1 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC 20549 ------------------------ FORM 10-K [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED SEPTEMBER 30, 1998 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 COMMISSION FILE NUMBER 001-11639 LUCENT TECHNOLOGIES INC. <TABLE> <S> <C> A DELAWARE I.R.S. EMPLOYER CORPORATION NO. 22-3408857 </TABLE> 600 MOUNTAIN AVENUE, MURRAY HILL, NEW JERSEY 07974 TELEPHONE NUMBER 908-582-8500 SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: SEE ATTACHED SCHEDULE A. SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: NONE. Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X] At November 30, 1998, the aggregate market value of the voting stock held by non-affiliates was approximately $113,500,000,000. At November 30, 1998, 1,318,615,011 common shares were outstanding. DOCUMENTS INCORPORATED BY REFERENCE (1) Portions of the registrant's annual report to security holders for the fiscal year ended September 30, 1998 (Part II) (2) Portions of the registrant's definitive proxy statement dated December 22, 1998, issued in connection with the annual meeting of shareholders (Part III) - -------------------------------------------------------------------------------- - --------------------------------------------------------------------------------
2 SCHEDULE A Securities registered pursuant to Section 12(b) of the Act: <TABLE> <CAPTION> TITLE OF EACH CLASS EXCHANGE ON WHICH REGISTERED - ------------------- ---------------------------- <S> <C> Common Stock (Par Value $.01 Per New York Stock Exchange Share) 6.90% Notes due July 15, 2001 New York Stock Exchange 7.25% Notes due July 15, 2006 New York Stock Exchange 6.50% Debentures due January 15, New York Stock Exchange 2028 5.50% Notes due November 15, 2008 New York Stock Exchange </TABLE> 1
3 TABLE OF CONTENTS <TABLE> <CAPTION> ITEM DESCRIPTION PAGE - ---- ----------- ---- <C> <S> <C> PART I 1. Business.................................................... 3 2. Properties.................................................. 22 3. Legal Proceedings........................................... 22 4. Submission of Matters to a Vote of Security-Holders......... 22 PART II 5. Market for Registrant's Common Equity and Related 22 Stockholder Matters......................................... 6. Selected Financial Data..................................... 22 7. Management's Discussion and Analysis of Financial Condition 22 and Results of Operations................................... 8. Financial Statements and Supplementary Data................. 22 9. Changes in and Disagreements with Accountants on Accounting 22 and Financial Disclosure.................................... PART III 10. Directors and Executive Officers of the Registrant.......... 23 11. Executive Compensation...................................... 23 12. Security Ownership of Certain Beneficial Owners and 23 Management.................................................. 13. Certain Relationships and Related Transactions.............. 23 PART IV 14. Exhibits, Financial Statement Schedules, and Reports on Form 24 8-K......................................................... </TABLE> This Report contains trademarks, service marks and registered marks of the Company and its subsidiaries, and other companies, as indicated. 2
4 PART I ITEM 1. BUSINESS. GENERAL Lucent Technologies Inc. ("Lucent" or the "Company") was incorporated in Delaware in November 1995. The Company has its principal executive offices at 600 Mountain Avenue, Murray Hill, New Jersey 07974 (telephone number 908-582-8500). Lucent was formed from the systems and technology units that were formerly part of AT&T Corp., including the research and development capabilities of Bell Laboratories. Prior to February 1, 1996, AT&T conducted Lucent's original business through various divisions and subsidiaries. On February 1, 1996, AT&T began executing its decision to separate Lucent into a stand-alone company (the "Separation") by transferring to Lucent the assets and liabilities related to its business. In April 1996, Lucent completed the initial public offering of its common stock ("IPO") and on September 30, 1996, became independent of AT&T when AT&T distributed to its shareowners all of its Lucent shares. As used herein, references to the "Company" or "Lucent" include the historical operating results and activities of the business and operations transferred to the Company in the Separation. In 1996, the Company changed its fiscal year to begin October 1 and end September 30, and reported audited financial results for a short fiscal period beginning January 1, 1996 and ending September 30, 1996. Accordingly, unless the context otherwise requires, references herein to "fiscal 1996" or similar terms mean the nine-month period January 1, 1996 through September 30, 1996 and references to 1998 or this year refer to the fiscal year ended September 30, 1998. The Company is one of the world's leading designers, developers and manufacturers of communications systems, software and products. The Company is a global leader in the sale of public communications systems, and is a supplier of systems or software to most of the world's largest network operators. The Company is also a global leader in the sale of business communications systems and in the sale of microelectronic components for communications applications to manufacturers of communications systems and computers. The Company's research and development activities are conducted through Bell Laboratories ("Bell Labs"), one of the world's foremost industrial research and development organizations. The communications industry is undergoing a revolution driven by technology, global changes in government regulation, the needs of service providers and enterprises, and customer demand. Communications technology is moving from voice networking to data networking, and from circuit switching to packet switching. This revolution is bringing about a convergence of voice and data, wired and wireless, optical and electronic, audio and video, and the Internet. SYSTEMS FOR NETWORK OPERATORS The Company designs, develops, manufactures and services systems and software which enable network operators and other service providers (together referred to as "service providers"), to provide wireline and wireless access, local, long distance and international voice, data and video services and cable television service. The Company's networks, which include switching, transmission and cable systems, are packaged and customized with application software, operations support systems and associated professional services. Systems and Services Communications Networking Systems. The Company designs, develops, manufactures and services advanced communications networking systems, which include equipment, software and associated professional services. These systems connect, route, manage and store voice, data and video in any combination, and are used for: wireline access; local and long distance switching; intelligent network services and signaling; wireless communications, including both cellular and personal communications services ("PCS"); and high-speed, broadband multifunctional communications. 3
5 The Company supplies each of the five broad elements that comprise communications networks: switching systems, which route information through the network; transmission systems, which provide the communications path through the network that carries information between points in the network; operation support systems, which enable service providers to manage the work flow, planning, surveillance, management, provisioning and continuous testing of their networks; intelligent network/application software, which enables service providers to offer a broad array of enhanced and differentiated services; and cable systems, which provide the transport media between points in a network. These systems collectively comprise the infrastructure that enables telecommunications network operators to provide traditional narrowband voice and data services and that enables both new and traditional network operators to offer broadband multimedia services. The Company has a wireline local access installed base (the number of access lines serviced by switches manufactured by the Company) of approximately 120 million lines. The Company's primary switching products are the 5ESS(R) switch for local and long distance switching and international gateways and the 4ESS(TM) Digital Switch for long distance and international switching. The 5ESS switch is used throughout the world to provide a combination of network applications, including local and long distance switching and international gateways, operator services, network signaling, intelligent networking and wireless switching. The 5ESS switch, with the Company's 5E12 AnyMedia(TM) software, enables network operators to offer a large number of new data services and local number portability, as well as simultaneous wireline and wireless, local, long distance and international services. The Company has announced new products, with expected 1999 deliveries, to address the convergence of voice and data in the network including the AnyMedia FAST Access System which provides both narrowband and wideband services, and the PacketStar(TM) Gateway Solution for converged voice/data networks. The AnyMedia Fast Access System can be deployed throughout the world to provide low cost telephony and ATM-based broadband services. The AnyMedia FAST Access System will deliver more bandwidth to the subscriber. The PacketStar Gateway Solution provides a single virtual transport system to interconnect voice capable edge elements and to implement both toll and tandem voice feature sets for both data and voice applications. The key elements of the PacketStar Gateway Solution include the PacketStar Voice Gateway to combine voice traffic on a data network; the PacketStar Connection Gateway which provides interface and connection management, and the PacketStar Feature Server which provides call services in a converged voice/data network. The Company designs, develops, manufactures and services a broad range of transmission access and transport systems. Network operators use these systems to transport any combination of voice, data and video between subscribers and the central office or between points within a network engaged in local, national or international communications. Most transmission systems currently comply with one of two similar standards designed to promote the implementation of maximum transmission capacity with the greatest simplicity and lowest cost for network operators. The Synchronous Optical Network ("SONET") standard has been widely adopted in North America. The Synchronized Digital Hierarchy ("SDH") predominates throughout the rest of the world. The Company markets systems supporting both standards. The Company offers a broad line of transmission access systems for the provision of a wide range of services, including traditional telecommunications service and broadband multifunctional services. Transmission access systems transport information between the subscriber and the central office. The Company's products include SLC(R)-2000, which extends fiber-based optical transmission into the local loop. The Company's products also include the SDV-2000, a switched digital video system which extends fiber to the curb, and ASOS, which enables network operators to manage the work flow, planning, surveillance, provisioning and continuous testing of their multifunctional networks. The Company's transmission transport systems are utilized for high capacity communications between points within a communications network. Many of these products are primarily digital and provide for the movement of any combination of voice, data, and video across fiber, coaxial and microwave based media. The 4
6 Company's products include fiber transport systems (FT 2000), digital multiplexer systems (DDM 2000) and digital access and cross connect systems (DACS family of products). In 1998, Lucent announced the Wavestar(TM) OLS 400G system, which combines up to 80 optical channels over a single fiber as well as the Wavestar Bandwidth Manager, which routes voice, Asynchronous Transfer Mode ("ATM"), Internet protocol and video traffic using significantly less equipment and space. The Company offers data networking intelligent switching products such as its PacketStar(TM) ATM Core Switch and application systems such as its PacketStar Internet Telephony System. The Company's operation support systems enhance a network operator's ability to activate, manage and maintain its networks. These systems continuously monitor network performance and activity level, and allow for rapid trouble identification, load balancing and planning for network utilization. The Company's systems support the efforts of network operators to reduce operating costs and minimize labor by automating labor intensive tasks. The Company's network management systems offer a broad array of modular software, including element managers designed for traditional telephony, video and wireless; network managers that monitor, test and optimize the utilization of a network; service managers that manage work flow; and business managers that include customer service systems. For example, the Company's NetMinder system is an advanced network management routing system that mitigates network congestion through efficient call routing and completion. The Company's A-I-NET(R) intelligent network products enable network operators to offer new services that can be created, deployed or managed by themselves, the Company, or third parties. Services created with A-I-NET products include toll free calling (800 and 888 service in the United States), call forwarding, call waiting, voice dialing and messaging. The Company has introduced products to address the growing demand for emerging broadband multifunctional services which permit the simultaneous transmission of any combination of voice, data and video, such as its high capacity switching product ATM, the GLOBEVIEW(R)-2000 Broadband System. In addition, the Company designs, develops, manufactures and services cable systems, which include optical fiber, fiber optic cable, and apparatus for both fiber and copper cable systems. The Company's cable systems are used to connect various devices in a network and terminal devices to public and private networks. These cable systems are deployed for outside plant and central office wiring, and for traditional telephony, cable television, wireless networks and broadband applications. The Company also supplies fiber optic cable systems, high strength, high performance fiber for underseas cablers and outside plant turn-key systems, which are generally large capital projects in emerging markets for the engineering and construction of telecommunications infrastructure. The Company's TRUEWAVE(R) optical fiber enables network operators to reduce their costs by increasing the distance between optical amplifiers. Wireless Network Systems. The Company designs, develops, manufactures and services wireless network infrastructure systems, which include the 5ESS switch, base stations, wireless network software and operation support systems. These systems provide network operators with the capability to offer a wide range of cellular and other wireless communications services, including PCS, wireless data and fixed wireless access. The Company's wireless cellular or PCS systems are in operation in 49 of the top 50 United States Metropolitan Statistical Areas. The Company's primary wireless system is the AUTOPLEX(R) System 1000 product family, which includes the high capacity Series II base station. The base station contains the radio transceiver that establishes wireless communications with a mobile telephone. Base stations are arranged geographically so that mobile customers can be "handed off" seamlessly from one base station to the next as they travel. The network intelligence to accomplish this is housed in the Company's Mobile Switching Center, which includes the 5ESS switch and which connects the base stations to the public telephone network. The Company also offers base stations for start-up applications and smaller markets, a minicell product for rural and international markets and a microcell for congested, high traffic areas. Wireless technology is evolving 5
7 from analog to digital. The Company provides networks based on a variety of the leading air interface standards: AMPS, CDMA, TDMA and GSM. In addition, the Company designs, develops, manufactures and services fixed wireless access systems. The Company offers the AIRLOOP(R) Wireless Local Loop system, which utilizes CDMA technology, as well as systems based on the DECT (digital enhanced cordless telephone) standard. Both systems enable service providers to expand their networks in markets where traditional wireline systems are not cost justified and to provide telephone services as an alternative to traditional network operators. The Company designs, develops, manufactures, and services CDPD-based wireless data systems which enable wireless network operators to offer data services as an overlay to their existing analog voice infrastructure without acquiring additional spectrum or upgrading to a digital network. These systems offer the increased reliability and efficiency of switched digital packet data systems. Due to the complexity of wireless systems, the Company also offers a broad range of professional services, which include project management, site acquisition, radio frequency engineering, microwave relocation, construction management, cellular optimization and wireless data support. During fiscal year 1998, Lucent acquired Livingston Enterprises, Inc., Yurie Systems, Inc., JNA Telecommunications Limited and MassMedia Communications Inc. Livingston and Yurie develop and provide remote access and ATM technologies which increase Lucent's data networking product offerings to network operators. JNA, an Australia based manufacturer and system integrator, gives Lucent added sales and support capabilities and technology in the Asia/Pacific region. MassMedia, a developer of next-generation network interoperability software will add enhanced voice, data and video internetworking capabilities to Lucent's data networking portfolio. Markets The principal customers for the Company's systems are network operators that provide wireline and wireless local, long distance and international telecommunications services, including local, long distance and international telecommunications companies, cable television companies and internet service providers. The Company's systems for network operators are installed to expand the capacity and features offered by existing networks, to replace older technology in existing networks and to establish new networks for entrants into deregulated or previously unserved markets. See "Outlook -- Reliance on Major Customers/Multi-Year Contracts." As a result of structural, public policy and technological changes, since the mid-1980's the telecommunications industry has undergone a period of significant growth in the number of lines in service and applications offered. In developed markets, deregulation has permitted new market entrants to construct networks in previously monopolistic markets. In response, existing network operators have expanded beyond traditional franchises and are offering new services. In emerging markets, privatization, competition and economic expansion have increased demand for networking systems. At the same time, technological advances also have increased demand by reducing operating costs and facilitating new applications, including multifunctional services. The Company markets and sells its products worldwide primarily through a direct sales force due to the complexity of these systems. Most of the Company's sales of systems for network operators are made pursuant to general purchase agreements, which establish the terms and conditions and provide for price determination to be made on a contract bid basis. In addition, certain of the large infrastructure projects are conducted under long-term, fixed-price contracts. See "Outlook -- Reliance on Major Customers/Multi-Year Contracts" and "-- Seasonality." As a result of the increased complexity of systems for network operators and the high cost of developing and maintaining in-house expertise, network operators typically demand complete, integrated and turn-key projects. Network operators increasingly are seeking overall network or systems solutions that require an increased software content which would enable them to deploy rapidly new and differentiable services. In response, the Company has formed an organization focused on turn-key network engineering projects for both 6
8 public and private sector customers. The Company markets integrated solutions for the project, and engineers, designs and installs the network, including equipment and software manufactured by both the Company and third parties. Increasingly, as a result of the financial demands of major network deployments, network operators are looking to their suppliers to arrange for financing. The ability to provide financing is a requirement to conduct business in certain emerging U.S. and foreign markets, and in some cases the Company furnishes or guarantees financing for customers. As a result, the Company works with its customers to structure and place financing packages. See "Outlook -- Future Capital Requirements." In order to market its product line worldwide, the Company has established wholly owned subsidiaries and joint ventures with local companies in many countries. Competition The Company believes that its key competitive factors are its broad product line, large installed base, relationship with key customers, technological expertise and new product development capabilities. The Company's primary competitors in the market for telecommunications systems are four very large European and North American companies which have substantial technological and financial resources and which offer similar broad product catalogs. These competitors are Alcatel Alsthom, Northern Telecom Limited, Siemens AG and Telefonaktiebolaget LM Ericsson ("Ericsson"). In 1997, the Company and these four competitors collectively accounted for about 40% of the world's public network systems sales, with the Company's sales accounting for about 10% of world sales. In addition, in all of the Company's product areas, the Company faces significant competition from other companies which do business in one or a number of such product areas. For example, in wireless systems, Northern Telecom Limited, Telefonaktiebolaget LM Ericsson, Motorola, Inc. and Nokia Corporation, which are very large companies with substantial technological and financial resources, are significant competitors. In transmission and cable systems, competition in the markets includes hundreds of smaller competitors. The Company is also encountering competition from companies that design and manufacture data network equipment such as Cisco Systems Inc. BUSINESS COMMUNICATIONS SYSTEMS The Company designs, develops, manufactures and services communications systems and products for large and small business customers, home offices and government agencies. The Company's business communications systems can be upgraded regularly with new software releases, support local and wide area voice and data networking and are often integral components of global enterprise networks. The Company's systems primarily are customer premises-based private switching systems and products, call center systems, voice processing systems, which include voice messaging and voice response systems, and the associated application software and professional support services. In addition, the Company has begun to participate in the emerging multi-media products business. The Company serves over 1.4 million business locations in the United States and approximately 100,000 business locations in over 90 other countries. Systems and Services The Company's core business communications system products are private switching systems, generally PBXs and key systems, usually located at the customer's premises, that permit a number of local telephones or terminals to communicate with one another, with or without use of the public telephone network. The Company offers wired and wireless communications systems, including the DEFINITY(R) family of products for large customers and the MERLIN LEGEND(R) and PARTNER(R) systems for smaller businesses and home offices. The DEFINITY Enterprise Communication Server provides real-time voice and mixed-media call processing. The FREEWORKS(TM) family of business mobility solutions enables communication throughout the workplace with full freedom of movement. 7
9 The Company's messaging and response systems store and forward voice, data and images and conduct initial call processing, which integrates PBX and computer functions. In addition, the Company is a technological leader in the development of speech recognition algorithms, which have been incorporated into both public and private call processing applications, such as operator services. The Company's principal systems include the INTUITY(TM), AUDIX(R) and DEFINITY(R) voice messaging systems and Octel Messaging Division systems, for use with the Company's or a competitor's PBX; INTUITY(TM) CONVERSANT(R), a multi-lingual interactive voice response system which can recognize speech in nine languages/dialects; and the INTUITY Multimedia Messaging System, a system that combines voice messaging and voice-response technology into a single desktop application. In September 1997, the Company acquired Octel Communications Corporation, a provider and developer of voice, fax and electronic messaging technologies that complement those offered by the Company. Octel's enterprise voice mail products, including unified messaging, work behind almost all types and models of PBX, central office and wireless switches and can be networked together. The Company's call center systems integrate the hardware and software associated with computing, telephony, and multimedia messaging and response applications. Call centers are the initial entry point for customers to access a business' telephone sales and support operation. The Company's systems permit the routing and administration of a large volume of incoming calls, and the integration with business databases of customer and product information. The Company's call center systems are used by companies in diverse industries such as financial services, retailing and transportation. The call center environment in which these companies operate is characterized by hundreds of telephone service agents located in geographically dispersed networked sites, processing tens of thousands of calls per hour. For example, using these systems, businesses can provide their customers with the ability to check balances or order status, to place orders, and to receive additional information and support. In September 1997, the Company introduced an enhanced portfolio of intelligent switching, access and network management products to improve data network performance. In addition, the Company introduced DEFINITY ATM to meet customer demand for voice-over-ATM solutions. In 1998, the Company acquired Prominet Corporation, a developer of Gigabit Ethernet networking technologies, SDX Business Systems plc, a United Kingdom provider of business communication servers and LANNET, an Israeli based networking company. Prominet enables Lucent to incorporate switching and data networking applications into its private branch exchange product lines. SDX and LANNET provide sales and distribution channels for Lucent products in Europe, Africa and Asia. In addition, the Company's SYSTIMAX(R) structured wiring system for business customers provides broadband multifunctional LAN interconnections within a building or campus. These systems are comprised of fiber optic and copper cable and associated apparatus. The Company offers NetCare(R) Services, a wide range of professional service options, including call center design, voice and data network engineering, training, remote diagnostics and dedicated on-site technicians. Their on-demand services involve routine testing and diagnostics, maintenance and repair, moves and rearrangements, and software and hardware upgrade installations. The Company's remote diagnostics and repair capability permits the Company to monitor, test, maintain and resolve problems from its regional service centers. Many of the Company's systems are designed with intelligent software which establishes a real-time link between the customer premises and a regional service center's expert system. This permits the customer to reduce its system down-time and enables the Company to automate many maintenance and repair tasks. Markets The Company markets its systems and services to large and small businesses and government agencies through a large, direct sales force and through a network of agents, dealers and distributors. In the United States, the Company effects these sales primarily through the direct sales force, while sales elsewhere occur through the efforts of dealers and distributors as well as the direct sales force. The Company's systems are 8
10 deployed in applications for customer sales and service, conferencing and collaboration, mobility and distributed work force, messaging and enterprise networking. The Company fields a large group of application specialists to design call center, distance learning and other customized applications. The Company believes that premises-based communications is transforming from distinct voice and data networks to multimedia networks that will be able to support any combination of voice, video and data communications simultaneously. The Company is designing certain business communications systems to enable its customers to simplify their premises networks by combining separate voice, video and data networks into a single architecture. Competition The Company considers its working relationships with its customers and knowledge of their individual business needs to be important competitive factors. The Company competes principally with three other large companies with substantial technological and financial resources in the sale of business communication systems. These competitors are Alcatel Alsthom, Northern Telecom Limited and Siemens AG. Together with the Company, in 1997 these competitors accounted for approximately 42% of the sales of business communications systems globally, with the Company accounting for approximately 9%. In addition, as the market transforms to multimedia systems, the Company is starting to encounter competition from companies that design and manufacture data network equipment. The Company believes that key competitive factors in this market are service support, the ability to upgrade existing systems for new applications, price and reliability. MICROELECTRONICS PRODUCTS The Company designs, manufactures and sells integrated circuits ("ICs"), electronic power systems and optoelectronic components for communications and computer applications. The Company supplies these components to manufacturers of communications systems and computers and also provides these components for many of the Company's own systems and products. The Company offers products in several IC product areas critical to communications applications, including digital signal processors ("DSPs") for digital cellular phones and modems and standard-cell application specific integrated circuits ("ASICs"). Products The Company's ICs are designed to provide advanced communications and control functions for a wide variety of electronic products and systems. The Company focuses on IC products that are used in communications and computing and that require high-performance and low power chip architectures; complex large-scale chip design in digital, analog and mixed-signal technologies; DSP architectures and algorithms; high-frequency and high-voltage technologies; and high speed data and signal processing. The Company offers a wide variety of standard, semi-custom and custom products for cellular equipment, communications networks, computers and computer peripherals, modems and consumer communications products. Products include DSPs, ASICs, field programmable gate arrays and communications ICs. The Company's products are manufactured using a variety of technologies, from low-power, low-voltage submicron CMOS (complementary metal oxide semiconductors) to high-frequency and high-voltage bipolar processes. The Company designs, develops and manufactures energy systems, electronic power supplies and associated magnetic components for the telecommunications and electronic data processing industries. These products serve applications ranging from modems for personal computers to large telephone central offices. Products include DC/DC converters, AC/DC switching power supplies, transformers, inductors and energy systems that provide alarm, control, and backup power management. The Company designs, develops and manufactures optoelectronic products which convert electricity to light (emitters) and light to electricity (detectors), thereby facilitating optical transmission of information. These products include semiconductor lasers, photodetectors, integrated transmitters and receivers, and advanced-technology erbium-doped fiber amplifiers. The Company provides these products worldwide to 9
11 manufacturers serving the telecommunications, cable television and network computing markets. Optoelectronic products extend the transmission capacity of fiber to meet the requirements of such applications as internet access video-on-demand, interactive video, teleconferencing, image transmission and remote database searching. The Company markets a number of advanced products, including critical optoelectronic components that support telecommunication transmission; long-wavelength optical data modules for data networking; and analog lasers for use in cable television fiber optic transmission. The Company believes that its optoelectronic products have higher photonics reliability than those of its competitors due to their low field failure rate and the Company's evaluation methodologies in manufacturing that allow the detection and elimination of early failures. The Company and Motorola have established a joint development center to design architectures and circuit implementations (cores) for future DSP products. In addition, the Company and Furukawa Electric Co. Ltd. have formed a partnership between two of their subsidiaries to manufacture optoelectronic components. The Company also is part of the DTV team currently consisting of the Company, Microsoft Corporation, Intel Corporation and Compaq Computer Corporation, which is an informal arrangement with the objective of accelerating the development of digital broadcast technology. In 1998, Lucent acquired Optimay GmbH, a German developer of software and chip sets for GSM cellular phones. Also in 1998, the Company made an equity investment in Chip Express Corporation, a developer of programmable logic ICs that enable quick delivery of products for their customers. In December 1996, the Company sold its operations for the design and manufacture of printed circuit boards and backplanes. Markets The Company's microelectronic products are sold globally to manufacturers of communications systems and computers. In addition, the Company's energy power systems are sold directly to U.S. and foreign telephone companies. The Company's customers are competing in markets characterized by rapid technological changes, decreasing product life cycles, price competition and increased user applications. These markets have experienced significant expansion in the number and types of products they offer to end-users, particularly in personal computing and portable access communication devices. As a result, the Company's customers continue to demand components which are smaller, require less power, are more complex, provide greater functionality, and are produced with shorter design cycles and less manufacturing lead time. Since 1995, the Company has also introduced a succession of GSM hardware platforms based upon a highly integrated multiple-chip design for digital cellular phones that performs all the key handset functions between the microphone and the antenna in both voice and data services. The Company also sells the associated software product elements necessary to support the GSM standard. In addition to the revenues from sales to third parties included in the Company's consolidated financial results, the Company's microelectronics products are also key components of its systems for network operators and business communications systems. The Company's microelectronics products compete with products of third-party manufacturers for inclusion in the Company's systems and products. Competition The Company considers its technological leadership, product leadership, and relationships with key customers to be important competitive factors. The market for microelectronic products is global and generally highly fragmented. The Company's competitors differ widely among product categories. The Company's competitors in certain IC product categories include Texas Instruments Incorporated, Rockwell International Corporation and LSI Logic Corp.; in electronic power systems include Astec Industries, Inc. and Unitech plc (through its subsidiary, NEMEC-Lambda); and in optoelectronics include Fujitsu Limited and Northern Telecom Limited. The Company believes that key competitive factors in the microelectronics marketplace are the early involvement in customers' future applications requirements, the speed of product and technological innova- 10
12 tion, price, customer service, and manufacturing capacity. Other important competitive factors include quality, reliability and local manufacturing presence. OTHER SYSTEMS AND PRODUCTS Other systems and products include products, services and integrated solutions provided to the United States Government for military and civilian use. In October 1997, the Company sold its Advanced Technology Systems ("ATS") unit. ATS designed and manufactured custom defense systems for the United States government. The Company sold its subsidiary, Paradyne, which designed and manufactured modems and other data communications equipment, in July 1996, and in December 1996 sold its Custom Manufacturing Services business. BELL LABORATORIES The Company has been and will continue to be supported by the technological expertise provided by Bell Labs, one of the world's foremost industrial research and development organizations. Bell Labs provides support for the businesses of the Company and conducts basic research. Bell Labs has made significant discoveries and advances in communications science and technology, software design and engineering, and networking. These contributions include the invention of the transistor and the design and development of ICs and many types of lasers. Areas of Bell Labs research and development work in recent years include: networking software; data networking; lightwave transmission, especially the wavelength division multiplexing systems which offer greater transmission capacity than other transmission systems; electronic switching technology, which enables rapid call processing, increased reliability and reduced network costs; and microelectronics components, which bring the latest advantages of very large scale integration to the full range of products offered by the Company. Bell Labs' research and development activities continue to focus on the core technologies critical to the Company's success, which are software, network design and engineering, microelectronics, photonics, data networking and wireless/cellular. Bell Labs is a leader in software research, development and engineering for communications applications. For example, its innovations in fault-tolerant software have enabled the Company to achieve a level of system reliability with off-the-shelf commercial processors that allows the Company to reduce its reliance on custom microprocessors. Bell Labs has contributed many innovations in voice quality, is a leader in the development of digital signal processing, and has developed a number of innovative algorithms for high-quality speech and audio. These innovations have contributed to the Company's implementation of speech processing applications which include text-to-speech synthesis, speech recognition and automatic translation of speech from one language to another. They are used in many of the Company's products, including the elemedia(R) products for Internet applications and are sold to outside customers. Bell Labs also has led in the development of software-based networking technologies that support the Company's systems and products. Recently, it has developed systems for digital cellular, PCS, mobile computing and wireless LANs, and its research in ATM led to the Company's offering of the first large ATM switch in 1993. Bell Lab's technology has allowed the recent introduction of data networking products such as the Internet Telephony Server SP, PacketStar IP switch, PacketStar IP Services platform and the Wavestar(TM) 400G high capacity WDM optical networking system. Similarly, Bell Labs' advances extend to the microlasers used in today's broadband multifunctional transmission systems, and to today's optical amplifiers and TRUEWAVE fiber. Current photonic research includes work on passive optical networks, photonic switching and quantum wire lasers. RECENT DEVELOPMENT On October 1, 1997, Lucent contributed its Consumer Products business to a new venture formed by Lucent and Philips Electronics N.V. ("Philips") in exchange for 40% ownership of the venture. The venture, Philips Consumer Communications ("PCC"), was formed to create a worldwide provider of personal 11
13 communications products. On October 22, 1998, Lucent and Philips announced their intention to end the venture in PCC. It is expected that Lucent and Philips will each regain control of the original businesses they contributed to the venture. Lucent plans to sell or close its portions of PCC. BACKLOG The Company's backlog, calculated as the aggregate of the sales price of orders received from customers less revenue recognized, was approximately $9,856 million and $12,141 million on September 30, 1998 and 1997, respectively. The decrease in backlog is due to completion of a majority of the milestones related to the Sprint Spectrum Holding LP ("Sprint PCS") purchase contract referred to under Outlook -- Future Capital Requirements below and a large long-term contract with the Ministry of Post and Telecommunications of Saudi Arabia. Approximately $3,400 million of the orders included in the September 30, 1998 backlog are scheduled for delivery after September 30, 1999. However, all orders are subject to possible rescheduling by customers. Although the Company believes that the orders included in the backlog are firm, some orders may be canceled by the customer without penalty, and the Company may elect to permit cancellation of orders without penalty where management believes that it is in the Company's best interest to do so. About $3,900 million of the amount at September 30, 1998 is under large, multi-year contracts of which about $3,000 million is scheduled for delivery after September 30, 1999 and is included in the $3,400 million referred to above. Of the $3,900 million under large, long-term contracts, the majority of the amount is with the Ministry of Post and Telecommunications of Saudi Arabia which require annual appropriations by the Saudi Arabian government. SOURCES AND AVAILABILITY OF MATERIALS The Company makes significant purchases of electronic components, copper, glass, silicon, and other materials and components from many domestic and foreign sources. The Company has been able to obtain sufficient materials and components from sources around the world to meet its needs. The Company also develops and maintains alternative sources for essential materials and components. Occasionally, additional inventories of specific components are maintained to minimize the effects of potential shortages. The Company does not have a concentration of sources of supply of materials, labor or services that, if suddenly eliminated, could severely impact its operations. See also Outlook -- Readiness for Year 2000. PATENTS AND TRADEMARKS From October 1, 1997 to September 30, 1998, the Company was issued 917 patents in the United States and 1,507 in foreign countries. The Company owns approximately 9,260 patents in the United States and 16,426 in foreign countries. These foreign patents are, for the most part, counterparts of the Company's United States patents. Many of the patents owned by the Company are licensed to others and the Company is licensed to use certain patents owned by others. In connection with the Separation, the Company has entered into an extensive cross-licensing agreement with AT&T and NCR Corporation ("NCR"). See "Separation Agreements -- Patent Licenses and Related Matters." The Company markets its products primarily under its own name and mark. The Company considers its many trademarks to be valuable assets. Most of its trademarks are registered throughout the world. OUTLOOK Forward Looking Statements This Outlook section and other sections of this Form 10-K report contain forward-looking statements, that are based on current expectations, estimates, forecasts and projections about the industries in which Lucent operates, management's beliefs and assumptions made by management. In addition, other written or oral statements which constitute forward-looking statements may be made by or on behalf of the Company. Words such as "expects," "anticipates," "intends," "plans," "believes," "seeks," "estimates," variations of such words and similar expressions are intended to identify such forward-looking statements. These statements are not guarantees of future performance and involve certain risks, uncertainties and assumptions ("Future 12
14 Factors") which are difficult to predict. Therefore, actual outcomes and results may differ materially from what is expressed or forecasted in such forward-looking statements. The Company undertakes no obligation to update publicly any forward-looking statements, whether as a result of new information, future events or otherwise. Future Factors include increasing price and product/services competition by foreign and domestic competitors, including new entrants; rapid technological developments and changes and the Company's ability to continue to introduce competitive new products and services on a timely, cost-effective basis; the mix of products/services; the achievement of lower costs and expenses; the outcome and impact of Year 2000 issues; domestic and foreign governmental and public policy changes which may affect the level of new investments and purchases made by customers; changes in environmental and other domestic and foreign governmental regulations; protection and validity of patent and other intellectual property rights; reliance on large customers; technological, implementation and cost/financial risks in the increasing use of large, multi-year contracts; the cyclical nature of the Company's business; the outcome of pending and future litigation and governmental proceedings and continued availability of financing, financial instruments and financial resources in the amounts, at the times and on the terms required to support the Company's future business. These are representative of the Future Factors that could affect the outcome of the forward-looking statements. In addition, such statements could be affected by general industry and market conditions and growth rates, general domestic and international economic conditions including interest rate and currency exchange rate fluctuations and other Future Factors. For a further description of Future Factors that could cause actual results to differ materially from such forward-looking statements, see the remainder of this Outlook section, including the other sections referred to in this section. Competition Lucent continues to face significant competition and expects that the level of competition on pricing and product offerings will intensify. Lucent expects that new competitors will enter its markets as a result of the trend toward global expansion by foreign and domestic competitors as well as continued changes in technology and public policy. These competitors may include entrants from the telecommunications, software, data networking and semiconductor industries. Existing competitors have, and new competitors may have, strong financial capability, technological expertise, well-recognized brand names and a global presence. Such competitors may include Alcatel Alsthom, Cisco Systems, Inc., Ericsson, Northern Telecom Limited, and Siemens AG. As a result, Lucent's management periodically assesses market conditions and redirects the Company's resources to meet the challenges of competition. Steps Lucent may take include acquiring or investing in new businesses and ventures, partnering with existing businesses, delivering new technologies, closing and consolidating facilities, disposing of assets, reducing work force levels or withdrawing from markets. Dependence on New Product Development New product development is being driven by the communications revolution described under GENERAL, above. The markets for the Company's principal products are characterized by rapidly changing technology, evolving industry standards, frequent new product introductions and evolving methods of building and operating communications systems for network operators and business customers. The Company's operating results will depend to a significant extent on its ability to continue to introduce new systems, products, software and services successfully on a timely basis and to reduce costs of existing systems, products, software and services. The success of these and other new offerings is dependent on several factors, including proper identification of customer needs, cost, timely completion and introduction, differentiation from offerings of the Company's competitors and market acceptance. In addition, new technological innovations generally require a substantial investment before any assurance is available as to their commercial viability, including, in some cases, certification by international and domestic standards-setting bodies. 13
15 Reliance on Major Customer/Multi-Year Contracts The purchasing behavior of Lucent's largest customers has increasingly been characterized by the use of fewer, larger contracts. Lucent has significant contracts for the sale of infrastructure systems to network operators which extend over a multi-year period, and expects to enter into similar contracts in the future. These contracts typically involve longer negotiating cycles, require the dedication of substantial amounts of working capital and other resources, and in general require costs that may substantially precede recognition of associated revenues. Moreover, in return for larger, longer-term purchase commitments, customers often demand more stringent acceptance criteria, which can also cause revenue recognition delays. Lucent has increasingly provided or arranged long-term financing for customers as a condition to obtain or bid on infrastructure projects. Certain multi-year contracts involve new technologies that may not have been previously deployed on a large-scale commercial basis. On its multi-year contracts, Lucent may incur significant initial cost overruns and losses that are recognized in the quarter in which they become ascertainable. Further, profit estimates on such contracts are revised periodically over the lives of the contracts, and such revisions can have a significant impact on reported earnings in any one quarter. See also discussion below under Future Capital Requirements. Lucent has been successful in diversifying its customer base and seeking out new types of customers globally. These new types of customers include competitive access providers, competitive local exchange carriers, wireless service providers, cable television network operators, computer manufacturers and internet service providers. Historically, a limited number of customers have provided a substantial portion of Lucent's total revenues. These customers include AT&T, which continues to be a significant customer, as well as other large service providers such as Sprint PCS, and the Regional Bell Operating Companies ("RBOCs"). The loss of any of these customers, or any substantial reduction in orders by any of these customers, could materially adversely affect the Company's operating results. In terms of total revenues, the Company's largest customer has been AT&T, although other large customers may purchase more of any particular system or product line. The contribution of AT&T to the Company's total revenues and percentage of total revenues for the two years and nine months ended September 30, 1998, 1997 and 1996 were $3,775 million (12.5%), $3,731 million (14.2%), and $1,970 million (12.4%), respectively. In addition, sales to seven network operators including AT&T (reduced from 9 in 1996 due to merger), some of which may vary from year to year, constituted approximately 35.4%, 37.5%, and 38% of total revenues in the twelve months ended September 30, 1998, 1997 and 1996, respectively. Readiness for Year 2000 Lucent is engaged in a major effort to minimize the impact of the Year 2000 date change on Lucent's products, information technology systems, facilities and production infrastructure. Lucent has targeted June 30, 1999 for completion of these efforts. The Year 2000 challenge is a priority within Lucent at every level of the company. Primary Year 2000 preparedness responsibility rests with program offices which have been established within each of Lucent's product groups and corporate centers. A corporate-wide Lucent Year 2000 Program Office ("LYPO") monitors and reports on the progress of these offices. Each program office has a core of full-time individuals augmented by a much larger group who have been assigned specific Year 2000 responsibilities in addition to their regular assignments. Further, Lucent has engaged third parties to assist in its readiness efforts in certain cases. LYPO has established a methodology to measure, track and report Year 2000 readiness status consisting of five steps: inventory; assessment; remediation; testing and deployment. Lucent is completing programs to make its new commercially available products Year 2000 ready and has developed evolution strategies for customers who own non-Year 2000 ready Lucent products. The majority of the upgrades and new products needed to support customer migration are already generally available. By the end of 1998, all but a few of these products are targeted for general availability. 14
16 Lucent has launched extensive efforts to alert customers who have non-Year 2000 ready products, including direct mailings, phone contacts and participation in user and industry groups. Recently, Lucent has set up a Year 2000 website www.lucent.com/y2k that provides Year 2000 product information. Lucent continues to cooperate in the Year 2000 information sharing efforts of the Federal Communications Commission and other governmental bodies. Lucent believes it has sufficient resources to provide timely support to its customers that require product migrations or upgrades. However, because this effort is heavily dependent on customer cooperation, Lucent continues to monitor customer response and will take steps to improve customer responsiveness, as necessary. Also, Lucent has begun contingency planning to address potential spikes in demand for customer support resulting from the Year 2000 date change. These plans are targeted for completion by April 30, 1999. Lucent has largely completed the inventory and assessment phases of the program with respect to its factories, information systems, and facilities. Approximately, two-thirds of the production elements included in the factory inventory were found to be Year 2000 ready. The factories have commenced the remediation phase of their effort through a combination of product upgrades and replacement. Plans have been developed to facilitate the completion of this work, as well as the related testing and deployment, by June 30, 1999. Currently, approximately 60% of Lucent's information technology infrastructure has been determined to be Year 2000 ready and is deployed for use. Approximately, 45% of the applications requiring Year 2000 remediation that are supported by Lucent's information technology group are now Year 2000 ready and have been deployed or are awaiting deployment. LYPO is monitoring the progress of readiness efforts across the Company, with a special emphasis on the early identification of any areas where progress to-date could indicate difficulty in meeting the Company's June 1999 internal readiness target date. Lucent is developing specific contingency plans, as appropriate. Lucent is also assessing the Year 2000 readiness of the large number of facilities that it owns or leases world-wide. Priority is being placed on Lucent-owned facilities, leased facilities that Lucent manages and other critical facilities that house large numbers of employees or significant operations. Based on the results of these assessment activities, Lucent plans to complete remediation efforts by March 31, 1999 and complete development of applicable contingency plans by May 31, 1999. To ensure the continued delivery of third party products and services, Lucent's procurement organization has analyzed Lucent's supplier base and has sent surveys to approximately 5,000 suppliers. Follow-up efforts have commenced to obtain feedback from critical suppliers. To supplement this effort, Lucent plans to conduct readiness reviews of the Year 2000 status of the suppliers ranked as most critical based on the nature of their relationship with Lucent, the product/service provided and/or the content of their survey responses. Almost all of Lucent's suppliers are still deeply engaged in executing their Year 2000 readiness efforts and, as a result, Lucent cannot, at this time, fully evaluate the Year 2000 risks to its supply chain. Lucent will continue to monitor the Year 2000 status of its suppliers to minimize this risk and will develop appropriate contingent responses as the risks become clearer. The risk to Lucent resulting from the failure of third parties in the public and private sector to attain Year 2000 readiness is the same as other firms in Lucent's industry or other business enterprises generally. The following are representative of the types of risks that could result in the event of one or more major failures of Lucent's information systems, factories or facilities to be Year 2000 ready, or similar major failures by one or more major third party suppliers to Lucent: (1) information systems -- could include interruptions or disruptions of business and transaction processing such as customer billing, payroll, accounts payable and other operating and information processes, until systems can be remedied or replaced; (2) factories and facilities -- could include interruptions or disruptions of manufacturing processes and facilities with delays in delivery of products, until non-compliant conditions or components can be remedied or replaced; and (3) major suppliers to Lucent -- could include interruptions or disruptions of the supply of raw materials, supplies and Year 2000 ready components which could cause interruptions or disruptions of manufacturing and delays in delivery of products, until the third party supplier remedied the problem or contingency measures were implemented. Risks of major failures of Lucent's principal products could include adverse 15
17 functional impacts experienced by customers, the costs and resources for Lucent to remedy problems or replace products where Lucent is obligated or undertakes to take such action, and delays in delivery of new products. Lucent believes it is taking the necessary steps to resolve Year 2000 issues; however, given the possible consequences of failure to resolve significant Year 2000 issues, there can be no assurance that any one or more such failures would not have a material adverse effect on Lucent. Lucent estimates that the costs of efforts to prepare for Year 2000 from calendar year 1997 through 2000 is about $535 million, of which an estimated $210 million has been spent as of September 30, 1998. Lucent has been able to reprioritize work projects to largely address Year 2000 readiness needs within its existing organizations. As a result, most of these costs represent costs that would have been incurred in any event. These amounts cover costs of the Year 2000 readiness work for inventory, assessment, remediation, testing and deployment including fees and charges of contractors for outsourced work and consultant fees. Costs for previously contemplated updates and replacements of Lucent's internal systems and information systems infrastructure have been excluded without attempting to establish whether the timing of non-Year 2000 replacement or upgrading was accelerated. While the Year 2000 cost estimates above include additional costs, Lucent believes, based on available information, that it will be able to manage its total Year 2000 transition without any material adverse effect on its business operations, products or financial prospects. The actual outcomes and results could be affected by Future Factors including, but not limited to, the continued availability of skilled personnel, cost control, the ability to locate and remediate software code problems, critical suppliers and subcontractors meeting their commitments to be Year 2000 ready and provide Year 2000 ready products, and timely actions by customers. European Monetary Union -- Euro On January 1, 1999, several member countries of the European Union will establish fixed conversion rates between their existing sovereign currencies, and adopt the Euro as their new common legal currency. As of that date, the Euro will trade on currency exchanges and the legacy currencies will remain legal tender in the participating countries for a transition period between January 1, 1999 and January 1, 2002. During the transition period, cash-less payments can be made in the Euro, and parties can elect to pay for goods and services and transact business using either the Euro or a legacy currency. Between January 1, 2002 and July 1, 2002, the participating countries will introduce Euro notes and coins and withdraw all legacy currencies so that they will no longer be available. Lucent has begun planning for the Euro's introduction. For this purpose, Lucent has in place a joint European-United States team representing affected functions within the Company. The Euro conversion may affect cross-border competition by creating cross-border price transparency. Lucent is assessing its pricing/marketing strategy in order to insure that it remains competitive in a broader European market. Lucent is also assessing its information technology systems to allow for transactions to take place in both the legacy currencies and the Euro and the eventual elimination of the legacy currencies, and reviewing whether certain existing contracts will need to be modified. Lucent's currency risk and risk management for operations in participating countries may be reduced as the legacy currencies are converted to the Euro. Final accounting, tax and governmental legal and regulatory guidance generally has not been provided in final form. Lucent will continue to evaluate issues involving introduction of the Euro. Based on current information and Lucent's current assessment, Lucent does not expect that the Euro conversion will have a material adverse effect on its business, results of operations, cash flows or financial condition. Seasonality Lucent has taken measures to manage the seasonality of its business by changing the date on which its fiscal year ends and its compensation programs for employees. As a result, Lucent has achieved a more uniform distribution of revenues -- accompanied by a related redistribution of earnings -- throughout the year. Revenues and earnings still remain higher in the first fiscal quarter primarily because many of Lucent's 16
18 large customers historically delay a disproportionate percentage of their capital expenditures until the fourth quarter of the calendar year (Lucent's first fiscal quarter). Future Capital Requirements The Company's working capital requirements and cash flow provided by (or used in) operating activities can vary greatly from quarter to quarter, depending on the volume of production, the timing of deliveries, the build-up of inventories, the payment terms offered to customers, and the extension of credit to customers. Network operators, inside and outside the United States, increasingly have required their suppliers to arrange or provide long-term financing for them as a condition to obtaining or bidding on infrastructure projects. These projects may require financing in amounts ranging from modest sums to over a billion dollars. Lucent has increasingly provided or arranged long-term financing for customers. As market conditions permit, Lucent's intention is to lay off these long-term financing arrangements, which may include both commitments and drawn down borrowings, to other financial institutions and investors. This enables Lucent to reduce the amount of its commitments and free up additional financing capacity. As of September 30, 1998, Lucent had made commitments or entered into an agreement to extend credit to certain customers, including Sprint PCS, up to an aggregate of approximately $2,300 million. As of September 30, 1998, approximately $400 million had been advanced and was outstanding. Included in the $2,300 million is approximately $1,230 million to six other PCS or wireless network operators (including fixed wireless) for possible future sales. As of September 30, 1998, approximately $130 million had been advanced under four of these arrangements. In addition, Lucent had made commitments or entered into agreements to extend credit up to an aggregate of approximately $370 million for two network operators other than PCS or wireless network operators. As of September 30, 1998, no amount was advanced under either of these agreements. In November 1998, a commitment for $110 million, included in the $370 million, was terminated. In October 1996, Lucent entered into a credit agreement to provide Sprint PCS long-term financing of $1,800 million for purchasing Lucent's equipment and services for its PCS network. In May 1997, Lucent closed transactions to lay off $500 million of loans and undrawn commitments and $300 million of undrawn commitments under the $1,800 million credit facility to a group of institutional investors and Sprint Corporation (a partner in Sprint PCS), respectively. As of September 30, 1998, all of these commitments were drawn down by Sprint PCS. On June 8, 1998, Lucent sold $645 million of loans in a private sale. As of September 30, 1998, Lucent has $253 million of undrawn commitments and $226 million of drawn loans outstanding. In November 1998, Sprint PCS repaid the entire outstanding loan balance and canceled the remaining undrawn commitments. On October 22, 1998, Lucent announced that it had entered into a five-year agreement with WinStar Communications, Inc. to provide WinStar with a fixed wireless broadband telecommunications network in major domestic and international markets. In connection with this agreement, Lucent entered into a credit agreement with WinStar to provide up to $2,000 million in equipment financing to fund the buildout of this network. The maximum amount of credit that Lucent is obligated to extend to WinStar at any one time is $500 million. In addition to the above arrangements, Lucent will continue to provide or commit to financing where appropriate for its business. The ability of Lucent to arrange or provide financing for its customers will depend on a number of factors, including Lucent's capital structure and level of available credit, and its continued ability to lay off commitments and drawn down borrowings on acceptable terms. The Company believes that its credit facilities, cash flow from operations and long- and short-term debt financings, will be sufficient to satisfy its future working capital, capital expenditure, research and development and debt service requirements. The Company has a shelf registration statement to register the possible offering from time to time of long-term debt of which $1,160 million remains available at September 30, 1998 after deducting $500 million of 10-year 5.5% Notes sold by Lucent on November 19, 1998. The Company believes that it will be able to access the capital markets on terms and in amounts that will be satisfactory to it, and that it will be able to obtain bid and performance bonds, to arrange or provide customer financing as necessary, and 17
19 to engage in hedging transactions on commercially acceptable terms, although there can be no assurance that the Company will be successful in this regard. Growth Outside the United States, Foreign Exchange and Interest Rates Lucent intends to continue to pursue growth opportunities in markets outside the United States. In many markets outside the United States, long-standing relationships between potential customers of Lucent and their local providers, and protective regulations, including local content requirements and type approvals, create barriers to entry. In addition, pursuit of such growth opportunities outside the United States may require significant investments for an extended period before returns on such investments, if any, are realized. Such projects and investments could be adversely affected by reversals or delays in the opening of foreign markets to new competitors, exchange controls, currency fluctuations, investment policies, repatriation of cash, nationalization, social and political risks, taxation, and other factors, depending on the country in which such opportunity arises. Difficulties in foreign financial markets and economies, and of foreign financial institutions, could adversely affect demand from customers in the affected countries. Lucent is exposed to market risk from changes in foreign currency exchange rates and interest rates, which could impact its results of operations and financial condition. Lucent manages its exposure to these market risks through its regular operating and financing activities and, when deemed appropriate, through the use of derivative financial instruments. A significant change in the value of the dollar against the currency of one or more countries where Lucent sells products to local customers or makes purchases from local suppliers may materially adversely affect Lucent's results. Lucent attempts to mitigate any such effects through the use of foreign currency contracts, although there can be no assurances that such attempts will be successful. While Lucent hedges actual and anticipated transactions with customers, the decline in value of the Asia/Pacific currencies or currencies in other regions may, if not reversed, adversely affect future product sales because Lucent products may become more expensive for customers to purchase in their local currency. Legal Proceedings and Environment See discussion below under Environmental Matters and Item 3. Legal Proceedings. Employee Relations See discussion below under Employee Relations. Intellectual Property The Company relies on patent, trademark, trade secret and copyright laws both to protect its proprietary technology and to protect the Company against claims from others. The Company believes that it has direct intellectual property rights or rights under cross-licensing arrangements covering substantially all of its material technologies. Given the technological complexity of the Company's systems and products, however, there can be no assurance that claims of infringement will not be asserted against the Company or against the Company's customers in connection with their use of the Company's systems and products, nor can there be any assurance as to the outcome of any such claims. The Company was assigned ownership of the substantial majority of AT&T's patents in connection with the Separation. Pursuant to the patent license agreement entered into among the Company, AT&T and NCR, the Company has been given rights, subject to specified limitations, to pass through to its customers certain rights under approximately 400 patents retained by AT&T. There can be no assurance that the Company's customers and potential customers will be satisfied with the pass-through rights available to them under the patents retained by AT&T or with any indemnification commitments the Company may be willing to provide in connection therewith. See "Separation Agreements -- Patent Licenses and Related Matters" and "-- Technology Licenses and Related Matters." 18
20 OPERATING REVENUE, RESEARCH AND DEVELOPMENT EXPENSE AND FOREIGN AND DOMESTIC OPERATIONS For information about the consolidated operating revenues contributed by the Company's major classes of products and services, consolidated research and development expenses, and foreign and domestic operations, see revenue tables and discussion on pages 38 through 41, Consolidated Statements of Income on page 49 and Note 11 thereto on pages 62-63 of the Company's annual report to security holders for the fiscal year ended September 30, 1998. Such information is incorporated herein by reference pursuant to General Instruction G(2). EMPLOYEE RELATIONS On September 30, 1998, Lucent employed approximately 141,600 persons, including 78.9% located in the United States. Of these domestic employees, about 40% are represented by unions, primarily the Communications Workers of America ("CWA") and the International Brotherhood of Electrical Workers ("IBEW"). During 1998, Lucent signed new five-year agreements with the CWA and IBEW expiring May 31, 2003. ENVIRONMENTAL MATTERS Lucent's current and historical operations are subject to a wide range of environmental protection laws. In the United States, these laws often require parties to fund remedial action regardless of fault. Lucent has remedial and investigatory activities underway at numerous current and former facilities. In addition, Lucent was named a successor to AT&T as a potentially responsible party ("PRP") at numerous "Superfund" sites pursuant to the Comprehensive Environmental Response, Compensation and Liability Act of 1980 ("CERCLA") or comparable state statutes. Under the Separation and Distribution Agreement, Lucent is responsible for all liabilities primarily resulting from or relating to the operation of Lucent's business as conducted at any time prior to or after the Separation including related businesses discontinued or disposed of prior to the Separation, and Lucent's assets including, without limitation, those associated with these sites. In addition, under such Separation and Distribution Agreement, Lucent is required to pay a portion of contingent liabilities paid out in excess of certain amounts by AT&T and NCR, including environmental liabilities. It is often difficult to estimate the future impact of environmental matters, including potential liabilities. Lucent records an environmental reserve when it is probable that a liability has been incurred and the amount of the liability is reasonably estimable. This practice is followed whether the claims are asserted or unasserted. Management expects that the amounts reserved will be paid out over the periods of remediation for the applicable sites which range from 5 to 30 years. Reserves for estimated losses from environmental remediation are, depending on the site, based primarily upon internal or third-party environmental studies, and estimates as to the number, participation level and financial viability of any other PRPs, the extent of the contamination and the nature of required remedial actions. Accruals are adjusted as further information develops or circumstances change. The amounts provided for in Lucent's consolidated financial statements for environmental reserves are the gross undiscounted amount of such reserves, without deductions for insurance or third-party indemnity claims. In those cases where insurance carriers or third-party indemnitors have agreed to pay any amounts and management believes that collectibility of such amounts is probable, the amounts are reflected as receivables in the financial statements. Although Lucent believes that its reserves are adequate, there can be no assurance that the amount of capital expenditures and other expenses which will be required relating to remedial actions and compliance with applicable environmental laws will not exceed the amounts reflected in Lucent's reserves or will not have a material adverse effect on Lucent's financial condition, results of operations or cash flows. Any amounts of environmental costs that may be incurred in excess of those provided for at September 30, 1998 cannot be determined. On November 16, 1998, Lucent signed a Consent Order with the Pennsylvania Department of Environmental Protection settling alleged violations resulting from etching equipment being installed in 1991 and 1992 without undergoing the proper state air permit with payment of a civil penalty of approximately $294,000, a portion of which will be devoted to the creation of community environmental projects. 19
21 SEPARATION AGREEMENTS For the purposes of governing certain of the relationships between the Company and AT&T (including NCR) following the Separation, the Company, AT&T and NCR entered into the Separation and Distribution Agreement and the Ancillary Agreements to which they are parties (collectively, the "Separation Agreements"). The Ancillary Agreements include the Employee Benefits Agreement; the Brand License Agreement; the Patent License Agreement and other patent-related agreements; the Technology License Agreement and other technology-related agreements; and the Tax Sharing Agreement and other tax-related agreements. Certain of the Separation Agreements, including certain of the Agreements summarized below, are exhibits to this Form 10-K. Reference is made to such exhibits for the full text of the provisions of those Agreements, and the agreement summaries below are qualified in their entirety by reference to the full text of such Agreements. Capitalized terms used in this section and not otherwise defined in this Form 10-K shall have their respective meanings set forth in the Separation and Distribution Agreement (except that the term "Company" is used in lieu of the term "Lucent") or other Separation Agreement. Separation and Distribution Agreement Under the Separation and Distribution Agreement, the Company assumed or agreed to assume, and agreed to perform and fulfill, all the "Lucent Liabilities" (as defined in such Agreement) in accordance with their respective terms. Without limitation, the Lucent Liabilities generally include all liabilities and contingent liabilities relating to Lucent's present and former business and operations, and contingent liabilities otherwise assigned to Lucent; contingent liabilities related to AT&T's discontinued computer operations (other than those of NCR) were assigned to the Company. The Separation and Distribution Agreement provides for the sharing of contingent liabilities not allocated to one of the parties in specified proportions, and also provides that each party will share specified portions of contingent liabilities related to the business of any of the other parties that exceed specified levels. Ability to Terminate Certain Rights. The Separation and Distribution Agreement provides that certain rights granted to the Company and the members of the Company Group will be subject to the following provisions. Except as otherwise expressly provided, in the event that, at any time prior to February 1, 2001, the Company or any member of the Company Group offers, furnishes or provides any Telecommunications Services of the type offered by the AT&T Services Business as of the Closing Date, then AT&T may, in its sole discretion: (a) terminate all or any portion of the rights granted by AT&T under the Brand License Agreement; (b) terminate all or any remaining portion of the purchase commitments made by AT&T and the members of the AT&T Group in the General Purchase Agreement; (c) exercise the right to require the Company to transfer to AT&T certain personnel, information, technology and software under the Supplemental Agreements; (d) terminate all or any portion of the rights to patents and technology of AT&T or any member of the AT&T Group granted to the Company and the members of the Company Group pursuant to the Patent License Agreement and the Technology License Agreement; and (e) direct the Company and the members of the Company Group to reconvey to AT&T all interests in any and all patents and technology in which the Company or any member of the Company Group was granted an undivided one-half interest pursuant to the Patent Assignments or the Technology Assignment and Joint Ownership Agreements. The Company and the members of the Company Group will not be deemed to offer, furnish or provide any Telecommunications Services (and the foregoing provisions will not apply) solely by virtue of certain specified investments in Persons that offer, furnish or provide Telecommunications Services or by virtue of offering, furnishing or providing Telecommunications Services below a specified de minimis amount. Employee Benefits Agreement AT&T and the Company entered into the Employee Benefits Agreement that governs the employee benefit obligations of the Company, including both compensation and benefits, with respect to active employees and retirees assigned to the Company. Pursuant to the Employee Benefits Agreement, the Company assumed and agreed to pay, perform, fulfill and discharge, in accordance with their respective terms, 20
22 all Liabilities (as defined) to, or relating to, former employees of AT&T or its affiliates employed by the Company and its affiliates and certain former employees of AT&T or its affiliates (including retirees) who either were employed in the Company Business (as defined) or who otherwise are assigned to the Company for purposes of allocating employee benefit obligations (including all retirees of Bell Labs). Patent Licenses and Related Matters The Company, AT&T and NCR executed and delivered assignments and other agreements, including a patent license agreement, related to patents then owned or controlled by AT&T and its subsidiaries. The patent assignments divided ownership of patents, patent applications and foreign counterparts among the Company, AT&T and NCR, with the substantial portion of those then owned or controlled by AT&T and its subsidiaries (other than NCR) being assigned to the Company. A small number of the patents assigned to the Company are jointly owned with either AT&T or NCR. Certain of the patents that the Company jointly owns with AT&T are subject to a joint ownership agreement under which each of the Company and AT&T has full ownership rights in the patents. The other patents that the Company jointly owns with AT&T, and the patents that the Company jointly owns with NCR, are subject to defensive protection agreements with AT&T and NCR, respectively, under which the Company holds most ownership rights in the patents exclusively. Under these defensive protection agreements, AT&T or NCR, as the case may be, has the ability, subject to specified restrictions, to assert infringement claims under the patents against companies that assert patent infringement claims against them, and has consent rights in the event the Company wishes to license the patents to certain third parties or for certain fields of use under specified circumstances. The defensive protection agreements also provide for one-time payments from AT&T and NCR to the Company. The patent license agreement entered into by the Company, AT&T and NCR provides for cross-licenses to each company, under each of the other company's patents that are covered by the licenses, to make, use, lease, sell and import any and all products and services of the businesses in which the licensed company (including specified related companies) is now or hereafter engaged. The cross-licenses also permit each company, subject to specified limitations, to have third parties make items under the other companies' patents, as well as to pass through to customers certain rights under the other companies' patents with respect to products and services furnished to customers by the licensed company. In addition, the rights granted to the Company and AT&T include the right to license third parties under each of the other company's patents to the extent necessary to meet existing patent licensing obligations as of March 29, 1996, and AT&T has the right, subject to specified restrictions and procedures, to ask the Company to license third parties under a limited number of identified patents that were assigned to the Company. Technology Licenses and Related Matters The Company, AT&T and NCR executed and delivered assignments and other agreements, including the Technology License Agreement, related to technology then owned or controlled by AT&T and its subsidiaries. Technology includes copyrights, mask works and other intellectual property other than trademarks, trade names, trade dress, service marks and patent rights. The technology assignments divide ownership of technology among the Company, AT&T and NCR, with the Company and AT&T owning technology that was developed by or for, or purchased by, the Company's business or AT&T's services business, respectively, and NCR owning technology that was developed by or for, or purchased by, NCR. Technology that is not covered by any of these categories is owned jointly by the Company and AT&T or, in the case of certain specified technology, owned jointly by the Company, AT&T and NCR. The Technology License Agreement entered into by the Company, AT&T and NCR provides for royalty-free cross-licenses to each company to use the other companies' technology existing as of April 10, 1996, except for specified portions of each company's technology as to which use by the other companies is restricted or prohibited. 21
23 ITEM 2. PROPERTIES. At September 30, 1998, the Company operated 30 manufacturing sites, of which 14 were located in the United States, occupying in excess of 19.0 million square feet, of which approximately 1.0 million square feet were leased. The remaining 16 sites were located in 10 countries. At September 30, 1998, the Company operated 228 warehouse sites, of which 192 were located in the United States, occupying in excess of 6.0 million square feet, substantially all of which were leased. The remaining 30 sites were located in 21 countries. At September 30, 1998, the Company operated 835 office sites (administration, sales, field service), of which 614 were located in the United States, occupying in excess of 20.0 million square feet, half of which were leased. The remaining 221 sites were located in 56 countries. At September 30, 1998, the Company operated additional sites in 19 cities, of which 7 were located in the United States, with significant research and development activities, occupying in excess of 9.0 million square feet, of which approximately 1.4 million square feet were leased. The Company believes its plants and facilities are suitable and adequate, and have sufficient productive capacity, to meet its current needs. ITEM 3. LEGAL PROCEEDINGS. In the normal course of business, the Company is subject to proceedings, lawsuits and other claims, including proceedings under laws and regulations related to environmental and other matters. (Also see Item 1. "Business -- Separation Agreements -- Separation and Distribution Agreement" regarding the assumption by the Company of certain liabilities and contingent liabilities.) All such matters are subject to many uncertainties and outcomes are not predictable with assurance. Consequently, the Company is unable to ascertain the ultimate aggregate amount of monetary liability or financial impact with respect to these matters at September 30, 1998. While these matters could affect operating results of any one quarter when resolved in future periods and, while there can be no assurance with respect thereto, it is management's opinion that after final disposition, any monetary liability or financial impact to the Company beyond that provided in the consolidated balance sheet at September 30, 1998 would not be material to the Company's annual consolidated financial statements. See also the discussion in Item 1. "Business -- Environmental Matters" for additional legal proceedings, and environmental matters and proceedings. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY-HOLDERS. During the fourth quarter of the fiscal year covered by this report on Form 10-K, no matter was submitted to a vote of Shareowners. PART II ITEMS 5. THROUGH 8. The information required by these items is included in pages 34 through 67 of the Company's annual report to security holders for the fiscal year ended September 30, 1998. The referenced pages of the Company's annual report to security holders have been filed as Exhibit 13 to this document. Such information is incorporated herein by reference, pursuant to General Instruction G(2). The New York Stock Exchange is the principal market for the Company's Common Shares. As of November 30, 1998, there were approximately 1,764,000 shareholders of record. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE. None. 22
24 PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT. Information regarding executive officers required by Item 401 of Regulation S-K is furnished in this separate disclosure because the Company did not furnish such information in its definitive proxy statement prepared in accordance with Schedule 14A. EXECUTIVE OFFICERS OF THE REGISTRANT (AS OF DECEMBER 1, 1998) <TABLE> <CAPTION> BECAME LUCENT EXECUTIVE NAME AGE OFFICER ON ---- ----- ------------- <S> <C> <C> <C> Richard A. McGinn......................... 52 Chairman of the Board and 2-96 Chief Executive Officer Donald K. Peterson........................ 49 Executive Vice President and 2-96 Chief Financial Officer Richard J. Rawson......................... 46 Senior Vice President, 2-96 General Counsel and Secretary Patricia F. Russo......................... 46 Executive Vice President, 2-96 Corporate Staff Operations Daniel C. Stanzione....................... 53 Executive Vice President and 2-96 Chief Operating Officer Bernardus J. Verwaayen.................... 46 Executive Vice President and 9-97 Chief Operating Officer </TABLE> All of the above executive officers have held high level managerial positions with the Company and prior thereto with AT&T or its affiliates for more than the past five years, except in the case of Messrs. Peterson and Verwaayen who have held such positions since September 1, 1995 and September 1, 1997, respectively. Prior to joining AT&T, Mr. Peterson held various senior executive positions at Northern Telecom, Inc., a telecommunications equipment company, which included President of Nortel Communications Systems, Inc. (from January 1993 to September 1995), Vice President of Finance of Northern Telecom, Inc. (from January 1991 to January 1993) and Group Vice President of Northern Telecom, Inc. (from September 1987 to January 1991). Mr. Verwaayen joined the Company after serving as President of PTT Telecom, the national telecommunications operator of the Netherlands since May 1988. He was a co-founder of Unisource, the pan-European alliance of Telia of Sweden, Swiss Telecom and PTT Telecom. Officers are not elected for a fixed term of office but hold office until their successors have been elected. The other information required by Item 10 is included in the Company's definitive proxy statement dated December 22, 1998, on pages 12 through 15. Such information is incorporated herein by reference, pursuant to General Instruction G(3). ITEMS 11. THROUGH 13. Section 16(a) Beneficial Ownership Reporting Compliance Section 16(a) of the Securities Exchange Act of 1934 requires the Company's Directors and officers to file reports of holdings and transactions in the Company's Common Shares with the Securities and Exchange Commission ("SEC") and the New York Stock Exchange. Based on Company records and other information, the Company believes that all SEC filing requirements applicable to its Directors and officers with respect to the Company's fiscal year ending September 30, 1998 were complied with. The other information required by Items 11 through 13 is included in the Company's definitive proxy statement dated December 22, 1998, on pages 8 through 11 and pages 35 through page 44. Such information is incorporated herein by reference, pursuant to General Instruction G(3). 23
25 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K. (a) Documents filed as a part of Form 10-K: <TABLE> <CAPTION> PAGES ----- <S> <C> (1) Management's Discussion and Analysis of Results of Operations and Financial Condition................................... * (2) Report of Management.......................... * (3) Report of Independent Accountants............. * (4) Financial Statements: (i) Consolidated Statements of Income....... * (ii) Consolidated Balance Sheets............. * (iii) Consolidated Statements of Changes in Shareowners' Equity........................... * (iv) Consolidated Statements of Cash Flows... * (v) Notes to Consolidated Financial Statements.................................... * (5) Financial Statement Schedules: (i) Report of Independent Accountants........ 27 (ii) Schedule II -- Valuation and Qualifying Accounts...................................... 28 </TABLE> Separate financial statements of subsidiaries not consolidated and 50 percent or less owned persons are omitted since no such entity constitutes a "significant subsidiary" pursuant to the provisions of Regulation S-X, Article 3-09. - --------------- * Incorporated herein by reference to the appropriate portions in pages 34 through 67 of the Company's annual report to security holders for the fiscal year ended September 30, 1998. (See Part II and Exhibit 13.) 24
26 (6) Exhibits: The following documents are filed as Exhibits to this report on Form 10-K or incorporated by reference herein. Any document incorporated by reference is identified by a parenthetical referencing the SEC filing which included such document. <TABLE> <CAPTION> EXHIBIT NUMBER - ------- <S> <C> (3)(i) Articles of Incorporation of the registrant, as amended April 8, 1996 (Exhibit 3(i) to Form 8-K dated July 18, 1996, File No. 001-11639). (3)(ii) By-Laws of the registrant, as amended July 17, 1996 (Exhibit 3(ii) to Form 8-K dated July 18, 1996, File No. 001-11639). (4)(i) Indenture dated as of April 1, 1996 between Lucent Technologies Inc. and the Bank of New York, as Trustee (Exhibit 4A to Registration Statement on Form S-3 No. 333- 01223). (4)(iii) Other instruments in addition to Exhibit 4(i) which define the rights of holders of long term debt, of the registrant and all of its consolidated subsidiaries, are not filed herewith pursuant to Regulation S-K, Item 601(b)(4)(iii)(A). Pursuant to this regulation, the registrant hereby agrees to furnish a copy of any such instrument to the SEC upon request. (10)(i)1 Separation and Distribution Agreement by and among Lucent Technologies Inc., AT&T Corp. and NCR Corporation, dated as of February 1, 1996 and amended and restated as of March 29, 1996 (Exhibit 10.1 to Registration Statement on Form S-1 No. 333-00703). (10)(i)2 Tax Sharing Agreement by and among Lucent Technologies Inc., AT&T Corp. and NCR Corporation, dated as of February 1, 1996 and amended and restated as of March 29, 1996 (Exhibit 10.6 to Registration Statement on Form S-1 No. 333-00703). (10)(i)3 Employee Benefits Agreement by and between AT&T and Lucent Technologies Inc., dated as of February 1, 1996 and amended and restated as of March 29, 1996 (Exhibit 10.2 to Registration Statement on Form S-1 No. 333-00703). (10)(i)4 Rights Agreement between Lucent Technologies Inc. and First Chicago Trust Company of New York, as Rights Agent, dated as of April 4, 1996 (Exhibit 4.2 to Registration Statement on Form S-1 No. 333-00703). (10)(i)5 Amendment to Rights Agreement between Lucent Technologies Inc. and First Chicago Trust Company of New York, dated as of February 18, 1998. (10)(ii)(B)1 General Purchase Agreement by and between AT&T Corp. and Lucent Technologies Inc., dated February 1, 1996 and amended and restated as of March 29, 1996 (Exhibit 10.3 to Registration Statement on Form S-1 No. 333-00703). (10)(ii)(B)2 Interim Services and Systems Replication Agreement by and among AT&T, Lucent Technologies Inc. and NCR, dated as of February 1, 1996 and amended and restated as of March 29, 1996 (Exhibit 10.4 to Registration Statement on Form S-1 No. 333-00703). (10)(ii)(B)3 Brand License Agreement by and between Lucent Technologies Inc. and AT&T, dated as of February 1, 1996 (Exhibit 10.5 to Registration Statement on Form S-1 No. 333-00703). (10)(ii)(B)4 Patent License Agreement among AT&T, NCR and Lucent Technologies Inc., effective as of March 29, 1996 (Exhibit 10.7 to Registration Statement on Form S-1 No. 333-00703). </TABLE> 25
27 <TABLE> <CAPTION> EXHIBIT NUMBER - ------- <S> <C> (10)(ii)(B)5 Amended and Restated Technology License Agreement among AT&T, NCR and Lucent Technologies Inc., effective as of March 29, 1996 (Exhibit 10.8 to Registration Statement on Form S-1 No. 333-00703). (10)(iii)(A)(1) Lucent Technologies Inc. Short Term Incentive Program (Exhibit (10)(iii)(A)(2) to the Quarterly Report on Form 10-Q for the quarter ended March 31, 1998).* (10)(iii)(A)2 Lucent Technologies Inc. 1996 Long Term Incentive Program (Exhibit(10)(iii)(A)1 to Quarterly Report on Form 10-Q for the quarter ended March 31, 1998).* (10)(iii)(A)3 Lucent Technologies Inc. Deferred Compensation Plan.* (10)(iii)(A)4 Pension Plan for Lucent Non-Employee Directors (Exhibit 10.11 to Registration Statement on Form S-1 No. 333-00703).* (This plan has been terminated) (10)(iii)(A)5 Lucent Technologies Inc. Stock Retainer Plan for Non-Employee Directors.* (10)(iii)(A)6 Lucent Technologies Inc. Excess Benefit and Compensation Plan (Exhibit (10)(iii)(A)5 to Annual Report on Form 10-K for Transition Period ended September 30, 1996).* (10)(iii)(A)7 Lucent Technologies Inc. Mid-Career Pension Plan (Exhibit (10)(iii)(A)6 to Annual Report on Form 10-K for Transition Period ended September 30, 1996).* (10)(iii)(A)8 Lucent Technologies Inc. Non-Qualified Pension Plan (Exhibit (10)(iii)(A)7 to Annual Report on Form 10-K for Transition Period ended September 30, 1996).* (10)(iii)(A)9 Lucent Technologies Inc. Officer Long-Term Disability and Survivor Protection Plan (Exhibit (10)(iii)(A)8 to the Annual Report on Form 10-K for Transition Period ended September 30, 1996).* (10)(iii)(A)10 Employment Agreement of Mr. Verwaayen dated June 12, 1997 (Exhibit (10)(iii)(A)(1)) to the Annual Report on Form 10-K for the period ended September 30, 1997).* (10)(iii)(A)11 Employment Agreement of Mr. Peterson dated August 8, 1995 (Exhibit (10)(iii)(A)(9) to the Annual Report on Form 10-K for the period ended September 30, 1997).* (10)(iii)(A)12 Consulting Agreement of Mr. Schacht, effective March 1, 1998 (Exhibit (10)(iii)(A)5 to the Quarterly Report on Form 10-Q for the period ended March 31, 1998).* (10)(iii)(A)13 Description of the Lucent Technologies Inc. Supplemental Pension Plan.* (10)(iii)(A)14 Lucent Technologies Inc. 1999 Stock Compensation Plan for Non-Employee Directors.* (10)(iii)(A)15 Lucent Technologies Inc. Voluntary Life Insurance Plan. (12) Computation of Ratio of Earnings to Fixed Charges. (13) Specified portions (pages 34 through 67) of the Company's Annual Report to security holders for the year ended September 30, 1998. (21) List of subsidiaries of Lucent Technologies Inc. (23) Consent of PricewaterhouseCoopers LLP (24) Powers of Attorney executed by officers and directors who signed this report. (27) Financial Data Schedule. </TABLE> - --------------- * Management contract or compensatory plan or arrangement. The Company will furnish, without charge, to a security holder upon request a copy of the annual report to security holders and the proxy statement, portions of which are incorporated herein by reference thereto. The Company will furnish any other exhibit at cost. (b) Reports on Form 8-K: No Reports on Form 8-K were filed by the Company during the last quarter of the fiscal year covered by this Report on Form 10-K. 26
28 REPORT OF INDEPENDENT ACCOUNTANTS To the Shareowners of Lucent Technologies Inc.: Our report on the consolidated financial statements of Lucent Technologies Inc. and subsidiaries has been incorporated by reference in this Form 10-K from page 48 of the 1998 Annual Report to the Shareowners of Lucent Technologies Inc. In connection with our audits of such financial statements, we have also audited the related consolidated financial statement schedule listed in the index on page 24 of this Form 10-K. In our opinion, the consolidated financial statement schedule referred to above, when considered in relation to the basic financial statements taken as a whole, presents fairly, in all material respects, the information required to be included therein. PricewaterhouseCoopers LLP New York, New York October 21, 1998 27
29 LUCENT TECHNOLOGIES INC. SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS (DOLLARS IN MILLIONS) <TABLE> <CAPTION> COLUMN A COLUMN B COLUMN C COLUMN D COLUMN E - ----------------------------------- ------------ ------------------------ ---------- --------- ADDITIONS ------------------------ BALANCE AT CHARGED TO CHARGED TO BALANCE BEGINNING OF COSTS & OTHER AT END DESCRIPTION PERIOD EXPENSES ACCOUNTS DEDUCTIONS OF PERIOD - ----------- ------------ ---------- ---------- ---------- --------- <S> <C> <C> <C> <C> <C> Year 1998 Allowance for doubtful accounts...................... 352 113 (59) 16(a) 390 Reserves related to business restructuring and facility consolidation................. 569 -- -- 318(b) 251 Deferred tax asset valuation allowance..................... 234 31 45 49 261 Inventory valuation.............. 637 146 30 177 636 Year 1997 Allowance for doubtful accounts...................... 273 111 5 37(a) 352 Reserves related to business restructuring and facility consolidation(d).............. 1,289 -- -- 720(b) 569 Deferred tax asset valuation allowance..................... 208 86 3 63 234 Inventory valuation.............. 644 221 19 247 637 Year 1996 Allowance for doubtful accounts...................... 248 64 -- 39(a) 273 Reserves related to business restructuring and facility consolidation(d).............. 1,907 -- -- 618(b) 1,289 Deferred tax asset valuation allowance..................... 142 7 102(c) 43 208 Inventory valuation.............. 790 92 9 247 644 </TABLE> - --------------- (a) Amounts written off as uncollectible, payments or recoveries. (b) Included in these deductions were cash payments of $176, $483 and $456 for the years ended September 30, 1998 and 1997, and for the nine months ended September 30, 1996, respectively. In addition, Lucent reversed $100, $201 and $98 for the years ended September 30, 1998 and 1997, and for the nine months ended September 30, 1996, respectively. See Note 6 of the Notes to Consolidated Financial Statements for background information. (c) Relates to net asset additions and net liability reductions from AT&T. See Note 1 of the Notes to Consolidated Financial Statements for background information. (d) Certain prior year amounts have been reclassified to conform to the 1998 presentation. 28
30 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. By /s/ JAMES S. LUSK --------------------------------------------- James S. Lusk Vice President and Controller (attorney-in-fact)* December 22, 1998 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the date indicated. <TABLE> <S> <C> Principal Executive Officer Richard A. McGinn Chief Executive Officer and President Principal Financial Officer Donald K. Peterson Executive Vice President and Chief Financial Officer Principal Accounting Officer By /s/ JAMES S. LUSK James S. Lusk --------------------------------------------- Vice President James S. Lusk Vice President and Controller (attorney-in-fact)* December 22, 1998 Directors Paul A. Allaire Carla A. Hills Drew Lewis Richard A. McGinn Paul H. O'Neill Donald S. Perkins Henry B. Schacht Franklin A. Thomas John A. Young - ------------------------------------------ * As Principal Accounting Officer and by power of attorney </TABLE> 29
31 EXHIBIT INDEX The following documents are filed as Exhibits to this report on Form 10-K or incorporated by reference herein. Any document incorporated by reference is identified by a parenthetical referencing the SEC filing which included such document. <TABLE> <CAPTION> EXHIBIT NUMBER - ------- <S> <C> (3)(i) Articles of Incorporation of the registrant, as amended April 8, 1996 (Exhibit 3(i) to Form 8-K dated July 18, 1996, File No. 001-11639). (3)(ii) By-Laws of the registrant, as amended July 17, 1996 (Exhibit 3(ii) to Form 8-K dated July 18, 1996, File No. 001-11639). (4)(i) Indenture dated as of April 1, 1996 between Lucent Technologies Inc. and the Bank of New York, as Trustee (Exhibit 4A to Registration Statement on Form S-3 No. 333- 01223). (4)(iii) Other instruments in addition to Exhibit 4(i) which define the rights of holders of long term debt, of the registrant and all of its consolidated subsidiaries, are not filed herewith pursuant to Regulation S-K, Item 601(b)(4)(iii)(A). Pursuant to this regulation, the registrant hereby agrees to furnish a copy of any such instrument to the SEC upon request. (10)(i)1 Separation and Distribution Agreement by and among Lucent Technologies Inc., AT&T Corp. and NCR Corporation, dated as of February 1, 1996 and amended and restated as of March 29, 1996 (Exhibit 10.1 to Registration Statement on Form S-1 No. 333-00703). (10)(i)2 Tax Sharing Agreement by and among Lucent Technologies Inc., AT&T Corp. and NCR Corporation, dated as of February 1, 1996 and amended and restated as of March 29, 1996 (Exhibit 10.6 to Registration Statement on Form S-1 No. 333-00703). (10)(i)3 Employee Benefits Agreement by and between AT&T and Lucent Technologies Inc., dated as of February 1, 1996 and amended and restated as of March 29, 1996 (Exhibit 10.2 to Registration Statement on Form S-1 No. 333-00703). (10)(i)4 Rights Agreement between Lucent Technologies Inc. and First Chicago Trust Company of New York, as Rights Agent, dated as of April 4, 1996 (Exhibit 4.2 to Registration Statement on Form S-1 No. 333-00703). (10)(i)5 Amendment to Rights Agreement between Lucent Technologies Inc. and First Chicago Trust Company of New York, dated as of February 18, 1998. (10)(ii)(B)1 General Purchase Agreement by and between AT&T Corp. and Lucent Technologies Inc., dated February 1, 1996 and amended and restated as of March 29, 1996 (Exhibit 10.3 to Registration Statement on Form S-1 No. 333-00703). (10)(ii)(B)2 Interim Services and Systems Replication Agreement by and among AT&T, Lucent Technologies Inc. and NCR, dated as of February 1, 1996 and amended and restated as of March 29, 1996 (Exhibit 10.4 to Registration Statement on Form S-1 No. 333-00703). (10)(ii)(B)3 Brand License Agreement by and between Lucent Technologies Inc. and AT&T, dated as of February 1, 1996 (Exhibit 10.5 to Registration Statement on Form S-1 No. 333-00703). (10)(ii)(B)4 Patent License Agreement among AT&T, NCR and Lucent Technologies Inc., effective as of March 29, 1996 (Exhibit 10.7 to Registration Statement on Form S-1 No. 333-00703). </TABLE>
32 <TABLE> <CAPTION> EXHIBIT NUMBER - ------- <S> <C> (10)(ii)(B)5 Amended and Restated Technology License Agreement among AT&T, NCR and Lucent Technologies Inc., effective as of March 29, 1996 (Exhibit 10.8 to Registration Statement on Form S-1 No. 333-00703). (10)(iii)(A)(1) Lucent Technologies Inc. Short Term Incentive Program (Exhibit (10)(iii)(A)(2) to the Quarterly Report on Form 10-Q for the quarter ended March 31, 1998).* (10)(iii)(A)2 Lucent Technologies Inc. 1996 Long Term Incentive Program (Exhibit(10)(iii)(A)1 to Quarterly Report on Form 10-Q for the quarter ended March 31, 1998).* (10)(iii)(A)3 Lucent Technologies Inc. Deferred Compensation Plan.* (10)(iii)(A)4 Pension Plan for Lucent Non-Employee Directors (Exhibit 10.11 to Registration Statement on Form S-1 No. 333-00703).* (This plan has been terminated) (10)(iii)(A)5 Lucent Technologies Inc. Stock Retainer Plan for Non-Employee Directors.* (10)(iii)(A)6 Lucent Technologies Inc. Excess Benefit and Compensation Plan (Exhibit (10)(iii)(A)5 to Annual Report on Form 10-K for Transition Period ended September 30, 1996).* (10)(iii)(A)7 Lucent Technologies Inc. Mid-Career Pension Plan (Exhibit (10)(iii)(A)6 to Annual Report on Form 10-K for Transition Period ended September 30, 1996).* (10)(iii)(A)8 Lucent Technologies Inc. Non-Qualified Pension Plan (Exhibit (10)(iii)(A)7 to Annual Report on Form 10-K for Transition Period ended September 30, 1996).* (10)(iii)(A)9 Lucent Technologies Inc. Officer Long-Term Disability and Survivor Protection Plan (Exhibit (10)(iii)(A)8 to the Annual Report on Form 10-K for Transition Period ended September 30, 1996).* (10)(iii)(A)10 Employment Agreement of Mr. Verwaayen dated June 12, 1997 (Exhibit (10)(iii)(A)(1)) to the Annual Report on Form 10-K for the period ended September 30, 1997).* (10)(iii)(A)11 Employment Agreement of Mr. Peterson dated August 8, 1995 (Exhibit (10)(iii)(A)(9) to the Annual Report on Form 10-K for the period ended September 30, 1997).* (10)(iii)(A)12 Consulting Agreement of Mr. Schacht effective March 1, 1998 (Exhibit (10)(iii)(A)5 to the Quarterly Report on Form 10-Q for the period ended March 31, 1998).* (10)(iii)(A)13 Description of the Lucent Technologies Inc. Supplemental Pension Plan.* (10)(iii)(A)14 Lucent Technologies Inc. 1999 Stock Compensation Plan for Non-Employee Directors.* (10)(iii)(A)15 Lucent Technologies Inc. Voluntary Life Insurance Plan. (12) Computation of Ratio of Earnings to Fixed Charges. (13) Specified portions (pages 34 through 67) of the Company's Annual Report to security holders for the year ended September 30, 1998. (21) List of subsidiaries of Lucent Technologies Inc. (23) Consent of PricewaterhouseCoopers LLP (24) Powers of Attorney executed by officers and directors who signed this report. (27) Financial Data Schedule. </TABLE> - --------------- * Management contract or compensatory plan or arrangement.