operations and cash flows.

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 certain 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.$ 131 million of lease obligations as of December 31, 2007 (U.S.$ 162 million of lease obligations as of December 31, 2006), 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 19.5 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.



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Lucent’s Guarantees of Certain of our Debt. On March 27, 2007, Lucent issued full and unconditional guaranties of our 4.375% bonds due 2009 (the principal amount of which was €805 million on December 31, 2007), our 6.375% notes due 2014 (the principal amount of which was €462 million on December 31, 2007) and our 4.750% Convertible and/or Exchangeable Bonds due 2011 (the principal amount of which was €1,022 million on December 31, 2007). 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.

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 that our capital expenditures in 2008 will be approximately €800 million, including Research and Development expenditures that will be capitalized. We believe that our current cash and cash equivalents, cash flows and funding arrangements provide us with adequate flexibility to meet our short-term and long-term financial obligations and to pursue our capital expenditure program as planned. We base this assessment on current and expected future economic and market conditions. Should economic and market conditions deteriorate, we may be required to engage in additional restructuring efforts and seek additional sources of capital, which may be difficult if there is no continued improvement in the market environment and given our limited ability to access the fixed income market at this point.



6.8

OUTLOOK FOR 2008

We see both positive long-term forces and some negative short-term forces affecting the market. On the positive side, developing countries are continuing to invest in their networks. The transition to IP in every aspect of the network continues, from fixed to mobile and from the core to the edge. There is a growing impact of video and content on broadband networks. Our customers are seeing the benefit of 3G wireless broadband services in the form of increased data revenues, which should drive additional spending to further enhance their broadband capabilities. In addition, there are a growing number of subscribers all around the world.

In the shorter term there are some downside risks. This continues to be a very competitive industry and a competitive environment. Some customers are assessing network-sharing arrangements that may have a negative impact on capital expenditures, but which might also offer opportunities from a services standpoint.

There is also some uncertainty around the macroeconomic environment and the potential repercussion of a recession in the United States on operators’ capital expenditures.

Given all these issues, and taking into account the weight of our business in the U.S., our initial projections for 2008 indicate that the global telecommunications equipment and related services market should be flat to slightly up at a constant €/U.S.$ exchange rate and slightly down at current exchange rates.

We will continue to execute our three-year plan that has been underway since the business combination with Lucent to restructure our business. The ongoing implementation of a more selective pricing approach and our product cost reduction program should enable us to improve our gross margin. We also intend to make continued good progress in our fixed costs reduction program.



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Given the expected improvement in the gross margin as well as a reduction in operating expenses (excluding the negative, non-cash impacts of Lucent’s purchase price allocation which are expected to be €(500) million this year), we expect operating margin (excluding the negative, non-cash impacts of Lucent’s purchase price allocation) in the low to mid-single digit range as a percentage of revenues in full year 2008.

We now estimate that the seasonality of historical Alcatel has not materially changed as a result of the business combination with Lucent and therefore expect a sequential decline in revenues of 20% to 25% in the first quarter of 2008. As a result, in the first quarter of 2008, we expect to incur a loss from operating activities before restructuring costs, impairment of assets, gain/(loss) on disposal of consolidated entities and post-retirement benefit plan amendment (excluding the negative non-cash impacts of Lucent’s purchase price allocation which are expected to be approximately €(125) million in the first quarter).



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, 2007 were mostly hedges of existing or future financial or commercial transactions or were related to issued debt.

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

Since we conduct commercial and industrial operations throughout the world, we are exposed to foreign currency risk, principally with respect to the U.S. dollar, but to a lesser extent with respect to the British pound and the Canadian dollar. We use derivative financial instruments to protect ourselves against fluctuations of foreign currencies which have an impact on our assets, liabilities, revenues and expenses.

Future transactions mainly relate to firm commercial contracts and commercial bids. Firm commercial contracts and other firm commitments are hedged using forward exchange contracts, while commercial bids are hedged using mainly currency options. The duration of future transactions that are not firmly committed does not usually exceed 18 months.



Counterparty risk

For our derivative financial instruments, we are exposed to credit risk if a counterparty defaults on its financial commitments to us. This risk is monitored on a daily basis, within strict limits based on the ratings of counterparties. The exposure of each market counterparty is calculated taking into account the nature and the duration of the transactions and the volatilities and fair value of the underlying market instruments. Counterparties are generally major international banks.



Foreign currency risk

Derivative foreign exchange instruments are mainly used to hedge future sales denominated in non-euro currencies.

Since we are a net seller of non-euro currencies, the rise of the euro against these currencies would have a positive impact on the fair value of the hedges. However, most of the change in fair value of derivative financial instruments would be offset by a change in the fair value of the underlying exposure.




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Interest rate risk

In the event of an interest rate decrease, the fair value of our fixed-rate debt would increase and it would be more costly for us to repurchase it (not taking into account that an increased 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 2007 and 2006, 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, 2007

December 31, 2006

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

894

894

10

(10)

1,942

1,942

10

(11)

Cash and cash equivalents (1)

4,377

4,377

-

-

4,749

4,749

0

0

Liabilities (2)

 

 

 

 

 

 

 

 

Convertible bonds

(2,273)

(2,104)

(136)

123

(2,682)

(2,834)

(314)

273

Non convertible bonds

(2,381)

(2,310)

(134)

118

(2,672)

(2,828)

(256)

221

Other financial debt

(394)

(394)

-

-

(855)

(856)

(1)

1

Interest rate derivatives

3

3

34

(32)

26

26

49

(46)

Loan to co-venturer

45

45

-

-

-

-

-

-

(DEBT)/CASH POSITION

271

511

(226)

199

508

199

(512)

438

(1)

For bank overdrafts, 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 2007, the fair value of our long-term debt was lower than its booked value due to increasing interest rates. At year-end 2006, the fair value of our long-term debt was higher than its booked value due to falling interest rates.

Assumptions and calculations

The fair value of the instruments in the table above is calculated with market standard financial software according to the market parameters prevailing on December 31, 2007.



Fair value hedge

The ineffective portion of changes in fair value hedges was a loss of €19 million at December 31, 2007, compared to a loss of €18 million at December 31, 2006 and a loss of €9 million at December 31, 2005. We did not have any amount excluded from the measure of effectiveness. There was no impact of contract cancellation in the income statement at December 31, 2007, 2006 and 2005.



Net investment hedge

We have stopped using investment hedges in foreign subsidiaries. At December 31, 2007, 2006 and 2005, 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.




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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 U.S.) 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:



Class A and Class O shareholders

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 Alcatel Class O shares and in other public statements regarding market demand for our former Optronics division’s products.

The lawsuits purported to be brought on behalf of persons who (i) acquired Alcatel Class O shares in or pursuant to the initial public offering of the American Depositary Shares (“ADSs”) conducted by historical Alcatel in October 2000, (ii) purchased Alcatel Class A and Class O shares in the form of ADSs between October 20, 2000 and May 29, 2001 and (iii) purchased Alcatel Class A shares in the form of ADSs between May 1, 2000 and May 29, 2001. The amount of damages sought by these lawsuits was not specified.

The actions were consolidated in the United States District Court, Southern District of New York. We filed a motion to dismiss this action on January 31, 2003 and a decision on the motion was rendered on March 4, 2005. The judge rejected a certain number of the plaintiffs’ demands with prejudice. He also rejected all the remaining claims under the federal securities laws for lack of specificity in the pleadings, but with leave to file a further amended complaint. This was filed, and we again moved to dismiss. On June 28, 2007, the court dismissed the complaint. The time to appeal has expired without an appeal having been filed. Accordingly, the matter is closed.



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. If the DOJ or the SEC determine that violations of law have occurred, they could seek civil or, in the case of the Department of Justice, 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 US District Court for the Southern District of Florida and pleaded guilty to violations of the FCPA.

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



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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. 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 compensation for the pecuniary damage caused by the alleged payments described above to the people and the Treasury of Costa Rica, and for the loss of prestige suffered by the Nation of Costa Rica (social damages). The ICE claim, which supersedes its prior claim of February 1, 2005, seeks compensation for the pecuniary 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. We intend to defend these actions vigorously and deny any liability or wrongdoing with respect to these claims.

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 €8 million in revenue from Costa Rican contracts in 2008. 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.

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, one of our German subsidiaries involved in the Taiwan Railway contract and 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, Alcatel 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 prosecutor has filed an appeal with the Taipei court of appeals. Should the higher court find Taisel guilty of the bid-rigging allegations in the indictment, Taisel may be banned from participating in government procurement contracts within Taiwan for a certain period and fines or penalties may be imposed on us, in an amount not to exceed €25,000.

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

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

As a group, we expect to generate approximately  €80 million of revenue from Taiwanese contracts in 2008, of which only a part will be 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 by CIT to a consultant arising out of a supply contract between CIT and a privately-owned company in Kenya in 2000. We understand that the French authorities are also conducting an investigation with respect to these payments. We are cooperating with the U.S. and French authorities and have submitted to these authorities our findings regarding those payments.



Government investigations related to Lucent

Saudi Arabia

In August 2003, the DOJ and the SEC informed Lucent that they had each commenced an investigation into possible violations of the FCPA with respect to Lucent’s operations in Saudi Arabia. These investigations followed allegations made by National Group for Communications and Computers Ltd. (NGC) in an action filed against Lucent on August 8, 2003, which is described below. Alcatel-Lucent does not expect any further action by the SEC or the DOJ relating to the Saudi allegations.



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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 €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.

Subpoenas and discovery requests

In May 2005, Lucent received subpoenas on two different matters, requesting specific documents and records. One of the subpoenas relates to a DOJ investigation of potential antitrust and other violations by various participants in connection with the United States government’s E-Rate program. The subpoena requires Lucent to produce documents before a grand jury of the U.S. District Court in Georgia. The second subpoena was from the Office of Inspector General, U.S. General Services Administration and relates to a federal investigation into certain sales to the federal government of telecommunications equipment and related maintenance services. During April 2006, the California Department of Justice served Lucent with discovery requests related to sales to California governmental agencies of telecommunications equipment and related maintenance services.



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, but the dismissal has been appealed to a higher court and that appeal is pending. Another such case, Chastain, et al. v. AT&T, was filed in the U.S. District Court in the Western District of Oklahoma. The Chastain case also involves claims related to changes to retiree health care benefits. That case too has been dismissed, but the dismissal has been appealed to a higher court. The appeal remains pending.

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 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 and motions for summary judgment are currently pending.

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 out of work because of maternity prior to 1980 and seeks the restoration of lost service credit prior to April 29, 1979, together with retroactive pension payment adjustments, corrections of service records, back pay and recovery of other damages and attorneys fees and costs. The case is stayed pending the disposition of another case raising similar issues. In the related case, the U.S. 9th 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.



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.



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Microsoft

On February 22, 2007, after a three-week trial in 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. This figure includes damages based on foreign sales (approximately 45% of sales), but a recent U.S. Supreme Court decision would likely eliminate that component of damages. 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. Lucent has appealed this ruling to the Court of Appeals for the Federal Circuit.

Lucent, Microsoft and Dell are involved in a number of patent lawsuits in various jurisdictions. In the summer of 2003, the 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 are scheduled in 2008. In one of the additional San Diego trials, on April 4, 2008, a jury awarded Alcatel-Lucent approximately U.S.$ 368 million in damages on additional patents. The remaining San Diego trial will involve counterclaims that Microsoft has asserted against us alleging that certain of our products infringe various Microsoft patents. Other trials are scheduled in Delaware and Texas for later this year and early 2009.

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. 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. As a result, Lucent has recognized a U.S.$ 303 million provision (including related interest and other costs of approximately U.S.$ 59 million) as of December 31, 2007. In addition, U.S.$ 311 million of cash is collateralizing a letter of credit that was issued during the second quarter of fiscal year 2006 in connection with this matter. Additional charges for post-judgment interest will be recognized in subsequent periods until this matter is resolved. On April 26, 2007, the U.S. District Court for the District of Delaware affirmed the decision of the Bankruptcy Court. Lucent has filed a notice of appeal of this decision with the United States Court of Appeals.

NGC

On August 8, 2003, NGC filed an action in the U.S. District Court for the Southern District of New York against Lucent, certain former officers and employees, Lucent’s subsidiary, Lucent Technologies International Inc., certain unaffiliated individuals and an unaffiliated company, alleging violations of the Racketeer Influenced Corrupt Organizations Act (RICO) and other improper activities. These allegations relate to activities in Saudi Arabia in connection with certain telecommunications contracts involving Lucent, the Kingdom of Saudi Arabia and other entities. The complaint seeks damages in excess of U.S.$ 63 million, which could be tripled under RICO. The allegations in this complaint appear to arise out of certain contractual disputes between NGC and Lucent that are the subject of a separate case that NGC previously filed against Lucent in U.S. District Court in New Jersey and other related proceedings brought by NGC in Saudi Arabia. On March 1, 2006, the District Court in New York granted Lucent’s motion to dismiss the case in its entirety. NGC has filed a notice of appeal. The parties have signed a settlement agreement calling for the global settlement of all claims NGC may have against Lucent. Included in this settlement are the suits filed in New Jersey and New York described above as well as all other claims filed by NGC against Lucent or its agent in Saudi Arabia. It is expected that the settlement agreement could take up to a year to be fully consummated.



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. We believe that our current investigations and cases will not have a material financial impact on us after final decision of the authorities or final disposition. However, 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 2007, in absolute value 15.2% of revenues was spent in innovation and in supporting our various product lines. These expenditures amounted to €2.7 billion before capitalization of development expenses 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;

·

a potential market for the products created during the project exists or their usefulness, in case of internal use, is demonstrated; and

·

adequate resources are available to complete the project.

These development costs are amortized over the estimated useful lives of the projects concerned. Specifically for software, useful life is determined as follows:

·

in case of internal use: over its probable service lifetime; and

·

in case of external use: according to prospects for sale, rental or other forms of distribution.

The amortization of capitalized development costs begins as soon as the product in question is released. Capitalized software development costs are those incurred during the programming, codification and testing phases. Costs incurred during the design and planning, product definition and product specification stages are accounted for as expenses. Customer design engineering costs (recoverable amounts disbursed under the terms of contracts with customers) are included in work in progress on construction contracts.

With regard to business combinations, we allocate a portion of the purchase price to in-process Research and Development projects that may be significant. As part of the process of analyzing these business combinations, we may make the decision to buy technology that has not yet been commercialized rather than develop the technology internally. Decisions of this nature consider existing opportunities for us to stay at the forefront of rapid technological advances in the telecommunications-data networking industry.

The fair value of in-process Research and Development acquired in business combinations is based on present value calculations of income, an analysis of the project’s accomplishments and an evaluation of the overall contribution of the project, and the project’s risks.

The revenue projection used to value in-process Research and Development is based on estimates of relevant market sizes and growth factors, expected trends in technology, and the nature and expected timing of new product introductions by us and our competitors. Future net cash flows from such projects are based on management’s estimates of such projects’ cost of sales, operating expenses and income taxes.

The value assigned to purchased in-process Research and Development is also adjusted to reflect the stage of completion, the complexity of the work completed to date, the difficulty of completing the remaining development, costs already incurred, and the projected cost to complete the projects.

Such value is determined by discounting the net cash flows to their present value. The selection of the discount rate is based on our weighted average cost of capital, adjusted upward to reflect additional risks inherent in the development life cycle.

Capitalized development costs considered as assets (either generated internally and capitalized or reflected in the purchase price of a business combination) are generally amortized over three to seven years.

In accordance with IAS 36 “Impairment of Assets,” whenever events or changes in market conditions indicate a risk of impairment of intangible assets, a detailed review is carried out in order to determine whether the net carrying amount of such assets remains lower than their recoverable amount, which is defined as the greater of fair value (less costs to sell) and value in use. Value in use is measured by discounting the expected future cash flows from continuing use of the asset and its ultimate disposal.

If the recoverable value is lower than the net carrying value, the difference between the two amounts is recorded as an impairment loss. Impairment losses for intangible assets with finite useful lives can be reversed if the recoverable value becomes higher than the net carrying value (but not exceeding the loss initially recorded).



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During the years ended December 31, 2007, 2006 and 2005, no trigger events occurred that would have required us to reassess the carrying values of acquired technology. Impairment losses for capitalized development costs of €41 million were accounted for in 2007 and impairment losses of €104 million and write-offs of €197 million were accounted for in capitalized development costs in 2006, and are 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, our acquisition of the UMTS business of Nortel in 2006 and our acquisition of Spatial in 2004, 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 Spatial and 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.

Spatial. We used the purchase method of accounting for Spatial, whereby the excess of cost over the net amounts assigned to assets acquired and liabilities assumed is allocated to goodwill and intangible assets based on their estimated fair values. Such intangible assets identified by us include U.S.$ 62.5 million allocated to developed technology and know how (“developed technology”) and U.S.$ 14.5 million allocated to in-process Research and Development.

At the acquisition date, Spatial was selling its distributed mobile switching solution: a centralized call server that manages call/session control for mobile voice and data services, commonly referred to as a “softswitch.” In March 2002, Spatial introduced its Atrium (TM) product, the industry’s first next-generation mobile core switch that supports 2G, 2.5G and 3G networks. The allocation of U.S.$ 62.5 million of the purchase price to the developed technology encompassed the call server technology.

In addition, at the time of the acquisition, Spatial was developing new software functionalities that integrate UMTS and Wi-Fi technology into our wireless softswitch technology platform. We estimated that this project had incurred approximately U.S.$ 4 million in costs as of the valuation date. We estimated the cost to complete the project at approximately U.S.$ 650,000 over four months following the acquisition. We estimated that the project was approximately 80% complete, in the aggregate, based on development costs.

At the time of the acquisition, we expected that estimated total revenues from the acquired developed technology and know how and from the in-process technology would peak in 2006 and 2008, respectively, and steadily decline thereafter, as other new products and technologies are introduced by Spatial.

The estimated costs of goods sold as well as operating expenses as a percentage of revenues for Spatial were expected to be materially consistent with historical levels, primarily due to the extremely competitive nature of the industry and the need to continue to spend heavily on Research and Development.

A discount rate of 30% was used for determining the value of the in-process Research and Development, while a rate of 18% was employed for determining the value of the developed technology and know how. The in-process Research and Development rate is higher than the implied weighted average cost of capital for the acquisition due to inherent uncertainties surrounding the successful development of the purchased in-process technology, the useful life of such technology, its profitability, and the uncertainty of technological advances that were unknown at that time.

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.



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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.

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 MANAGEMENT






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Information on the current Directors and board observers

Serge TCHURUK

Chairman of the Board of directors

Born on November 13, 1937, French national

Appointed November 2006(1) to 2010

Business address:

Alcatel-Lucent
54, rue La Boétie – 75008 Paris
France

Career

·

A graduate of the Paris École polytechnique and of the École nationale supérieure de l’armement, Mr. Tchuruk began his career within the Mobil group in a number of positions before taking up management appointments in France and the USA (1964-1979). In 1979, he became President of Mobil in the Benelux. He then joined Rhône Poulenc, the international chemical and pharmaceuticals group (1980-1986) and held several senior executive positions in the chemicals sector before becoming the company’s Managing Director in 1983. He moved on to become President and CEO of Orkem (formerly CDF-Chimie), a European chemicals company working in the area of special chemicals and petrochemicals (1986-1990). He was then Chairman and CEO of Total, one of the world’s leading oil companies (1990-1995). From June 1995 to November 2006 Mr. Tchuruk was Chairman and CEO of Alcatel. On November 30, 2006 he was appointed Chairman of the Board of directors of Alcatel-Lucent.

·

Expertise: 45 years in the industrial sector.

Current Directorships and professional positions

·

In France: Chairman of the Board of directors of Alcatel-Lucent, Director of Total SA and of Thales, Member of the Board of directors of École polytechnique.

Directorships over the last 5 years

·

In France: Chairman and CEO of Alcatel, Director of Société Générale and the Institut Pasteur.

·

Abroad: Chairman of the Board of Alcatel USA Holdings Corp, member of the Supervisory Board of Alcatel-Lucent Holding GmbH*.

Company shareholding

·

236,150 ordinary shares of Alcatel-Lucent and 215 units in FCP 2AL.



(1)

Originally appointed to the Alcatel Board in 1995.

*

Term of office expiring during 2007.



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Patricia F. RUSSO

CEO and Director

Born on June 12, 1952, U.S. national

Appointed November 2006 to 2010

Business address:

Alcatel-Lucent
54, rue La Boétie – 75008 Paris
France

Career

·

A graduate from Georgetown University, she began her career in sales and marketing at IBM Corporation before joining AT&T in 1981, where she managed some of the group’s largest divisions and discharged key corporate functions for more than twenty years. She also served as President and Chief Operating Officer at Eastman Kodak Company (2001-2002) before returning to Lucent, which she had helped launch in 1996, as CEO in 2002. Since November 30, 2006, she has been CEO of Alcatel-Lucent, resulting from the business combination of historical Alcatel and Lucent Technologies Inc.

·

Expertise: 34 years in the industrial and services  sectors.

Current Directorships and professional positions

·

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

·

Abroad: Director of Schering-Plough Corporation.

Directorships over the last 5 years

·

Abroad: Chairman and CEO of Lucent Technologies Inc.

Company shareholding

·

539,329 American Depositary Shares of Alcatel-Lucent.



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Daniel BERNARD

Independent Director

Born on February 18, 1946, French national

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 has worked with Delcev Industries (1969-1971), Socam Miniprix (1971-1975) and 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 the current Chairman of Provestis.

·

Expertise: 38 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 (UK).

Directorships over the last 5 years

·

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

·

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

Company shareholding

·

141,125 ordinary shares of Alcatel-Lucent.



(1)

Originally appointed to the Alcatel Board in 1997.



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W. Frank BLOUNT

Independent Director

Born on July 26, 1938, U.S. national

Appointed November 2006(1) to 2010

Business address

1040 Stovall Boulevard NE 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. 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: 47 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 Chief Executive Officer of TTS Management Corp.*, 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 in 1999.

*

Term of office expiring during 2007.



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Jozef CORNU

Independent Director

Born on November 15, 1944, Belgian national

Appointed November 2006(1) to 2010

Business address:

Agfa-Gevaert
Septestraat 27, 2640 Mortsel
Belgium

Career

·

The holder of a doctorate in electrical and mechanical engineering from the University of Leuven (Belgium) and of a Ph.D. from the University of Carleton (Canada), Mr. Cornu worked as CEO of Mietec (Bell Telephone group) (1982-1984), member of the Board of directors and CEO of Bell Telephone (1984-1987), Vice President responsible for the public network group (1987), member of the Management Board responsible for technical and industrial matters at Alcatel NV (1988-1995), President of Alcatel Networks Systems (1990-1995), Director responsible for Technical Matters, Alcatel Alsthom (1992), COO of Alcatel Telecom and member of the Executive Committee of Alcatel Alsthom (1995) and later of the Alcatel group. He was advisor to the President of Alcatel (1999-2004). Since November 30th, 2007 he has been appointed CEO of Agfa-Gevaert.

·

Expertise: 40 years in the industrial sector.

Current Directorships and professional positions

·

In France: Independent Director of Alcatel-Lucent and of Alcatel-Lucent France (ex Alcatel CIT).

·

Abroad: Chief Executive Officer and Director of Agfa-Gevaert (Belgium), Chairman of the Board of directors of Alcatel-Lucent Bell NV (Belgium), Member of the Supervisory Board of Alcatel-Lucent Deutschland AG (Germany) and of Alcatel-Lucent Holding GmbH (Germany), Director of KBC (Belgium).

Directorships over the last 5 years

·

Abroad: Chairman of the Board of directors of Tijd NV (Belgium), of Medea+ (the EUREKA cluster for Microelectronics Research in Europe), Director of Barco* (Belgium), of Arinso International* (Belgium) and of Essensium* (Belgium), Chairman of the Information Society Technologies Advisory Group of the European Commission*.

Company shareholding

·

20,500 ordinary shares of Alcatel-Lucent, 1,791 units in FCP 2AL.



(1)

Originally appointed to the Alcatel Board in 2000.

*

Term of office expiring during 2007.



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Linnet F. DEILY

Independent Director

Born on June 20, 1945, US national

Appointed November 2006 to 2010

Business address:

Alcatel-Lucent
600 Mountain Avenue Murray Hill, New Jersey
USA

Career

·

A graduate from the University of Texas, she has held various positions in banking, including First Interstate Bancorp where she served as Chairman, President and CEO of the First Interstate Bank of Texas and Vice-Chairman of the Charles Schwab Corporation. She served as a member of the advisory council to the Federal Reserve Bank’s board of governors. Most recently, she held the position of Deputy US Trade Representative (2001-2005) and of US Ambassador to the World Trade Organization (WTO).

·

Expertise: 31 years in finance.

Current Directorships and professional positions

·

In France: Independent Director of Alcatel-Lucent.

·

Abroad: Director of Chevron Corporation and of Honeywell International Inc.

Directorships over the last 5 years

·

Abroad: Director of Lucent Technologies Inc., Deputy US Trade Representative.

Company shareholding

·

9,618 American Depositary Shares of Alcatel-Lucent.



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Robert E. DENHAM

Independent Director

Born on August 27, 1945, US national

Appointed November 2006 to 2010

Business address:

Munger, Tolles & Olson LLP
355 South Grand Avenue – 35th floor
Los Angeles, CA 90071 – USA

Career

·

A graduate of Harvard Law School, Mr. Denham worked with the law firm Munger, Tolles & Olson LLP for twenty years, including five years as Managing Partner until he joined Salomon in 1991 as General Counsel, and became Chairman and CEO of Salomon Inc. in 1992. He rejoined the law firm Munger, Tolles & Olson LLP as a Partner in 1998 after negotiating the sale of Salomon Inc.

·

Expertise: 36 years in law and finance.

Current Directorships and professional positions

·

In France: Independent Director of Alcatel-Lucent.

·

Abroad: Partner of Munger, Tolles & Olson LLP (law firm), Director of Chevron Corporation, of Wesco Financial Corporation, of Fomento Economico Mexicano SA de CV, Vice-Chairman of Good Samaritan Hospital of Los Angeles, Chairman of Financial Accounting Foundation and of John D. and Catherine T. MacArthur Foundation, Director of New School University, Member of the Board of Oaktree Capital Group LLC.

Directorships over the last 5 years

·

Abroad: Director of Lucent Technologies Inc., of Russell Sage Foundation*, Member of the Board of United States Trust Company* and its wholly-owned banking subsidiary United States Trust Company N.A*.

Company shareholding

·

43,840 American Depositary Shares of Alcatel-Lucent.


*

Term of office expiring during 2007.



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Edward E. HAGENLOCKER

Independent Director

Born on November 18, 1939, US national

Appointed November 2006 to 2010

Business address:

Alcatel-Lucent
600 Mountain Avenue Murray Hill, New Jersey
USA

Career

·

After having earned a doctorate in physics from Ohio State University, Dr. Hagenlocker went on to earn an MBA from Michigan State University. He joined Ford Motor Company as a research scientist in 1964 and held various positions before being elected Vice President and General Manager of Ford’s Truck Operations in 1986, Vice President of general operations for Ford North American Automotive Operations in 1992 and Executive Vice President in 1993. He served as Vice Chairman of Ford Motor Company in 1996 and Chairman of Visteon Automotive Systems from 1997 until his retirement in 1999.

·

Expertise: 35 years in the industrial sector.

Current Directorships and professional positions

·

In France: Independent Director of Alcatel-Lucent.

·

Abroad: Director of Air Products and Chemicals, of Trane, Inc. and of AmeriSourceBergen Corporation.

Directorships over the last 5 years

·

Abroad: Director of Lucent Technologies Inc.

Company shareholding

·

20,587 American Depositary Shares of Alcatel-Lucent.



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Jean-Pierre HALBRON

Independent Director

Born on August 31st, 1936, French national

Appointed November 2006(1) to 2010

Business address:

Alcatel-Lucent
54, rue La Boétie – 75008 – Paris
France

Career

·

Mr. Halbron is a former student of the École polytechnique, with an engineering qualification from the corps des Mines and a degree from the Institut français du pétrole. He was an engineer seconded to the corps des Mines (1963), CEO (1968) and later President of the Management Board (1974-1982) of Compagnie Financière Holding, President/CEO of Compagnie Générale du Jouet (1969), Financial Director (1982-1985) and later Deputy CEO (1986) of the Rhône-Poulenc group, deputy Director and then CEO (1987-1990) of CdF Chimie, later Orkem, President of La Grande Paroisse (1987-1990) and of Lorilleux International (1987-1990), Financial Director of the Total group (1990-1991), President of OFP (1990) and of the Wasserstein Perella France Bank (1991-1995), Director of Strategy and Finance (1995-1997) and later Deputy CEO (1997-1999), Financial Director (1997-2001) and President (2000-2002) of Alcatel.

·

Expertise: 48 years in finance and industry.

Current Directorships and professional positions

·

In France: Independent Director of Alcatel-Lucent, Director of Électro Banque.

Directorships over the last 5 years

·

In France: Chairman and CEO of Électro Banque.

·

Abroad: Chairman of the Board of directors of Alcatel USA Inc., of Alcatel Finance Inc., Director of Alcatel USA LP Inc.

Company shareholding

·

28,670 ordinary shares of Alcatel-Lucent, 2,002 units in FCP 2AL.


 (1)

Originally appointed to the Alcatel Board in 1999.



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Sylvia JAY

Independent Director

Born on November 1st, 1946, British national

Appointed November 2006 to 2009

Business address:

L’Oréal UK
255 Hammersmith Road
W6 8AZ London – UK

Career

·

Lady Jay, CBE was educated at the University of Nottingham (United Kingdom) and the London School of Economics. She held various positions as a senior civil servant in the British civil service between 1971 and 1995, being involved in particular in financial aid to developing countries. She was seconded to the French Ministry of Co-operation and the French Treasury, and later helped set up the European Bank for Reconstruction and Development, before spending again several years in Paris as wife of the British ambassador. She entered the private sector in 2001, as Director General of the UK Food and Drink Federation until 2005.

·

Expertise: 7 years in industry and 31 years in public service

Current Directorships and professional positions

·

In France: Independent Director of Alcatel-Lucent, Non-executive Director of the Compagnie de Saint-Gobain.

·

Abroad: Vice Chairman of L’Oréal UK Ltd, Chairman of Food From Britain, Non-executive Director of Lazard Limited, Chairman of the Pilgrim Trust, Trustee of the Prison Reform Trust and of the Entente Cordiale Scholarships Scheme.

Directorships over the last 5 years

·

In France: Non-executive Director of Carrefour.

·

Abroad: Director General of the UK Food and Drink Federation.

Company shareholding

·

500 ordinary shares of Alcatel-Lucent.



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Karl J. KRAPEK

Independent Director

Born on December 5, 1948, U.S. national

Appointed November 2006 to 2010

Business address:

The Keystone Companies LLC
56 E. Main st., Suite 202 Avon, CT 06001
USA

Career

·

Mr. Krapek started his career with Pontiac Motor Car Division of General Motors. He previously served as President of Otis Elevator Company from 1989 to 1990, then as Chairman, President and CEO of Carrier Corporation from 1990 to 1992, as President of Pratt and Whitney Aircraft Engine Company from 1992 to 1999 and, in 1997, was named Executive Vice President and Director of United Technologies Corporation, to finally take the position as President and Chief Operating Officer of United Technologies from which he retired in 2002.

·

Expertise: 35 years in the industrial sector.

Current Directorships and professional positions

·

In France: Independent Director of Alcatel-Lucent.

·

Abroad: Managing Director of The Keystone Companies LLC, Director of Visteon Corporation, of The Connecticut Bank and Trust Company and of Prudential Financial Inc.

Directorships over the last 5 years

·

Abroad: Director of Delta Airlines Inc.* and of Lucent Technologies Inc.

Company shareholding

·

36,570 American Depositary Shares of Alcatel-Lucent.



*

Term of office expiring during 2007.



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Daniel LEBÈGUE

Independent Director

Born on May 4, 1943, French national

Appointed November 2006(1) to 2010

Business address:

Institut Français des Administrateurs (IFA)
27, avenue de Friedland
75382 Paris Cedex 08 – France

Career

·

The holder of a degree in law, a graduate of the Institut d’études politiques of Lyon and of the École nationale d’Administration, Mr. Lebègue has worked at the French Ministry of the Economy and Finance as an administrateur civil (senior civil service Officer) in the Treasury (1969-1973), financial attaché to the French Embassy in Japan (1974-1976), head of the Balance of Payments and Exchange Office within the Treasury (1976-1979), chef de bureau at the Treasury (1979-1980), Assistant Director Savings and Financial Markets (1980-1981), technical advisor with responsibility for economic and financial affairs in the staff of Pierre Mauroy (Prime Minister) (1981-1983), Deputy Director to the Central Administration of the Ministry of the Economy and Finance (1983-1984), Treasury Director (1984-1987), CEO (1987-1996) and later Vice chairman and Advisor to the President of Banque nationale de Paris (1996-1997), Director General of Caisse des dépôts et consignations (1997-2002), President of the Institute of Sustainable Development and International Relations (IDRI) (2002). He is President of the Institut Français des Administrateurs since 2003.

·

Expertise: 39 years in banking, finance and insurance.

Current Directorships and professional positions

·

In France: Independent Director of Alcatel-Lucent, Director of SCOR SE, of Technip and of Crédit Agricole SA, Chairman of the Institut Français des Adminis­trateurs (Association), Chairman of Transparency International (Association) and of IEP Lyon.

·

Abroad: Director of SCOR U.S.

Directorships over the last 5 years

·

In France: Chairman of the Board of directors of Compagnie Financière Eulia, Director of Thales, of C3D, of Gaz de France, Director General of Caisse des Dépôts et Consignations, Chairman of the Supervisory Board of CDC Ixis, Member of the Supervisory Boards of CNP, of Caisse Nationale des Caisses d’épargne and of CDC Ixis Capital Market, President of the Institut Théseus, Professor at the IEP Paris and at the Technical Institute of Bank.

Company shareholding

·

500 ordinary shares of Alcatel-Lucent.



(1)

Originally appointed to the Alcatel Board in 2003.



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Henry B. SCHACHT

Independent Director

Born on October 16, 1934, U.S. national

Appointed November 2006 to 2010

Business address:

Warburg Pincus LLC
466 Lexington Avenue
New York, NY 10017 – 3147 – USA

Career

·

A graduate of Yale University and Harvard University, he began his career at the American Brake Shoe Co. in 1956. After serving in the Navy, Mr. Schacht joined Irwin Management Co. and then Cummins Engine Company Inc. as Vice-President-Finance and then Chairman and CEO until 1995. He was named Chairman and CEO of Lucent later that year, position he held until 1997 and from 2000 to 2002.

·

Expertise: 46 years in industry and finance.

Current Directorships and professional positions

·

In France: Independent Director of Alcatel-Lucent.

·

Abroad: Managing Director and Senior Advisor of Warburg Pincus LLC, Director of ALCOA Inc. and Trustee of the Metropolitan Museum of Art.

Directorships over the last 5 years

·

Abroad: Director of Lucent Technologies Inc., Chairman of the Board of directors of Lucent Technologies Inc., CEO of Lucent Technologies Inc., Director of Johnson & Johnson and of the New York Times Company.

Company shareholding

·

225,589 American Depositary Shares of Alcatel-Lucent.



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Jean-Cyril SPINETTA

Independent Director

Born on October 4, 1943, French national

Appointed November 2006 to 2009

Business address:

Air France – KLM
45, rue de Paris
95747 Roissy Charles de Gaulle Cedex – France

Career

·

A graduate in public law and from the Institut d’études politiques of Paris, Jean-Cyril Spinetta began his career as assistant lecturer and later central administration attaché (1961-70). After moving to the École nationale d’administration, he held a number of positions within the National Education Ministry. He was several times seconded to other Departments, as Auditor of the Conseil d’État (1976-78), chargé de mission to the General Secretariat of the Government (1978-81), head of the Information Department of Prime Minister Pierre Mauroy (1981-83), chief of staff to Michel Delebarre when Minister for Employment, Minister of Social Affairs, Minister of Transport and later Minister of Equipment (1984-86 and 1988-90), chargé de mission and industrial advisor to the Office of the President of the Republic (1994-95), préfet (1995), technical advisor to the cabinet of Edith Cresson, EU Commissioner (1996), and expert for France seconded to the European Commission (1997). After a period as President and CEO of Compagnie Air Inter (1990-93), he has been Director and President of Air France (since 1997), President of Air France-KLM (since 2003) and President and CEO of the Air France-KLM group (since 2004). Mr. Spinetta has also been President of the Board of Governors of the International Association of Air Transport (IATA) since 2004 and Director of Compagnie de Saint-Gobain since 2005.

·

Expertise: 14 years in air transport and 36 years in public service.

Current Directorships and professional positions

·

In France: Independent Director of Alcatel-Lucent, Chairman and CEO of Air France-KLM, of Société Air France, Director of the Compagnie de Saint-Gobain, Permanent Representative of Air France-KLM to the Board of directors of Le Monde des Entreprises.

Directorships over the last 5 years

·

In France: Director of CNES.

·

Abroad: Director of Alitalia* and of Unilever*, Chairman of the Board of Governors of IATA*.

Company shareholding

·

500 ordinary shares of Alcatel-Lucent.



*

Term of office expiring during 2007.



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Thierry de LOPPINOT

Board observer

Born on March 26, 1944, French national

Appointed November 2006 to 2008

Business address:

Alcatel-Lucent
54, rue La Boétie – 75008 Paris
France

Career

·

After taking a Ph.D. in law (1970), Mr. de Loppinot was responsible for real estate within the Legal Department of Compagnie Française de Raffinage (Total) 1972-1973. He then became head of Property for the Autonomous Port of Rouen (1974-1975) and one of the heads of the Legal Department of SEITA (1976-1984). Since November 1984 he has been an in-house lawyer working at the head office of Alcatel-Lucent.

·

Expertise: 37 years in law and the industrial sector.

Current Directorships and professional positions

·

In France: Lawyer at the head office of Alcatel-Lucent, Board observer of Alcatel-Lucent.

Directorships over the last 5 years

·

In France: Director of Alcatel, of Société Immobilière Kléber- Lauriston (SIKL), Chairman of the Supervisory Board of the Actionnariat Alcatel-Lucent mutual fund (FCP 2AL)*.

Company shareholding

·

6,339 ordinary shares of Alcatel-Lucent and 6,095 units in FCP 2AL.



*

Term of office expiring during 2007.



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Jean-Pierre DESBOIS

Board observer

Born on April 14, 1954, French national

Appointed November 2006 to 2008

Business address:

Alcatel-Lucent France
Centre de Villarceaux, Route de Villejust
91620 Nozay – France

Career

·

Mr. Desbois has been an engineer with Alcatel-Lucent France (ex Alcatel CIT) since 1986. He began his career in 1974 in the deployment of telephone systems. From 1981, he was put in charge of software developments in R&D teams. From 2000 to 2007, he became head of Contract Management and Supply Chain into the Business Division “Applications”. Now he is in charge of process improvement for the Payment product group.

·

Expertise: 33 years in telecommunications.

Current Directorships and professional positions

·

In France: Engineer with Alcatel-Lucent France, Board observer of Alcatel-Lucent, Chairman of the Supervisory Board of Actionnariat Alcatel-Lucent mutual fund (FCP 2AL)*.

Company shareholding

·

1,720 units in FCP 2AL.



*

Appointed in 2008.




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7.2

BOARD OF DIRECTORS

We uphold the principles of corporate governance recommended in October 2003 by the Association française des entreprises privées (French association of non-governmental companies – AFEP) and the Mouvement des entreprises de France (MEDEF – National Confederation of French Employers). These principles result from the consolidation of the reports of 1995, 1999 and 2002 and govern, among other things, the rules of operation of our Board of directors and its Committees, as described in the Board of directors’ operating rules. In addition, since our American Depository Shares are listed on the New York Stock Exchange, we make every effort to comply with the recommendations of the NYSE, and are subject to the provisions of the U.S. Sarbanes-Oxley Act, which came into force in 2002. Finally, our governance principles adhere to the provisions of the agreement of April 2, 2006 that provided for the business combination of historical Alcatel and Lucent Technologies, Inc., as approved at the Shareholders’ Meeting of September 7, 2006.



Members of the Board of directors

Our Board of directors consists of fourteen Directors: six from historical Alcatel’s Board, six from Lucent’s Board and two jointly-selected independent European Directors (one of whom is French).  The composition of our Board conforms to what was established in the April 2006 merger agreement.

The functions of our Chairman of the Board, performed by the former Chairman and CEO of historical Alcatel, and those of our Chief Executive Officer, performed by the former CEO of Lucent, have been separated.

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

The specific majority rule that applied to coopt new Directors under the April 2006 agreement expired at the end of 2007; a new Director may now be coopted by a simple majority of Directors who are present and represented.

According to our Articles of Association, our Board of directors must also propose to the Shareholders’ Meeting two observers 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).

Pursuant to the Articles of Association, the Board of directors appoints a secretary who may also be assisted by a deputy secretary selected under the same conditions.

The membership of our Board of directors did not change during 2007. At December 31, 2007 the Board consisted of Directors representing five different nationalities, including three women, and the average age of its members was 64.

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 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 7.1, “Management”.

Chairman of the Board of directors and Chief Executive Officer

At a meeting on November 30, 2006, our Board of directors appointed Mr. Serge Tchuruk as Chairman of the Board and Ms. Patricia Russo as CEO.

Our Articles of Association provide that until the third anniversary of the closing of the Lucent transaction, that is, until November 29, 2009, separation of the positions of Chairman of the Board and CEO, as well as the removal and replacement of both the Chairman and the CEO, must be approved by a two-thirds majority of the Board of directors.



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At a meeting on November 30, 2006, the Board defined the respective powers of the Chairman and the CEO. It broadly defined its own powers while limiting those of the 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 per transaction 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 debt 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;

·

the appointment of members of the Security Committees of Alcatel USA and Lucent Technologies Inc. pursuant to the NSA;

·

the appointment of officers of Alcatel USA and Lucent Technologies Inc.;

·

any significant changes to the allocation of tasks (and corresponding capital expenditures) between Bell Labs and other Research and Development centers of Alcatel-Lucent; and

·

any significant changes to the legal structure of Alcatel-Lucent’s subsidiaries in the United States.

In addition, the Board of directors granted to Ms. Patricia Russo, in her capacity as CEO, specific delegations of power concerning the issuance of debt, securities for up to €1 billion (which include the €400 million our CEO has the power to issue without the prior approval of our Board), stock option grants, trading in our shares and guarantees and security granted by our company.

The Board of directors also granted to Mr. Serge Tchuruk, in his capacity as Chairman of the Board of directors, the authority to represent the Group in its high-level relations, particularly vis-à-vis public institutions.

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 based on the definition provided in the AFEP-MEDEF report, the recommendations of the New York Stock Exchange, the provisions of the Sarbanes-Oxley Act, and on the general principle that Directors, regardless of years of service, 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 by its Operating Rules.

In March 2008, our Board of directors conducted a detailed review of its independence criteria and reaffirmed them. Specifically, with regard to the rule concerning the length of time before a former employee can be considered an independent Director, the Board applied the New York Stock Exchange rule of three years after the expiration of the Director’s employment contract. Based on all of these criteria, the Board determined that Linnet Deily, Lady Jay, Daniel Bernard, W. Frank Blount, Jozef Cornu, Robert Denham, Edward Hagenlocker, Jean-Pierre Halbron, Karl Krapek, Daniel Lebègue, Henry Schacht and Jean-Cyril Spinetta, that is, 12 of its 14 members (85%), are independent.

Conflicts of interest

To our knowledge, there are no potential conflicts of interest between the Director’s 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.

To our knowledge, there is no arrangement or agreement with a shareholder, client, supplier or any third party to nominate or appoint our CEO or a member of our Board of directors or of our Management Committee, except for the agreement dated April 2, 2006, entered into between Alcatel and Lucent, concerning the business combination between the two companies, with respect to the appointment of the members of the Board, according to the principles described above.



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To our knowledge, no member of the Board of directors or any executive officer of our company has been convicted of fraud during the last five years; has been a Director or executive officer of a company involved in a bankruptcy, court escrow or liquidation in 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.



Powers of the Board of directors

Our Board, in addition to matters that come under its legal or regulatory authority, regularly decides on the Group’s strategic direction and the key decisions affecting its activities. It fully exercises its authority and tries to ensure that each Director’s contribution is entirely effective, in accordance with the principles of corporate governance described above and the provisions of its Operating Rules.

Our Board of directors also make sure that its activities are transparent to our shareholders by reporting generally on its activities and those of its Committees during the previous year and on its procedures, in our annual report.

Finally, the Board performs an annual evaluation of the manner in which it does its work and of the performance of the executive officers. At least once every three years, it has its performance evaluated by an outside consultant.

Excerpt from the Board of directors’ Operating Rules

“In addition to matters related to its legal or regulatory function, the board shall regularly decide upon, among other things, the Group’s strategic orientations and the main decisions affecting its activities. This relates in particular to the projects of important investments of organic growth and the operations of internal reorganizations, major acquisitions and divestitures of shares and assets, transactions or commitments that may significantly affect the financial results of the group or considerably modify the structure of its balance sheet and the strategic alliances and financial cooperation agreements.”



Preparation of meetings, organization and functioning of the Board of directors

The Operating Rules govern the manner in which our Board of directors functions. The Board meets at least once each quarter either at our head office or at any other location indicated in the notice of meeting, whether in France or abroad.

We provide our Directors with all the information they need to perform their duties. Board members regularly receive relevant information concerning our company, such as press articles and financial analysts reports. They may also seek the opinion of senior officers within the Group on any subject they deem appropriate.

The documentation provided at Board meetings supports the items on the agenda and includes the documents sent to the Directors prior to the meeting as well as additional documents. In general, each item on the agenda is supported by internal and/or external documentation, depending on the nature of the topic discussed and, if applicable, is accompanied by a draft of the proposed resolution of the Board. Where appropriate in light of the agenda, the documentation also includes a draft press release, which is generally published the day after the meeting and before Euronext Paris opens, in accordance with the AMF’s recommendations. Lastly, the documentation contains a list of the main contracts and agreements signed since the previous meeting as well as information about changes in our share price.

The work of the Board is generally based on presentations made by our senior management, which generate open discussions among the Directors. However, certain portions of Board meetings are not attended by our CEO or employees, pursuant to one of the recommendations of the New York Stock Exchange and the principles of corporate governance recommended by the AFEP and the MEDEF in October 2003.

Directors may participate in Board meetings by videoconference or by means of telecommunication through which they can be identified. Directors participating in this manner are deemed in attendance for determining the quorum and the majority of votes unless the matters being discussed are prohibited by law from being considered by these means.

Directors must notify the Chairman of the Board of any conflict of interest, even potential. Moreover, if this conflict concerns a particular matter, they must refrain from voting on such matter.

Depending on the Board’s agenda and the nature of the topics discussed at the meeting, Board meetings may be preceded by a meeting of one or several of its four specialized committees.

Excerpt from the Board of directors’ Operating Rules

“In the course of carrying out its various responsibilities, the Board of directors may create specialized committees, composed of Directors appointed by the Board, that review matters within the scope of the Board’s responsibilities and submit to the Board their opinions and proposals, in accordance with the internal rules governing such committees. The Board of directors shall have the following standing committees: the corporate governance and nominating committee, the compensation committee, the audit and finance committee and the strategy and investments committee.”



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Except in case of an emergency, all information required for the Board’s discussions is sent prior to the meeting in a manner that is consistent with the confidentiality to be respected when delivering insider information, and that allows the Directors to carefully review the documents prior to the meeting. This also applies to the specialized committees created by the Board of directors.

Board meetings called to prepare the year-end, six-month and quarterly financial statements are systematically preceded by a review of the financial statements by the Audit and Finance Committee.



Activity of the Board in 2007 and early 2008

Our Board of directors met 10 times in 2007. To the meeting schedule for the year 2007 set in the prior year, there were added two extraordinary meetings, in view of new developments. The average attendance rate of its members at these meetings was 93%. Despite the fact that some meetings were held outside the country in which certain Directors reside and although Directors are permitted by law to participate in meetings remotely, 77% of the members attended meetings in person in 2007.

In early 2008, our Board of directors met four times, in February, in March and early April, and the attendance rate of its members was 93%.

The Board’s meetings were held at the company’s head office in Paris or in Murray Hill, New Jersey. They lasted three and a half hours on average and were often preceded or followed by informal meetings with members of the Management Committee, which allowed the Directors to discuss on a periodic basis with the Group’s main operating executives our strategic and technological direction.

In 2007, the Board met on two occasions, and in 2008 on two occasions, without the CEO and employees being in attendance.

The main topics addressed by the Board of directors in 2007 and early 2008 were as follows:

Accounts and financial position

In 2007, our Board reviewed and approved the year-end Alcatel-Lucent and the Group’s consolidated financial statements for the fiscal year ended December 31, 2006, which were subsequently approved by our Shareholders at the meeting held in June 2007. It approved a budget forecast for 2007, and proposed an appropriation of results, that is, the appropriation of the profit or loss of the final year to legal reserves, statutory reserves or retained earnings. It reviewed certain matters related to the accounting principles either temporarily or permanently applicable as a result of the business combination with Lucent, such as the election of the “SORIE” method (Statement of Recognized Income and Expense) as permitted by the IASB for recognizing actuarial gains/losses and changes in asset ceiling outside the income statement. It also studied the impact of eliminating the reconciliation of our net income and shareholders’ equity, prepared in accordance with IFRS, with U.S. GAAP, which new SEC regulations allow, in certain circumstances.

In addition, it reviewed and approved the quarterly and half-year consolidated financial statements for the year ended December 31, 2007. At each of these meetings, the accounts were examined in the presence of our Statutory Auditors and a report was presented on the work of the Audit and Finance Committee. More generally, our Board monitored changes in the Group’s results and financial structure as well as the progress of restructuring and cost reduction plans. This prompted the Board to convene two extraordinary meetings and to request various specific reports from senior management as well as the preparation of a general action plan in late October 2007.

Moreover, on several occasions the Board addressed the specific issue of Lucent’s pension fund management. The Board concluded that it was incumbent upon the Board to establish general guidelines for allocating the assets of these funds, and to appoint the members of the advisory committee responsible for overseeing this management (Pension Benefits Investment Committee). The Board therefore appointed the members of this Committee and approved a change to the asset allocation policy.

Our Board was also informed of the terms and conditions under which the revolving syndicated lines of credit previously issued to historical Alcatel and Lucent were renegotiated for the benefit of the Group following the business combination with Lucent.

In 2008, our Board reviewed and approved the year-end Alcatel-Lucent and consolidated financial statements for the year ended December 31, 2007, to be submitted to the shareholders for definitive approval. It approved a budget forecast for 2008, and proposed an appropriation of results.

The Group’s strategic direction

Our Board of directors reviewed regularly our position in the market and focused at length on the Group’s strategic direction, including by considering the reports on the work matters adressed by the Strategy and Investments Committee. In particular, the Committee conducted an in-depth analysis of the sectors in which material investments were needed to ensure the Group’s position in next-generation technologies. The Board also studied several proposed acquisitions of various sizes, some of which were pursued and successfully completed. More specifically, it monitored the implementation of the National Security Agreement with the U.S. government, as well as developments in the intellectual property lawsuits between Alcatel-Lucent and Microsoft. Two of the meetings of this committee were open to all the Board members (see below in Section 7.3, the subheading “Strategy and Investments Committee”), and approved an action plan in October 2007, with the goal of improving the Group’s profitability.



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Compensation policy

Our Board of directors studied the recommendations of the Compensation Committee on the proposed grant of stock options and bonus shares for fiscal year 2007. After determining that, due to French tax law, the grant of bonus shares (authorized by the Shareholders’ Meeting of September 7, 2006) would be unattractive for foreign employees, it adopted a stock option plan in favor of certain employees under customary conditions. It also gave the CEO authorization to grant options in order to honor promises made at the time of recruitment of new talent or to certain employees in exceptional situations.

Our Board of directors noted the amount of variable compensation to be paid in 2007 to Mr. Tchuruk for the fiscal year ended December 31, 2006, calculated on a pro rata basis through November 30, 2006, the date as of which he ceased receiving any remuneration other than director’s fees. It defined the conditions of the CEO’s variable compensation for 2007, which is based on the same performance criteria that apply to all executives subject to the “Global Annual Incentive Plan” (see Section 7.4, “Compensation” of this document), and approved the terms of its payment. As required by law, it established the proportion of shares acquired by the CEO as a result of option exercises that are to be retained by the CEO (see Section 7.5, “Stock option and other securities held by Directors and senior executives”).

Our Board of directors considered the recom­mendations of the Compensation Committee regarding the compensation of the members of the Management Committee.

Finally, after discussing a change in the amount of Directors’ fees, which we believed were below international standards, the Board in view of the restructuring actions that we are taking, submitted to the Shareholders’ Meeting in June 2007 an adjustment in the total amount of Directors’ fees in order to keep the individual amount received by each Director equivalent to the amount that historical Alcatel Directors received before the business combination with Lucent. This was approved by the Shareholders. Upon the Board’s recommendation, at the same meeting, the Shareholders approved the grant of €50,000 in annual compensation per observer. Our Board did not request a reevaluation of the directors’ fees for 2008.

In 2008, our Board approved a stock option plan in favor of certain employees under customary conditions, and the award of stock options to our Chief Executive Officer, under the same customary conditions. It established the performance criteria of the variable portion of the remuneration of executives (including our Chief Executive Officer) covered by the “Global Annual Incentive Plan” (see Section 7.4, “Compensation”) for fiscal year 2008. In addition, our Board, after discussing the recommendations of the Compensation Committee, decided on the performance criteria applicable to the grant of bonus shares to our Chief Executive Officer in 2008 pursuant to an undertaking provided in 2006 and on the grant of restricted cash units, also subject to performance criteria, as part of her long-term incentive package. Finally, in accordance with law, we established the performance criteria which must be satisfied in the future in order for the company to fulfill the obligations to our Chief Executive Officer upon the termination or change of her duties (see Section 7.4, “Compensation”).

Business ethics

Our Board of directors reviewed the reports of the Audit and Finance Committee, which was informed at regular intervals of pending inquiries and legal proceedings following allegations made against employees of the historical Alcatel companies (prior to the business combination with Lucent) in China, Costa Rica, Taiwan and Kenya regarding business practices, and of the settlement reached with U.S. authorities with respect to certain business practices of Lucent in China prior to the business combination. In early 2008, the training program aimed at employees of the Group, called “Alcatel-Lucent’s Anti-corruption Program”, was shown to the Board.

Corporate governance

Operating Rules and Director’s Charter

The work carried out by our Board in terms of corporate governance mainly entailed adopting new Operating Rules of each of the Board’s committees, as well as revising the Director’s Charter significantly changed which defines the ethics rules that apply to its members.

Evaluations

Since the composition of our Board was largely renewed at the end of 2006, and given the changes in the manner the Board operates since the business combination with Lucent, the Board deemed it premature to proceed with its annual self-evaluation in 2007.

An evaluation of the Board of directors’ operations was carried out at the beginning of 2008 by an independent firm, Spencer Stuart. The report of the expert, which highlighted certain possible improvements to the way the Board functions, is being reviewed in detail by the Corporate Governance and Nominating Committee and the Board will hold a specific meeting on this topic.

Independence of the Directors

Our Board of directors reviewed the independence of its members when they took office on November 30, 2006. Since no member’s situation had changed from November 2006, the Board did not consider it necessary to repeat this review in 2007. A review of the Directors’ independence was therefore carried out by the Board of directors on March 25, 2008.

Shareholders’ Meetings

In 2007, our Board of directors set June 1, 2007 as the date for a Combined Shareholders’ Meeting, for which it prepared the agenda and related documents. The Board recommended that the Shareholders vote against a resolution submitted by a group of shareholders, which called for the deletion from our Articles of Association of provisions regarding the limitation of voting rights and which, ultimately, was adopted by the Shareholders. The Board also called a meeting for holders of bonds with a conversion and/or exchange option for new or existing Alcatel-Lucent shares in order to submit to them certain resolutions which had been submitted to the Shareholders’ Meeting. The Board answered questions that had been submitted in writing prior to the Shareholders’ Meeting by certain Shareholders or that arose out of discussions between senior management and certain institutional shareholders.



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In early 2008, the Board of directors set May 30, 2008 for the next Combined Shareholders’ Meeting to approve the financial statements for the fiscal year ended December 31, 2007, for which it prepared the agenda and related documents. It also called a meeting for holders of bonds with a conversion and/or exchange option for new or existing Alcatel-Lucent shares in order to submit to them certain resolutions submitted to the Shareholders’ Meeting.



7.3

COMMITTEES OF THE BOARD

Prior to our business combination with Lucent in November 2006, our Board of directors had three specialized committees: the Audit Committee, the Nominating and Compensation Committee and the Strategy Committee. On November 30, 2006, the date of the business combination, the Board of directors decided to create four committees: the Audit and Finance Committee, the Corporate Governance and Nominating Committee, the Compensation Committee and the Strategy and Investment Committee. Each committee reports to the Board of directors, which has the sole authority to make decisions concerning the subjects presented to it. The CEO may attend all meetings of the committees of the Board in an advisory capacity, with the exception of Compensation Committee meetings that concern her personal situation. In early 2007, each of these committees adopted new Operating Rules.



Audit and Finance Committee

Members

This committee consists of no less than four members, at least one of whom must have proven financial expertise.

All the Directors who serve on this committee must be “independent”. Therefore, no executive officers may be members. In addition, Directors who hold executive positions at our company may not be members of this committee.

Since November 30, 2006, the members of this committee are Mr. Robert Denham, committee chairman, Mr. Jean-Pierre Halbron, Mr. Daniel Lebègue and Mr. Karl Krapek.

Responsibilities

The Audit and Finance Committee’s role and operation meet the requirements of the Sarbanes-Oxley Act and follow the key recommendations of the various reports on corporate governance. Its main areas of activity concern the company’s accounts, internal controls, financial position and relations with our Statutory Auditors.

Financial statements

The role of our Audit and Finance Committee, as defined by the Board of directors’ Operating Rules, is to review the accounting standards applied by the company, the company’s risks and significant off-balance sheet commitments, and all financial or accounting matters presented to it by the CEO or the Chief Financial Officer.

The committee therefore reviews and approves the appropriateness and consistency of the accounting methods used to prepare the consolidated and parent company financial statements and ensures that significant transactions receive proper accounting treatment at the Group level.

The committee examines the consolidation scope and, where relevant, the reasons why certain companies should not be included in this scope.

It reviews the accounting standards that are applicable to and applied by our Group, both according to IFRS and French GAAP (with respect to the parent company’s financial statements, as required by French law) as well as their effects and the resulting differences in accounting treatment.

It examines the quarterly, half-year and year-end parent company and consolidated financial statements and the Group’s budgets.



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Internal control

The Audit and Finance Committee ensures that internal procedures for collecting and verifying financial information are in place to ensure the reliability of this information. The head of internal audit within the Group periodically reports to the committee on the results of the work of his department. In addition, twice a year the committee reviews the Group’s internal audit plan and the operation and organization of the Internal Audit Department. The committee is consulted when necessary on the selection of the internal audit manager and on his eventual replacement.

The committee examines all complaints, alerts or other reports, including those on an anonymous basis, that reveal a potential malfunction in the financial and consolidation processes set up within the Group.

Our Audit and Finance Committee meets periodically with our Chief Compliance Officer to check the adequacy of our compliance programs, any significant violations of these programs and the corrective measures taken by us.

Financial position

Our Audit and Finance Committee also reviews our indebtedness and our capitalization and possible changes in this capitalization, as well as all financial or accounting matters presented to it by the Chairman of the Board or the Chief Financial Officer (such as risk hedging or centralized cash management).

It examines the risks to which the Group may be exposed (and the measures taken by senior management to mitigate their effects) and the Group’s significant off-balance sheet commitments.

It also reviews financial transactions having a significant impact on the Group’s accounts, such as issuance of securities in excess of €400 million.

Statutory Auditors

Our Audit and Finance Committee oversees the selection process for our Statutory Auditors and makes a recommendation on such auditors to the Board.

Assignments that do not pertain to the audit of our accounts, or that are neither incidental nor directly supplemental to our audit, but which are not incompatible with the functions of the Statutory Auditors must be authorized by the Audit and Finance Committee, regardless of their scope. The committee ensures that these assignments do not violate the provisions of article L. 822.11 of the French Commercial Code.

It also reviews and determines the independence of the Statutory Auditors and expresses an opinion on the amount of their fees for the audit of the accounts.

Based on the total amount of the fees paid for the audit of our accounts during a given fiscal year, our committee sets the level(s) of fees beyond which the Committee must give a specific authorization for previously authorized assignments.

The Committee’s work in 2007 and early 2008

The members of the Audit and Finance Committee met six times in 2007. Their attendance rate at these meetings was 96%.

In 2007, the Audit and Finance Committee conducted a review of the year-end financial statements for the year ended December 31, 2006 and the half-year consolidated financial statements for 2007 prepared under IFRS and and reconciled to U.S. GAAP. It also reviewed the quarterly financial statements for the Group based on IFRS and the year-end parent company financial statements based on French GAAP. To prepare for this review, it relied on the work of the Disclosure Committee created to meet the requirements of the Sarbanes-Oxley Act in order to ensure the disclosure of reliable information about the Group. At each of its meetings, the Audit and Finance Committee was briefed by the Chief Financial Officer and the Statutory Auditors and examined, in the Auditors’ presence, the key points discussed with the Chief Financial Officer at the time of preparation of the financial statements. At the beginning of the year, the budget and financial forecasts for 2007 were presented. On several occasions, the Committee also discussed the risks specific to certain large contracts.

With regard to accounting principles, the committee reviewed the option offered by an amendment to IAS 19 – “Employee benefits” for recognizing actuarial gains and losses and an adjustment arising from asset ceiling, net of deferred taxes, in the period in which they occur, outside the income statement. It also reviewed the consequences of applying SFAS 158 “Employer’s accounting for defined benefit pension and other post-retirement plans” on deferred taxes. The Committee approved the way the segment information should be presented. In addition, it provided information for the Board’s decisions regarding the general guidelines for allocating Lucent’s pension fund assets and the appointment of the members of the advisory committee charged with overseeing the management of these assets (Pension Benefits Investment Committee). It studied the new provisions of the U.S. securities laws that eliminates the need to reconcile, under certain circumstances, accounts prepared according to IFRS with U.S. GAAP standards.

Our Audit and Finance Committee received the Internal Audit department’s annual report for 2006 as well as the internal audit plan for 2007. In the context of its review of the internal audits, the Committee was briefed by the Internal Audit department and, together with it, analyzed the department’s resources. At regular intervals, the committee monitored the progress made regarding the certification required by Article 404 of the Sarbanes-Oxley Act. On several occasions, it was briefed by the General Counsel about developments in the Costa Rica, Taiwan and Kenya matters (see Section 6.10, “Legal matters”). Finally, the committee implemented a new financial alert procedure as required by the Sarbanes-Oxley Act, while at the same time complying with the requirements of the “Commission nationale de l’informatique et des libertés” or CNIL, the French authority charged with the enforcement of data privacy laws.



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Our Audit and Finance Committee gave prior authorization for assignments carried out by its Statutory Auditors which are not related to statutory audits. After presentations by the Chief Financial Officer and the Statutory Auditors, the committee also set the Auditors’ fees for 2007.

Our Audit and Finance Committee met twice in the first quarter of 2008 to conduct a review of the results and financial statements for the year ended December 31, 2007 and of the annual report of the Internal Audit department for 2007, as well as the internal audit plan for 2008. It reviewed the draft annual report on Form 20-F and the “reference document”, and the internal and external auditors’ reports on internal control procedures in place within our Group.



Corporate Governance and Nominating Committee

Members

The Corporate Governance and Nominating Committee consists of no less than three members, at least two-thirds of whom must be independent.

Since November 30, 2006, the members of this committee are Mr. Daniel Bernard, committee chairman, Ms. Linnet Deily, Mr. Frank Blount, Mr. Henry Schacht and Mr. Jean-Cyril Spinetta.

Responsibilities

The first responsibility of our Corporate Governance and Nominating Committee, as defined by the Board of directors’ Operating Rules, is to review questions related to the composition, organization and operation of the Board of directors and its committees, to identify and propose to the Board individuals who are qualified to hold the position of Director and serve on committees, to develop and recommend to the Board a set of corporate governance principles applicable to the company, and to oversee the evaluations of the Board and its committees.

The second responsibility of our Corporate Governance and Nominating Committee is to examine the succession plans for the Chairman of the Board, the CEO and our Group’s other senior executives.

The Committee’s work in 2007 and early 2008

Our Corporate Governance and Nominating Committee met three times in 2007. Among other things, it reviewed the Director’s Charter, advised the Board as to the position it should take on the amendments to the Articles of Association proposed by certain shareholders concerning statutory limitations on voting rights and double voting rights, examined the succession plans for members of the Management Committee, reviewed the training of Directors, proposed the appointment of a deputy secretary to the Board, and made suggestions for changing the organization of the management team.

The committee met once in early 2008. It reviewed in depth the self-evaluation report of the Board, examined the independence of the Directors (see in this Section "Activity of the Board in 2007 and early 2008") and considered the candidates for the replacement of the current observers.



Compensation Committee

Members

The Compensation Committee consists of no less than three members, at least two-thirds of whom must be independent.

Since November 30, 2006, the members of this committee are Mr. Edward Hagenlocker, committee chairman, Ms. Linnet Deily, Lady Jay and Mr. Jean-Pierre Halbron.

Responsibilities

The role of our Compensation Committee, as defined by the Board of directors’ Operating Rules, is to study and make proposals to the Board regarding compensation of the Directors, the Chairman, the CEO and the key senior executives, to review policies related to the grant of stock options and bonus shares to senior managers and employees, and to examine proposals to increase the company’s capital in the form of an issuance of shares reserved for employees.

Compensation policy

The Compensation Committee makes recommendations to the Board concerning the annual evaluation of our management. Each year, it recommends to the Board the fixed compensation and the method of calculation of the variable compensation paid to executive officers, the rules for setting this variable portion based on the executives’ performance and the company’s medium-term strategy, and the objectives on which this performance evaluation will be based.

Our Compensation Committee also oversees and helps define the compensation policy and the benefits strategy applicable to all our staff.



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Stock options, bonus shares and capital increases reserved for employees

Our Compensation Committee is responsible for reviewing the general stock option policy, including in particular the frequency of stock option grants, vesting conditions, etc. It advises the Board whether to establish stock purchase or subscription option plan(s), as well as extraordinary plans that may be proposed by our management when the circumstances warrant it. It also reviews and makes recommendations to the Board concerning programs related to bonus shares granted to employees and/or executive officers.

In addition, our Compensation Committee examines proposed capital increases reserved for the Group’s employees.

The Committee’s work in 2007 and early 2008

Our Compensation Committee met six times in 2007 and had an average attendance rate of 92%.

It analyzed the terms of our March 2007 stock option plan and the draft resolution concerning the bonus shares submitted to the Shareholders’ Meeting. It set the amount of the variable portion of the Chairman and CEO’s compensation for the first 11 months of 2006 and analyzed the effects of the differences in the methods used to compensate performance in 2006 for managers coming from Alcatel and for managers coming from Lucent.

The committee reviewed the proposed performance criteria for defining the variable compensation of the CEO and that of senior executives for 2007 (see Section 7.4, “Compensation”). It also reviewed the benefits in kind granted to the CEO and the application of the rule concerning the obligation to keep shares resulting from the exercise of stock options or from bonus shares until her term expires (see Section 7.5, “Stock option and other securities held by Directors and senior executives”). It discussed the determination of the compensation for certain senior executives upon their promotion. Finally, it discussed the reassessment of Directors’ fees (see Section 7.2, “Board of Directors”).

In early 2008, the Committee met four times and reviewed in particular the proposed grant of stock options for 2008 and developed recommendations concerning the grants to employees and to our Chief Executive Officer.

The committee reviewed the application of the criteria for the variable portion of the compensation of executives (including our CEO) covered by the “Global Annual Incentive Plan” for fiscal year 2007, and issued a recommendation with respect to the criteria for such variable compensation for fiscal year 2008.  The Committee also made recommendations concerning the compensation of the members of the Management Committee, the performance criteria for the grant of bonus shares to our Chief Executive Officer in 2008, the grant of restricted cash units, also subject to performance criteria, as part of Ms. Russo’s long-term incentive package, and the performance criteria that must be satisfied in the future in order for the company to fulfill the obligations to our Chief Executive Officer upon the termination or change of her duties. It also reviewed the draft resolutions presented to the Shareholders' Meeting concerning stock options and the distribution of bonus shares, and the directors' fees (see in this Section "Activity of the Board in 2007 and early 2008").

The Committee also proposed that the management of the stock option exercises by the members of the Management Committee be entrusted to an independent financial intermediary, in order to enhance corporate governance.



Strategy and Investments Committee

Members

The committee consists of no less than four members, and is chaired by the Chairman of the Board.

Since November 30, 2006, the members of this committee are Mr. Serge Tchuruk, committee chairman, Mr. Jozef Cornu, Mr. Edward Hagenlocker and Mr. Henry Schacht.

Responsibilities

The role of our Strategy and Investments Committee, as defined by the Board of directors’ Operating Rules, is to review our Group’s proposed strategic direction and investments, all related internal restructuring activities, all proposed investments and sales of assets, and in particular, to monitor, on the Board’s behalf, the integration of historical Alcatel and Lucent and the creation of synergies.

This committee’s role is to ensure that our financial and human resources are allocated as efficiently as possible in order to achieve the growth and profitability objectives established by the Board.

Our Strategy and Investments Committee reviews the annual strategic plans presented to it by management. These plans include an analysis of the markets that are relevant for the company, their expected evolution and the company’s positioning in these markets (market share, financial results).

These plans include proposed commercial and R&D initiatives and any legal or other constraints that may apply, and take into consideration other avenues available to us in the form of internal development, cooperation agreements and business acquisitions or sales of businesses.

Our Strategy and Investments Committee reviews the proposed decisions that the CEO must submit to the Board of directors for prior approval.

It also examines the Group’s annual budget and annual investment plan.



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The Committee’s work in 2007 and early 2008

Our Strategy and Investments Committee held four meetings in 2007, two of which were open to all Directors and to the observers. During these meetings, the committee heard reports on progress made in integrating historical Alcatel and Lucent, reviewed specific topics such as digital home networks, next-generation networks (NGN), third generation mobile networks (W-CDMA standard) and plans to diversify the Group’s customer base (the enterprise markets, and “industry and public sector” markets). One of its meetings was dedicated to facilitating the Board’s review of the management’s action plan announced at the end of October 2007.

Our Strategy and Investments Committee met once during the first quarter of 2008 to discuss the budget for 2008, relations with investors and the current strategic projects. This meeting was open to Directors and observers.



7.4

COMPENSATION



Directors’ and observers’ fees

The aggregate Directors’ fees for 2007 approved at  the Combined Shareholders’ Meeting on June 1, 2007 were €700,000.

Directors’ fees are distributed based on the following principle: one half of the total fee is divided among the Board members equally, and the remaining amount is allocated among the Board members according to their attendance at meetings of the Board and of the Committees they belong to. However, the Chief Executive Officer does not receive any Director’s fees, and the Chairman of the Board receives proportionatly twice the amount received by the other Directors. The Directors’ fees are paid in two installments, one after the Annual Meeting of Shareholders and the other at the end of the year.

The Operating Rules of the Board of directors were amended on November 30, 2006 to take into account the new manner in which Board fees would be distributed.

The observers receive a fee set at the Shareholders’ Meeting divided equally between them and paid in the same way as the Director’s fees. The Combined Shareholders’ Meeting of June 1, 2007 set the total amount of observers’ fees at €100,000.



Directors’ fees (in euros)

2007

2006

Serge Tchuruk

96,890

-

Patricia Russo

-

-

Daniel Bernard

46,770

70,684

W. Frank Blount

46,770

50,631

Jozef Cornu (1)

46,770

45,352

Linnet F. Deily

56,818

131,411 (3)

Robert E. Denham

50,120

151,322 (3)

Edward E. Hagenlocker

58,493

143,358 (3)

Jean-Pierre Halbron (2)

53,469

47,250

Lady Sylvia Jay

51,794

-

Karl J. Krapek

50,120

135,393 (3)

Daniel Lebègue

50,120

59,708

Henry B. Schacht

53,469

131,411 (3)

Jean-Cyril Spinetta

38,397

-

Observers’ fees (in euros)

2007

2006

Thierry de Loppinot

50,000

47,250

Jean-Pierre Desbois

50,000

-

(1)

Mr. Cornu also received a total of €57,775 in respect of his position as Director of certain companies of the Group.

(2)

Mr. Halbron also received €3,118 in respect of his position as Director of Electro Banque, a Group subsidiary.

(3)

Total amount of Directors’ fees paid by Lucent Technologies Inc. in 2006 (exchange rate €1.00 = $1.2556).

With the exception of the payments made to the Chief Executive Officer and to the Chairman of the Board of directors explained below, the remuneration specified in the above table represents the only fees we paid to the Directors during fiscal year 2007.





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Compensation of the Chairman and senior executives

Chairman of the Board of directors

Mr. Tchuruk does not receive any specific  remuneration for his duties as Chairman of the Board, other than Director’s fees amounting proportionately to twice the amount of the Directors’ fees due to each of the other Directors (see the table above concerning directors’ fees).

As Mr. Tchuruk‘s duties as Chief Executive Officer ended on November 30, 2006, he has not been entitled to any further compensation in respect of this position since that date.

In June 2007 Mr. Tchuruk received the variable portion of his remuneration due in respect of his duties as Chief Executive Officer for the first 11 months of 2006, which amounted to €244,544, as compared to a variable portion of € 1,105,255 paid in June 2006 in respect of fiscal year 2005. The amount of €244,544 was determined by applying the same criteria as those applicable to all senior executives for fiscal year 2006: based 30% on consolidated revenue (as defined under IFRS standards), 40% on the net profit after minority interests, and 30% on net change in free cash flow, each measured on a pro forma basis with a consolidation perimeter including the Alcatel Group without giving effect to the business combination with Lucent or the businesses transferred to Thales.

In addition, Mr. Tchuruk benefits from a company car with a driver and the services of a secretary. The company has no other commitments towards him.

Chief Executive Officer

The annual compensation of the Chief Executive Officer, like that of all of the Group’s executives, consists of a fixed part and a variable component. It is decided, upon the proposal of the Compensation Committee, by the Board of directors. The variable portion set each year by the Board takes into account the prospects for development and the results for the Group for the following year, according to specified stable criteria. It is paid during the year following the fiscal year to which it relates.

Remuneration in 2007

The total gross remuneration paid to Ms. Russo in respect of her duties as Chief Executive Officer of the company for fiscal year 2007 was €1,652,237 plus benefits in kind valued at €164,480.

The gross fixed annual remuneration of the Chief Executive Officer amounted to €1.2 million.

The rules regarding the remuneration of the Group’s Chief Executive Officer, effective beginning January 1, 2007, were defined by the Board of directors on November 30, 2006.

The variable remuneration received by Ms. Russo in 2007 in respect of her duties as Chief Executive Officer of Lucent for the period from October to December 2006 amounted to €344,284 (representing about 26% of Ms. Russo’s target bonus).

The criteria fixed by the Leadership Development and Compensation Committee of Lucent were based on Lucent’s operating income and revenue and on individual performances. The three-month period of October 1 through December 31, 2006 included two months of Lucent's 2007 fiscal year (October and November) before the closing of the business combination and one month of Alcatel-Lucent's 2006 fiscal year (December) after the closing of the business combination.


Payments made to the Chief Executive Officer
(in euros) (1)

2007

2006

2005

Fixed remuneration

1,200,000

955,718

955,718

Variable remuneration

344,284

527,238

1,553,042

Long-term incentive plan (2)

-

371,668

2,266,114

Other remuneration (3)

107,953

25,327

41,904

Benefits in kind

164,480

14,595

60,389

(1)

2005-2006 exchange rate €1.00 = $1.2556; 2007 exchange rate €1.00 = $1.37096.

(2)

These amounts reflect cash payments in respect of the long-term incentive plans that became due in 2005 and 2006 for the CEO. A portion of the incentive payment for each of these performance cycles was paid to Ms. Russo in the form of restricted stock units. These long-term incentive plans were closed on the effective date of the business combination between historical Alcatel and Lucent for all of the employees concerned (for further information, see Alcatel’s Prospectus approved by the AMF under reference No. 06-287 on August 7, 2006).

(3)

This amount corresponds essentially to an adjustment to take into account social security payments in France.


Remuneration in 2008

The gross annual fixed compensation of the Chief Executive Officer for 2008 remains unchanged,  at €1.2 million.

The variable remuneration to be paid to our Chief Executive Officer in 2008, for fiscal year 2007, is based on the same criteria that apply to all of the senior executives as well as to a large portion of the executives of the Group.

As decided by the Board of directors on March 28, 2007, this amount is based on the Group achieving targets for consolidated revenue, operating profit and net change in free cash flow, each of such criteria counting for 50%, 25% and 25%, respectively, in the calculation of the variable remuneration.

On March 25, 2008 the Board of directors set the gross amount of the variable compensation to be paid to Ms. Russo at €635,400 for fiscal year 2007, representing 35.3% of the target bonus.



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Concerning the variable compensation of the Chief Executive Officer for fiscal year 2008, at the same meeting the Board of directors set the same criteria for the CEO as those applicable to all of the senior executives as well as to a large portion of the executives of the Group. These criteria relate to the Group’s consolidated revenue and operating profit, counting for 40% and 60%, respectively, in the calculation of the variable remuneration. The target bonus for our Chief Executive Officer is 150% of her annual fixed compensation. This percentage remains unchanged from fiscal years 2006 and 2007.

The Chief Executive Officer also receives reimbursement of part of her housing expenses in Paris, as well as a company car with a driver.

Commitment made to the Chief Executive Officer in the event of termination

The provisions of the Officer Severance Policy that applied to Ms. Russo in the event of termination of her position as Chief Executive Officer of Lucent were reaffirmed by our Board of directors on November 30, 2006.

This Officer Severance Policy applies to certain executives of Lucent in the event of dismissal without cause or, following a change of control, resignation for good reason, each as defined in the Policy.

More specifically, the Policy provides for maintaining the fixed remuneration for a two-year period referred to as the “continuation period”, and for the payment in December for each of the two years occurring during the continuation period, of a bonus equal to the target amount of her variable remuneration, as well as for the accelerated vesting of her stock options. The continuation period and the corresponding payments are taken into account when determining the age, years of service and remuneration for purposes of pension benefits. The various employment benefits, pension benefits and benefits in kind provided also continue during this period.

These provisions were approved at the General Meeting of Shareholders on June 1, 2007 in the context of the procedure concerning regulated agreements.

Consistent with the procedure applicable to regulated agreements, the Board of directors, at its meeting held on March 25, 2008, took the necessary steps to conform the company’s commitments to our Chief Executive Officer to the new rules governing undertakings related to the termination of the duties of a chief executive officer. Accordingly, it decided that the severance provisions as referred to above be made subject, effective as of January 1, 2009 to the condition that, over the period from that date until her termination, at least 90% of the performance target in respect of revenue or 75% of the performance target in respect of operating profit, as set by the Board of directors for entitlement of our Chief Executive Officer to variable compensation (which must be the same targets as those applicable to approximately 75% of the employees of the company) shall have been met.

The above decision will remain in effect until the expiry of the Chief Executive Officer’s current term of office. It will be submitted at the next Shareholders Meeting on May 30, 2008, for ratification in accordance with law.

Other benefits and long-term incentive compensation

In addition, the Chief Executive Officer is entitled to the same benefits as those applicable to a great part of Lucent’s employees, calculated with respect to most benefits, on the basis of the annual fixed and variable compensation from the Group.

These benefits include the Lucent pension plan and the disability insurance programs. Ms. Russo also benefits from life insurance.

Pursuant to her employment contract concluded with Lucent in 2002, Ms. Russo is entitled to a retirement benefit equal to the greater of U.S.$ 740,000 per year, or the amount that would be allocated to her under the Alcatel-Lucent Retirement Income Plan which provides general coverage for most of management employees of Lucent Technologies Inc. Under this pension plan, each participant hired prior to January 1, 1999, like Ms. Russo, receives an amount equal to 1.4% of the sum of (a) the average annual remuneration of the beneficiary over the five-year period ending on December 31, 1998 (excluding the variable compensation paid in December 1997) multiplied by the number of years of service at that date, (b) the remuneration received by the participant after 1998 and (c) the variable part of his/her pay received in December 1997. The average annual remuneration includes both fixed and variable components of the remuneration (excluding benefits in kind) which for Ms. Russo covers all of the amounts received from our Group.

In addition, pursuant to a commitment made on November 30, 2006, the Board of directors will award during the third quarter of 2008 a maximum of 278,000 bonus shares to our Chief Executive Officer based on performance criteria relating to the company’s revenues, operating profit, achievement of synergies and operating expenses in 2007 and the first half of 2008, as determined beforehand by the Compensation Committee and approved by the Board at its meeting of April 4, 2008. The award of these shares will become definitive at the expiry of a period of four years, and will be subject to the obligation to retain the Alcatel-Lucent shares resulting from the exercise of stock options and bonus shares (see below Section 7.5, “Stock options and other securities held by directors and senior executives”).



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Finally, the Board also decided at its meeting of April 4, 2008 to award up to 366,300 “Restricted Cash Units” (RCUs) to our Chief Executive Officer if certain criteria are met over the two-year period following the Board’s decision. Each of these RCUs will give right to an amount of cash corresponding to the average price of the Alcatel-Lucent share over a period of twenty trading days before the date of the vesting. Vesting will be subject to the presence of our Chief Executive Officer at Alcatel-Lucent for  a period of two years expiring April 3, 2010, and to the average opening price of the Alcatel-Lucent share over a twenty trading day period having equalled or exceeded a target level in the course of the same two-year period, according to the following scale:

·

if the average price is equal to or above €6, 25% of the RCUs will vest;

·

if the average price is equal to or above €7.25, 50% of the RCUs will vest;

·

if the average price is equal to or above €8.5, 100% of RCUs will vest.

Senior management

The total amount of the gross remuneration and benefits paid in 2007 to the senior management, the members of which are mentioned below, excluding extraordinary items, amounted to €8.5 million (compared to a total of €12.1 million in 2006), the fixed portion of which came to €4.1 million.

Extraordinary items (severance pay resulting from contractual commitments) relating to the senior executives amounted to €6.8 million for fiscal year 2007 (compared to a total of €7.5 million in 2006).

The total amount of the remuneration paid to the senior management in 2007 includes a fixed portion and a variable portion based on the company’s performance and on their individual performance, pursuant to criteria reviewed by the Compensation Committee:

·

the fixed portion includes in addition the benefits in kind and, where applicable, the expatriation premium and housing allowances for expatriates;

·

the variable portion, to which are added the retention bonuses, is linked for fiscal year 2006 to the consolidated revenue, the net profit after minority interests, and to the net change in the free cash flow.

The figures above are based on the information included in Note 32 to the consolidated financial statements included elsewhere in this document. In accordance with IAS 24, that Note encompasses the remuneration to the members of the Management Committee and to the members of the Board of directors. However the figures above only include the remuneration of the Management Committee and of the Chairman of the Board of directors (but in this case only to the extent of the variable portion paid in 2007 for fiscal year 2006, representing €244,544).

Only members of the Management Committee who were members between January 1 and December 31, 2007 are covered by this information, that is, a total of 11 individuals (compared to 15 individuals in 2006).

The remuneration taken into account is calculated pro rata temporis for the period during which the executive was a member of the Management Committee:

·

the members of the Management Committee from January 1 through October 30, 2007: Ms. Patricia Russo, Mr. Jean-Pascal Beaufret, Mr. Frank D’Amelio, Mr. Étienne Fouques, Ms. Claire Pedini, Mr. Michael Quigley;

·

the members of the Management Committee from October 31, 2007 to December 31, 2007: Ms. Patricia Russo, Ms. Cindy Christy, Mr. Étienne Fouques, Mr. John Meyer, Ms. Claire Pedini, Mr. Hubert de Pesquidoux, Mr. Michel Rahier and Mr. Frédéric Rose.

The variable portion of the salary to be paid in 2008 in respect of fiscal year 2007 is based on the consolidated revenue, operating profit and net change in free cash flow.

The Directors’ fees received by the senior managers for their participation in meetings of the Board of directors of Group companies, if any, are deducted from the total remuneration paid.



Pension and other benefits

Pension plans for the CEO and certain Directors

As mentioned earlier, Ms. Russo is covered by the Lucent Retirement Income Plan.

Certain Directors who were or are part of the management of the company, benefit from the private pension plan applicable to the senior executives of the Group, who represent approximately 80 executives. Such executives are employees of Alcatel-Lucent or of its French subsidiaries which are owned more than 50% by Alcatel-Lucent and which are members of this plan.

This defined benefit scheme set up in 1976 supplements, for each beneficiary, the private plan of the French General Association of Pensions Institutions for Managerial Staff (AGIRC), offering benefits exceeding the upper limit provided for by that plan, according to a system and method of calculation similar to those of the AGIRC plan.

The Group is bound by a contract with an insurance company funded by Alcatel-Lucent as from the time of settlement for each beneficiary (which normally occurs at the age of 65) and within the limit of the pension obligations.

Except for the contractual commitments described above, we have no commitments towards the Directors or the CEO that constitute remuneration, allowances or benefits due or likely to be due on account of termination or change of duties, subsequent to such termination or change of duties.



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Amount reserved for pension and other benefits

The aggregate amount of the benefit obligation related to pension or similar benefits for our Directors and our Management Committee as a group, at December 31, 2007 was €40.2 million (compared to €53.1 million in 2006).

Of this amount, €28.1 million relate to the Directors and the Chief Executive Officer (compared to €33.5 million in 2006) and €12.1 million relate to the members of the Management Committee (compared to €19.6 million in 2006).

The corresponding amount of pension reserve accounted for due to these covenants made for the benefit of the members of the Board of directors and of the Management Committee of our company, taking into account plan assets, amounted to €12.0 million as of December 31, 2007.



7.5

STOCK OPTIONS AND OTHER SECURITIES HELD BY DIRECTORS AND SENIOR EXECUTIVES

OPTIONS GRANTED IN 2007

Beneficiaries

Plan

Average
exercise price (€)

Number

Expiration date

S. Tchuruk

-

-

-

-

P.F. Russo

Alcatel-Lucent Plan

9.10

800,000

2015

Management Committee (1)

Alcatel-Lucent Plans

8.89

2,740,000

2015

OPTIONS AND OTHER INSTRUMENTS EXERCISED IN 2007

Beneficiaries

Plan

Average
exercise price (€)

Number

Expiration date

S. Tchuruk

-

-

-

-

P.F. Russo

Lucent RSU (3)

-

42,347

-

Management Committee (1)

Alcatel Plans

6.70

70,028

2011

 

Lucent RSU

-

33,641

-




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OPTIONS AND OTHER INSTRUMENTS OUTSTANDING  AS OF JANUARY 1, 2008

Beneficiaries

Plan

Average
exercise price (€)

Number

Expiration date

S. Tchuruk

Alcatel Plans

22.02

1,300,000

2009-2012

P.F. Russo

Alcatel-Lucent Plan

9.10

800,000

2015

 

Lucent Plans

33.35

3,260,566

2008-2013

 

Lucent RSU

-

73,913

 

J. Cornu

Alcatel Plan

50.00

30,000

2009

R.E. Denham

Lucent Plans

11.23

2,082

2012-2013

E.E. Hagenlocker

Lucent Plans

9.39

976

2013

J.P. Halbron

Alcatel Plan

50.00

200,000

2009

K.J. Krapek

Lucent Plans

7.05

976

2013

H.B. Schacht

Lucent Plans

63.40

395,863

2009-2013

Management Committee (2)

Alcatel Plans 2000-2007

11.75

3,171,228

2008-2015

 

Lucent Plans

10.74

1,310,279

2008-2013

 

Lucent RSU

 

55,736

 

(1)

Members present between January 1, and December 31, 2007, not including Ms. Russo.

(2)

Members on January 1, 2008, not comprising Ms. Russo.

(3)

Each restricted stock unit entitles the holder to one Alcatel-Lucent share.

ALCATEL-LUCENT SECURITIES OWNED AT DECEMBER 31, 2007 (1)

Holders

Alcatel-Lucent shares

ADSs

FCP 2AL units (4)

Total

Percentage of share capital

Board of directors (2)

434,284

879,201

11,825

1,325,310

0.05

Management Committee (3)

46

49,167

4,245

53,458

0.01

TOTAL

434,330

928,368

16,070

1,378,768

0.06

(1)

See details regarding the directors’ holding in Section 7.1.

(2)

Including two observers and Ms. Russo.

(3)

Excluding Ms. Russo.

(4)

Part in the mutual fund FCP 2AL.


During fiscal year 2007, we were not notified by the Directors of any transactions in Alcatel-Lucent securities.

Obligation to retain the Alcatel-Lucent shares resulting from the exercise of stock options and bonus shares

Simultaneously with the grant of options approved in 2007 to the employees and senior executives of the Group, the Board of directors imposed new obligations on the Chief Executive Officer, in accordance with the requirements under French law applicable to the Chairman, the CEO and the executive vice-presidents of a company (mandataires sociaux).

The Chief Executive Officer must retain in a registered account a portion of the shares issued either upon the exercise of options allocated to her or upon the definitive acquisition of rights over bonus shares until the end of her term as Chief Executive Officer. The number of shares to be held in this restricted account must be equal in value to 40% of the capital gains recognized upon exercise of the options, net of tax, any other mandatory deductions and the value of any shares used in a cashless exercise of such options.

These provisions apply to the 800,000 options granted to the Chief Executive Officer on April 4, 2008, and will apply to the bonus shares, if any, which may be awarded during the third quarter of 2008 (see paragraph “Other benefits and long-term incentive compensation” above).

However, if the value of all of the shares of Alcatel-Lucent held by our Chief Executive Officer exceeds her fixed and variable annual remuneration (assuming 100% of the target for the year preceding the exercise of the options and/or the definitive acquisition of rights over bonus shares), this obligation to hold shares in a restricted account will be suspended.

The Chief Executive Officer is the only person subject to this obligation to retain shares.

Valuation of the options granted in 2007 to the Chief Executive Officer

Options granted to Ms. Russo in 2007 have been valued in the financial statements included elsewhere herein on the basis of a value of €3.01 per share. This value results from theorical computations. In fact, gains actually realized will depend on the share price on the date on which the shares issued upon exercise of options are sold.





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7.6

STATEMENT OF BUSINESS PRINCIPLES

Our Statement on Business Principles is a code of conduct that defines our vision of appropriate business behavior. It covers many areas, from business ethics and corporate governance to human rights and environmental concerns. Our Statement of Business Principles provides that our policy is to conduct our worldwide operations in accordance with the highest business ethical standards, to comply with the laws of the countries in which we operate and to be a good corporate citizen.

In 2006, we established the position of Chief Compliance Officer. The Chief Compliance Officer is charged with overseeing regulatory compliance according to applicable international laws and standards and our corporate governance and business practices.

We also established a Compliance Council to, among other things, ensure our compliance with the Statement of Business Principles.



7.7

REGULATED AGREEMENTS AND COMMITMENTS, AND RELATED PARTY TRANSACTIONS

“Regulated” agreements under French law are agreements made between a company and either of its CEO, an Executive Vice President, a director or a shareholder who owns more than 10% of the voting rights which, while authorized by French law, do not involve transactions in the ordinary course entered into under normal terms and conditions.

These agreements, as well as any new commitment made to senior executives in the event of termination of their duties, must be authorized in advance by the Board of directors through a specific legal procedure, must be the subject of a special Statutory Auditors’ report and must be presented for consultation to the Shareholders’ Meeting.

Related party agreements and transactions (under U.S. law) include, among others, agreements entered into with the company’s directors and senior executives, shareholders who hold more than 5% of the company’s capital, or these individuals’ close family members. They are not subject to the prior authorization procedure required by French law, unless they fall under the regulation applicable to regulated agreements.



Regulated agreements and commitments of our Group

We did not enter into any regulated agreements during 2007. Two regulated agreements that had previously been approved by this procedure in prior years continued in 2007.

The list of regulated agreements, which is available to shareholders at our registered office, does not include any agreement that is likely to have a significant impact on our financial position.

Agreements entered into with Thales

The agreements signed in December 2006 and which became effective in January 2007 replaced existing agreements entered into in 1998-1999. They are the following:

·

a memorandum of understanding with Groupe Industriel Marcel Dassault (GIMD), TSA and Thales, terminating the 1998 and 1999 shareholders’ agreements;

·

a new shareholders’ agreement with TSA;

·

an agreement with the French government on the protection of the national strategic interests in Thales;

·

a cooperation agreement with Thales and TSA; and

·

a “Master Agreement” with Alcatel-Lucent Participations, our subidiary, and Thales concerning the transfer to Thales of our assets in space activities, railway signals and safety systems.

For more information on these agreements, see Material contracts in Section 4.5 of this annual report.



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Assistance provided to subsidiaries

Although the agreements involved are not, strictly speaking, covered by article L. 225-38 of the French Commercial Code (concerning regulated agreements), our Board of directors authorized the contribution by the companies of the Group to the Research and Development and industrial property costs. The sums owed are paid in full to Alcatel-Lucent, and Alcatel-Lucent distributes them among our subsidiaries based on their financing requirements.

For fiscal year 2007, the amounts received by Alcatel-Lucent totaled €657,613,367.17 and the amounts owed by Alcatel-Lucent to its subsidiaries totaled €639,055,357.85.



Conformity of agreement

Consistent with the procedure applicable to regulated agreements, the Board of Directors, at its meeting held on March 25, 2008, took the necessary steps to conform our commitment to our Chief Executive Officer to new French rules governing undertakings related to the termination of the duties of a chief executive officer.

The provisions are described in Section 7.4, “Compensation”.



Related party transactions

There are no agreements between the company and any shareholder who holds more than 5% of the company’s capital.

Details about related party transactions, as defined by IAS 24, entered into by the Group’s companies in 2005, 2006 and 2007 are presented in Note 32, “Transactions with related parties”, to the consolidated financial statements included elsewhere in this document.

These transactions mainly concern jointly controlled entities (consolidated using proportionate consolidation) and companies consolidated using the equity method.




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8

INFORMATION CONCERNING OUR CAPITAL



8.1

SHARE CAPITAL AND VOTING RIGHTS

Our capital at December 31, 2007 was €4,634,882,840, represented by 2,317,441,420 shares, each with a par value of €2.

The total number of voting rights, as published by Alcatel-Lucent, was 2,351,256,934 at December 31, 2007 (including the treasury stock held by the parent company and by its subsidiaries).

To allow shareholders to determine whether they have exceeded an ownership threshold, we post the total number of voting rights monthly on our website. For the discussion of ownership thresholds, see Section 10.2, “Specific provisions of the Articles of Association and of Law.”

Information on voting rights, which is considered Regulated Information under the general rules of the AMF, may be reviewed at the following address: www.alcatel-lucent.com, under “Shareholders and Investors” and then “Regulated Information”.



8.2

DILUTED CAPITAL


 

Total number of shares

Capital at December 31, 2007

2,317,441,420

Alcatel-Lucent stock options

148,618,289

ORANE notes

1,919,130

4.75% OCEANE June 2003

63,192,019

Convertible bonds*

33,139,094

Convertible debt securities issued by Lucent Technologies Inc.

146,600,693

Diluted capital at December 31, 2007**

2,710,910,645

*

The number of convertible bonds was reduced from 56,260,251 to 33,139,094 to take into account the cancellation of stock options during the year.

**

For a description of the dilutive instruments, see the Section 8.6, “Outstanding instruments giving right to shares”.





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8.3

AUTHORIZATIONS CONCERNING OUR CAPITAL

Currently, we have the following authorizations to issue capital, which authorizations were approved at our Shareholders’ Meetings on May 20, 2005 and June 1, 2007:




At December 31, 2007

Expiration date

Total duration

Maximum authorized amount

Use

I. Issues with pre-emptive rights

    

Shares or convertible bonds with pre-emptive rights including increase by capitalization of reserves created as permitted by French law

8/1/2009

26 months

20% of the capital, representing approximately €920 million or 460 million shares


€6,000 million in debt securities

None

II. Issues without pre-emptive rights

    

Shares or convertible bonds issue without pre-emptive rights

8/1/2009

26 months

5% of the capital, representing approximately €230 million or 115 million shares


€6,000 million in debt securities

None

     

Issue of securities in consideration of contributions in kind

8/1/2009

26 months

10% of the capital representing approximately 230 million shares

None

Overall limitation for issuances pursuant to I and II

for ordinary shares

€920 million
or 460 million shares

None

for debt securities

€6,000 million

None

III. Issues reserved for employees

    

Share issue reserved for members of an employee savings plan

8/1/2009

26 months

3% of the capital

None

Stock options (price without discount)

7/20/2008

38 months

6% of the capital and in any event, the number of outstanding Alcatel-Lucent options must be less than 12% of the total number of shares

2.54%

Bonus shares

12/1/2008

18 months

1% of the capital

None

IV. Share repurchase program

    

Share repurchase

12/1/2008

18 months

10% of the capital

None

Share cancellation

12/1/2008

18 months

10% of the capital

None



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8.4

CHANGES IN OUR CAPITAL OVER THE LAST FIVE YEARS

Type of transaction

Number of shares

Amount of capital (in euros)

Share premium
(in euros)

A shares

O shares(1)

Capital at 12/31/2002

1,239,193,498

25,515,000

2,529,416,996

21,601,843,469.99

Stock options exercised

108,632

  

619,778.80

Redemption of Deborah Acquisition bonds:

    

– acquisition of iMagic TV Inc.

 

485,000

 

2,379,410.00

Redemption into historical Alcatel shares of bonds issued by Coralec in the context of the following transactions:

    

– acquisition of iMagic TV Inc.

3,531,332

  

19,210,446.08

– acquisition of TiMetra Inc.

15,534,934

  

94,452,398.72

– acquisition of Astral Point Communications Inc.

40,000

  

576,400.00

Redemption of historical Alcatel 7.917% bonds

1,828

  

6,105.52

Conversion of category O shares into ordinary shares

26,000,000

(26,000,000)

  

Capital at 12/31/2003

1,284,410,224

 

2,568,820,448

21,719,088,009.11

 

Ordinary shares

  

Stock options exercised

1,508,728

 

3,017,456

6,856,478.00

Redemption into historical Alcatel shares of bonds issued by Coralec in the context of the following transactions:

    

– acquisition of Astral Point Communications Inc.

300,000

 

600,000

4,323,000.00

– acquisition of Telera Inc.

400,000

 

800,000

1,304,000.00

– acquisition of iMagic TV Inc.

50,000

 

100,000

272,000.00

– acquisition of TiMetra Inc.

1,000,000

 

2,000,000

6,080,000.00

– acquisition of Spatial Wireless

17,783,297

 

35,566,594

176,268,039.86

Redemption of historical Alcatel 7.917% bonds

3,212

 

6,424

10,728.08

Losses charged against additional paid-in capital

   

(14,156,675,224.11)

Capital at 12/31/2004

1,305,455,461

 

2,610,910,922

7,757,527,030.92

Stock options exercised

1,855,913

 

3,711,826

8,316,745.80

Redemption into historical Alcatel shares of bonds issued by Coralec in the context of the following transactions:

    

– acquisition of iMagic TV Inc.

50,000

 

100,000

272,000.00

– acquisition of Spatial Wireless

400,000

 

800,000

3,964,800.00

Redemption of historical Alcatel 7.917% bonds

120,780,266

 

241,560,532

403,406,088.44

Capital at 12/31/2005

1,428,541,640

 

2,857,083,280

8,173,486,665.15

Stock options exercised

2,697,886

 

5,395,772

13,528,427.68

Redemption into historical Alcatel shares of bonds issued by Coralec in the context of the acquisition of Spatial Wireless

300,000

 

600,000

2,973,600

Issue of Alcatel-Lucent shares in a number equivalent to the number of Alcatel ADSs granted to shareholders of Lucent Technologies Inc. in connection with the business combination with the latter

878,139,615

 

1,756,279,230

7,163,619,258.40(2)

Capital at 12/31/2006

2,309,679,141

 

4,619,358,282

15,353,607,951.24

Allocation of expenses related to the business combination with Lucent

   

86,523.34

Stock options exercised

2,726,675

 

5,453,350

13,262,790.90

Exercise of warrants issued by Lucent Technologies Inc.

28,612

 

57,224

224,468.53

Convertible securities issued by Lucent Technologies Inc.

4,506,992

 

9,013,984

36,236,215.68

Redemption into Alcatel-Lucent shares of bonds issued by Coralec in the context of the acquisition of TiMetra Inc. transactions:

500,000

 

1,000,000

3,040,000

Capital at 12/31/2007

2,317,441,420

 

4,634,882,840

15,406,457,949.69

(1)

The shares comprising the capital are shares of a single class since the decision at the Shareholders’ Meeting of April 17, 2003, which approved the conversion of the Class O shares into Alcatel’s ordinary shares and ADSs, as applicable.

(2)

This amount takes into account the expenses related to the business combination.





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8.5

PURCHASES OF ALCATEL-LUCENT SHARES BY THE COMPANY

In 2007, we did not effect any transactions pursuant to our share repurchase program. At December 31, 2007, the number of shares held directly by Alcatel-Lucent was 25,343,255, representing 1.09% of the capital. At that date, our subsidiaries held shares representing 1.43% of our capital. At December 31, 2007, these shares were booked as a deduction from consolidated shareholders’ equity.

The Combined Shareholders’ Meeting of June 1, 2007 authorized the Board of directors (or pensions delegated under French  law) to repurchase Alcatel-Lucent shares up to a maximum of 10% of the capital of the company. This authorization would expire in 18 months.

The maximum purchase price per share may not exceed €40 and the minimum selling price per share may not be less than €2. This program has not been implemented.

At its meeting of March 25, 2008, the Board of directors proposed a resolution to be voted upon at our next Shareholders’ Meeting, to be held on May 30, 2008, that the existing authorization for a share repurchase program to be cancelled and that a new authorization for an 18-month repurchase program be established.

Description of the repurchase program pursuant to Articles 241-1 and following of the AMF rules

Date of the Shareholders’ Meeting authorizing the program

The purchase by the company of its own shares will be submitted for approval at the Combined Shareholders’ Meeting on May 30, 2008.

Number of shares and percentage of capital held directly or indirectly by the company

At February 29, 2008, the company held 25,343,255 shares directly and 33,043,651 shares indirectly.

Goals of the repurchase program

The goals of the repurchase program are:

·

to cancel shares by means of a capital reduction within the limits prescribed by law and in accordance with the authorization to be submitted for approval at the Shareholders’ Meeting to be held on May 30, 2008;

·

to use the shares in fulfilling grants of stock or options to the Group’s employees, directors and CEO under the terms and conditions prescribed by law (stock options, employee profit-sharing plans, bonus shares, etc.);

·

to comply with obligations related to the issue of securities giving access to our capital;

·

to hold the shares and, at a later stage, to deliver such shares in exchange or as payment, including in connection with external growth transactions pursued by the company;

·

to ensure the liquidity of Alcatel-Lucent’s shares and stimulate the secondary market of the shares through a liquidity contract made with an investment service provider which complies with an ethics charter recognized by the AMF; and

·

to implement of any market practice that may come to be recognized by the AMF, and more generally, any transaction that complies with current regulations.

Repurchase terms and conditions

Shares may, at any time and within the limits of the regulations in force, be purchased, sold, exchanged or transferred, whether on the market, privately or otherwise, by any means, including in particular by transfers of blocks, options transactions or the use of derivative instruments.

Maximum share of capital, maximum number and characteristics of shares, maximum purchase price

The program concerns the shares of Alcatel-Lucent (ISIN FR 0000130007) listed on the Euronext Paris stock exchange – Compartment A.



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The maximum percentage that may be purchased under the authorization to be proposed at the Combined Shareholders’ Meeting of May 30, 2008 is 10% of the total number of shares comprising the capital on the date of purchase. In view of the number of shares that comprise our capital at December 31, 2007, this limit represents 231,744,142 shares or, based on the maximum authorized purchase price, a maximum theoretical amount of €4,634,882,840, not including the shares already held by the company.

The maximum purchase price per share is set at €20.

Duration of the program

In accordance with the resolution to be submitted for approval to the Combined Shareholders’ Meeting of May 30, 2008, the share repurchase program would be implemented over a period of 18 months following the date of this meeting and would therefore expire on December 1, 2009.



8.6

OUTSTANDING INSTRUMENTS GIVING RIGHT TO SHARES



Warrants and convertible debt securities issued by Lucent Technologies Inc.

Warrants

In 2004, as part of the settlement of a lawsuit involving a securities class action, Lucent Technologies Inc. issued to the plaintiffs warrants entitling holders to purchase shares of Lucent Technologies Inc.

As of the date of the business combination between Lucent Technologies Inc. and historical Alcatel, these warrants entitled holders to a total of 38,907,871 Alcatel-Lucent shares.

In 2007, 28,612 Alcatel-Lucent shares were issued pursuant to these warrants, based on a unit conversion price of U.S.$ 14.09.

These warrants expired on December 10, 2007, so no warrants were outstanding at December 31, 2007.

Convertible bonds

Lucent Technologies Inc. had also issued debt securities convertible into Lucent Technologies Inc. shares. As of the date of the business combination between historical Alcatel and Lucent, in accordance with the Board of directors’ decision of November 30, 2006, these securities entitled holders to:

·

44,463,075 Alcatel-Lucent shares, concerning the 7.75% convertible bonds maturing on March 15, 2017;

·

43,832,325 Alcatel-Lucent shares, concerning the 2.75% Series A convertible bonds maturing on June 15, 2023;

·

55,087,690 Alcatel-Lucent shares, concerning the 2.75% Series B convertible bonds maturing on June 15, 2025; and

·

15,988,842 Alcatel-Lucent shares, concerning the 8% subordinated convertible bonds maturing on August 1, 2031.

The unit price of the Alcatel-Lucent shares issued through conversion of the above convertible debt securities is equal to the conversion or exercise price of these securities divided by the exchange ratio set in connection with the business combination between historical Alcatel and Lucent (that is, 0.1952 Alcatel share for one Lucent share), namely:

·

the equivalent in euros, the day of the conversion of U.S.$ 24.80 for the 7.75% convertible bonds;

·

the equivalent in euros, the day of the conversion, of U.S.$ 17.11 for the Series A convertible bonds;

·

the equivalent in euros, the day of the conversion, of U.S.$ 15.98 for the Series B convertible bonds;

·

the equivalent in euros, the day of the conversion, of U.S.$ 30.43 for the 8% subordinated convertible bonds.

On December 14, 2006, we sought the consent of the 2.75% Series A and B convertible bondholders to modify our disclosure requirements. At that time, the interest rate of these bonds was increased from 2.75% to 2.875%, the conversion price was changed to U.S.$ 16.75 for the Series A and U.S.$ 15.35 for the Series B and an additional clause providing for new disclosure requirements was finalized in late December 2006.

In March 2007, the entire 8% convertible bond issue was redeemed early.

At December 31, 2007, €1.925 billion of these convertible bonds were outstanding, giving right to 146,600,693 shares of Alcatel-Lucent.





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Stock options and other stock-based compensation instruments issued by Lucent Technologies Inc.

As part of the business combination with Lucent, we agreed to issue Alcatel-Lucent shares to holders of stock options and other stock-based compensation instruments (restricted stock units, performance shares and Directors’ deferrals) granted by Lucent Technologies Inc., in the event of such holders’ exercise or conversion of the rights attached to their instruments.

As of November 30, 2006, the date of the business combination between historical Alcatel and Lucent, these instruments entitled holders to a total of 311,307,596 common shares of Lucent Technologies Inc.

Consequently, and in accordance with the decision made by our Board of directors on November 30, 2006, acting on the authority granted by the Shareholders’ Meeting of September 7, 2006, Alcatel-Lucent’s Coralec subsidiary issued to Lucent 60,767,243 bonds, each of which may be converted into one Alcatel-Lucent share.

When the Lucent stock options or other stock-based compensation instruments are exercised by their holders, Lucent requests conversion of the corresponding number of convertible bonds and immediately delivers the number of Alcatel-Lucent shares resulting from the conversion to those holders who have exercised their rights.

At December 31, 2007, there was a total of 56,260,251 outstanding bonds convertible into Alcatel-Lucent shares. However only a maximum of 33,139,094 of these bonds may still be converted, given the cancellation of stock options on that same date.

These bonds are not listed on any stock exchange.



Redeemable notes (ORAs)

Issues related to acquisitions

In 2004, we authorized the issuance by our subsidiary Coralec of debt represented by notes redeemable for Alcatel-Lucent shares (ORAs), in order to allow for the acquisition of Spatial Wireless (United States).

In connection with this acquisition, 18,988,334 notes redeemable for Alcatel-Lucent shares were issued to historical Alcatel at a unit price of €11.91. There were no redemptions in 2007 and the number of Alcatel-Lucent shares issued since the issuance of the ORAs to repay these notes is 18,483,297.

In 2003, we authorized the issuance by Coralec of debt represented by notes redeemable for Alcatel-Lucent shares, in order to allow for the acquisition of iMagic TV Inc. (Canada) and TiMetra Ltd. (United States).

In connection with the acquisition of iMagic TV Inc., 3,717,254 notes redeemable for Alcatel-Lucent shares were issued to historical Alcatel at a unit price of €7.44. There were no redemptions in 2007. The number of Alcatel-Lucent shares issued since the issuance of the ORAs to repay these notes is 3,631,332.

In connection with the acquisition of TiMetra Ltd., 17,979,738 notes redeemable for Alcatel-Lucent shares were issued to historical Alcatel at a unit price of €8.08. During 2007, 500,000 shares were issued in exchange for these notes, thus bringing the number of Alcatel-Lucent shares issued since the issuance of these notes to repay the ORAs to 17,034,934.

In 2002, we authorized the issuance by Coralec of debt represented by notes redeemable for Alcatel-Lucent shares, in order to allow for the acquisition of Astral Point Communications Inc. (United States).

In connection with the acquisition of Astral Point Communications Inc., 9,506,763 notes redeemable for Alcatel-Lucent shares were issued to historical Alcatel at a unit price of €16.41. There were no redemptions in 2007 and the number of Alcatel-Lucent shares issued since issuance of the ORAs to repay these notes is 9,123,396.

At December 31, 2007, there was a total of 1,919,130 outstanding notes redeemable for Alcatel-Lucent shares.

These bonds are not listed on any stock exchange.

Issues related to financial transactions

June 2003 OCEANE (bonds convertible into new or existing shares)

In accordance with the authorization granted at our Combined Shareholders’ Meeting of April 17, 2003, on June 12, 2003 historical Alcatel issued debt represented by bonds with a conversion and/or exchange option for new or existing shares. The issue concerned a principal amount of €1.022 billion, represented by 63,192,019 bonds with a unit value of €16.18 each convertible into new or existing Alcatel-Lucent shares.

The bonds, which have a term of seven and a half years, bear an annual interest rate of 4.75%.

The proceeds from this issue were intended primarily for the partial retirement, via a tender offer, of three bond issues maturing in 2004 (5.75% February 2004 and 5% October 2004) and 2005 (5.87% September 2005). Upon completion of this offer, we retired bonds in a nominal amount of €342 million.

At December 31, 2007, there was a total of 63,192,019 outstanding OCEANEs, listed on Euronext Paris.





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Securities not convertible into equity

These securities concern the following two bond issues of Alcatel-Lucent:

·

the 4.375% bond issue in the amount of €805 million (maturing in February 2009) traded on Euronext Paris;

·

the 6.375% bond issue in the amount of €462 million (maturing in April 2014) traded on the Luxembourg Stock Exchange.

At December 31, 2007, these issues were outstanding.




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9

STOCK EXCHANGE AND SHAREHOLDING



9.1

LISTING

Our shares are traded on Eurolist by Euronext, which represents the principal trading market for our ordinary shares. Our ordinary shares have been traded on the Euronext Paris SA since June 3, 1987. In addition to Eurolist, our ordinary shares are also listed on Euronext Amsterdam, Antwerp, Basle, Euronext Brussels, Frankfurt, Geneva, Tokyo and Zurich exchanges, and are quoted on SEAQ (Stock Exchange Automated Quotation) International in London.

Since May 1992, our shares have been listed on The New York Stock Exchange in the form of American Depository Shares (ADSs).

The Bank of New York is the depositary of the ADSs. Each ADS represents one ordinary share.



ISIN Code

Since June 30, 2003, all securities quoted on the Euronext Paris stock market are identified by an International Securities Identification Number (ISIN).

Alcatel-Lucent: FR0000130007.

Mnemo: ALU.



Indexes

Our share is included in the following stock market indexes: CAC 40 and Dj Euro Stoxx 50.




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9.2

TRADING OVER THE LAST FIVE YEARS



Trading on Euronext Paris

The following table sets forth, for the periods indicated, the high and low prices on Euronext Paris SA for our ordinary shares:


 

Price per share in €

High

Low

2003

11.89

4.16

2004

14.82

8.77

2005

11.70

8.14

2006

13.82

8.27

First Quarter

13.49

10.38

Second Quarter

13.82

9.07

Third Quarter

10.10

8.27

Fourth Quarter

11.06

9.30

2007

11.86

4.87

First Quarter

11.86

8.51

Second Quarter

10.71

8.76

Third Quarter

10.73

6.11

Fourth Quarter

7.41

4.87

2007

  

October

7.41

6.36

November

6.67

4.91

December

5.71

4.87

2008

  

First Quarter

5.15

3.24

2008

  

January

5.15

3.83

February

4.43

3.80

March

3.90

3.24



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Trading on The New York Stock Exchange

The following table sets forth, for the periods indicated, the high and low prices on The New York Stock Exchange for our ADSs:


 

Price per share in U.S.$

High

Low

2003

13.68

4.60

2004

18.32

10.76

2005

15.75

10.44

2006

16.51

10.63

First Quarter

16.12

12.68

Second Quarter

16.51

11.56

Third Quarter

12.91

10.63

Fourth Quarter

14.49

11.64

2007

15.43

7.15

First Quarter

15.43

11.41

Second Quarter

14.09

11.71

Third Quarter

14.57

10.10

Fourth Quarter

10.47

7.15

2007

  

October

10.47

9.03

November

9.34

7.28

December

8.31

7.15

2008

  

First Quarter

7.40

5.08

2008

  

January

7.40

5.54

February

6.60

5.84

March

5.92

5.08

9.3

SHAREHOLDER PROFILE



Breakdown of the capital by type of shareholder at December 31, 2007










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Breakdown of the capital by location of record owner at December 31, 2007






*

Source: Capital Bridge.

Number of shares at December 31, 2007: 2,317,441,420.




9.4

BREAKDOWN OF CAPITAL AND VOTING RIGHTS




Situation on December 31, 2007

Shares

% Capital

Voting rights

%

Brandes Investment Partners, L.P. (1)

 237,102,900

10.23

 237,102,900

10.08

Pzena Investment Management (1) (2)

113, 482,400

4.90

113, 482,400

4.83

Tradewinds Global Investors (1) (2)

76,958,800

3.32

76,958,800

3.27

Other institutional investors in France (5)

68, 334,600

2.95

68,334,600

2.91

Fidelity Investments (2) (3)

53,961,100

2.33

53, 961,100

2.29

Caisse des Dépôts et Consignations (CDC) (2)

48, 001,700

2.07

48,288,650

2.05

BT Pension Scheme/Hermès (1) (2)

40,128,584

1.73

40,128,584

1.71

BNP PARIBAS Asset Management (2)

38, 740,100

1.67

38,740,100

1.65

Crédit Agricole Asset Management (2)

36,306,500

1.57

36,306,500

1.54

Mutual Fund FCP 2AL (1)

29,188,686

1.26

54,590,086

2.32

Treasury stock held by the parent company

25,343,255

1.09

-

-

Treasury stock held by the subsidiaries

33,056,313

1.43

-

-

Public

1,516,836,482

65.45

1,583,363,214

67.35

TOTAL

2,317,441,420

100.00

2,351,256,934 

(4)

100.00

(1)

Source: shareholders.

(2)

Source: Alcatel-Lucent (TPI as of at December 31, 2007).

(3)

Fidelity Management & Research (U.S.) and Fidelity International Ltd.

(4)

Total gross number of voting rights, published by Alcatel-Lucent, including the treasury stock held by the parent company and the treasury stock held by the subsidiaries.

(5)

Other institutional investors in France holding more than 1% of the capital.


At December 31, 2007, shareholders benefiting from double voting rights had a total of 67,631,028 votes, representing 2.88% of the voting rights.

The members of the Board of directors and of the Management Committee together held, as of December 31, 2007, 1,362,698 shares of Alcatel-Lucent (including ADSs) and 16,070 parts of FCP 2AL, that is, 0.06% of the capital and the voting rights of Alcatel-Lucent (see details of their holding in Sections 7.1, “Management” and 7.5, “Stock options and other securities held by directors and senior executives”).

As of December 31, 2007, to our knowledge, there is no shareholder other than Brandes Investment Partners, LP, who holds more than 5% of our capital.

At April 4, 2008, to our knowledge, there are no shareholders' agreements or agreements concerning our shares which, if implemented at a later date, would have an impact on the control of the company.



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Pledges of Alcatel-Lucent Shares

At December 31, 2007, 4,092 Alcatel-Lucent shares, held by a total of 27 shareholders in registered form, both directly and through an administered account, were the subject of a pledge.

Share ownership thresholds

During 2007 and through March 25, 2008, a certain number of shareholders and registered intermediaries acting primarily on behalf of their customers, informed us of declarations concerning the reaching of the following legal and statutory thresholds:


Date on which the threshold was reached

Trend

% capital

% voting rights

Declaring company

March 28, 2007

Decrease

4.74

4.67

FMR Corp. & Fidelity International (1)

April 19, 2007

Increase

10.00

9.86

Brandes Investment Partners (2)

July 2, 2007

Increase

2.56

2.51

Natixis Asset Management

August 17, 2007

Increase

4.34

4.26

Pzena Investment Management LLC

November 13, 2007

Increase

5.04

4.95

Pzena Investment Management LLC

January 10, 2008

Increase

2.00

NC (3)

BT Pension Scheme/Hermès

February 15, 2008

Increase

5.01

3.50

T. Rowe Price Group, Inc. (4)

March 3, 2008

Increase

5.32

5.25

Pzena Investment Management LLC (5)

(1)

Notice to AMF n° 207C0592.

(2)

Notice to AMF n° 207C0720 including the declaration of intent of Brandes Investment Partners.

(3)

Not communicated.

(4)

Notice to AMF n° 208C0376, T. Rowe Price Group, Inc. also declared that it holds 90,575 of 7.75% convertible bonds giving right to 3,652,889 shares of Alcatel-Lucent.

(5)

Notice to AMF n° 208C0428.


Pursuant to article L. 233-7 of the French Commercial Code, Brandes Investment Partners declared, on April 19, 2007, that it acquired Alcatel-Lucent shares solely for its customers for investment purposes, that it did not intend to request that it be named to the Board of directors and that it was not acting in concert with another party.



9.5

CHANGES IN SHAREHOLDING OVER THE LAST THREE YEARS



Situation on December 31,

2007

2006

2005

(In %)

% Capital

% Voting rights

% Capital

% Voting rights

% Capital

% Voting rights

Brandes Investment Partners, L.P.

10.23

10.08

9.75

9.86

10.67

10.88

Pzena Investment Management

4.90

4.83

NC (1)

NC

NC

NC

Tradewinds Global Investors

3.32

3.27

NC

NC

NC

NC

Other institutional investors in France

2.95

2.91

NC

NC

NC

NC

Fidelity

2.33

2.29

5.22

5.27

NC

NC

Caisse des Dépôts et Consignations (CDC)

2.07

2.05

2.08

2.11

4.12

4.22

BT Pension Scheme/Hermès

1.73

1.71

NC

NC

NC

NC

BNP Paribas Asset Management

1.67

1.65

0.44

0.44

NC

NC

Crédit Agricole Asset Management

1.57

1.54

2.74

2.77

NC

NC

FCP 2AL

1.26

2.32

1.23

2.34

1.89

3.14

Treasury stock held by parent company

1.09

N/A

1.10

N/A

1.77

N/A

Treasury stock held by subsidiaries

1.43

N/A

1.45

N/A

2.35

N/A

Public

65.45

67.35

75.99

77.21

79.20

81.76

TOTAL

100

100

100

100

100

100

(1)

In this table, NC means “non communicated”.



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9.6

SHAREHOLDERS’ GENERAL MEETING

The most recent Shareholders’ Meeting was held on June 1, 2007, the date for which it was initially convened, and was chaired by Mr. Tchuruk.

A report on the Meeting was published in the press on June 12 and 15, 2007. The report was sent to holders of registered shares in the letter to shareholders.

Shareholders present or represented by proxy had in the aggregate a total of 887.6 million shares, which represented a quorum of 39.36%.

The shareholder attendance rate increased from 25.4% in 2001 to 39.4% at the most recent meeting held on June 1, 2007, a 14% increase in attendance.

EVOLUTION OF THE RATE OF PARTICIPATION FROM 2001 TO 2007







Method of participation at the 2007 Shareholders’ Meeting

The table and the chart below reflect the breakdown of the participants according to the method of participation used by the shareholder.

Shareholders can participate in Shareholders’ Meetings in one of three ways:

1.

Physically attend or be represented at the Meeting,

2

vote by mail, and

3.

proxy granted to the Chairman.


Method of participation

Number of shareholders

Shares (in millions)

Shareholders present

1,502

149.1

Shareholders who were represented

310

0.4

Powers given to the President

31,297

28.8

Voters by mail

8,267

709.3

Total

41,376

887.6



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EVOLUTION OF THE METHOD OF PARTICIPATION OF THE SHAREHOLDERS FROM 2001 TO 2007 (1)


(1)

Based on the number of shareholders participating in the Meeting.


All of the resolutions that were presented at the General Shareholders' Meeting of June 1, 2007 were adopted. Voting results were published on line on our Internet site.



9.7

EVOLUTION OF THE DIVIDEND OVER THE LAST FIVE YEARS

Year of payment

2007

2006

2005

2004

2003

Dividend distributed (in euros, per share)

0.16*

0.16**

-

-

-

*

The dividend for the 2006 fiscal year was paid on June 4, 2007.

**

The dividend for the 2005 fiscal year was paid on September 11, 2006.

Dividends not claimed within five years are turned over to the French Treasury.

The dividend policy is defined by our Board of directors following an analysis, in particular, of the Group’s financial position and earnings and taking into account its capital requirements and performance, current and future returns, and market practices in relation to distribution of dividends, especially in the sector of activity within which we operate. In the light of our financial results, investment needs and requirements in terms of debt management, we may decide to adjust a dividend distribution, or to not distribute a dividend.

At its meeting of February 7, 2008, our Board of directors determined that it is prudent to suspend the dividend payment for the fiscal year 2007.




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10

ADDITIONAL INFORMATION



10.1

LEGAL INFORMATION



Company name and head office

Alcatel Lucent

54, rue La Boétie – 75008 Paris

Telephone: + 33 1 40 76 10 10



Commercial name

Alcatel-Lucent



Corporate structure and applicable law

French limited liability company subject to all the regulations governing commercial entities in France, particularly the provisions of the French Commercial Code.



Date of incorporation and expiry date

The company was incorporated on June 18, 1898 and will expire on June 30, 2086, unless there is an early dissolution or extension.



Corporate purpose

The company’s corporate purpose is the design, manufacture, operation and sale of all equipment, material and software related to domestic, industrial, civil, military or other applications concerning electricity, telecommunications, computers, electronics, aerospace industry, nuclear energy, metallurgy, and, in general, of all the means of production or transmission of energy or communications (cables, batteries and other components), as well as, secondarily, all activities relating to operations and services in connection with the above-mentioned means. It may acquire interests in any company, regardless of its form, in associations, French or foreign business groups, whatever their corporate purpose and activity may be and, in general, may carry out any industrial, commercial, financial, assets or real estate transactions, in connection, directly or indirectly, totally or partially, with any of the corporate purposes set out in Article 2 of the Articles of Association and with all similar or related purposes.



Registration number at the Registry of Commerce

The company is registered at the Paris Commerce and Companies Registry under number 542 019 096. Its APE business activity code is 7010 Z.



Fiscal year

Our fiscal year begins on January 1 and ends on December 31.




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10.2

SPECIFIC PROVISIONS OF THE ARTICLES OF ASSOCIATION AND OF LAW

The data set out below are extracts from our Articles of Association (articles 7, 9, 12, 13, 16, 17, 18, 21, 22 and 24), of the decisions taken by our Board of directors on November 30, 2006, and the legal and regulatory provisions applicable to companies having their registered office in France and whose securities are listed on a regulated market.



Holding of shares and obligations of the shareholders

a) Form

The shares are not represented by a certificate.

Bearer shares are recorded in the books of the financial intermediary (bank or broker) in the name of the shareholder with Euroclear.

Shares are registered when the nominal value is fully paid.

Fully paid shares may be in registered or bearer form at the Shareholder's choice up until the shareholder reaches a threshold of 3% of the total number of shares. Once the individual threshold of 3% of the company’s total number of shares is reached, the shares must be registered. The obligation to register shares applies to all the shares already held as well as to any shares which may be acquired subsequently in excess of this threshold.

b) Exceeding the statutory thresholds

In accordance with the statutory provisions, any individual or legal entity and/or shareholder that comes to own a number of shares in the company equal to or above 2% of the total number of shares must, within a period of five trading days from the date on which this share ownership threshold is exceeded, inform the company of the total number of shares owned, by letter or fax. A further notification must be sent in the same manner each time a new threshold of 1% is exceeded.

If the threshold of 3% of the total number of shares is exceeded, the shareholder must, within a period of five trading days from the date on which this share ownership threshold is reached, request the registration of the shares. The copy of the request for registration, sent by letter or fax to the company within fifteen days from the date on which this share ownership threshold is exceeded, is deemed to be a notification that the threshold has been reached. A further request must be sent in the same manner each time a further threshold of 1% is exceeded, up to 50%.

For purposes of the calculation of the thresholds, indirectly held shares which are considered to be owned pursuant to Articles L. 233-7 et seq. of the French Commercial Code must be taken into account.

In each notification referred to above, the shareholder must certify that all securities held indirectly as well as the shares considered to be owned are included. The notification must also indicate the date(s) of acquisition.

These obligations of share notification and registration apply to the holders who own shares through ADSs.

If a shareholder fails to comply with the provisions relating to notification that the thresholds have been exceeded, the voting rights for the shares exceeding the thresholds are, at the request of one or more shareholders holding at least 3% of the share capital, suspended under the conditions provided for by law.

Any shareholder whose shareholding falls below either of the thresholds provided for above must also inform the company thereof, within the same period of five trading days and in the same manner.

c) Exceeding the legal thresholds

Beyond the notification obligations, provided for in our Articles of Association, French law requires that any individual or legal entity, acting alone or in concert, which comes to hold a total number of shares (including through ADSs), above 5%, 10%, 15%, 20%, 25%, 33 1/3%, 50%, 66 2/3%, 90% or 95% of the capital or of the voting rights of a company, notify the company and the AMF within five trading days from the date on which these thresholds are exceeded.

This notification must also be made, within the same period, when the holding in capital or voting rights falls below these thresholds.

In the event of failure to appropriately notify that these thresholds have been exceeded, the voting rights of the shares in excess of the threshold that should have been notified are suspended for any shareholders’ meeting that might be held up to the expiration of a period of two years from the date the notification is eventually filed.



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d) Shareholders’ agreements

Any clause of a shareholders’ agreement which includes preferential conditions to transfer or to acquire shares listed on a regulated market and relating to at least 0.5% of the company’s capital or voting rights, must be disclosed to the company and to the AMF within five trading days from the date of the signature of such agreement.

e) Holding of a stake equal to one third and tender offer

When an individual or legal entity, acting alone or in concert, comes to hold more than one third of the capital or voting rights of the company, it must immediately inform the AMF and launch a tender offer for all of the equity securities and securities giving access to the capital or voting rights, of the company.

f) Information on the number of voting rights

To allow shareholders to determine whether they have exceeded an ownership threshold, we publish the total number of voting rights monthly on our Internet site.

g) Cross-shareholdings

In accordance with French legislation relating to cross-shareholdings, a limited liability company may not own shares in another company if the latter holds more than 10% of the share capital of the former. In the event of a cross-shareholding that violates this rule, the company owning the smaller percentage of shares in the other company must sell its stake. Until sold, the voting rights of these shares are suspended.

In the case where the cross-shareholding is held by a subsidiary, the shares are simply deprived of voting rights.

h) Identity of the holders

In accordance with the laws and regulations in effect, and subject to the penalties provided therein, the company may request from all organizations or authorized intermediaries any information concerning shareholders or holders of securities giving access, immediately or in the future, to voting rights, their identity, the number of securities held and any restrictions eventually applicable to the securities.



Rights and obligations relating to the shares

Shareholders are liable only up to the nominal amount of each share held. Any call for payment in excess of such amount is prohibited.

Each share gives right to a portion of the company’s profits, in the proportion prescribed by the Articles of Association.

Dividends and other income from shares issued by the company are paid under the conditions authorized or provided for under the regulations in effect and in such a manner as the General Meeting of Shareholders, or, alternatively, the Board of directors may decide.

Rights and obligations remain attached to a share regardless of who holds the share. Ownership of a share entails automatic acceptance of the company’s Articles of Association and resolutions of the General Meeting of Shareholders.

Shares are indivisible vis-à-vis the company: joint owners of shares must be represented by a single person. Shares subject to usufruct must be identified as such in the share registration.



Changes in the capital

a) Capital increases

In accordance with applicable law, our capital may be increased by cash or in-kind contributions, pursuant to a resolution of the Extraordinary General Meeting approved by two-thirds of the shareholders present or represented. This power may also be delegated to the Board of directors. In the event of a delegation to the Board of directors, the Chief Executive Officer may be granted specific powers to make the capital increase.

The capital may also be increased:

·

by the capitalization of reserves, profits or issuance premium pursuant to a decision of the General Meeting of Shareholders taken with the approval of a simple majority of the shareholders present or represented;

·

in case of payment of a dividend in shares decided by an Ordinary General Meeting of Shareholders; or

·

upon tender of securities or rights giving access to the company’s capital (bonds convertible into shares, bonds repayable in shares, warrants to purchase shares or other securities).

b) Capital decreases

The share capital may be decreased pursuant to a decision of two-thirds of the shareholders present or represented at an Extraordinary General Meeting of Shareholders, either by decreasing the nominal value of the shares or by reducing the number of shares outstanding.





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Management of the company

Our company is managed by a Board of directors consisting of at least six and not more than fourteen members.

If there is any vacancy following the death or resignation of one or more Directors, the Board of directors must temporarily appoint for each vacancy one replacement Director, such appointment being subject to approval at the next General Meeting of Shareholders. The appointment of a replacement Director in the event of a vacancy by reason of death or resignation requires the simple majority of the Directors present or represented.

Each Director must hold at least 500 company shares.



Term of Directors’ mandate – Age Limit

Directors are elected for a four-year term. Directors may be re-elected subject to the following provisions.

A Director appointed to replace another Director may hold office only for the remainder of his predecessor’s term of office.

The maximum age for holding a Directorship shall be 70. This age limit does not apply if less than one third, rounded up to the nearest whole number, of serving Directors have reached the age of 70.

No Director over 70 may be appointed if, as a result, more than one third of the serving Directors rounded up as defined above, are over 70.

If for any reason whatsoever the number of serving Directors over 70 should exceed one third as defined above, the oldest Director(s) shall automatically be deemed to have retired at the ordinary General Meeting of Shareholders called to approve the accounts of the fiscal year in which the proportion of Directors over 70 years was exceeded, unless the proportion was re-established in the meantime.

Directors representing legal entities are taken into account when calculating the number of Directors to which the age limit does not apply.

Legal entities that are represented on the  Board must replace any 70 year old representative at the latest at the ordinary General Meeting of Shareholders called to approve the accounts of the fiscal year in which such representative reached the age of 70.

The age limitations apply to any Chairman of the Board of directors, provided that such Chairman is not at the same time the Chief Executive Officer of the Company, in which case the age limitation of 68 shall apply.



Powers and responsibilities of the Board of directors

1° The Board of directors is vested with all the powers granted to it by the current legislation.

The Board determines the business strategies of the Company and ensures their implementation.

Subject to the authority expressly reserved for the Shareholder Meetings, and within the limits of the corporate purpose, the Board of directors adresses any question that affects the Company’s operations and governs the affairs of the Company through its deliberations.

2° The Board of directors decides whether the management of the Company will be performed by the Chairman of the Board of directors or by a Chief Executive Officer.



Chairman, Vice-Chairmen, Chief Executive Officer, Executive Vice-Presidents and Secretary

1° The Chief Executive Officer is responsible for the general management of the company, unless the Board of directors decides, upon the affirmative vote of at least two-thirds of the Directors in office until November 30, 2009, and of a simple majority thereafter, to entrust the general management to the Chairman of the Board of directors.

2° The Board of directors appoints from among its members, upon the affirmative vote of at least two-thirds of the Directors in office until November 30, 2009, and thereafter upon the affirmative vote of the majority of the Directors present or represented, a Chairman for a term not exceeding the term of his or her position as a Director. The Board of directors may remove the Chairman at any time, upon the affirmative vote of at least two-thirds of the Directors in office until November 30, 2009, and thereafter upon the affirmative vote of the majority of the Directors present or represented.

The Chairman of the Board of directors performs the missions assigned to her by law and notably she shall ensure the proper functioning of the company’s governing bodies. She shall chair meetings of the Board of directors, organize the work of the Board and ensure that the Directors are able to fulfill their mission.



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The Board of directors may appoint, if it so wishes, one or more Vice-Chairmen, and set their term of office, which may not exceed their term as Director. The Vice-Chairman, or the most senior Vice-Chairman, performs the duties of the Chairman when the Chairman is unable to do so.

3° If it does not assign the general management of the company to the Chairman, the Board of directors appoints, whether among its members or not, upon the affirmative vote of at least two-thirds of the Directors in office until November 30, 2009 and thereafter upon the affirmative vote of the majority of the Directors present or represented, a Chief Executive Officer for a term determined by it, not to exceed the term of his or her position as a Director, if applicable. The Board of directors may remove the Chief Executive Officer at any time, upon the affirmative vote of at least two-thirds of the Directors in office until November 30, 2009, and thereafter upon the affirmative vote of the majority of the Directors present or represented.

4° The Chief Executive Officer is vested with the fullest power to act in all circumstances in the name of the company, within the limits of the corporate purpose, the limitations set by the Board of directors on November 30, 2006 (as previously described in Section 7.2, “Board of Directors” of this document) and subject to the powers that the law expressly bestows on Shareholders’ Meetings and the Board of directors.

The Chief Executive Officer represents the company in its relations with third parties. She represents the company before the courts.

When the Chairman of the Board of directors assumes management of the company, the provisions of this Article and the law governing the Chief Executive Officer apply to her.

5° On the proposal of the Chief Executive Officer, the Board of directors may authorize one or more persons to assist her, as Executive Vice-Presidents.

The maximum number of Executive Vice-Presidents that may be appointed has been set at five.

The scope and term of the powers delegated to Executive Vice-Presidents is determined by the Board of directors in agreement with the Chief Executive Officer.

Executive Vice-Presidents have the same authority as the Chief Executive Officer.

In the event the office of Chief Executive Officer becomes vacant, the functions and powers of the Executive Vice-Presidents continue until the appointment of a new Chief Executive Officer, unless otherwise decided by the Board of directors.

6° The Board of directors, on the recommendation of the Chairman or Chief Executive Officer, the Chairman or the Chief Executive Officer themselves and the Executive Vice-Presidents may, within the limits set by law, delegate such powers as they deem fit, either for the management or conduct of the company’s business or for one or more specific purposes, to all authorized agents, whether members of the Board or not or part of the company or not, individually or as committees. Such powers may be permanent or temporary and may or may not be delegated to deputies.

7° The Board shall appoint a secretary and may also appoint a deputy secretary on the same terms.



Age limit for corporate executives

The Chief Executive Officer and Executive Vice-Presidents may hold office for the period set by the Board of directors, but this period may not exceed their term of office as Directors, if applicable, nor in any event may such period extend beyond the date of the Ordinary General Meeting of Shareholders called to approve the financial statements for the fiscal year in which they shall have reached 68 years of age. The same age limit applies to the Chairman when he is also the Chief Executive Officer.

When the Chairman does not also occupy the position of Chief Executive Officer, she may hold the office of Chairman for the period set by the Board of directors, but this period shall not exceed her term as Director, as well as the age limit set for the Directors.



Board observers

Upon the proposal of the Chairman, the Board of directors must in turn propose to the Ordinary General Meeting of Shareholders the appointment of two observers satisfying the conditions described below. The observers are invited and participate in Board meetings, but have no vote. They are appointed for two years and may be renewed.

They must, at the time of their appointment, be both employees of Alcatel-Lucent or a company of the Group, and members of a mutual investment fund as described below. Any mutual investment fund which satisfies the conditions defined below may propose to the Board candidates with a view to their being appointed as observers.

For purposes of the preceding requirements:

1/

a company of the Alcatel-Lucent group is a company in which Alcatel-Lucent holds directly or indirectly at least one half of the voting rights and/or any company in which a company of the Alcatel-Lucent group holds directly or indirectly at least one half of the voting rights;

2/

the mutual investment funds referred to above are those created pursuant to a corporate savings plan in which the company or a Group company participates, and where the portfolio includes at least 75% of company shares.



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On the Chairman’s recommendation, the Board of directors may propose to the Ordinary General Meeting of Shareholders the appointment of one or several additional observers who do not fulfill the conditions above, whether they are shareholders or not, but the total number of observers may not exceed six.

The observers receive an annual remuneration, set at the Ordinary General Meeting of Shareholders and allocated by the Board of directors.



Shareholders’ Meetings

1° The General or Extraordinary Shareholders’ Meetings are convened and held under the conditions provided by law.

The decisions of the Shareholders’ Meetings are binding on all shareholders, including those not present or who dissent.

2° Meetings take place at the registered office or any other place specified in the notice of Meeting.

3° All shareholders may attend the meeting in person or be represented by proxy, or by vote by correspondence, on proof of identity and registration of the securities on the third working day preceding the meeting at midnight, Paris time, either in the company’s accounts of registered securities, or in the bearer share accounts held by a duly authorized intermediary.

Subject to the conditions defined by regulations and in accordance with the procedures defined beforehand by the Board of directors, shareholders may participate and vote in all General or Extraordinary Shareholders’ Meetings by video-conference or any telecommunications method that allows for their identification.

4° Subject to the conditions set by the regulations in effect, shareholders may send their proxy or form for voting by mail for any General or Extraordinary Shareholders’ Meetings either in paper form or, upon the decision of the Board reflected in the notices of Meetings, by electronic transmission.

In order to be considered, all mail voting forms or proxies must be received at the company’s registered office or at the location stated in the notice of Meeting at least three days before the date of the General Meeting. This time limit may be shortened by a decision of the Board of directors. Instructions given electronically that include a proxy or power of attorney may be accepted by the company under the conditions and within the deadlines set by the regulations in effect.

5° The Meeting may be re-broadcast by video-conference and/or electronic transmission. If applicable, this is mentioned in the notice of Meeting.

6° All shareholders having expressed their vote electronically, sent a power of attorney or asked for their admission card or a confirmation of participation, may nevertheless transfer all or part of the shares for which they have voted electronically, sent a power of attorney or asked for an admission card or a confirmation. However, if the transfer is made before the third working day preceding the Meeting at midnight, Paris time, the company, upon notification of the intermediary authorized to hold the account, will invalidate or modify as a result, as the case may be, the electronic vote, the power of attorney, the admission card or confirmation. No transfer or any transaction made after the third working day preceding the Meeting at midnight, Paris time, whatever the means used, shall be notified by the authorized intermediary or taken into account by the company, notwithstanding any agreement to the contrary.

7° The Shareholders’ Meeting is chaired either by the Chairman or one of the Vice-Chairmen of the Board of directors, or by a Director appointed by the Board or by the Chairman.

The shareholders appoint the officers of the Meeting, that is, the chairman, two scrutineers and a secretary.

The scrutineers must be the two members of the Meeting representing the largest number of votes or, should they refuse, those who come after in descending order until the duties are accepted.

8° Copies or extracts of the minutes may be authenticated by the Chairman of the Board, the secretary of the Shareholders’ Meeting, or the Director appointed to chair the Meeting.

The Ordinary General Meeting of shareholders may deliberate on a first call only if the shareholders present or represented hold at least one-fifth of the shares with voting rights. No quorum is required for a meeting held upon a second call.

The Extraordinary General Meeting may deliberate on a first call only if the shareholders present or represented hold at least one-quarter of the shares with voting rights, and one-fifth of the shares with voting rights in the event of a second call.



Voting rights

At General Meeting of Shareholders held on June 1, 2007, the Shareholders vote to eliminate the statutory limitation on voting rights at General Meetings; as a result and subject to what is described below, each member at every Meeting has the right to as many votes as the number of shares that he owns or represents.

However, fully paid registered shares, registered in the name of the same holder for at least three years, have double voting rights.

In accordance with Article L. 225-99, paragraph 2 of the French Commercial Code, the elimination of double voting rights must be decided by the Extraordinary General Meeting, with the authorization of a special meeting of holders of these rights.

Double voting rights are cancelled automatically for any share that is converted into a bearer share or the ownership of which is transferred. However, the period mentioned above is interrupted, and the right acquired is preserved, in the event of a transfer from registered to unregistered form, as a result of intestate or testamentary succession, the division between spouses of a common estate, or donation inter vivos in favor of a spouse or heirs.

Voting rights in all ordinary, extraordinary or special General Meetings of Shareholders belong to the usufructuary.





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Appropriation of the result – Dividend

The difference between the proceeds and the expenses of the fiscal year, after provisions, constitutes the profits or losses for the fiscal year. An amount equal to 5% of the profits, minus previous losses, if any, is deducted in order to create the legal reserves, until such legal reserves are at least equal to 1/10th of the capital. Additional contributions to the legal reserves are required if the legal reserves fall below that fraction for any reason.

The distributable profits, that is, the profits for the fiscal year minus the previous losses and the deduction mentioned above, plus income carried over, is available to the General Meeting which, upon proposal of the Board, may decide to carry over some or all of the profits, to allocate them to general or special reserve funds or to distribute them to the shareholders as a dividend.

In addition, the General Meeting may decide the distribution of sums deducted from the optional reserves, either as a dividend or as a supplemental dividend, or as a special distribution. In this case, the decision must clearly indicate the reserves from which said sums are deducted. However, the dividends must be deducted first from the distributable profits of the fiscal year.

The General Meeting of Shareholders may grant each shareholder, for all or part of the dividend distributed or the interim dividend, the option to receive payment of the dividend or interim dividend in cash or in shares.

The General Meeting or the Board of directors, in the event of an interim dividend, must determine the date as of which the dividend is paid.



10.3

AMERICAN DEPOSITARY SHARES, TAXATION AND CERTAIN OTHER MATTERS



Description of the ADSs

Each of our American Depositary Shares, or ADSs, represents one of our ordinary shares. Our ADSs trade on the New York Stock Exchange.

The following is a summary of certain provisions of the deposit agreement for the ADSs and is qualified in its entirety by reference to the deposit agreement among Alcatel-Lucent, the Bank of New York, as depositary, and the holders from time to time of the ADSs.

The form of the deposit agreement for the ADS and the form of American depositary receipt (ADR) that represents an ADS have been filed as exhibits to our registration statement on Form F-6 that we filed with the Securities and Exchange Commission on November 16, 2006. Copies of the deposit agreement are available for inspection at the principal office of The Bank of New York, located at 101 Barclay Street, New York, New York 10286, and at the principal office of our custodian, Société Générale, located at 32, rue du Champ de Tir, 44312 Nantes, France.



Dividends, other distributions and rights

The Bank of New York is responsible for making sure that it or the custodian, as the case may be, receives all dividends and distributions in respect of deposited shares.

Amounts distributed to ADS holders will be reduced by any taxes or other governmental charges required to be withheld by the custodian or The Bank of New York. If The Bank of New York determines that any distribution in cash or property is subject to any tax or governmental charges that The Bank of New York or the custodian is obligated to withhold, The Bank of New York may use the cash or sell or otherwise dispose of all or a portion of that property to pay the taxes or governmental charges. The Bank of New York will then distribute the balance of the cash and/or property to the ADS holders entitled to the distribution, in proportion to their holdings.

Cash dividends and cash distributions. The Bank of New York will convert into dollars all cash dividends and other cash distributions that it or the custodian receives in a foreign currency. The Bank of New York will distribute to the ADS holders the amount it receives, after deducting any currency conversion expenses. If The Bank of New York determines that any foreign currency it receives cannot be converted and transferred on a reasonable basis, it may distribute the foreign currency (or an appropriate document evidencing the right to receive the currency), or hold that foreign currency uninvested, without liability for interest, for the accounts of the ADS holders entitled to receive it.

Distributions of ordinary shares. If we distribute ordinary shares as a dividend or free distribution, The Bank of New York may, with our approval, and will, at our request, distribute to ADS holders new ADSs representing the shares. The Bank of New York will distribute only whole ADSs. It will sell the shares that would have required it to use fractional ADSs and then distribute the proceeds in the same way it distributes cash. If The Bank of New York deposits the shares but does not distribute additional ADSs, the existing ADSs will also represent the new shares.



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If holders of shares have the option of receiving a dividend in cash or in shares, we may also grant that option to ADS holders.

Other distributions. If The Bank of New York or the custodian receives a distribution of anything other than cash or shares, The Bank of New York will distribute the property or securities to the ADS holder, in proportion to such holder’s holdings. If The Bank of New York determines that it cannot distribute the property or securities in this manner or that it is not feasible to do so, then, after consultation with us, it may distribute the property or securities by any means it thinks is fair and practical, or it may sell the property or securities and distribute the net proceeds of the sale to the ADS holders.

Rights to subscribe for additional ordinary shares and other rights. If we offer our holders of shares any rights to subscribe for additional shares or any other rights, The Bank of New York will, if requested by us:

·

make the rights available to all or certain holders of ADSs, by means of warrants or otherwise, if lawful and practically feasible; or

·

if it is not lawful or practically feasible to make the rights available, attempt to sell those rights or warrants or other instruments.

In that case, The Bank of New York will allocate the net proceeds of the sales to the account of the ADS holders entitled to the rights. The allocation will be made on an averaged or other practicable basis without regard to any distinctions among holders.

If registration under the Securities Act of 1933, as amended, is required in order to offer or sell to the ADS holders the securities represented by any rights, The Bank of New York will not make the rights available to ADS holders unless a registration statement is in effect or such securities are exempt from registration. We do not, however, have any obligation to file a registration statement or to have a registration statement declared effective. If The Bank of New York cannot make any rights available to ADS holders and cannot dispose of the rights and make the net proceeds available to ADS holders, then it will allow the rights to lapse, and the ADS holders will not receive any value for them.

Voting of the underlying shares. Under the deposit agreement, an ADS holder is entitled, subject to any applicable provisions of French law, our articles of association and bylaws and the deposited securities, to exercise voting rights pertaining to the shares represented by its ADSs. The Bank of New York will send to ADS holders English-language summaries of any materials or documents provided by us for the purpose of exercising voting rights. The Bank of New York will also send to ADS holders directions as to how to give it voting instructions, as well as a statement as to how the underlying ordinary shares will be voted if it receives blank or improperly completed voting instructions.

ADSs will represent ordinary shares in bearer form unless the ADS holder notifies The Bank of New York that it would like the shares to be held in registered form.

Changes affecting deposited securities. If there is any change in nominal value or any split-up, consolidation, cancellation or other reclassification of deposited securities, or any recapitalization, reorganization, business combination or consolidation or sale of assets involving us, then any securities that The Bank of New York receives in respect of deposited securities will become new deposited securities. Each ADS will automatically represent its share of the new deposited securities, unless The Bank of New York delivers new ADSs as described in the following sentence. The Bank of New York may, with our approval, and will, at our request, distribute new ADSs or ask ADS holders to surrender their outstanding ADRs in exchange for new ADRs describing the new deposited securities.

Amendment of the deposit agreement. The Bank of New York and we may agree to amend the form of the ADRs and the deposit agreement at any time, without the consent of the ADS holders. If the amendment adds or increases any fees or charges (other than taxes or other governmental charges) or prejudices an important right of ADS holders, it will not take effect as to outstanding ADSs until three months after The Bank of New York has sent the ADS holders a notice of the amendment. At the expiration of that three-month period, each ADS holder will be considered by continuing to hold its ADSs to agree to the amendment and to be bound by the deposit agreement as so amended. The Bank of New York and we may not amend the deposit agreement or the form of ADRs to impair the ADS holder’s right to surrender its ADSs and receive the ordinary shares and any other property represented by the ADRs, except to comply with mandatory provisions of applicable law.

Termination of the deposit agreement. The Bank of New York will terminate the deposit agreement if we ask it to do so and will notify the ADS holders at least 30 days before the date of termination. The Bank of New York may also terminate the deposit agreement if it resigns and a successor depositary has not been appointed by us and accepted its appointment within 90 days after The Bank of New York has given us notice of its resignation. After termination of the deposit agreement, The Bank of New York will no longer register transfers of ADSs, distribute dividends to the ADS holders, accept deposits of ordinary shares, give any notices, or perform any other acts under the deposit agreement whatsoever, except that The Bank of New York will continue to:

·

collect dividends and other distributions pertaining to deposited securities;

·

sell rights as described under the heading “Dividends, other distributions and rights — Rights to subscribe for additional shares and other rights” above; and

·

deliver deposited securities, together with any dividends or other distributions received with respect thereto and the net proceeds of the sale of any rights or other property, in exchange for surrendered ADRs.

One year after termination, The Bank of New York may sell the deposited securities and hold the proceeds of the sale, together with any other cash then held by it, for the pro rata benefit of ADS holders that have not surrendered their ADSs. The Bank of New York will not have liability for interest on the sale proceeds or any cash it holds.





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Ownership of shares by non-French persons

Under French law and our articles of association and bylaws, no limitation exists on the right of non-French residents or non-French shareholders to own or vote our securities.

Any non-French resident (both E.U. and non-E.U.) must file an administrative notice ("déclaration administrative") with the French authorities in connection with any transaction which, in the aggregate, would result in the direct or indirect holding by such non-French resident of at least 33.33% of the capital or the voting rights of a French company.

The payment of all dividends to foreign shareholders must be effected through an accredited intermediary. All registered banks and credit establishments in France are accredited intermediaries.

You should refer to “Rights and obligations relating to the shares” above for a description of the filings required based on shareholdings.



Exchange controls

Under current French exchange control regulations, no limits exist on the amount of payments that we may remit to residents of the United States. Laws and regulations concerning foreign exchange controls do require, however, that an accredited intermediary handle all payments or transfer of funds made by a French resident to a non-resident.



Taxation

The following is a general summary of the material U.S. federal income tax and French tax consequences to you if you acquire, hold and dispose of our ordinary shares or ADSs. It does not address all aspects of U.S. and French tax laws that may be relevant to you in light of your particular situation. It is based on the applicable tax laws, regulations and judicial decisions as of the date of this annual report, and on the Convention between the United States of America and the Republic of France for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with respect to Taxes on Income and Capital dated as of August 31, 1994 (the “Treaty”) entered into force on December 30, 1995, and the 2004 Protocol amending the Treaty which became effective on December 21, 2006, all of which are subject to change, possibly with retroactive effect, or different interpretations.

This summary may only be relevant to you if all of the following five points apply to you:

·

You own, directly or indirectly, less than 10% of our capital;

·

You are any one of (a), (b), (c) or (d) below:

(a)

an individual who is a citizen or resident of the United States for U.S. federal income tax purposes,

(b)

a corporation, or other entity taxable as a corporation that is created in or organized under the laws of the United States or any political subdivision thereof,

(c)

an estate, the income of which is subject to U.S. federal income tax regardless of its source, or

(d)

a trust, if a court within the United States is able to exercise a primary supervision over its administration and one or more U.S. persons have the authority to control all of the substantial decisions of such trust, or certain electing trusts that were in existence on August 20, 1996 and were treated as domestic trusts on August 19, 1996;

·

You are entitled to the benefits of the Treaty under the “limitations on benefits” article contained in the Treaty;

·

You hold our ordinary shares or ADSs as capital assets; and

·

Your functional currency is the U.S. dollar.

You generally will not be eligible for the reduced withholding tax rates under the Treaty if you hold our ordinary shares in connection with the conduct of business through a permanent establishment or the performance of services through a fixed base in France, or you are a nonresident in the United States for U.S. tax purposes.

The following description of tax consequences should be considered only as a summary and does not purport to be a complete analysis of all potential tax effects of the purchase or ownership of our ordinary shares or ADSs. Special rules may apply to U.S. expatriates, insurance companies, tax-exempt organizations, financial institutions, persons subject to the alternative minimum tax, securities broker-dealers, traders in securities that elect to use a mark-to-market method of accounting for the securities’ holdings, and persons holding their ordinary shares or ADSs as part of a hedging, straddle, conversion transaction or other integrated investment, among others. Those special rules are not discussed in this annual report. This summary does not address all potential tax implications that may be relevant to you as a holder, in light of your particular circumstances. You should consult your tax advisor concerning the overall U.S. federal, state and local tax consequences, as well as the French tax consequences, of your ownership of our ordinary shares or ADRs and ADSs represented thereby.

For purposes of the Treaty and the U.S. Internal Revenue Code of 1986, as amended (the “Code”), if you own ADSs evidenced by ADRs, you will be treated as the owner of the ordinary shares represented by such ADSs.



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Taxation of dividends

Withholding Tax and Tax Credit. For dividends paid on and after January 1, 2006, French resident individuals will be subject to taxation at the progressive rate on only 60% of the dividends received by them from both French and foreign companies, in addition to the annual allowance equal to €1,525 for single individuals, widows, widowers, divorced persons or married persons or members of a union agreement subject to separate taxation, and €3,050 for married persons or members of a union agreement subject to joint taxation. This exemption will apply to any dividend distributed by a company that is subject to corporation tax or an equivalent tax and that is located in an EU member state or a country that has signed a tax treaty with France.

In addition, French resident individuals will receive a tax credit equal to 50% of the dividends (which we refer to as the Tax Credit), capped at €115 for single individuals, widows, widowers, divorced persons or married persons and members of a union agreement subject to separate taxation, and €230 for married persons and members of a union agreement subject to joint taxation.

For dividends paid on and after January 1, 2008, French resident individuals can elect for dividends to be subject to an 18% withholding tax. The Tax Credit is not available for dividends subject to the withholding tax regime.

French companies normally must deduct a 25% French withholding tax from dividends paid to nonresidents of France. Under the Treaty, this withholding tax is reduced to 15% if your ownership of our ordinary shares or ADSs is not effectively connected with a permanent establishment or a fixed base that you have in France.

If your ownership of the ordinary shares or ADSs is not effectively connected with a permanent establishment or a fixed base that you have in France, we will withhold tax from your dividend at the reduced rate of 15%, provided that you (i) complete the French Treasury Form entitled “Certificate of Residence” (Form 5000), which establishes that you are a resident of the U.S. under the Treaty, (ii) have it certified either by the Internal Revenue Service or the financial institution that is in charge of the administration of the ordinary shares or ADSs, and (iii) send it to us before the date of payment of the dividend.  

If you have not completed and sent the “Certificate of Residence” before the dividend payment date, we will deduct French withholding tax at the rate of 25%. In that case, you may claim a refund from the French tax authorities, provided that you (i) duly complete the French Form 5000 and Form 5001; (ii) have the forms certified either by the Internal Revenue Service or the financial institution that is in charge of the administration of the ordinary shares or ADSs, and (iii) send the forms to us before December 31 of the second calendar year following the year during which the dividend is paid.

You can obtain the Certificate of Residence, the Form 5001 and their respective instructions from the Depositary, the Internal Revenue Service or the French Centre des Impôts des non-résidents, the address of which is 10 rue du Centre, TSA, 93160 Noisy-Le-Grand, France. Copies of Form 5000 and Form 5001 may also be downloaded from the French tax authorities website (www.impots.gouv.fr).

Any French withholding tax refund is generally expected to be paid within 12 months after you file the relevant French Treasury Form. However, it will not be paid before January 15, following the end of the calendar year in which the related dividend is paid.

If you are a U.S. individual holder, you may be entitled to a refund of the Tax Credit (less a 15% withholding tax), provided that you are subject to U.S. federal income tax on the Tax Credit and the related dividend. French tax authorities have not issued any guidance with regards to the procedure for claiming the Tax Credit. You should consult your own tax advisor in this case.

The refund of the Tax Credit, like the refund to the French withholding tax discussed above, is not likely to be paid before January 15, following the end of the calendar year in which the dividend is paid.

U.S. holders that are legal entities, pension funds or other tax-exempt holders are no longer entitled to tax credit payments from the French Treasury.

For U.S. federal income tax purposes, the gross amount of any distribution (including any related Tax Credit) will be included in your gross income as dividend income to the extent paid or deemed paid out of our current or accumulated earnings and profits as calculated for U.S. federal income tax purposes. You must include this amount in income in the year payment is received by you, which, if you hold ADSs, will be the year payment is received by the Depositary. Dividends paid by us will not give rise to any dividends-received deduction allowed to a U.S. corpo