Edgar Filing: ALCATEL

FORM 20-F

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 20-F

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2004

Commission file number: 1-11130

ALCATEL

(Exact name of Registrant as specified in its charter)

Republic of France

(Jurisdiction of incorporation or organization)

54, rue La Boétie

75008 Paris, France

(Address of principal executive offices)

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


		Name of each exchange
Title of each class		on which registered

American Depositary Shares, each representing one ordinary share,
nominal value € 2 per share*		New York Stock Exchange


*	Listed, not for trading or quotation purposes, but only in connection with the registration of the American Depositary Shares pursuant to the requirements of the Securities and Exchange Commission.

Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act:

None.

The number of outstanding shares of the issuer’s classes of capital or common stock as of December 31, 2004 was as follows: 1,305,455,461 ordinary shares, nominal value € 2 per share.

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes þ No o

Indicate by check mark which financial statement item the registrant has elected to follow:

Item 17 o Item 18 þ

TABLE OF CONTENTS


		Page

Item 1.	Identity of Directors, Senior Management and Advisers		1
Item 2.	Offer Statistics and Expected Timetable		1
Item 3.	Key Information		1
Item 4.	Information on the Company		10
Item 5.	Operating and Financial Review and Prospects		21
Item 6.	Directors, Senior Management and Employees		55
Item 7.	Major Shareholders and Related Party Transactions		65
Item 8.	Financial Information		66
Item 9.	The Offer and the Listing		69
Item 10.	Additional Information		70
Item 11.	Quantitative and Qualitative Disclosures About Market Risk		85
Item 12.	Description of Securities Other than Equity Securities		85
Item 13.	Defaults, Dividend Arrearages and Delinquencies		85
Item 14.	Material Modifications to the Rights of Security Holders		85
Item 15.	Controls and Procedures		85
Item 16.	Reserved		86
Item 16A.	Audit Committee Financial Expert		86
Item 16B.	Code of Ethics		86
Item 16C.	Principal Accounting Fees and Services		86
Item 16D.	Exemptions from the Listing Standards for Audit Committee		87
Item 16E.	Purchases of Equity Securities by the Issuer and Affiliated Purchasers		87
Item 17.	Financial Statements		88
Item 18.	Financial Statements		88
Item 19.	Exhibits		88
EXHIBIT 10.1
EXHIBIT 12.1
EXHIBIT 12.2
EXHIBIT 13.1
EXHIBIT 13.2

PART I


Item 1.	Identity of Directors, Senior Management and Advisers

Not applicable.


Item 2.	Offer Statistics and Expected Timetable

Not applicable.


Item 3.	Key Information

SELECTED FINANCIAL DATA

Alcatel Selected Consolidated Financial Data

The following table represents selected consolidated financial data for Alcatel for the five-year period ended December 31, 2004, which have been derived from the audited consolidated financial statements of Alcatel. The selected consolidated financial data is qualified by reference to, and should be read in conjunction with, Alcatel’s consolidated financial statements and the notes to those statements and Item 5 — “Operating and Financial Review and Prospects” appearing elsewhere in this annual report.

French GAAP differs from U.S. GAAP in certain significant respects. For a discussion of significant differences between U.S. GAAP and French GAAP as they relate to Alcatel’s consolidated financial statements and a reconciliation to U.S. GAAP of net income and shareholders’ equity, please refer to Notes 37 through 40 to Alcatel’s consolidated financial statements.


			At December 31,

			2004⁽¹⁾			2004			2003			2002			2001			2000

			(in millions, except per share and ADS data)
Income Statement Data Amounts in accordance with French GAAP:
Net sales			$	16,604		€	12,265		€	12,513		€	16,547		€	25,353		€	31,408
Income (loss) from operations				1,324			978			332			(727	)		(361	)		2,251
Restructuring costs				(412	)		(304	)		(1,314	)		(1,474	)		(2,124	)		(143	)
Amortization of goodwill				(552	)		(408	)		(578	)		(589	)		(1,933	)		(576	)
Other revenue (expense)⁽²⁾				493			364			120			(830	)		(213	)		623
Net income (loss)				380			281			(1,944	)		(4,745	)		(4,963	)		1,324
Earnings per Ordinary Share
Net income (loss) — Basic⁽³⁾⁽⁴⁾				0.28			0.21			(1.46	)		(3.99	)		(4.29	)		1.23
Net income (loss) — Diluted⁽⁴⁾⁽⁵⁾				0.28			0.21			(1.46	)		(3.99	)		(4.29	)		1.18
Dividends per ordinary share⁽⁴⁾⁽⁶⁾							—			—			—			0.16			0.48
Dividend per ADS⁽⁶⁾							—			—			—			0.16			0.48
Amounts in accordance with U.S. GAAP ⁽⁷⁾
Net sales				17,143			12,663			12,528			16,549			25,627			31,382
Income (loss) from operations				744			550			(1,349	)		(8,300	)		(5,285	)		(179	)
Net income (loss)				744			550			(1,721	)		(11,511	)		(4,937	)		(481	)
Basic earnings per ordinary share⁽³⁾⁽⁴⁾:
	Income (loss) before extraordinary items			0.61			0.45			(1.46	)		(7.29	)		(4.05	)		(0.45	)
	Net income (loss)			0.61			0.45			(1.42	)		(9.67	)		(4.26	)		(0.45	)
Diluted earnings per ordinary share ⁽⁴⁾⁽⁵⁾:
Income (loss) before extraordinary items				0.58			0.43			(1.46	)		(7.29	)		(4.05	)		(0.45	)
		Net income (loss)		0.58			0.42			(1.42	)		(9.67	)		(4.26	)		(0.45	)
Basic earnings per ADS⁽⁴⁾:
	Income (loss) before extraordinary items			0.61			0.45			(1.46	)		(7.29	)		(4.05	)		(0.45	)
	Net income (loss)			0.61			0.45			(1.42	)		(9.67	)		(4.26	)		(0.45	)
Diluted earnings per ADS^(4):
	Income (loss) before extraordinary items			0.58			0.43			(1.46	)		(7.29	)		(4.05	)		(0.45	)
		Net income (loss)		0.58			0.42			(1.42	)		(9.67	)		(4.26	)		(0.45	)


	2004⁽¹⁾		2004		2003		2002		2001		2000

Balance Sheet Data Amounts in accordance with French GAAP:
Total assets	$	25,772	€	19,037	€	21,132	€	25,880	€	36,549	€	42,978
Short-term investments and cash and cash equivalents		6,919		5,111		6,269		6,109		5,013		3,060
Short-term debt		1,403		1,036		883		1,096		1,796		1,813
Long-term debt		4,499		3,323		4,410		4,687		5,879		5,577
Shareholders’ equity after appropriation		4,560		3,368		3,030		5,007		9,630		14,361
Minority interests		509		376		363		343		219		435
Amounts in accordance with U.S. GAAP ⁽⁷⁾
Shareholders’ equity		9,292		6,864		6,414		8,184		20,788		26,140
Total assets⁽⁸⁾		32,340		23,888		25,998		30,435		49,046		54,323
Long-term debt		4,912		3,628		4,713		5,070		6,202		5,577


(1)	Translated solely for convenience into dollars at the noon buying rate of € 1.00 = $ 1.3538 on December 31, 2004.

(2)	Other revenue (expense) includes capital gains (loss) on share disposals, tangible and intangible asset disposals, non-recurring expenses and revenues linked to ordinary business that are exceptional in terms of materiality and frequency, and extraordinary expenses (revenues).

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

Ordinary shares: 1,349,528,158 in 2004 for French GAAP earnings per share (including 120,782,388 shares related to bonds mandatorily redeemable for ordinary shares) and 1,228,745,770 for U.S. GAAP earnings per share; 1,332,364,920 in 2003 for French GAAP earnings per share (including 120,784,953 shares related to bonds mandatorily redeemable for ordinary shares) and 1,211,579,968 in 2003 for U.S. GAAP earnings per share; 1,190,067,515 in 2002, 1,158,143,038 in 2001 and 1,077,084,401 in 2000 for both French GAAP and U.S. GAAP earnings per share.


(4)	All ordinary share and per ordinary share data and all ADS and per ADS data for the years ended December 31, 2002, 2001 and 2000 have been adjusted to reflect (i) the five-for-one stock split that became effective on May 22, 2000 and (ii) the conversion on April 17, 2003 of all of our outstanding Class O shares and Class O ADSs into our ordinary shares and ADSs, as applicable, on a one-to-one basis. We no longer have Class O shares trading on the Euronext Paris or Class O ADSs trading on the NASDAQ National Market.

(5)	Diluted earnings per share takes into account share equivalents having a dilutive effect after deduction of the weighted average number of share equivalents owned by our subsidiaries. Net income is adjusted for after-tax interest expense related to our convertible bonds. The dilutive effect of stock option plans is calculated using the treasury stock method. The number of shares taken into account is as follows:


	—	French GAAP: ordinary shares: 1,363,661,187 in 2004; 1,332,364,920 in 2003; 1,190,067,515 in 2002; 1,158,143,038 in 2001 and 1,077,084,401 in 2000.

	—	U.S. GAAP: ordinary shares: 1,363,661,187 in 2004; 1,211,579,968 in 2003; 1,190,067,515 in 2002; 1,158,143,038 in 2001 and 1,077,084,401 in 2000.


(6)	Year to which dividend relates. Under French company law, payment of annual dividends must be made within nine months following the end of the fiscal year to which they relate.

(7)	For information concerning the differences between French GAAP and U.S. GAAP, see Notes 37 to 40 to our consolidated financial statements included elsewhere herein.

(8)	Advance payments received from customers are not deducted from the amount of total assets. See Note 36(l) to our consolidated financial statements included elsewhere herein.

Exchange Rate Information

The table below shows the average noon buying rate of euro from 2000 to 2004. As used in this document, the term “noon buying rate” refers to the rate of exchange for the euro, expressed in U.S. dollars per euro, as announced by the Federal Reserve Bank of New York for customs purposes as the rate in The City of New York for cable transfers in foreign currencies.


Year	Average rate⁽¹⁾

2004	$	1.2478
2003		1.1411
2002		1.0531
2001		0.8929
2000		0.9174


(1)	The average of the noon buying rate for euro on the last business day of each month during the year.

The table below shows the high and low noon buying rates expressed in U.S. dollars per euro for the previous six months.


Period	High		Low

September 2004	$	1.2417	$	1.2052
October 2004		1.2783		1.2271
November 2004		1.3288		1.2703
December 2004		1.3625		1.3224
January 2005		1.3476		1.2954
February 2005		1.3274		1.2773

On March 30, 2005, the noon buying rate was € 1.00 = $ 1.29944.

RISK FACTORS

Risks Relating to our Operations

Our business, financial condition or results of operations could suffer material adverse effects due to any of the following risks. We have described the specific risks that we consider material to our business but the risks described below are not the only ones we face: we do not discuss risks that would generally be equally applicable to companies in other industries, due to the general state of the economy or the markets, or other factors. Additional risks not known to us or that we now consider immaterial may also impair our business operations.

Renewed weakness in the telecommunications market could once again have a material adverse effect on our business, operating results and financial condition, and cause us to continue to incur net losses in the future.

Our business is extremely sensitive to market conditions in the telecommunications industry. For the three-year period immediately preceding 2004, our operating results were adversely affected as a result of unfavorable economic conditions and reduced capital spending by carriers and businesses, particularly in the United States and Europe. While there has been some improvement in capital spending trends in 2004, it is difficult to know whether this improvement will continue. Capital spending for telecommunications equipment and related services depends upon the extent of existing unused capacity and the growth rate in voice and data traffic levels, including growth in Internet and electronic commerce generated traffic. If this capital spending does not maintain its current level or does not increase from current levels, the market for our products may decline or fail to develop as expected. This would result in reduced sales and the carrying of excess inventory and may result in our incurring net losses in the future. We have recently experienced slower than expected demand for access products in the U.S. and for fixed-line products in China.

While we expect the market for triple-play products and services to develop over the course of 2005, delays in the development of this market or the failure of the market to develop as anticipated could have an adverse effect on our sales.

If we fail to keep pace with rapid changes in technology, our business could suffer.

Technology in the telecommunications industry continues to advance at a rapid pace, particularly in the fields of mobile telecommunication networks and services, data processing and transmission. Failure to introduce or develop new products and technologies in a timely manner or failure to respond to changes in market demand may harm our business.

Our inability to compete effectively with existing or new competitors could result in reduced revenues, reduced margins and loss of market share.

The telecommunications industry continues to have excess capacity and there has not been any significant consolidation. On the contrary, new competitors continue to emerge and grow. Asian-based competitors are now providing fierce competition not only in Asia but in other markets as well. Accordingly, the industry remains highly competitive and pricing pressures are intense across a growing range of products and services. Some of our competitors have a stronger position than us with respect to certain products or in particular markets. Also, the continued strength of the euro against the U.S. dollar and the major Asian currencies may give a competitive advantage to those of our competitors that incur a great portion of their costs outside the euro area.

Gross margins may be adversely affected by increased price competition, excess capacity, higher material or labor costs, obsolescence charges, additional inventory write-downs, introductions of new products, increased levels of customer services, changes in distribution channels, and changes in product and geographic mix.

In order to maintain or increase market share and to acquire new clients we may need to enter into contracts on terms that are less advantageous to us than what has been our general practice and as a result, our gross margin may be adversely impacted.

Our restructuring plan may not achieve its target and may require refinement based on the changing market environment.

In response to continued changes in the telecommunications industry and general economic conditions, we have restructured, and continue to restructure, our activities to more strategically realign our resources. Our restructuring plan is based on certain assumptions regarding the cost structure of our business, the nature and severity of the competition and continuing price pressure in the telecommunications industry and our expected revenue rate. One or more of these assumptions may prove to be inaccurate. The plan has involved the implementation of a number of initiatives to streamline our business, reduce our fixed assets and improve our balance sheet through the reduction in net debt-corresponding to our cash and cash equivalents net of financial debt (see Note 26 to our consolidated financial statements) — and inventory levels, the write-off of tangible and intangible assets, the exit from certain businesses, the sale of manufacturing plants, the reduction in the number of employees, the implementation of our outsourcing programs for manufacturing and the refocusing of our research and development efforts toward products that meet our customers’ requirements. We can provide no assurance that the completed or planned steps will be sufficient, that we will not be required to refine, expand or extend our restructuring plan or that our margins will continue to improve as a result of the plan.

We can provide no assurance that the costs actually incurred in connection with our restructuring plans will not be higher than the amount that we have estimated. Current and additional restructuring actions may result in further cash and/or non-cash charges that could have a material adverse effect on our business, operating results and financial condition. In addition, reductions in our assets, employees and businesses may negatively impact our efforts to enhance our existing products and services, develop new services and products or keep pace with technological advances in our field. Therefore, our restructuring plan may reduce

our ability to benefit from a further recovery in the telecommunications industry as a whole or in certain segments of the telecommunications industry.

Our business requires significant amounts of cash, and we may require additional sources of funds if our sources of liquidity are unavailable or insufficient to fund our operations.

Our working capital requirements and cash flows historically have been, and are expected to continue to be, subject to quarterly and yearly fluctuations, depending on a number of factors. If we are unable to manage fluctuations in cash flow, our business, operating results and financial condition may be materially adversely affected. Factors which could lead us to suffer cash flow fluctuations include:


	•	the level of sales;

	•	the collection of receivables;

	•	the timing and size of capital expenditures; and

	•	customer financing obligations.

In order to finance our business, we have entered into a syndicated credit facility allowing for the drawdown of significant levels of debt, but our ability to draw on this facility is conditioned upon our compliance with a financial covenant, and we can provide no assurance that we will be in compliance with such covenant at all times in the future.

In the future, we may need to secure additional sources of funding if our existing facility and borrowings are not available or insufficient to finance our business. We can provide no assurance that such funding will be available on terms satisfactory to us. If we were to incur high levels of debt, this would require a larger portion of our operating cash flow to be used to pay principal and interest on our indebtedness. The increased use of cash to pay indebtedness could leave us with insufficient funds to finance our operating activities, such as research and development expenses and capital expenditures, which could have a material adverse effect on our business.

Our short-term debt rating allows us a very limited access to the commercial paper market, and the non-French commercial paper market is generally not available to us on terms and conditions that we find acceptable. Our ability to access the capital markets and our financing costs are, in part, dependent on Standard & Poor’s, Moody’s or similar agencies’ ratings with respect to our debt and corporate credit and their outlook with respect to our business. Our current short-term and long-term credit ratings as well as any possible future lowering of our ratings may result in higher financing costs and reduced access to the capital markets. We can provide no assurance that our credit ratings will not be reduced in the future by Standard & Poor’s, Moody’s or similar rating agencies.

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

A substantial portion of our sales are to customers in the telecommunications industry. These customers have often required their suppliers to provide extended payment terms, direct loans or other forms of financial support as a condition to obtaining commercial contracts. As of December 31, 2004, net of reserves, we had provided customer financing of approximately € 253 million, and we had outstanding commitments to provide further direct loans or financial guarantees of approximately € 92 million. We continuously monitor and manage the credit we extend to our customers and attempt to limit credit risks by, in some cases, obtaining security interests or by transferring to banks or export credit agencies a portion or all of the risk associated with this financing. We expect to continue to provide or commit to financing where appropriate for our business. Our ability to arrange or provide financing for our customers will depend on a number of factors, including our credit rating, our level of available credit, and our ability to sell off commitments on acceptable terms.

More generally, as part of our business we routinely enter into long-term contracts involving significant amounts to be paid by our customers over time. Pursuant to these contracts, we may deliver products and services representing an important portion of the contract price before receiving any payment from the

customer. As is the case with customer financing, we continuously monitor and manage this commercial risk exposure.

As a result of the financing provided to customers and our commercial risk exposure under long-term contracts, our business could be adversely affected if the financial condition of our customers erodes. Over the past few years certain of our customers have filed with the courts seeking protection under the bankruptcy or reorganization laws of the applicable jurisdiction or have experienced financial difficulties. Upon the financial failure of a customer, we have experienced, and in the future may experience, losses on credit extended and loans made to such customer, losses relating to our commercial risk exposure, as well as the loss of the customer’s ongoing business. Should additional customers fail to meet their obligations to us, we may experience reduced cash flows and losses in excess of reserves, which could materially adversely impact our results of operations and financial position. We review the levels of our customer commercial risk exposure and financing reserves on a regular basis. In addition to being selective in providing customer financing, we have various programs in place to monitor and mitigate customer commercial risk exposure and credit risk, including a prior approval process by our Risk Assessment Committee and by our Trade & Project Finance Department, performance milestones, other conditions of funding, and active customer financing portfolio and repayment record reviews. With respect to customer financing, our management is focused on the strategic use of our limited customer financing capacity, on revolving that capacity as quickly and efficiently as possible, and on managing the absolute euro amount of our customer financing obligations. However, we can provide no assurance that all these measures will reduce our exposure to customers’ credit and general repayment risk. While we believe that our allowances for credit losses and commercial non-repayment losses are adequate, we cannot assure investors that such allowances will cover actual losses.

Our sales are made to a relatively limited number of large customers. The loss of one of these customers or our inability to obtain new customers would result in lower sales.

Historically, orders from a relatively limited number of customers have accounted for a substantial portion of our sales and we expect that, for the foreseeable future, this will continue to be the case. For example, in 2004 our 10 largest customers accounted for 24% of our net sales. However, no single customer accounted for more than 10% of our net sales. In addition, even if we are successful in attracting new customers, new market entrants may not have access to sufficient financing to purchase our products and equipment.

An increasing amount of our sales, particularly in mobile networks, is made in emerging markets.

We are experiencing increased sales in emerging markets in Asia, Africa and Latin America. This is particularly the case with respect to mobile infrastructure products and related services. In these markets we are faced with several risks that are more significant than in other countries. These risks include economies that may be dependent on only a few products and therefore subject to significant fluctuations, weak legal systems which may affect our ability to enforce contractual rights, possible exchange controls, unstable governments, privatization actions or other government actions affecting the flow of goods and currency.

Our financial condition and results of operations may be harmed if we do not successfully reduce market risks through the use of derivative financial instruments.

Since we conduct operations throughout the world, a substantial portion of our assets, liabilities, revenues and expenses are denominated in various currencies other than the euro, principally the U.S. dollar, and, to a lesser extent, the British pound. Because our financial statements are denominated in euros, fluctuations in currency exchange rates, especially the U.S. dollar against the euro, could continue to have a material impact on our reported results. In 2003 and 2004, the relative strength of the euro against the U.S. dollar had a significant negative impact on our net sales. The weakness of the dollar against the euro has meant that competition is particularly intense from competitors with a large part of their costs outside the euro area. This has put pressure on our margins and might continue to do so. If the dollar continues to be weak against the euro in 2005, this may have a further negative impact on our sales and our margins. We also experience other market risks, including changes in interest rates and in prices of marketable equity securities

that we own. We use derivative financial instruments to reduce certain of these risks. If our strategies to reduce market risks are not successful, our financial condition and operating results may be harmed.

Because of our significant international operations, we are exposed to a variety of risks, many of which are beyond our control.

In addition to the currency risks described elsewhere in this section, our international operations are subject to a variety of risks arising out of the economy, the political outlook, the language and cultural barriers in countries where we have operations or do business, which is virtually every country in the world.

We have significant operations and sales in many countries outside of Western Europe and North America, particularly in Asia. As such, our business activities are exposed to shifting government policies, legal systems that may not provide full protection of intellectual property rights or contractual commitments. We take appropriate measures to control the risks inherent in such activities but we recognize that changes in government policies or an inability to protect our legal rights may have an adverse impact on our financial conditions.

As a result of being active in many countries we are continually moving products from one country to another and we often provide services in one country from a base in another. We continually monitor the applicable customs and tax laws and regulations to ensure that our activities are conducted in line with local requirements. Nevertheless, we remain vulnerable to abrupt changes in customs and tax regimes that may have significant negative impacts on our financial condition and operating results.

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

We are involved in several significant joint venture companies, some of which are fully consolidated in our accounts. Although we believe these companies present significant strategic advantages, the related joint venture agreements may require unanimous consent or the affirmative vote of a qualified majority of the shareholders to take certain actions, thereby possibly slowing down the decision-making process.

Risks Relating to Ownership of our ADSs

The trading price of our ADSs may be affected by fluctuations in the exchange rate for converting euro into U.S. dollars.

Fluctuations in the exchange rate for converting euro into U.S. dollars may affect the value of our ADSs.

If a holder of our ADSs fails to comply with the legal notification requirements upon reaching certain ownership thresholds under French law or our governing documents, the holder could be deprived of some or all of the holder’s voting rights and be subject to a fine.

French law and our governing documents require any person who owns our outstanding shares or voting rights in excess of certain amounts specified in the law or our governing documents to file a report with us upon crossing this threshold percentage and, in certain circumstances, with the French stock exchange regulator (Autorité des marchés financiers). If any shareholder fails to comply with the notification requirements:


	•	the shares or voting rights in excess of the relevant notification threshold may be deprived of voting power on the demand of any shareholder;

	•	all or part of the shareholder’s voting rights may be suspended for up to five years by the relevant French commercial court; and

	•	the shareholder may be subject to a fine.

Holders of our ADSs will have limited recourse if we or the depositary fail to meet obligations under the deposit agreement between us and the depositary.

The deposit agreement expressly limits our obligations and liability and the obligations and liability of the depositary. Neither we nor the depositary will be liable if the depositary:


	•	is prevented or hindered in performing any obligation by circumstances beyond our control;

	•	exercises or fails to exercise discretion under the deposit agreement;

	•	performs its obligations without negligence or bad faith;

	•	takes any action based upon advice from legal counsel, accountants, any person presenting our ordinary shares for deposit, any holder or any other qualified person; or

	•	relies on any documents it believes in good faith to be genuine and properly executed.

This means that there could be instances where you would not be able to recover losses that you may have suffered by reason of our actions or inactions or the actions or inactions of the depositary pursuant to the deposit agreement. In addition, the depositary has no obligation to participate in any action, suit or other proceeding in respect of our ADSs unless we provide the depositary with indemnification that it determines to be satisfactory.

We are subject to different corporate disclosure standards that may limit the information available to holders of our ADSs.

As a foreign private issuer, we are not required to comply with the notice and disclosure requirements under the Securities Exchange Act of 1934, as amended, relating to the solicitation of proxies for shareholder meetings. Although we are subject to the periodic reporting requirement of the Exchange Act, the periodic disclosure required of non-U.S. issuers under the Exchange Act is more limited than the periodic disclosure required of U.S. issuers. Therefore, there may be less publicly available information about us than is regularly published by or about other public companies in the United States.

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

An investor in the United States may find it difficult to:


	•	effect service of process within the United States against us and our non-U.S. resident directors and officers;

	•	enforce U.S. court judgments based upon the civil liability provisions of the U.S. federal securities laws against us and our non-U.S. resident directors and officers in both the United States and France; and

	•	bring an original action in a French court to enforce liabilities based upon the U.S. federal securities laws against us and our non-U.S. resident directors and officers.

Preemptive rights may not be available for U.S. persons.

Under French law, shareholders have preemptive rights to subscribe for cash issuances of new shares or other securities giving rights to acquire additional shares on a pro rata basis. U.S. holders of our ADSs or ordinary shares may not be able to exercise preemptive rights for their shares unless a registration statement under the Securities Act of 1933 is effective with respect to such rights or an exemption from the registration requirements imposed by the Securities Act is available. We may, from time to time, issue new shares or other securities giving rights to acquire additional shares at a time when no registration statement is in effect and no Securities Act exemption is available. If so, U.S. holders of our ADSs or ordinary shares will be unable to exercise their preemptive rights.

Item 4. Information on the Company

History and Development

We are a leading, worldwide provider of a wide variety of telecommunications equipment and services. We had net sales of € 12.3 billion in 2004 and have approximately 56,000 employees in 130 countries. Our telecommunications equipment and services enable our customers to send or receive virtually any type of voice or data transmission. Our customers include fixed line and wireless telecommunications operators, sometimes referred to as carriers, Internet service providers, governments and businesses.

Alcatel is a French société anonyme, established in 1898, originally as a publicly owned company. Alcatel’s corporate existence will continue until June 30, 2086, which date may be extended by shareholder vote. We are subject to all laws governing business corporations in France, specifically the provisions of the commercial code and decree No. 67-236 of March 23, 1967.

Our registered office and principal place of business is 54, rue la Boétie, 75008 Paris, France, our telephone number is 33 (1) 40.76.10.10 and our website address is www.alcatel.com. The contents of our website are not incorporated into this Form 20-F. The address for Steven Sherman, our authorized representative in the United States, is Alcatel USA, Inc., 3400 West Plano Parkway, Plano, Texas 75075.

Our total capital expenditures were € 380 million for the year ended December 31, 2004, compared to € 253 million in 2003 and € 490 million in 2002. Our capital expenditures are incurred in the ordinary course of our business and operations and are generally funded out of our cash flow from operations. Further information with respect to capital expenditures and funding sources is set forth in Item 5 — “Operating and Financial Review and Prospects — Liquidity and Capital Resources.”

As used in this Form 20-F, unless the context otherwise indicates, the terms “we,” “us,” “our” or similar expressions, as well as references to “Alcatel” or the “Group,” mean Alcatel and its consolidated subsidiaries.

Overview

The telecommunications market showed a modest recovery in 2004, primarily boosted by an increased demand for broadband services for data transmission and voice and data services on wireless infrastructures. The major telecommunications carriers increased their capital spending to meet this demand and to meet the growing competitive threat from smaller independent service providers.

As a result of this improved market environment, our revenues increased by 5.7 % in 2004 as compared to 2003. Excluding the impact of the currency exchange rate between the Euro and the U.S. dollar and other currencies linked to the U.S. dollar, our sales would have increased by 9.5%. For the full year our gross margin was 37.3%, and our operating margin was 8.0%, reflecting improved profitability in all three of our business segments. In particular, the improvement in our fixed communications segment was primarily due to a return to profitability in our optical networking business following significant restructuring efforts.

In terms of overall business trends in 2005, we expect that our fixed communication segment sales will be weaker in the first half of 2005, but will be stronger in the second half of 2005, in each case as compared to the comparable periods of 2004. Our fixed communications sales are expected to be driven by our “triple play” offerings combining video, voice and data transmission, which requires increased bandwidth in the network. We expect our mobile communications segment to grow due to our competitive positioning in emerging markets, and we expect to achieve growth in our private communications group due to growth in the private sector market, somewhat offset by lower satellite revenues.

Recent Events

Acquisition of Native Networks. On March 17, 2005, we completed the acquisition of Native Networks, Inc. for $55 million in cash. Native Networks is a provider of optical Ethernet transport solutions.

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

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

Moody’s long-term debt outlook on review for possible upgrade. On February 24, 2005, Moody’s changed its outlook for our long-term debt from “positive” to “rating under review” for possible upgrade, on the basis of our continued improvement on key metrics and the expectation that our overall business performance will continue to improve.

Merger of space activities. On January 28, 2005, we entered into a definitive agreement with Finmeccanica, S.p.A., an Italian aerospace and defense company, to merge our space activities and to form alliances in the space sector through the creation of two sister companies. This agreement provides that we will own approximately 67%, and Alenia Spazio, a unit of Finmeccanica, will own approximately 33%, of the new company, which will combine our industrial space activities with those of Finmeccanica. The agreement further provides for the creation of a second company, of which Finmeccanica will own approximately 67% and we will own approximately 33%, in order to combine our respective satellite operations and service activities.

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

Highlights of Transactions during 2004

Acquisitions

Acquisition of Spatial Wireless. On December 16, 2004, we completed the acquisition of Spatial Communications Technologies, Inc. for consideration consisting of our ADSs having a value of approximately € 226 million (based on the market value of our ADSs on the date of the acquisition). Spatial develops and markets mobile switching equipment that can operate using any of the major mobile technologies and related software. We believe that this acquisition will enable us to offer next-generation mobile switching equipment and will facilitate our ability to provide carriers with systems that can be updated relatively easily in the future.

Acquisition of eDial. On September 17, 2004, we acquired eDial for consideration consisting of cash and ADSs having an aggregate value of € 22 million (based on the market value of our ADSs on the date of the acquisition). eDial provides conferencing and related services for businesses and carriers. We expect that this acquisition will complement our communications software development strategy.

Dispositions

Sale of battery business. On January 14, 2004, we completed the sale of our battery business, Saft, to Doughty Hanson, a European private equity firm, for € 390 million in cash.

Other Transactions

Sale of a portion of shareholding in Avanex. On December 14, 2004, we sold a portion of our shareholding in Avanex in a block trade market transaction, which reduced our shareholding in this company to 19.65% of its share capital.

Creation of joint venture for mobile handset business. On August 31, 2004, our joint venture with TCL Communication Technology Holdings Limited commenced operations. This joint venture will engage in research and development, manufacturing, and sales and distribution of mobile handsets and peripheral devices. We contributed cash and our mobile handset business having an approximate aggregate value of

€ 45 million in exchange for a 45% equity stake in the joint venture, and TCL Communications contributed cash of € 55 million in exchange for a 55% equity stake in the joint venture.

Creation of joint venture for optical fiber cable business. On July 1, 2004, we combined our global fiber and communication cable business with that of Draka Holding, N.V, a Dutch cable and cable systems producer, and created a new company, Draka Comteq B.V., owned 50.1% by Draka and 49.9% by us.

No dividends for 2003. On June 4, 2004, our shareholders approved a resolution recommended by our board of directors to the effect that no dividends be paid on our ordinary shares and ADSs with respect to 2003. Alcatel’s distributable profits for 2003 were not sufficient to pay dividends.

Moody’s Investor Service upgrades outlook and credit rating. On May 10, 2004, Moody’s Investor Service revised its outlook for our long-term debt from stable to positive, and on September 8, 2004, Moody’s upgraded our long-term debt credit rating from B1 to Ba3 and confirmed its positive outlook for our long-term debt, based on the stabilization of our revenues, our positive net income and healthy cash position.

Standard & Poor’s upgrades credit rating. On March 10, 2004, Standard & Poor’s upgraded our long-term corporate credit and senior unsecured debt rating to BB-. Standard & Poor’s outlook continues to be stable and it also affirmed our short-term B corporate credit rating. Standard & Poor’s stated that “the upgrade reflects Alcatel’s improving operating and financial performance on the back of healthier market conditions and prospects for the telecom equipment industry and the company’s severe cost cutting.”

Highlights of Transactions during 2003

Acquisitions

Acquisition of iMagicTV. On April 30, 2003, we acquired, for 3.5 million of our American Depositary Shares, or ADSs, having a market value on that date of € 26 million, the 84% of the outstanding shares that we did not own of iMagicTV, a Canadian supplier of software products and services that enable service providers to create, deliver and manage digital television and media services over broadband networks. This acquisition, together with our acquisition of ThirdSpace and Packet Video, enabled us to add to our portfolio of content and systems integration products.

Acquisition of TiMetra. On July 18, 2003, we acquired, for 18 million ADSs, having a market value on that date of € 145 million, TiMetra, Inc., a privately held, Silicon Valley-based company that produces routers (devices that interconnect computer networks and move information from one network to another). The customers for our routers are generally carriers.

Dispositions

Sale of optical components business. On August 1, 2003, we sold our optical components business to Avanex. Under the terms of the agreement, we received 28% of Avanex’s stock. We contributed cash in the transaction in the amount of U.S. $110 million, the majority of which related to the restructuring of the optical business. We also entered into a supply agreement with Avanex, under which it will provide optical components for Alcatel’s optical networking products over a three-year period.

Sale of European factories. In 2003, we sold a number of manufacturing facilities in Europe. The principal transactions were: our Saintes, France factory that engaged in cutting, stamping and general sheet metal work was sold, and 300 employees were transferred, to GMD, a French industrial company; our Coutances, France that specialized in producing printed circuit boards used in telecommunications applications was sold in a leveraged management buyout and 220 employees were transferred; our Hoboken, Belgium factory that produced electro-mechanical devices was sold, and 241 employees were transferred, to Scanfil Oyi. These facilities comprised nearly 80,000 square meters.

Sale of shareholding in Atlinks. On February 12, 2003, we exercised our option to sell our 50% shareholding in Atlinks to Thomson, our joint venture partner. Atlinks is a manufacturer of residential telephones. The sale price was € 68 million.

Other Transactions

Conversion of Class O shares into our ordinary shares. On February 3, 2003, our board of directors decided to submit for approval a resolution at our annual shareholders’ meeting to convert all outstanding Class O shares and Class O ADSs into our ordinary shares and ADSs, as applicable, on a one-for-one basis. This decision was taken after our board analyzed the market conditions of the opto-electronic industry and noted that the conditions were very different than those that existed at the time the Class O shares were created and that the conditions in early 2003 negatively affected the Optronics division’s performance and appeared likely to continue to do so throughout 2003 and later. Our management believed that the elimination of the tracking stock would give us more flexibility as we addressed the future of the Optronics business and continued to explore strategic alternatives for this division. On April 17, 2003, our shareholders approved this resolution and, immediately thereafter, all Class O shares and Class O ADSs were converted into our ordinary shares and ADSs, as applicable.

No dividends for 2002. On April 17, 2003, our shareholders approved a resolution recommended by our board of directors to the effect that no dividends be paid on our Class A and Class O shares and ADSs with respect to 2002. Alcatel’s distributable profits for 2002 were not sufficient to pay dividends.

Highlights of Transactions during 2002

Acquisitions

Acquisition of Astral Point Communications. In April 2002, we acquired Astral Point Communications, Inc., a privately held U.S. company that produces optic-based telecommunications networks for metropolitan areas. Under the terms of the agreement, nine million Class A shares, a majority of which were represented by our Class A ADSs, valued at approximately € 144 million, were exchanged for the outstanding share capital of Astral Point.

Acquired control of Alcatel Shanghai Bell. In July 2002, we completed the transaction to acquire control of Alcatel Shanghai Bell, thereby completing the integration of our key operations in China. We hold 50% plus one share in Alcatel Shanghai Bell, with Chinese entities owning the remaining shares. We reached this ownership in 2002 through the acquisition of an 18.35% interest in the entity for an aggregate price of approximately U.S. $312 million.

Acquisition of Telera. In August 2002, we acquired Telera, Inc., a privately held U.S. company that manufactures software to enable carriers and businesses to develop advanced voice applications, permitting a telephone user to obtain Web-based information. Under the terms of the agreement, approximately 15.5 million Class A shares, a majority of which were represented by our Class A ADSs, valued at € 79 million, were exchanged for the outstanding share capital of Telera.

Dispositions

Sale of European enterprise distribution and service business. In April 2002, we completed the sale of Neco, our European enterprise distribution and services business to Platinum Equity LLC, a U.S.-based venture capital group at a loss of € 35 million. The agreement also included a post-closing adjustment based on net assets and a six-year earnout provision, which under certain circumstances, would allow us to more than offset the cash payment made by us. One of Platinum Equity’s portfolio companies, Nextira One, distributes our enterprise voice and data products in the U.S. and Europe.

Transfer of French factory. In June 2002, we completed a transaction with Jabil Circuit to outsource the European manufacturing of our private branch exchange, corporate telephone systems. The agreement transferred our Brest, France manufacturing facility to Jabil and Jabil will continue to manufacture our private branch exchange products. Seven hundred of our employees were transferred to Jabil Circuit upon the closing of the transaction.

Sale of microelectronics business. In June 2002, we sold our microelectronics business to STMicroelectronics for € 390 million in cash. As part of this transaction we entered into a cooperation agreement with ST for the joint development of chipsets that are available for sale by ST to third parties.

Cooperation agreement. In June 2002, we completed a transaction with ST Microelectronics for the development of certain components for mobile phones and other wireless products. Under the terms of a cooperation agreement, we transferred our team of mobile phone integrated circuit designers to ST and ST received access to our know-how and intellectual property related to these components. The components developed through this cooperation agreement also are available for sale by ST to third parties. This arrangement also includes a multiyear agreement with ST to supply us with these components.

Sale of European factories. In 2002, we completed all of the phases of the sale of our manufacturing facilities in Cherbourg, France; Gunzenhausen, Germany; and Toledo, Spain to Sanmina-SCI Corporation, a leading electronics contract manufacturer. These facilities comprised nearly 100,000 square meters (1,000,000 square feet) and employed approximately 1,500 employees, who became Sanmina-SCI employees.

Sale of microelectromechanical and other assets and a plant closure. In 2002, we sold Alcatel Optronics Netherlands, a subsidiary that produced microelectromechanical systems and software, in a management buyout; sold the majority of assets of Alcatel Optronics USA to Sanmina; and closed its Gatineau, Canada plant and facilities and transferred all of its manufacturing activities to Livingston, Scotland.

Sale of investments. During 2002, we sold a portion of our interests in Thales and Nexans and all of our interest in Thomson for € 568 million in cash. We retained a 9.5% and 15.1% interest, respectively, in the share capital of Thales and Nexans as of December 31, 2004, but sold our remaining interest in Nexans on March 16, 2005.

Business Organization

In January 2003, we reorganized our activities along three market segments covering the entire range of voice and data communication products and services: fixed communications, mobile communications and private communications. The organizational chart below sets forth the three business segments and their principal business activities as of the end of 2004:



Fixed Communications	Mobile Communications	Private Communications

• Access Networks • Fixed Solutions • Internet Protocol • Optical Networks	• Mobile Networks • Mobile Solutions • Wireless Transmission	• Enterprise Solutions • Space Solutions • Transport Solutions • Integration and Services

For financial information by operating segment and geographic market, see Note 3 to our consolidated financial statements and Item 5 — “Operating and Financial Review and Prospects.”

Fixed Communications

General

Our Fixed Communications segment is comprised of the following divisions: access networks, fixed solutions, internet protocol (IP), and optical networks. We have a broad portfolio of products and services used by carriers in all facets of their network operations, from the carriers’ central office to the end-user. In 2004, our Fixed Communications segment had net sales of € 5,131 million (excluding inter-company sales), representing 41.8% of our total net sales.

Access Networks

We are the worldwide leader in broadband access, commonly referred to as digital subscriber lines, or DSL. For the fourth quarter of 2004, we had a 37.8% market share, according to the industry analyst firm Dell’Oro. Our access products consist of equipment that transports information at high speeds, using a large bandwidth called “broadband,” over existing copper wire telephone lines. These broadband products enable carriers to generate additional revenues by providing advanced services to their residential and business customers. Our newest access Internet Protocol (or IP)-based product, introduced in 2004, is designed to accommodate expanding demand for new applications requiring greater bandwidth. It permits carriers to offer voice, data and video (triple play functionality), and to deliver to their customers virtually unlimited broadcast channels, video on demand, HDTV (high definition TV), VoIP (voice over IP), high speed Internet, and business access services. Our products permit carriers to serve the needs of their urban, suburban and rural customers.

We believe that our large installed DSL base provides us with a competitive advantage, as carriers modernize their networks by migrating to fiber-based services. Our fiber-based products enable the delivery of high quality voice, high-speed data and high definition interactive video, supporting hundreds of analog and digital channels. These products are complementary to our DSL products, depending on network configuration and the area of installation.

Fixed Solutions

In addition to our broadband access infrastructure products described above, our Open Media Suite enables carriers to deliver broadband entertainment, permitting them to generate potential new revenues from their broadband networks. By offering carriers the ability to provide IPTV to their customers, we enable carriers to create and deliver entertainment services, such as broadcast TV, video on demand, personal video recorder and other services, which can be designed and customized for local markets.

We have market-leading positions in many countries in access, signaling, switching and related equipment for voice transmission. We are upgrading our voice offerings from both a performance and a cost perspective. Moreover, we have worked with carriers over the years to migrate their networks to the latest technologies. Our next generation networking (NGN) program known as Open Path to Enhanced Networking (OPEN) addresses carriers’ needs to enhance their service offerings, thereby generating new revenues, while lowering the carriers’ related costs.

Internet Protocol

Our portfolio of data offerings is led by three products — our multiservice, multiprotocol switching platform, a service router and our Ethernet service switch. Our multiservice switching platform has been designed to provide flexibility to carriers when they build and expand their networks. This platform is based on a blend of technologies, which has integrated Internet protocol and multiprotocol switching functions, thereby allowing carriers to expand their service offerings at their option and to adapt their networks to meet the growth of traffic over the Internet. A service router is a device that interconnects computer networks and moves information from one network to another. Our Ethernet service switch, introduced in 2004, enables carriers to deliver virtual private networks, or VPNs, and triple play offerings (data, voice and video) using an Ethernet standard. Each of these products is designed to deliver high margin data services, including the full variety of network-based virtual private networks and other data services used for business applications. The service router features a new generation of processing power and many customized and scaleable applications designed to appeal to carriers. It provides high value, differentiated IP services to businesses. We believe our product provides services and applications that go well beyond what is possible with the single purpose routing products that are generally available today.

We have developed an Internet protocol portfolio of products to meet our customers’ varying requirements. For instance, our multiservice switch platform can interface with our service router to deliver seamless networking services regardless of technology. Seamless interfacing between the two products allows carriers to combine their newer Internet protocol or Ethernet-based networking products with their older

network or base of services to offer customers a smooth service migration to these more advanced technologies.

Optical Networks

Our optical networks division produces equipment to transport information for long distances over land (terrestrial) and undersea (submarine), as well as for short distances in metropolitan and regional areas. We believe that we have had the largest optical networking market share since 2001 according to industry analyst firm Dell’Oro.

Terrestrial. Our terrestrial products are designed for long haul and metropolitan/ regional applications. With our products, carriers can manage voice, data and video traffic patterns based on different applications or platforms and benefit from new competitive service offerings by introducing a wide variety of data-managed services, including different service quality capabilities, variable service rates and traffic congestion management. Most importantly, these products allow our customers to offer these new services without impacting their existing investment program for their current networks.

We also offer products and services for metropolitan/ business applications. Our metro WDM (wave division multiplexing) products address carriers’ requirements for cost-effective networks to meet their growing business and data networking needs. Our products are scaleable, in that they permit our customers to easily enlarge their networks as their business and data networking needs grow. These products provide cost-effective, managed platforms that support different services and are suitable for applications in diversified network configurations.

Submarine. We are an industry leader in the development, manufacture, installation and management of undersea telecommunications cable networks. Our submarine network systems can connect continents (using regeneration due to the long distances), as well as span distances up to 400km (using no regeneration) to connect mainland and an island, or several islands together or many points along a coast.

Mobile Communications

General

Our Mobile Communications segment serves the needs of wireless carriers throughout the world. We provide an extensive range of mobile communications products and services, including radio access and core network hardware and software, applications hardware and software and a wide range of services, including installation, maintenance and operation systems. In 2004, our Mobile Communications segment had net sales of € 3,301 million (excluding inter-company sales), accounting for 26.9% of our total net sales.

Mobile Networks

We develop Evolium^tm mobile radio stations and core switches for all major mobile technologies — GSM/GPRS/EDGE and UMTS (described below). Our mobile radio products are designed to minimize total cost of ownership through a continuous re-engineering program and the use of a highly modular framework that facilitates rapid network deployment and expansion, flexible network evolution, including the easy introduction of new technologies and easier maintenance, and allows for the evolution to a third generation, or 3G, network without loss of operability.

Global System for Global Communications/ General packet Radio Service, or GSM/GPRS, remains by far the world’s dominant mobile technology.

Enhanced Data for Global Evolution, or EDGE, provides a relatively simple, cost-effective development step beyond GSM/GPRS that can be an alternative to, or complement, the implementation of UMTS (described below). Compared to GSM/GPRS, the main benefits of EDGE are higher data transmission speeds and better geographic coverage and improved operating characteristics. EDGE does not support the full range of services provided by UMTS, such as video-telephony, and it cannot compete with UMTS data transmission speeds. However, EDGE can be faster and cheaper to deploy and has better coverage in rural areas

deployments. All of our Evolium^tm Base Stations have been shipped fully EDGE-ready since early 2001, enabling EDGE to be introduced through an easy software upgrade.

UMTS. Universal Mobile Telephone Communications Systems, or UMTS or 3G, represents an important evolutionary step over GSM/GPRS/EDGE networks in terms of services, voice quality and data transmission speeds. Our joint venture with Fujitsu, launched in 2000, provides us with competitive and comprehensive UMTS mobile radio and core network products.

During the year we continued our strategy of working with partners, forming an alliance with Intel for the development of end-to-end solutions using WiMAX standards that provide broadband connectivity over wireless networks and initiating an alliance with Datang Mobile to foster the development of the 3G mobile standard, TD-SCDMA, in China. In addition we also executed partnership agreements for the development of solutions based on Advanced Telecom Computing Architecture (ATCA), a standard that will reduce the cost and complexity of mobile infrastructure solutions.

Mobile Solutions

Our mobile solutions business consists of mobile core network products and mobile software applications. In software applications, our extensive range of platforms and software products enables mobile operators to deliver new value-added mobile services. End-user needs addressed by our products include personal multimedia communication, access to information and entertainment services, and mobile commerce. We are a leader in intelligent network platforms and services with over 110 customers worldwide, and we are recognized by industry analysts for our array of innovative messaging services (for instance, multimedia messaging, mobile music and mobile video) and convergent payment applications (voice/data, pre/post-paid).

In 2004, we further built upon our competency in the mobile core network business segment by acquiring Spatial Wireless, a Next Generation Network (NGN) market leader with products and software in commercial use and in market trials with major mobile operators throughout the world. With the contribution of Spatial’s products and expertise, our mobile NGN products and software offer wireless carriers the opportunity to significantly reduce capital and operating costs while preparing for the introduction of IP Multimedia Subsystems (IMS).

Wireless Transmission

We are a leader in the point-to-point telecommunications microwave radio market, serving the transmission needs of wireless and fixed carriers and non-carrier vertical markets. Our product portfolio includes high capacity, long and short-haul wireless transmission solutions for both European telecommunications standards (ETSI) and American standard-based (ANSI) environments.

Private Communications

General

Our Private Communications segment develops communications products and applications, which we market directly to medium and large size communication-intensive businesses and other organizations, particularly those involved in transportation, oil/gas and utilities, banking and finance and security, as well as governmental agencies. Our Private Communications segment also provides a broad range of space-based systems that include the high speed transport of voice, data and multimedia communications. In 2004, our Private Communications segment had total net sales of € 3,965 million (excluding intercompany sales), accounting for 32.3% of our total net sales.

Enterprise Solutions

We produce hardware and software communications products that we market to enterprise users and that are designed to improve their communications systems. Our enterprise product portfolio spans voice and data, including traditional and IP telephone systems, call center software and applications, and IP networking products.

Our enterprise communications products are based on open industry standards and protocols to support our customers’ current systems and future communications needs. We offer our customers equipment that can be relatively easily upgraded, and we provide on-premise installations, support and related services. Our call center products help businesses manage customer interactions and communications, as well as customer service operations and staffing, enabling businesses to intelligently route all incoming customer interactions in real time, including phone, email and Web contacts. We were recognized by several analyst firms, including Gartner and Forrester Research, as a leading supplier of enterprise voice and data products in 2004.

Building on a long-standing strategy to expand our enterprise communications software offerings, we acquired U.S.-based eDial, a provider of software-based multimedia conferencing voice, data and web products. This acquisition significantly broadened our enterprise communications products and services, including providing us with a platform for delivering future conferencing and collaboration products.

We also established some significant partnerships to support our enterprise business in 2004. For the U.S. market, we signed a distribution agreement with a major U.S.-based carrier that permits it to sell the entire Alcatel portfolio of enterprise voice and data products. Our contact center software subsidiary signed a strategic agreement with Microsoft to deliver products that link telephony and instant messaging applications to deliver real-time voice and data enterprise communications.

Space Solutions

We develop a broad range of satellites and related space-based technology for the private and public sectors for use in telecommunications, navigation, optical and radar observation, meteorology, and other scientific fields. During 2004, we developed satellite telecommunication products for broadband access, wireless local loop backhaul, and GSM/GPRS backhaul. In addition, we added satellite Internet protocol applications to our portfolio of products and services.

For the public sector, we provide space-based products and services, including applications for telecommunications, navigation, radar and optical observation. We are also a strong contributor to the Galileo project (satellite navigation system), to the GMES project (Global Monitoring for Environment and Security) and to studies for the development of future communication satellites. During 2004, we received orders for two payloads and seven satellites, of which two were for telecommunications, three were for defense and two were for observation.

Transport Solutions

We provide control and signaling system products and services for trains and subways around the world. We have developed a new generation of train routing systems (Electronic Interlocking) and train control systems (European Train Control Systems for Main Line and Communications Based Train Control for Automated Metro), that use computer platforms to execute complex safety related functions in order to improve the safety of rail networks and at the same time to increase efficiency (more trains on the same infrastructure), thus improving passenger service.

In 2004, we continued the development of strategic new products, such as radio-based train control (first commercial application commissioned in Las Vegas in the fourth quarter of 2004) and urban electronic interlocking (first commercial application in New York in 2005). We maintained our position as a leader in the European Train Control System (ETCS) market and successfully completed the first commercial, cross-border, interoperable ETCS solution on the important rail corridor between Vienna and Budapest (which will enter into full operation in 2005). We have key roles in the supply of four high speed ETCS lines in Spain.

Integration and Services

We plan, design, install, operate and maintain networks for our carrier and public sector customers. We tailor these networks to our customers’ objectives and infrastructure requirements: voice or data, wireless or wireline, regional or national, or any combination of these requirements. The networks that we serve can consist entirely of our comprehensive portfolio of products and applications, or can integrate products or

services produced or supplied by others. Through our network of Regional Support Centers that manage customer projects, we can deploy, manage and upgrade all aspects of our customers’ networks. The integration and services division provides the following: Network Design and Build, responsible for turnkey communication projects in wireline, wireless and vertical markets; Outsourcing, responsible for outsourcing and network support services, including operations and maintenance; and Software and Systems Integration, responsible for software and systems integration for the management of networks.

In 2004, we continued our strategy to improve and expand our service portfolio to include network outsourcing for carriers and system integration for non-carriers. These two strategic directions are intended to improve and expand the services we offer. By outsourcing their network activities to us, our customers seek to shift their focus from managing infrastructure to developing new customer services and optimizing their processes to gain efficiency.

Marketing and Competition

Marketing and Distribution

We sell all of our products, other than our private branch exchange products, through our direct sales force worldwide, except in China where our products are also marketed through joint ventures that we have formed with Chinese companies.

Competition

We have one of the broadest product and services offerings in the telecommunications service provider market, both for the carrier and non-carrier markets. Our addressable market segment is very broad and our competitors include large companies, such as Avaya, Cisco, Ericsson, Fujitsu, Huawei, Lucent, Motorola, Nokia, Nortel and Siemens. There are also a number of smaller companies that we consider to be competitors, in one segment or another.

In light of the significant reductions in recent years in capital expenditures by telecommunications carriers and other purchasers of our products, the level of competition has increased, causing some of our competitors to withdraw certain technologies or to exit certain geographical regions, while other competitors are emerging to take market share. In the high technology sectors, new competitors can benefit from a technological shift or rapidly gain market share.

We believe that technological advancement, quality, reliable on-time delivery, product cost, flexible manufacturing capacities, local field presence and long-standing customer relationships are the main factors that distinguish competitors of each of our segments in their respective markets.

Research and Development and Intellectual Property

Research and Development

As of December 31, 2004, 14,000 of our employees occupied research and development positions, of which 19% were based in North America, 66% were based in Europe, the Middle East and Africa and 15% were based in Asia and Pacific Rim countries. In 2004, our research and development expenses were € 1,587 million, representing 12.9% of our total sales. For a detailed discussion of our research and development expenditures for the past three years and certain accounting policies relating to our research and development and acquired technologies, see Item 5 — “Operating and Financial Review and Prospects.”

Research and development is one of our key priorities. Following the severe telecommunications business downturn beginning in 2000 and continuing through 2003, we carefully examined our research and development policies and implemented cost cutting and efficiency measures intended to reduce spending on mature technologies, discontinue non-competitive programs and non-core programs, slow down research and development in non-urgent programs, such as the development of advanced optical technologies, and reduce capital expenditures relating to investments in platforms, test tools, and certain development efforts. We also adopted measures intended to promote the reuse of existing technology, particularly among our business

segments, the introduction of new processes to increase efficiency, especially in the area of software production; and to focus on mid-term customer requirements to develop products and services that will increase our customers’ revenues. As a result, our research centers are now built around six centers worldwide: three in Europe (France, Belgium, Germany), two in North America (Canada and the United States), and one in Asia (China).

In addition to our continued focus on cost efficiency, key priorities in 2004 included pursuing developments in broadband access, second and third generation technology in mobile communications, next generation transmission technologies, IP and converged fixed/ mobile applications.

Most of our research and development effort is under the direct control of our business groups and divisions in order to provide flexible and customer-oriented development and rapid utilization of innovations in new products and applications.

Intellectual Property

We rely on patent, trademark, trade secret and copyright laws both to protect our proprietary technology and to protect us against claims from others. We believe that we have direct intellectual property rights or rights under licensing arrangements covering substantially all of our material technologies. However, there can be no assurance that claims of infringement will not be asserted against us or against our customers in connection with their use of our systems and products, nor can there be any assurance as to the outcome of any such claims, given the technological complexity of our systems and products.

We consider patent protection to be particularly important to our businesses due to the emphasis on research and development and intense competition in our markets. We filed 700 patent applications in 2004, and have a patent portfolio of approximately 9,600 patent families. We do not believe that any single patent or group of related patents is material to our business as a whole.

Sources and Availability of Materials

We make significant purchases of electronic components, aluminum, steel, precious metals, plastics and other materials and components from many domestic and foreign sources. We continue to develop and maintain alternative sources of supply for essential materials and components. We believe that we will be able to obtain sufficient materials and components from European and other world market sources to meet our production requirements.

Properties

We have administrative, production, manufacturing and research and development facilities worldwide. A substantial portion of our production and research activities in all business areas is conducted in France and China. We also have operating affiliates and production plants in many other countries, including Germany, Italy, Spain, Belgium, Denmark, the United Kingdom, Canada, the United States and Mexico. As of December 31, 2004, our total global productive capacity was approximately 440,000 square meters, as described below.


				North		Rest of
Business Group		Europe		America		World		Total

		(in thousands of square meters)
Fixed Communications			171		12		28		211
Mobile Communications			68		34		28		130
Private Communications			98		2		—		99

	Group Total		337		48		55		439

We believe that our current facilities are in good condition and adequate to meet the requirements of our present and foreseeable future operations.

We have been largely outsourcing the manufacturing of many of our telecommunications products in an effort to obtain greater flexibility to adapt quickly to economic and market changes. In 2004, we reduced the number of square meters used for production by 196,000 square meters.

Environmental Matters

We are subject to national and local environmental and health and safety laws and regulations that affect our operations, facilities and products in each of the jurisdictions in which we operate. These laws and regulations impose limitations on the discharge of pollutants into the air and water, establish standards for the treatment, storage and disposal of solid and hazardous waste and may require us to clean up a site at significant cost. We have incurred significant costs to comply with these laws and regulations and we expect to continue to incur significant compliance costs in the future.

It is our policy to comply with environmental requirements and to provide workplaces for employees that are safe and environmentally sound and that will not adversely affect the health or environment of communities in which we operate. Although we believe that we are in substantial compliance with all environmental and health safety laws and regulations and that we have obtained all material environmental permits required for our operations and all material environmental authorizations required for our products, there is a risk that we may have to incur expenditures significantly in excess of our expectations to cover environmental liabilities, to maintain compliance with current or future environmental and health and safety laws and regulations or to undertake any necessary remediation.

Seasonality

Our quarterly results reflect seasonality in the sale of our services and products. Sales are generally stable over the first three quarters of the year, with the strongest sales in the fourth quarter.


Item 5.	Operating and Financial Review and Prospects

Forward-Looking Information

This Form 20-F, including the discussion of our Operating and Financial Review and Prospects contains forward-looking statements based on beliefs of our management. We use the words “anticipate,” “believe,” “expect,” “may,” “will,” “intend,” “should,” “plan,” “project,” or similar expressions to identify forward-looking statements. Such statements reflect our current views with respect to future events and are subject to risks and uncertainties. Many factors could cause the actual results to be materially different, including, among others, changes in general economic and business conditions, changes in currency exchange rates and interest rates, introduction of competing products, lack of acceptance of new products or services and changes in business strategy. Such forward-looking statements include, but are not limited to, the forecasts and targets set forth in this Form 20-F, such as the discussion in Item 4 — “Information on the Company — History and Development — Overview” and below in this Item 5 under the heading “Overall Perspective” with respect to (i) our expectation that the losses incurred to develop or acquire new technologies and to establish our presence in certain potential high growth markets will be temporary, (ii) our ability to attain our priority target of a 10% operating margin, (iii) the restructuring costs in 2005 after expenditures of our current restructuring reserves, (iv) our fixed communications sales in each half of 2005, (v) the growth of our mobile communications segment and in our private communications group, (vi) expected cash receipts, capital expenditures and other cash outlays in 2005 and (vii) the amount we would be required to pay in the future pursuant to our existing contractual obligations and off-balance sheet contingent commitments, included below in this Item 5 in this discussion under the heading “Contractual obligations and off-balance sheet contingent commitments.”

Presentation of Financial Information

The following discussion of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and the related notes presented elsewhere in this document. Our consolidated financial statements have been prepared in accordance with French generally

accepted accounting principles (“French GAAP”), which differ in certain significant ways from U.S. generally accepted accounting principles (“U.S. GAAP”). The most significant differences that affect the presentation of our financial results relate to the use of the French pooling-of-interests accounting method, goodwill amortization, accounting of derivative instruments and hedging activities, accounting for sale and leaseback transactions and accounting for restructuring costs. For a discussion of the significant differences between French GAAP and U.S. GAAP as they relate to our consolidated financial statements as of and for the period ended December 31, 2004, and a reconciliation of our net income (loss) for that period and shareholders’ equity as of that date to U.S. GAAP, please refer to Notes 37 through 40 in our consolidated financial statements included elsewhere in this document.

Changes in Accounting Standards as of January 1, 2004

The “Comité de Règlementation Comptable” (Committee of Accounting Regulations) approved by decree dated December 12, 2002, the “règlement relatif à l’amortissement et à la dépréciation des actifs” (regulations on depreciation and amortization of assets) no. 02-10, which became effective as of January 1, 2005, with optional implementation as of January 1, 2002. We did not apply this new accounting standard to our 2002, 2003 or 2004 financial statements. We do not anticipate a material impact from the implementation of this regulation on our net income or on our financial position starting with the year 2005.

On April 1, 2003, the “Comité de Règlementation Comptable” (Committee of Accounting Regulations) issued a recommendation on post retirement employee benefits, no. 2003-R01, which became effective as of January 1, 2004, with optional implementation as of January 1, 2003. We fully applied this new accounting standard to our 2004 financial statements as this recommendation is very similar to IAS 19 (Employee Benefits) and such application allowed us to anticipate the transition to this new standard.

As part of the changeover to International Financial Reporting Standards/ International Accounting Standards (“IFRS”) on and after January 1, 2005 as discussed below, the presentation of certain income statement captions has been modified. Primarily, the presentation changes concern recurring goodwill amortization charges (charges that will no longer be incurred in accordance with IFRS 3), which are presented separately from exceptional amortization charges (resulting from goodwill impairment tests), and research and development costs (see Note 4 of our consolidated financial statements). These modifications to the captions in our income statement, which were already implemented in our financial statements for the first half of 2004 in anticipation of the changeover to IFRS, are not exhaustive. The new reporting standards will lead to other changes that are described below. In addition, as of January 1, 2004 we no longer use the “pooling of interests” method of accounting for business combinations (the use of this method was optional) (see Note 10 of our consolidated financial statements).

Adoption in 2005 of new accounting standards (International Financial Reporting Standards)

Effective January 1, 2005, we adopted International Financial Reporting Standards along with other European listed companies, in accordance with European Union regulations. This will require us to present our 2005 consolidated financial statements, together with 2004 comparative information, in accordance with IFRS. For the quarter ending March 31, 2005, and thereafter, we intend to provide consolidated financial statements prepared under IFRS accounting and valuation principles. During 2005, we will also provide comparative information for the previous period, restated using IFRS. The information provided in the notes to the consolidated financial statements at the time of the quarterly statements will have a similar level of detail as the previous information published in accordance with French accounting standards. We will only provide the detailed disclosure required by International Accounting Standard (IAS) 34 (Interim Financial Reporting) with respect to quarterly information concerning the year 2006, consistent with the requirement of IAS 34. Each quarter during 2005, Alcatel will provide tables in accordance with IFRS 1 (First-time Adoption of IFRS) that reconcile the 2004 profit or loss and equity, published in accordance with French GAAP, with the profit or loss and equity restated under IFRS.

Detailed interpretations or recommendations on the application of IFRS are not yet available and vary substantially from one expert to another. If we had applied IFRS during prior periods, certain transactions

might have been effected differently. In addition, the European Community has approved a certain number of standards that could be amended by the end of 2005, with the possibility of early application of the changes in 2005. We cannot forecast the potential accounting impact of IFRS on future transactions. Certain standards, applicable as of January 1, 2005, will not be applied retroactively to restate the opening balance sheet in accordance with IFRS 1 (First-time Adoption of IFRS). However, due to the listing of our ADSs on The New York Stock Exchange, we may be obligated to present a second year of comparative information, which would advance the opening balance sheet date to January 1, 2003, although the Securities and Exchange Commission has recently proposed some relief on this issue. This matter is currently under review by the Securities and Exchange Commission. As a result of the foregoing, the following information is subject to change.

The principal areas that may be affected by the change to IFRS are described below.

Property, plant and equipment

The application of IAS 16 (Property, Plant and Equipment) and IAS 36 (Impairment of Assets) does not have a significant impact on our financial statements. We have elected not to choose the option provided by IFRS 1 (First-time Adoption of IFRS) that allows certain property, plant and equipment to be recorded at fair value in the opening balance sheet. Furthermore, the rules governing depreciation methods (determination of the estimated useful life of the asset, inclusion of residual values and related matters) are either already applied by us or should not have a major impact on our opening balance sheet. Marine vessels represent the main category of our property, plant and equipment that will require restatement in order to comply with IFRS.

The application of IAS 36 does not have a major impact on us with respect to impairment losses. We performed impairment tests of our property, plant and equipment in 2002, 2003 and 2004, using methods comparable to those required by IFRS, and, as a result, significant impairments were recognized, as indicated in Note 12b to our consolidated financial statements.

Our fixed assets used in the context of financial leasing contracts are already recognized as assets in our consolidated financial statements in accordance with the criteria defined in IAS 17 (Leases) and we do not own any significant property within the scope of IAS 40 (Investment Property).

Fixed assets to be sold, as defined in IFRS 5 (Non-current Assets Held for Sale and Discontinued Operations), will be recorded as non-current assets and will no longer be depreciated, which will not have a significant impact on our 2005 consolidated net income and did not have a significant impact on our 2004 consolidated net income recalculated under IFRS.

Construction contracts

The principles of IAS 11 (Construction Contracts) are very close to those already used by us to account for construction contracts (or long-term contracts). In particular, the percentage of completion method of accounting that we apply (see Note 11 to our consolidated financial statements) complies with IAS 11. Contract segmentation and combination rules are also very close to the accounting principles we use. The methods for recognizing reserves for penalties (changes are recorded in contract revenues under IFRS but in contract costs in our 2004 and prior financial statements), and accounting for the financial impact in net sales of deferred payments when they are material, has a limited effect on the presentation of our income statement and no effect on either our gross profit or on our opening shareholders’ equity using IFRS.

The presentation of assets and liabilities related to construction contracts under specific balance sheet captions, and the application of specific offset rules as required by IAS 11, reduces our working capital due to certain reserves for product sales being presented as a deduction of this amount.

Research and development costs

As indicated in Note 1 to our consolidated financial statements, research and development costs are generally expensed, with the exception of certain software development costs. The application of the

principles defined in IAS 38 (Intangible Assets) will require us to capitalize a part of the development costs that are currently expensed when incurred. This increases significantly the intangible assets and shareholders’ equity in the opening balance sheet prepared in accordance with IFRS.

Assuming a constant volume of research work, the capitalization of certain development costs in accordance with IAS 38 should not have a material impact on our net income. However, full retroactive application of this standard will not be possible due to the lack of prior period information, which would have enabled the eligibility criteria for the capitalization of certain expenditures to have been met, as set forth in IAS 38. For two or three years, this will have a positive impact on net income, which will gradually dissipate. The impact on our capitalization will be presented under a specific income statement caption to isolate the ramp-up effect of the capitalization of development costs.

Convertible bonds or notes mandatorily redeemable for shares

The convertible bonds (OCEANE) and notes mandatorily redeemable for shares (ORANE) issued by us in 2003 and 2002 are compound financial instruments (according to IAS 32) that include a debt component and an equity component. The first-time adoption of IFRS will have the effect of recording a part or all of these convertible bonds or notes as of January 1, 2004 in shareholders’ equity. The notes mandatorily redeemable for shares (ORANE) are currently recorded in other equity and the convertible bonds (OCEANE) are currently recorded in financial debt.

The IFRS standard will have positive and negative effects on the future level of financial expense, due, on the one hand, to accounting for prepaid expenses in shareholders’ equity as of January 1, 2004 (ORANE), and, on the other hand, to amortizing the equity component in financial income (OCEANE).

Goodwill and business combinations

As indicated in Note 1b and f and Note 10 to our consolidated financial statements, in connection with major acquisitions in the past, we have used the special exemption provided by paragraph 215 of Regulation 99-02, which permits the difference between the purchase price of the business acquired and the corresponding share of net assets to be recorded directly in our shareholders’ equity.

Insofar as we have elected to adopt the IFRS 1 option not to restate business combinations that do not comply with IFRS 3 (Business Combinations) and which occurred prior to January 1, 2004, first-time adoption of IFRS will not result in any changes to the accounting methods previously applied.

In addition, for business combinations prior to January 1, 2004, regardless of the accounting method used, the review of assets and liabilities recorded in the context of these combinations and the analysis of their compliance with IFRS accounting principles should not have a significant impact on our shareholders’ equity, with the exception of the accounting treatment of stock options existing in the acquired company on the date of acquisition. Provision was made based on the intrinsic value of these items, a treatment that does not comply with the IFRS 2 (Share-based Payment) and IFRS 3 rules.

Other acquired assets and liabilities, in particular intangible assets recorded in our consolidated financial statements resulting from business combinations, are generally in compliance with IFRS. We have not identified any significant unrecorded intangible assets that should have been recorded in accordance with IFRS, other than the goodwill in the business combinations.

With respect to goodwill recorded as of December 31, 2003 (see Note 10 to our consolidated financial statements), the application of an impairment test based on the criteria defined in IAS 36 should not result in any significant impairment loss in the opening balance sheet. Starting January 1, 2004, goodwill is no longer amortized but is tested for impairment annually.

Financial instruments

Under IFRS, financial assets available for sale (as defined in IAS 39) are recorded at fair value in the 2004 opening balance sheet. For listed securities, the restatement will consist of recording, in opening

shareholders’ equity, the difference between the carrying value and the market value, net of any possible deferred tax impacts. Since we own few listed securities, and because of the valuation rules we use (see Note 1s for marketable securities), the impact on shareholders’ equity will be positive. The market values of unconsolidated listed securities are disclosed in Notes 14 and 19 to our consolidated financial statements.

With respect to customer receivables sold without recourse (see Note 15 to our consolidated financial statements), the “derecognition” (that is, the transfer) of these receivables from our balance sheet should not result in a significant restatement upon transition to IFRS, insofar as it is considered that, for trade receivables sold without recourse, in case of non-payment, substantially all of the risks and rewards associated with the asset have been effectively transferred to the buyer. However, a more restrictive interpretation of the concept of “substantial transfer of risks and rewards” could result in an accounting treatment different from that adopted by us.

In accordance with the provisions of IAS 39 on financial instruments, derivatives have to be recorded at fair value in the balance sheet. Most of our interest rate derivatives are fair value hedges, and the changes in their value should be largely offset in income by revaluations of the underlying debt. We use currency derivatives primarily to hedge future cash flows or firm commitments, except for those currency derivatives we use to hedge commercial bids, whose changes in fair value will impact income. We have chosen to apply IAS 39 as of January 1, 2004.

The impact resulting from recording hedges of commercial bids at market value will be accounted for in cost of sales in the income statement. The accounting method used to record hedges under IAS 39 (derivatives not meeting hedge accounting criteria) will lead to volatility in net income in the period preceding the date of effectiveness of the commercial contract, which may make the understanding of our financial results more difficult.

Retirement and other employee benefits

The methods for determining pensions and other post-employment benefits, as described in Notes 1i and 24 to our consolidated financial statements, are in compliance with IAS 19 (Employee Benefits), subject to interpretations currently in progress, insofar as we have applied, starting January 1, 2004, the “Conseil National de la Comptabilité” recommendation 2003-R01. The impact of applying this recommendation as of January 1, 2004, particularly on shareholders’ equity, is presented in Note 24 to our consolidated financial statements.

Share-based payment

The application of IFRS 2 (Share-based Payment) will modify the method of accounting for stock options granted to our employees. Only stock option plans established after November 2002, and whose stock options had not yet vested at December 31, 2004, will be restated. This will affect our 2003 and 2004 plans, as described in Note 21c to our consolidated financial statements, and the plans resulting from business combinations completed after November 2002, under which the stock options had not yet vested at December 31, 2004 (see Notes 2 and 21c to our consolidated financial statements). We decided not to adopt the full retroactive application option provided for in this standard, since the fair values of the stock options granted in the past had not been published and the method of valuing the stock options for determining the pro forma income per share in accordance with U.S. GAAP (see note 39(2) on the application of SFAS 123 and SFAS 148) is not identical to that adopted for the application of IFRS 2.

The impact on 2004 net income, restated in accordance with IFRS, corresponds to the allocation of the fair value over the vesting period of the stock options granted that fall within the scope of IFRS 2. This impact will be presented under a specific income statement caption.

Since the compensation expense does not result in an outflow of cash and since the counter entry to the expense is recorded in consolidated reserves, the application of this standard will have no impact on shareholders’ equity.

Off balance sheet commitments and “derecognition” (that is, transfer) of financial assets and liabilities

Our off balance sheet commitments are described in Note 31 to our consolidated financial statements. On December 31, 2003, we participated in two structured securitization programs (the SVF program and a customer receivable securitization program), described in Note 31. The special purpose vehicle used in the SVF program was consolidated as of January 1, 2004, following changes in French accounting regulations. The impact on our consolidated financial statements was described in Note 30 to our December 31, 2003 consolidated financial statements. The impact on the IFRS 2004 opening balance sheet is similar. The special purpose entity used in the customer receivables securitization program was already consolidated at December 31, 2003 and the application of IFRS to this program should not, therefore, have a significant impact on our consolidated financial statements. In addition, the carryback receivable sold in 2002, as explained in Note 31, will be recorded as an asset at discounted value in the IFRS opening balance sheet, as security for the corresponding financial liability that results from the consideration received.

At this stage, other off balance sheet commitments described in Note 31 to our consolidated financial statements do not require specific comment concerning the first-time adoption of IFRS.

Reserves for restructuring and other liabilities

We have applied the CNC (“Comité Nationale de la Comptabilité) regulation 00-06 to liabilities since January 1, 2002. Since it is very similar to IAS 37 (Provisions, Contingent Liabilities and Contingent Assets), we do not anticipate that accounting for reserves for restructuring and other liabilities will have a material impact on the IFRS 2004 opening balance sheet. However, discussions are continuing, particularly in the area of convergence between IFRS and U.S. GAAP, which could result in stricter rules for recording restructuring reserves under IFRS. Since no exposure draft has as yet been released by the International Accounting Standards Board on this topic and as these changes should not be applicable before 2006, we do not believe that we will adopt these changes until at least 2006.

Presentation of financial statements

The application of IAS 1 (as revised December 2003) and, to a lesser extent, the application of IAS 7 (Cash Flow Statements), IAS 14 (Segment Reporting) and IFRS 5 (Non-current Assets Held for Sale and Discontinued Operations) will have significant consequences on the manner of presenting our financial information.

IFRS requires a distinction to be made between current and non-current items in the balance sheet, which is different from our current presentation that is based on the type and/or liquidity of assets and liabilities. In addition, certain specific rules governing the offsetting of assets and liabilities (for example, certain reserves for product sales relating to construction contracts that have to be deducted from contract assets) may result in reclassifications compared to current practice.

The removal of the concept of extraordinary income or loss in IFRS will result in the reclassification in operating income and/or financial income of certain revenues and expenses currently recorded by us in other revenue/ expense (see Note 1m, n, o and Note 7 to our consolidated financial statements). The extent of the changes in presentation will be such that we expect that we will present the effect of the transition to IFRS in our 2005 financial statements, by indicating, first, the 2005 and 2004 income statements under IFRS and, second, the 2004 and 2003 income statements, under French GAAP, on separate pages and using the income statement presentations corresponding to each set of standards.

Other standards

The other requirements of IFRS do not require any specific comment and we do not currently anticipate any major impact on our IFRS opening balance sheet as a result of applying these other standards. This is the case for IAS 2 (Inventories), IAS 12 (Income Taxes), IAS 18 (Revenue), IAS 20 (Accounting for Government Grants and Disclosure of Government Assistance), IAS 21 (Effects of Changes in Foreign Exchange Rates), IAS 23 (Borrowing Costs), IAS 27 (Consolidated and Separate Financial Statements), IAS 28 (Investments in

Associates), IAS 29 (Financial Reporting in Hyperinflationary Economies), and IAS 31 (Interests in Joint Ventures). Moreover, we already apply some standards, notably IAS 19 (Employee Benefits), IAS 22 (Earnings Per Share), and IAS 24 (Related Party Disclosures).

Reconciliation of certain key 2004 figures from French GAAP to IFRS

For a reconciliation of our shareholders’ equity and net income in 2004 from French GAAP to IFRS, please refer to our Report on Form 6-K filed with the Securities and Exchange Commission on March 31, 2005.

Critical Accounting Policies

Our Operating and Financial Review and Prospects are based on our 2004 consolidated financial statements, which are prepared in accordance with French GAAP as described in Note 1 to our consolidated financial statements. As discussed above, the principal differences between French and U.S. GAAP are detailed in the Notes to our consolidated financial statements. Some of the accounting methods and policies used in preparing our consolidated financial statements under French GAAP and the reconciliation of our net income and shareholders’ equity to U.S. GAAP are based on complex and subjective assessments by our management or on estimates based on past experience and assumptions deemed realistic and reasonable based on the circumstances concerned. The actual value of our assets, liabilities and shareholders’ equity and of our earnings could differ from the value derived from these estimates if conditions changed and these changes had an impact on the assumptions adopted.

We believe that the accounting methods and policies listed below are the most likely to be affected by these estimates and assessments:

Valuation allowance for inventory

We record inventories at the lower of the net realizable value expected from these assets and their carrying value. This valuation is calculated based on our analysis of any predictable changes in demand, technology or the markets, mainly to identify any excess or obsolete inventory.

We record valuation allowances as cost of sales, other expenses or restructuring costs, depending on the nature and the materiality of the amounts concerned (see the definition of other expenses in Note 1 of our consolidated financial statements).

We have recorded significant charges in recent years due to declining market conditions and discontinuation of certain product lines. The impact of the valuation of inventories at the lower of cost or market on our net income (before taking into account the effect of any taxes) was a profit of approximately € 22 million during 2004 (an expense of € 67 million in 2003 and € 562 million in 2002). Due to the modest recovery of the telecommunications market, our revenues were positively impacted in 2004 by the sale of inventories with respect to which valuation allowances had been made in 2002 and 2003. If the recovery of the telecommunications market continues, it is possible that future revenues may also be positively impacted.

The material valuation allowances accounted for in 2002 were the following:


	•	Valuation allowances on excess and obsolete inventories accounted for by Alcatel USA amounting to € 157 million (of which € 121 million was accounted for as a cost of sales and € 36 million was accounted for as restructuring costs) related to the Wireline and Transmission product lines, due to the dramatic decrease in demand and discontinuation of certain product lines.

	•	An adjustment of € 195 million to reduce transatlantic cable inventories to their estimated market value, accounted for as other expenses. The project was in fact developed for a consortium of three operators. In September 2000, two of these operators decided to withdraw from the project. After renegotiation in 2002 with the remaining operator, the contract was downsized, as prices in the long-haul sector fell sharply, reducing the economic value of the network.

Reversal of allowances on inventories accounted for in 2002, 2003 and 2004 were mainly related to the definitive write-off of inventories and therefore had no material effect on gross margin.

Valuation allowance for doubtful accounts receivable and loans (customer financing)

A valuation allowance is recorded for customer receivables if the estimated recovery value is less than the book value. The amount of the valuation allowances recorded reflects both the customers’ ability to honor their debts and the age of the debts in question. A higher default rate than estimated or the deterioration of our major customers’ creditworthiness could have an adverse impact on our future results. Valuation allowances were € 284 million as of December 31, 2004 (compared with € 436 million as of December 31, 2003 and € 1,092 million as of December 31, 2002). The impact of valuation allowances for trade receivables on our net income (before taking into account the effect of any taxes) was a profit of € 42 million in 2004, a profit of € 149 million in 2003 and a charge of € 292 million in 2002.

Provisions on customer loans and other financial assets (mainly represented by assets related to customer financing arrangements) amounted to € 908 million as of December 31, 2004 (compared to € 1,104 million as of December 31, 2003 and € 1,416 million as of December 2002). The impact of these provisions on our net income (before taking into account the effect of any taxes) was a profit of € 77 million in 2004, a charge of € 39 million in 2003 and a charge of € 514 million in 2002.

Goodwill and other intangible assets

When there are signs during the course of the year of a significant adverse change in the business climate, impairment tests are conducted on the assets concerned, and impairment losses are recorded, if necessary. These exceptional amortizations are calculated based on the forecasted discounted operating cash flow or on the market value of such assets if an active market exists. A change in the markets may cause us to review the value of some of our goodwill or other intangible assets and to record additional exceptional amortizations.

The net amount of goodwill under French GAAP was € 3,586 million as of December 31, 2004 (€ 3,839 million as of December 31, 2003 and € 4,597 million as of December 31, 2002). Other intangible assets, net, were € 397 million as of December 31, 2004 (€ 284 million as of December 31, 2003 and € 312 million as of December 31, 2002) under French GAAP (of which € 284 million, € 258 million and € 274 million, respectively, concerned software).

Certain acquisitions that we made (DSC, Genesys, Newbridge, Kymata, Astral Point and Telera) were recorded at book value under French GAAP, in accordance with the optional method authorized under Article 215 of accounting rule 99-02. Under this method (which is a pooling of interests method), goodwill, corresponding to the difference between the net book value of the acquired company’s assets and liabilities, and the transaction price, was charged to shareholders’ equity. Under U.S. GAAP (which applies purchase accounting), goodwill, corresponding to the difference between the fair value and the transaction price, was recorded as an intangible asset. Since January 1, 2004 we have used purchase accounting to record our stock acquisitions.

Beginning January 1, 2002, for our U.S. GAAP reconciliation, we adopted Statement of Financial Accounting Standards (“SFAS”) 142, “Goodwill and other intangible assets.” SFAS 142 requires that goodwill be tested for impairment at least annually using a two-step approach at the reporting unit level (corresponding to the Business Division level in our company). In the first step, the fair value of the division is compared to its book value, including goodwill. In order to determine the fair value of the division, significant management judgment is applied in order to estimate the underlying discounted future cash flows. If the fair value of the division is less than its book value, a second step is performed which compares the implied value of the division’s goodwill to the book value of its goodwill. The implied value of the goodwill is determined based upon the difference between the fair value of the division and the net of the fair value of the identifiable assets and liabilities of the division. If the implied value of the goodwill is less than its book value, the difference is recorded as an impairment.

The annual impairment test for 2004 was performed in May 2004. No impairment charge was recorded at that time under U.S. GAAP. The annual impairment test for 2003 was performed in May 2003. No impairment charge was recorded at that time under U.S. GAAP, and since the impairment test used in our consolidated financial statements prepared in accordance with French GAAP is carried out at a lower level of segmentation than that required by SFAS 142 (see Note 1.f to our consolidated financial statements), a portion of the total impairment charges of € 171 million accounted for in 2003 for French GAAP has been restated for the U.S. GAAP reconciliation. In 2002, due to the continued and sharp deterioration of the telecommunication market, goodwill was tested for impairment three times during the year (initial impairment test as of January 1, 2002, annual impairment test in May 2002, and an additional impairment test performed in December 2002). Significant impairment charges were booked in our U.S. GAAP reconciliation for 2002 representing € 6,918 million. In 2002, impairment losses related to acquired technology were also recorded in our U.S. GAAP reconciliation in compliance with SFAS 144 requirements in the amount of € 553 million, of which € 371 million related to Newbridge, € 122 million related to DSC, € 36 million related to Genesys and € 24 million related to Kymata. All these valuations of intangible assets are based upon short- and long-term projections of future cash flows and take into account assumptions regarding the evolution of the market and our ability to successfully develop and commercialize our products. Changes in market conditions or future restructuring plans could have a major impact on the valuation of these assets and could justify additional impairment losses.

Impairment of tangible long-lived assets

Whenever events or changes in market conditions indicate a risk of impairment of property, plant, equipment and other tangible assets, a detailed review is carried out in order to determine whether the net carrying amount of such assets remains higher than their fair values. When testing for other than temporary impairment of a tangible asset, the sum of the undiscounted cash flows for the identified tangible assets is compared to the carrying value of these assets. If this sum is lower than the carrying value, an impairment loss is recorded based upon the fair value of the asset concerned. Fair value is measured by discounting forecasted operating cash flow or market value, if any.

Planned closure of certain facilities, further reductions in personnel and reduction in market expectations due to the industry downturn were considered impairment events during 2003 and 2002. Following our analysis of potential impairment on certain tangible assets, we recorded impairment charges of € 231 million during 2003 and € 860 million during 2002, mainly in the fixed communications segment. We recorded a very minor impairment charge in 2004 (€ 3 million).

Significant assumptions and estimates are taken into account to determine the fair value of our tangible long-lived assets, including market expectations, economic obsolescence and realizable value in case of liquidation. Changes in these estimates could have a major impact on the assessment of the value of these assets and could require us to book additional impairments.

Customer warranties

Reserves are recorded for warranties given to customers on our products to cover manufacturing defects. These reserves are calculated based on historical return rates and warranty costs expensed as well as on estimates. These allowances are part of the cost of sales and are accounted for when the products in question are sold. They represent the best possible estimate, at the time the sale is made, of the expenses to be incurred under the warranty granted. The real costs recorded may differ from the amounts covered by the allowances and therefore may affect future earnings.

Warranty reserves amounted to € 380 million as of December 31, 2004 (€ 574 million at the end of 2003 and € 751 million at the end of 2002). The net impact of the change in the warranty reserves on our net income (before taking into account the effect of any taxes) during 2004 was a profit of € 18 million (compared to a charge of € 97 million during 2003 and a charge of € 181 million during 2002). For further information concerning changes in warranty reserves during 2004, see Note 25 to our consolidated financial statements.

Deferred tax assets

Our deferred tax assets mainly result from deductible temporary differences between the book value of our assets and liabilities and their tax basis, net operating loss carryforwards and tax credit carryforwards. Net deferred tax assets are recognized if it is more likely than not they will be realized in future years.

On December 31, 2004, our net deferred tax assets amounted to € 1,572 million (of which € 838 million pertained to the United States and € 482 million pertained to France). Significant management judgment is required when determining the recoverability of net deferred tax assets. Management considers all available evidence, both positive and negative, to determine whether it is more likely than not that the deferred tax assets will be realized. Such evidence mainly includes the history of operating loss and the reasons for such loss, the carryforward period associated with the deferred tax assets and the future earnings potential determined through the use of internal forecasts. This analysis is performed on a regular basis in each tax jurisdiction where material net deferred tax assets have been recognized, mainly the United States and France.

The deterioration of our forecasts during 2002 led us to depreciate most of our gross deferred tax assets generated as of the second quarter of 2002, and all of our research and development credits in the United States.

If our actual results are materially worse than the estimates or forecasts referred to above, we will need to adjust them in future periods and, consequently, we may need to write off a portion or all of the net deferred tax assets currently recognized, which could materially adversely impact our financial position and results of operations. If our actual results are materially better than the estimates or forecasts referred to above, we may need to reverse a portion of the valuation allowances related to deferred tax assets, which would have a beneficial effect on our net income in a future period.

Pensions and post-retirement benefits

We and our subsidiaries have defined benefit and defined contribution plans and other retirement benefits that cover employees in different locations in Europe, North America and Asia.

Defined contribution plans are post-employment benefit plans under which we pay fixed contributions into a fund and have no obligation to make any further contributions. No reserve is booked for such plans.

Our obligation for the defined benefit pension plans can be divided basically into two categories:


	•	Termination indemnities paid at retirement, which apply to employees of our French and Italian companies: These obligations are to be covered by appropriate book reserves, as we do not make contributions with respect to these obligations to a separate trust or similar entity.

	•	Defined benefits schemes, which are offered in several countries, mainly throughout Europe and the United States: To the extent possible in accordance with local regulation we make contributions with respect to these obligations to a trust or similar entity, which results in the assets contributed being held separate from our corporate assets. Due to local regulation constraints, 72% of the total benefit obligation in Germany has not been contributed to a separate entity, and therefore we have booked appropriate reserves to cover this portion of the obligation.

Moreover, we provide North American employees with other post-employment benefits, including a post-retirement medical and life insurance plan. These benefits are being progressively terminated for most of the beneficiaries, and will be completely terminated by 2006.

Since 2004, Alcatel has retained a worldwide actuary in order to insure consistency and standardization in the actuarial process. The actuarial valuation for the defined benefits and other applicable retirement benefits are based upon the projected unit credit cost using actuarial assumptions such as discount rate, expected return, future salary increases, turnover rates and mortality tables.

We update these assumptions on an annual basis. The discount rate is determined by reference to the risk-free rate on bonds issued by the highest-rated companies, and possibly government securities when no such issuers exist. Moreover, the bonds used as reference have a maturity that is consistent with the period to

maturity of the benefits. Management sets the discount rates for each currency and each unit within Alcatel applies that rate so that we can have consistent assumptions across the organization. However, each unit within Alcatel determines its set of local assumptions, such as withdrawal rate and salary increase rates, to take into account specific local conditions. These assumptions are described in Note 24 to our consolidated financial statements. The weighted average discount rate used to calculate our projected benefit obligation with respect to defined benefit plans was reduced from 4.81% in 2003 to 4.46% in 2004, reflecting changes in interest rates.

Expected returns on assets are determined using the expected rate of return on plan assets (calculated taking into account historic returns, change in asset allocation and expected future returns) and the “value of assets.” Since 2004, as a result of applying the CNC’s recommendation No. 2003-R01, value of assets is equal to the market value (market-related value is no longer applicable). In 2004, the expected return of plan assets was 4.70% (the weighted average rate calculated on a pro rata basis according to the fair value of the various pension assets). This rate is a reflection of our assets allocation: in 2004, 27% of plan assets were invested in equities; the remainder of plan assets was invested 40% in bonds, 18% in cash and 15% in real estate.

In accordance with clarifications made by the CNC in its press release dated July 22, 2004, we recognized in shareholder’s equity the actuarial gains and losses as of January 1, 2004 related to experience adjustments and adjustments linked to changes in actuarial assumptions.

Actuarial gains and losses that have occurred (resulting from changes in assumptions and from differences between assumptions and actual experience) are amortized over the expected remaining service periods of active plan participants (to the extent they exceed 10% of the higher of the projected benefit obligation and the fair value of plan assets).

If all other assumptions were constant, a 0.5% increase or decrease in the expected return of plan assets would have increased or decreased the 2004 net pension cost by approximately € 10 million. If all other assumptions were constant, a 0.5% increase in the discount rate would have decreased the 2004 net pension cost by approximately € 6 million, and a 0.5% decrease in this discount rate would have increased such costs by approximately € 7 million.

Excluding the impact of non-recurring gains or losses arising from restructuring activities, our net pension cost was approximately € 119 million in 2004, € 138 million in 2003 and € 200 million in 2002. Our € 119 million net pension cost for 2004 consisted of € 67 million of operating costs and € 52 million of financial costs.

We believe that our assumptions are appropriate, but future changes in those assumptions may materially affect our pension obligation, and future funding requirements may arise depending on market conditions.

Revenue recognition

Most of our revenues result from a wide range of activities: from designing, integrating and installing fixed and mobile networks, and developing and supplying turn-key optical, submarine and terrestrial network solutions and voice/data network infrastructure and application software for businesses, to supplying satellite systems for telecommunications, navigation, etc.; all of which require significant revenue recognition assessments, especially in activities going beyond simple deliveries of equipment.

For revenues generated from construction contracts, primarily those related to customized network designs and network build-outs, we generally use the percentage of completion method of accounting, provided certain specified conditions are met, based either on the achievement of contractually defined milestones or on costs incurred compared with total estimated costs. We exercise significant judgment in estimating revenue and costs on such contracts and in measuring progress towards completion, which underpins the timing of revenue recognition and the level of contract profitability. Revenue and costs are reviewed periodically based on the contractual terms and conditions. Any losses foreseen on contracts are recognized immediately. If uncertainty exists relating to customer acceptance, or the construction contract’s

duration is relatively short, revenues are recognized only to the extent of costs incurred that are recoverable, or on completion of the contract.

For revenues generated from licensing, selling or otherwise marketing software, we recognize revenue generally upon delivery of the software and on the related services as and when they are performed. For arrangements to sell software licenses with services, we recognize software license revenue separately from the related service revenue, provided the transaction adheres to certain criteria (as prescribed by the AICPA’s SOP 97-2), such as the existence of sufficient vendor-specific objective evidence of fair value to permit allocation of the revenue to the various elements of the arrangement. If the arrangement does not meet the specified criteria, revenue is deferred and recognized ratably over the service period. For arrangements to sell services only, revenue from training, consulting, installation and other services is recognized when the services are performed. Maintenance service revenue, including post-contract customer support, is deferred and recognized ratably over the contracted service period.

We are increasingly entering into the operator service business, which involves multiyear service contracts. Revenues from this activity are deferred and recognized ratably over the contractual service period.

We also sell products to resellers and distributors, for which revenue is recognized at the time of shipment to the distribution channel. In this particular market, collectibility of revenues is critical. Accordingly, estimated returns are recorded at the same time as the corresponding revenue based on contract terms and prior claims experience.

In the context of the current market environment, assessment of the collectibility of revenues is generally critical. Based on the credit quality of our customers and on our ability to sell customer receivables, we assess whether trade receivables and other accounts receivable are reasonably assured of collection. Where we are able to sell the receivable, revenue is recognized to the extent of the value realizable from the sale. After initial revenue recognition, if we are uncertain as to whether we can collect the receivable, a valuation allowance is set up to cover the estimated loss.

OPERATING AND FINANCIAL REVIEW AND PROSPECTS

Overall Perspective

In order to facilitate a meaningful comparison of our business between periods, the analysis in this section of our results of operations for the year ended December 31, 2004, compared to the year ended December 31, 2003, is based on the unaudited pro forma amounts for 2003 (which reflect the disposition of our optical components, battery and electrical power systems businesses and the contribution of our optical fiber and mobile phone businesses to form joint ventures, as described below).

As a result of this improved market environment, our sales increased by 5.7% in 2004 as compared to 2003. Excluding the impact of the currency exchange rate between the Euro and the U.S. dollar and other currencies linked to the U.S. dollar, our sales would have increased by 9.5%. For the full year our gross margin was 37.3%, and our operating margin was 8.0%, reflecting improved profitability in all three of our business segments. In particular, the improvement in our fixed communications segment was primarily due to a return to profitability in our optical networking business following significant restructuring efforts. We had net income of € 281 million for 2004, including € 304 million in restructuring costs for continuing restructuring programs in France, Germany and Spain and including ongoing goodwill amortization of € 408 million.

During 2004, we maintained an aggressive strategy of developing or acquiring new technologies, and of establishing our presence in certain potential high growth markets in the emerging world, accepting what we

expect will be temporary losses as an investment in our future growth. We intend to monitor closely our operations in order to attain our priority target, which is a 10% operating margin. Even if market conditions stay very competitive, we believe that we can grow our revenues, given the positioning of our product offerings and our momentum in the marketplace. Even assuming that we achieve our operating margin target and our anticipated reduction of fixed expenses, we expect our gross margin will fluctuate in the event that we make investments in new markets or new technologies as required. After we expend our current restructuring reserves, we expect new restructuring costs to be approximately 1% of sales in 2005.

We expect that our fixed communication segment sales will be weaker in the first half of 2005, but will be stronger in the second half of 2005, in each case as compared to the comparable periods of 2004. Our fixed communications sales are expected to be driven by our “triple play” offerings combining video, voice and data transmission, which requires increased bandwidth in the network. We expect our mobile communications segment to grow due to our competitive positioning in emerging markets, and we expect to achieve growth in our private communications group due to growth in the private sector market, somewhat offset by lower satellite revenues.

Highlights of Transactions during 2004. On December 16, 2004, we completed the acquisition of Spatial Communications Technologies, Inc. for consideration consisting of our ADSs having a value of approximately € 226 million (based on the market value of our ADSs on the date of the acquisition). Spatial develops and markets mobile switching equipment that can operate using any of the major mobile technologies and related software. We believe that this acquisition will enable us to offer next-generation mobile switching equipment and will facilitate our ability to provide carriers with systems that can be updated relatively easily in the future. On September 17, 2004, we acquired eDial for consideration consisting of cash and ADSs having an aggregate value of € 22 million (based on the market value of our ADSs on the date of the acquisition). eDial provides conferencing and related services for businesses and carriers. We expect that this acquisition will complement our communications software development strategy.

In January 2004 we completed the sale of Saft, our battery business, to Doughty Hanson, a European private equity firm, for € 390 million in cash. In September 2004 we signed an agreement with Ripplewood, a U.S. private equity firm, to divest all of our electrical power system activities, which was completed in January 2005.

On December 14, 2004, we sold a portion of our shareholding in Avanex in a block trade market transaction, which reduced our shareholding in this company to 19.65% of its share capital. As from the date of this sale we do not treat Avanex as an equity affiliate, since we consider that we no longer exercise significant influence on the company.

Joint ventures. In August 2004, we formed a joint venture with TCL Communication Technology Holdings Limited, which is owned 55% by TCL and 45% by us. We contributed cash and our mobile handset business having an approximate aggregate value of € 45 million, to the joint venture and TCL contributed € 55 million in cash. In July 2004 we entered into an agreement to form Draka Comteq B.V., a company owned 50.1% by Draka and 49.9% by us. Draka Comteq holds the global optical fiber and communication cable business previously owned by the partners. In June 2004, we entered into a memorandum of understanding with Finmeccanica to form two sister companies to which both partners would contribute their respective satellite industrial and service activity.

Highlights of Transactions during 2003. In April 2003, we acquired, for 3.5 million ADSs, the 84% of the outstanding shares that we did not own of iMagicTV, a Canadian supplier of software products and services. In July 2003, we acquired, for 18 million ADSs, TiMetra, Inc., a company specializing in Internet protocol/ multiprotocol label switching service routing. This acquisition, together with our acquisition of ThirdSpace and Packet Video, enabled us to add to our portfolio of content and systems integration products.

In February 2003, we exercised our option to sell our 50% shareholding in Atlinks to Thomson, our joint venture partner.

In April 2003, after receiving the approval of our shareholders, we converted all outstanding Class O shares and Class O ADSs into our ordinary shares and ADSs, as applicable, on a one-for-one basis. In

August 2003, we sold our optical components business to Avanex, receiving 28% of Avanex’s stock, and entered into a supply agreement with Avanex, under which it will provide solutions for our optical networking products over a three-year period. Our investment in Avanex is accounted for using the equity method.

Highlights of Transactions during 2002. We acquired two companies in 2002, in addition to acquiring control of Alcatel Shanghai Bell. In April 2002, we acquired Astral Point Communications, Inc., a privately held U.S. company that focuses on next-generation synchronous optical network (SONET) metropolitan optical systems for 9 million Alcatel Class A shares, valued at approximately € 144 million, which were exchanged for the outstanding share capital of Astral Point. In July 2002, we completed the transaction to acquire control of Alcatel Shanghai Bell, the first company limited by shares with foreign ownership in China’s telecommunications sector. This completed the integration of our key operations in China with Shanghai Bell as first announced in October 2001. We now hold 50% plus one share in Alcatel Shanghai Bell, which was fully consolidated into our financial accounts as of July 1, 2002. In August 2002, we acquired Telera, Inc., a privately held U.S. company that manufactures software to enable service providers and enterprises to develop advanced voice applications that will transform the telephone into a tool to access Web-based information. Approximately 15.1 million Alcatel Class A shares, valued at € 79 million, were exchanged for the outstanding share capital of Telera.

In April 2002, we completed the sale of Neco, our European enterprise distribution and services business to Platinum Equity LLC, a U.S.-based venture capital group at a loss of € 35 million. The agreement also includes a post-closing adjustment based on net assets and a six-year earnout provision. In June 2002, we completed the transaction with Jabil Circuit to outsource the European manufacturing of our private branch exchange (PBX) and Internet protocol (IP)-based PBX corporate telephone systems. In June 2002 we also sold our microelectronics business to STMicroelectronics for € 390 million in cash. Additionally, we completed a transaction with STMicroelectronics for the development of future GSM/GPRS chipsets for mobile phones and other wireless connectivity applications. In 2002, we completed all phases of the sale of our manufacturing facilities in Cherbourg, France, Gunzenhausen, Germany and Toledo, Spain to Sanmina-SCI Corporation, a leading electronics contract manufacturer. In 2002, we sold Alcatel Optronics Netherlands, sold the majority of assets of Alcatel Optronics USA to Sanmina and closed the Gatineau, Canada plant and facilities of our optical components business. Finally, during 2002, we sold a portion of our interests in Thales and Nexans and all of our interests in Thomson for € 568 million in cash.

Consolidated Results of Operations for the Year Ended December 31, 2004 Compared to the Year Ended December 31, 2003

As a result of the disposition of some of our businesses in 2003 and 2004 (including by way of contribution of our optical fiber and mobile phone businesses to form joint ventures), the financial results of these businesses for both years have been accounted for as discontinued operations. The businesses disposed of and the date of the transactions are as follows: optical components in July 2003; batteries (SAFT) in January 2004; optical fiber in July 2004, mobile phones in August 2004; and electrical power systems in September 2004. The table below sets forth certain income data showing: (i) our financial results for 2004; (ii) our pro forma financial results for 2003, reflecting the transactions described above; and (iii) our historical (as published) financial results for 2003 (including the results of the optical components, batteries, optical

fiber, mobile phone and electrical power systems businesses). See also Note 2 in our consolidated financial statements included elsewhere in this document.


	2004		2003 pro forma			2003 historical

			(unaudited)			(as published)
	(in millions of euros except for share
	and per share amounts)
Net sales		12,265		11,606			12,513
Income from operations		978		449			332
Net income before goodwill and minority interests		756		(1,357	)		(1,346	)
Net income		281		(1,944	)		(1,944	)
Earnings per share — diluted		0.21		(1.46	)		(1.46	)
Earnings per ADS*		0.28		(1.97	)		(1.97	)
Number of shares (billions)		1.36		1.33			1.33


*	Earnings per ADS have been calculated using the U.S. Federal Reserve Bank of New York noon euro/dollar buying rate of US$ 1.35 as of December 31, 2004

In order to facilitate a meaningful comparison of our business between periods, and in compliance with French GAAP, we have prepared pro forma income statements reflecting the transactions described above in income from discontinued operations for 2003. These pro forma statements are set forth in Note 2 to our consolidated financial statements. The analysis of our results of operations for the year ended December 31, 2004 compared to the year ended December 31, 2003 is based on the unaudited pro forma amounts for 2003 and the actual 2004 amounts.

Net Sales. Consolidated net sales increased by 5.7% to € 12,265 million for 2004 compared to € 11,606 million for 2003. Approximately 40% of our consolidated net sales are denominated in or linked to the U.S. dollar. When we translate these sales into euros for accounting purposes, there is an exchange rate impact based on the relative value of the U.S. dollar and the euro. During 2004, the decreases in the value of the U.S. dollar relative to the euro had a negative impact on our sales. If there had been a constant euro/U.S. dollar exchange rate in 2004 as compared to 2003, our consolidated net sales would have increased by approximately 9.5%. This is based on applying (i) to our sales made directly in U.S. dollars or currencies linked to U.S. dollars effected during 2004, the average exchange rate that applied in 2003, instead of the average exchange rate that applied in 2004, and (ii) to our exports (mainly from Europe) effected during 2004 which are denominated in U.S. dollars and for which we enter into hedging transactions, our average euro/U.S. dollar hedging rate that applied in 2003. Our management believes that providing our investors with our consolidated net sales in constant euro/U.S. dollar exchange rates facilitates the comparison of the evolution of our sales with that of the industry. Both our mobile and private communications segments registered a sales increase due to continued success in markets in emerging countries for our mobile communications segment and to growth in the rail communications and space activities in our private communications segment. We experienced an increase in our sales to the rest of the world primarily due to the growing presence of our mobile communications activity in emerging countries. These increases offset the decline in our fixed communications segment, primarily driven by the decline in voice networks.

Net sales in Europe increased to € 6,074 million in 2004 from € 5,664 million in 2003; net sales in North America decreased to € 1,785 million in 2004 from € 1,833 million in 2003; net sales in Asia decreased to € 1,868 million in 2004 from € 2,083 million in 2003; and net sales in the rest of the world increased to € 2,538 million in 2004 from € 2,026 million in 2003. In 2004, Europe, North America, Asia and the rest of the world accounted for 49.5%, 14.6%, 15.2% and 20.7%, respectively, of our total net sales compared with the following percentages of net sales for 2003: Europe 48.8%, North America 15.8%, Asia 17.9%, and the rest of the world 17.5%.

Gross Profit. Gross profit of € 4,575 million in 2004 represented 37.3% of net sales compared to 34.4%, or € 3,992 million, in 2003. This improvement in our gross margin was due primarily to a reduction in fixed operating costs resulting from our restructuring efforts in 2004 and more efficient management of our inventories. In addition, this improvement was in part the result of a new accounting presentation relating to

research and development that we adopted in 2004 as part of the changeover to IFRS beginning January 1, 2005: for 2004, gross profit takes into account revenues from licenses and R&D grants, which were previously deducted from R&D costs, and customer funded research is no longer recorded in cost of sales, but rather included in R&D costs. Calculated on the basis of this new presentation, our 2003 gross margin would have been 35.4% instead of 34.4%. See Note 4 to our consolidated financial statements.

Administrative and Selling Expenses. Administrative and selling expenses were € 2,010 million for 2004 compared to € 2,033 million in 2003. As a percentage of net sales, administrative and selling expenses were 16.4% of net sales in 2004 compared to 17.5% of net sales in 2003, decreasing despite the increase in sales primarily due to the decrease in our fixed costs resulting from our restructuring efforts.

R&D Costs. Research and development expenses were € 1,587 million in 2004 compared to € 1,510 million in 2003, an increase of 5.1% (and compared to € 1,654 in 2003 under the new accounting presentation mentioned under the heading “Gross Profit” above, a decrease of 4.0%). As a percentage of net sales, research and development expenses amounted to 12.9% in 2004 from 13.0% in 2003 (and from 14.1% under the new accounting presentation). See Note 4 to our consolidated financial statements.

Income (Loss) from Operations. We recorded income from operations of € 978 million for 2004 compared to € 449 million for 2003. This improvement resulted primarily from increased profitability in all of our segments, in particular, our fixed communications segment, primarily due to the return to profitability of our optical networks as a result of our significant restructuring efforts.

Financial Income (Loss). Financial loss was € (132) million for 2004 compared to € (248) million in 2003. This decrease is due primarily to the reversal of reserves relating to customer loans after partial repayments from customers and reduction of interest costs.

Restructuring Costs. Restructuring costs were € (304) million for 2004, compared to € (1,260) million in 2003. The restructuring cost for 2004 reflected new restructuring plans in 2004 attributable to continuing headcount reductions in France, Spain and Germany.

Other Revenue (Expense). Other revenue (expense) was € 364 million for 2004 compared to € 248 million in 2003. Other revenue for 2004 was composed of a net capital gain of € 351 million, primarily related to the sale of our battery business and to the sale of some of our real estate holdings.

Income (Loss) Before Amortization of Goodwill and Tax. Income before amortization of goodwill and tax charge was € 862 million for 2004 compared to a loss of € (858) million for 2003.

Income Tax. Income tax amounted to a charge of € (9) million for 2004 compared to a charge of € (81) million in 2003. The charge for 2004 resulted from a current income tax benefit of € 103 million related to the favorable outcome of tax litigations and from a deferred income tax charge of € (112) million, primarily due to the write-off deferred tax assets.

Share in the Net Income of Equity Affiliates and Disposed of or Discontinued Operations. Our share in the net income of equity affiliates and discontinued operations was a loss of € (97) million in 2004 (of which a net loss of € (66) million related to the discontinued optical fiber and mobile handset businesses) compared to a loss of € (418) million in 2003 (of which a net loss of € (406) million related to the 2004 and 2003 discontinued businesses).

Amortization of Goodwill. Amortization of goodwill was € (408) million for 2004 compared with € (567) million in 2003. Amortization of € (567) million for 2003 included € (160) million of exceptional amortization, primarily related to the reassessment of our business plan as it related to Gigabit Ethernet routing software across all product lines resulting in a write-off of € (85) million.

Net Income (Loss). As a result of the foregoing, we recorded net income of € 281 million for 2004 compared to a net loss of € (1,944) million in 2003.

Results of Operations by Business Segment for the Year Ended December 31, 2004 Compared to the Year Ended December 31, 2003

The table below sets forth the consolidated sales (before elimination of inter-segment sales, except for “Total Group” results and “Other and Eliminations”), income from operations and capital expenditures for tangible assets for each of our business segments for fiscal 2004 (as published) and for fiscal 2003 (pro forma numbers, reflecting the disposal of our optical components, batteries, optical fiber, mobile phone and electrical power systems businesses). The discussion of the segments following the table is based on the unaudited pro forma numbers for 2003 and the actual 2004 numbers.


		Fixed		Mobile		Private		Other &
		Communications		Communications		Communications		Eliminations			Total Group

Year Ended December 31, 2004
	Sales	€	5,131	€	3,301	€	3,965	€	(132	)	€	12,265
	Income (loss) from operations		429		401		235		(87	)		978
	Capital expenditures for tangible assets		65		82		78		1			226
Year Ended December 31, 2003 (pro forma)
	Sales	€	5,364	€	2,929	€	3,627	€	(314	)	€	11,606
	Income (loss) from operations		155		315		123		(144	)		449
	Capital expenditures for tangible assets		52		39		47		—			138

Fixed Communications

Sales of our fixed communications segment were € 5,131 million for 2004, compared to € 5,364 million for 2003, a decrease of 4.3%. This decrease was primarily due to a decrease in our fixed line business where carriers are continuing their transition to next generation networks and therefore reducing their capital expenditures for narrow band switching. This decrease was partially offset by the growth in our business that supplies applications and products to update networks to the next generation, and by the growth in our IP business that supplies products to transmit data through high bandwidth in the networks. This growth was due to the increasing demand for new bandwidth applications.

Even though we continued to increase our line deliveries in our broadband access business (19.6 million in 2004, as compared to 15.8 million in 2003), our broadband revenues declined slightly due to substantial pricing pressures.

The fixed communications segment’s income from operations was € 429 million for 2004, compared to € 155 million in 2003. This increase in profitability was due primarily to (a) the return to profitability of our optical networks business as a result of our significant restructuring efforts and (b) the results of our Internet Protocol division, which registered a significant increase in volume, partially offsetting research and development expenditures.

Mobile Communications

Sales of our mobile communications segment were € 3,301 million for 2004, compared to € 2,929 million in 2003, an increase of 12.7%. This increase was primarily due to continued strong growth in our 2/2.5G radio access business, particularly in emerging countries, partially offset by a decrease in our wireless transmission activity, which experienced product delays during the first half of the year.

The mobile communications segment’s income from operations was € 401 million for 2004, compared to € 315 million in 2003. This increase was primarily due to an increase in our mobile networks business.

Private Communications

Sales of our private communications segment were € 3,965 million for 2004, compared to € 3,627 million in 2003, an increase of 9.3%. This increase was primarily due to growth in our rail communications and space activities due to a strong order book and to our enterprise business, which registered especially good growth in Europe. This increase was somewhat offset by a slight decline in our integration and services activity.

The private communications segment’s income from operations was € 235 million for 2004, compared to € 123 million in 2003. This increase was primarily a result of an increase in our enterprise solutions division, particularly our call center activity and our space activity and, to a lesser extent, the increase in our rail communications business.

Consolidated Results of Operations for the Year Ended December 31, 2003 Compared to the Year Ended December 31, 2002

As a result of the disposition in August 2003 of our optical components business and in January 2004 of our battery business (Saft), the financial results of these businesses for 2003 have been accounted for as discontinued operations. The table below sets forth certain income statement data showing (i) our financial results for 2003, (ii) our pro forma financial results for 2002, reflecting the exclusion of the results of our optical components and battery businesses and (iii) our historical financial results, as published (including the results of the optical components and battery businesses). See also Note 2 in our consolidated financial statements included elsewhere in this document.


	2003			2002 pro forma			2002 historical

				(unaudited)			(as published)
	(in millions of euros except for share
	and per share amounts)
Net Sales		12,513			16,014			16,547
Income from operations		332			(606	)		(727	)
Net income before goodwill and minority interests		(1,346	)		(4,195	)		(4,138	)
Net Income		(1,944	)		(4,745	)		(4,745	)
Earnings per share — diluted		(1.46	)		(3.99	)		(3.99	)
Earnings per ADS*		(1.84	)		(5.03	)		(5.03	)
Number of shares (billions)		1.33			1.19			1.19


*	Earnings per ADS has been calculated using the U.S. Federal Reserve Bank of New York noon euro/dollar buying rate of US$ 1.26 as of December 31, 2003

In order to facilitate a meaningful comparison of our business between periods, and in compliance with French GAAP, we have prepared pro forma income statements reflecting the transactions described above in income from discontinued operations for 2002. These pro forma statements are set forth in Note 2 to our consolidated financial statements. The analysis of our results of operations for the year ended December 31, 2003 compared to the year ended December 31, 2002 is based on the pro forma restated amounts for 2002 (which exclude the results of our optical components and battery businesses).

Net Sales. Consolidated net sales decreased by 21.9% to € 12,513 million for 2003 compared to € 16,014 million for 2002. Approximately 25% of our consolidated net sales are denominated in or linked to the U.S. dollar. When we translate these sales into euros for accounting purposes, there is an exchange rate impact based on the relative value of the U.S. dollar and the euro. During 2003, the decrease in the value of the U.S. dollar relative to the euro had a negative impact on our sales. If there had been a constant euro/U.S. dollar exchange rate in 2003 as compared to 2002, our consolidated net sales in 2003 would have decreased by 16.0% from 2002. The decrease in net sales for 2003 compared to 2002 was due to the continued deterioration in the telecommunications markets that affected our fixed communications segment, which registered significant sales declines in its optical networking division as well as in its optical fiber business and, to a lesser extent, our fixed line voice activity. In the mobile communications segment, the

stable sales in our mobile network division were adversely impacted by a significant decline in the sales of mobile phones. We experienced a decline in our North American revenues as a percentage of sales as a result of the depressed optics market, partially mitigated by the growing broadband access market.

Net sales in Europe decreased to € 6,319 million in 2003 from € 7,983 million in 2002; net sales in North America decreased to € 1,879 million in 2003 from € 2,729 million in 2002; net sales in Asia decreased to € 2,206 million in 2003 from € 2,744 million in 2002; and net sales in the rest of the world decreased to € 2,109 million in 2003 from € 2,558 million in 2002. In 2003, Europe, North America, Asia and the rest of the world accounted for 50.5%, 15.0%, 17.6% and 16.9%, respectively, of our total net sales compared with the following percentages of net sales for 2002: Europe 49.9%, North America 17.0%, Asia 17.1%, and the rest of the world 16.0%.

Gross Profit. Gross profit of € 4,098 million in 2003 represented 32.7% of net sales compared to 26.9%, or € 4,306 million, in 2002. This improvement in our margin was due primarily to the decrease in fixed operating cost resulting from our restructuring efforts in 2003 and what we consider to be close to a normalized level of inventory depreciation and operating reserves compared to the relatively high levels in 2002.

SG&A. Selling, general and administrative expenses were € 2,173 million for 2003 compared to € 2,757 million in 2002, a decrease of 21.2%. This decrease was primarily attributable to the decrease in fixed costs resulting from our restructuring efforts. As a percentage of net sales, selling, general and administrative expenses were 17.4% of net sales in 2003 compared to 17.2% of net sales in 2002, remaining stable despite the decrease in net sales in 2003 compared to 2002.

R&D. Research and development expenses were € 1,593 million in 2003 compared to € 2,155 million in 2002, a decrease of 26.1%. This decrease was primarily due to restructuring measures, mainly head count reduction and the reorganization of our research facilities, significantly reducing the number of our research and development facilities and our fixed costs. As a percentage of net sales, research and development expenses decreased to 12.7% in 2003 from 13.5% in 2002.

Income (Loss) from Operations. We recorded income from operations of € 332 million for 2003 compared to a loss from operations of € (606) million for 2002. This improvement resulted primarily from increased profitability in our broadband access business in our fixed communications segment, coupled with a significant narrowing of losses in the optical networks division, due to our restructuring efforts and to a significantly lower level of write-offs for excess and obsolete inventory compared to 2002.

Financial Loss. Financial loss was € (242) million for 2003 compared to € (1,008) million in 2002. The decreased loss was primarily due to the fact that reserves related to investments made and guarantees issued by us and customer financing provided by us were € (39) million, significantly less than the € (669) million of reserves taken in 2002. In addition, the decrease in financial loss related to € 102 million of net interest expense for 2003, compared to € 151 million in 2002.

Restructuring Costs. Restructuring costs were € (1,314) million for 2003, compared to € (1,379) million in 2002. The restructuring cost for 2003 reflected € 1,160 million for new restructuring plans in 2003 in response to the continuing deterioration of the telecommunications industry and the general economic environment and € (154) million for fixed assets write-offs. The expenses relating to the 2003 restructuring plans are mainly costs attributable to continuing layoffs in France, Italy, Spain, Germany and the United States.

Other Revenue (Expense). Other revenue (expense) was € 120 million for 2003 compared to € (737) million in 2002. Other revenue for 2003 was composed of revenue of € 104 million, representing a net capital gain of € 199 million, primarily related to the sale of some of our real estate holdings, partially offset by a net capital loss of € (95) million that primarily related to the disposal of our optical components business. Other non-recurring revenue in 2003 amounted to € 16 million and included an expense of € (151) million that primarily related to an impairment charge on fixed assets in the private communications segment, offset by a reversal of trade receivable reserves of € 90 million, also primarily in the fixed communication segment.

Loss Before Amortization of Goodwill and Taxes. Loss before amortization of goodwill and taxes was a loss of € (1,151) million for 2003 compared to a loss of € (3,731) million for 2002.

Income Taxes. Income taxes amounted to a charge of € (82) million for 2003 compared to a benefit of € 49 million in 2002 due mainly to carry-back receivables. As a result of our decision in 2002 to extend the scope of countries where we no longer record deferred tax assets, there was a deferred income tax charge for 2003 of € (20) million and for 2002 of € (264) million. For this reason, and because we continue to pay income taxes in some countries, despite our overall net loss in 2003, our effective tax rate (net income taxes divided by net income (loss) before taxes, share in net income of equity affiliates and discontinued operations and amortization of goodwill and purchased research and development) was a tax charge of 7.1%, instead of a tax gain of 32.85% of our net loss.

Share in the Net Income of Equity Affiliates and Discontinued Operations. Our share in the net income of equity affiliates and discontinued operations was a loss of € 113 million in 2003 (of which a net loss of € 101 million related to the discontinued Saft and Optronics businesses) compared to a loss of € (513) million in 2002 (primarily related to Optronics discontinued business).

Amortization of Goodwill. Amortization of goodwill was € (578) million for 2003 compared with € (532) million in 2002. The goodwill amortization of € (578) million for 2003 included € (171) million of exceptional amortization, primarily related to the reassessment of our business plan as it related to Gigabit Ethernet routing software across all product lines amounting to € (85) million.

Net Income (Loss). As a result of the foregoing, we recorded a net loss of € (1,944) million for 2003 compared to a net loss of € (4,745) million in 2002. As described above, this loss was primarily attributable to restructuring charges and accelerated goodwill.

Results of Operations by Business Segment for the Year Ended December 31, 2003 Compared to the Year Ended December 31, 2002

Prior to 2003, our business was organized along technology or product lines. As noted in Item 4 — “Information on the Company — Business Organization,” in early January 2003, we reorganized our activities along three market segments covering the entire range of voice and data communication solutions: fixed communications, mobile communications, and private communications. The fixed and mobile communications segments primarily address the telecommunications carrier market for which we act as a system supplier, while the private communications segment serves customers who are end users.

The simplified organizational chart below sets forth our four business segments as they were reflected in our consolidated financial statements for 2002, and the principal business activities of each segment.

Space and

Carrier Networking

Optics

e-Business

Components

• Broadband Networks
• Mobile Networks
• Voice Networks
• Application Software
• Alcatel Services

• Optronics
• Optical Networks
• Optical Fibers
• Wireless Transmission

• e-Business Networking
• e-Business Application
• Mobile Phones

• Space
• Batteries
• Components

The simplified organizational chart below sets forth the three business segments and their principal business activities since January 1, 2003:



Fixed Communications	Mobile Communications	Private Communications

• Access Networks • Fixed Solutions • Internet Protocol • Optical Networks	• Mobile Networks • Mobile Solutions • Wireless Transmission	• Enterprise Solutions • Space Solutions • Transport Solutions • Integration and Services

The table below sets forth the consolidated sales (before elimination of inter-segment sales, except for “Total Group” results and “Other and Eliminations”), income from operations and capital expenditures for tangible assets for each of our business segments for fiscal 2003 (reported) and for fiscal 2002 (pro forma, reflecting the new organization of our business and the disposal of the Optronics division and of the batteries (Saft) division). The discussion of the segments following the table is based on the unaudited pro forma numbers for 2002 and the actual 2003 numbers.


		Fixed			Mobile		Private		Other &
		Communications			Communications		Communications		Eliminations			Total Group

		(in millions)
Year Ended December 31, 2003
	Sales	€	5,708		€	3,539	€	3,627	€	(361	)	€	12,513
	Income (loss) from operations		127			226		123		(144	)		332
	Capital expenditures for tangible assets		55			40		47					142
Year Ended December 31, 2002 (pro forma)
	Sales	€	7,826		€	4,542	€	4,109	€	(463	)	€	16,014
	Income (loss) from operations		(784	)		204		115		(141	)		(606	)
	Capital expenditures for tangible assets		173			45		105		18			341

Fixed Communications

Sales of our fixed communications segment were € 5,708 million for 2003, compared to € 7,826 million for 2002, a decrease of 27.1%. This decrease was primarily in the fixed networks division, which experienced a significant decline in its optical networking activity, both terrestrial and submarine, due mainly to the depressed long-haul optical market. To a lesser extent, our fixed line voice business also contributed to the decrease, particularly in Europe, where telecom operators continued to reduce capital expenditures for narrow band switching. Even though the volume of line deliveries doubled in 2003 as compared to 2002 (15,800 million in 2003, as compared to 7,800 million in 2002), our broadband access revenue increased only slightly, due to substantial pricing pressures.

The fixed communications segment’s income from operations was € 127 million for 2003, compared to a loss from operations of € 784 million in 2002. This return to profitability was primarily the result of our restructuring effort during 2003, which yielded a significant narrowing of the losses in our optical networking, voice switching and optical fiber divisions. We also improved profitability in our broadband access division.

Mobile Communications

Sales of our mobile communications segment were € 3,539 million for 2003, compared to € 4,542 million in 2002, a decrease of 22.1%. This decrease was primarily due to a significant decline in sales of our mobile handsets and, to a lesser extent, to decreases in our wireless transmission business. This decline more

than offset the growth in our 2/2.5G radio access business and our next generation 3G solutions activity, which accelerated in the second half of 2003.

The mobile communications segment’s income from operations was € 226 million for 2003, compared to € 204 million in 2002. This increase was primarily due to an increase in the mobile networks business, in particular radio access, and in our wireless transmission division. This increase was partially offset by our mobile phones division, which experienced a loss from operations.

Private Communications

Sales of our private communications segment were € 3,627 million for 2003, compared to € 4,109 million in 2002, a decrease of 11.7%. This decrease was mostly due to a decline in our integration and services business, which was primarily a result of the low level of spending by European carriers, to which we sell an important portion of these services, and, to a lesser extent, a decrease in sales at our enterprise solutions division, which sells products and services to businesses, in particular data activity, and space. The increase in sales by our transport solutions division was more than offset by the declines in these other activities.

The private communications segment’s income from operations was € 123 million for 2003, compared to € 115 million in 2002. This increase was primarily a result of an increase in our enterprise solutions division, in particular our call center activity, as well as our voice PBX offerings, partially offset by our space activity, which registered a decline in its business.

Liquidity and Capital Resources

Liquidity

Cash Flow for the Year Ended December 31, 2004 and 2003

Cash Flow Overview

Cash and cash equivalents decreased € 1,583 million during 2004 to € 4,611 million at December 31, 2004 excluding short-term investments and listed securities. This decrease was mainly due to net cash used by operating activities of € 289 million, net cash used by investing activities of € 141 net cash used by financing activities of € 1,102 million and by the net effect of exchange rate changes, which amounted to € 51 million.

Net Cash Provided (Used) by Operating Activities. Net cash used by operating activities during 2004 was € 289 million, compared to net cash provided of € 444 million for 2003. Net cash provided by operating activities before changes in working capital was € 338 million, due to a net income of € 281 million for 2004 adjusted for cash outlays for restructuring of € 606 million (compared to € 980 million in 2003), and for non-cash items. These non-cash items were primarily depreciation and amortization, changes in valuation allowances and other reserves, our share in net income of equity affiliates, and net gain on disposal of non-current assets (mainly sale of our battery business and sale of some of our real estate). Net cash provided of € 338 million was more than offset by an increase in working capital of € 627 million which was due in part to the increase in sales volume during the fourth quarter of 2004 compared to the fourth quarter of 2003 (working capital requirements increase or decrease depending on our quarterly revenue level).

Net Cash Provided (Used) by Investing Activities. Net cash used by investing activities was € 141 million during 2004 compared to net cash provided by investing activities of € 700 million in 2003. The decrease is mainly due to an increase in short term investment of € 443 million in 2004 compared to a decrease of € 257 million in 2003. The decrease is also due to a higher amount of cash used by discontinued activities, € 247 million in 2004 compared with € 56 million in 2003, and to lower cash proceeds from the disposal of fixed assets and the sale of unconsolidated companies or previously consolidated companies, which provided € 577 million in cash in 2004 (primarily relating to the sale of the battery business) compared to € 652 million in 2003 (primarily relating to the sale of real estate assets through sale and lease-back transactions). Capital expenditures increased from € 253 million during 2003 to € 380 million during 2004.

On the other hand, cash proceeds from loans made to our customers and from other financial assets increased from € 207 million in 2003 to € 557 million in 2004, corresponding mainly to reimbursements.

Net Cash Provided (Used) by Financing Activities. Net cash used by financing activities was € 1,102 million in 2004 compared to net cash used of € 564 million in 2003. The principal reason for this change was that the decrease in short-term debt of € 1,567 million in 2004 (which included the repayment of € 543 million of outstanding bonds maturing in 2004 and € 983 million anticipated repayment of bonds maturing after 2004) was in the same range as the decrease in 2003 (€ 1,580 million), while in 2004 € 462 million were received from issuance of new bonds due 2014 (see “Long-Term Debt,” below), compared with € 1,022 million received in 2003 from the issuance of new bonds redeemable for ordinary shares.

Capital Resources

Resources and Cash Flow Outlook. We derive our capital resources from a variety of sources, including the generation of positive cash flow from on-going operations, on-going divestitures of assets considered to be non-core to our main telecommunications activities, the issuance of debt and equity in various forms, and banking facilities including the revolving credit facility of € 1,000 million maturing in June 2009 and on which we have not drawn (see “Syndicated Facility” below). Our ability to draw upon these resources is dependent upon a variety of factors, including our customers’ ability to make payments on outstanding accounts receivable, the perception of our credit quality by debtors and investors, our ability to meet the financial covenant for our syndicated facility and debt and equity market conditions generally.

Our short-term cash requirements are primarily related to funding our operations, including our restructuring program, capital expenditures and short-term debt repayments. We believe that our cash and cash equivalents, including short-term investments of € 5,099 million as of December 31, 2004 are sufficient to fund our cash requirements for the next twelve months.

During 2005 we expect to make cash outlays for our restructuring programs of approximately € 500 million, and to make capital expenditures, which should remain below € 600 million. We also expect to repay short term debt that will not be renewed, such as the € 576 million of our bonds maturing in 2005. In addition, our expected growth in revenues in 2005 compared to 2004 may result in additional cash requirements linked to an increase in working capital.

We can provide no assurance that our actual cash requirements will not exceed the currently expected cash outlays. If we cannot generate sufficient cash from operations to meet cash requirements in excess of our current expectations, we might be required to obtain supplemental funds through additional operating improvements or through external sources, such as capital market proceeds (if conditions are considered favorable by us), assets sales or financing from third parties, the availability of which is dependent upon a variety of factors, as noted above. During 2005 we will also continue our bond repurchase program targeted at short term maturities.

Credit Ratings. As of March 31, 2005, our credit ratings were as follows:

Rating Agency

Long-term Debt

Short-term Debt

Outlook

Last Update

Standard & Poor’s

Stable

November 10, 2004

Moody’s

Ba3

Not Prime

Rating Under Review

February 24, 2005

Standard & Poor’s. On November 10, 2004, Standard & Poor’s upgraded our long-term corporate credit and senior unsecured debt rating to BB on the basis of our stabilized sales, adequate cost structure positioning and strong cash level, as well as healthier market conditions for the telecom equipment industry and our severe cost cutting. Standard & Poor’s outlook for us continues to be stable and it also affirmed our short-term B corporate credit rating. The rating grid of Standard & Poor’s ranges from AAA (the strongest rating) to D (the weakest rating). Our BB rating is in the BB category, which also includes BB+ and BB- ratings. Standard & Poor’s gives the following definition to the BB category: “[a]n obligation rated “BB’ is less vulnerable to nonpayment than other speculative issues. However, it faces major ongoing uncertainties or

exposure to adverse business, financial, or economic conditions, which could lead to the obligor’s inadequate capacity to meet its financial commitment on the obligation. Debt rated B is more vulnerable to non payment than debt rated BB, but the obligor currently has the capacity to meet its financial commitment on the obligation. Adverse business, financial, or economic conditions will likely impair the obligor’s capacity or willingness to meet its financial commitment on the obligation.”

Moody’s. On May 10, 2004 Moody’s upgraded its outlook for our long-term debt credit rating from stable to positive, and on September 8, 2004 Moody’s upgraded our long-term debt credit rating from B1 to Ba3 and confirmed its positive outlook for our long-term debt, based on the stabilization of our revenues, our positive net income and a healthy cash position. The “Not Prime” rating for our short-term debt was confirmed. The rating grid of Moody’s ranges from Aaa, which is considered to carry the smallest degree of investment risk, to C, which is the lowest rated class. Alcatel’s Ba3 rating is in the Ba category which also includes Ba1 and Ba2 ratings. Moody’s gives the following definition of its Ba category: “debt which is rated Ba is judged to have speculative elements and is subject to substantial credit risk.” On February 24, 2005, Moody’s changed its outlook for our long-term debt from “positive” to “rating under review” for possible upgrade, on the basis of our continued improvement on key metrics and the expectation that our overall business performance will continue to improve.

We can provide no assurances that our credit ratings will not be lowered in the future by Standard & Poor’s, Moody’s or similar rating agencies. In addition, a security rating is not a recommendation to buy, sell or hold securities, and each rating should be evaluated separately of any other rating. Our current short-term and long-term credit ratings as well as any possible future lowering of our ratings may result in additional higher financing costs and in reduced access to the capital markets.

Our short-term debt rating allows us a very limited access to commercial paper, and the non-French commercial paper market is generally not available to us on terms and conditions that we find acceptable.

At December 31, 2004, our total financial debt amounted to € 4,359 million compared to € 5,293 million at December 31, 2003.

Short-term Debt. At December 31, 2004, we had € 1,036 million of short-term financial debt outstanding, which included € 576 million of bonds and € 61 million in commercial paper, with the remainder representing other bank loans and lines of credit and other financial debt and accrued interest payable.

Long-term Debt. At December 31, 2004 we had € 3,323 million of long-term financial debt outstanding.

On April 7, 2004, we closed an exchange offer for our 7.00% Notes due 2006, of which € 995 million principal amount was then outstanding, for new notes of a longer maturity. The main objective of the exchange offer was to lengthen our average debt maturity. We exchanged € 366 million principal amount of our 7.00% Notes due 2006 for € 412 million principal amount of our new 6.375% Notes due 2014. We also issued and sold an additional € 50 million principal amount of our new 6.375% Notes due 2014. Interest on the 6.375% Notes is payable annually.

Rating Clauses Affecting our Debt. Our outstanding bonds do not contain clauses that would trigger an accelerated repayment in the event of a lowering of our credit ratings. However, the € 1,200 million bond issue maturing in December 2006 includes a “step up rating change” clause, which provides that the interest rate will be increased by 150 basis points if our ratings fall below investment grade. This clause was triggered when our credit ratings were lowered to below investment grade status in July 2002. The 150 basis point increase in the interest rate from 7% to 8.5% became effective in December 2002, and applied to the payment of the December 2003 and 2004 coupons. This bond issue also contains a “step down rating change” clause that provides that the interest rate will be decreased by 150 basis points if our ratings move back to investment grade. Our new 6.375% Notes due 2014, which we exchanged for a portion of our 7.00% Notes due 2006, as described above, do not provide for a “step up rating change.”

Syndicated Facility. On June 21, 2004, we closed a € 1,300 million syndicated three-year revolving credit facility that replaced the then existing undrawn € 1,375 million syndicated facility maturing in April

2005. On March 15, 2005, we closed an amendment of this facility by extending its maturity to June 2009 (with a possible extension until 2011), reducing its amount to € 1,000 million, and eliminating one of the two then applicable financial covenants.

The availability of this syndicated revolving credit facility does not depend upon our credit ratings. At December 31, 2004, this facility had not been drawn and remained undrawn on February 2, 2005, the date our Board of Directors approved the 2004 financial statements. Our ability to draw on this facility is conditioned upon our compliance with certain financial covenants. Until its amendment on March 15, 2005, the facility contained two financial covenants: the first was a gearing ratio (net debt/equity including minority interests) and the second a ratio linked to our capacity to generate cash to reimburse our debt. We tested these covenants every quarter. We were in compliance with these financial covenants at December 31, 2004 (the date of the last published financial statements); as we had cash and cash equivalents in excess of our gross financial debt at December 31, 2004, these ratios were actually not applicable at such year-end. In the context of the March 15, 2005 amendment to the facility, the gearing ratio covenant was eliminated. We will continue to test the cash-generation covenant quarterly. We can provide no assurance that we will remain compliant with such financial covenant in the future.

Debt to Equity Ratio. Total net financial debt (total financial debt less cash and cash equivalents, including short-term investments) on December 31, 2004 was a net cash position of € 740 million, compared with a net cash position of € 976 million at December 31, 2003, and therefore a net financial debt to shareholders’ equity (including minority interests) ratio is not meaningful. Debt linked to our banking subsidiary activities, Electro Banque (which was € 105 million on December 31, 2004) is not included in our total net financial debt.

Contractual obligations and off-balance sheet contingent commitments

Contractual obligations. We have certain contractual obligations that extend beyond 2004. Among these obligations we have long-term debt, capital leases, operating leases, commitments to purchase fixed assets and other unconditional purchase obligations. Our total contractual cash obligations at December 31, 2004 for these items are presented below based upon the minimum payments we will have to make in the future under such contracts and firm commitments. Amounts related to financial debt and capital lease obligations are fully reflected in our consolidated balance sheet included in this document.


	Payment Deadline

	Less than						After
Contractual payment obligations	one year		1-3 years		4-5 years		5 years		Total

	(in millions)
Financial debt (excluding capital leases)	€	1,031	€	752	€	1,027	€	1,504	€	4,314
Capital lease obligations		5		40		—		—		45

Sub-total — included in our balance sheet	€	1,036	€	792	€	1,027	€	1,504	€	4,359

Operating leases		104		160		118		164		546
Commitments to purchase fixed assets		28		—		—		—		28
Unconditional purchase obligations^(a)		161		59		1		—		221

Sub total — not included in our balance sheet	€	293	€	219	€	119	€	164	€	795

Total contractual obligations	€	1,329	€	1,011	€	1,146	€	1,668	€	5,154


(a)	Other firm commitments result mainly from purchase obligations related to multi-year equipment supply contracts linked to the sale of businesses or plants to third parties.

Off-balance sheet commitments and contingencies. On December 31, 2004, our off-balance sheet commitments and contingencies amounted to € 2,696 million, consisting primarily of € 1,484 million in undertakings on long-term contracts for the supply of telecommunications equipment and services. Generally we provide these undertakings to back performance bonds issued to customers through financial institutions. These performance bonds and counter-guarantees are standard industry practice for long-term supply

contracts. If certain events occur subsequent to our including these commitments within our off-balance sheet contingencies, such as the delay in promised delivery or claims related to an alleged failure by us to perform on our long-term contracts, or the failure by one of our customers to meet its payment obligations, we reserve the estimated risk on our consolidated balance sheet under the line item “Reserves for product sales” (see Note 25 to our consolidated financial statements) or in inventory reserve. Not included in the € 2,696 million of off-balance sheet commitments and contingencies is a € 605 million guarantee granted to the bank implementing our cash pooling program. This guarantee covers any intraday debit position that could result from the daily transfers between our central treasury account and our subsidiaries’ accounts. Also not included in the € 2,696 million is our contingent liability pursuant to the securitization of accounts receivable and the sale of a carry-back receivable described below.

Only performance guarantees issued by our Group to financial institutions are presented in the table below. The figures published in 2002 also included guarantees given by parent companies of our Group in respect of their subsidiaries’ contracts which, in accordance with current practice, are no longer considered to represent an off-balance sheet commitment of the Group. These amounted to € 5,743 million at December 31, 2002.

Off-balance sheet contingent commitments (excluding our commitment to provide further customer financing, as described below) given in the normal course of business of our Group are as follows:


	December 31,			December 31,		December 31,
	2004			2003		2002

	(in millions)
Guarantees given on contracts made by Group entities and by non-consolidated subsidiaries⁽¹⁾	€	1,742		€	2,106	€	2,787
Discounted notes receivable with recourse⁽²⁾		5			25		14
Other contingent commitments		793	⁽³⁾		702		833

Sub-total — Contingent commitments⁽⁴⁾	€	2,540		€	2,833	€	3,634
Secured borrowings⁽⁵⁾		156			157		262

Total off-balance sheet commitments and secured borrowings⁽⁴⁾	€	2,696		€	2,990	€	3,896


(1)	This amount is not reduced by any amounts that may be recovered under recourse or similar provisions, guarantees received, or insurance proceeds, as explained more fully below. Of this amount, € 258 million represent undertakings we provided on contracts of non consolidated companies.

(2)	This contingent liability relates to our obligation pursuant to the applicable law of certain jurisdictions (mainly France) to repurchase discounted notes receivable in certain circumstances, such as if there is a payment default.

(3)	Included in the € 793 million are € 90 million of guarantees provided to tax authorities in connection with tax assessments contested by us, € 3 million of commitments of our banking subsidiary, Electro Banque, to third parties providing financing to non-consolidated entities, € 299 million of commitments related to leasing of sale and lease-back transactions and € 401 million of various guarantees given by certain subsidiaries in the Group.

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

(5)	The amounts in this item represent borrowings and advance payments received which are secured through security interests or similar liens granted by us. The borrowings are reflected in the table under the heading “Contractual obligations,” above.

The amounts of guarantees given on contracts reflected in the preceding table represent the maximum potential amounts of future payments (undiscounted) we could be required to make under current guarantees granted by the Group. These amounts are not reduced by any amounts that may be recovered under recourse provisions in the guarantees or guarantees given by customers for the Group’s benefit. In addition, most of the parent company guarantees and performance bonds given to our customers are insured; therefore, the estimated exposure related to the guarantees set forth in the preceding table may be reduced by insurance proceeds that we may receive in case of a claim.

Commitments related to product warranties and pension and post retirement benefits are not included in the preceding table. These commitments are fully reflected in our consolidated financial statements.

Contingent liabilities arising out of litigation, arbitration or regulatory actions are not included in the preceding table either, with the exception of those linked to the guarantees given on our long-term contracts. Potential commitments linked to the incorporation into French law of the European Directive on Waste Electrical and Electronic Equipment, which will only be applicable as of August 2005, are also not included. The commitments related to this European directive will not have a material impact on our financial position.

Commitments related to contracts that have been cancelled or interrupted due to the default or bankruptcy of the customer are included in the above mentioned “Guarantees given on contracts made by Group entities and by non-consolidated subsidiaries” as long as the legal release of the guarantee is not obtained.

Guarantees given on third party long-term contracts could require us to make payments to the guaranteed party based on a non-consolidated company’s failure to perform under an agreement. The fair value of these contingent liabilities, corresponding to the premium to be received by the guarantor for issuing the guarantee, was € 3 million as of December 31, 2004 (€ 3 million at December 31, 2003 and € 5 million at December 31, 2002).

Customer Financing. Based on standard industry practice, from time to time we extend financing to our customers by granting extended payment terms, making direct loans, and providing guarantees to third-party financial institutions. As of December 31, 2004, net of reserves we had provided customer financing of approximately € 253 million. This amount includes € 207 million of customer deferred payments and accounts receivable, and € 39 million of other financial assets. In addition, we had outstanding commitments to make further direct loans or provide guarantees to financial institutions in an amount of approximately € 92 million.

More generally, as part of our business we routinely enter into long-term contracts involving significant amounts to be paid by our customers over time.

SVF Trust Program. In 1999, we established a securitized customer financing (SVF) program arranged by Citibank, which was amended in June 2000, May 2002 and May 2003.

As we did not own any equity interest in the SVF trust, the SVF trust was not consolidated within the Group’s accounts, in accordance with Regulation no. 99-02 of the “Comité de Réglementation Comptable”. However, in accordance with new financial regulations applicable from the first financial year of a company beginning after August 2, 2003, the SVF trust was consolidated since January 1, 2004.

In April 2004, as part of a reassessment of our financing requirements and credit facilities, and with a view to optimizing our financial costs, we decided to cancel this securitized program. As a result, the banks no longer have any financing commitments in this respect, and, we bought back from the SVF trust all outstanding receivables at their nominal value during the second quarter of 2004. The cancellation of the program did not have a significant impact on the results and financial position of the Group.

Sale of carry-back receivable. In May 2002, we sold to a credit institution a carry-back receivable with a face value of € 200 million resulting from the choice to carry back tax losses from 2001. The cash received from this sale amounted to € 149 million, corresponding to the discounted value of this receivable, that matures in five years. The difference between the net cash proceeds and the nominal value is recorded over the five year period as a financial expense. The financial expense for 2004 amounted to € 10 million.

We are required to indemnify the purchaser in case of any error or inaccuracy concerning the amount or nature of the carry-back receivable sold. The sale would be retroactively cancelled if future changes in law resulted in a substantial change in the rights attached to the carry-back receivable sold.

Securitization of accounts receivables. In December 2003, Alcatel entered into a securitization program for the sale of customer receivables without recourse. Eligible receivables are sold to a special purpose vehicle, which benefits from a bank financing, and from a subordinated financing from our Group representing an over-collateralization determined on the basis of the risk profile of the portfolio of receivables sold. The special purpose vehicle is fully consolidated in accordance with paragraph 10052 of Regulation no. 99-02 of the “Comité de Réglementation Comptable”. The receivables sold at December 31, 2004, which amounted to € 82 million (€ 54 million at December 31, 2003), are therefore maintained in our consolidated

balance sheet. At December 31, 2004, the maximum amount of bank financing that we could obtain through the sale of receivables was € 150 million, which could be increased to € 250 million under the same terms. The actual amount of such funding for each receivable is a percentage of the amount of the receivable and the percentage varies depending on the quality of the receivables sold. The purpose of this securitization program is to optimize the management and recovery of receivables, in addition to providing extra financing.

Contractual payment obligations and off-balance sheet contingent commitments under U.S. GAAP. The following table presents minimum payments we will have to make in the future under contracts and firm commitments under U.S. GAAP.


	Payment Deadline

	Less than						After
Contractual payment obligations	one year		1-3 years		4-5 years		5 years		Total

	(in millions of euros)
Financial debt (excluding capital leases)		1,041		953		1,051		1,550		4,595
Capital lease obligations		10		21		21		32		84

Subtotal — included in Balance Sheet		1,051		974		1,072		1,582		4,679

Operating leases		96		144		102		137		479
Commitments to purchase fixed assets		28		—						28
Unconditional purchase obligations^(a)		161		59		1				221

Subtotal — Commitments		285		203		103		137		728

Total — Contractual obligations		1,336		1,177		1,175		1,719		5,407


(a)	Other firm commitments result mainly from purchase obligations related to multi-year equipment supply contracts linked to the sale of businesses or locations to third parties.

The main differences between contractual obligations under U.S. GAAP and under the accounting principles that we follow are:


	•	the carry back receivable (mentioned above) is included in our financial debt under U.S. GAAP due to our continuing involvement in this asset, through our ability to reacquire the receivable in certain circumstances.

	•	the application of SFAS 133 to the accounting of some derivative instruments (mainly derivative instruments used to reduce exposure to interest rate risk), as described in Note 39(3) to our consolidated financial statements, and

	•	some of our lease contracts are recorded as capital leases under U.S. GAAP, and as operating leases under French GAAP.

Customer Credit Approval Process and Risks. We engage in a thorough credit approval process prior to providing financing to our customers or guarantees to financial institutions, which provide financing to our customers. Any significant undertakings have to be approved by a central Risk Assessment Committee and by our Trade & Project Finance Department, independent from our commercial departments. We continuously monitor and manage the credit we have extended to our customers, and attempt to limit credit risks by, in some cases, obtaining security interests or by transferring to banks or export credit agencies a portion or all of the risk associated with this financing.

Although, as discussed above, we engage in a rigorous credit approval process and have taken actions to limit our exposure to customer credit and commercial repayment risks, the global downturn and deterioration of the telecommunications industry through 2003 caused certain of our customers to experience financial difficulties and others to file for protection under the bankruptcy laws. Upon the financial failure of a customer, we realized losses on extended credit given and loans made to the customer, on guarantees provided for the customer, losses relating to our commercial risk exposure under long-term contracts, as well as the loss of the customer’s ongoing business. If economic conditions and the telecommunications industry in particular deteriorate once again, we may in the future realize similar losses. In such a context, should

additional customers fail to meet their obligations to us, we may experience reduced cash flows and losses in excess of reserves, which could materially adversely impact our results of operations and financial position. For fiscal 2004, we had a net revenue of approximately € 14 million related to doubtful customer accounts under “Other revenue (expense)”, compared with a net revenue of € 63 million for fiscal year 2003, and a profit of € 77 million in 2004 related to customer financing arrangements under “Financial income (loss)”, compared with a charge of € 39 million in 2003.

Capital Expenditures. We expect our capital expenditures in 2005 to be less than € 600 million.

We believe that our current cash and cash equivalents, cash flows and funding arrangements provide us with adequate flexibility to meet our short-term and long-term financial obligations and to pursue our capital expenditure program as planned. We base this assessment on current and expected future economic and market conditions. Should economic and market conditions deteriorate, we may be required to engage in additional restructuring efforts and seek additional sources of capital, which may be difficult if there is no continued improvement in the market environment and given our limited ability to access the fixed income market at this point. In addition, as mentioned in “Capital Resources” above, if we do not meet the financial covenant contained in our syndicated facility, we may not be able to rely on this funding arrangement to meet our cash needs.

Qualitative and Quantitative Disclosures About Market Risk

Financial instruments

We enter into derivative financial instruments primarily to manage our exposure to fluctuations in interest rates and foreign currency exchange rates. Our policy is not to take speculative positions. Our strategies to reduce exchange and interest rate risk have served to mitigate, but not eliminate, the positive or negative impact of exchange and interest rate fluctuations.

Derivative financial instruments held by us at December 31, 2004 were mostly hedges of existing or future financial or commercial transactions or were related to issued debt.

The most important part of our issued debt is in euro. Interest rate derivatives are used to convert the fixed rate debt into floating rate in order to cover the interest rate risk.

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

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

Counterparty risk

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

Foreign currency risk

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

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

Interest rate risk

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

In the table below, the potential change in fair value for interest rate sensitive instruments is based on a hypothetical and immediate one percent fall or rise for 2004 and 2003, in interest rates across all maturities and for all currencies. Interest rate sensitive instruments are fixed-rate, long-term debt or swaps.


	December 31, 2004												December 31, 2003

							Fair value			Fair value									Fair value			Fair value
							variation if			variation if									variation if			variation if
	Booked			Fair			rates fall			rates rise			Booked			Fair			rates fall			rates rise
	value			value			by 1%			by 1%			value			value			by 1%			by 1%

	(in millions of euros)
Assets
Short term investments and cash and cash equivalents⁽¹⁾		5,099			5,160			0			0			6,269			6,317			0			0
Liabilities⁽²⁾
Convertible bonds		(1,022	)		(1,219	)		(64	)		60			(1,022	)		(1,148	)		(73	)		66
Other bonds and other financial debt		(3,337	)		(3,514	)		(108	)		102			(4,271	)		(4,426	)		(126	)		121
Interest rate derivative		0			178			122			(112	)		0			165			136			(126	)
(Debt)/Cash position		740			605			50			50			976			908			(63	)		62


(1)	For bank overdrafts, the booked value is considered as a good estimation of the fair value.

(2)	Over 90% of our bonds have been issued with fixed rates. At year-end 2004 and 2003, the fair value of our long-term debt is higher than its booked value due to a fall in interest rates.

Assumptions and Calculations

The fair value of the instruments in the table above is calculated with market standard financial software according to the market parameters prevailing on December 31, 2004.

Fair value hedge

The ineffective portion of changes in fair value hedge was not material in the income statement at December 31, 2004 and at December 31, 2003. We did not have any amount excluded from the measure of effectiveness. There was no impact of contract cancellation in the income statement at December 31, 2004 and 2003.

Net investment hedge

We have stopped using investment hedges in foreign subsidiaries. At December 31, 2004 and 2003, there were no derivatives that qualified as investment hedges. The portion of derivatives that does not qualify as a hedge had been recorded in the income statement in 2003 and had generated a loss of € 17 million at December 31, 2003.

Equity risks

We may use derivative instruments to manage the equity investments in listed companies that we hold in our portfolio. We may sell call options on shares held in our portfolio and any profit would be measured by the difference between our book value for such securities and the exercise price of the option, plus the premium received.

We may also use derivative instruments on Alcatel shares held in treasury. Such transactions are authorized as part of the buy back program approved at our shareholders’ general meeting held on June 4, 2004.

Since April 2002, we did not have any derivative instruments in place on investments in listed companies or on Alcatel shares held in treasury.

Additional information regarding market and credit risks, including the hedging instruments used, is provided in Note 27 to our consolidated financial statements included in this annual report.

Research and Development

Expenditures. In fiscal 2004, our research and development expenditures totaled € 1,587 million (12.9% of 2004 consolidated net sales) compared to € 1,510 million in 2003 (13.0% of 2003 consolidated net sales) and € 1,958 million in 2002 (13.7% of 2002 consolidated net sales). Our research and development expenditures in 2003 would have totaled € 1,654 under the new accounting presentation mentioned in “Operating and Financial Review and Prospects — Consolidated Results of Operations for the Year Ended December 31, 2004 Compared to the Year Ended December 31, 2003 — “R&D Costs” (14.1% of 2003 consolidated net sales under such presentation).

Accounting policies. Our policy is to record research and development expenses for the year in which they are incurred, except as follows. Software development costs are included in intangible assets when they strictly comply with the following criteria: the project is clearly defined and costs are separately identified and reliably measured; the technical feasibility of the software is demonstrated; the software will be sold or used in-house; a potential market exists for the software, or its usefulness, in case of internal use, is demonstrated; and adequate resources required for completion of the project are available. Software costs are amortized, in case of internal use, over their probable service lifetime, or in case of external use, according to prospects for sale, rental or other forms of distribution. The amortization corresponds to the greater of either the cumulative amounts using straight-line amortization or the cumulative amounts based on the criteria discussed above. Recoverable amounts disbursed under the terms of contracts with customers are included in work-in-progress on long-term contracts.

In connection with accounting for the Timetra acquisition in 2003 and for the Genesys and Newbridge acquisitions in 2000 under U.S. GAAP for reconciliation purposes, we allocated a significant portion of the purchase price of each acquisition to in-process research and development projects. As part of the process of analyzing the Timetra, Genesys and Newbridge acquisitions, we made our decision to buy technology that had not yet been commercialized rather than develop the technology internally.

In estimating the fair value of in-process research and development for the Timetra, Genesys and Newbridge acquisitions, we considered present value calculations of income, an analysis of project accomplishments and remaining outstanding items, an assessment of overall contributions and project risks.

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

The value assigned to purchased in-process research and development was determined by discounting the net cash flows to their present value. The selection of the discount rate was based on a consideration of our weighted average cost of capital, adjusted upward to reflect additional risks inherent in the development life cycle. This value was also adjusted to reflect stage of completion, the complexity of the work completed to date, the difficulty of completing remaining development, costs already incurred, and projected cost to complete the projects.

As of the date of each of the acquisitions, the development of the in-process research and development projects at each of Timetra, Genesys and Newbridge had not yet reached technological feasibility and the

research and development in progress had no alternative future uses. Accordingly, the value allocated to these projects was capitalized and immediately expensed at acquisition.

Impairment of acquired technology. Acquired technology, representing developed technology of acquired businesses, is stated at cost and is amortized on a straight line basis over the estimated useful lives, which are typically five to 10 years. Each period, we analyze the ability to commercialize our acquired technology assets whenever events or changes in circumstances indicate that the carrying value may not be recoverable as required under GAAP. Acquired technologies related to business combinations accounted for using French “pooling of interests” method are not recognized in the primary financial statements but only in the reconciliation of our consolidated financial statements to U.S. GAAP, as described in Note 36(a) to our consolidated financial statements.

In August 2001, the Financial Accounting Standards Board issued SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.” SFAS No. 144 supersedes SFAS No. 121 and the accounting and reporting provisions of APB Opinion No. 30 for the disposal of a segment of a business. The provisions of SFAS No. 144 are required to be applied for fiscal years beginning after December 15, 2001.

During the year ended December 31, 2002, we performed an assessment of the carrying values of acquired technology pursuant to SFAS No. 144 in connection with the DSC Communications, Genesys, Kymata, Innovative Fibers and Newbridge acquisitions. The assessment was performed due to sustained negative economic conditions impacting our operations and expected future revenues. Current economic indicators suggest that these conditions may continue for the foreseeable future. As a result, we recorded impairment charges of € 553 million related to acquired technology to reflect these assets at their current estimated fair values. The impairments represent the amount by which the carrying values of these assets exceeded their fair values. These charges have been recorded as impairment of long-lived assets in income from operations in our consolidated statements reconciled to U.S. GAAP that are presented in Note 38 to our consolidated financial statements.

During the year ended December 31, 2004, no trigger events occurred that would require us to reassess the carrying values of acquired technology.

Application of accounting policies to certain significant acquisitions. Set forth below is a description of our methodology for estimating the fair value of the in-process research and development of Genesys, Newbridge, Timetra and Spatial at the time of acquisition and the status of the projects at the end of 2004. We cannot give assurances that the underlying assumptions used to estimate expected project sales, development costs or profitability, or the events associated with such projects, as described below, will take place as estimated.

Genesys. At the acquisition date, Genesys was conducting design, development, engineering and testing activities associated with the completion of several projects related to Genesys release 6. The allocation of $100 million of the purchase price to the in-process research and development projects represented their estimated fair values using the methodology described above.

Approximately $22 million had been spent on the research and development projects as of the valuation date. Costs to complete the projects were estimated at approximately $25 million over the 10 months following the acquisition. Management estimated that the aforementioned projects were in various stages of development and were approximately 50% complete, in the aggregate, based on development costs.

Estimated total revenues from the acquired in-process technology were expected to peak in 2003 to 2004 and steadily decline thereafter as other new products and technologies were expected to be introduced by us.

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

of such technology, the profitability levels of such technology, and the uncertainty of technological advances that were unknown at the time.

In May 2002, an impairment test was performed in compliance with SFAS 144 requirements and an impairment charge of € 36 million is recorded in the reconciliation of our net income (loss) and shareholders’ equity to U.S. GAAP in Note 37 to our consolidated financial statements. As of December 31, 2002, the carrying value of the acquired technology of Genesys under U.S. GAAP amounted to € 13 million.

During the year ended December 31, 2004, no trigger events occurred that would require us to reassess the carrying values of acquired technology.

Newbridge. At the acquisition date, Newbridge was conducting design, development, engineering and testing activities associated with the completion of numerous projects aimed at developing next-generation technologies that were expected to address emerging market demands for the telecommunications equipment market. The allocation of $750 million of the purchase price to these in-process research and development projects represented their estimated fair value using the methodology described above. More specifically, the development, engineering and testing activities associated with the following technologies were allocated portions of the purchase price: switching and routing ($505 million) and access ($245 million).

Approximately $135 million had been spent on the research and development projects as of the valuation date. Costs to complete the projects were estimated at approximately $100 million over the 12 to 18 months following the acquisition. Management estimated that the aforementioned projects were in various stages of development and ranged from 50% to 80% complete based on development costs.

Estimated total revenues from the acquired in-process technology were expected to peak in 2004 and 2005 and steadily decline thereafter as other new products and technologies were expected to be introduced by us.

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

A discount rate of 20% was used for determining the value of the in-process research and development. This rate is higher than the implied weighted average cost of capital for the acquisition due to the inherent uncertainties surrounding the successful development of the purchased in-process technology, the useful life of such technology, the profitability levels of such technology, and the uncertainty of technological advances that were unknown at the time.

We have completed many of the original research and development projects in accordance with the plans outlined above, and have expanded several other projects to integrate our technologies. The majority of the projects are on schedule, but delays occurred due to changes in technological and market requirements for telecommunications/data networking equipment. Further, factors such as the inherent complexity and breadth of the projects delayed the development of certain projects as well. We currently believe that actual results have been lower than forecasts with respect to revenues generated by the acquired in-process research and development. However, we believe that expenses incurred to date associated with the development and integration of the in-process research and development projects are consistent with our estimates at the time of acquisition.

In May and December 2002, impairment tests were performed in compliance with SFAS 144 requirements and an impairment charge of € 371 million is recorded in the reconciliation of our net income (loss) and shareholders’ equity to U.S. GAAP in Note 37 to our consolidated financial statements. As of December 31, 2002, the carrying value of the acquired technology of Newbridge under U.S. GAAP amounted to € 15 million. During the year ended December 31, 2004, no trigger events occurred that would requires us to reassess the carrying values of acquired technology.

Timetra. At the acquisition date, Timetra was developing routers to handle data traffic at what is known as the network edge, the part of the data network that links offices, homes and other buildings to the long distance “core” network. In June 2003, Timetra introduced its first product, a family of service routers for

next generation carrier networks. The allocation of $6 million of the purchase price to these in-process research and development projects represented their estimated fair values using the methodology described above.

Approximately $42 million had been spent on research and development projects as the valuation date. Costs to complete the projects were estimated at approximately $9 million over 24 months following the acquisition. Management estimated that the aforementioned projects were in various stages of development and were approximately 80% complete, in the aggregate, based on development costs.

Estimated total revenues from the acquired in-process technology were expected to peak in 2006 and 2007 and steadily decline thereafter as other new products and technologies were expected to be introduced by us.

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

A discount rate of 35% was used for determining the value of the in-process research and development. This rate is higher than the implied weighted average cost of capital for the acquisition due to inherent uncertainties surrounding the successful development of the purchased in-process technology, the useful life of such technology, the profitability levels of such technology, and the uncertainty of technological advances that were unknown at that time. However, we believe that expenses incurred to date associated with the development and integration of the in-process research and development projects are consistent with our estimates at the time of acquisition.

Spatial. We used the purchase method of accounting for Spatial, whereby the excess of cost over the net amounts assigned to assets acquired and liabilities assumed is allocated to goodwill and intangible assets based on their estimated fair values. Such intangible assets identified by us include $58 million allocated to developed technology and know how (“developed technology”) and $10 million allocated to in-process research and development.

At the acquisition date, Spatial was selling its distributed mobile switching solution; a centralized call server that manages call/session control for mobile voice and data services, commonly referred to as a “softswitch.” In March 2002, Spatial introduced its Atrium^tm product, the industry’s first next-generation mobile core switch that supports 2/2.5/3G GSM and CDMA networks. This developed technology and know-how was valued using the income approach. The cash flow forecast utilized in the analysis of the technology-based assets was based on Spatial’s long-term revenue and expense forecast as provided by management. The allocation of $58 million of the purchase price to the developed technology encompassed in the call server technology represented its estimated fair value using the income approach.

In addition, at the time of acquisition, Spatial was developing new software functionalities that integrate UMTS (Universal Mobile Telecommunications System) and Wi-Fi technology into our wireless softswitch technology platform. It was estimated that the project had incurred approximately $4 million in costs as of the valuation date. Cost to complete the project was estimated at approximately $650,000 over four months following the acquisition. Management estimated that the project was approximately 80% complete, in the aggregate, based on development costs.

Estimated total revenues from the acquired developed technology and know-how and in-process technology were expected to peak in 2006 and 2008, respectively, and steadily decline thereafter, as other new products and technologies are introduced by Spatial.

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

A discount rate of 30% was used for determining the value of the in-process research and development, while a rate of 18% was employed for determining the value of the developed technology and know-how. The in-process R&D rate is higher than the implied weighted average cost of capital for the acquisition due

to inherent uncertainties surrounding the successful development of the purchased in-process technology, the useful life of such technology, the profitability levels of such technology, and the uncertainty of technological advances that were unknown at that time. The developed technology rate reflects the reduced risk of an established technology, relative to the other acquired assets. However, we believe that expenses incurred to date associated with the development and integration of the in-process research and development projects are consistent with our estimates at the time of acquisition.


Item 6.	Directors, Senior Management and Employees

In accordance with French company law governing a société anonyme, our business is managed by our board of directors and by our Chairman and Chief Executive Officer.

Board of Directors

The following table sets forth, as of March 31, 2005, the following information for each of our directors: name, age, year of election to the board, year in which the term on the board expires, principal business activities performed outside of Alcatel (including other principal directorships) and the number of Alcatel securities owned.


			Year		Year
			Initially		Term		Principal Business Activities	Number of
Name	Age		Appointed		Expires		Outside of Alcatel	Securities Held

Serge Tchuruk		67		1995		2007	Director of Thales and Total; Member of the Board of Directors of the Ecole Polytechnique, Chairman of Alcatel USA Holdings Corp., and Member of the Supervisory Board of Alcatel Deutschland GmbH (Chairman and CEO of Alcatel)	105,450 ordinary shares 209 FCP 3A⁽¹⁾

Daniel Bernard		59		1997		2007	Director of Saint-Gobain	141,125 ordinary shares

Philippe Bissara		63		1997		2005	Honorary Managing Director of ANSA (National Association of Limited Liability Companies); honorary instructing judge at the Conseil d’État (the highest administrative court of France); Director of Société d’Oxygène et d’Acétylène d’Extrême-Orient; Member of the Académie de Comptabilité; Member of the Board of Directors of the French branch of the International Fiscal Association; Assistant Secretary General of EALIC (European Association for Listed Companies)	53,645 ordinary shares 4,469 FCP 3A⁽¹⁾

Frank W. Blount		66		1999		2005	Chairman of JI Ventures Inc. and TTS Management Corp.; Director of Entergy Corporation, Caterpillar Inc., Adtran Inc. and Hanson Plc	1,000 ADSs

Jozef Cornu		60		2000		2008	Chairman of Alcatel Bell and Tijd NV; Director of Alcatel CIT; Member of the Supervisory Board of Alcatel SEL AG; Director of Taiwan International Standard Electronics Ltd, Barco, KBC and Agfa Gevaert	20,500 ordinary shares 1,734 FCP 3A

Philippe Germond		48		2003		2007	Director of Essilor, Ingenico, Atos Origin and Alcatel USA Inc.; Member of the Supervisory Board of Alcatel Deutschland GmbH (President and Chief Operating Officer of Alcatel)	3,500 ordinary shares

Jean-Pierre Halbron		68		1999		2005	Director of Electro Banque (Chairman of the Ethics Committee)	21,020 ordinary shares 1,969 FCP 3A

David Johnston		63		2001		2005	President of the University of Waterloo (Canada); Director of CGI, Masco and Sustainable Development Technology Foundation	2,080 ordinary shares

Daniel Lebègue		61		2003		2007	Director of Crédit Agricole, Scor, Technip and Gaz de France; Member of the Supervisory Board of Areva; Chairman of the Institut Français des Administrateurs and Transparency International (France)	500 ordinary shares

Year

Initially

Term

Principal Business Activities

Number of

Name

Age

Appointed

Expires

Outside of Alcatel

Securities Held

Pierre-Louis Lions

1996

2005

Professor at the Collège de France and the Ecole Polytechnique; Chairman of the Conseil Scientifique d’EDF, the Conseil Scientifique du CEA-DAM and Evaluation Commission of INRIA; Member of the Académie des Technologies, the Académie des Sciences, the Academia Europea, the Conseil Scientifique de la Défense, the Société Mathématique de France, the Société de Mathématiques appliquées et industrielles, the American Mathematical Society, the European Mathematical Society, the International Association of Mathematical Physics and the Instituto Lombardo; Consultant to EADS — Launch Vehicles, Paribas and CAI

520 ordinary shares

Thierry de Loppinot

1997

2005

Legal counsel at Alcatel’s Head Office; Chairman of the Supervisory Board of the “Actionnariat Alcatel” Unit Trust (FCP 3A); Chairman of Formalec; Director of the Société Immobilière Kléber-Lauriston

6,053 ordinary shares
4,424 FCP3A

Peter Mihatsch

2002

2005

Chairman of the Supervisory Board of Giesecke and Devrient; Member of the Supervisory Board of Vodafone GmbH and Vodafone — Mobilfunk, ARCOR — Vodafone, Member of the Board of 3i p.l.c.

1,200 ordinary shares

Bruno Vaillant

1997

2005

Engineer with Alcatel Space Industries (Information Systems Division); Director of the Caisse de Prévoyance Haussmann; Member of the Supervisory Board of the “Actionnariat Alcatel” Unit Trust (FCP 3A); Expert qualified before the Court of Appeals of Toulouse

1,850 ordinary shares
4,761 FCP 3A

Marc Viénot

1987

2007

Honorary Chairman and Director of Société Générale; Member of the Supervisory Board of Aventis; Director of Société Générale Marocaine de Banque Ciments Français; Member of the Board of the Association Française des Entreprises Privées; Member of the Supervisory Board of Groupe Barrière

4,950 ordinary shares


(1)	FCP 3A is the unit trust of our employees governed by Article 20 of French law dated December 23, 1988. Our articles of association and bylaws require that two members of our board be employed by us, and that they participate in a FCP at the time of their appointment to our board and during their terms of office as directors.

The following table sets forth the amount of compensation paid by us during 2004 to each of the individuals who were, during 2004, members of our board of directors, in connection with such person’s service as a director and, if applicable, an executive of Alcatel.


Director	Amount

Daniel Bernard	€	61,807
Philippe Bissara		48,060
Frank Blount		43,625
Jozef Cornu⁽¹⁾		399,926
Philippe Germond⁽²⁾		1,505,496
Jean-Pierre Halbron		41,186
David Johnston		43,182
Daniel Lebègue		70,676
Pierre-Louis Lions		45,621
Thierry de Loppinot⁽³⁾		144,643
Peter Mihatsch		43,182
Serge Tchuruk⁽⁴⁾		2,303,610
Bruno Vaillant⁽⁵⁾		123,586
Marc Viénot		65,798


(1)	€ 354,305 of this amount consisted of Mr. Cornu’s salary, € 45,621 consisted of directors’ fees and the remainder consisted of benefits in kind.

(2)	€ 1,500,000 of this amount consisted of Mr. Germond’s salary (of which € 750,000 was a bonus) and the remainder consisted of benefits in kind.

(3)	€ 99,022 of this amount consisted of Mr. de Loppinot’s salary and the remainder consisted of director’s fees.

(4)	€ 2,294,490 of this amount consisted of Mr. Tchuruk’s salary (of which € 770,000 was a bonus) and the remainder consisted of benefits in kind.

(5)	€ 77,965 of this amount consisted of Mr. Vaillant’s salary and the remainder consisted of director’s fees.

The amount of directors’ fees paid for 2004 totaled € 600,000. A portion of the directors’ fees is distributed equally among all directors and a portion is distributed among the members of the board based on the number of board and committee meetings and on attendance at such meetings by the directors. Neither Mr. Tchuruk nor Mr. Germond receives directors’ fees from our company.

In February 2003, in view of the corporate governance requirements or recommendations contained in the Sarbanes-Oxley Act of 2002, in The New York Stock Exchange’s then proposed revised listing standards and in the AFEP-MEDEF report (a French report relating to corporate governance standards), our board of directors modified its charter and adopted internal regulations governing our board of directors’ functions and the conduct of our directors. In accordance with the provisions of this charter and internal regulations, our board of directors regularly considers the functions of the board and the independence of its members.

At its meeting held on March 10, 2005, our board of directors evaluated the independence of its members and determined that eight of its members (which represents more than half of the members of the board) are independent under the independence criteria set by the board and those set by The New York Stock Exchange. Such members are Messrs. Bernard, Bissara, Blount, Johnston, Lebègue, Lions, Mihatsch and Viénot.

Senior Management

The table below sets forth, as of March 31, 2005, the following information for each of our senior executives: name, age, current position with our company and the year in which such person was appointed a member of the Alcatel executive committee.


Name	Age		Current Position and Year Appointed to Executive Committee

Serge Tchuruk		67	Chairman and Chief Executive Officer (1995)
Philippe Germond		48	President and Chief Operating Officer (2003)
Jean-Pascal Beaufret		54	Chief Financial Officer (2002)
Jacques Dunogué		54	Executive Vice President of Alcatel and President of Alcatel Europe and South (2002)
Thomas Edig		43	Senior Vice President of Alcatel and Corporate Human Resources (2002)
Etienne Fouques		56	Executive Vice President of Alcatel and President of Mobile Communications Group (2001)
Olivier Houssin		52	Executive Vice President of Alcatel and President of Private Communications Group (2000)
Mike Quigley		52	Senior Executive Vice President of Alcatel; President of Alcatel North America and President of Fixed Communications Group (2001)
Christian Reinaudo		50	Executive Vice President of Alcatel and President of Alcatel Asia-Pacific (2000)
Ronald Spithill		63	Executive Vice President of Alcatel and Chief Marketing Officer (2000)

There are no family relationships between any director and senior executive. No director or senior executive was elected or appointed as a result of any arrangement or understanding with any third party. At December 31, 2004, none of our senior executives owned more than one percent of the total outstanding number of our ordinary shares.

Compensation

For the year ended December 31, 2004, the aggregate amount of compensation, including benefits, that we paid to those persons who were senior executives on December 31, 2004 as a group, for services in all capacities was € 11.6 million. The compensation for senior executives consists of both a base salary and a bonus, which is determined based partly on our performance and partly on the executive’s performance, pursuant to criteria reviewed by the nominating and compensation committee. For 2004, the bonus was based on the improvement in our 2003 income from operations and working capital needs. Of the total compensation paid to our senior executives in 2004, € 7.2 million was paid in base salary and € 4.4 million was paid in bonus, which represents 38% of their total salary. Directors’ fees that senior executives receive from various companies as a result of their employment with us are deducted from their salary. Our directors and senior executives did not exercise any stock options in 2004.

In 2004, Mr. Tchuruk was paid a base salary of € 1,524,490. This amount has remained unchanged since 2000. A bonus of € 770,000 was paid to Mr. Tchuruk in 2004 with respect to our 2003 fiscal year. Generally, Mr. Tchuruk’s bonus for each fiscal year is set by the board of directors upon a recommendation of the nomination and compensation committee. Such bonus is determined in accordance with a method that is reviewed each year by the board of directors and that takes into account the prospects of growth and prospective results of our Group for the following fiscal year. Mr. Tchuruk’s bonus is paid during the fiscal year following the fiscal year to which the bonus relates, after approval by the shareholders of the financial statements of our Group for the preceding fiscal year. In 2004, the amount of the bonus for fiscal year 2003 was set by our board of directors after considering the performance of Mr. Tchuruk in connection with the recovery of our Group and of our operating income, achieved in a difficult context. On March 10, 2004, Mr. Tchuruk received options for 400,000 ordinary shares at an exercise price of € 13.20 per share, expiring on or prior to March 9, 2012. The options are not exercisable until March 10, 2008. A bonus of € 1,314,873 will be paid to Mr. Tchuruk in 2005 with respect to the year 2004. The amount of this bonus was set by our board of directors in accordance with the method set for 2004, after considering the level of 2004 consolidated net income before goodwill amortization and minority interests. Mr. Tchuruk who, pursuant to his request, did not receive any options under the stock option plan approved by our board of directors at its meeting held on March 10, 2005, stated after this meeting that he intends to invest the total net amount of this bonus in our ordinary shares.

Upon ceasing to be our Chairman and Chief Executive Officer (except by reason of conduct contrary to the interest of the Group), Mr. Tchuruk will be entitled to receive a termination payment equal to twice his remuneration. He will be entitled to retirement benefits pursuant to which he will receive a pension capped, taking into account all retirement benefits, at 40 percent of his remuneration, in accordance with the terms approved by our board of directors.

Upon ceasing to be our President and Chief Operating Officer (except by reason of conduct contrary to the interest of the Group), Mr. Germond will be entitled to receive a termination payment equal to twice his remuneration and will be entitled to retirement benefits under the terms of a plan covering approximately 80 executives of the Group, in accordance with his employment agreement.

The aggregate amount that we accrued to provide pension, retirement or similar benefits for our directors listed in the table under the heading “Board of Directors” above and our senior executives listed in the table under the heading “Senior Management” above, as a group, for 2004 was approximately € 15.8 million.

Committees of the Board

In February 2003, in light of the corporate governance requirements or recommendations contained in the Sarbanes-Oxley Act of 2002, in The New York Stock Exchange proposed revised listing standards and in

the French AFEP-MEDEF report, our board of directors adopted charters governing our audit committee, nomination and compensation committee and strategy planning committee.

Audit Committee

Currently, the audit committee consists of three members: Daniel Lebègue, chairman of the committee (served since 2003), Marc Viénot (served since 1995) and Daniel Bernard (served since 1997). David Johnston, who had served since 2001, resigned from the committee during 2004. Our board has determined that each of the members of the audit committee is “independent” under the applicable rules promulgated by the Securities and Exchange Commission and by The New York Stock Exchange. Prior to April 17, 2003, Marc Viénot served as the chairman of the committee. The audit committee reviews all subjects of an accounting or financial nature (including closing of the financial statements, relevance of accounting methods and review of internal audit procedures and plans and external auditors’ independence and fees) and issues opinions on the renewal or appointment of auditors. For more information regarding the audit committee’s policies and procedures for the appointment of outside auditors, see Item 16C. — “Principal Accounting Fees and Services.”

Nomination and Compensation Committee

The board of directors established the nomination and compensation committee on July 25, 2001. Currently, the nomination and compensation committee consists of three members: Daniel Bernard, chairman of the committee, Philippe Bissara and Frank Blount. Our board of directors has determined that each of the members of the nomination and compensation committee is “independent” as such term is defined under the applicable rules of The New York Stock Exchange. Serge Tchuruk may attend and participate in the meetings of the nomination and compensation committee, but may not be present at any deliberation of the committee that concern him. The nomination and compensation committee is responsible for studying issues related to the composition, organization, and operation of the board of directors and its committees. It also determines procedures governing the nomination of directors and the evaluation of their performance. In addition, the nomination and compensation committee advises the board of directors on issues related to the compensation of corporate officers, including compensation of the Chairman, stock purchase and stock option plans and capital increases reserved for employees.

Strategy Planning Committee

The board of directors established the strategic planning committee on July 25, 2001. Currently, the strategy planning committee consists of three members: Serge Tchuruk, chairman of the committee, Pierre-Louis Lions and Peter Mihatsch. Our board of directors has determined that Mr. Lions and Mr. Mihatsch are “independent” as such term is defined under the applicable rules of The New York Stock Exchange. The strategic planning committee is responsible for considering our strategic orientation, identifying investment opportunities and monitoring our performance.

Statement on Business Practices, Ethics Committee and Code of Ethics

Our statement on business practices, adopted in 1997 and revised in 2003, is a code of conduct that defines our vision of appropriate business behavior. It covers many areas, from business ethics and corporate governance to human rights and environmental concerns. Our statement on business practices provides that our policy is to conduct our worldwide operations in accordance with the highest business ethical considerations, to comply with the laws of the countries in which we operate and to conform to locally accepted standards of good corporate citizenship.

We have established an ethics committee to enforce our statement on business practices. The ethics committee is chaired by Jean-Pierre Halbron, and it includes members of our management. The ethics committee reports to our Chairman and Chief Executive Officer.

In addition, on February 4, 2004, our board of directors adopted a code of ethics that applies to our Chief Executive Officer, President, Chief Operating Officer, Chief Financial Officer and Corporate Controller.

Employees

As reported, at December 31, 2004, we employed 55,718 people worldwide, primarily in Europe, compared with 60,484 at December 31, 2003 and 75,940 at December 31, 2002. The tables below show the geographic locations in which our employees worked at December 31, 2002, 2003 and 2004 and the business segments in which our employees worked at December 31, 2002, 2003 and 2004 after taking into account the discontinuance of certain of our businesses, as follows: in 2002, our enterprise distribution and micro-electronic businesses; in 2003, our battery and optical components businesses; and in 2004, our optical fiber, mobile phones and electrical power systems businesses. As restated to exclude the employees of all of these discontinued businesses, we employed 56,690 people at December 31, 2003 and 66,481 people at December 31, 2002.


	Fixed		Mobile		Private
	Communications		Communications		Communications		Other

2002		31,342		13,966		20,467		706
2003		23,461		13,355		19,282		592
2004		18,446		15,350		21,367		555


	France		Germany		Rest of Europe		Asia		North America		Rest of World

2002		20,275		7,698		16,788		8,271		9,799		3,650
2003		17,206		6,736		12,502		8,110		8,811		3,325
2004		16,161		5,951		11,918		8,338		8,783		4,567

Membership of our employees in trade unions varies from country to country. Although differing from country to country, we believe that relations with our employees are satisfactory. The number of temporary workers at December 31, 2004 was 2,102.

Share Ownership

Directors and Senior Executives

Our articles of association and bylaws provide that each of our directors must own at least 500 shares. As of December 31, 2004, none of our directors or senior executives beneficially owned, or held options to purchase, 1% or more of our ordinary shares.

Shares. As of March 31, 2005 our directors, including directors who were also senior executives, and other senior executives, as a group, beneficially held an aggregate of 498,685 ordinary shares (including ADSs and FCP 3A interest).

Options. As of March 31, 2005 our directors listed in the table under the heading “Board of Directors” above and our senior executives listed in the table under the heading “Senior management” above, as a group, beneficially owned the following options:


	•	for 635,000 ordinary shares granted pursuant to a share purchase plan approved by our board in December 1998 at an exercise price of € 20.52 per share expiring on December 31, 2005;

	•	for 1,080,000 ordinary shares granted pursuant to a share subscription plan approved by our board in March 2000 at an exercise price of € 48 per share expiring on December 31, 2005 or 2007, depending on whether the beneficiary is an employee of a company with a registered office in France;

	•	for 1,848 ordinary shares pursuant to options awarded to participants in a share subscription plan in connection with a capital increase reserved for employees in March 2000, at an exercise price of € 48 per share expiring on June 30, 2004 or 2006, depending on whether the beneficiary is an employee of a company with a registered office in France;

	•	for 15,000 ordinary shares granted pursuant to a share subscription plan approved by our board in December 2000 at an exercise price of € 65 per share expiring on December 31, 2005 or 2007,


		depending on whether the beneficiary is an employee of a company with a registered office in France;

	•	for 998,400 ordinary shares granted pursuant to a share subscription plan approved by our board in March 2001 at an exercise price of € 50 per share expiring on March 6, 2009;

	•	for 300 ordinary shares pursuant to options awarded to participants in a share subscription plan in connection with a capital increase reserved for employees in March 2001, at an exercise price of € 50 per share expiring on June 30, 2005 or 2006, depending on whether the beneficiary is an employee of a company with a registered office in France;

	•	for 1,201,800 ordinary shares granted pursuant to a share subscription plan approved by our board in December 2001 at an exercise price of € 20.80 per share expiring on December 18, 2009;

	•	for 260 ordinary shares granted to those persons who participated in our March 2000 and March 2001 capital increases, pursuant to a share subscription plan approved by our board in December 2001 at an exercise price of € 20.80 per share expiring on December 31, 2005 or 2006, depending on whether the beneficiary is an employee of a company with a registered office in France;

	•	for 1,341,200 ordinary shares granted pursuant to share subscription plans approved by our board in March 2003 at an exercise price of € 6.70 per share expiring on or prior to March 6, 2011;

	•	for 56 ordinary shares granted to those persons who participated in our March 2000 and March 2001 capital increases, pursuant to a share subscription plan approved by our board in March 2003, at an exercise price of € 6.70 per share expiring on June 30, 2007 or 2008, depending on whether the beneficiary is an employee of a company with a registered office in France;

	•	for 5,000 ordinary shares granted pursuant to a share subscription plan approved by our chief executive officer in June 18, 2003 at an exercise price of € 7.60 per share expiring on June 17, 2011;

	•	for 50,000 ordinary shares granted pursuant to a share subscription plan approved by our chief executive officer in September 1, 2003 at an exercise price of € 9.30 per share expiring on August 31, 2011;

	•	for 1,356,000 ordinary shares granted pursuant to share subscription plans approved by our board in March 2004 at an exercise price of € 13.20 per share expiring on or prior to March 9, 2012; and

	•	for 721,000 ordinary shares granted pursuant to share subscription plans approved by our board in March 2005 at an exercise price of € 10 per share expiring on or prior to March 9, 2013.

During 2004, none of our directors or senior executives exercised any options.

Employee stock options

At December 31, 2004, there were 118,850,969 options outstanding pursuant to existing share subscription plans and 10,566,000 options outstanding pursuant to existing share purchase plans, each option giving a right to acquire one ordinary share.

Our board of directors and chief executive officer have granted stock options to specialists, high-potential employees and future executives as well as members of senior management pursuant to the share subscription plans and share purchase plans listed below. In order to maintain in all circumstances the stability of the activities of our group and the personnel that is key to our development, our board of directors has the ability to render outstanding options under our share subscription plans immediately exercisable in the event of a merger pursuant to which Alcatel is merged into another company, a tender offer for our shares or a withdrawal of our shares from public listing (a “going private” transaction), and this regardless of any delay in the vesting of such options provided for in the initial terms of the plans. However, any such acceleration would not apply to stock options held by any member of our board of directors, our chief executive officer or any deputy executive officer, that is, by a “mandataire social”, as such term is defined in French law, who

was a “mandataire social” either at the date of the grant of the option or at the date of the decision of the board of directors to accelerate vesting.

Share Subscription Plans. At our shareholders’ meeting held on April 18, 2002, our shareholders authorized our board of directors to grant options to subscribe for a number of newly issued ordinary shares not to exceed 15% of the total number of outstanding ordinary shares, to our employees and executives.

The following table sets forth information as at December 31, 2004 with respect to share subscription plans approved by our board of directors:

Number of

options

Number of

Exercise period

authorized

options

recipients

Exercise

Date of approval of plan

at grant date

outstanding

at grant date

From

price

04/17/1997

8,199,500

7,436,500

961

05/01/2002

12/31/2004

€

19.27

12/10/1997

367,000

297,000

12/11/2002

12/31/2004

€

20.95

03/29/2000

15,239,250

13,066,055

3,887

04/01/2003

⁽¹⁾

12/31/2005

⁽¹⁾

€

48.00

04/01/2005

⁽²⁾

12/31/2007

⁽²⁾

03/29/2000

8,905,804

⁽³⁾

3,261,660

58,957

07/01/2005

⁽²⁾

06/30/2006

⁽²⁾

€

48.00

12/13/2000

1,235,500

1,021,850

478

12/13/2003

⁽¹⁾

12/31/2005

⁽¹⁾

€

65.00

12/13/2005

⁽²⁾

12/31/2007

⁽²⁾

12/13/2000

306,700

207,741

340

12/13/2001

⁽⁴⁾

12/12/2008

€

64.00

12/13/2004

⁽²⁾⁽⁴⁾

03/07/2001

37,668,588

27,928,326

30,790

03/07/2002

⁽⁴⁾

03/06/2009

€

50.00

03/07/2005

⁽²⁾⁽⁴⁾

03/07/2001

275,778

⁽⁵⁾

272,220

2,024

07/01/2004

⁽¹⁾

06/30/2005

⁽¹⁾

€

50.00

07/01/2005

⁽²⁾

06/30/2006

⁽²⁾

12/19/2001

27,871,925

20,531,141

25,192

12/19/2002

⁽⁴⁾

12/18/2009

€

20.80

12/19/2005

⁽²⁾⁽⁴⁾

12/19/2001

565,800

339,506

521

12/19/2002

⁽⁴⁾

12/18/2009

€

9.30

12/19/2005

⁽²⁾⁽⁴⁾

12/19/2001

935,660

⁽⁶⁾

894,630

45,575

01/01/2005

⁽¹⁾

12/31/2005

⁽¹⁾

€

20.80

01/01/2006

⁽²⁾

12/31/2006

⁽²⁾

03/07/2003

25,626,865

21,671,314

23,650

03/07/2004

⁽¹⁾⁽⁴⁾

03/06/2011

⁽¹⁾

€

6.70

03/07/2007

⁽²⁾⁽⁴⁾

03/06/2011

⁽²⁾

03/07/2003

827,348

⁽⁶⁾

809,411

31,600

07/01/2006

⁽¹⁾

06/30/2007

⁽¹⁾

€

6.70

07/01/2007

⁽²⁾

06/30/2008

⁽²⁾

03/10/2004

18,094,315

17,370,250

14,810

03/10/2005

⁽¹⁾

03/09/2012

⁽¹⁾

€

13.20

05/10/2008

⁽²⁾

03/09/2012

⁽²⁾


(1)	Options granted to employees of any of our companies with a registered office outside France.

(2)	Options granted to employees of any of our companies with a registered office in France.

(3)	On March 29, 2000, our board of directors approved a capital increase reserved for employees. In connection therewith, 2,226,451 ordinary shares were issued on June 29, 2000 at a price of € 48 per share, and for each share subscribed, the participant received an option to purchase four additional shares.

(4)	One quarter of these options vest upon the first anniversary of the grant date and the remaining options vest thereafter at a monthly rate of 1/48th of the total number of options initially granted.

(5)	On March 7, 2001, our board of directors approved a capital increase reserved for employees In connection therewith, 91,926 ordinary shares were issued at a price of € 50 per share, and for each share subscribed the participant received an option to purchase three additional shares.

(6)	Options granted to recipients who subscribed to the capital increases of March 2000 and March 2001, and remain our employees.

On March 10, 2005 our board of directors approved a share subscription plan for 16,756,690 ordinary shares at an exercise price of € 10 per share for 9,470 recipients. The options expire on or prior to March 9,

2013. Options granted to employees of any companies in France are not exercisable during the first four years after grant.

In 2001, 2002, 2003 and 2004 our Chief Executive Officer approved certain share subscription plans pursuant to authority delegated to him by our board of directors. Pursuant to this delegation of authority, our Chief Executive Officer may grant certain stock subscription options to our, or to our affiliates’, new employees or, under exceptional circumstances, to our or to our affiliates’ existing employees.

The following table sets forth information as at December 31, 2004 with respect to share subscription plans approved by our chief executive officer:


	Number of
	options		Number of		Number of		Exercise period
	authorized		options		recipients							Exercise
Date of approval of plan	at grant date		outstanding		at grant date		From			To		price

04/02/2001		48,850		12,250		13		04/02/2002	⁽¹⁾		04/01/2009	€	41.00
04/02/2001		2,500		2,500		1		04/02/2002	⁽¹⁾		04/01/2009	€	39.00
06/15/2001		977,410		783,621		627		06/15/2002	⁽¹⁾		06/14/2009	€	32.00
								06/15/2005	⁽¹⁾⁽²⁾
09/03/2001		138,200		106,050		58		09/03/2002	⁽¹⁾		09/02/2009	€	19.00
								09/03/2005	⁽¹⁾⁽²⁾
11/15/2001		162,000		106,000		16		11/15/2002	⁽¹⁾		11/14/2009	€	9.00
								11/15/2005	⁽¹⁾⁽²⁾
02/15/2002		123,620		83,367		37		02/15/2003	⁽¹⁾		02/14/2010	€	17.20
								02/15/2006	⁽¹⁾⁽²⁾
04/02 2002		55,750		35,750		24		04/02/2003	⁽¹⁾		04/01/2010	€	16.90
05/13/2002		54,300		44,581		23		05/13/2003	⁽¹⁾		05/12/2010	€	14.40
								05/13/2006	⁽¹⁾⁽²⁾
06/03/2002		281,000		243,479		176		06/03/2003	⁽¹⁾		06/02/2010	€	13.30
								06/03/2006	⁽¹⁾⁽²⁾
09/02/2002		1,181,050		654,390		226		09/02/2003	⁽¹⁾		06/01/2010	€	5.20
								09/02/2006	⁽¹⁾⁽²⁾
10/07/2002		30,500		13,459		16		10/07/2003	⁽¹⁾		10/06/2010	€	3.20
								10/07/2006	⁽¹⁾⁽²⁾
11/14/2002		111,750		75,993		26		11/14/2003	⁽¹⁾		11/13/2010	€	4.60
								11/14/2006	⁽¹⁾⁽²⁾
12/02/2002		54,050		38,238		16		12/02/2003	⁽¹⁾		12/01/2010	€	5.40
								12/02/2006	⁽¹⁾⁽²⁾
06/18/2003		338,200		299,602		193		06/18/2004	⁽¹⁾		06/17/2011	€	7.60
								06/18/2007	⁽¹⁾⁽²⁾
07/01/2003		53,950		29,526		19		07/01/2004	⁽¹⁾		06/30/2011	€	8.10
								07/01/2007	⁽¹⁾⁽²⁾
09/01/2003		149,400		141,497		77		09/01/2004	⁽¹⁾		08/31/2011	€	9.30
								09/01/2007	⁽¹⁾⁽²⁾
10/01/2003		101,350		71,974		37		10/01/2004	⁽¹⁾		09/30/2011	€	10.90
								10/01/2007	⁽¹⁾⁽²⁾
11/14/2003		63,600		61,600		9		11/14/2004	⁽¹⁾		11/13/2011	€	11.20
								11/14/2007	⁽¹⁾⁽²⁾
12/01/2003		201,850		163,988		64		12/01/2004	⁽¹⁾		11/30/2011	€	11.10
								12/01/2007	⁽¹⁾⁽²⁾
04/01/2004		48,100		40,750		19		04/01/2005	⁽¹⁾		03/31/2012	€	13.10
								04/01/2008	⁽¹⁾⁽²⁾
05/17/2004		65,100		62,550		26		05/17/2008	⁽¹⁾		05/16/2012	€	12.80
								05/17/2005	⁽¹⁾⁽²⁾

Number of

options

Number of

Exercise period

authorized

options

recipients

Exercise

Date of approval of plan

at grant date

outstanding

at grant date

From

price

07/01/2004

313,450

299,950

187

07/01/2005

⁽¹⁾

06/30/2012

€

11.70

07/01/2008

⁽¹⁾⁽²⁾

09/01/2004

38,450

09/01/2005

⁽¹⁾

08/31/2012

€

9.90

09/01/2008

⁽¹⁾⁽²⁾

10/01/2004

221,300

10/01/2005

⁽¹⁾

09/30/2012

€

9.80

10/01/2008

⁽¹⁾⁽²⁾

11/12/2004

69,600

11/12/2005

⁽¹⁾

11/11/2012

€

11.20

11/12/2008

⁽¹⁾⁽²⁾

12/01/2004

42,900

12/01/2005

⁽¹⁾

11/30/2012

€

11.90

12/01/2008

⁽¹⁾⁽²⁾


(1)	One quarter of these options vest upon the first anniversary of the grant date and the remaining options vest thereafter at a monthly rate of 1/48th of the total number of options initially granted.

(2)	Options granted to employees of any of our companies with a registered office in France are not exercisable during the first four years after grant.

Under certain of the share subscription plans described above, options granted to employees of our companies with a registered office in Belgium may become exercisable or vest, as applicable, over a longer period, as in France.

On January 3, 2005, our Chief Executive Officer approved a share subscription plan for 497,500 ordinary shares at an exercise price of € 11.41 per share for 183 recipients. The options expire on or prior to January 2, 2013.

Share Purchase Plans. Our share purchase plans are comprised of options to purchase existing, and not newly issued, ordinary shares. If the options are exercised, we will sell the optionees ordinary shares that we had acquired in connection with our buy-back program approved by our board of directors on September 21, 1998 and subject to the annual approval of our shareholders. Under a December 1998 plan, options to purchase up to 11,602,500 ordinary shares were granted with an exercise period from December 9, 2003 to December 31, 2005 at an exercise price of € 20.52. As at December 31, 2004, there were options to purchase up to 10,122,250 ordinary shares outstanding under the December 1998 plan. Our board of directors also approved a share purchase plan in September 1999 and granted options to purchase up to 545,000 ordinary shares with an exercise period from September 8, 2004 to December 31, 2005 and at an exercise price of € 28.40 per share. As at December 31, 2004, there were options to purchase up to 443,750 ordinary shares outstanding under the September 1999 plan. The options granted under the December 1998 and September 1999 plans are exercisable, since the target of consolidated income from operations of at least 6.5% of our total net sales for the year ending December 31, 2000 was achieved.

Option plans for acquired companies

Option plans of companies that we acquired now provide for the issuance of ordinary shares or ADSs upon exercise of options granted under such plans, in lieu of the issuance of shares of the acquired companies. Except in the case of Astral Point, Telera, Imagic TV, TiMetra and Spatial Communications Technologies Inc. we will not issue new ordinary shares (or consequently, ADSs) to satisfy these options, but rather, will use outstanding ADSs. In addition, Alcatel USA, Inc. has also adopted share purchase plans for executives and employees of U.S. and Canadian companies. In total, options to purchase up to 11,142,851 ADSs or ordinary shares were outstanding as of December 31, 2004 under the assumed stock option plans and the share purchase plans of Alcatel USA, Inc. The following table sets forth information as of

December 31, 2004 with respect to option plans of our acquired companies and the share purchase plans of Alcatel USA, Inc.


	Outstanding Options								Exercisable Options

					Weighted
	Exercise price		Number		remaining		Weighted		Amount		Weighted
	(giving right to		outstanding		exercise		average		exercisable		average
	one ordinary		at		period		exercise		at		exercise
Company	share or ADS)		12/31/2004		(years)		price		12/31/2004		price

Packet Engines		0.29-0.86 USD		14,372		2.89		0.50		14,372		0.50
Xylan		0.05-18.14 USD		1,897,842		3.02		8.60		1,897,842		8.60
Internet Devices, Inc		0.26-1.17 USD		26,480		3.83		0.89		26,480		0.89
DSC		16.57-44.02 USD		110,150		1.24		30.76		110,150		30.76
Genesys		0.01-41.16 USD		3,407,778		4.26		20.70		3,407,778		20.70
Newbridge		11.72-52.48 USD		389,110		0.26		42.55		389,110		42.55
Astral Point		0.29-58.71 EUR		254,395		6.33		16.83		253,363		16.84
Telera		0.43-6.36 EUR		188,605		5.23		5.23		173,042		5.13
Imagic TV		2.84-64.68 EUR		130,372		2.55		15.40		95,694		17.59
TiMetra		0.53-7.97 EUR		2,172,909		5.83		5.31		1,069,286		3.80
Spatial Communications Technologies Inc.		0.24-9.1 EUR		1,563,396		8.97		4.48		408,532		2.92
Alcatel USA Inc.		21.40-84.88 USD		11,142,851		5.19		53.89		11,117,069		53.92

Total number of options				21,298,260						18,962,718


Item 7.	Major Shareholders and Related Party Transactions

Major Shareholders

At December 31, 2004, to our knowledge, no shareholder (other than Caisse des Dépôts et Consignations, whose ownership interest is set forth in the table below) beneficially owned 5% or more of either our ordinary shares.

The table below lists our principal shareholders as of December 31, 2004:


Principal Shareholders	Capital			Voting Rights

Caisse des Dépôts et Consignations		5.22	%		5.37	%
Employee Investment Fund (FCP 3A)		1.95	%		3.34	%
Société Générale Group		0.89	%		1.49	%
Shares held by Alcatel subsidiaries		1.94	%		—
Treasury Stock		2.98	%		—
Public		87.01	%		89.80	%

Total		100	%		100	%

Each fully paid ordinary share that is held in registered form by the same holder for at least three years entitles the holder to double voting rights at any of our shareholder meetings. The dual voting right will automatically terminate for any share which has been subject to conversion into a bearer share or for which ownership has been transferred. Regardless of the number of ordinary shares held, the total voting rights per shareholder cannot exceed 8% of the total voting rights present or represented at any of our shareholder meetings (16% if double voting rights apply). For further details about voting rights of our shares please refer to Item 10 — “Additional Information — Description of Ordinary Shares.”

The number of ordinary shares held by the Caisse des Dépôts et Consignations Group (the “CDC Group”) as of December 31, 2002, December 31, 2003 and December 31, 2004 was, 73,761,473, 74,340,807 and 68,100,807, respectively.

According to Amendment Number 3 to a Schedule 13G filed with the SEC on February 14, 2005, Brandes Investment Partners, LLC was, as of December 31, 2004, the beneficial owner of 44,204,964 ADSs and 60,078,199 ordinary shares, representing 8% of our capital. Brandes Investment Partners, LLC is an investment adviser registered under the Investment Advisers Act of 1940. The ordinary shares and ADSs owned by Brandes Investment Partners, LLC are included in the line item “Public” in the table above.

As of December 31, 2004, 134,921,247 ADSs were outstanding in the United States, representing approximately 10.3% of the total outstanding ordinary shares. At such date, the number of registered ADS holders in the United States was 3,326.

We are not directly or indirectly owned or controlled by another corporation, by any foreign government or by any other natural or legal person. We are not aware of any arrangements that may result in a change of control of Alcatel.

Related Party Transactions

In December 1999, we entered into an amended agreement (originally entered into in 1998) with Thales, a company in which Mr. Tchuruk serves as a director, pursuant to which we agreed to cooperate with Thales on strategic and operational matters.

In July 2001, we acquired the remaining 48.83% interest in Alcatel Space owned by Thales, a company in which Mr. Tchuruk serves as a director, for € 795 million, paid half in cash and half in Thales shares owned by Alcatel. As a result of this transaction, Alcatel Space became a wholly owned subsidiary of Alcatel. We currently have a 9.46% interest in Thales.


Item 8.	Financial Information

Consolidated statements and other financial information

See Alcatel’s consolidated financial statements elsewhere in this annual report.

Legal matters

In addition to legal proceedings incidental to the conduct of our business (including employment-related collective actions in France and the U.S.), which our management believes are adequately reserved against in our financial statements or will not result in any significant costs for us, we are involved in the following legal proceedings:

France Telecom. Since 1993, a legal investigation has been ongoing concerning “overbillings” which are alleged to have been committed at Alcatel CIT to the detriment of its principal client, France Telecom, based on an audit of production costs conducted in 1989 in the Transmission division and in 1992 in the Switching division (which are now the part of the Fixed Communications segment).

We entered into two settlement agreements with France Telecom, one in 1993, in relation to the Transmission division, and the other in May 2004, in relation to the Switching activity and the financial impact of which has been fully reserved in our December 31, 2004 financial statements. In the context of the latter settlement, France Telecom acknowledged that the parties’ dispute on pricing did not involve fraud by Alcatel CIT.

In April 1999, we learned that the criminal investigation had been extended to determine whether our corporate funds as well as those of Alcatel CIT had been misused. As a consequence, both Alcatel CIT and we have filed civil complaints to preserve our respective rights in this respect.

In January 2000, the investigating magistrate declared his investigation closed on the alleged “overbillings”. Since then, there have been several procedural developments on this matter, including appeals relating to the closing of the investigation phase by several indicted defendants. It is unlikely that the investigating magistrate will be able to close his investigation before June of 2005 at the earliest.

Class Actions Relating to the Optronics Division. Several purported class action lawsuits were filed in the United States District Court for the Southern District of New York since May 2002 against us and certain of our officers and directors, asserting various claims under the federal securities laws. These actions have been consolidated. The consolidated action challenges the accuracy of certain public disclosures that were made in the prospectus for the initial public offering for Class O shares and other public statements regarding Alcatel, and in particular, the Optronics division.

On November 18, 2002, a consolidated amended class action complaint was filed in the consolidated action by certain plaintiffs designated by the Court as “lead plaintiffs.” The complaint purports to bring claims on behalf of the lead plaintiffs and a class of persons consisting of (i) all persons who acquired Class O shares in or traceable to the initial public offering of ADSs conducted by us in October 2000, (ii) all persons who purchased Class O shares in the form of ADSs between October 20, 2000 and May 29, 2001, and (iii) all persons who purchased Class A shares in the form of ADSs between May 1, 2000 and May 29, 2001. The amount of damages sought is not specified.

We are defending this action vigorously and deny any liability or wrongdoing with respect to this litigation. We filed a motion to dismiss this action on January 31, 2003, and a decision on the motion was rendered on March 4, 2005. The judge rejected a certain number of the plaintiffs’ demands with prejudice. He also rejected all the remaining claims under the federal securities laws for lack of specificity in the pleadings, but with leave to file a further amended complaint.

Costa Rica. Beginning in early October 2004, reports have been published, primarily in the Costa Rican media, regarding payments alleged to have been made by consultants on behalf of Alcatel de Costa Rica to various state and local officials in Costa Rica, two political parties in Costa Rica and representatives of ICE, the state owned telephone company, in connection with the procurement of one or more contracts for network equipment and services from ICE. Upon learning of these allegations, we immediately commenced and are continuing an investigation into this matter.

In Costa Rica and other countries, we retain consultants to assist us with our local operations and contracts. Our contracts with persons through whom we deal locally strictly prohibit the provision of any pecuniary or other advantage in contravention of applicable laws. In addition, Alcatel has a strict Statement of Business Practice (a copy of which is available on our web site, www.alcatel.com, under the heading Sustainable Development — Values and Charters) that imposes the highest standards of legal and ethical conduct on our employees. We rigorously enforce this Statement of Business Practice across the entire company and, when violations occur, we take prompt and appropriate action against the persons involved.

Alcatel has terminated the employment of the president of Alcatel de Costa Rica and a vice president-Latin America of a French subsidiary. We are also in the process of pursuing criminal actions against the former president of Alcatel de Costa Rica, the local consultants and the employee of the French subsidiary based on our suspicion of their complicity in an improper payment scheme and misappropriation of funds. The contracts with the local consultants were limited to the specific projects involved and are no longer in effect or have been terminated, and any payments due under those contracts have been suspended. Our internal investigation is continuing.

We contacted the United States Securities and Exchange Commission and the United States Department of Justice and informed them that Alcatel will cooperate fully in any inquiry or investigation into these matters. The SEC is conducting an inquiry into the allegations. If the Department of Justice or the SEC determines that violations of law have occurred, it could seek civil or, in the case of the Department of Justice, criminal sanctions, including monetary penalties against us. Neither the Department of Justice nor the SEC has informed us what action, if any, they will take.

against Alcatel CIT to seek compensation for the pecuniary damage caused by the alleged payments described above to ICE and its customers, and for the tarnishment to the reputation of ICE resulting from these events. The amount of damages sought by these lawsuits has not yet been specified. We intend to defend these actions vigorously and deny any liability or wrongdoing with respect to these litigations.

We are unable to predict the outcome of these investigations and civil lawsuit and their effect on our business. If the Costa Rican authorities conclude criminal violations have occurred, Alcatel may be banned from participating on public contracts within Costa Rica for a certain period and fines or penalties may be imposed on us, in an amount which we are not able to determine at this time. We expect to generate approximately € 9 million in revenue from Costa Rican contracts in 2005. Based on the amount of revenue received from these contracts, we do not believe a loss of business in Costa Rica would have a material adverse effect on Alcatel as whole. However, these events may have a negative impact on the image of our company in Latin America.

Taiwan. Certain employees of Alcatel Taisel, the 60%-owned Taiwanese subsidiary of Alcatel, and Siemens Taiwan, along with a few suppliers and a legislative aide, have been the subject of an investigation by the Taipei Investigator’s Office of the Ministry of Justice relating to an axel counter supply contract awarded to Alcatel Taisel by Taiwan Railways in 2003. The amount of the contract that is the subject of the inquiry is € 20.2 million. It has been alleged that persons in Alcatel Taisel and Siemens Taiwan and subcontractors hired by them were involved in a bid rigging and payment arrangement for the Taiwan Railways contract.

Upon learning of these allegations, we immediately commenced and are continuing an investigation into this matter. We terminated the former president of Alcatel Taisel. A director of international sales and marketing development of a German subsidiary who was involved in the Taiwan Railways contract has resigned and is under ongoing investigation by the Taiwanese authorities.

On February 21, 2005, the former president of Alcatel Taisel and Alcatel Taisel were indicted for violation of the Taiwanese Government Procurement Act. If the former country senior officer is found guilty of the allegations in the indictment, Alcatel Taisel may be banned from participating in governmental contracts within Taiwan for a certain period and fines or penalties may be imposed on us, in an amount not to exceed € 25,000. As a group, we expect to generate approximately € 80 million in all or part of this revenue from Taiwanese contracts in 2005. Based on the amount of revenue received from these contracts, we do not believe a loss of business in Taiwan would have a material adverse effect on Alcatel as whole.

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

Although it is not possible at this stage of the investigations and cases to predict their outcome with certainty, we do not believe that the ultimate outcome of these proceedings will have a material adverse effect on our consolidated financial position or results from our operations. We are not aware of any other proceedings that would or may have a significant effect on our activities, financial position or assets.

Dividend policy

General. Under French law, our board of directors must first propose the distribution of any dividend to a general meeting of all our shareholders, voting together as a single class. A majority of the holders of our ordinary shares must then approve the distribution. Under French law, the aggregate amount of any dividends paid on our ordinary shares will, for any year, be limited to our distributable profits (bénéfice distribuable) for that year. In any fiscal year, our distributable profits will equal the sum of the following:


	•	our profits for the fiscal year, less

	•	our losses for the fiscal year, less


	•	any required contribution to our legal reserve fund under French law, plus

	•	any additional profits that we reported, but did not distribute in our prior fiscal year.

	•	In the future, we may offer our shareholders the option to receive any dividends in shares instead of cash.

See “Item 10 — “Additional Information — Taxation” for a summary of certain U.S. federal and French tax consequences to holders of Alcatel shares or ADSs. Holders of Alcatel shares or ADSs should consult their own tax advisors with respect to the tax consequences of an investment in Alcatel shares or ADSs. Dividends paid to holders of ADSs will be subject to a charge by the Depositary for any expenses incurred by the Depositary in the conversion of euro to U.S. dollars. You should refer to Item 10 — “Additional Information — Description of ADSs” for a further discussion of the payment of dividends on the ADSs.

No dividends for 2004. On February 3, 2005, we announced that our board of directors will propose a resolution at our 2005 shareholders’ meeting approving the board of directors’ recommendation that no dividends be paid on our ordinary shares and ADSs with respect to 2004.


Item 9.	The Offer and the Listing

General

In September 2000, the Paris Bourse (SBF) SA, or the “SBF,” the Amsterdam Exchange and the Brussels Exchange merged to create Euronext, the first Pan-European exchange. Securities quoted on exchanges participating in Euronext are traded over a common Euronext platform, with central clearinghouse, settlement and custody structures. However, these securities remain listed on their local exchanges. As part of Euronext, the SBF retains responsibility for the admission of shares to the Paris Bourse’s trading markets as well as the regulation of those markets.

Since February 18, 2005, Premier, Second and Nouveau Marchés of Euronext Paris merged to create one market, Eurolist by Euronext. Prior to this change, our ordinary shares were traded on the Premier Marché. All shares and bonds are now traded on the same market and listed alphabetically.

The principal trading market for our ordinary shares is the Eurolist. Our ordinary shares have been traded on the Euronext Paris SA since June 3, 1987. The ordinary shares are also listed on Euronext Amsterdam, Antwerp, Basle, Euronext Brussels, Frankfurt, Geneva, Tokyo and Zurich exchanges and are quoted on SEAQ International in London. In addition, our ADSs have been listed on The New York Stock Exchange since May 1992.

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


		Price per share

		High		Low

2000⁽¹⁾		€	97.15	€	39.10
2001			72.35		11.34
2002			21.62		2.05
2003			11.89		4.16
	First Quarter		7.59		4.16
	Second Quarter		8.54		6.10
	Third Quarter		11.89		7.56
	Fourth Quarter		11.67		9.89
2004			14.82		8.77
	First Quarter		14.82		10.25
	Second Quarter		14.10		10.88
	Third Quarter		12.86		8.77
	Fourth Quarter		12.38		9.49


		Price per share

		High		Low

2005
	January		11.70		10.38
	February		11.32		9.36
	March (through March 30, 2005)		10.27		9.40


(1)	Adjusted to reflect a five-for-one stock split effective May 22, 2000.

Trading in the United States

The Bank of New York serves as the Depositary with respect to the ADSs traded on The New York Stock Exchange. Each ADS represents one ordinary share.

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


			ADS
			price per share

			High		Low

2000⁽¹⁾			$	86.25	$	37.00
2001				66.94		10.53
2002				19.14		2.02
2003				13.68		4.60
	First Quarter			8.09		4.60
	Second Quarter			10.15		6.81
	Third Quarter			13.25		8.28
	Fourth Quarter			13.68		11.78
2004				18.32		10.76
	First Quarter			18.32		13.06
	Second Quarter			17.08		13.09
	Third Quarter			15.30		10.76
	Fourth Quarter			16.20		11.98
2005
		January		15.75		13.42
		February		14.70		12.20
		March (through March 30, 2005)		13.55		12.19


(1)	A five-for-one stock split and a change in the ratio of ordinary shares to ADSs was effective as of May 22, 2000.


Item 10.	Additional Information

Memorandum and articles of association

Our purpose. Our purposes can be found in Article 2 of our articles of association and bylaws. Generally, our purpose in all countries is to take any and all types of actions relating to electricity, telecommunications, computer, electronics, the space industry, nuclear power, metallurgy and generally to all types of energy and communications production and transmission systems. In addition, we may create companies regardless of activity, own stock in other companies and manage shares and securities. We are listed in the Paris Trade Register under number 542 019 096 and our APE code is 741 J.

Director issues

General. Our articles of association and bylaws stipulate that our directors shall be elected by our shareholders and that our board of directors shall consist of no fewer than six and no more than 18 directors. Our board of directors presently consists of 14 directors. Two directors are required to be our employees or employees of our subsidiaries and participants in a mutual fund for our employees that holds our shares

(FCP). Directors elected after May 2000 are elected for terms of up to four years, which term can only be renewed by the vote of our shareholders. However, directors may be elected to multiple, and consecutive, terms. Our board of directors appoints, and has the power to remove, the chairman and chief executive officer. The chairman serves for the term determined by the board when the chairman is elected, which may not exceed the chairman’s term as a director. Our governing documents also provide for one or more vice-chairmen, who may be elected by the board.

Directors can be individuals or entities, including corporations. If an entity is a director, it must appoint an individual to act as its permanent representative.

Our articles of association and bylaws provide that the board of directors is responsible for managing the company. In accordance with article 17 of our articles of association and bylaws, the board of directors has the discretion to determine whether the management of the company will be performed by the chairman of the board of directors or by a chief executive officer. On April 24, 2002 and on April 17, 2003, our board of directors determined that Mr. Tchuruk will exercise the functions of both the chairman of the board of directors and the chief executive officer.

In February 2003, our board of directors adopted internal rules requiring our directors to notify the board of any situation involving a potential conflict of interest between them and Alcatel. In addition, our directors are precluded from voting on matters relating to such conflicts of interest.

Shareholdings. Each director must own at least 500 shares. Two directors must be our employees and must participate in a FCP at the time of appointment.

Retirement. Generally, the maximum age for holding a directorship is 70. However, this age limit does not apply if less than one-third, rounded up to the nearest whole number, of serving directors has reached the age of 70. No director over 70 may be appointed if, as a result of the appointment, more than one-third of the directors would be over 70.

If for any reason more than one-third of the number of serving directors are over 70, then the oldest director shall be deemed to have retired at the ordinary shareholders’ meeting called to approve our accounts for the fiscal year in which the one-third threshold was exceeded, unless the board proportion is reestablished prior to the meeting.

If a company or other legal entity has the right to appoint a director and that director reaches 70, the company or legal entity must replace the director by the date of the ordinary shareholders’ meeting called to approve our accounts for the fiscal year in which such director reached 70.

The retirement age for the chief executive officer is 68. As noted above (see “Director Issues — General”), currently the chief executive officer is also the chairman of the board of directors. We will submit for approval at our next shareholders’ meeting a resolution to the effect that, in the event in the future our board of directors decides to separate the function of chairman of the board from that of chief executive officer, then the maximum age for holding the chairmanship of the board will be 70.

Description of Ordinary Shares

Form of shares. Under French company law, ownership of ordinary shares is not represented by share certificates. Bearer shares are recorded in the books of an accredited financial intermediary in an account opened in the name of the shareholder at EUROCLEAR France (formerly Sicovam SA) (an accredited financial intermediary is a French broker, bank or authorized financial institution registered as such in France). Upon our request, EUROCLEAR France will disclose to us the name, nationality, address and number of shares held by each shareholder who holds them in bearer form. This information may only be requested by us and may not be communicated to third parties.

Ordinary shares that are fully paid-up may be held in registered or bearer form at the option of the holder, subject to the next paragraph. Ownership of ordinary shares in registered form is recorded in books maintained by us or our appointed agent. A holder of ordinary shares in registered form may manage its own ordinary shares or appoint an accredited financial intermediary. Ordinary shares held in bearer form by a

person who is not a resident of France may, at the request of such holder, be physically delivered in the form of bearer certificates representing such ordinary shares, provided that the ordinary shares are held and traded outside France. In determining whether or not to issue physical certificates in these circumstances, the accredited financial intermediary considers certification practices in foreign markets and may consult with us.

Registration of shares. Any holder owning 3% of the total number of ordinary shares (including ADSs) must request, within five trading days of reaching that ownership level, registration of the shares in non-transferable form. In addition, this registration requirement will apply to all ordinary shares (including ADSs) that the holder may subsequently acquire each time a holder of 3% or more of the total number of shares increases its holding by 0.5%, up to and including 50%. The holder is required to notify us of any such subsequent acquisition within two weeks and such notice shall set forth the number of shares held, the acquisition date and a certification that all shares owned by such holder are reported. Compliance with this requirement is deemed to be in compliance with the notification requirements described below under “— Holdings exceeding certain percentages.” Failure to comply with this requirement may, upon petition of one or more shareholders representing 3% or more of our share capital, result in the loss of the voting rights attached to the shares in excess of the relevant threshold.

Transfer of shares. Ordinary shares held in registered form are transferred by means of an entry recorded in the transfer account maintained by us or on our behalf for this purpose. In order for ordinary shares in registered form to be traded on a stock exchange in France, the shares must first be converted into bearer form by a financial intermediary upon receipt of a selling order from the holder. Upon completion of the trade, the new holder is required to register the shares in its name within five trading days, only if such trade causes the holder to cross the 3% threshold specified by our articles of association and bylaws. Bearer shares are held and recorded in the securities account of the holder and may be traded without any further requirement. Ordinary shares held in bearer form by a person who is not a resident of France are transferable outside France by delivery of the bearer certificates representing the ordinary shares.

Holdings exceeding certain percentages. Under French law, any individual or entity, acting alone or in concert with others, who becomes the owner of more than 5%, 10%, 20%, 33¹/3%, 50% or 66²/3% of our outstanding share capital or voting rights (including through ADSs), or whose holding subsequently falls below any of these thresholds, must notify us of the number of ordinary shares it holds within five trading days of the date the relevant threshold was crossed. The individual or entity must also notify the French stock exchange and securities regulator (Autorité des marchés financiers) within five trading days of the date the threshold was crossed.

In addition, our articles of association and bylaws provide that any individual or entity which at any time owns, directly or indirectly, a number of shares equal to or more than 0.5%, or any multiple thereof up to and including 2.5%, of our issued share capital, or whose holding falls below any of these thresholds, must within fifteen days of exceeding this threshold, notify us by letter, fax or telex of the total number of each class of shares owned. Failure to provide timely written notice to us may, upon petition of one or more shareholders representing 3% or more of our share capital, result in the loss of the voting rights attached to the shares in excess of the relevant threshold.

We will submit a resolution for approval at our next shareholders’ meeting increasing the ownership reporting threshold set forth in our articles of association and bylaws from 0.5% to 2% of our issued share capital and requiring that once this threshold is reached, every further increase of 1% also be reported. In addition, we will propose to shorten the notification deadline to five trading days, to make it consistent with the deadline imposed by French law.

French company law and the regulations of the French stock exchange and securities regulator impose additional reporting requirements on any person or persons acting alone or in concert who acquire more than 10% or 20% of our share capital or voting rights. An acquiror exceeding those thresholds must file a statement with us, the French securities regulator and stock exchange regulator. The notice must specify the acquirer’s intentions for the 12-month period following the acquisition of its 10% or 20% stake, including whether or not it intends to (1) increase its stake, (2) acquire a controlling interest in us or (3) seek the election of nominees to our board of directors. The statement must be filed within 10 trading days after the

date either of these thresholds was crossed. The statement is published by the French stock exchange and securities regulator. Similar reporting requirements must be complied with if the acquiror’s intentions have changed due to material events.

In addition, under French law and the regulations of the French stock exchange and securities regulator, any person or persons, acting alone or in concert, who enter into an agreement containing provisions granting preferential treatment, with respect to the sale of shares, voting rights, or otherwise, for shares representing 0.5% or more of our share capital or voting rights must file such provisions with the French stock exchange and securities regulator.

Under French law and the regulations of the French stock exchange and securities regulator, and subject to limited exemptions granted by it, any person or persons, acting alone or in concert, who acquires shares representing one-third or more of our share capital or voting rights must initiate a public tender offer for the balance of our share capital and all other outstanding securities (such as convertible bonds) that are convertible into or exchangeable for our share capital.

If a shareholder (including a holder of ADSs) fails to comply with these notification requirements, the shareholder will be deprived of voting rights attached to the shares it holds in excess of the relevant threshold. The shareholder will be deprived of its voting rights at all shareholders’ meetings held until the end of a two-year period following the date on which the shareholder has complied with the notification requirements. Furthermore, any shareholder who fails to comply with these requirements, including the notification requirements of our articles of association and bylaws, may have all or part of its voting rights (and not only with respect to the shares in excess of the relevant threshold) suspended for up to five years by court decree at the request of our chairman, any of our shareholders or the French stock exchange and securities regulator. Such shareholder may also be subject to criminal penalties.

In order to permit shareholders to give the notice required by law and our articles of association and bylaws, we are obligated to publish in the French official newspaper (Bulletin des annonces légales obligatoires, or BALO), not later than 15 calendar days after our annual ordinary shareholders’ meeting, information with respect to the total number of votes available as of the date of the meeting. In addition, if we are aware that the number of available votes has changed by at least five percent since the last publication of the number of available votes, we must publish the number of votes then available in the BALO within 15 calendar days of that change and provide the French stock exchange regulator with written notice.

Shareholder Meetings. Annual ordinary and extraordinary meetings of our shareholders are convened and held in accordance with French law. Any shareholder may attend a properly convened meeting of shareholders in person or by proxy upon confirmation of such shareholder’s identity and ownership of shares at least three days before the shareholders’ meeting, which period may be reduced at the discretion of our board of directors.

Voting rights. Each ordinary share entitles a holder to one vote at all meetings of our shareholders subject to the provisions concerning double voting rights described below. For each ordinary share fully paid and registered in the name of the same person for at least three years, the holder will be entitled to double voting rights with respect to such ordinary share at any of our meetings, whether ordinary or extraordinary. The double voting right will automatically terminate for any share which has been subject to conversion into a bearer share or for which ownership has been transferred. Any transfer of shares as a result of inheritance, division of community property by spouses or donation to a spouse or heir shall not affect a share’s double voting rights. Since ADSs are held in the name of the Depositary, holders of our ADSs are not entitled to double voting rights.

Regardless of the number of ordinary shares held, the total voting rights per shareholder cannot exceed 8% of the total voting rights present or represented at any meeting of shareholders (16% if double voting rights apply). This limit applies whether or not the shares are voted directly or by proxy. However, this limit does not apply if a shareholder, acting alone or in concert, owns at least 66²/3% or more of our outstanding shares as a result of a public tender offer or exchange offer for all our shares. In addition, this limit does not apply to the votes cast by the chairman of the meeting pursuant to a blank proxy.

Preemptive rights. Under French law, shareholders will have preemptive rights to subscribe on a pro rata basis for additional shares of any equity securities or other securities giving a right, directly or indirectly, to equity securities issued by us for cash. During the subscription period relating to a particular offering of shares, shareholders may transfer preferential subscription rights that they have not previously waived. In order to issue additional ordinary shares without preemptive rights, beyond issuances already approved, we must obtain the approval of two-thirds of the voting rights present or represented by proxy at an extraordinary meeting of our shareholders, voting together as a single class.

Liquidation. Upon our liquidation, after payment of all prior claims, holders of ordinary shares will be entitled to receive a pro rata amount of all our net assets. The pro rata amount will be calculated, first to repay the paid-up and non-liquidated capital and any surplus will be divided among all shareholders, subject to any applicable rights arising from the different classes of shares.

Dividends. You should refer to Item 8 — “Dividend Policy” for a description of how dividends are calculated and paid on our ordinary shares.

Changes in Share Capital

Capital increases. In accordance with French law and subject to the exceptions discussed below, our share capital may be increased only with the approval of a two-thirds vote of the shareholders present or represented by proxy voting together as a single class at an extraordinary meeting. The shareholders may delegate to our board of directors, which in turn may delegate to the chairman of the board of directors, the power required to effect, in one or more phases, certain increases in share capital previously approved by our shareholders.

Our share capital may be increased by the issuance of additional shares or by an increase in the nominal value of our existing shares. Our share capital may also be increased through the capitalization of existing reserves, profits or premium, in which case we must obtain the approval of a majority of the shareholders present or represented by proxy voting together as a single class at an extraordinary meeting of our shareholders. In case of an increase in our share capital by capitalization of reserves, profits or premium, shares attributed to a shareholder will be allocated pro rata based on the respective total nominal value of the ordinary shares held by such shareholder. The shares received by a shareholder will be of the same class as those owned by such shareholder.

Share dividends may be approved by the shareholders, in lieu of payment of cash dividends, at an ordinary meeting.

Additional ordinary shares may be issued:


	•	for cash;

	•	in satisfaction of or set off against liabilities, including indebtedness;

	•	for assets contributed to us in kind; or

	•	upon the conversion, exchange or redemption of securities or upon exercise of warrants to purchase ordinary shares.

Capital decreases. Our share capital may generally only be decreased with the approval of two-thirds of the shareholders present or represented by proxy voting together as a single class at an extraordinary meeting. Reductions in share capital may be made either by decreasing the nominal value of the shares or reducing the number of shares. The number of shares may be reduced if we either exchange or repurchase and cancel shares. As a general matter, reductions of capital occur pro rata among all shareholders, except (1) in the case of a share buyback program, or a public tender offer to repurchase shares (offre publique de rachat d’actions (OPRA)), where such a reduction occurs pro rata only among tendering shareholders; and (2) in the case where all shareholders unanimously consent to an unequal reduction.

Cross shareholdings and holding of our shares by our subsidiaries. French law prohibits a company from holding our shares if we hold more than 10% of that company’s share capital. French law also prohibits

us from owning any interest in a French company holding more than 10% of our share capital. In the event of a cross-shareholding that violates this rule, the company owning the smaller percentage of shares in the other company must sell its interest. Until sold, these shares are not entitled to voting rights. Failure by the officers or directors of a company to sell these shares is a criminal offense. In the event that one of our subsidiaries holds our shares, these shares are not entitled to voting rights. However, French law does not require the subsidiary to sell the shares.

Description of ADSs

The following is a summary of certain provisions of the deposit agreement for the ADSs and is qualified in its entirety by reference to the deposit agreement among Alcatel, The Bank of New York as depositary, and the holders from time to time of ADRs and the form of ADR itself, copies of which are attached as an exhibit to the registration statement on Form F-6 that we filed with the Securities and Exchange Commission on March 19, 2003. Additional copies of the deposit agreement are also available for inspection at the principal office of The Bank of New York, which is located at 101 Barclay Street, New York, New York 10286, and at the principal office of the custodian, Société Générale, located at 32, rue du Champ de Tir, 44312 Nantes, France.

American depositary receipts. Each ADS represents one ordinary share. An American depositary receipt (ADR) may evidence any whole number of ADSs. The ordinary shares underlying the ADRs will be deposited with the custodian or any successor custodian, under the terms of the deposit agreement. Under French law and our articles of association and bylaws, shareholders must disclose the amount of their shareholding in certain circumstances.

Deposit and withdrawal of ordinary shares. As used in this discussion, “deposited securities” means the ordinary shares deposited under the deposit agreement and all other securities, property and cash received by The Bank of New York or the custodian in respect or in lieu of the ordinary shares.

If ordinary shares are deposited with the custodian, or at The Bank of New York’s principal office for forwarding to the custodian, The Bank of New York will issue ADRs representing a whole number of ADSs. Upon the payment of required taxes, charges and fees and the receipt of all required certifications, The Bank of New York will register the ADRs in the name of the person or persons specified by the depositor of the ordinary shares. No ordinary shares will be accepted for deposit unless accompanied by evidence satisfactory to The Bank of New York that any necessary approval has been granted by (a) the French governmental agency, if any, that regulates currency exchange and (b) the French governmental authority, if any, that regulates foreign ownership of French companies. We will not, and will not permit any of our subsidiaries to, deposit ordinary shares for which any necessary approval has not been granted.

Upon surrender of ADRs at The Bank of New York’s principal office, and upon payment of the fees provided for in the deposit agreement, the ADR holder is entitled to the whole number of deposited ordinary shares that underlie the ADSs evidenced by the surrendered ADRs. The Bank of New York will deliver the underlying deposited ordinary shares to an account designated by the ADR holder. At the ADR holder’s request, risk and expense, The Bank of New York will deliver at its principal office certificates or other documents of title for the deposited securities, as well as any other property represented by the ADSs.

Pre-release of ADRs. The Bank of New York may, unless we instruct it not to, issue ADRs prior to the receipt of ordinary shares. This is called a “pre-release.” In addition, The Bank of New York may also deliver ordinary shares upon the receipt and cancellation of ADRs, even if the ADRs were issued as a pre-release for which ordinary shares have not been received. In addition, The Bank of New York may receive ADRs in lieu of ordinary shares in satisfaction of a pre-release. Before or at the time of such a transaction, the person to whom ADRs or ordinary shares are delivered must represent that it or its customer:


	•	owns the ordinary shares or ADRs to be delivered to The Bank of New York;

	•	assigns to The Bank of New York in trust all rights to the ordinary shares or ADRs; and

	•	will not take any action inconsistent with the transfer of ownership of the ordinary shares or ADRs.

In addition, each transaction must be:


	•	fully collateralized (marked to market daily) with cash, U.S. government securities or other collateral of comparable safety and liquidity;

	•	terminable by The Bank of New York on not more than five business days’ notice; and

	•	subject to further indemnities and credit regulations as The Bank of New York deems appropriate.

The Bank of New York will generally limit the number of ordinary shares represented by pre-release ADRs to 30% of the ordinary shares on deposit with the custodian under the ordinary deposit agreement.

Dividends, Other Distributions and Rights

The Bank of New York is responsible for making sure that it or the custodian, as the case may be, receives all dividends and distributions in respect of deposited ordinary shares.

Amounts distributed to ADR holders will be reduced by any taxes or other governmental charges required to be withheld by the custodian or The Bank of New York. If The Bank of New York determines that any distribution in cash or property is subject to any tax or governmental charges that The Bank of New York or the custodian is obligated to withhold, The Bank of New York may use the cash or sell or otherwise dispose of all or a portion of that property to pay the taxes or governmental charges. The Bank of New York will then distribute the balance of the cash and/or property to the ADR holders entitled to the distribution, in proportion to their holdings.

Cash dividends and cash distributions. The Bank of New York will convert into dollars all cash dividends and other cash distributions that it or the custodian receives, to the extent that it can do so on a reasonable basis, and transfer the resulting dollars to the United States within one day. The Bank of New York will distribute to the ADR holder the amount it receives, after deducting any currency conversion expenses. If The Bank of New York determines that any foreign currency it receives cannot be converted and transferred on a reasonable basis, it may distribute the foreign currency (or an appropriate document evidencing the right to receive the currency), or hold that foreign currency uninvested, without liability for interest, for the accounts of the ADR holders entitled to receive it.

Distributions of ordinary shares. If we distribute ordinary shares as a dividend or free distribution, The Bank of New York may, with our approval, and will, at our request, distribute to ADR holders new ADRs representing the ordinary shares. The Bank of New York will distribute only whole ADRs. It will sell the ordinary shares that would have required it to use fractional ADRs and then distribute the proceeds in the same way it distributes cash. If The Bank of New York deposits the ordinary shares but does not distribute additional ADRs, the existing ADRs will also represent the new ordinary shares.

If holders of ordinary shares have the option of receiving a dividend in cash or in ordinary shares, we may also grant that option to ADR holders.

Other distributions. If The Bank of New York or the custodian receives a distribution of anything other than cash or ordinary shares, The Bank of New York will distribute the property or securities to the ADR holder, in proportion to such holder’s holdings. If The Bank of New York determines that it cannot distribute the property or securities in this manner or that it is not feasible to do so, then, after consultation with us, it may distribute the property or securities by any means it thinks is fair and practical, or it may sell the property or securities and distribute the net proceeds of the sale to the ADR holders.

Rights to subscribe for additional ordinary shares and other rights. If we offer our holders of shares any rights to subscribe for additional ordinary shares or any other rights, The Bank of New York will, if requested by us:


	•	make the rights available to all or certain holders of ADRs, by means of warrants or otherwise, if lawful and feasible; or


	•	if it is not lawful or feasible to make the rights available, attempt to sell those rights or warrants or other instruments.

In that case, The Bank of New York will allocate the net proceeds of the sales to the account of the ADR holders entitled to the rights. The allocation will be made on an averaged or other practicable basis without regard to any distinctions among holders.

If registration under the Securities Act of 1933, as amended, is required in order to offer or sell to the ADR holders the securities represented by any rights, The Bank of New York will not make the rights available to ADR holders unless a registration statement is in effect or such securities are exempt from registration. We do not, however, have any obligation to file a registration statement or to have a registration statement declared effective. If The Bank of New York cannot make any rights available to ADR holders and cannot dispose of the rights and make the net proceeds available to ADR holders, then it will allow the rights to lapse, and the ADR holders will not receive any value for them.

Record dates. The Bank of New York will fix a record date any time:


	•	a dividend or distribution is to be made;

	•	rights are issued; or

	•	The Bank of New York receives notice of any meeting of holders of ordinary shares or other securities represented by the ADRs.

The persons who are ADR holders on the record date will be entitled to receive the dividend, distribution or rights, or to exercise the right to vote.

Notices and reports. When we give notice, by publication or otherwise, of a shareholders’ meeting or of the taking of any action regarding any dividend, distribution or offering of any rights, we will also transmit to the custodian a copy of the notice, in the form given or to be given to holders of deposited securities. The Bank of New York will arrange for the mailing to ADR holders of copies of those notices in English, as well as other reports and communications that are received by the custodian as the holder of deposited securities.

Voting of the underlying ordinary shares. Under the deposit agreement, an ADR holder is entitled, subject to any applicable provisions of French law, our articles of association and bylaws and the deposited securities, to exercise voting rights pertaining to the ordinary shares represented by its ADSs. The Bank of New York will send to ADR holders English-language summaries of any materials or documents provided by us for the purpose of exercising voting rights. The Bank of New York will also send to ADR holders directions as to how to give it voting instructions, as well as a statement as to how the underlying ordinary shares will be voted if it receives blank or improperly completed voting instructions.

The voting rights per holder of ADSs cannot exceed 8% of the total number of voting rights present or represented at a meeting of shareholders (16% if double voting rights apply). ADSs will represent ordinary shares in bearer form unless the ADR holder notifies The Bank of New York that it would like the ordinary shares to be held in registered form.

If The Bank of New York receives properly completed voting instructions, on or before the date specified, it will either vote the deposited securities in accordance with the instructions or forward the instructions to the custodian. If the voting instructions are forwarded to the custodian, the custodian will endeavor, insofar as practicable and permitted under applicable provisions of French law, our articles of association and bylaws and the deposited securities, to vote, or cause to be voted, the deposited securities in accordance with any nondiscretionary instructions. The Bank of New York will only vote ordinary shares or other securities that the ADRs represent in accordance with the ADR holder’s instructions. If it receives a blank proxy or improperly completed voting instructions, it will vote in accordance with a default position that will be stated in the proxy materials.

Inspection of transfer books. The Bank of New York will keep books at its principal office in New York City for the registration and transfer of ADRs. Those books are open for inspection by ADR holders at

all reasonable times, except that inspection is not permitted for purposes of communicating with holders of ADRs on matters that are not related to our business, the deposit agreement or the ADRs.

Changes affecting deposited securities. If there is any change in nominal value or any split-up, consolidation, cancellation or other reclassification of deposited securities, or any recapitalization, reorganization, merger or consolidation or sale of assets involving us, then any securities that The Bank of New York receives in respect of deposited securities will become new deposited securities. Each ADR will automatically represent its share of the new deposited securities, unless The Bank of New York delivers new ADRs as described in the following sentence. The Bank of New York may, with our approval, and will, at our request, distribute new ADRs or ask ADR holders to surrender their outstanding ADRs in exchange for new ADRs describing the new deposited securities.

Charges of The Bank of New York. The Bank of New York will charge ADR holders the following fees and expenses:


	•	fees for the registration of ADRs, the transfer, splitting-up or combination of ADRs, and the delivery of dividends, distributions or rights;

	•	taxes and other governmental charges;

	•	cable, telex, facsimile transmission and delivery expenses;

	•	expenses of conversions of foreign currency into U.S. dollars; and

	•	a fee of $5.00 (or less) per each 100 ADSs (or portion thereof) for the execution and delivery of ADRs and for the surrender of ADRs and withdrawal of deposited securities.

Amendment of the deposit agreement. The Bank of New York and we may agree to amend the form of the ADRs and the deposit agreement at any time, without the consent of the ADR holders. If the amendment adds or increases any fees or charges (other than taxes or other governmental charges) or prejudices an important right of ADR holders, it will not take effect as to outstanding ADRs until three months after The Bank of New York has sent the ADR holders a notice of the amendment. At the expiration of that three-month period, each ADR holder will be considered by continuing to hold its ADRs to agree to the amendment and to be bound by the deposit agreement as so amended. The Bank of New York and we may not amend the deposit agreement or the form of ADRs to impair the ADR holder’s right to surrender its ADRs and receive the ordinary shares and any other property represented by the ADRs, except to comply with mandatory provisions of applicable law.

Termination of the deposit agreement. The Bank of New York will terminate the deposit agreement if we ask it to do so and will notify the ADR holders at least 30 days before the date of termination. The Bank of New York may likewise terminate the deposit agreement if it resigns and a successor depositary has not been appointed by us and accepted its appointment within 90 days after The Bank of New York has given us notice of its resignation. After termination of the deposit agreement, The Bank of New York will no longer register transfers of ADRs, distribute dividends to the ADR holders, accept deposits of ordinary shares, give any notices, or perform any other acts under the deposit agreement whatsoever, except that The Bank of New York will continue to:


	•	collect dividends and other distributions pertaining to deposited securities;

	•	sell rights as described under the heading “— Dividends, other distributions and rights — Rights to subscribe for additional ordinary shares and other rights” above; and

	•	deliver deposited securities, together with any dividends or other distributions received with respect thereto and the net proceeds of the sale of any rights or other property, in exchange for surrendered ADRs.

One year after termination, The Bank of New York may sell the deposited securities and hold the proceeds of the sale, together with any other cash then held by it, for the pro rata benefit of ADR holders

that have not surrendered their ADRs. The Bank of New York will not have liability for interest on the sale proceeds or any cash it holds.

Transfer of ADRs. ADRs are transferable upon surrender by the ADR holder, if the ADRs are properly endorsed and accompanied by the proper instruments of transfer. The Bank of New York will execute and deliver a new ADR to the person entitled to it. The Bank of New York may not suspend the surrender of ADRs and withdrawal of deposited securities, except for:


	•	temporary delays caused by the closing of transfer books maintained by The Bank of New York, us or our transfer agent or registrar;

	•	temporary delays caused by the deposit of ordinary shares in connection with voting at a shareholders’ meeting or the payment of dividends;

	•	the payment of fees, taxes and similar charges; or

	•	compliance with laws or governmental regulations relating to the Class A ADRs or to the withdrawal of deposited securities.

The Bank of New York may refuse to deliver ADRs or to register transfers of ADRs when the transfer books maintained by The Bank of New York or our transfer agent or registrar are closed, or at any time that The Bank of New York or we think it is advisable to do so.

Governing Law. The deposit agreement and the ADRs are governed by the laws of the State of New York.

Ownership of shares by non-French persons

Under French law and our articles of association and bylaws, no limitation exists on the right of non-French residents or non-French shareholders to own or vote our securities.

Both E.U. and non-E.U. residents must file an administrative notice (“déclaration administrative”) with French authorities in connection with the acquisition of a controlling interest in any French company. Under existing administrative rulings, ownership of 20% or more of a listed company’s share capital or voting rights is regarded as a controlling interest; however, a lower percentage may be held to be a controlling interest in certain circumstances depending upon such factors as the acquiring party’s intentions, its ability to elect directors or financial reliance by the French company on the acquiring party.

The payment of all dividends to foreign shareholders must be effected through an accredited intermediary. All registered banks and credit establishments in France are accredited intermediaries.

You should refer to “Description of Ordinary Shares” above for a description of the filings required based on shareholdings.

Material contracts

Exchange Trust Agreement dated as of May 25, 2000 between Alcatel, Alcatel Holdings Canada Corp., Newbridge Networks Corporation and Montreal Trust Company of Canada. This agreement provides, among other things, the appointment of a trustee for the holders of Newbridge exchangeable shares and for the issuance of Class A ADSs in exchange for outstanding exchangeable shares upon the liquidation of Newbridge or Alcatel.

Support Agreement dated as of May 25, 2000 between Alcatel, Alcatel Holdings Canada Corp. and Newbridge Networks Corporation. This agreement provides, among other things, that Alcatel will cause Newbridge to declare an equivalent dividend on Newbridge exchangeable shares when we pay dividends on our ADSs. In addition, we agreed to take necessary actions so that Newbridge and Alcatel Holdings may be able to perform their respective obligations relating to the Newbridge exchangeable shares.

Exchange controls

Under current French exchange control regulations, no limits exists on the amount of payments that we may remit to residents of the United States. Laws and regulations concerning foreign exchange controls do require, however, that an accredited intermediary must handle all payments or transfer of funds made by a French resident to a non-resident.

Taxation

The following is a general summary of the material U.S. federal income tax and French tax consequences to you if you acquire, hold and dispose of our ordinary shares or ADSs. It does not address all aspects of U.S. and French tax laws that may be relevant to you in light of your particular situation. It is based on the applicable tax laws, regulations and judicial decisions as of the date of this annual report, and on the Convention between the United States of America and the Republic of France for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with respect to Taxes on Income and Capital dated as of August 31, 1994 (the “Treaty”) entered into force on December 30, 1995, all of which are subject to change, possibly with retroactive effect, or different interpretations.

This summary may only be relevant to you if all of the following five points apply to you:


	•	You own, directly or indirectly, less than 10% of our capital,

	•	You are any one of (a), (b), (c) or (d) below:


	(a)	an individual who is a citizen or resident of the United States for U.S. federal income tax purposes,

	(b)	a corporation, or other entity taxable as a corporation that is created in or organized under the laws of the United States or any political subdivision thereof,

	(c)	an estate, the income of which is subject to U.S. federal income tax regardless of its source, or

	(d)	a trust, if a court within the United States is able to exercise a primary supervision over its administration and one or more U.S. persons have the authority to control all of the substantial decisions of such trust,


	•	You are entitled to the benefits of the Treaty under the “limitations on benefits” article contained in the Treaty,

	•	You hold our ordinary shares or ADSs as capital assets, and

	•	Your functional currency is the U.S. dollar.

You generally will not be eligible for the reduced withholding tax rates under the Treaty if you hold our ordinary shares in connection with the conduct of business through a permanent establishment or the performance of services through a fixed base in France, or you are a nonresident in the United States for U.S. tax purposes.

The following description of tax consequences should be considered only as a summary and does not purport to be a complete analysis of all potential tax effects of the purchase or ownership of our ordinary shares or ADSs. Special rules may apply to U.S. expatriates, insurance companies, tax-exempt organizations, financial institutions, persons subject to the alternative minimum tax, securities broker-dealers, traders in securities that elect to use a mark-to-market method of accounting for the securities’ holdings and persons holding their ordinary shares or ADSs as part of a hedging, straddle or conversion transaction, among others. Those special rules are not discussed in this annual report. Because this summary does not address all potential tax implications, you should consult your tax advisor concerning the overall U.S. federal, state and local tax consequences, as well as the French tax consequences, of your ownership of our ordinary shares or ADRs and ADSs represented thereby.

For purposes of the Treaty and the U.S. Internal Revenue Code of 1986, as amended (the “Code”), if you own ADSs evidenced by ADRs, you will be treated as the owner of the ordinary shares represented by such ADSs.

Taxation of Dividends

Withholding Tax and Tax Credit. In France, companies may only pay dividends out of income remaining after tax has been paid. When shareholders resident in France receive dividends from French companies, they historically were entitled to a tax credit, known as the avoir fiscal tax credit. However, the French Finance Law of 2004 eliminated the avoir fiscal mechanism and the related précompte mechanism. The avoir fiscal tax credit is no longer available for dividends paid after January 1, 2004 to corporate shareholders and after January 1, 2005 to individual shareholders.

To compensate for the abolition of the avoir fiscal, for dividends paid as from January 1, 2005, French resident individuals will be subject to taxation on only 50 percent of the dividends received by them from both French and foreign companies. This “half-base” system will apply to any dividend distributed by a company that is subject to corporation tax or an equivalent tax and that is located in an EU member state or a country that has signed a tax treaty with France.

In addition, French resident individuals will receive a tax credit equal to 50 percent of the dividends (which we refer to as the Tax Credit), capped at €115 for single individuals or married persons subject to separate taxation and € 230 for married couples and members of a union agreement subject to joint taxation.

However, in February 2005, we announced that our board of directors will propose a resolution at our 2005 shareholders’ meeting approving the board of directors’ recommendation that no dividends be paid on the ordinary shares and ADSs with respect to our 2004 fiscal year.

French companies normally must deduct a 25% French withholding tax from dividends paid to nonresidents of France. Under the Treaty, this withholding tax is reduced to 15% if your ownership of our ordinary shares or ADSs is not effectively connected with a permanent establishment or a fixed base that you have in France.

If your ownership of the ordinary shares or ADSs is not effectively connected with a permanent establishment or a fixed base that you have in France, we will withhold tax from your dividend at the reduced rate of 15%, provided that you (i) complete the French Treasury Form entitled “Certificate of Residence” which establishes that you are a resident of the U.S. under the Treaty, (ii) have it certified either by the Internal Revenue Service or the financial institution that is in charge of the administration of the ordinary shares or ADSs, and (iii) send it to us before the date of payment of the dividend.

If you have not completed and sent the “Certificate of Residence” before the dividend payment date, we will deduct French withholding tax at the rate of 25%. In that case, you may claim a refund from the French tax authorities of any excess withholding tax in accordance with the following procedures.


	1.	If you are an “eligible” U.S. holder as defined below, you must complete French Treasury Form RF1 A EU-No. 5052, entitled “Application for Refund of French Taxes on Dividends Entitled to the Tax Credit,” and send it to us early enough to enable us to file it with the French tax authorities before December 31st of the year following the year during which the dividend is paid.

	2.	If you are not an “eligible” U.S. holder but nonetheless qualify as a resident of the United States under the Treaty, you must complete French Treasury Form RF1 B EU-No. 5053, entitled “Application for Refund of French Taxes on Dividends where the Recipient is not Entitled to the Tax Credit,” and send it to us early enough to enable us to file it with the French tax authorities before December 31st of the year following the year during which the dividend is paid.

You are “eligible” if any one of the following four points applies to you:


	1.	You are an individual or other noncorporate holder that is a resident of the United States for purposes of the Treaty;

	2.	You are a U.S. corporation, other than a regulated investment company;

	3.	You are a U.S. corporation which is a regulated investment company, provided that less than 20% of your ordinary shares or ADSs are beneficially owned by persons who are neither citizens nor residents of the United States; or

	4.	You are a partnership or trust that is a resident of the U.S. for purposes of the Treaty, but only to the extent that your partners, beneficiaries or grantors would qualify as “eligible” under point 1 or point 2 above.

You can obtain the certificate, the forms and their respective instructions from the Depositary, the Internal Revenue Service or the French Centre des Impôts des non-résidents the address of which is 9 rue d’Uzès, 75094 Paris Cedex 2, France. If you are a U.S. holder of ADSs, the Depositary will file your completed certificate or form as long as you deliver it to the Depositary within the time period specified in the distribution to registered U.S. holders of ADSs.

Any French withholding tax refund is generally expected to be paid within 12 months after you file the relevant French Treasury Form. However, it will not be paid before January 15, following the end of the calendar year in which the related dividend is paid.

Prior to the French tax reform described above, an “eligible” U.S. individual holder could also claim the avoir fiscal tax credit (net of applicable withholding tax) in addition to the reduced rate of withholding tax. Instead, qualifying nonresident individuals who were previously entitled to a refund of the avoir fiscal tax credit may benefit, under the same conditions as for the avoir fiscal tax credit, from a refund of the Tax Credit (net of applicable withholding tax). Thus, if you are an “eligible” U.S. individual holder, you may be entitled to a refund of the Tax Credit (less a 15% withholding tax), provided that you are subject to U.S. federal income tax on the Tax Credit and the related dividend. The French tax authorities have not issued guidance with respect to the refund of the Tax Credit to nonresident individuals, but have claimed that such refund, if possible, may likely entail compliance with cumbersome formalities.

U.S. holders that are legal entities, pension fund or other tax-exempt holders are no longer entitled to tax credit payments from the French Treasury.

For U.S. federal income tax purposes, the gross amount of any distribution (including any related Tax Credit) will be included in your gross income as dividend income to the extent paid or deemed paid out of our current or accumulated earnings and profits as calculated for U.S. federal income tax purposes. You must include this amount in income in the year payment is received by you, which, if you hold ADSs, will be the year payment is received by the Depositary. Dividends paid by us will not give rise to any dividends-received deduction allowed to a U.S. corporation under Section 243 of the Code. They will generally constitute foreign source “passive” income for foreign tax credit purposes (or, for some holders, foreign source “financial services” income).

For tax years beginning before January 1, 2009, a maximum U.S. federal income tax rate of 15% will apply to dividend income received by an individual (as well as certain trusts and estates) from a U.S. corporation or from a “qualified foreign corporation” provided certain holding period requirements are met. A non-U.S. corporation (other than a foreign personal holding corporation, foreign investment company, or passive foreign investment company) generally will be considered to be a qualified foreign corporation if (i) the shares of the non-U.S. corporation are readily tradable on an established securities market in the United States, or (ii) the non-U.S. corporation is eligible for the benefits of a comprehensive U.S. income tax treaty determined to be satisfactory to the United States Department of the Treasury. The United States Department of the Treasury and the Internal Revenue Service have determined that the Treaty is satisfactory for this purpose. In addition, the United States Department of the Treasury and the Internal Revenue Service have determined that ordinary shares, or an American Depositary Receipt in respect of such shares (which

would include the ADSs), is considered readily tradable on an established securities market if it is listed on an established securities market in the United States such as the New York Stock Exchange. Information returns reporting dividends paid to U.S. persons will identify the amount of dividends eligible for the reduced tax rates.

Also, for U.S. federal income tax purposes, the amount of any dividend paid in a foreign currency such as euros, including any French withholding taxes, will be equal to the U.S. dollar value of the euros on the date the dividend is included in income, regardless of whether you convert the payment into U.S. dollars. If you hold ADSs, this date will be the date the payment is received by the Depositary. You will generally be required to recognize U.S. source ordinary income or loss when you sell or dispose of the euros. You may also be required to recognize foreign currency gain or loss if you receive a refund of tax withheld from a dividend in excess of the 15% rate provided for under the Treaty. This foreign currency gain or loss will generally be U.S. source ordinary income or loss.

To the extent that any dividends paid exceed our current and accumulated earnings and profits as calculated for U.S. federal income tax purposes, the distribution will be treated as follows:


	•	First, as a tax-free return of capital to the extent of your basis in your ordinary shares or ADSs, which will reduce the adjusted basis of your ordinary shares or ADSs. This adjustment will increase the amount of gain, or decrease the amount of loss, which you will recognize if you later dispose of those ordinary shares or ADSs.

	•	Second, the balance of the distribution in excess of the adjusted basis will be taxed as capital gain.

French withholding tax imposed on the dividends you receive on your ordinary shares or ADSs at 15% under the Treaty is treated as payment of a foreign income tax eligible for credit against your federal income tax liability. Under the Code, the limitation on foreign taxes eligible for credit is not calculated with respect to all worldwide income, but instead is calculated separately with respect to specific classes of income. For this purpose, the dividends you receive on your ordinary shares or ADSs generally will constitute “passive” income (or, for some holders, foreign source “financial services” income). Foreign tax credits allowable with respect to each class of income cannot exceed the U.S. federal income tax otherwise payable with respect to such class of income. The consequences of the separate limitation calculation will depend in general on the nature and sources of your income and deductions. Alternatively, you may claim all foreign taxes paid as an itemized deduction in lieu of claiming a foreign tax credit. A deduction does not reduce U.S. tax on a dollar-for-dollar basis like a tax credit. The deduction, however, is not subject to the limitations described above.

The Précompte Tax. For taxable years ending before January 1, 2005, a French company is required to pay an equalization tax known as the précompte tax to the French tax authorities if it distributes dividends out of:


	•	profits which have not been taxed at the ordinary corporate income tax rate, or

	•	profits which have been earned and taxed more than five years before the distribution.

The amount of the précompte tax is equal to 50% of the net dividend before withholding tax.

Under the French Finance Law of 2004, distributions made by French companies from 2005 on will no longer be subject to the précompte tax. However, an exceptional levy of 25% will be imposed on distributions of untaxed earnings paid in 2005. Although the base for the exceptional levy will be the same as that for the précompte tax, the levy will apply to all distributions of earnings, including exceptional distributions from company reserves. The exceptional levy will not be refundable to shareholders.

Distributions made from 2006 on will not give rise to précompte tax or the exceptional levy.

Taxation of Capital Gains

If you are a resident of the United States for purposes of the Treaty, you will not be subject to French tax on any gain if you sell your ordinary shares or ADSs unless you have a permanent establishment or fixed

base in France and such ordinary shares or ADSs were part of the business property of that permanent establishment or fixed base. Special rules apply to individuals who are residents of more than one country.

In general, for U.S. federal income tax purposes, you will recognize capital gain or loss if you sell or otherwise dispose of your ordinary shares or ADSs based on the difference between the amount realized on the disposition and your tax basis in the ordinary shares or ADSs. Any gain or loss will generally be U.S. source gain or loss. If you are a noncorporate holder, any capital gain will generally be subject to U.S. federal income tax at preferential rates if you meet certain minimum holding periods. Long-term capital gains realized upon a sale or other disposition of the ordinary shares or ADSs before the end of a taxable year which begins before January 1, 2009 generally will be subject to a maximum U.S. federal income tax rate of 15%.

Transfer Tax on Sale of Ordinary Shares or ADSs

A 1% transfer tax capped at € 3,049 per transfer applies to certain transfers of ordinary shares or ADSs in French corporations. As from January 1, 2006, the rate will be increased to 1.10% and the cap will be increased to € 4,000. The transfer tax does not apply to transfers of ordinary shares or ADSs in French publicly-traded companies that are not evidenced by a written agreement, or where that agreement is executed outside France. Therefore, you should not be liable to pay the transfer tax on the sale or disposition of your ordinary shares or ADS provided such sale or disposition is not evidenced by a written agreement or such agreement is not executed in France.

French Estate and Gift Taxes

Under “The Convention Between the United States of America and the French Republic for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Estates, Inheritance and Gifts of November 24, 1978,” if you transfer your ordinary shares or ADSs by gift, or if they are transferred by reason of your death, that transfer will be subject to French gift or inheritance tax only if one of the following applies:


	•	you are domiciled in France at the time of making the gift, or at the time of your death, or

	•	you used the ordinary shares or ADSs in conducting a business through a permanent establishment or fixed base in France, or you held the ordinary shares or ADS for that use.

French Wealth Tax

The French wealth tax generally does not apply to you if you are a “resident” of the United States for purposes of the Treaty.

U.S. Information Reporting and Backup Withholding

In general, if you are a non-corporate U.S. holder of our ordinary shares or ADSs (or do not come within certain other exempt categories), information reporting requirements will apply to distributions paid to you and proceeds from the sale, exchange, redemption or disposal of your ordinary shares or ADSs.

Additionally, if you are a non-corporate U.S. holder of our ordinary shares or ADSs (or do not come within certain other exempt categories) you may be subject to backup withholding at a current rate of 28% (increased to 31% for taxable years 2011 and thereafter) with respect to such payments, unless you provide a correct taxpayer identification number (your social security number or employer identification number), certify that you are not subject to backup withholding and otherwise comply with applicable requirements of the backup withholding rules. Generally, you will provide such certification on Internal Revenue Service Form W-9 (“Request for Taxpayer Identification Number and Certification”) or a substitute Form W-9.

If you do not provide your correct taxpayer identification number, you may be subject to penalties imposed by the Internal Revenue Service, as well as backup withholding. However, any amount withheld under the backup withholding rules may be allowable as a credit against your U.S. federal income tax

liability (which might entitle you to a refund), provided that you furnish the required information to the Internal Revenue Service.

A non-U.S. holder of our ordinary shares or ADSs generally will be exempt from information reporting requirements and backup withholding, but may be required to comply with certification and identification procedures in order to obtain an exemption from information reporting and backup withholding.

U.S. State and Local Taxes

In addition to U.S. federal income tax, you may be subject to U.S. state and local taxes with respect to your ordinary shares or ADSs. You should consult your own tax advisor concerning the U.S. state and local tax consequences of holding your ordinary shares or ADSs.

Documents on display

We file reports with the Securities and Exchange Commission that contain financial information about us and our results or operations. You may read or copy any document that we file with the Securities and Exchange Commission at the Securities and Exchange Commission’s Public Reference Room at 450 Fifth Street, N.W., Washington, D.C. 20549. You may obtain information about the Public Reference Room by calling the Securities and Exchange Commission for more information at 1-800-SEC-0330. All of our Securities and Exchange Commission filings made after February 4, 2002 are available to the public at the SEC web site at http://www.sec.gov. Our web site at http://www.alcatel.com includes information about our business and also includes some of our Securities and Exchange Commission filings prior to February 4, 2002. The contents of our website are not incorporated by reference into this Form 20-F. You may also inspect any reports and other information we file with the Securities and Exchange Commission at the offices of the New York Stock Exchange, 20 Broad Street, New York, New York 10005.


Item 11.	Quantitative and Qualitative Disclosures About Market Risk

See Item 5 under “Qualitative and Quantitative Disclosures About Market Risk.”


Item 12.	Description of Securities Other than Equity Securities

Not applicable.

PART II


Item 13.	Defaults, Dividend Arrearages and Delinquencies

Not applicable.


Item 14.	Material Modifications to the Rights of Security Holders

Not applicable.


Item 15.	Controls and Procedures

(a) We performed an evaluation of the effectiveness of our disclosure controls and procedures that are designed to ensure that the material financial and non-financial information required to be disclosed on Form 20-F and filed with the Securities and Exchange Commission is recorded, processed, summarized and reported timely. Based on our evaluation, our management, including our Chief Executive Officer and Chief Financial Officer, have concluded that our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended) as of the end of the period covered by this report are effective. Notwithstanding the foregoing, there can be no assurance that our disclosure controls and procedures will detect or uncover all failures of persons within Alcatel to disclose material information otherwise required to be set forth in our reports. Also, as disclosed in Item 8 of this report and Note 34 to

our consolidated financial statements, we noted some internal control weaknesses with respect to certain foreign operations, which may involve the U.S. Foreign Corrupt Practices Act. We believe these deficiencies do not have a material impact on our financial results. We have taken actions which our management believes will enhance our controls in these and other foreign operations.

(b) Other than as noted in (a) above, there have been no significant changes in our internal controls or in other factors that could significantly affect these controls subsequent to the date of the evaluation thereof.


Item 16.	Reserved


Item 16A.	Audit Committee Financial Expert

Our board of directors has determined that Daniel Lebègue is an “audit committee financial expert” and that he is independent under the applicable rules promulgated by the Securities and Exchange Commission and the New York Stock Exchange.


Item 16B.	Code of Ethics

On February 4, 2004, our board of directors adopted a Code of Ethics for Senior Financial Officers that applies to our chief executive officer and president, chief operating officer, chief financial officer and corporate controller. A copy of our Code of Ethics for Senior Financial Officers has been posted on our Internet website, http://www.alcatel.com. This Code of Ethics is in addition to our statement on business practices which also applies to our senior financial officers (see Item 6 — “Directors, Senior Management and Employees — Statement on Business Practices, Ethics Committee and Code of Ethics”).


Item 16C.	Principal Accounting Fees and Services


	Fees and Services.

Under French law, we are required to have two auditors, and we have appointed Barbier Frinault & Autres (Ernst & Young) and Deloitte & Associés to act in that capacity. These firms received approximately 98% of the total audit fees that we and our consolidated subsidiaries paid during 2004.

The table below summarizes the audit fees paid by us and our consolidated subsidiaries during each of 2004 and 2003. Fees paid by our non-consolidated subsidiaries are not reflected in this table, and represent less than 5% of our total audit fees.


	2004										2003

						Barbier Frinault										Barbier Frinault
						& Autres										& Autres
	Deloitte & Associés					(Ernst & Young)					Deloitte & Associés					(Ernst & Young)

	Amount		%			Amount		%			Amount		%			Amount		%

	(in thousands of euros)
Audit Fees
Audit Fees	€	5,162		70.4	%	€	3,506		58.3	%	€	5,288		79.1	%	€	3,959		50.1	%
Audit-Related Fees⁽¹⁾		1,041		14.2	%		2,090		34.7	%		890		13.3	%		2,819		35.7	%

Subtotal		6,203		84.5	%		5,597		93.0	%		6,178		92.4	%		6,778		85.8	%
Other Services
Tax Fees⁽²⁾		967		13.2	%		342		5.7	%		366		5.5	%		1,040		13.2	%
All Other Fees⁽³⁾		167		2.3	%		77		1.3	%		143		2.1	%		79		1.0	%

Subtotal		1,134		15.5	%		419		7.0	%		509		7.6	%		1,119		14.2	%

Total		7,337		100.0	%		6,015		100.0	%		6,687		100.0	%		7,897		100.0	%


(1)	“Audit-related fees” are fees generally related to due diligence investigations, audits of combined financial statements prepared for purposes of the contemplated disposal of certain of our activities or of combined financial statements of companies that we acquired, and to other assignments relating to internal accounting functions and procedures.


(2)	“Tax fees” are fees for professional services rendered by our auditors for tax compliance, tax advice on actual or contemplated transactions, tax consulting associated with international transfer prices and employee tax services.

(3)	“All other fees” are principally fees related to information technology and training and support services.

Audit Committee’s pre-approval policies and procedures.

The audit committee of our board of directors chooses and engages our independent auditors to audit our financial statements, subject to the approval of our shareholders.

According to the audit and non-audit pre-approval policy implemented in 2003, the audit committee gives its approval before engaging our auditors to provide any other audit or permitted non-audit services to us or our subsidiaries. This policy, which is designed to assure that such engagements do not impair the independence of our auditors, requires the audit committee to pre-approve various audit and non-audit services that may be performed by our auditors. In addition, in approving non-audit services in advance, the audit committee limits the aggregate amount of fees our auditors may receive under the pre-approval policy for non-audit services in a given year; services generating fees in excess of such aggregate amount require specific approval.

On a quarterly basis, we inform the audit committee of the pre-approved services actually provided by our auditors. Services of a type that are not pre-approved by the audit committee require pre-approval by the audit committee’s chairman on a case-by-case basis. The chairman of our audit committee is not permitted to approve any engagement of our auditors if the services to be performed either fall into a category of services that are not permitted by applicable law or the services would be inconsistent with maintaining the auditors’ independence.


Item 16D.	Exemptions from the Listing Standards for Audit Committee

Not Applicable.


Item 16E.	Purchases of Equity Securities by the Issuer and Affiliated Purchasers

At our annual meeting of shareholders held on June 4, 2004, our shareholders approved a resolution authorizing us, prior to the annual shareholders’ meeting to be held in 2005 and at the discretion of our board of directors, to purchase our shares and to hold up to 10% of our share capital. This resolution superseded a similar resolution approved by our shareholders at the annual shareholders’ meeting held in 2003. Although such authorizations were in place, during 2004 neither we nor any of our subsidiaries purchased any of our shares. As of December 31, 2004, we held directly 25,343,255 of our ordinary shares, and our subsidiaries held a total of 38,964,778 of our ordinary shares.

PART III


Item 17.	Financial Statements

See Item 18.


Item 18.	Financial Statements

The following consolidated financial statements of Alcatel, together with the report of Deloitte & Associés for the years ended December 31, 2002, 2003 and 2004, are filed as part of this annual report.


	Page

Report of Independent Registered Public Accounting Firm		F-1
Consolidated Income Statements for the years ended December 31, 2004, 2003 and 2002		F-2
Consolidated Balance Sheets at December 31, 2004, 2003 and 2002		F-3
Consolidated Statements of Cash Flows for the years ended December 31, 2004, 2003 and 2002		F-5
Consolidated Statement of Changes in Shareholders’ Equity for the years ended December 31, 2004, 2003 and 2002		F-7
Notes to Consolidated Financial Statements:
• Summary of Accounting Policies		F-8
• Changes in Consolidated Companies		F-15
• Information by business segment		F-18
• Information by geographical segment		F-21
• Other		F-22

All schedules have been omitted since they are not required under the applicable instructions or the substance of the required information is shown in the financial statements.


Item 19.	Exhibits

1.1 Statuts (Articles of Association and By-Laws) of Alcatel (English translation) (incorporated by reference to Alcatel’s Report of Foreign Issuer on Form 6-K filed October 14, 2004).

2.1 Form of Amended and Restated Deposit Agreement, as further amended and restated as of March 19, 2003, among Alcatel, The Bank of New York, as Depositary, and the holders from time to time of the ADRs issued thereunder, including the form of ADR (incorporated by reference to Exhibit A to Alcatel’s Registration Statement on Form F-6) (File No. 333-103885).

4.1 Merger Agreement, dated February 22, 2000, between Alcatel and Newbridge Networks Corporation (incorporated by reference to Exhibit 99.1 to Schedule 13D of Alcatel dated March 3, 2000).

4.4 Exchange Trust Agreement dated as of May 25, 2000 between Alcatel, Alcatel Holdings Canada Corp., Newbridge Networks Corporation and Montreal Trust Company of Canada (incorporated by reference to Exhibit 4.5 to Alcatel’s Annual Report on Form 20-F for the fiscal year ended December 31, 2000).

4.5 Support Agreement dated as of May 25, 2000 between Alcatel, Alcatel Holdings Canada Corp. and Newbridge Networks Corporation (incorporated by reference to Exhibit 4.6 to Alcatel’s Annual Report on Form 20-F for the fiscal year ended December 31, 2000).

8. List of subsidiaries (see Note 35 to Alcatel’s consolidated financial statements).

10.1 Consent of Independent Registered Public Accounting Firm.

12.1 Certification of the Chief Executive Officer pursuant to §302 of the Sarbanes-Oxley Act of 2002.

12.2 Certification of the Chief Financial Officer pursuant to §302 of the Sarbanes-Oxley Act of 2002.

13.1 Certification of the Chief Executive Officer pursuant to 18 U.S.C. Section 1350.

13.2 Certification of the Chief Financial Officer pursuant to 18 U.S.C. Section 1350.

SIGNATURE

The registrant hereby certifies that it meets all of the requirements for filing on Form 20-F and that it has duly caused and authorized the undersigned to sign this annual report on its behalf.


	ALCATEL


	By:	/s/ Jean-Pascal Beaufret



	Name: Jean-Pascal Beaufret
	Title: Chief Financial Officer

March 31, 2005

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Shareholders and the Board of Directors of Alcatel:

We have audited the accompanying consolidated balance sheets of Alcatel and its subsidiaries (the “Group”) as of December 31, 2004, 2003 and 2002 and the related consolidated statements of income, cash flows and change in stockholders’ equity, for the years then ended. These consolidated financial statements are the responsibility of the Group’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

We conducted our audits in accordance with standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Group is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances but not for the purpose of expressing an opinion on the effectiveness of the Group’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Alcatel and its subsidiaries as of December 31, 2004, 2003 and 2002 and the results of their operations and their cash flows for each of the years then ended, in conformity with accounting principles generally accepted in France.

Without qualifying the conclusion expressed above, we draw attention to the changes in accounting principles under French Generally Accepted Accounting Principles described in Note 1 and 31 to the consolidated financial statements that relate to:


	•	the application as of January 1, 2004 of new consolidation rules for Special Purposes Entities, as introduced by the “Loi de Sécurité Financière” in France;

	•	the adoption as of January 1, 2004 of the “Conseil National de la Comptabilité” recommendation 2003-R01 relating to standards of accounting for, and measurement of, employee retirement and other similar benefits, in order to apply the accounting principles set forth in IAS 19, Employee Benefits;

	•	the application as of January 1, 2002 of the “Regulation 00-06 on liabilities”.

Accounting principles generally accepted in France vary in certain significant respects from accounting principles generally accepted in the United States of America. Information relating to the nature and effect of such differences is presented in notes 37 to 40 to the consolidated financial statements.


	Deloitte & Associés

Neuilly-sur-seine, France

March 30, 2005

F-1

ALCATEL AND SUBSIDIARIES

CONSOLIDATED INCOME STATEMENTS


	Note			2004^(a)			2004			2003*			2002^(b)

				(in millions except per share information)
Net sales		(3	)		16,604		€	12,265		€	12,513		€	16,547
Cost of sales		(4	)		(10,411	)		(7,690	)		(8,415	)		(12,186	)

Gross profit		(4	)		6,193			4,575			4,098			4,361
Administrative and selling expenses					(2,721	)		(2,010	)		(2,173	)		(2,862	)
R&D costs		(4	)		(2,148	)		(1,587	)		(1,593	)		(2,226	)

Income (loss) from operations		(3	)		1,324			978			332			(727	)
Interest expense on notes mandatorily redeemable for shares		(23	)		(60	)		(44	)		(47	)		(1	)
Financial income (loss)		(5	)		(179	)		(132	)		(242	)		(1,018	)
Restructuring costs		(25	)		(411	)		(304	)		(1,314	)		(1,474	)
Other revenue (expense)		(7	)		493			364			120			(830	)

Income (loss) before amortization of goodwill and taxes					1,167			862			(1,151	)		(4,050	)
Income tax		(8	)		(12	)		(9	)		(82	)		19
Share in net income of equity affiliates and disposed of or discontinued operations		(6	)		(132	)		(97	)		(113	)		(107	)

Consolidated net income (loss) before amortization of goodwill and purchased R&D					1,023			756			(1,346	)		(4,138	)
Amortization of goodwill		(10	)		(552	)		(408	)		(407	)		(447	)
Exceptional amortization of goodwill		(10	)		—			—			(171	)		(142	)
Purchased R&D					(1	)		(1	)		—			—
Minority interests					(90	)		(66	)		(20	)		(18	)

Net income (loss)					380			281			(1,944	)		(4,745	)

*Ordinary Shares^(c)*
Basic earnings per share		(9	)		0.28			0.21			(1.46	)		(3.99	)
Diluted earnings per share		(9	)		0.28			0.21			(1.46	)		(3.99	)


(a)	Translation of amounts from € into $ has been made merely for the convenience of the reader at the Noon Buying Rate of € 1 = $ 1.3538 on December 31, 2004.

(b)	These are the company’s historical results. In order to make comparisons easier, restated income statements for 2003 and 2002 are presented in note 2 to take into account the disposals of the optical components business, the Saft group and the optical fiber, mobile phone and electrical power systems businesses.

(c)	Net (loss) per share for 2002 has been restated to take into account the conversion of Class O shares into ordinary shares, on a one-for-one basis, as approved at the shareholders’ meeting of April 17, 2003, and the changes made to IAS 33 in December 2003.

The accompanying Notes are an integral part of these Consolidated Financial Statements

F-2

ALCATEL AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS AT DECEMBER 31

ASSETS


	Note		2004^(a)			2004			2003			2002

			(in millions)
Goodwill, net		(10)		4,855			3,586		€	3,839		€	4,597
Other intangible assets, net		(11)		537			397			284			312

Intangible assets, net				5,392			3,983			4,123			4,909

Property, plant and equipment		(12)		6,565			4,849			6,317			8,236
Depreciation		(12)		(4,993	)		(3,688	)		(4,817	)		(5,737	)

Property, plant and equipment, net		(12)		1,572			1,161			1,500			2,499

Share in net assets of equity affiliates and net assets and liabilities of disposed of or discontinued operations		(13)		615			454			391			306
Other investments and miscellaneous, net		(14)		701			518			822			975

Investments and other financial assets				1,316			972			1,213			1,281

TOTAL FIXED ASSETS				8,280			6,116			6,836			8,689

Inventories and work in progress, net		(15) and (16)		2,067			1,527			1,432			2,329

Trade receivables and related accounts, net		(15) and (17)		4,765			3,520			3,364			4,716
Other accounts receivable, net		(18)		3,757			2,775			3,231			4,037

Accounts receivable, net				8,522			6,295			6,595			8,753

Short term investments				661			488			45			258
Marketable securities, net		(19)		2,712			2,003			1,590			458	^(b)
Cash, net				3,531			2,608			4,634			5,393

Cash and cash equivalents				6,243			4,611			6,224			5,851	^(b)

Short term investments and cash and cash equivalents				6,903			5,099			6,269			6,109

TOTAL CURRENT ASSETS				17,493			12,921			14,296			17,191

TOTAL ASSETS				25,773			19,037			21,132			25,880


(a)	Translation of amounts from € into $ has been made merely for the convenience of the reader at the Noon Buying Rate of € 1 = $1.3538 on December 31, 2004.

(b)	The total cash and cash equivalents at December 31, 2002 included, within marketable securities, listed securities amounting to € 44 million. Excluding listed securities, cash and cash equivalents amounted to € 5,807 million, which corresponds to the total of the cash and cash equivalents at the end of the period as indicated in the consolidated statements of cash flows. In 2003 and 2004, those € 44 million of listed securities are included in short term investments.

The accompanying Notes are an integral part of these Consolidated Financial Statements

F-3

ALCATEL AND SUBSIDIARIES

LIABILITIES AND SHAREHOLDERS’ EQUITY


				2004^(a)			2004						2003			2002

				After			Before			After			After			After
		Note		Appropriation			Appropriation						Appropriation			Appropriation

			(in millions)
Capital stock (€ 2 nominal value: 1,305,455,461 ordinary shares issued at December 31, 2004, 1,284,410,224 ordinary shares issued at December 31, 2003 and 1,239,193,498 Class A shares and 25,515,000 Class O shares issued at December 31, 2002)					3,535		€	2,611		€	2,611		€	2,569		€	2,529
Additional paid-in capital					10,503			7,758			7,758			7,562			21,602
Retained earnings					(6,825	)		(5,041	)		(4,760	)		(4,855	)		(17,107	)
Cumulative translation adjustments					(861	)		(636	)		(636	)		(518	)		(283	)
Net income (loss)					380			281			—			—			—
Less treasury stock at cost					(2,173	)		(1,605	)		(1,605	)		(1,728	)		(1,734	)

SHAREHOLDERS’ EQUITY		(20)			4,559			3,368			3,368			3,030			5,007

MINORITY INTERESTS		(21)			509			376			376			363			343

OTHER EQUITY
Notes mandatorily redeemable for shares		(22)			873			645			645			645			645

Accrued pension and retirement obligations		(23)			1,549			1,144			1,144			1,010			1,016
Other reserves		(24)			3,084			2,278			2,278			3,049			3,301

TOTAL RESERVES FOR LIABILITIES AND CHARGES					4,633			3,422			3,422			4,059			4,317

Convertible bonds					1,384			1,022			1,022			1,022			—
Bonds and notes issued					3,712			2,742			2,742			3,782			5,325
Other borrowings					806			595			595			489			458

TOTAL FINANCIAL DEBT		(25)			5,902			4,359			4,359			5,293			5,783

	(of which medium and long-term portion)				4,499			3,323			3,323			4,410			4,687

Customers’ deposits and advances		(14) and (27	)		1,576			1,164			1,164			1,181			1,482
Trade payables and related accounts		(14)			4,549			3,360			3,360			3,617			4,162
Debts linked to bank activity		(28)			142			105			105			224			246
Other payables		(29)			3,030			2,238			2,238			2,720			3,895

TOTAL OTHER LIABILITIES					9,297			6,867			6,867			7,742			9,785

TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY					25,773			19,037			19,037			21,132			25,880


(a)	Translation of amounts from € into $ has been made merely for the convenience of the reader at the Noon Buying Rate of € 1 = $1.3538 on December 31, 2004.

The accompanying Notes are an integral part of these Consolidated Financial Statements

F-4

ALCATEL AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS


	2004^(a)			2004			2003^(c)			2002

	(millions)
Cash flows from operating activities
Net income (loss)		380			281		€	(1,944	)	€	(4,745	)
Minority interests		89			66			20			18
Adjustments to reconcile income before minority interests to net cash provided by operating activities:
— Depreciation and amortization, net		600			443			605			1,010
— Amortization and depreciation of goodwill and purchased R&D		552			408			577			589
— Net allowances in reserves for pension obligations, net		(51	)		(38	)		(7	)		(3	)
— (Utilization) and increase/(reversal) of other reserves, net		(796	)		(588	)		54			1,358
— Net (gain) loss on disposal of non-current assets		(475	)		(351	)		(104	)		(287	)
— Share in net income of equity affiliates and disposed of or discontinued operations (net of dividends received)		158			117			126			188

Net cash provided (used) by operating activities before changes in working capital		457			338			(673	)		(1,872	)

Net change in current assets and liabilities:
— Decrease (increase) in inventories		(208	)		(154	)		478			2,000
— Decrease (increase) in accounts receivable		(313	)		(231	)		1,264			3,436
— Decrease (increase) in advances and progress payments		11			8			33			110
— Increase (decrease) in accounts payable and accrued expenses		122			90			(404	)		(1,084	)
— Increase (decrease) in customers’ deposits and advances		(172	)		(127	)		(206	)		(173	)
— Increase (decrease) in other receivables and debts		(288	)		(213	)		(48	)		306

Net cash provided (used) by operating activities(1)		(391	)		(289	)		444			2,723

Cash flows from investing activities
Proceeds from disposal of fixed assets		295			218			457			280
Capital expenditures		(514	)		(380	)		(253	)		(490	)
Decrease (increase) in loans(2)		754			557			207			(839	)
Cash expenditures for acquisition of consolidated companies, net of cash acquired, and for acquisition of unconsolidated companies		(278	)		(205	)		(107	)		(193	)
Cash proceeds from sale of previously consolidated companies, net of cash sold, and from sale of unconsolidated companies		486			359			195			813
Decrease (increase) in short term investments		(600	)		(443	)		257			177
Disposed of or discontinued operations^(b)		(334	)		(247	)		(56	)		—

Net cash provided (used) by investing activities		(191	)		(141	)		700			(252	)

Net cash flows after investment		(582	)		(430	)		1,144			2,471

F-5


	2004^(a)			2004			2003^(c)			2002

	(millions)
Cash flows from financing activities
Increase (decrease) in debt		(2,121	)		(1,567	)		(1,580	)		(1,469	)
Proceeds from issuance of long-term debt		625			462			—			—
Proceeds from issuance of convertible bonds (ORANE) or notes mandatorily redeemable for shares (OCEANE)					—			1,022			645
Proceeds from issuance of shares		16			12			1			8
Dividends paid		(12	)		(9	)		(7	)		(276	)

Net cash provided (used) by financing activities		(1,492	)		(1,102	)		(564	)		(1,092	)

Net effect of exchange rate changes		(69	)		(51	)		(136	)		(150	)

Net increase (decrease) in cash and cash equivalents		(2,143	)		(1,583	)		444			1,229

Cash and cash equivalents at beginning of year including discontinuing and disposed of activities		8,426			6,224			5,807			4,578

Cash and cash equivalents at beginning of year excluding discontinuing and disposed of activities		8,387			6,195			5,780			—

Cash and cash equivalents at end of year excluding listed securities		6,242			4,611			6,224			5,807

Operational cash flows (1) + (2) = Net cash provided (used) by operating activities + Decrease (increase) in loans (2)		363			268			651			1,884


(a)	Translation of amounts from € into $ has been made merely for the convenience of the reader at the Noon Buying Rate of € 1 = $1.3538 on December 31, 2004.

(b)	The consolidated statements of cash flows are presented so as to isolate cash flows relating to disposed of or discontinued operations (see note 6).

(c)	The corporate tax paid for 2004 amounted to € 40 million (€ 14 million for 2003 and € 30 million for 2002) and the gross financial charges amounted to € 179 million (€ 294 million for 2003 and € 674 million for 2002).

The accompanying Notes are an integral part of these Consolidated Financial Statements

F-6

ALCATEL AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS’ EQUITY


																									Treasury
			Number of		Number of																				stock
			shares		shares					Additional						Exchangeable			Cumulative			Net			owned by			Share-
			outstanding		outstanding			Capital		paid-in			Retained			shares Alcatel			translation			Income			consolidated			holders’
	Note		Class A		Class O			stock		capital			earnings			Networks Corp.			adjustments			(loss)			subsidiaries			equity

			(in millions of euros except for number of shares outstanding)
Balance at December 30, 2001 after appropriation				1,146,823,155		25,503,345			2,481		21,425			(13,072	)		823			(185	)		—			(1,842	)		9,630

Capital increase linked to the acquisition of Astral Point				8,783,396					18		126																		144
Capital increase linked to the acquisition of Telera				15,147,728					30		49																		79
Other capital increases				7,577					—		2			6															8
Exchangeable shares Alcatel Networks Corporation														573			(573	)											—
Acquisition of Astral Point														(162	)														(162	)
Acquisition of Telera														(60	)														(60	)
Net change in treasury stock of Class A shares owned by consolidated subsidiaries				5,715,418										(7	)											108			101
Other adjustments^(a)														110															110
Translation adjustments																				(98	)								(98	)
Net income (loss)																							(4,745	)					(4,745	)
Appropriation of net income														(4,745	)								4,745						—

Balance at December 30, 2002 after appropriation				1,176,477,274		25,503,345			2,529		21,602			(17,357	)		250			(283	)		—			(1,734	)		5,007

Conversion of Class O shares into ordinary shares				26,000,000		(26,000,000	)																						—
Acquisition of Imagic TV				3,531,332					7		19																		26
Repayment of notes mandatorily redeemable for shares (ORANE)				1,828					0		0																		0
Acquisition of TiMetra				15,534,934					31		94			(141	)														(16	)
Other capital increases				148,632		485,000			2		4																		6
Exchangeable shares Alcatel Networks Corporation														44			(44	)											—
Net change in treasury stock of shares owned by consolidated subsidiaries				144,005		11,655								(1	)											6			5
Adjustment relating to the acquisition of Kymata														68															68
Other adjustments^(b)														113															113
Translation adjustments																				(235	)								(235	)
Net income (loss)																							(1,944	)					(1,944	)
Appropriation of net income (loss)											(14,157	)		12,213									1,944						—

Balance at December 30, 2003 after appropriation				1,221,838,005		—			2,569		7,562			(5,061	)		206			(518	)		—			(1,728	)		3,030

Other capital increases		(21b)		3,258,728					6		20																		26
Exchangeable shares Alcatel Networks Corporation														3			(3	)											—
Repayment of notes mandatorily redeemable for shares (ORANE)		(23)		3,212					0		0																		0
Net change in treasury stock of shares owned by consolidated subsidiaries		(21e)		2,310,066										(88	)											123			35
First-time application of the CNC’s 2003-R.01 recommendation		(24b)												(209	)														(209	)
Acquisition of Spatial Wireless		(21b)		17,783,297					36		176																		212
Other adjustments^(c)														111															111
Translation adjustments																				(118	)								(118	)
Net income (loss)																							281						281
Balance at December 31, 2004 before appropriation				1,245,193,308		—			2,611		7,758			(5,244	)		203			(636	)		281			(1,605	)		3,368

Allocation of net income (loss)		(20)		—		—			—		—			281			—			—			(281	)		—			0

Balance at December 31, 2004 after appropriation				1,245,193,308		—			2,611		7,758			(4,963	)		203			(636	)		—			(1,605	)		3,368


(a)	Relating mainly from the follow-up of opening balance sheets of companies acquired according to “pooling of interests” accounting for stock-for-stock business combinations (provided for in paragraph 215 of regulation CRC 99-02), from the implementation as of January 1, 2002 of regulation n°00-06 (regulation on liabilities) approved by the “Comité de Réglementation Comptable” and from the consolidation of Alcatel Shanghai Bell, which had been previously accounted for under the equity method.

(b)	Relating mainly from the follow-up of opening balance sheets of companies acquired according to “pooling of interests” accounting for stock-for-stock business combinations (provided for in paragraph 215 of regulation CRC 99-02) and from the consolidation of Alcatel Shanghai Bell, which had been previously accounted for under the equity method.

(c)	Relating mainly from the follow-up of opening balance sheets of companies acquired according to “pooling of interests” accounting for stock-for-stock business combinations (provided for in paragraph 215 of regulation CRC 99-02).

The accompanying Notes are an integral part of these Consolidated Financial Statements

F-7

ALCATEL AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 1 — Summary of accounting policies

The consolidated financial statements of Alcatel and its consolidated subsidiaries (“Alcatel” or the “Group”) are prepared in accordance with French accounting principles in compliance with the “Principles and accounting methodology relative to consolidated financial statements” regulation No. 99-02 of the “Comité de la Réglementation Comptable” approved by decree dated June 22, 1999.

From January 1, 2002, Alcatel has applied regulation No. 00-06, Regulation on liabilities, approved by the “Comité de la Réglementation Comptable”.

As part of the changeover to International Financial Reporting Standards (“IFRS”) in 2005, Alcatel decided to revise the method of presenting certain income statement captions and to anticipate the application of certain accounting rules, to the extent that these are compatible with French accounting principles. The main changes made in this respect in 2004 were:


	—	application of the “Conseil National de la Comptabilité” (CNC)’s recommendation 2003-R01 relating to standards of accounting for, and measurement of, employee retirement and other similar benefits, in order to apply the accounting principles set forth in IAS 19 (Employee Benefits),

	—	presentation of recurring goodwill amortization charges (charges that will no longer be incurred in accordance with IFRS 3) separately from exceptional amortization charges (resulting from goodwill impairment tests),

	—	presentation of research and development costs (see note 4),

	—	abandonment of the “pooling of interests” method of accounting for business combinations starting January 1, 2004 (see note 10).


(a)	Consolidation methods

Companies over which the Group has control are fully consolidated.

Companies over which the Group has joint control are accounted for using proportionate consolidation.

Companies over which the Group has a significant influence (“equity affiliates”) are accounted for under the equity method. Significant influence is generally assumed when the Group’s interest is more than 20%.

All significant intra-group transactions are eliminated.


(b)	Business combinations

Once a controlled company becomes consolidated, its assets and liabilities are accounted for at their fair value in accordance with regulation No. 99-02. Any difference between the fair value and the carrying value is accounted for, including minority interests and not only the Group interest (entity theory). Any residual difference is recorded as goodwill (see note 1f, intangible and tangible assets).

As an exception to the above-described rule (the purchase method) and in accordance with paragraph 215 of regulation No. 99-02, in the event that:


	—	an acquisition is effected in one transaction and involves at least 90% of the capital of the acquired company,

	—	the purchase price is paid in capital stock of a consolidated company,

	—	the acquisition agreement does not provide for a cash payment which is more than 10% of the total value of the capital stock issued, and

F-8

ALCATEL AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


	—	the substance of the acquisition agreement remains consistent for the two years following the acquisition,

the assets and liabilities of the acquired company are maintained at their carrying value at the date of the acquisition, adjusted for the Group’s accounting methods; the difference between this value and the acquisition cost of the shares remains in shareholders’ equity.

The material acquisitions of the Group that have been accounted for using this “pooling of interests” method are described in note 10 regarding goodwill. Alcatel abandoned this “pooling of interests” method starting January 1, 2004 in anticipation of the changeover to IFRS.

In accordance with the position taken in Bulletin No. 7 210 of the “Commission des Opérations de Bourse”, no goodwill has been recorded directly in shareholders’ equity for business combinations prior to the first application of regulation No. 99-02 of the “Comité de la Réglementation Comptable”.


(c)	Translation of financial statements denominated in foreign currencies

The balance sheets of consolidated subsidiaries outside the euro zone are translated into euros at the year-end rate of exchange, and their income statements and cash flow statements are translated at the average annual rate of exchange. The resulting translation adjustments are included in shareholders’ equity under the line item “Cumulative translation adjustments”.


(d)	Translation of foreign currency transactions

Foreign currency transactions are translated at the rate of exchange applicable on the transaction date. At year-end, foreign currency receivables and payables are translated at the rate of exchange prevailing on that date. The resulting exchange gains and losses are recorded in the income statement.

Exchange gains or losses on foreign currency financial instruments that represent an economic hedge of a net investment in a foreign subsidiary are reported as translation adjustments in shareholders’ equity under the line item “Cumulative translation adjustments”.


(e)	Research and development expenses

These are recorded as expenses for the year in which they are incurred, except for:


	—	Certain software development costs, which are capitalized when they strictly comply with the following criteria:


	—	the project is clearly defined, and costs are separately identified and reliably measured;

	—	the technical feasibility of the software is demonstrated;

	—	the software will be sold or used in-house;

	—	a potential market exists for the software, or its usefulness, in case of internal use, is demonstrated; and

	—	adequate resources required for completion of the project are available.


	—	Software development costs are amortized as follows:


	—	in case of internal use: over their probable service lifetime,

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

The amortization corresponds to the greater of either the cumulative amounts using straight-line amortization or the cumulative amounts based on the above-mentioned criteria.

F-9

ALCATEL AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Recoverable amounts disbursed under the terms of contracts with customers, are included in work in progress on long-term contracts.

In connection with the treatment of business combinations accounted for using the purchase method (see note 1b), Alcatel may allocate a significant portion of the purchase price to in-process research and development projects. As part of the process of analyzing these acquisitions, Alcatel may make the decision to buy technology that has not yet been commercialized rather than develop the technology internally, so as to stay at the forefront of rapid technological advances in the telecommunications/data networking industry.

The fair value of in-process research and development acquired in acquisitions is based on present value calculations of income, an analysis of the project’s accomplishments and an evaluation of the overall contribution of the project, as well as the project’s risks.

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

The value assigned to purchased in-process research and development is determined by discounting the net cash flows to their present value. The selection of the discount rate is based on consideration of Alcatel’s weighted average cost of capital, adjusted upward to reflect additional risks inherent in the development life cycle.

This value is also adjusted to reflect the stage of completion, the complexity of the work completed to date, the difficulty of completing the remaining development, costs already incurred, and the projected cost to complete the projects.

Commencing on January 1, 2004 and in anticipation of applying the principles laid down in IFRS, Alcatel has capitalized the in-process research and development projects that are acquired in a business combination and correspond to applied research projects and development in progress, and which are identifiable and can be reliably evaluated and which have a real chance of being commercially profitable. In previous years, Alcatel did not systematically capitalize in-process research and development projects when the above criteria were met, as amounts that were attributed to projects that had not reached technical feasibility and that did not have any other possible future use were immediately expensed at the time of acquisition.

Capitalized research and development is amortized over three to seven years.


(f)	Intangible and tangible assets

Whenever events or changes in market conditions indicate a risk of impairment of intangible assets (excluding goodwill) and property, plant and equipment, a detailed review is carried out in order to determine whether the net carrying amount of such assets remains lower than their fair value.

Whenever such review indicates that fair values are lower than carrying amounts, the Group further considers the effect on its future cash flows of alternative business strategies, such as restructuring plans at affected companies. If necessary, a reserve for these intangible assets and plant, property and equipment is established to reduce their carrying amount to fair value, as measured by their discounted forecasted operating cash flow or market value, if any.

Goodwill

Goodwill is amortized using the straight-line method over a period, determined for each transaction, not to exceed 20 years.

F-10

ALCATEL AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Following the significant decline in the Group’s market capitalization during 2002 and the deterioration of the telecommunications sector, all goodwill is tested for impairment at least annually during the second quarter of each year. The impairment test methodology is based on a comparison between the fair values of each of the Group’s business divisions with the business divisions’ net asset carrying values (including goodwill). Such fair values are mainly determined using pre-tax discounted cash flows over five years and a discounted terminal value. The discount rate used for 2004 was the Group’s weighted average cost of capital of 10.8% (10.2% for 2003 and 11% for 2002). Management believes the assumptions used concerning sales growth and terminal values are reasonable and in line with market data available for each business division.

This method is very similar to step 1 of the impairment test as defined in SFAS 142 as well as to the approach described in IAS 36 (Impairment of Assets). The impairment test used in the consolidated financial statements prepared in accordance with French GAAP is, however, carried out at a lower level of segmentation than that recommended by SFAS 142. As a result, the test can lead, in certain cases, to accounting for exceptional goodwill amortization relative to a sub-activity within a business division, which will be restated in the Group’s U.S. GAAP consolidated financial statements.

This impairment test was performed as of January 1, 2002, June 30, 2002, December 31, 2002, June 30, 2003 and June 30, 2004. Furthermore, an additional review of the recoverability of goodwill relating to certain business divisions was carried out at December 31, 2003. All these impairment tests resulted in no exceptional goodwill amortization charge for 2004 (€ 171 million in 2003 and € 142 million in 2002) (see note 10).

Other intangible assets

Software reported as intangible assets is either acquired or created for internal use or is master software intended for sale to customers. For master software, copies of which will be sold, only research and development costs related to the production phase (programming, coding, test and test sets) are capitalized. Software is depreciated using the straight-line method over no more than five years.

Property, plant and equipment

Property, plant and equipment are valued at historical cost for the Group (excluding any revaluation). Depreciation is generally calculated over the following useful lives:


Industrial buildings, plant and equipment buildings for industrial use			20 years
• infrastructure and fixtures			10-20 years
• equipment and tools			5-10 years
• small equipment and tools			3 years
Buildings for administrative and commercial use			20-40 years

Depreciation expense is determined using the straight-line method.

Fixed assets acquired through capital lease arrangements or long-term rental arrangements that transfer substantially all of the benefits and risks of ownership to the Group are capitalized.


(g)	Investments

Investments are stated at the lower of historical cost (excluding revaluations) or fair value (market value for investments in listed companies), and are assessed investment by investment according to their value in use for Alcatel.

F-11

ALCATEL AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


(h)	Inventories

Inventories are valued at the lower of cost (including indirect production costs where applicable) or net realizable value. Cost is primarily calculated on a weighted average price basis.


(i)	Pension and retirement obligations and other employee and post-employment benefit obligations

Since January 1, 2004, the Group has applied the CNC’s recommendation 2003-R.01 relating to standards of accounting for, and measurement of, employee retirement and other similar benefits, in order to apply the accounting principles in IAS 19 (Employee Benefits). The impact of applying this recommendation for the first time is described in note 24b.

In accordance with the laws and practices of each country, the Group participates in employee benefit plans and provides early retirement benefit plans and special termination benefits.

For defined contribution plans, the Group expenses contributions as and when they are due. As the Group is not liable for any legal or constructive obligations under the plans beyond the contributions paid, no provision therefor is made. Defined benefit pension plans, liabilities and prepaid expenses are determined as follows:


	—	using the Projected Unit Credit Method (with projected final salary), which provides that each period of service gives rise to an additional unit of benefit entitlement and measures each unit separately to build up the final obligation. Actuarial assumptions comprise mortality, rates of employee turnover and projection of future salary levels;

	—	recognizing, over the expected average remaining working lives of the employees participating in the plan, actuarial gains and losses in excess of more than 10% of the present value of the defined benefit obligation or 10% of the fair value of any plan assets.

Since January 1, 2004, the Group has also accrued certain other post-employment benefits, such as life insurance and health insurance, as a result of applying the CNC’s recommendation No. 2003-R.01.

In accordance with clarifications made by the CNC in its press release dated July 22, 2004, Alcatel recognized in shareholders’ equity the actuarial gains and losses as of January 1, 2004 related to experience adjustments and adjustments linked to changes in actuarial assumptions.

As described above, actuarial gains and losses that have occurred since January 1, 2004 are accounted for using the “corridor” method, which consists of accounting for them as an adjustment of the reserve and of recognizing them in income if they exceed a threshold of 10%.

The expense resulting from the change in net pension and other post-retirement obligations is recorded in income from operations or in financial income (loss) depending upon the nature of the underlying obligation.

As the CNC’s recommendation 2003-R.01 specifically excludes awards granted to employees based on their length of service from the definition of benefits similar to pensions and retirement indemnities, such long-service awards have been accounted for in other reserves beginning January 1, 2003.


(j)	Reserves for restructuring

Reserves for restructuring costs are provided when the restructuring programs have been finalized and approved by Group management and have been announced before the balance sheet date of the Group’s financial statements, resulting in an obligation of the Group to third parties. Such costs primarily relate to severance payments, early retirement, costs for notice periods not worked, training costs of terminated

F-12

ALCATEL AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

employees, and other costs linked to the shut-down of facilities. Write-offs of fixed assets, inventories and other assets directly linked to restructuring measures are also accounted for in restructuring costs.


(k)	Deferred taxation

Deferred income taxes are computed under the liability method for all temporary differences arising between tax bases of assets and liabilities and their reported amounts, including the reversal of entries recorded in individual accounts of subsidiaries solely for tax purposes. All amounts resulting from changes to the tax rate are recorded in the year in which the tax rate change is decided.

Provisions are made for taxes on proposed dividends to be distributed by subsidiaries. No provision is made for taxes payable on undistributed retained earnings.

Deferred income tax assets are recorded in the consolidated balance sheet when it is more likely than not that the tax benefit will be realized in the future.

Due to the difficulty in determining the period in which certain material temporary differences are likely to reverse, deferred tax assets and liabilities are not discounted and are calculated based on the most recently voted tax rate applicable to the following fiscal year.

To assess the ability of the Group to recover tax assets, the following elements have been taken into account:


	—	forecasts of future tax results,

	—	analysis of income or loss in recent years, excluding non-recurring items,

	—	historical data concerning recent years’ tax results,

	—	undervalued assets, if any, which the Group intends to dispose of.


(l)	Net sales and long-term contracts

Net sales include sales and revenues net of value added taxes (VAT). In general, the Group recognizes revenue from the sale of goods and equipment when persuasive evidence of an arrangement with its customer exists, delivery has occurred, the amount of revenue can be measured reliably and it is probable that the economic benefits associated with the transaction will flow to the Group. In arrangements where the customer specifies final acceptance of the goods, equipment, services or software, revenue is generally deferred until all the acceptance criteria have been met.

For revenues generated from construction contracts, primarily those related to customized network construction and build-outs, the Group applies the percentage of completion method of accounting in application of the above principles, provided certain specified conditions are met, based either on the achievement of contractually defined milestones or on costs incurred compared with total estimated costs. Any estimated construction contract losses are recognized immediately when known. If uncertainty exists relating to customer acceptance, or the contract’s duration is relatively short, revenues are recognized only to the extent of costs incurred that are recoverable, or on completion of the contract. Work in progress on construction contracts is stated at production cost, excluding administrative and selling expenses.

Partial payments received on long-term contracts are recorded in customers’ deposits and advances.

For revenues generated from licensing, selling or otherwise marketing software solutions, the Group recognizes revenue generally upon delivery of the software and on the related services as and when they are performed, in application of the principles described in the second preceding paragraph. For arrangements to sell software licenses with services, software license revenue is recognized separately from the related service revenue, providing the transaction adheres to certain criteria (as prescribed by the AICPA’s SOP 97-2), such

F-13

ALCATEL AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

as the existence of sufficient vendor-specific objective evidence of fair value to permit allocation of the revenue to the various elements of the arrangement. If the arrangement does not meet the specified criteria, revenue is deferred and recognized ratably over the service period. For arrangements to sell services only, revenue from training or consulting services is recognized when the services are performed. Maintenance service revenue, including post-contract customer support, is deferred and recognized ratably over the contracted service period.

For product sales made through resellers and distributors, revenue is recognized at the time of shipment to the distribution channel. Accruals for any estimated returns are recorded at the same time based on contract terms and prior claims experience.

The Group accrues for warranty costs, sales returns and other allowances based on contract terms and its historical experience.


(m)	Income from operations

Income from operations includes gross margin, administrative and selling expenses, research and development expenses (see note 1e), pension costs (without financial component, note 1i) and employee profit sharing. Income from operations is calculated before interest expenses on notes mandatorily redeemable for shares, financial income (loss), restructuring costs, other revenue and expense, income tax, share in net income of equity affiliates and disposed of or discontinued operations, and amortization of goodwill.


(n)	Financial income (loss)

Financial income (loss) includes interest charges and income, dividends received from unconsolidated companies, reserves for investments in unconsolidated companies, marketable securities and other financial assets, net exchange gain (loss) (excluding hedging of commercial transactions), financial component of pension costs and other financial expenses and income (capital gain/loss on disposal of marketable securities, for example).

Alcatel’s banking subsidiary (Electro Banque) is fully consolidated. The operational banking revenues and costs are presented in financial income (loss), as the bank’s activity, being primarily an extension of the Group’s activity, enables savings to be made in interest expense and contributes to the financing of net sales (see note 1t).


(o)	Other revenue and expense

Other revenue and expense includes capital gain/loss on share disposals and tangible and intangible asset disposals; non-recurring expenses and revenues linked to ordinary business that are exceptional in terms of materiality and frequency; and extraordinary expenses and revenues.


(p)	Structure of consolidated balance sheet

Most of the Group’s activities in the various business segments involve long-term operating cycles. As a result, the consolidated balance sheet combines trading assets (inventories and work in progress and accounts receivable) and trading liabilities (reserves for liabilities and charges, customers’ deposits and advances, trade payables and other payables) without distinction between the amounts due in less than one year and due after more than one year.


(q)	Financial instruments

The Group uses financial instruments to manage and reduce its exposure to fluctuations in interest rates, foreign currency exchange rates and metal prices. When these contracts qualify as hedges, gains and losses on

F-14

ALCATEL AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

such contracts are accounted for in the same period as the item being hedged; otherwise, changes in the market value of these instruments are recognized in the period of change.


(r)	Cash and cash equivalents

Cash and cash equivalents in the consolidated statements of cash flows includes cash as well as short-term investments that are readily convertible to fixed amounts of cash. Cash and cash equivalents does not include investments in listed securities or bank accounts restricted in use, other than restrictions due to regulations applied in a specific country or sector of activities (exchange controls, etc.). Bank overdrafts considered as financing are also excluded from cash and cash equivalents.

Cash and cash equivalents in the balance sheets corresponds to the cash and cash equivalents defined above, including listed securities accounted for as marketable securities.


(s)	Marketable securities

Marketable securities are valued at the lower of cost or market value.


(t)	Customer financing

The Group undertakes two types of customer financing:


	—	financing relating to the operating cycle and directly linked to actual contracts;

	—	longer-term financing (beyond the operating cycle) through customer loans, minority investments or other forms of financing.

The first category of financing is accounted for in current assets, and loan allowances are accounted for in income from operations or in other expenses (see note 1o). Changes in net loans receivable are presented in net change in current assets of the consolidated statements of cash flows.

The second category of financing is accounted for in other investments and miscellaneous, net, and impairments are included in financial income (loss) or in other expenses (see note 1o). Changes in net loans receivable are included in cash flows from investing activities (decease/ increase in loans) of the consolidated statements of cash flows.

Furthermore, the Group may give guarantees to banks in connection with customer financing. These are included in off balance sheet commitments (see note 31).

Note 2 — Changes in the consolidated companies

The main changes in consolidated companies for 2004 were as follows:


	•	On January 14, 2004, Alcatel, pursuant to its announcement in October 2003, finalized the sale of SAFT, a subsidiary of the Group that specialized in battery operations, to Doughty Hanson for € 390 million. The battery operations were recorded as a discontinued operation for the year ended December 31, 2003. The gain on disposal amounted to € 255 million and was recorded in 2004 under the caption “other revenue (expense)” (see note 7).

	•	On April 26, 2004, Alcatel and TCL Communication Technology Holdings Limited announced the execution of a memorandum of understanding to form a joint venture mobile handset company. The joint venture company officially started operations on August 31, 2004 and is 55% owned by TCL and 45% owned by Alcatel. It is consolidated under the equity method in Alcatel’s accounts from September 1, 2004. The mobile phone business has been accounted for as a disposed of activity as

F-15

ALCATEL AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


		from January 1, 2004 (see note 6). The gain on disposal was recorded in 2004 under the caption “other revenue (expense)” (see note 7).

	•	On May 17, 2004, Alcatel announced that it had signed definitive binding documentation with Draka Holding N.V. (“Draka”) in relation to the proposed combination of their respective global optical fiber and communication cable businesses. The final agreement was signed on July 2, 2004. Draka owns 50.1% and Alcatel owns 49.9% of the new company, Draka Comteq B.V. This company was consolidated under the equity method as of July 1, 2004. Alcatel’s optical fiber activity has been accounted for as a disposed operation as of and after January 1, 2004 (see note 6). As the 2004 financial statements for Draka Comteq BV were not available at the closing date of Alcatel’s financial statements, an estimated gain/loss on disposal and an estimated share in the net result of Draka Comteq BV were taken into account in the income statement at December 31, 2004.

	•	On June 18, 2004, Alcatel and Finmeccanica announced the execution of a memorandum of understanding to merge their space activities through the creation of two sister companies, to which both partners will contribute their respective satellite industrial and service activities.


	The first company, Alcatel Alenia Space, of which Alcatel will hold 67% and Finmeccanica 33%, will combine Alcatel Space and Alenia Spazio’s industrial activities. This company will concentrate on the design, development, and manufacture of space systems, satellites, equipment, instruments, payloads and associated ground systems. The management team of Alcatel Alenia Space will be located in France. The company will operate through five business divisions (Telecommunications, Optical Observation and Science, Observation Systems and Radar, Navigation, Infrastructure and Transportation).

	The second company, of which Finmeccanica will hold 67% and Alcatel 33%, will combine Telespazio (Finmeccanica group) with Alcatel Space’s operations and services activities. This company will concentrate on operations and services for satellite solutions, which includes control and exploitation of space systems as well as value-added services for networking, multimedia and earth observation. Its management team will be located in Italy.

	The definitive agreement relating to the creation of these two new companies was signed on January 28, 2005, this agreement is subject to the necessary approvals of the regulatory authorities.


	•	On September 17, 2004, Alcatel announced that it had acquired privately held, U.S.-based eDial Inc., a leading provider of conferencing and collaboration services for businesses and telephone companies. The acquisition price was € 22 million (based on the market value at that date of Alcatel’s American Depositary Shares) and was paid for in Alcatel ADSs and cash.

	•	On September 17, 2004, Alcatel signed an agreement with a private equity firm, Ripplewood, to divest all of its electrical power system activities (Saft Power Systems). The closing of this sale took place on January 25, 2005. The results of this business were recorded as a discontinued operation in 2004 (see notes 6). The gain/loss on disposal will be recorded in the first quarter of 2005.

	•	On December 14, 2004, Alcatel announced that it had sold 7.1 million Avanex shares, bringing the Group’s stake in this company to below 20%. With this partial sale of its investment and in the absence of a seat on Avanex’s board of directors, the Group considers that it no longer exercises significant influence on Avanex and, as a result, as from this date, the remaining net book value of the shares has been accounted for as a non-consolidated investment and no longer as an equity affiliate.

	•	On December 16, 2004, Alcatel completed the acquisition of the privately held, U.S.-based Spatial Communications (known as Spatial Wireless), a leading provider of software-based and multi-standard distributed mobile switching solutions. All of Spatial Wireless shares were acquired for

F-16

ALCATEL AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


		17.4 million Alcatel’s ADSs, representing a value of € 207 million (based upon the market price of ADSs on the closing date).

The main changes for 2003 in the consolidated companies were as follows:


	•	In February 2003, Alcatel exercised its option to put its 50% shareholding in Atlinks to Thomson, its joint venture partner. This put option was part of the initial contract signed in 1999 with Thomson. Alcatel received € 68 million. Atlinks was consolidated under the equity method and this disposal has not had a significant impact on the Group’s financial statements (see note 6).

	•	At the end of April 2003, Alcatel completed the acquisition of iMagic TV Inc, a Canadian company, which develops software products that enable service providers to create, deliver and manage digital television and media services over broadband networks. Alcatel already owned 16% of this company. The remaining 84% of the company was acquired for 3.5 million Alcatel ADSs, resulting in an acquisition price of € 26 million (based upon the market price of ADSs on the closing date). This company is consolidated from May 1, 2003. This acquisition has not had a significant impact on the accounts of Alcatel.

	•	In May 2003, Alcatel announced that it had entered into a binding agreement with Avanex to divest its optical components business. This transaction was completed on July 31, 2003. As part of this transaction, Avanex also acquired certain assets of Corning Incorporated’s photonics activities. In consideration for the assets contributed, Alcatel received 28% of the capital of Avanex, which is consolidated using the equity method. The financial results and financial position of the optical components business have been accounted for as a disposed of or discontinued operation (see note 5).

	•	In June 2003, Alcatel entered into a settlement that brought to an end its litigation against Loral and its subsidiary, Space Systems/ Loral Inc. With this agreement, Alcatel purchased Loral’s shares in the company, Europe*Star, bringing Alcatel’s stake in this company to 95% from 51%. This company, previously accounted for under the proportionate consolidation method at 51%, was fully consolidated from July 1, 2003. As a result of this change in the method of consolidation, financial debt increased by € 111 million. There was no other significant impact on the consolidated financial statements. On July 15, 2003, Loral filed for bankruptcy protection from its creditors under Chapter 11 of the United States Bankruptcy Code. Although it is not possible at this time to determine the consequences resulting from this event, Alcatel considers that its impact will not have a material effect on its financial position.

	•	In July 2003, Alcatel completed the acquisition of TiMetra Inc., a California company, specializing in IP/MPLS service routing at the network edge. All of the TiMetra shares were acquired for 18 million Alcatel ADSs, resulting in an acquisition price of € 145 million (based upon the market price of ADSs on the closing date). This company is consolidated from August 1, 2003.

In order to make comparisons easier, restated income statements, which are unaudited, are presented to take into account changes in the consolidated companies and discontinuation of the following businesses:

2003 and 2002 restated to account for dispositions in 2004:


	—	sale of the optical components business announced in May 2003 and finalized in July 2003;

	—	disposal of Saft announced in October 2003 and finalized in January 2004;

	—	disposal of the optical fiber activity announced in May 2004 and completed in July 2004;

	—	disposal of the mobile phones activity announced in April 2004 and completed in August 2004; and

F-17

ALCATEL AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


	—	disposal of the electrical power systems activity (Saft Power Systems), announced in September 2004 and completed in January 2005.

In 2003, Alcatel published restated income statements for 2002 to take account of the following dispositions:


	—	sale of the optical components business announced in May 2003 and finalized in July 2003;

	—	disposal of Saft announced in October 2003 and finalized in January 2004.

Data for 2004, 2003 and 2002 have been restated to show the results of the above businesses under the caption including disposed of or discontinued operations:


				2003			2002			2002
				restated			restated			restated
				(unaudited)			(unaudited)			(unaudited)
				for 2004			for 2004			for 2003
	2004			dispositions			dispositions			dispositions

	(In millions of euro except per share information)
Net sales		12,265			11,606			14,337			16,014
Cost of sales		(7,690	)		(7,614	)		(10,192	)		(11,708	)

Gross profit		4,575			3,992			4,145			4,306

Administrative and selling expenses		(2,010	)		(2,033	)		(2,652	)		(2,757	)
R&D costs		(1,587	)		(1,510	)		(1,958	)		(2,155	)

Income (loss) from operations		978			449			(465	)		(606	)

Interest expense on notes mandatorily redeemable for shares		(44	)		(47	)		(1	)		(1	)
Financial income (loss)		(132	)		(248	)		(1,004	)		(1,008	)
Restructuring costs		(304	)		(1,260	)		(1,168	)		(1,379	)
Other revenue (expense)		364			248			(445	)		(737	)
Income (loss) before amortization of goodwill and taxes		862			(858	)		(3,082	)		(3,731	)

Income tax		(9	)		(81	)		34			49
Share in net income of equity affiliates and discontinued operations		(97	)		(418	)		(1,149	)		(513	)

Consolidated net income (loss) before amortization of goodwill and purchase R&D		756			(1,357	)		(4,197	)		(4,195	)

Amortization of goodwill		(408	)		(407	)		(388	)		(386	)
Exceptional amortization of goodwill		—			(160	)		(142	)		(142	)
Purchased R&D		(1	)		—			—
Minority interests		(66	)		(20	)		(18	)		(18	)

Net income (loss)		281			(1,944	)		(4,745	)		(4,745	)

*Ordinary Shares*
Basic earnings per share		0.21			(1.46	)		(3.99	)		(3.99	)
Diluted earnings per share		0.21			(1.46	)		(3.99	)		(3.99	)

Note 3 — Information by business segment and by geographical area

(a) Information by business segment

The tables below present information by the following business segments; they take into account the organization put into place at the beginning of 2003, comprising three business segments, addressing three principal markets. Previously, Alcatel was organized along technology lines.

F-18

ALCATEL AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

The first two business segments, Fixed Communications and Mobile Communications, serve the telecom service provider markets and comprise:


	—	infrastructure equipment divisions responsible for network equipment and pre and post commissioning tasks; these divisions have a strong focus on network solutions in their respective markets; and

	—	a division focusing on applied solutions, which includes application software activities and which interacts with the equipment divisions.

The third business segment, Private Communications, fulfills a dual function:


	—	it is responsible for all communication markets other than telecom operator markets and is organized along vertical market segment lines covering equipment, network solutions and applied solutions; and

	—	it provides network services supporting the entire portfolio of Alcatel customers.

The segment Other includes miscellaneous businesses outside Alcatel’s core businesses, such as corporate purchasing, reinsurance and banking activities and corporate holding companies accounting mainly for corporate expenses. None of these activities are sufficiently significant to be disclosed as reportable segments.

The information by segment follows the same accounting policies as those used and described in these consolidated financial statements.

Data for 2003 and 2002 have been restated to take into account the organization put in place at the beginning of 2003 and the disposal and discontinuation of significant businesses described in note 2 and accounted for in the presentation of the restated income statements. In addition, Alcatel published data for 2002 that was restated to take into account the organization put in place in 2003 and the disposal and discontinuation of significant businesses during 2003 described in note 2. Such data for 2002 is also listed below.

Profit and loss for each reportable segment is measured using “income from operations”.


	Fixed			Mobile			Private									Total
	Communications			Communications			Communications			Other			Eliminations			Group

	(in millions of euros except for number of staff)
2004
Sales
— segments		5,131			3,301			3,965			—			—			12,397
— between segments		(34	)		(3	)		(95	)		—			—			(132	)
Net sales		5,097			3,298			3,870			—			—			12,265
Income (loss) from operations		429			401			235			(87	)		—			978
Depreciation of property, plant and equipment		(160	)		(73	)		(100	)		—			—			(333	)
Changes in operational reserves
(current assets and accrued contract costs)		41			(60	)		(29	)		—			—			(48	)
Capital expenditures		65			82			78			1			—			226
Property, plant and equipment, net		523			285			349			4			—			1,161
Operating assets^(a)		1,846			1,634			1,716			12			(72	)		5,136


(a)	Operating assets includes net inventories and work in progress, net customer receivables and advances and progress payments.

F-19

ALCATEL AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


	Fixed			Mobile			Private									Total
	Communications			Communications			Communications			Other			Eliminations			Group

	(in millions of euros except for number of staff)
2003 restated to account for dispositions in 2004 (unaudited)
Sales
— segments		5,364			2,929			3,627			16			—			11,936
— between segments		(106	)		(31	)		(192	)		(1	)		—			(330	)
Net sales		5,258			2,898			3,435			15			—			11,606
Income (loss) from operations ^(a)		155			315			123			(144	)		—			449
Depreciation of property, plant and equipment		(245	)		(71	)		(132	)		(1	)		—			(449	)
Changes in operational reserves
(current assets and accrued contract costs)		184			68			(41	)		—			—			211
Capital expenditures		52			39			47			—			—			138
Property, plant and equipment, net		655			247			497			(38	)		—			1,361
Operating assets^(b)		2,001			1,249			1,481			34			(108	)		4,657


(a)	For 2003, due to their unusual amounts, reserves on receivables, non-recurring expenses linked to the interruption of contracts and costs related to operations to be discontinued, have been reclassified under the line “other revenue (expense)” (Note 6).

(b)	Operating assets includes net inventories and work in progress, net customer receivables and advances and progress payments.


	Fixed			Mobile			Private									Total
	Communications			Communications			Communications			Other			Elimination			Group

	(in millions of euros except for number of staff)
2002 restated to account for dispositions in 2004 (unaudited)
Sales
— segments		7,284			3,351			4,109			21			—			14,765
— between segments		(198	)		(60	)		(170	)		—			—			(428	)
Net sales		7,086			3,291			3,939			21			—			14,337
Income (loss) from operations ^(a)		(686	)		248			115			(142	)		—			(465	)
Depreciation of property, plant and Equipment		(403	)		(91	)		(152	)		4			—			(642	)
Changes in operational reserves
(current assets and accrued contract costs)		503			159			112			—			—			774
Capital expenditures		112			42			87			18			—			259
Property, plant and equipment, net		1,113			309			573			34			—			2,029
Operating assets^(b)		3,355			1,547			1,829			38			(113	)		6,656


(a)	For 2002, due to their unusual amounts, reserves on receivables, non-recurring expenses linked to the interruption of contracts and costs related to operations to be discontinued, have been reclassified under the line “other revenue (expense)” (Note 7).

(b)	Operating assets includes net inventories and work in progress, net customer receivables and advances and progress payments.

F-20

ALCATEL AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


	Fixed			Mobile			Private									Total
	Communications			Communications			Communications			Other			Elimination			Group

	(in millions of euros except for number of staff)
2002 restated (unaudited) for 2003 dispositions as published in 2003
Sales
— segments		7,826			4,542			4,109			21			—			16,498
— between segments		(252	)		(62	)		(170	)		—			—			(484	)
Net sales		7,574			4,480			3,939			21			—			16,014
Income (loss) from operations ^(a)		(784	)		204			115			(141	)		—			(606	)
Depreciation of property, plant and Equipment		(515	)		(96	)		(174	)		4			—			(781	)
Changes in operational reserves
(current assets and accrued contract costs)		566			193			103			—			—			862
Capital expenditures		173			45			105			18			—			341
Property, plant and equipment, net		1,495			324			646			34			—			2,499
Operating assets^(b)		3,589			1,723			1,829			38			(157	)		7,022


(a)	For 2002, due to their unusual amounts, reserves on receivables, non-recurring expenses linked to the interruption of contracts and costs related to operations to be discontinued, have been reclassified under the line “other revenue (expense)” (Note 7).

(b)	Operating assets includes net inventories and work in progress, net customer receivables and advances and progress payments.

(b) Information by geographical segment


						Other
						Western		Rest of		Asia		North		Rest of
	France			Germany		Europe		Europe		Pacific		America		world		Consolidated

	(in millions of euros except for number of staff)
2004
Net sales
— by subsidiary location		4,394			1,189		2,302		253		1,423		1,819		885		12,265
— by geographical market		1,676			794		2,712		892		1,868		1,785		2,538		12,265
Income (loss) from operations		276			86		138		30		132		286		30		978
Property, plant and equipment, net		365			168		293		20		97		174		44		1,161
Total assets		10,280			827		2,875		202		1,944		2,271		638		19,037
2003 restated (unaudited) for 2004 dispositions
Net sales
— by subsidiary location		3,960			1,028		2,130		266		1,496		1,969		757		11,606
— by geographical market		1,439			757		2,611		857		2,083		1,833		2,026		11,606
Income (loss) from operations		(7	)		28		116		43		154		90		25		449
Property, plant and equipment, net		393			180		388		28		92		226		54		1,361
Total assets		11,853			1,014		2,714		195		1,944		2,411		534		20,665

F-21

ALCATEL AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


							Other
							Western			Rest of		Asia		North			Rest of
	France			Germany			Europe			Europe		Pacific		America			world		Consolidated

	(in millions of euros except for number of staff)
2002 restated (unaudited) for 2004 dispositions
Net sales
— by subsidiary location		4,698			1,354			2,609			390		1,648		2,666			972		14,337
— by geographical market		1,966			1,074			2,840			974		2,408		2,637			2,438		14,337
Income (loss) from operations		(146	)		(28	)		(260	)		45		122		(268	)		71		(464	)
Property, plant and equipment, net		602			229			579			41		132		369			77		2,029
Total assets		13,095			1,238			3,997			249		2,252		3,097			683		24,611
2002 restated (unaudited) for 2003 dispositions as published in 2003
Net sales
— by subsidiary location		5,811			1,481			2,756			390		1,840		2,761			975		16,014
— by geographical market		2,299			1,186			3,334			1,164		2,744		2,729			2,558		16,014
Income (loss) from operations		(260	)		(32	)		(261	)		45		131		(299	)		70		(606	)
Property, plant and equipment, net		744			252			609			41		161		448			83		2,338
Total assets		13,498			1,318			4,071			249		2,305		3,244			706		25,391

The above information is analyzed by subsidiary location, except for net sales which are also analyzed by geographical market.

Note 4 — Research and development costs


				2003
	2004			published

	(in millions of euros)
Research costs		83			218
Development costs		1,442			1,375
Customer-funded research and development		62			—

R&D costs		1,587			1,593

Customer-funded research and development		—			59
Customer design engineering costs		237			278
Capitalized development costs		32			10

R&D effort		1,856			1,940

As a percentage of sales		15.1	%		15.5	%

Customer design engineering costs represent amounts disbursed under the terms of contracts with customers and are expensed to cost of sales. Certain software development costs are capitalized. The net effect of this capitalization (being the capitalization of certain costs of the period less the amortization charge of previously capitalized costs) results in a decrease of research and development costs.

As part of the changeover to IFRS in 2005, the method of presenting research and development costs has been revised as from January 1, 2004 to better reflect the requirements of IAS 18 (Revenue) and IAS 20 (Accounting for Government Grants and Disclosure of Government Assistance).

In previous years, research and development grants and license revenues received were deducted from R&D costs, and costs incurred in respect of customer-funded research and development or research contracts were systematically recorded in cost of sales.

As a result, commencing on January 1, 2004, research and development costs are recorded gross and include research financed by institutions or carried out in the framework of research contracts.

F-22

ALCATEL AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

The purpose of changing the manner in which the research and development effort is presented is to improve the quality of the information given, to prepare for the changeover to IFRS and to be more in line with the accounting practice of Alcatel’s principal competitors.

The new method of presentation described above would have had the following impacts on Alcatel’s results for the year ended December 31, 2003 and for each quarter in 2003:


		New presentation

		Q1 2003			Q2 2003			Q3 2003			Q4 2003			December 31,
		restated			restated			restated			restated			2003 restated

		(in millions of euros)
Net sales			2,632			2,848			2,742			3,469			11,691
	of which revenue relating to R&D		15			19			25			26			85
Cost of sales			(1,765	)		(1,880	)		(1,689	)		(2,221	)		(7,555	)

Gross profit			867			968			1,053			1,248			4,136

Administrative and selling expenses			(549	)		(512	)		(482	)		(490	)		(2,033	)
R&D costs			(421	)		(409	)		(400	)		(424	)		(1,654	)

Income (loss) from operations			(103	)		47			171			334			449


		Previous presentation

		Q1 2003			Q2 2003			Q3 2003			Q4 2003			December 31,
		restated			restated			restated			restated			2003 restated

		(in millions of euros)
Net sales			2,616			2,829			2,718			3,443			11,606
	of which revenue relating to R&D		—			—			—			—			—
Cost of sales			(1,771	)		(1,898	)		(1,703	)		(2,242	)		(7,614	)

Gross profit			845			931			1,015			1,201			3,992

Administrative and selling expenses			(549	)		(512	)		(482	)		(490	)		(2,033	)
R&D costs			(399	)		(372	)		(362	)		(377	)		(1,510	)

Income (loss) from operations			(103	)		47			171			334			449

Note 5 — Financial income (loss)


	2004			2003			2002

	(in millions of euros)
Net interest (expense) income		(90	)		(102	)		(159	)
Dividends		6			4			9
Provision^(a)		39			(39	)		(669	)
Net exchange gain (loss)		(14	)		(21	)		(82	)
Financial component of the pension costs		(50	)		(70	)		(70	)
Other financial items (net)		(23	)		(14	)		(47	)

Net financial income (loss)		(132	)		(242	)		(1,018	)


(a)	Of which: € (480) million and € (171) million, respectively, represented reserves to cover guarantees issued by a member of the Group and vendor financing in 2002 and 2001.

F-23

ALCATEL AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Note 6 — Equity affiliates and disposed of or discontinued operations

Income statement


	2004			2003			2002

	(in millions of euros)
Share in net income of equity affiliates^(a)		(31	)		(12	)		(75	)
Income (loss) on disposed of or discontinued operations ^(b)		(66	)		(101	)		(32	)

Total		(97	)		(113	)		(107	)


(a)	For 2002, € (79) million related to the actual share of the net income of Thales since an estimated figure had been included in the 2001 full year results. From January 1, 2002, share in net income of Thales was taken into account only after the publication of Thales’ financial statements. 2004 information for Thales was not available at the closing date of Alcatel’s financials, so no share in net income of Thales was taken into account in the income statement for the second half of 2004.

(b)	Disposed of or discontinued operations for 2003 and 2004 are described in note 2.

The income statements of disposed of or discontinued operations for 2004, 2003 and 2002 are as follows:


	2004			2003			2002

	(in millions of euros)
Net sales^(a)		571			545			318
Cost of sales^(a)		(476	)		(412	)		(257	)

Gross margin		95			133			61

Administrative and selling expenses		(93	)		(83	)		(82	)
R&D costs		(61	)		(34	)		—

Income (loss) from operations		(59	)		16			(21	)

Net income (loss)		(66	)		(101	)		(32	)


(a)	The net sales and cost of sales represent transactions outside the Group and are therefore after elimination of intra-Group transactions.

The cash flows of disposed of or discontinued operations in 2004 and 2003 were as follows:


	2004			2003

	(in millions of
	euros)
Net income (loss)		(66	)		(101	)
Net cash provided (used) by operating activities before changes in working capital		(122	)		(3	)
Net cash provided (used) by operating activities		(246	)		(5	)
Net cash provided (used) by investing activities		(4	)		(51	)
Net cash provided (used) by financing activities		231			60	^(a)
Net effect of exchange rate changes		2			(5	)
Net increase (decrease) in marketable securities and cash		(17	)		(1	)


(a)	Alcatel Group’s Central Treasury provided financing for disposed of or discontinued activities until the date of disposal.

Disposed of or discontinued operations as of December 31, 2003 were the optical components business (Optronics France and Optronics UK, formerly Kymata) and the Saft Group.

Disposed of or discontinued operations as of December 31, 2004 were the optical fiber, mobile phone and electrical power systems businesses (see note 2).

F-24

ALCATEL AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Note 7 — Other revenue (expense)


	2004			2003			2002

	(in millions of euros)
Net capital gains (loss) on disposal of property, plant and equipment		93			199			(9	)
Net capital gains (loss) on disposal of shares		258			(95	)		296

Net capital gains (loss) on disposal of assets^(a)		351			104			287

Write-off of trade receivables and inventories^(b)		36			90			(548	)
Write-off of other assets^(c)		(22	)		(151	)		(473	)
Cost linked to the termination or disposal of activities ^(d)		—			5			(2	)
Other		(1	)		72			(94	)

Other revenue (expense)		13			16			(1,117	)

Total		364			120			(830	)


(a)	of which:


	— disposal of Vivendi, Société Générale, Thales and Thomson Multimedia shares	—	—		261
	— disposal of Nexans securities	—	—		(22	)
	— disposal of Saft shares	255
	— disposal of Alcatel Microelectronics shares	7	6		221
	— disposal of properties	66	215		—
	— disposal of optical components business	4	(76	)	—
	— miscellaneous (less than € 100 million of net value each)	19	(41	)	(164	)
(b) of which:
	— related to the Fixed Communications segment	36	74		(450	)
	— related to the Mobile Communications segment		—		—
	— related to the Private Communications segment	—	16		(98	)
(c) of which:
	— impairment of fixed assets in Fixed Communications segment	—	(126	)	(394	)
(d) of which:
	— shut-down of the LMDS activity	—	—		—
	— disposal of CPE activities	—	5		10
	— write-off of acquired technologies	—	—		(9	)
	— miscellaneous	—	—		(3	)

Note 8 — Income tax

(a) Analysis of income tax (charge) benefit


	2004			2003			2002^(a)

	(in millions of euros)
Current income tax (charge) benefit		103			(62	)		283
Deferred income tax (charge) benefit, net		(112	)		(20	)		(264	)

Income tax (charge) benefit		(9	)		(82	)		19


(a)	Due to the decision taken to carry back tax losses, mainly in France, a current income tax profit has been recorded during 2002 (see Note 30b) of which the counterpart is a charge in deferred income tax.

Given income expectations in 2002 and local tax regulations, the Group extended as from the second quarter of 2002 the scope of countries where deferred tax assets were no longer recorded. This action explains the deferred income tax charges for 2004 of € 112 million, for 2003 of € 20 million and for 2002 of € 264 million.

F-25

ALCATEL AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

As income expectations are now more favorable, deferred tax assets were recorded in Belgium in 2004 for € 44 million. These were more than offset by the write-off of deferred tax assets in other countries. The current income tax benefit recorded in 2004 related primarily to the favorable outcome of tax litigation.

Geographical origin:


	2004			2003			2002

	(in millions of euros)
France		62			7			264
Foreign		41			(69	)		19

Current income tax (charge) benefit		103			(62	)		283

France		(120	)		(27	)		(101	)
Foreign		8			7			(163	)

Deferred income tax (charge) benefit		(112	)		(20	)		(264	)

Income tax (charge) benefit		(9	)		(82	)		19

France		(33	)		(1,032	)		(1,914	)
Foreign		487			(697	)		(2,724	)

Income (loss) before tax (after amortization of goodwill)		454			(1,729	)		(4,639	)

(b) Effective income tax rate

The effective tax rate can be analyzed as follows:


	2004			2003			2002

	(in millions of euros, except
	for percentages)
Income (loss) before taxes, share in net income of equity affiliates, amortization of goodwill and purchased R&D		862			(1,151	)		(4,050	)
Average income tax rate		29.04	%		32.85	%		35.6	%

Expected tax (charge) benefit		(250	)		378			1,442

Impact of:
— reduced taxation of certain revenues^(a)		—			4			5
— utilization (unrecognized) tax loss carry forwards		(12	)		(575	)		(1,903	)
— tax credits		35			(3	)		25
— other permanent differences		218			114			450

Actual income tax (charge) benefit		(9	)		(82	)		19

Effective tax rate		1.04	%		(7.1	)%		0.5	%


(a)	Primarily capital gains on disposal of assets.

Average income tax rate is the sum of income (loss) before taxes multiplied by the local statutory rate for each subsidiary, divided by consolidated income (loss) before taxes.

F-26

ALCATEL AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(c) Deferred tax balances

Deferred tax assets (liabilities) are included in the following captions of the consolidated balance sheet:


	2004	2003	2002

	(in millions of euros)
Other accounts receivable
— deferred tax assets recognizable	6,125	6,317	6,284
— deferred tax assets not recognized	(4,473)	(4,306)	(4,128)

Total^(a)	1,652	2,011	2,156

Other payables
— deferred tax liabilities	(80)	(70)	(112)

Total^(a)	(80)	(70)	(112)

Net deferred tax assets (liabilities)	1,572	1,941	2,044


(a)	See notes 18 and 30.

The Group carries out an analysis of its deferred taxes in each country by applying to each subsidiary or tax grouping the national tax regulations, particularly those regarding tax losses carried forward.

Due to the importance of tax losses in 2002 within certain companies or tax groupings, it was decided, in the second quarter of 2002, to extend the scope of countries where deferred tax assets are no longer recorded. Moreover, deferred tax assets have been assessed based on forecasts of future tax results and Alcatel’s ability to recover those assets. Only deferred tax assets with supportable and tangible proof of recovery in the future were recorded as of December 31, 2004. Projections of future taxable results, providing support for the recording of deferred tax assets, have been restricted to a maximum time-frame of 10 years, which is significantly less than the tax loss carryforward periods available under certain countries’ tax laws.

Deferred tax assets primarily relate to tax loss carry forwards, accrued pension and retirement obligations and other non-tax deductible reserves.

The potential impact of the U.S. American Jobs Creation Act on the deferred tax assets carried in the United States is under investigation.

Deferred taxes that are not recognized because of their uncertain recovery amount to € 4,473 million, € 4,306 million, € 4,128 million respectively at December 31, 2004, 2003 and 2002.

(d) Tax losses carried forward

Total tax losses carried forward represented a potential tax saving of € 4,858 million at December 31, 2004 (€ 4,483 million at December 31, 2003 and € 4,292 million at December 31, 2002).

F-27

ALCATEL AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Tax losses carried forward expire as follows:


Years	Amount

	(in millions
	of euros)
2005		9
2006		14
2007		124
2008		80
2009 and thereafter^(a)		4,631

Total		4,858


(a)	Of which € 2,900 million with unlimited carry forward period.

Note 9 — Earnings per share

Earnings per share is calculated in compliance with IAS 33 (as revised December 2003).

Basic earnings per share is computed using the weighted average number of shares issued after deduction of the weighted average number of shares owned by consolidated subsidiaries. Regarding the Newbridge acquisition, the entire issuance of Alcatel shares is taken into account for the earnings per share calculation (including shares exchangeable within five years for ADSs).

In accordance with IAS 33 as revised (paragraph 23), the weighted average number of shares to be issued upon conversion of notes mandatorily redeemable for shares is included in the calculation of basic earnings per share for 2004, 2003 and 2002.

Diluted earnings per share takes into account share equivalents having a dilutive effect, after deducting the weighted average number of share equivalents owned by consolidated subsidiaries, but not share equivalents that do not have a dilutive effect. Net income is adjusted for after-tax interest expense relating to convertible and redeemable bonds.

The dilutive effects of stock option or stock purchase plans are calculated using the “treasury stock method”, which provides that proceeds to be received from exercise or purchase, are assumed to be used first to purchase shares at market price. The dilutive effects of notes mandatorily redeemable for shares are calculated on the assumption that the notes will be systematically redeemed for shares (the “if converted method”).

As a result of the approval received at the shareholders’ meeting held on April 17, 2003, Alcatel’s Class O shares were converted into ordinary shares on a one-for-one basis. The earnings per share amounts for the ordinary shares presented below are therefore restated to include the Class O shares, which are considered to be ordinary shares for all periods presented.

F-28

ALCATEL AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

The tables below reconcile basic earnings per share to diluted earnings per share for the three years presented:


	Ordinary shares

	Net income		Number		Per share
	(loss)		of shares		amount

	(in million of euros)
2004
Basic earnings per share		281		1,349,528,158	€	0.21
Stock option plans		—		14,133,029		—
Convertible bonds and notes mandatorily redeemable for shares		—		—		—

Diluted earnings per share		281		1,363,661,187	€	0.21

Ordinary shares:

Consolidated subsidiaries of the Group owned 61,839,627 Alcatel ordinary shares and no share equivalents.

Shares subject to future issuance:

The number of stock options not exercised as of December 31, 2004 amounted to 150,715,229 shares. Only 14,133,029 share equivalents have been taken into account for the calculation of the diluted earnings per share, as the remaining share equivalents had an anti-dilutive effect.

Furthermore, 63,192,027 new or existing Alcatel ordinary shares, which are issuable in respect of Alcatel’s convertible bonds (OCEANE) issued on June 12, 2003, have not been taken into account in the calculation of the diluted earnings per share amount due to their anti-dilutive effect.


	Ordinary shares

	Net income			Number		Per share
	(loss)			of shares		amount

	(in million of euros)
2003
Basic earnings per share		(1,944	)		1,332,364,920	€	(1.46	)
Stock option plans		—			—		—
Convertible bonds and notes mandatorily redeemable for shares		—			—		—

Diluted earnings per share		(1,944	)		1,332,364,920	€	(1.46	)

Ordinary shares:

Consolidated subsidiaries of the Group owned 62,988,536 Alcatel ordinary shares and no share equivalents.

Shares subject to future issuance:

The number of stock options not exercised as of December 31, 2003 amounted to 156,681,418 shares. These shares, subject to issuance in the future, have not been taken into account in the calculation of the diluted earnings per share amount due to their anti-dilutive effect.

F-29

ALCATEL AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


	Ordinary shares

	Net income			Number		Per share
	(loss)			of shares		amount

	(in million of euros)
2002
Basic earnings per share		(4,745	)		1,190,067,515	€	(3.99	)
Stock option plans		—			—		—

Diluted earnings per share		(4,745	)		1,190,067,515	€	(3.99	)

Ordinary shares:

Consolidated subsidiaries owned 63,333,004 Alcatel ordinary shares and no share equivalents.

Shares subject to future issuance

The number of stock options not exercised as of December 31, 2002 amounted to 101,011,736 shares. These shares, subject to issuance in the future, have not been taken into account in the calculation of the diluted earnings per share amount due to their anti-dilutive effect.

Note 10 — Goodwill, net


			2004							2003
																	2002
	Amort		Gross		Cumulative					Gross		Cumulative
Acquisitions	length		value		amortization			Net		value		amortization			Net		Net

	(in millions of euros)
CFA^(a)		20		3,614		(2,631	)		983		3,614		(2,451	)		1,163		1,344
Telettra		20		1,703		(1,362	)		341		1,703		(1,320	)		383		424
“Submarine cables” activities		20		328		(147	)		181		328		(131	)		197		213
Alcatel Submarine Networks Tel		20		865		(735	)		130		866		(722	)		144		165
Alcatel Network Systems Inc.		20		490		(385	)		105		528		(398	)		130		177
Alcatel Space		20		1,226		(401	)		825		1,236		(357	)		879		971
Thales		20		262		(91	)		171		261		(76	)		185		196
Xylan/Packet Engines		20		894		(634	)		260		964		(664	)		300		482
Alcatel Shanghai Bell		20		132		(16	)		116		142		(7	)		135		200
Spatial Wireless		—		182		—			182		—		—			—		—
Other		5 to 20		694		(402	)		292		755		(432	)		323		425

Total				10,390		(6,804	)		3,586		10,397		(6,558	)		3,839		4,597


(a)	Corresponds to the buy-back of the activities of ITT Corporation’s subsidiaries in the 1990s.

For 2004, the amortization charge amounted to € 408 million.

F-30

ALCATEL AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

In 2004, changes of gross values and amortization of goodwill were as follows:


								Other
Gross value	31/12/2003		Acquisitions		Disposal			movements			31/12/2004

	(in millions of euros)
CFA		3,614		—		—			—			3,614
Telettra		1,703		—		—			—			1,703
“Submarine cables” activities		328		—		—			—			328
Alcatel Submarine Networks Tel		866		—		—			(1	)		865
Alcatel Network Systems Inc.		528		—		—			(38	)		490
Alcatel Space		1,236		—		—			(10	)		1,226
Thales		261		—		—			1			262
Xylan/ Packet Engines		964		—		—			(70	)		894
Alcatel Shanghai Bell		142		—		—			(10	)		132
Spatial Wireless				200		—			(18	)		182
Other		755		45		(27	)		(79	)		694

Total		10,397		245		(27	)		(225	)		10,390

Other changes correspond primarily to exchange rate fluctuations and to the removal of Avanex and Saft Power Systems from the consolidated companies (see note 2).

In 2002, the Group acquired an additional 18.35% interest in the capital of Alcatel Shanghai Bell, which enabled the Group to assume control of this company in which it had held a 31.65% interest and had previously accounted for under the equity method. As a result, this entity has been fully consolidated since July 1, 2002 and final goodwill of € 142 million was booked at December 31, 2003 (€ 132 million at December 31, 2004 due to changes in the exchange rate).

Historically, Alcatel has not charged goodwill to shareholders’ equity. However, certain acquisitions have been accounted for using the pooling of interests method of accounting for stock-for-stock business combinations (provided for in article 215 of Regulation No. 99-02 of the “Comité de la Réglementation Comptable” (CRC). As a result of the changeover to International Financial Reporting Standards in 2005, this method of accounting has been abandoned beginning January 1, 2004, since it is not in compliance with the IFRS 3 reporting standard. Details of the last acquisitions completed and accounted for by this method are given below.

During the third quarter of 2002, Alcatel disposed of 10.3 million Thales shares, resulting in a decrease of € 166 million in gross goodwill and of € 39 million in cumulative amortization.

The acquisition of Telera during the second half of 2002 was financed by a capital increase. The pooling of interests method of accounting for stock-for-stock business combinations was also applied to this acquisition. As a result, € 60 million, representing the difference between the acquisition price and the net book value of Telera’s assets and liabilities acquired, was charged to shareholders’ equity.

The acquisition of Astral Point during the first six months of 2002 was financed by a capital increase. The pooling of interests method of accounting for stock-for-stock business combinations was also applied to this acquisition. As a result, € 162 million, representing the difference between the acquisition price and the net book value of Astral Point’s assets and liabilities, was charged to shareholders’ equity.

The acquisition of TiMetra during the third quarter 2003 was financed by a capital increase. The pooling of interests method of accounting for stock-for-stock business combinations was also applied to this acquisition. As a result, € 141 million, representing the difference between the acquisition price and the net book value of TiMetra’s assets and liabilities acquired, was charged to shareholders’ equity.

F-31

ALCATEL AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Other than TiMetra, the pooling of interests method of accounting for stock-for-stock business combinations was also applied to the acquisitions of Astral Point, Telera, DSC, Genesys and Newbridge.

The acquisition of Spatial Wireless during the third quarter 2004 was financed by a capital increase of € 212 million. This business combination was accounted for using the purchase method. Allocation of the cost of the combination resulted in recording € 71 million of intangible assets (acquired technologies, customer contractual relationships, etc.) and goodwill of € 200 million.


							Changes in
			2004		Exceptional		consolidated			Other
Amortization	31/12/2003		Appropriation		Amortization		companies			movements			31/12/2004

	(in millions of euros)
CFA		2,451		180		—		—			—			2,631
Telettra		1,320		42		—		—			—			1,362
“Submarine cables” activities		131		16		—		—			—			147
Alcatel Submarine Networks Tel		722		15		—		—			(2	)		735
Alcatel Network Systems Inc.		398		18		—		—			(31	)		385
Alcatel Space		357		55		—		—			(11	)		401
Thales		76		13		—		—			2			91
Xylan/ Packet Engines		664		20		—		—			(50	)		634
Alcatel Shanghai Bell		7		11		—		—			(2	)		16
Spatial Wireless		—		—		—		—			—			—
Other		432		38		—		(19	)		(49	)		402

Total		6,558		408		—		(19	)		(143	)		6,804

Other changes correspond primarily to exchange rate fluctuations and to the removal of Avanex and Saft Power Systems from the consolidated companies (see note 2).

The method applied for the goodwill impairment tests performed in 2004, 2003 and 2002 is described in note 1f.

F-32

ALCATEL AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Note 11 — Other intangible assets, net


(a)	Changes in other intangible assets


	Gross value

	Software			Other			Total

	(in millions of euros)
December 31, 2001		962			296			1,258

Additions		144			6			150
Disposals		(112	)		(18	)		(130	)
Write-offs		(57	)		(1	)		(58	)
Other movements		(308	)		(32	)		(340	)

December 31, 2002		629			251			880

Additions		104			7			111
Disposals		(128	)		(25	)		(153	)
Write-offs		—			—			—
Other movements		(24	)		(51	)		(75	)

December 31, 2003		581			182			763

Additions		148			4			152
Disposals		(21	)		(1	)		(22	)
Write-offs		—			—			—
Other movements		(37	)		110	^(a)		73

December 31, 2004		671			295			966


(a)	Other changes relate primarily to other intangible assets acquired with business combinations.

F-33

ALCATEL AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


(b)	Changes in accumulated amortization of other intangible assets


	Accumulated amortization

	Software			Other			Total

	(in millions of euros)
December 31, 2001		564			222			786

Amortization charge		192			31			223
Write-backs		(108	)		(18	)		(126	)
Write-offs and exceptional amortization charges		(12	)		8			(4	)
Other movements		(281	)		(30	)		(311	)

December 31, 2002		355			213			568

Amortization charge		111			16			127
Write-backs		(127	)		(23	)		(150	)
Write-offs and exceptional amortization charges		—			—			—
Other movements		(16	)		(50	)		(66	)

December 31, 2003		323			156			479

Amortization charge		118			9			127
Write-backs		(21	)		(1	)		(22	)
Write-offs and exceptional amortization charges		—			18			18
Other movements		(33	)		—			(33	)

December 31, 2004		387			182			569

F-34

ALCATEL AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


(c)	Changes in other intangible assets, net


	Net value

	Software			Other			Total

	(in millions of euros)
December 31, 2001		398			74			472

Additions		144			6			150
Net impact of disposals		(4	)		—			(4	)
Amortization charge		(192	)		(31	)		(223	)
Write offs and exceptional amortization charges		(45	)		(9	)		(54	)
Other movements		(27	)		(2	)		(29	)

December 31, 2002		274			38			312

Additions		104			7			111
Net impact of disposals		(1	)		(2	)		(3	)
Amortization charge		(111	)		(16	)		(127	)
Write offs and exceptional amortization charges		—			—			—
Other movements		(8	)		(1	)		(9	)

December 31, 2003		258			26			284

Additions		148			4			152
Net impact of disposals		—			—			—
Amortization charge		(118	)		(9	)		(127	)
Write offs and exceptional amortization charges		—			(18	)		(18	)
Other movements		(4	)		110			106

December 31, 2004		284			113			397

F-35

ALCATEL AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


Note 12 —	Property, plant and equipment, net


(a)	Changes in property, plant and equipment, gross


	Gross value

							Plant,
							equipment
	Land			Buildings			and tools			Other			Total

	(in millions of euros)
December 31, 2001		189			2,237			5,618			1,654			9,698

Additions		8			33			168			131			340
Disposals		(4	)		(167	)		(626	)		(230	)		(1,027	)
Write-offs		(9	)		(1	)		(85	)		(65	)		(160	)
Other changes		(11	)		11			(272	)		(343	)		(615	)

December 31, 2002		173			2,113			4,803			1,147			8,236

Additions		—			9			86			47			142
Disposals		(19	)		(229	)		(743	)		(101	)		(1,092	)
Write-offs		—			(2	)		(26	)		—			(28	)
Other changes		3			(100	)		(532	)		(312	)		(941	)

December 31, 2003		157			1,791			3,588			781			6,317

Additions		—			12			134			80			226
Disposals		(14	)		(171	)		(413	)		(69	)		(667	)
Write-offs		—			(1	)		(7	)		(5	)		(13	)
Other changes		(18	)		(302	)		(555	)		(139	)		(1,014	)

December 31, 2004		125			1,329			2,747			648			4,849

Property, plant and equipment acquired under capital leases and long-term rental arrangements account for less than 1% of the Group’s total property, plant and equipment.

F-36

ALCATEL AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


(b)	Changes in accumulated depreciation of property, plant and equipment


	Accumulated depreciation

							Plant,
							equipment
	Land			Buildings			and tools			Other			Total

	(in millions of euros)
December 31, 2001		11			1,010			3,615			860			5,496

Depreciation charge		2			111			572			102			787
Write-backs		6			(102	)		(542	)		(133	)		(771	)
Write-offs and exceptional depreciation charges		—			129			518			2			649
Other changes		—			(49	)		(298	)		(77	)		(424	)

December 31, 2002		19			1,099			3,865			754			5,737

Depreciation charge		1			124			295			58			478
Write-backs		(1	)		(75	)		(666	)		(94	)		(836	)
Write-offs and exceptional depreciation charges		3			73			127			6			209
Other changes		(1	)		(96	)		(583	)		(91	)		(771	)

December 31, 2003		21			1,125			3,038			633			4,817

Depreciation charge		1			71			224			37			333
Write-backs		(1	)		(69	)		(408	)		(65	)		(543	)
Write-offs and exceptional depreciation charges		—			(1	)		(4	)		(5	)		(10	)
Other changes		(4	)		(309	)		(519	)		(77	)		(909	)

December 31, 2004		17			817			2,331			523			3,688

F-37

ALCATEL AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


(c)	Changes in property, plant and equipment, net


	Net Value

							Plant,
							equipment
	Land			Buildings			and tools			Other			Total

	(in millions of euros)
December 31, 2001		178			1,227			2,003			794			4,202

Additions		8			33			168			131			340
Net impact of disposals		(10	)		(65	)		(84	)		(97	)		(256	)
Depreciation charges		(2	)		(111	)		(572	)		(102	)		(787	)
Write-offs and exceptional depreciation charges		(9	)		(130	)		(603	)		(67	)		(809	)
Other changes		(11	)		60			26			(266	)		(191	)

December 31, 2002		154			1,014			938			393			2,499

Additions		—			9			86			47			142
Net impact of disposals		(18	)		(154	)		(77	)		(7	)		(256	)
Depreciation charges		(1	)		(124	)		(295	)		(58	)		(478	)
Write-offs and exceptional depreciation charges		(3	)		(75	)		(153	)		(6	)		(237	)
Other changes		4			(4	)		51			(221	)		(170	)

December 31, 2003		136			666			550			148			1,500

Additions		—			12			134			80			226
Net impact of disposals		(13	)		(102	)		(5	)		(4	)		(124	)
Depreciation charges		(1	)		(71	)		(224	)		(37	)		(333	)
Write-offs and exceptional depreciation charges		—			—			(3	)		—			(3	)
Other changes		(14	)		7			(36	)		(62	)		(105	)

December 31, 2004		108			512			416			125			1,161

Note 13 — Share in net assets of equity affiliates and net assets and liabilities of disposed of or discontinued operations

(a) Equity affiliates:


	Percentage owned						Value in millions of euros

	2004		2003		2002		2004		2003		2002

Draka Comteq BV^(a)		49.9		—		—		136		—		—
TAMP^(b)		45.0		—		—		32		—		—
Avanex^(c)		—		26.2		—		—		33		—
Thales (formerly Thomson-CSF)^(d)		9.5		9.5		9.7		134		128		129
Atlinks^(e)		—		—		50.0		—		—		36
Other (less than € 50 million)		—		—		—		134		124		141

Total share of equity affiliates								436		285		306

Assets, net of liabilities, of discontinued operations^(f)								18		106		—

Total								454		391		306


(a)	Under the agreement, dated July 2, 2004, between Alcatel and Draka Holding BV concerning the business combination of the optical fiber and communication cable activities of the two groups, a new company Draka Comteq BV was created. Alcatel owns 49.9% of this new company, which is consolidated under the equity method beginning July 1, 2004 (see note 2).

F-38

ALCATEL AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


(b)	Under the agreement, dated August 31, 2004, between Alcatel and TCL Communication Technology Holdings Limited concerning the creation of a new joint venture for mobile handsets, a new company was created. Alcatel owns 45% of this company, which is consolidated under the equity method beginning September 1, 2004 (see note 2).

(c)	Under the agreement, dated July 31, 2003, between Alcatel and Avanex, providing for the disposal of Alcatel’s optical components business, Alcatel received 28% of the capital of Avanex in consideration for the assets contributed (see note 2). As a result of capital increases made by Avanex since July 31, 2003, Alcatel’s percentage ownership was reduced to 26.2% at December 31, 2003. With the partial disposal by Alcatel in December 2004 of its investment, and Alcatel’s loss of significant influence over this company, the remaining investment of 19.7% is no longer consolidated under the equity method.

(d)	Further to prior disposals, Alcatel’s stake in Thales decreased from 25.29% to 20.03% in July 2001, to 15.83% in November 2001 and to 9.7% in September 2002. Alcatel confirms nevertheless its position as the largest private shareholder of Thales, with three seats on Thales’ Board of Directors. Due to the Group’s continuing significant influence on this company, Alcatel still accounts for Thales using the equity method. At December 31, 2004, Alcatel’s stake was 9.5% (12.8% in voting rights).

(e)	Alcatel’s interest in Atlinks was sold to Thomson in February 2003 (see note 2).


(f)	Relates to disposal in progress of Saft Power Systems at December 31, 2004 and of Saft at December 31, 2003 (see note 2).

(b) Information on equity affiliates

Summarized financial information for Thales at December 31:


	2004		2003		2002

	(in millions of euros)
Balance sheet data
Non-current assets		4,033		4,276		4,680
Current assets		12,442		14,075		13,529

Total assets		16,475		18,351		18,209

Shareholders’ equity		2,097		2,014		2,139
Minority interests		50		43		29
Financial debt		2,170		2,131		2,376
Reserves and other liabilities		12,158		14,163		13,665

Total liabilities and shareholders’ equity		16,475		18,351		18,209

Income statement data
Net sales		10,288		10,569		11,105
Income from operations		619		497		447
Net income (loss)		198		112		111

Aggregated financial information for other equity affiliates as if those entities were fully consolidated:


	2004			2003			2002

	(in millions of euros)
Total assets		1,303			712			607
Shareholders’ equity		689			336			151
Net sales		712			396			295
Net income		(103	)		(91	)		(70	)

F-39

ALCATEL AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Note 14 — Other investments and miscellaneous, net

At December 31:


	2004							2003		2002

	At cost		Provision			Net value		Net value		Net value

	(in millions of euros)
Investments in:
— listed companies^(a)		271		(237	)		34		1		22
— unlisted companies		326		(184	)		142		209		245

Total		597		(421	)		176		210		267

Electro Banque/ Customer loans and advances^(b)		105		—			105		224		176
Other^(c)		1,133		(908	)		225		388		532

Total		1,835		(1,329	)		506		822		975

(a) Market value 2004: € 71 million

2003: € 8 million

2002: € 31 million


(b)	See note 29.

(c)	€ 820 million reserve on 360 Networks bonds at December 31, 2004 (€ 820 million at December 31, 2003 and 2002).

Investments in listed companies at December 31, 2004:


	%			Net		Market		Shareholders’			Net
	interest			value		value		equity			income

	(in percentage and millions of euros)
Loral^(a)		1.9	%		0		0		(721	)		(108	)
Avanex^(b)		19.7	%		33		69		100			(100	)
Other (less than € 10 million of net value)					1		2

Total					34		71


(a)	Data set forth are at September 30, 2004 for shareholders’ equity and for net income (loss) (nine months from January 1 to September 30, 2004), because financial data at December 31, 2004 were not published at the closing date of Alcatel’s financial statements.

(b)	Data set forth are at September 30, 2004 for shareholders’ equity and at June 30, 2004 for net income (loss) (12 months from July 1, 2003 to June 30, 2004), because financial data at December 31, 2004 were not available at the date of publication of Alcatel’s financial statements.

F-40

ALCATEL AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Note 15 — Operating working capital


							Change in			Translation
							consolidated			adjustments
	31/12/2003			Cash flow			companies			and other			31/12/2004

	(in millions of euros)
Inventories and work in progress, net		2,410			154			(103	)		(439	)		2,022
Receivables and related accounts, net^(a)		3,800			231			(180	)		(47	)		3,804
Advances and progress payments, net		106			(8	)		(6	)		(3	)		89
Advances and customer deposits		(1,181	)		127			1			(111	)		(1,164	)
Accounts payables and accrued expenses		(3,617	)		(90	)		287			60			(3,360	)

Operating working capital requirement — gross		1,518			414			(1	)		(540	)		1,391

Valuation allowance		(1,414	)		—			51			584			(779	)

Operating working capital requirement — net		104			414			50			44			612


(a)	Customer receivables sold without recourse amounted to € 861 million at December 31, 2004 (€ 898 million at December 31, 2003 and € 1,010 million at December 31, 2002).

Note 16 — Inventories and work in progress, net

At December 31:


	2004			2003			2002

	(in millions of euros)
Raw materials and goods		501			620			1,181
Industrial work in progress		522			589			696
Work in progress on long-term contracts		354			221			397
Finished products		645			980			1,449

Gross value		2,022			2,410			3,723

Valuation allowance		(495	)		(978	)		(1,394	)

Net value		1,527			1,432			2,329

Note 17 — Trade receivables and related accounts, net


	2004			2003			2002

	(in millions of euros)
Receivables on long-term contracts		965			744			1,268
Receivables bearing interest		155			198			462
Other trade receivables		2,684			2,858			4,078

Gross value		3,804			3,800			5,808

Valuation allowance		(284	)		(436	)		(1,092	)

Net value		3,520			3,364			4,716

F-41

ALCATEL AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Note 18 — Other accounts receivable, net

At December 31:


	2004			2003			2002

	(in millions of euros)
Advances and progress payments		89			107			147
Prepaid taxes		324			257			351
Deferred taxes		1,652			2,011			2,156
Prepaid expenses		158			234			236
Advances made to employees		30			31			21
Other accounts		576			626			1,162

Gross value		2,829			3,266			4,073

Valuation allowance		(54	)		(35	)		(36	)

Net value		2,775			3,231			4,037


Note 19 —	Marketable securities, net

Marketable securities primarily consist of investments in money market instruments, bonds and other transferable securities.

The market value of these securities was € 2,003 million at December 31, 2004, € 1,590 million at December 31, 2003 and € 473 million at December 31, 2002.

Following the disposal of 1,500,000 Nexans shares on October 30, 2002, the remaining interest of the Group in this company was reclassified as listed marketable securities at the market value on the day of the transaction, which was € 44 million. The Group believes that it no longer has a significant influence on Nexans. In 2003 and 2004, the remaining interest in Nexans has been reclassified as short-term investments for the historical value of € 44 million.

The market value of the remaining interest in Nexans was € 101 million at December 31, 2004 (€ 92 million at December 31, 2003 and € 55 million at December 31, 2002).


Note 20 —	Allocation of 2004 result

The Board of Directors will propose to the Shareholders’ Ordinary Annual General Meeting not to distribute any dividend for the year ended December 31, 2004 (distributions for previous years: no dividends were distributed for 2003 and 2002).


Note 21 —	Shareholders’ equity


(a)	Capital increase program for employees with subscription stock option plan

Under a capital increase program for employees of the Group, approved by the Board of Directors on March 7, 2001, 91,926 Class A shares were issued at a price of € 50 per share. Each share subscribed included the right to receive three options, each exercisable for one Class A share. 275,778 options were granted and are exercisable during the one-year period from July 1, 2004 until July 1, 2005 or from the end of the unavailability period set by article 163 bis C of the General Tax Code (4 years on this date), for the beneficiaries who were employees of a member of the Group whose registered office is located in France at the time the options were granted.

F-42

ALCATEL AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


(b)	Capital stock and additional paid-in capital:

At December 31, 2004, the capital stock consisted of 1,305,455,461 ordinary shares of nominal value € 2 (1,284,410,024 Class A shares of nominal value € 2 at December 31, 2003 and 1,239,193,498 Class A shares of nominal value € 2 and 25,515,000 Class O shares of nominal value € 2 at December 31, 2002).

During 2004, increases in capital stock and additional paid-in capital amounted to € 238 million. These increases related to the following actions:


	—	issuance of 1,508,728 shares for € 9.9 million, as a result of the exercise of 1,508,728 options (including additional paid-in capital of € 6.9 million);

	—	ORANE redemption of 3,212 notes issued in 2002 and redeemable for new or existing Alcatel shares, generating a capital increase of € 0.02 million, including additional paid-in capital of € 0.01 million;

	—	acquisition of Spatial Wireless in December 2004, which resulted in the issuance of 17,390,262 shares for € 207.2 million (including additional paid-in capital of € 172.4 million). In addition, of the 1,598,072 bonds redeemable for Alcatel shares issued in this transaction by Coralec (a subsidiary of Alcatel) at the price of € 11.912 to cover the exercise of options and warrants, 393,035 bonds were redeemed by the issuance of an equal number of Alcatel shares, generating a capital increase of € 4.7 million, including additional paid-in capital of € 3.9 million; and

	—	redemption of 300,000, 400,000, 50,000 and 1,000,000 bonds redeemable for Alcatel shares to cover option exercises, warrant exercises and note conversions issued in connection with the acquisitions of Astral Point in 2002, Telera in 2002, iMagic TV in 2003 and TiMetra in 2003, generating capital increases of € 4.9 million, € 2.1 million, € 0.4 million and € 8.1 million, including additional paid-in capital of € 4.3 million, € 1.3 million, € 0.3 million and € 6.1 million, respectively.

During 2003, increases in capital stock and additional paid-in capital amounted to € 157 million. These increases related to the following actions:


	—	issuance of 108,632 shares for € 0.8 million, as a result of the exercise of 108,632 options (including additional paid-in capital of € 0.6 million);

	—	acquisition of iMagic TV in April 2003, which resulted in the issuance of 3,301,322 shares for € 24 million (including additional paid-in capital of € 18 million). In addition, of the 415,922 bonds redeemable for Alcatel shares issued in this transaction by Coralec at a price of € 7.44, to cover the exercise of options and the conversion of notes, 230,000 bonds were redeemed by the issuance of an equal number of Alcatel shares, generating a capital increase of € 2 million, including additional paid-in capital of € 1 million;

	—	acquisition of TiMetra in July 2003, which resulted in the issuance of 14,378,738 shares for € 116.2 million (including additional paid-in capital of € 87 million). In addition, of the 3,601,000 bonds redeemable for Alcatel shares issued in this transaction by Coralec at the price of € 8.08 to cover the exercise of options and warrants, 1,156,196 bonds were redeemed by the issuance of an equal number of Alcatel shares, generating a capital increase of € 9.3 million, including additional paid-in capital of € 7 million;

	—	redemption of 40,000 and 485,000 bonds redeemable for Alcatel shares issued to cover options and warrant exercises in connection with the acquisitions of Astral Point in 2002 and Kymata in 2001, generating capital increases of € 0.7 million (including additional paid-in capital of € 0.6 million) and € 3.3 million (including additional paid-in capital of € 2.4 million), respectively.

F-43

ALCATEL AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


	—	redemption of 1,828 bonds issued in 2002 and redeemable for new or existing Alcatel shares, generating a capital increase of € 0.009 million, including additional paid-in capital of € 0.006 million.


(c)	Stock options:

At December 31, 2004, stock options plans were as follows:


														1999			1999-2000
	1996 Plans					1997 Plans					1998 Plan			Plans			U.S. Plans			2000 Plans

	(in number of options)
																		USD 21.40-
Exercise price		€ 12.96		€ 13.42			€ 19.27		€ 20.95			€ 20.52			€ 28.40			USD 84.88			€ 48.00		€ 48.00		€ 65.00		€ 64.00

Exercise period
From		07.01.98		07.01.98			05.01.02		12.11.02			12.09.03			09.08.04						04.01.03		07.01.03		12.13.03		12.13.01
																					04.01.05		07.01.05		12.13.05		12.13.04
To		12.31.03		12.31.03			12.31.04		12.31.04			12.31.05			12.31.05						12.31.05		06.30.04		12.31.05		12.12.08
																					12.31.07		06.30.06		12.31.07		12.12.08

Outstanding at January 1, 1996		—		—			—		—			—			—			—			—		—		—		—
Granted		9,069,500		394,000			—		—			—			—			—			—		—		—		—
Exercised		—		—			—		—			—			—			—			—		—		—		—
Forfeited		(185,000	)	—			—		—			—			—			—			—		—		—		—
Expired		—		—			—		—			—			—			—			—		—		—		—

Outstanding at December 31, 1996		8,884,500		394,000			—		—			—			—			—			—		—		—		—

Granted							8,199,500		367,000			—			—			—			—		—		—		—
Exercised		—		—			—		—			—			—			—			—		—		—		—
Forfeited		(396,000	)	(7,500	)		(115,000	)	—			—			—			—			—		—		—		—
Expired		—		—			—		—			—			—			—			—		—		—		—

Outstanding at December 31, 1997		8,488,500		386,500			8,084,500		367,000			—			—			—			—		—		—		—

Granted		—		—			—		—			11,602,500			—			—			—		—		—		—
Exercised		(2,163,950	)	(114,000	)		—		—			—			—			—			—		—		—		—
Forfeited		(30,500	)	(5,000	)		(45,000	)	(5,000	)		—			—			—			—		—		—		—
Expired		—		—			—		—			—			—			—			—		—		—		—

Outstanding at December 31, 1998		6,294,050		267,500			8,039,500		362,000			11,602,500			—			—			—		—		—		—

Granted		—		—			—		—			—			545,000			7,866,630							—		—
Exercised		(1,630,425	)	(38,250	)		(35,000	)	—			—			—			—			—		—		—		—
Forfeited		(5,000	)	—			(100,000	)	(7,500	)		(427,250	)		—			(143650	)		—		—		—		—
Expired		—		—			—		—			—			—			—			—		—		—		—

Outstanding at December 31, 1999		4,658,625		229,650			7,904,500		354,500			11,175,250			545,000			7,722,980			—		—		—		—

Granted		—		—			—		—			—			—			19,407,838			15,239,250		8,905,804		1,235,500		306,700
Exercised		(1,277,690	)	(92,750	)		(56,000	)	—			—			—			(393,296	)		(10,000	)	—		—		—
Forfeited		—		—			(112,500	)	(2,500	)		(412,000	)		(46,250	)		(3,060,818	)		(923,120	)	(47,328	)	—		—
Expired		—		—			—		—			—			—			—			—		—		—		—

Outstanding at December 31, 2000		3,380,935		136,500			7,736,000		352,000			10,763,250			498,750			23,676,704			14,306,130		8,858,476		1,235,500		306,700

Exercised		(732,728	)	(1,250	)		(15,000	)	—			—			—			(261,205	)		(3,000	)	(376	)	—		—
Forfeited		—		—			(30,000	)	—			(60,000	)		(5,000	)		(3,327,376			(161,500	)	(122,364	)	(130,150	)	(3,600	)
Expired		—		—			—		—			—			—			—			—		—		—		—

Outstanding at December 31, 2001		2,648,207		135,250			7,691,000		352,000			10,703,250			493,750			20,088,123			14,141,630		8,735,736		1,105,350		303,100

F-44

ALCATEL AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


														1999			1999-2000
	1996 Plans					1997 Plans					1998 Plan			Plans			U.S. Plans			2000 Plans

	(in number of options)
Exercised		(6,577	)	—			(1,000	)	—			—			—			—			—		—		—		—
Forfeited		(12,000	)	—			(157,500	)	(30,000	)		(306,000	)		(22,500	)		(3,871,401	)		(581,075	)	(37,684	)	(40,000	)	(5,100	)
Expired		—		—			—		—			—			—			—			—		—		—		—

Outstanding at December 31, 2002		2,629,630		135,250			7,532,500		322,000			10,397,250			471,250			16,216,722			13,560,555		8,698,052		1,065,350		298,000

Exercised		—		—			—		—			—			—			—			—		—		—		—
Forfeited		(27,500	)	—			(40,000	)	(10,000	)		(165,000	)		(17,500	)		(2,797,641	)		(320,500	)	(6,524	)	(32,500	)	(86,421	)
Expired		—		—			—		—			—			—			—			—		—		—		—

Outstanding at December 31, 2003		2,602,130		135,250			7,492,500		312,000			10,232,250			453,750			13,419,081			13,240,055		8,691,528		1,032,850		211,579

Exercised		—		—			—		—			—			—			—			—		—		—		—
Forfeited		—		—			(56,000	)	(15,000	)		(110,000	)		(10,000	)		(2,276,230	)		(174,000	)	(5,429,868	)	(11,000	)	(3,838	)
Expired		(2,602,130	)	(135,250	)		—		—			—			—			—			—		—		—		—

Outstanding at December 31, 2004		—		—			7,436,500		297,000			10,122,250			443,750			11,142,851			13,066,055		3,261,660		1,021,850		207,741


	2001 Plans

	(in number of options)
Exercise price	€ 50.00			€ 50.00			€ 41.00			€ 39.00		€ 32.00			€ 19.00			€ 9.00			€ 20.80			€ 9.30			€ 20.80

Exercise period
From		03.07.02			07.01.04			04.02.02			04.02.02		06.15.02			09.03.02			11.15.02			12.19.02			12.19.02			01.01.05
		03.07.05			07.01.05								06.15.05			09.03.05			11.15.05			12.19.05			12.19.05			01.01.06
To		03.06.09			06.30.05			04.01.09			04.01.09		06.14.09			09.02.09			11.14.09			12.18.09			12.18.09			12.31.05
		03.06.09			06.30.06								06.14.09			09.02.09			11.14.09			12.18.09			12.18.09			12.31.06

Granted		37,668,588			275,778			48,850			2,500		977,410			138,200			162,000			27,871,925			565,800			935,660
Exercised		—			—			—			—		—			—			—			—			—			—
Forfeited		(1,075,160	)		(825	)		(7,050	)		—		(19,350	)		—			—			—			—			—
Expired		—			—			—			—		—			—			—			—			—			—

Outstanding at December 31, 2001		36,593,428			274,953			41,800			2,500		958,060			138,200			162,000			27,871,925			565,800			935,660

Exercised		—			—			—			—		—			—			—			—			—			—
Forfeited		(1,271,749	)		(2,343	)		(5,500	)		—		(21,175	)		(10,300	)		(30,000	)		(2,283,225	)		(37,200	)		(16,840	)
Expired		—			—			—			—		—			—			—			—			—			—

Outstanding at December 31, 2002		35,321,679			272,610			36,300			2,500		936,885			127,900			132,000			25,588,700			528,600			918,820

Exercised		—			—			—			—		—			—			—			—			(64,444	)		—
Forfeited		(6,345,632	)		(150	)		(24,050	)		—		(119,780	)		(13,050	)		(23,000	)		(2,517,719	)		(68,750	)		(23,950	)
Expired		—			—			—			—		—			—			—			—			—			—

Outstanding at December 31, 2003		28,976,047			272,460			12,250			2,500		817,105			114,850			109,000			23,070,981			395,406			894,870

Exercised		—			—			—			—		—			—			(3,000	)		—			(42,574	)		—
Forfeited		(1,047,721	)		(240	)		—			—		(33,484	)		(8,800	)		—			(2,539,840	)		(13,326	)		(240	)
Expired		—			—			—			—		—			—			—			—			—			—

Outstanding at December 31, 2004		27,928,326			272,220			12,250			2,500		783,621			106,050			106,000			20,531,141			339,506			894,630

F-45

ALCATEL AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


	2002 Plans

	(in number of options)
Exercise price	€ 17.20			€ 16.90			€ 14.40			€ 13.30			€ 5.20			€ 3.20			€ 4.60			€ 5.40

Exercise period
From		02.15.03			04.02.03			05.13.03			06.03.03			09.02.03			10.07.03			11.14.03			12.02.03
		02.15.06						05.13.06			06.03.06			09.02.06			10.07.06			11.14.06			12.02.06
To		02.14.10			04.01.10			05.12.10			06.02.10			06.01.10			10.06.10			11.13.10			12.01.10
		02.14.10						05.12.10			06.02.10			06.01.10			10.06.10			11.13.10			12.01.10

Granted		123,620			55,750			54,300			281,000			1,181,050			30,500			111,750			54,050
Exercised		—			—			—			—			—			—			—			—
Forfeited		(14,250	)		(1,000	)		—			(17,660	)		(64,250	)		—			—			—
Expired		—			—			—			—			—			—			—			—

Outstanding at December 31, 2002		109,370			54,750			54,300			263,340			1,116,800			30,500			111,750			54,050

Exercised		—			—			—			—			(32,182	)		(853	)		(3,375	)		—
Forfeited		(20,425	)		(13,000	)		(5,250	)		(14,090	)		(165,232	)		(9,138	)		(4,250	)		(10,250	)
Expired		—			—			—			—			—			—			—			—

Outstanding at December 31, 2003		88,945			41,750			49,050			249,250			919,386			20,509			104,125			43,800

Exercised		—			—			—			—			(204,147	)		(3,165	)		(20,838	)		(3,562	)
Forfeited		(5,578	)		(6,000	)		(4,469	)		(5,771	)		(60,849	)		(3,885	)		(7,294	)		(2,000	)
Expired		—			—			—			—			—			—			—			—

Outstanding at December 31, 2004		83,367			35,750			44,581			243,479			654,390			13,459			75,993			38,238


	2003 Plans

	(in number of options)
Exercise price	€ 6.70			€ 6.70			€ 7.60			€ 8.10			€ 9.30			€ 10.90			€ 11.20			€ 11.10

Exercise period
From		03.07.04			07.01.06			06.18.04			07.01.04			09.01.04			10.01.04			11.14.04			12.01.04
		03.07.07			07.01.07			06.18.07			07.01.07			09.01.07			10.01.07			11.14.07			12.01.07
To		03.06.11			06.30.07			06.17.11			06.30.11			08.31.11			09.30.11			11.13.11			11.30.11
		03.06.11			06.30.08			06.17.11			06.30.11			08.31.11			09.30.11			11.13.11			11.30.11

Granted		25,626,865			827,348			338,200			53,950			149,400			101,350			63,600			201,850
Exercised		(7,750	)		(28	)		—			—			—			—			—			—
Forfeited		(1,583,230	)		(17,193	)		—			—			—			—			—			—
Expired		—			—			—			—			—			—			—			—

Outstanding at December 31, 2003		24,035,885			810,127			338,200			53,950			149,400			101,350			63,600			201,850

Exercised		(1,221,749	)		(111	)		(6,944	)		(473	)		(1,603	)		—			—			(562	)
Forfeited		(1,142,822	)		(605	)		(31,654	)		(23,951	)		(6,300	)		(29,376	)		(2,000	)		(37,300	)
Expired		—			—			—			—			—			—			—			—

Outstanding at December 31, 2004		21,671,314			809,411			299,602			29,526			141,497			71,974			61,600			163,988

F-46

ALCATEL AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


	2004 Plans

	(in number of options)
Exercise price	€ 13.20			€ 13.10			€ 12.80			€ 11.70			€ 9.90		€ 9.80		€ 11.20		€ 11.90

Exercise period
From		03.10.05			04.01.05			05.17.05			07.01.05			09.01.05		10.01.05		11.1205		12.01.05
		05.10.08			04.01.08			05.17.08			07.01.08			09.01.08		10.01.08		11.12.08		12.01.08
To		03.09.12			03.31.12			05.16.12			06.30.12			08.31.12		09.30.12		11.11.12		11.30.12
		03.09.12			03.31.12			05.16.12			06.30.12			08.31.12		09.30.12		11.11.12		11.30.12

Granted		18,094,315			48,100			65,100			313,450			38,450		221,300		69,600		42,900
Exercised		—			—			—			—			—		—		—		—
Forfeited		(724,065	)		(7,350	)		(2,550	)		(13,500	)		—		—		—		—
Expired		—			—			—			—			—		—		—		—

Outstanding at December 31, 2004		17,370,250			40,750			62,550			299,950			38,450		221,300		69,600		42,900

The option plans of companies that were acquired by Alcatel provide for the issuance of Alcatel shares or ADSs upon exercise of options granted under such plans in an amount determined by applying the exchange ratio used in the acquisition to the number of shares of the acquired company that were the subject of the options (see the following table).

The following table sets forth the U.S. and Canadian companies, the range of exercise prices, the number of outstanding and exercisable options as of December 31, 2004, the weighted average exercise price and the weighted average exercise period.


			Outstanding options						Exercisable options

					Weighted
					remaining		Weighted				Weighted
			Number		exercise		average		Amount		average
			outstanding at		period		exercise		exercisable at		exercise
Company	Exercise price		31/12/2004^(a)		(years)		price		31/12/2004^(a)		price

Packet Engines		USD 0.29-USD 0.86		14,372		2.89		0.50		14,372		0.50
Xylan		USD 0.05-USD 18.14		1,897,842		3.02		8.60		1,897,842		8.60
Internet Devices Inc.		USD 0.26-USD 1.17		26,480		3.83		0.89		26,480		0.89
DSC		USD 16.57-USD 44.02		110,150		1.24		30.76		110,150		30.76
Genesys		USD 0.01-USD 41.16		3,407,778		4.26		20.70		3,407,778		20.70
Newbridge		USD 11.72-USD 52.48		389,110		0.26		42.55		389,110		42.55
Astral Point		EUR 0.29-EUR 58.71		254,395		6.33		16.83		253,363		16.84
Telera		EUR 0.43-EUR 6.36		188,605		5.23		5.23		173,042		5.13
Imagic TV		EUR 2.84-EUR 64.68		130,372		2.55		15.40		95,694		17.59
TiMetra		EUR 0.53-EUR 7.97		2,172,909		5.83		5.31		1,069,286		3.80
Spatial Wireless		EUR 0.24-EUR 9.1		1,563,396		8.97		4.48		408,532		2.92

Total number of options				10,155,409						7,845,649


(a)	In number of Alcatel shares.

In the case of Astral Point, Telera, iMagic TV, TiMetra and Spatial Wireless, upon exercise, Alcatel will issue new ADSs (or, consequently, shares); the options set forth in the above table for Packet Engines, Xylan, Internet Devices, DSC, Genesys and Newbridge entitle the holders to purchase existing ADSs held by Group subsidiaries.

The option plans of Alcatel Optronics U.K. Ltd (formerly Kymata Ltd) acquired in September 2001, provided for the issuance of up to 402,595 Class O ADSs or Alcatel Class O shares at exercise prices ranging from € 0.80 to € 35.15. As part of the disposal of Alcatel’s optical components business, these stock option plans were transferred to Avanex.

F-47

ALCATEL AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Only stock option plans established after November 7, 2002 and whose stock options had not yet vested as of January 1, 2005 fall within the scope of IFRS 2 (Share-based Payment), which will be applied starting January 1, 2005.

The following schedule details the options falling within the scope of IFRS:


			Exercise period

Year	Exercise price		from		to		Number of options

2002		€ 4.60		11.14.03		11.13.10		45,281
				11.14.06		11.13.10
		€ 5.40		12.02.03		12.01.10		19,900
				12.02.06		12.01.10
2003		€ 6.70		03.07.04		03.06.11		12,079,954
				03.07.07		03.06.11
		€ 7.60		06.18.04		06.17.11		184,844
				06.18.07		06.17.11
		€ 8.10		07.01.04		06.30.11		19,356
				07.01.07		06.30.11
		€ 9.30		01.09.04		08.31.11		98,244
				09.01.07		08.31.11
		€ 10.90		10.01.04		09.30.11		56,206
				10.01.07		09.30.11
		€ 11.20		11.14.04		11.13.11		46,375
				11.14.07		11.13.11
		€ 11.10		12.01.04		11.30.11		131,288
				12.01.07		11.30.11
		€ 0.53-€ 7.97						1,011,892
2004		€ 13.20		03.10.05		03.09.12		17,370,250
				05.10.08		03.09.12
		€ 13.10		04.01.05		03.31.12		40,750
				04.01.08		03.31.12
		€ 12.80		05.17.05		05.16.12		62,550
				05.17.08		05.16.12
		€ 11.70		07.01.05		06.30.12		299,950
				07.01.08		06.30.12
		€ 9.90		09.01.05		08.31.12		38,450
				09.01.08		08.31.12
		€ 9.80		10.01.05		09.30.12		221,300
				01.10.08		09.30.12
		€ 11.20		11.12.05		11.11.12		69,600
				11.12.08		11.11.12
		€ 11.90		12.01.05		11.30.12		42,900
				12.01.08		11.30.12
		EUR 0.24-EUR 9.1						1,563,396

Total								33,402,486

F-48

ALCATEL AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(d) Distributable retained earnings

Not all consolidated retained earnings are available for the distribution of dividends, due primarily to the impact of consolidation adjustments. At December 31, 2004, Alcatel, the parent company, had distributable retained earnings of € 1,868 million. Distributable retained earnings were € 1,873 million at December 31, 2003 and € 0 million at December 31, 2002.

(e) Treasury stock

Alcatel has established a buy-back program for the ordinary shares, authorized at the shareholders’ ordinary annual general meetings held on April 18, 2002, April 17, 2003 and June 4, 2004, in order to optimize return on equity and to carry out transactions to improve earnings per share. The purchases may only relate up to a maximum of 10% of the capital stock over a period of up to 18 months from the most recent shareholders’ general meeting. As part of this program, no shares had been purchased as of December 31, 2004 (no shares had been purchased as of December 31, 2003 and 2002).

Alcatel shares owned by Group consolidated subsidiaries, which amounted to € 1,605 million at December 31, 2004 (€ 1,728 million at December 31, 2003 and € 1,734 million at December 31, 2002), are deducted at cost from retained earnings.

Note 22 — Minority interests


	(in millions
	of euros)

Balance at December 31, 2001		219

Other changes^(a)		106
Minority interests in 2002 income		18

Balance at December 31, 2002		343

Other changes		—
Minority interests in 2003 income		20

Balance at December 31, 2003		363

Other changes^(b)		(53	)
Minority interests in 2004 income		66

Balance at December 31, 2004		376


(a)	Of which € 252 million related to the consolidation of Alcatel Shanghai Bell.

(b)	This amount relates to translation adjustments and to the distribution of dividends.

Note 23 — Other equity

On December 19, 2002, Alcatel issued 120,786,517 notes, of nominal value € 5.34 each, mandatorily redeemable for new or existing shares (ORANE) (one share for one note), for a total amount of € 645 million, with a maturity date of December 23, 2005. The notes carry an annual interest rate of 7.917%. On January 2, 2003, Alcatel paid the full amount of the discounted interest, calculated from the settlement date to the maturity date at a discount rate of 7.917%, which amounted to € 1.09115 for each note.

Interest due on the ORANEs for 2004 was € 44 million.

For the repayment of the ORANEs, Alcatel may either issue new shares, use treasury shares held by consolidated companies, or shares acquired not for cash but in connection with restructuring operations.

F-49

ALCATEL AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

During 2004, 3,660 notes were repaid by issuance of 3,212 shares. In 2003, 2,338 notes were repaid by issuance of 1,828 shares. The difference in the amount of notes and shares corresponds to the reimbursement of prepaid interest by the noteholders.

Note 24 — Pensions, retirement indemnities and other post-retirement benefits

In accordance with the laws and customs of each country, the Group provides to its employees pension plans, health insurance and reimbursement of medical expenses. In France, Group employees benefit from a retirement indemnity plan. In other countries, the plans depend upon local legislation, the business and the historical practice of the subsidiary concerned.

Over and above state pension plans, the plans can be defined contribution plans or defined benefit plans. In the latter case, the plans are wholly or partially funded by assets solely to support such plans (securities, bonds, insurance contracts or other types of dedicated investments).

(1) State plans

In certain countries, and more particularly in France and Italy, the Group participates in state plans, for which contributions expensed correspond to the contributions due to the state organizations. State plans are considered to be defined contribution plans.

(2) Defined contribution plans

The benefits paid out depend solely on the amount of contributions paid into the plan and the investment returns arising from the contributions. The Group’s obligation is limited to the amount of contributions that are expensed.

(3) Defined benefit plans

Independent actuaries calculate annually the Group’s obligation in respect of these plans, using the projected unit credit method. Actuarial assumptions comprise mortality, rates of employee turnover, projection of future salary levels and revaluation of future benefits. Future estimated benefits are discounted using discount rates appropriate to each country. These plans have differing characteristics:


	—	perpetual annuity: the retirees benefit from the receipt of a pension during their retirement. These plans are to be found primarily in Germany, United Kingdom and the United States.

	—	lump-sum payment on the employee’s retirement or departure: These plans are to be found primarily in France, Belgium and Italy.

	—	post-employment medical care during retirement: in the United States, Alcatel contributes to plans that reimburse medical expenses of certain retired employees.

(a) Post-employment benefits and retirement indemnities

Post-employment benefits are determined in accordance with the accounting principles presented in note 1i).

For retirement plans, actuarial gains and losses are recognized as income or expense in accordance with the “corridor” method (net cumulative actuarial gains and losses exceeding the greater of 10% of the present value of the defined benefit obligations and 10% of the fair value of the plan assets are amortized as income or expense over the expected average remaining working lives of the employees participating in those plans).

For plans reimbursing medical expenses, the actuarial gains and losses are amortized as income or expense over the average remaining working lives of the employees participating in those plans.

F-50

ALCATEL AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

To determine actuarial valuations, actuaries have determined general assumptions on a country-by-country basis and specific assumptions (rate of employee turnover, salary increases) company by company. The assumptions for 2004, 2003 and 2002 are as follows (the rates indicated are weighted average rates):


	2004		2003		2002

Discount rate		4.46%		4.81%		5.75%
Future salary increases		3.52%		3.55%		3.72%
Expected long-term return on assets		4.70%		4.50%		4.47%
Post-retirement cost trend rate		5.00%		5.00%		NA
Average residual active life		15-27 years		15-27 years		15-27 years
Amortization period of transition obligation		NA		15 years		15 years

The above rates are broken down by geographical segment as follows for 2004, 2003 and 2002:


							Expected long-term
	Discount rate			Future salary increases			return on assets

2004
France		4.32	%		2.82	%		4.73	%
Belgium		4.30	%		5.98	%		4.00	%
United Kingdom		5.25	%		4.50	%		6.50	%
Germany		4.31	%		2.75	%		4.50	%
Rest of Europe		3.96	%		2.55	%		4.68	%
North America		5.27	%		4.76	%		5.37	%
Other		5.03	%		4.16	%		3.37	%
2003
France		4.30	%		2.25	%		3.42	%
Belgium		4.80	%		7.00	%		1.50	%
United Kingdom		5.30	%		2.60	%		6.50	%
Germany		4.80	%		3.00	%		5.81	%
Rest of Europe		4.83	%		4.27	%		4.02	%
North America		5.28	%		4.00	%		7.01	%
Other		5.12	%		4.19	%		4.92	%
2002
France		5.50	%		2.57	%		5.00	%
Belgium		6.00	%		7.00	%		1.50	%
United Kingdom		5.50	%		3.75	%		6.00	%
Germany		6.00	%		2.98	%		7.00	%
Rest of Europe		5.36	%		4.64	%		3.59	%
North America		6.50	%		4.93	%		7.40	%
Other		6.45	%		5.11	%		5.98	%

The discount rates are obtained by reference to market yields on high quality bonds having maturity dates equivalent to those of the plans.

The returns on plan assets depend upon the make-up of the investment portfolio, the maturity dates of the assets and the expected future performance.

F-51

ALCATEL AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Components of net periodic cost:


		2004			2003			2002

		(in millions of euros)
Service cost			72			96			138
Interest cost			146			153			180
Expected return on plan assets			(96	)		(95	)		(110	)
Amortization of transition obligation			—			(2	)		(2	)
Amortization of prior service cost			—			5			5
Amortization of recognized actuarial gain/(loss)			(5	)		(19	)		(11	)
Effect of curtailments			(15	)		(55	)		(35	)
Effect of settlements			—			23			23
Special termination benefits			—			1			(1	)

Effect of adjustment on net asset			2
Net periodic benefit cost			104			107			187

Of which operational costs			54			37			117
	financial costs		50			70			70

The change in the obligation recorded in the balance sheet is as follows:


	2004			2003			2002

	(in millions of euros)
CHANGE IN BENEFIT OBLIGATION
Benefit obligation at beginning of year		3,282			3,270			3,305
Service cost		72			96			138
Interest cost		146			153			180
Plan participants’ contributions		4			5			8
Amendments		(29	)		23			101
Business combinations		—			—			1
Disposals		(72	)		(36	)		(157	)
Curtailments		(14	)		(73	)		(73	)
Settlements		(19	)		(65	)		(44	)
Special termination benefits		0			1			(1	)
Actuarial loss/(gain)		41			211			139
Benefits paid		(166	)		(186	)		(250	)
Other (foreign currency translation)		(18	)		(117	)		(77	)

Benefit obligation at end of year		3,227			3,282			3,270

Benefit obligation excluding effect of future salary increases		2,886			2,825			2,852
Effect of future salary increases		341			457			418

Benefit obligation		3,227			3,282			3,270

Of which retirement plans		3,210			3,282			3,270
Of which post-employment medical care plans		17			—			—

F-52

ALCATEL AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


	2004			2003			2002

	(in millions of euros)
CHANGE IN PLAN ASSETS
Fair value of plan assets at beginning of year		2,050			2,137			2,281
Actual return on plan assets		143			91			(36	)
Employers’ contribution		84			68			103
Plan participants’ contributions		4			5			8
Amendments		(56	)		4			78
Business combinations		—			—			19
Disposals		(10	)		(5	)		(71	)
Curtailments		—			(3	)		—
Settlements		(15	)		(61	)		(83	)
Benefits paid/Special termination benefits		(108	)		(108	)		(129	)
Other (foreign currency translation)		(8	)		(78	)		(33	)

Fair value of plan assets at end of year		2,084			2,050			2,137

Present value of defined benefit obligations that are wholly or partly funded		(3,110	)		(3,120	)		(3,103	)
Fair value of plan assets		2,084			2,050			2,137

Funded status of defined benefit obligations that are wholly or fully funded		(1,026	)		(1,070	)		(966	)

Present value of defined benefit obligations that are wholly unfunded		(117	)		(162	)		(167	)

Funded status		(1,143	)		(1,232	)		(1,133	)

Unrecognized actuarial loss/(gain)		16			162			45
Unrecognized transition obligation		—			(3	)		2
Unrecognized prior service cost		—			63			70
Unrecognized surplus (due to application of asset ceiling)		(17	)		—			—

NET AMOUNT RECOGNIZED		(1,144	)		(1,010	)		(1,016	)

The unfunded status, which amounted to € 1,143 million at December 31, 2004 (€ 1,232 million at December 31, 2003 and € 1,133 million at December 31, 2002), relates primarily to France and Germany. Decisions on funding the benefit obligations are taken based on each country’s legal requirements and the tax-deductibility of the contributions made. In France and Germany, the funding of pension obligations relies primarily on defined contribution plans; setting up other funding arrangements is not common practice. Furthermore, in Germany, the benefits accruing to employees are guaranteed in the event of bankruptcy through a system of mutual insurance common to all companies involved in similar plans.

Plan assets are invested as follows:


	Private and			Equity			Marketable			Property
	public bonds			shares			securities			assets			Total

	(in millions of euros and percentage)
2002		952			597			390			198			2,137
		45	%		28	%		18	%		9	%		100	%

2003		845			546			372			287			2,050
		41	%		27	%		18	%		14	%		100	%

2004		844			555			373			312			2,084
		40	%		27	%		18	%		15	%		100	%

The investment policy relating to plan assets within the Group depends upon local practices. In all cases, the proportion of equity securities cannot exceed 80% of plan assets and no individual equity security may

F-53

ALCATEL AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

represent more than 5% of total equity securities within the plan. The equity securities held by the plan must be listed on a recognized exchange.

The bonds held by the plan must have a minimum “A” rating according to Standard & Poor’s or Moody’s rating criteria.

Marketable securities must also have a long-term minimum “A” rating according to Standard & Poor’s or Moody’s rating criteria.

b) Impact of first-time application of the CNC’s 2003-R.01 recommendation

The actuarial gains and losses linked to experience adjustments and to the effects of changes in actuarial assumptions that were recorded at December 31, 2003, have been recorded in shareholders’ equity in accordance with the option provided by the CNC in its press release dated July 22, 2004, in order to adopt the same accounting treatment that will be applied in the opening balance sheet in accordance with IFRS (International Financial Reporting Standards).

Actuarial gains and losses arising since January 1, 2004 have been recorded in accordance with the “corridor’ method, which consists of recording the actuarial differences as an adjustment to the defined benefit liability and amortizing them to income insofar as they exceed a certain threshold.

Applying this recommendation has resulted in:


	—	recording the actuarial differences at December 31, 2003, as described above, in shareholders’ equity;

	—	harmonizing the Group’s methods for calculating employee benefit obligations;

	—	recording provisions for post-employment benefits that had not been previously provided.

The impact of the first-time application of the CNC’s recommendation 2003-R01 resulted in a decrease in shareholders’ equity of € 209 million, analyzed as follows:


	(in millions
	of euros)

— Recognition in shareholders’ equity of unrecognized amounts at December 31, 2003 (unrecognized actuarial gains and losses, transition obligation and prior service costs already vested)		222
— First-time accounting for post-employment medical care plans		17
— Harmonization of the Group’s methods for the calculation of employee benefit obligations		(30	)
Total impact on Group shareholders’ equity		209

F-54

ALCATEL AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

The table below presents the principal figures for 2004, 2003 and 2002 in accordance with the 2003 accounting method and, for 2004, in accordance with the new method now adopted.


	2004

	Former
	method			New
	(unaudited)			method			2003			2002

	(in millions of euros)
Present value of funded obligations at December 31		(3,200	)		(3,227	)		(3,282	)		(3,270	)
Fair value of plan assets at December 31		2,084			2,084			2,050			2,137
Unfunded status		(1,116	)		(1,143	)		(1,232	)		(1,133	)
Actuarial gains and losses, effect of curtailments and/or settlements, transition obligation and, for 2004 only, unrecognized surplus		239			(1	)		222			117

Liability recognized in the balance sheet		(877	)		(1,144	)		(1,010	)		(1,016	)

Expense recognized in the income statement		72			104			107			187

Of which: operating expense		29			54			37			117
finance cost		43			50			70			70

Note 25 — Other reserves

(a) Balance at closing


	2004		2003		2002^(a)

	(in millions of euros)
Reserves for product sales		928		1,203		1,489
Reserves for restructuring		662		1,068		919
Reserves for litigation		97		76		—
Other reserves		591		706		893

Total		2,278		3,049		3,301


(a)	Provisions for litigation at December 31, 2002 are included in other reserves.

Reserves for product sales relate primarily to warranties, contract losses and penalties relating to commercial contracts.

In 2003, and following the CNC’s recommendation 2003-R.01, for the first time, long-service awards to employees were accounted for in other reserves (see note 1), resulting in an impact in other expense of € 34.2 million (accounted for at January 1, 2003) and a reduction in the reserve for 2003 of € 0.3 million (accounted for in income (loss) from operations).

F-55

ALCATEL AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(b) Change during 2004


												Change in
	December 31,											consolidated						December 31,
	2003		Appropriation			Utilization			Reversals			companies			Other			2004

	(in millions of euros)
Reserves for product sales		1,199		428			(337	)		(299	)		(68	)		5			928
Reserves for restructuring		1,068		368			(606	)		(64	)		(67	)		(37	)		662
Reserves for litigation^(a)		76		67			—			(43	)		—			(3	)		97
Other reserves^(b)		706		72			(44	)		(117	)		10			(36	)		591

Total		3,049		935			(987	)		(523	)		(125	)		(71	)		2,278

Effect on the income statement (net of expenses booked):
— income from operations^(a)				(505	)					376									(129	)
— financial income				(3	)					7									4
— restructuring costs				(368	)					64									(304	)
— other revenue (expense)				(46	)					28									(18	)
— taxes^(b)				(13	)					48									35

Total				(935	)					523									(412	)


(a)	Of which, € 28 million results from the reversal of a reserve made in income (loss) from operations in each of 2000 and 2001 in connection with the resolution of legal proceedings with a distributor pursuant to an arbitration award that occurred during the first half 2004.

(b)	Of which, € 48 million results from the reversal of a reserve in income taxes corresponding to the change in the estimate of a provision for tax risks.

(c) Analysis of restructuring reserves


	2004			2003			2002

	(in millions of euros)
Opening balance		1,068			919			1,113

Expensed during year		(606	)		(980	)		(1,105	)
New plans and adjustments to previous estimates^(a)		304			1,160			1,081
Effect of acquisition (disposal) of consolidated subsidiaries		(67	)		(20	)		(41	)
Currency translation adjustments and others		(37	)		(11	)		(129	)

Closing balance		662			1,068			919


(a)	In 2004, € 304 million of restructuring costs related to new plans and adjustments to previous estimates (in 2003, restructuring costs amounted to € 1,314 million, of which € 1,160 million related to new plans and adjustments to previous estimates and € 154 million related to asset write-offs).

For 2004, restructuring reserves concern primarily continuing layoffs in France, Germany and Spain.

For 2003, restructuring reserves related mainly to costs linked to continuing layoffs in France, Italy, Spain, Germany and the United States.

For 2002, the restructuring reserves related mainly to:

— Costs linked to the continuation of restructuring in the United States (carrier networking activities).

— Costs linked to the continuation of layoffs in European activities (carrier networking activities).

— Costs linked to restructuring in the optics division, mainly optronics and optical fiber.

F-56

ALCATEL AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Note 26 — Financial debt

On December 31, 2004, outstanding Alcatel bonds amounted to € 3,764 million compared to € 4,804 million a year before. This is the result of the following transactions in 2004:


				Maturing			Maturing
				in 2004			after 2004
	Total
	(in millions of euros)
• Tender offer to exchange bonds and issuance of new bonds		96			—			96
• Buy-back of bonds from the market		(617	)		(24	)		(593	)
• Repayments		(519	)		(519	)		—

Total repurchases, repayments and exchange		(1,040	)		(543	)		(497	)

(a) Analysis of debt by type


	2004		2003		2002

	(in millions of euros)
Convertible bonds		1,022		1,022		—
Bonds		2,742		3,782		5,325
Bank loans and overdrafts		411		313		244
Capital lease obligations		45		57		80
Accrued interest		139		119		134

Total		4,359		5,293		5,783

On June 12, 2003, Alcatel issued 63,192,027 bonds having a nominal value of €16.18 each, convertible into new or existing Alcatel ordinary shares (OCEANE) for a total value of € 1,022 million. These bonds mature on January 1, 2011 and bear interest at a rate of 4.75% per annum.

Changes in 2004:

• Offer to exchange bonds:

On March 17, 2004, Alcatel launched an offer to exchange bonds in a strategy primarily to lengthen its average debt maturity. On March 30, 2004, Alcatel announced that bonds with a nominal value of € 366 million, which were part of Alcatel’s 7% bond issue of € 1.2 billion, due 2006, had been exchanged by the holders for new euro bonds having a nominal value of € 412 million, due 2014. The new bonds bear interest at 6.375% per annum and produce a return of 6.49%. Additional bonds having a nominal value of € 50 million, which are interchangeable with the new bonds, were also issued. The total nominal value of the new and additional bonds, due 2014, amounts to € 462 million. The exchange offer, which closed on April 7, 2004, was recorded in the second quarter 2004. The loss arising on the exchange offer (€ 43 million) will be amortized over the life of the bonds in accordance with the requirements of IAS 39. The amortization charge for 2004 included in financial income (loss) was € 3 million.

F-57

ALCATEL AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

• Repurchases and repayments:

During 2004, certain other bonds were subject to buy-back and cancellation, amounting to € 643 million and corresponding to a nominal value of € 617 million, detailed as follows:


	Nominal value
Repurchased bonds	repurchased

5.75% FRF due February 2004	€	762,245
5% EUR due October 2004	€	22,819,000
5.875% EUR due September 2005	€	217,102,000
Zero-rate coupon due June 2006	€	111,191,052
5.625 % EUR due March 2007	€	38,874,495
7% EUR due December 2006	€	226,209,000

The difference between the repurchased amount and the nominal value was included in financial income (loss) in “other financial items (net)” (see note 5).

The other changes for 2004 were the repayment on February 17, 2004 of the residual € 183 million on € 305 million in bonds issued by Alcatel at a fixed rate of 5.75% in February 1994, and the repayment on October 12, 2004 of the residual € 336.4 million in bonds issued at a rate of 5% on October 12, 1999.

Changes in 2003

During 2003, € 987 million of bonds were repurchased and cancelled, either on the occasion of the tender offer, or as a result of selective buy-back operations.


•	2003 tender offer to repurchase bonds

Following the issuance of bonds convertible into new or existing Alcatel ordinary shares (OCEANE) referred to above, and with the aim of extending the maturity dates of its financial debt, Alcatel announced on June 16, 2003 a tender offer to bondholders to repurchase part of the bonds of three debt issues maturing in 2004 and 2005. This offer, which began on June 16, 2003, was made by way of book building by institutional investors, followed by a fixed price offer to individuals. By the expiration date of the offer, Alcatel had purchased € 352 million of bonds, having a nominal value of € 342 million. The difference between the purchase price and the nominal value has been included in financial income (loss).

The result of this offer is set out in the following table:


	Nominal value
Repurchased bonds	repurchased

5.75% FRF due February 2004	€	72,722,746
5% EUR due October 2004	€	108,912,000
5.875% EUR due September 2005	€	160,701,000

The offer closed on July 7, 2003.

F-58

ALCATEL AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Other changes in 2003:

In addition to the tender offer to repurchase bonds, certain other bonds were subject to buy-back and cancellation in 2003, amounting to € 642 million, corresponding to a nominal value of € 645 million, detailed as follows:


	Nominal value
Maturity date	repurchased

September 2003	€	287,167,000
February 2004	€	30,902,972
October 2004	€	31,855,000
September 2005	€	45,878,000
December 2006	€	110,025,000
March 2007	€	35,342,277
February 2009	€	103,250,000

The difference between the repurchased amount and the nominal value was also included in financial income (loss).

Other changes for 2003 were as follows:


	—	Repayment on September 12, 2003 of the residual € 271 million on € 600 million in floating rate bonds issued by Alcatel in September 2000,

	—	Repayment on October 22, 2003 of the residual € 284 million on € 305 million in bonds at a fixed rate of 6.375% issued by Alcatel in October 1993.

The main changes for 2002 were as follows:


	—	Repayment on March 20, 2002 of the residual Yen 28 billion (€ 243 million) on the initial Yen 30 billion bond issued by Alcatel in March 2000,

	—	Repayment on June 20, 2002 of the residual € 315 million on € 600 million in floating rate bonds issued by Alcatel in June 2000,

	—	Buy-back and cancellation of bonds in the amount of € 86 million (€ 41 million related to bonds maturing in September 2003, € 21 million related to bonds maturing in October 2003, € 17 million related to bonds maturing in February 2004 and € 7 million related to bonds maturing in February 2009).

F-59

ALCATEL AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(b) Analysis by maturity date


	2004		2003

	(in millions of
	euros)
Short-term financial debt		1,036		883

2005		—		847
2006		598		1,308
2007		194		223
2008		9		—
2009		1,018		1,010
2010 and thereafter		1,504		1,022

Long-term financial debt		3,323		4,410

Total		4,359		5,293

(c) Debt analysis by rate


	2004				2003				2002

	Before		After		Before		After		Before		After
	hedging		hedging		hedging		hedging		hedging		hedging

	(in millions of euros)
Total fixed rate debt		4,221		905		5,100		1,297		4,927		1,800
Total floating rate debt		138		3,454		193		3,996		856		3,983

Total		4,359		4,359		5,293		5,293		5,783		5,783

At December 31, 2004, the weighted average interest rate of financial debt before accounting for hedging instruments was 5.18% (5.6% as of December 31, 2003).

At December 31, 2004, the weighted average interest rate of financial debt after accounting for hedging instruments was 3.72% (4% as of December 31, 2003).

(d) Debt analysis by currency


	2004				2003				2002

	Before		After		Before		After		Before		After
	hedging		hedging		hedging		hedging		hedging		hedging

	(in millions of euros)
Euro		4,265		4,265		5,143		5,161		5,597		3,530
U.S. dollar		52		52		86		86		90		2,093
Other		42		42		64		46		96		160

Total		4,359		4,359		5,293		5,293		5,783		5,783

(e) Fair value

The fair value of Alcatel’s debt is determined for each loan by discounting the future cash flows using a discount rate corresponding to bond yields at the end of the year, adjusted by the Group’s credit rate risk. The fair value of debt and bank overdrafts at floating interest rates approximates the net carrying amounts.

At December 31, 2004, the fair value of debt before hedging (and credit spread) amounted to € 4,733 million (€ 5,574 million as of December 31, 2003). The fair value of the financial instruments that hedge the

F-60

ALCATEL AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

debt is calculated in accordance with the same method, based on the net present value of the future cash flows.

At December 31, 2004, the fair value of the debt after hedging was € 4,555 million (€ 5,409 million as of December 31, 2003).

(f) Credit rating and financial covenant

As of January 8, 2005, Alcatel credit ratings were as follows:

Rating Agency

Long-term Debt

Short-term Debt

Outlook

Last Update

Standard & Poor’s

Stable

November 10, 2004

Moody’s

Ba3

Not Prime

Positive

September 8, 2004

In 2004, Standard and Poor’s decided to revise Alcatel’s long-term debt credit rating from B+ to BB-, outlook stable and Moody’s revised its long-term rating from B1 to Ba3, maintaining an outlook positive.

Recent history of Alcatel’s long-term debt credit rating


Date	Standard & Poor’s

November 10, 2004		BB	Outlook Stable
March 10, 2004		BB-	Outlook Stable
August 11, 2003		B+	Outlook Stable
October 4, 2002		B+	Outlook Negative
July 12, 2002		BB+	Outlook Negative


Date	Moody’s

September 8, 2004		Ba3	Outlook Positive
May 10, 2004		B1	Outlook Positive
December 5, 2003		B1	Outlook Stable
November 20, 2002		B1	Outlook Negative
July 9, 2002		Ba1	Outlook Negative

Rating clauses affecting Alcatel debt at December 31, 2004

Alcatel’s short-term debt rating allows a very limited access to the commercial paper market. Alcatel’s outstanding bonds do not contain clauses that could trigger an accelerated repayment in the event of a lowering of its credit ratings. However, the € 1.2 billion bond issue maturing in December 2006 includes a “step up rating change” clause, which provides that the interest rate is increased by 150 basis points if Alcatel’s ratings fall below investment grade. This clause was triggered when Alcatel’s credit rating was lowered to below investment grade status in July 2002. The 150 basis point increase in the interest rate from 7% to 8.5% became effective in December 2002, and was first applied to the payment of the December 2003 coupon. This bond issue also contains a “step down rating change” clause that provides that the interest rate will be decreased by 150 basis points if Alcatel’s ratings move back to investment grade.

Syndicated bank credit facility

On June 21, 2004, Alcatel closed a € 1,300 million 3-year multi-currency revolving credit facility. This facility replaced the undrawn € 1,375 million syndicated facility maturing in April 2005 that was put in place on April 9, 2002 (for an initial amount of € 2,075 million, of which € 700 million matured within one year).

The availability of this syndicated credit facility of € 1,300 million is not dependent upon Alcatel’s credit ratings. At December 31, 2004, the credit facility had not been drawn and remained undrawn at the date of approval of the 2004 financial statements by Alcatel’s Board of Directors. Alcatel’s ability to draw on this facility is conditioned upon its compliance with certain financial covenants. The facility contains two financial covenants, the first is a gearing ratio (net debt/equity including minority interests) and the second is a ratio linked to the capacity of Alcatel to generate sufficient cash to repay its net debt. Alcatel was in compliance with these financial covenants at December 31, 2004, 2003 and 2002. As the Group had cash and cash

F-61

ALCATEL AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

equivalents in excess of its gross financial debt at December 31, 2004 and December 31, 2003, the above-mentioned ratios were not applicable at these dates.

Note 27 — Market-related exposures

The Group has a centralized treasury management in order to minimize the Group’s exposure to market risks, including interest rate risk, foreign exchange risk, and counterparty risk. The Group uses derivative financial instruments having off balance sheet risk characteristics to manage and reduce its exposure to fluctuations in interest rates and foreign exchange rates.

All of Alcatel’s debt is issued in euros. Interest rate derivatives are used primarily to convert fixed rate debt into floating rate debt.

Firm commercial contracts or other firm commitments are hedged by forward foreign exchange transactions, while commercial bids, which are not firmly committed, are hedged by currency options. The duration of such bids does not usually exceed 18 months.

Because of the diversity of its customers and their diverse geographical locations, management believes that the credit risk relating to customers is limited and that there is no risk of significant credit concentration.

A — Interest rate risk

Derivative financial instruments held at December 31, 2004 are intended to reduce the cost of debt and to hedge interest rate risk. As of December 31, 2004 and 2003, outstanding interest rate derivatives have the following characteristics:

(a) Outstanding interest rate derivatives at December 31, 2004

Analysis by type and maturity date


		2004

		Contract notional amounts
		Maturity date											2003

		Less than		1 to		After				Market					Market
		one year		5 years		5 years		Total		value			Total		value

		(in millions of euros)
Interest rate swaps
	Pay fixed rate		727		3,312		49		4,088		27			1,707		(42	)
	Pay floating rate		1,190		5,547		548		7,285		149			5,563		204
Caps
	Buy		1,482		2,247		—		3,729		13			14,606		3
	Sell		981		1,990		—		2,971		(11	)		13,824		—
Floors
	Buy		367		—		—		367		2			9,452		100
	Sell		367		—		—		367		(2	)		9,452		(100	)
Forward rate agreements
	Buy		—		—		—		—		—			600		(1	)
	Sell		—		—		—		—		—			600		1
Options on interest rate swaps USD Libor
	Buy		—		—		—		—		—			871		7
	Sell		—		—		—		—		—			871		(7	)

Total market value											178					165

F-62

ALCATEL AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(b) Interest rate sensitivity

Interest rate sensitivity in terms of financial cost

An immediate increase in interest rates of 1%, applied to financial assets and liabilities and related hedging instruments, would decrease interest expense by € 14 million for 2004 (€ 15 million for 2003).

Interest rate sensitivity in terms of mark-to-market

An increase of 1% in the interest rate curve, applied to financial debt and related hedging instruments, would have a positive impact of € 50 million on the market value of the financial debt in 2004 (€ 62 million in 2003).

B — Currency risk

The financial instruments held or issued at December 31, 2004 are hedges of exchange risks arising from payables or receivables, either commercial or financial, and known future transactions as of the year-end. The latter mainly relate to commercial bids expressed in foreign currency. Most of the currency derivatives mature within one year.

At December 31, 2004, off balance sheet financial instruments held to manage currency risk were as follows:

Outstanding currency derivatives at December 31


	2004											2003

	U.S.		Pound						Market					Market
	dollar		sterling		Other		Total		value			Total		value

	(in millions of euros)
Buy/Lend currency
Forward exchange contracts		784		232		706		1,722		(37	)		2,146		(74	)
Short-term exchange swaps		—		80		52		132		(2	)		163		(6	)
Cross currency swaps		—		—		—		—		—			19		(6	)
Currency option contracts:
— Buy call		634		669		103		1,406		18			2,372		140
— Sell put		460		1,174		1,019		2,653		(72	)		1,388		(55	)

Total		1,878		2,155		1,880		5,913		(93	)		6,088		(1	)

Sell/Borrow currency
Forward exchange contracts		2,204		338		382		2,924		177			3,165		235
Short-term exchange swaps		264		13		108		385		5			807		27
Cross currency swaps		—		—		—		—		—			73		27
Currency option contracts:
— Sell call		660		629		166		1,455		(17	)		2,304		(146	)
— Buy put		776		1,209		1,047		3,032		86			1,917		73

Total		3,904		2,189		1,703		7,796		251			8,266		216

Total market value										158					215

Most of the currency derivatives entered into have a maturity of less than one year.

F-63

ALCATEL AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

C — Fair value of cash and cash equivalents, net of financial debt


	2004						2003

	Carrying			Fair			Carrying			Fair
	value			value			value			value

							(in millions of
							euros)
Assets
Short term investments and cash and cash equivalents		5,099			5,160			6,269			6,317
Liabilities
Convertible bonds		(1,022	)		(1,219	)		(1,022	)		(1,148	)
Bonds and notes issued		(2,742	)		(2,913	)		(3,782	)		(3,929	)
Other borrowings		(595	)		(601	)		(489	)		(497	)
Interest rate derivatives		0			178			—			165

Cash and cash equivalents, net of financial debt		740			605			976			908

Currency derivatives		0			158

The fair value of listed financial instruments is based on the quoted market price on the last trading day of the year.

Fair values of non-listed financial instruments were estimated using one or more valuation models that incorporate observable or quantifiable market information. As a result of the subjective nature and the limitations of such estimates, the values presented for non-listed financial instruments may differ from the values that could have been obtained at December 31, 2004 in the event of a sale. The fair values used were based on market conditions existing at December 31, 2004. Minor changes in assumptions concerning those market conditions could have a material effect on the estimated values.

Methods and assumptions used to estimate the fair value of gross financial debt are described in note 26 e.

For non-listed investments and cash, the carrying amount is considered as a reasonable estimate of fair value.

Fair values of currency and interest-rate derivatives were obtained by calculating the discounted value of firm or expected future cash flows, based on market conditions observed at December 31, 2004.


	Instruments used to manage interest rates:

The fair values of these instruments have been obtained by discounting the future estimated interest differential cash flows, at the current market interest rate at the end of 2003. For option-type instruments, the fair values have been estimated by obtaining a market price from a third party bank and/or models widely used by the financial community.


	Currency swaps:

The fair values have been estimated as the difference between the current, year-end rate and the future rate specified in the swap agreement.


	Currency and interest rate swaps:

The estimate of fair value involves splitting the swap into its borrowing and lending elements and discounting the future expected currency cash flows relating to each element. The present values calculated have been converted at the year end rate and netted to give an estimated fair value.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


	Currency options:

The fair values have been estimated by requesting the price of an option to exactly close out the position held from a third party bank or by using a well-known quotation software.


	Investments:

For non-listed investments, the estimated fair value is given as the Group’s share of the net asset value.


	Fixed rate bonds and notes:

The fair values are based on expected future cash flows discounted at the current market rate on similar bond issues.


	Floating rate bonds and notes:

The fair value is estimated assuming that the value is par at the next rate fixing date and discounting the par value, and the interest element until the next rate fixing date, at the current market rate.


	Cash and short-term investments:

For the assets, the carrying amount is a reasonable estimate of fair value.


	Borrowings:

The fair values of Alcatel’s borrowings are estimated on the basis of the range of interest rates and maturity profile compared with market rates available for debt of similar remaining maturities.

D — Stock market risk

Alcatel and its subsidiaries are not engaged in speculative trading in the stock markets. Subject to approval by Alcatel, subsidiaries may make equity investments in selected companies (see note 14).

At December 31, 2004, no transactions are in progress on Alcatel shares or on other shares held by Alcatel.

Note 28 — Customers’ deposits and advances


	2004		2003		2002

	(in millions of euros)
Advance payments received on long-term contracts		637		842		1,024
Other deposits and advances received from customers		527		339		458

Total customers’ deposits and advances		1,164		1,181		1,482

Note 29 — Debt linked to the bank activity

2004

2003

2002

(in millions of euros)

Debt linked to the bank activity

105

224

246

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

This debt corresponds to the amount of customer loans and advances presented under the captions “Other investments” and “Other accounts receivable”:


	—	2004: “Other investments” were € 105 million (note 14)

	—	2003: “Other investments” were € 224 million (note 14).

	—	2002: “Other investments” were € 176 million (note 14) and under “Other accounts receivable” were € 70 million.

Note 30 — Other payables

Analysis is as follows:


	2004		2003		2002

	(in millions of euros)
Accrued payables and other		825		1,330		2,354
Wages, salaries and other social payables		839		913		1,001
Accrued taxes		449		361		380
Deferred taxes		80		71		112
Dividends to be paid		4		—		—
Government grants		41		45		48

Total		2,238		,720		3,895

Note 31 — Contractual obligations and disclosure related to off balance sheet commitments

(a) Contractual obligations

The following table presents minimum payments that the Group will have to make in the future under contracts and firm commitments. Amounts related to financial debt and capital lease obligations are fully reflected in the consolidated balance sheet.


	Maturity date

	Less than						After
Contractual cash obligations	one year		1-3 years		4-5 years		5 years		Total

	(in millions of euros)
Financial debt (excluding capital leases)		1,031		752		1,027		1,504		4,314
Capital lease obligations		5		40		—		—		45

Sub-total — included in Balance Sheet		1,036		792		1,027		1,504		4,359

Operating leases		104		160		118		164		546
Commitments to purchase fixed assets		28		—		—		—		28
Unconditional purchase obligations^(a)		161		59		1		—		221

Sub total — Commitments		293		219		119		164		795


(a)	Other firm commitments result mainly from purchase obligations under multi-year supply contracts linked to the sale of businesses to third parties.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Rental expense (excluding capital lease rental payments) is as follows:


	2004			2003		2002

	(in millions of euros)
Minimum rentals		49			47		116
Indexed rentals		61			88		46
Sublease rentals		(5	)		—		—

Total		105			135		162

(b) Off balance sheet commitments

Off balance sheet commitments of the Group were primarily as follows:


	—	certain guarantees given to the Group’s customers for contract execution (performance bonds, guarantees on advances received issued by financial institutions...);

	—	guarantee relating to the maximum intra-day bank overdraft allowed for Group subsidiaries under the Group’s cash pooling agreement with certain banks;

	—	guarantees given under securitization programs or on sale of receivables (see description below).

Alcatel does not rely on special purpose entities to deconsolidate these risks.


	2004		2003		2002

	(in millions of euros)
Guarantees given on contracts made by entities within the Group or by non-consolidated subsidiaries		1,742		2,106		2,787
Discounted notes receivable and other		5		25		14
Other contingent commitments		793		702		833

Sub-total — Contingent commitments		2,540		2,833		3,634

Debt security interests granted and other debt guarantees		156		157		262
Guarantees on cash pooling		605		652		807

Total		3,301		3,642		4,703

No material commitments are omitted from this note 31 in accordance with current accounting practice.

Contingent commitments


	Deadline

	Less than						After
Contingent commitments	one year		1-3 years		4-5 years		5 years		Total

	(in millions of euros)
Guarantees on Group contracts^(a)		1,188		197		47		52		1,484
Guarantees on third party contracts		168		70		14		6		258
Discounted notes receivable and other		3		1		—		1		5
Other contingent commitments		342		58		213		180		793

Total		1,701		326		274		239		2,540

Counter guarantees received		301		87		12		4		404


(a) Reflected in balance sheet	478

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

The amounts reflected in the preceding table represent the maximum potential amounts of future payments (undiscounted) that the Group could be required to make under current guarantees granted by the Group. These amounts are not reduced by any amounts that may be recovered under recourse provisions in the guarantees or guarantees given by customers for the Group’s benefit, which are included in the “counter guarantees received” line.

Commitments related to product warranties, pension and end-of-career indemnities are not included in the preceding table. These commitments are fully reflected in the financial statements. Contingent liabilities arising out of litigation, arbitration or regulatory actions are not included in the preceding table with the exception of those linked to Group long-term contracts. For more information concerning litigation, see note 34. Potential commitments linked to the inclusion in French law of the European Directive on Waste Electrical and Electronic Equipment, which will only be applicable as from August 2005, are also not included.

Guarantees given on Group long-term contracts consist of performance bonds issued by financial institutions to customers and bank guarantees given to secure advance payments received from customers (excluding security interests and restricted cash which are indicated in the table “Guarantees granted on borrowings and advance payments received such as security interests” of this note). Alcatel gives guarantees related to advances and payments received from customers, or commits to indemnify the customer, if the subsidiary contractor does not perform the contract in compliance with the terms of the contract. In the event that, due to occurrences, such as delay in delivery or litigation related to failure in performance on the underlying contracts, it becomes likely that Alcatel will become liable for such guarantees, the estimated risk is reserved for on the consolidated balance sheet under the caption “product sale reserves” (see note 25) or in inventory reserve. The amounts concerned are given in the preceding table in the specific line item “(1) Reflected in balance sheet”.

Commitments related to contracts that have been cancelled or interrupted due to the default or bankruptcy of the customer are included in the above-mentioned “Guarantees on Group contracts” as long as the legal release of the guarantee has not been obtained.

Additionally, most of the performance guarantees given to Group customers are insured. The evaluation of risk related to guarantees should take into account the insurance proceeds that may be received in case of a claim.

Guarantees given on third party long-term contracts could contingently require the Group to make payments to the guaranteed party based on a non-consolidated company’s failure to perform under an agreement. The fair value of these contingent liabilities, corresponding to the premiums received by the guarantor for issuing the guarantees, was € 3 million at December 31, 2004 (€ 3 million at December 31, 2003 and € 5 million at December 31, 2002).

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Guarantees granted on debt, advance payments received and security interests granted


	Deadline

	Less than						After 5
Guarantees on borrowings and advance payments received	one year		1-3 years		4-5 years		years		Total

	(in millions of euros)
Security interests granted		6		—		—		4		10
Other guarantees given		103		4		9		30		146

Total		109		4		9		34		156

Net book value of assets given in guarantee:
— financial assets		—		—		—		4		4
— other assets		6		—		—		—		6

Guarantee on cash pooling

Not included in the preceding table is a guarantee granted to the banks that implement the Group cash pooling. This guarantee covers the risk involved in any debit position that could remain outstanding after daily transfers between Alcatel Central Treasury’s accounts and the Group subsidiaries’ accounts. As of December 31, 2004, this guarantee was valued at € 0.6 billion (€ 0.7 billion as of December 31, 2003 and € 0.8 billion as of December 31, 2002).

Other specific commitments linked to significant operations

SVF trust program

In 1999, Alcatel launched a vendor financing securitization program, called the SVF trust, which was amended in May 2003, following previous amendments in June 2000 and May 2002.

As Alcatel does not own any equity share in the trust, the SVF trust was not consolidated within the Group’s accounts in accordance with the “Comité de la Réglementation Comptable” Regulation 99-02. However, in accordance with new financial regulations, which are applicable from the first financial accounting year beginning after August 2, 2003, the SVF trust is consolidated with the Group’s accounts starting January 1, 2004.

In April 2004, as part of a reassessment of its financing requirements and credit facilities and with a view to optimizing its financial costs, Alcatel decided to cancel this securitization program. As a result, the banks no longer have any financing commitments in this respect and Alcatel bought back from the SVF trust all outstanding receivables at nominal value during the second quarter 2004. The cancellation of the program did not have a significant impact on the results and financial position of the Group.


	Sale of carry-back receivable

In May 2002, Alcatel sold to a credit institution a carry-back receivable with a face value of € 200 million resulting from Alcatel’s decision to carry back 2001 tax losses. The cash received from this sale was € 149 million, corresponding to the discounted value of this receivable that will mature in five years. The difference between the net cash proceeds and the nominal value is being recorded over the five-year period as a financial expense. The financial expense for 2004 amounted to € 10 million.

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

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


	Securitization of customer receivables

In December 2003, Alcatel entered into a securitization program for the sale of customer receivables without recourse. Eligible receivables are sold to a special purpose vehicle, which benefits from a subordinated financing from the Group representing an over-collateralization determined on the basis of the portfolio of receivables sold. This special purpose vehicle is fully consolidated in accordance with paragraph 10052 of the “Comité de la Réglementation Comptable” Regulation 99-02. The receivables sold at December 31, 2004, which amounted to € 82 million (€ 54 million at December 31, 2003), are therefore maintained in the consolidated balance sheet. At December 31, 2004, the maximum amount of receivables that can be sold amounted to € 150 million, representing a credit line available to the Group. This amount can be increased to € 250 million. The purpose of this securitization program is to optimize the management and recovery of receivables in addition to providing extra financing.

Note 32 — Related party transactions

The definition of related parties retained by the Group, effective January 1, 2003, is that of IAS 24 (revised in December 2003).

Management is not aware of any shareholder holding more than 5.22% of the parent company’s share capital.

Transactions with related parties during 2004 and 2003 were as follows:


	2004			2003

	(in millions
	of euros)
Net sales of goods and services
— Non-consolidated affiliates		42			47
— Equity affiliates		11			10
Cost of sales
— Non-consolidated affiliates		(67	)		29
— Equity affiliates		(4	)		6

Outstanding balances arising from related party transactions at December 31, 2004 and 2003 were as follows:


	2004			2003

	(in millions of euros)
Assets:
— Non-consolidated affiliates		41			23
— Equity affiliates		14			4
— Valuation allowances		(6	)		(5	)
Other liabilities:
— Non-consolidated affiliates		(20	)		56
— Equity affiliates		(15	)		7
Financial debt:
— Non-consolidated affiliates		(11	)		5
— Equity affiliates		(31	)		17

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ALCATEL AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Key management personnel being members of the Group’s executive committee are listed in the Corporate Governance section of the Annual Report. In 2004, the total compensation paid to members of the executive committee was as follows:


	2004		2003

	(in millions of euros)
Salary and benefits in kind paid		11.6		7.5


	2004		2003

	(in number of options)
Stock options granted		1,355,000		1,396,256

Note 33 — Payroll, staff and staff training rights

(a) Payroll and staff training rights


		2004		2003		2002

		(in millions of euros and
		number of staff)
Wages and salaries (including social security / pension costs)			3,740		4,004		5,488
	of which remuneration of executive officers^(a)		11.6		7.5		7.7
Staff training rights in hours^(b)			312,400		60,486		75,940


(a)	Compensation paid for the full year to the 11 members of the Senior Management as of December 31, 2004 because of their functions in Alcatel or in consolidated companies.

(b)	Cumulated number of training hours acquired by staff (French companies only) at December 31, 2004. No staff requests for training had been received at December 31, 2004.

(b) Staff


	2004			2003			2002

	(in number of staff)
Fixed communications		18,446			26,502			36,104
Mobile communications		15,350			14,110			14,816
Private communications		21,367			19,282			24,314
Other		555			592			706

Total		55,718			60,486			75,940

France		16,161			18,989			25,282
Germany		5,951			7,381			8,561
Other Western Europe		10,401			11,285			15,915
Rest of Europe		1,517			1,694			2,298
Asia Pacific		8,338			8,716			8,960
North America		8,783			9,075			10,788
Rest of world		4,567			3,346			4,136

Total		55,718			60,486			75,940

of which Executives and senior technical staff^(a)		61	%		55	%		53	%


(a)	Executives, senior technical staff and positions normally requiring a minimum of three years of higher education.

F-71

ALCATEL AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Note 34 — Contingencies

In addition to legal proceedings incidental to the conduct of its business (including employment-related collective actions in France and the US) which management believes are adequately reserved against in the financial statements or will not result in any significant costs to the Group, Alcatel is involved in the following legal proceedings:

France Telecom

Since 1993, a legal investigation has been ongoing concerning “overbillings” which are alleged to have been committed in Alcatel CIT to the detriment of its principal client, France Telecom, based on an audit of production costs conducted in 1989 in the transmission division, and in 1992 in the switching division: in the latter it was recognized that parties’ dispute on pricing did not involve fraud by Alcatel CIT. Two settlement agreements were entered into with France Telecom, one in 1993 in relation to the transmission division, and the other in May 2004 in relation to the switching activity: in the latter it was recognized that the parties’ dispute on pricing did not involve fraud by Alcatel CIT.

In April 1999, Alcatel learned that the criminal investigation had been extended to determine whether corporate funds of Alcatel CIT and Alcatel had been misused. As a consequence, both Alcatel CIT and Alcatel filed civil complaints to preserve their rights with respect to this investigation.

In January 2000, the investigating magistrate declared his investigation closed. Since then, the file has been the subject of several procedural developments, including appeals relating to the closing of the investigation phase with respect to a former employee of Alcatel CIT, who has been indicted. At the end of November 2004, the investigating magistrate again declared his investigation closed, following which three other indicted defendants took new procedural steps. It is therefore unlikely that the investigating magistrate will be able to close his investigation before June 2005 at the earliest.

Class A and Class O shareholders

Several purported Class action lawsuits have been filed since May 2002 against Alcatel and certain of its officers and directors challenging the accuracy of certain public disclosures that were made in the prospectus for the initial public offering of Alcatel Class O shares and in other public statements regarding market demand for the former Optronics division’s products.

The lawsuits purport to be brought on behalf of persons who (i) acquired Alcatel Class O shares in or pursuant to the initial public offering of the American Depositary Shares conducted by Alcatel in October 2000, (ii) purchased Alcatel Class A and Class O shares in the form of ADSs between October 20, 2000 and May 29, 2001 and (iii) purchased Alcatel Class A shares in the form of ADSs between May 1, 2000 and May 29, 2001. Amount of damages sough by these lawsuits has not yet been specified.

The actions have been consolidated in the United States District Court, Southern District of New York. Alcatel is conducting a vigorous defense and denies any liability or wrongdoing with respect to this litigation. Alcatel filed a motion to dismiss this action on January 31, 2003 and a decision on the motion was rendered on March 4, 2005. The judge rejected a certain number of the plaintiffs’ demands with prejudice. He also rejected all the remaining claims under the federal securities laws for lack of specificity in the pleadings, but with leave to file a further amended complaint.

Costa Rica

Beginning in early October 2004, Alcatel learned that investigations had been launched in Costa Rica by the Costa Rican Attorney General and the National Congress, regarding payments alleged to have been made by a consultant on behalf of an Alcatel subsidiary to various state and local officials in Costa Rica, two

F-72

ALCATEL AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

political parties in Costa Rica and representatives of ICE, the state owned telephone company, in connection with the procurement by the Alcatel subsidiary of several contracts for network equipment and services from ICE. Upon learning of these allegations, Alcatel immediately commenced and is continuing an investigation into this matter.

In Costa Rica and other countries, Alcatel retains consultants to assist it with its local operations and contracts. Alcatel’s contracts with persons through whom Alcatel deals locally strictly prohibit the provision of any pecuniary or other advantage in contravention of applicable laws. In addition, Alcatel has a strict Statement of Business Practice (a copy of which is available on its web site, www.alcatel.com, under the heading Sustainable Development — Values and Charters) that imposes the highest standards of legal and ethical conduct on its employees. Alcatel rigorously enforce this Statement of Business Practice across the entire company and, when violations occur, Alcatel take prompt and appropriate action against the persons involved.

Alcatel has terminated the employment of the president of Alcatel de Costa Rica and a vice president-Latin America of a French subsidiary. Alcatel is also in the process of pursuing criminal actions against the former president of Alcatel de Costa Rica, the local consultants and the employee of the French subsidiary based on its suspicion of their complicity in an improper payment scheme and misappropriation of funds. The contracts with the local consultants were limited to the specific projects involved and are no longer in effect or have been terminated, and any payments due under those contracts have been suspended. Alcatel’s internal investigation is continuing.

Alcatel contacted the United States Securities and Exchange Commission and the United States Department of Justice and informed them that Alcatel will cooperate fully in any inquiry or investigation into these matters. The SEC is conducting an inquiry into the allegations. If the Department of Justice or the SEC determines that violations of law have occurred, it could seek civil or, in the case of the Department of Justice, criminal sanctions, including monetary penalties against Alcatel. Neither the Department of Justice nor the SEC has informed Alcatel what action, if any, they will take.

Several investigations have been launched in Costa Rica concerning this matter by both the Costa Rican Attorney General and the Costa Rican National Congress. On November 25, 2004, the Costa Rican Attorney General’s Office commenced a civil lawsuit against Alcatel CIT to seek compensation for the pecuniary damage caused by the alleged payments described above to the people and the Treasury of Costa Rica, and for the loss of prestige suffered by the Nation of Costa Rica. On February 1, 2005, ICE commenced a lawsuit against Alcatel CIT to seek compensation for the pecuniary damage caused by the alleged payments described above to ICE and its customers, and for the tarnishment to the reputation of ICE resulting from these events. The amount of damages sought by these lawsuits has not yet been specified. Alcatel intends to defend these actions vigorously and deny any liability or wrongdoing with respect to these litigations.

Alcatel is unable to predict the outcome of these investigations and civil lawsuit and their effect on our business. If the Costa Rican authorities conclude criminal violations have occurred, Alcatel may be banned from participating on public contracts within Costa Rica for a certain period and fines or penalties may be imposed on Alcatel, in an amount which Alcatel is not able to determine at this time. Alcatel expects to generate approximately € 9 million in revenue from Costa Rican contracts in 2005. Based on the amount of revenue received from these contracts, Alcatel does not believe a loss of business in Costa Rica would have a material adverse effect on Alcatel as whole. However, these events may have a negative impact on the image of its company in Latin America.

Taiwan

Certain employees of Alcatel Taisel, a Taiwanese subsidiary of Alcatel, and Siemens Taiwan, along with a few suppliers and a legislative aide, have been the subject of an investigation by the Taipei Investigator’s

F-73

ALCATEL AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Office of the Ministry of Justice relating to an axle counter supply contract awarded to Alcatel Taisel by Taiwan Railways in 2003. It has been alleged that persons in Alcatel Taisel and Siemens Taiwan and subcontractors hired by them were involved in a bid rigging and payment arrangement for the Taiwan Railways contract.

Upon learning of these allegations, Alcatel immediately commenced and is continuing an investigation into this matter. Alcatel terminated the former president of Alcatel Taisel. A director of international sales and marketing development of a German subsidiary who was involved in the Taiwan Railways contract has resigned and is under ongoing investigation by the Taiwanese authorities.

On February 21, 2005, the former president of Alcatel Taisel and Alcatel Taisel were indicted for violation of the Taiwanese Government Procurement Act. If the former country senior officer is found guilty of the allegations in the indictment, Alcatel Taisel may be banned from participating in governmental contracts within Taiwan for a certain period and fines or penalties may be imposed on Alcatel, in an amount not to exceed € 25,000. As a group, Alcatel expects to generate approximately € 80 million in all or part of this revenue from Taiwanese contracts in 2005. Based on the amount of revenue received from these contracts, Alcatel does not believe a loss of business in Taiwan would have a material adverse effect on Alcatel as whole.

Effect of the investigations. Alcatel reiterates that its policy is to conduct its business with transparency, and in compliance with all laws and regulations, both locally and internationally. Alcatel will fully cooperate with all governmental authorities in connection with the investigation of any violation of those laws and regulations.

Although it is not possible at this stage of these cases to predict the outcome with any degree of certainty, Alcatel believes that the ultimate outcome of these proceedings will not have a material adverse effect on its consolidated financial position or its income from operations. Alcatel is not aware of any other exceptional circumstances or proceedings that have had or may have a significant impact on the business, the financial position, the net income or the assets of Alcatel or the Group.

Note 35 — Main consolidated companies*

Consolidation

Company

Country

% control

% interest

method

Alcatel^(a)(b)

France

Parent company

OPERATING COMPANIES*

Alcatel Australia Limited

Australia

Full consolidation

Alcatel Austria A.G.

Austria

Full consolidation

Alcatel Bell NV

Belgium

Full consolidation

Alcatel Business Systems S.A.

France

Full consolidation

Alcatel Canada Inc.

Canada

Full consolidation

Alcatel Cable France

France

Full consolidation

Alcatel CIT

France

Full consolidation

Alcatel España S.A.

Spain

Full consolidation

Alcatel Indetel S.A. de C.V.

Mexico

Full consolidation

Alcatel Italia S.p.A.

Italy

Full consolidation

Alcatel Optical Fiber GmbH

Germany

Full consolidation

Alcatel Polska SA

Poland

Full consolidation

Alcatel Portugal SA

Portugal

Full consolidation

Alcatel Network Systems SDN BHD

Malaysia

Full consolidation

Alcatel Schweiz AG

Switzerland

Full consolidation

Alcatel SEL A.G.

Germany

Full consolidation

Alcatel Shanghai Bell^(c)

R.P.C.

Full consolidation

Alcatel Space

France

Full consolidation

Alcatel Submarine Networks S.A.

France

Full consolidation

Alcatel Telecom Limited

U.K.

Full consolidation

Alcatel Telecom Nederland BV

The Netherlands

Full consolidation

F-74

ALCATEL AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Consolidation

Company

Country

% control

% interest

method

Alcatel Telecom Norway A/S

Norway

Full consolidation

Alcatel Telecommunicacoes SA

Brazil

Full consolidation

Alcatel Teletas Telekommunikasyon^(b)

Turkey

Full consolidation

Alcatel USA Inc.

U.S.

Full consolidation

Alcatel Vacuum Technology

France

Full consolidation

Genesys Telecommunications Laboratories Inc.

U.S.

Full consolidation

Radio Frequency Systems GmbH

Germany

Full consolidation

Radio Frequency Systems Inc.

U.S.

Full consolidation

Shanghai Bell Samsung Communications

China

25.5

Full consolidation

Taiwan International Standard Electronics Ltd (Taisel)

Taiwan

Full consolidation

Alda Marine

France

Proportionate

Evolium Holding SAS

France

Proportionate

Draka Comteq BV

The Netherlands

49,9

Equity

TAMP (TCL & Alcatel Mobile Phones Ltd)

China

Equity


(a)	Publicly traded.

(b)	The financial data of Alcatel, as the parent company, are included under the business segment “Others”.

(c)	The Group owns 50% plus one share.

*	Percentages of control and interest equal 100% unless otherwise specified.

Consolidation

Company

Country

% control

% interest

method

HOLDINGS AND OTHER^(b)

Aerospace, defence and IT&S

Thales (ex Thomson-CSF)^(a)

France

12.8

9.5

Equity

Financial Holdings

Alcatel China Investment Co. Ltd.

China

Full consolidation

Alcatel Holding Canada Corp.

Canada

Full consolidation

Alcatel NV

Netherlands

Full consolidation

Alcatel Participations

France

Full consolidation

Alcatel Participations China

France

Full consolidation

Alcatel UK Limited

U.K.

Full consolidation

Compagnie Financière Alcatel

France

Full consolidation

Coralec

France

Full consolidation

Florelec

France

Full consolidation

Lubelec

France

Full consolidation

Financial Services

Electro Banque

France

Full consolidation

Electro Ré

Luxembourg

Full consolidation


(a)	Publicly traded.

(b)	Financial data for Alcatel, as the parent company, are included in this business segment.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Note 36 — Quarterly information (not reviewed)

(a) Consolidated income statements


	Q1 2004			Q2 2004			Q3 2004
	Restated			Restated			Restated
	(not reviewed)			(not reviewed)			(not reviewed)			Q4 2004			Total

	(in millions of euros, except per share amounts)
Net sales		2,533			2,911			3,009			3,812			12,265
Cost of sales		(1,562	)		(1,755	)		(1,872	)		(2,501	)		(7,690	)

Gross profit		971			1,156			1,137			1,311			4,575

Administrative and selling expenses		(498	)		(532	)		(486	)		(494	)		(2,010	)
R&D costs		(369	)		(413	)		(381	)		(424	)		(1,587	)

Income from operations		104			211			270			393			978

Interest expense on notes mandatorily redeemable for shares		(11	)		(11	)		(11	)		(11	)		(44	)
Financial income (loss)		(40	)		(3	)		(44	)		(45	)		(132	)
Restructuring costs		(64	)		(67	)		(14	)		(159	)		(304	)
Other revenue (expense)		245			32			47			40			364

Income before amortization of goodwill, tax and purchased R&D		234			162			248			218			862

Income tax		16			28			(13	)		(40	)		(9	)
Share in net income of equity affiliates and disposed of or discontinued operations		(16	)		(43	)		(19	)		(19	)		(97	)

Consolidated net income before amortization of goodwill and purchased R&D		234			147			216			159			756

Amortization of goodwill		(104	)		(102	)		(103	)		(99	)		(408	)
Exceptional amortization of goodwill		—			—			—			—			—
Purchased R&D		(1	)		—			—			—			(1	)
Minority interests		5			(22	)		(29	)		(20	)		(66	)

Net income		134			23			84			40			281

*Ordinary shares*
Basic earnings per share (in euros)		0.10			0.02			0.06			0.03			0.21
Diluted earnings per share (in euros)		0.10			0.02			0.06			0.03			0.21

Data for Q1, Q2 and Q3 have been restated to take into account the principal changes in the consolidated companies during 2004, as described in note 2. The following businesses have been restated as discontinued operations:


	—	disposal of the optical fiber business.

	—	disposal of the mobile phones business.

	—	disposal of Saft Power Systems business.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


2003 restated (not reviewed)	Q1			Q2			Q3			Q4			Total

	(in millions of euros, except per share amounts)
Net sales		2,616			2,829			2,718			3,443			11,606
Cost of sales		(1,771	)		(1,898	)		(1,703	)		(2,242	)		(7,614	)

Gross profit		845			931			1,015			1,201			3,992

Administrative and selling expenses		(549	)		(512	)		(482	)		(490	)		(2,033	)
R&D costs		(399	)		(372	)		(362	)		(377	)		(1,510	)

Income (loss) from operations		(103	)		47			171			334			449

Interest expense on notes mandatorily redeemable for shares		(12	)		(12	)		(11	)		(12	)		(47	)
Financial income (loss)		(32	)		(67	)		(72	)		(77	)		(248	)
Restructuring costs		(266	)		(284	)		(188	)		(522	)		(1,260	)
Other revenue (expense)		214			38			(11	)		7			248

Income (loss) before amortization of goodwill, tax and purchased R&D		(199	)		(278	)		(111	)		(270	)		(858	)

Income tax		(28	)		(14	)		(20	)		(19	)		(81	)
Share in net income of equity affiliates and disposed of or discontinued operations		(87	)		(286	)		(48	)		3			(418	)

Consolidated net income (loss) before amortization of goodwill and purchased R&D		(314	)		(578	)		(179	)		(286	)		(1,357	)

Amortization of goodwill		(105	)		(105	)		(100	)		(97	)		(407	)
Exceptional amortization of goodwill		(47	)		—			—			(113	)		(160	)
Purchased R&D		—			—			—			—			—
Minority interests		5			8			(5	)		(28	)		(20	)

Net income (loss)		(461	)		(675	)		(284	)		(524	)		(1,944	)

*Ordinary shares*
Basic earnings per share (in euros)		(0.35	)		(0.51	)		(0.21	)		(0.39	)		(1.46	)
Diluted earnings per share (in euros)		(0.35	)		(0.51	)		(0.21	)		(0.39	)		(1.46	)

(b) Information by segment


2004 restated	Q1			Q2			Q3			Q4			Total

	(in millions of euros)
Net sales
Fixed Communications		1,086			1,303			1,209			1,533			5,131
Mobile Communications		617			714			894			1,076			3,301
Private Communications		865			929			935			1,236			3,965
Other		—			—			—			—			—
Eliminations		(35	)		(35	)		(29	)		(33	)		(132	)

Total		2,533			2,911			3,009			3,812			12,265

Income (loss) from operations
Fixed Communications		28			134			118			149			429
Mobile Communications		88			71			103			139			401
Private Communications		35			35			68			97			235
Others		(47	)		(29	)		(19	)		8			(87	)

Total		104			211			270			393			978

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


2003 restated (not reviewed)	Q1			Q2			Q3			Q4			Total

	(in millions of euros)
Net sales
Fixed Communications		1,234			1,314			1,258			1,558			5,364
Mobile Communications		658			728			697			846			2,929
Private Communications		817			868			839			1,103			3,627
Other		3			4			4			5			16
Eliminations		(96	)		(85	)		(80	)		(69	)		(330	)

Total		2,616			2,829			2,718			3,443			11,606

Income (loss) from operations
Fixed Communications		(59	)		8			63			143			155
Mobile Communications		40			44			107			124			315
Private Communications		(34	)		21			41			95			123
Others		(50	)		(26	)		(40	)		(28	)		(144	)

Total		(103	)		47			171			334			449


(c)	Earnings per share

Earnings per share is determined according to the method described in note 9. The following tables present a reconciliation of basic earnings per share and diluted earnings per share for Q4 2004 and Q4 2003.


	Ordinary shares

	Net income		Number of		Per share
Q4 2004	(loss)		shares		amount

	(in millions
	of euros)
Basic earnings per share		40		1,350,765,467	€	0.03
Stock option plans		—		13,579,097		—
Notes mandatorily redeemable for shares		—		—		—

Diluted earnings per share		40		1,364,344,564	€	0.03

Ordinary shares:

Consolidated subsidiaries of the Group owned 60,624,711 Alcatel ordinary shares and no share equivalents.

Shares subject to future issuance:

The number of stock options not exercised as of December 31, 2004 amounted to 150,715,229 shares. Only 13,579,097 share equivalents were taken into account for the calculation of the diluted earnings per share, as the balance of share equivalents had an anti-dilutive effect.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


	Ordinary shares

	Net income			Number of		Per share
Q4 2003	(loss)			shares		amount

	(in millions
	of euros)
Basic earnings per share		(524	)		1,342,366,503	€	(0.39	)
Stock option plans		—			—		—
Notes mandatorily redeemable for shares		—			—		—

Diluted earnings per share		(524	)		1,342,366,503	€	(0.39	)

Ordinary shares:

The earnings per share computation takes into account that consolidated subsidiaries of the Group owned 62,789,755 Alcatel ordinary shares and no share equivalents.

Shares subject to issuance in the future have not been taken into account in the calculation of the diluted earnings per share amount due to their anti-dilutive effect. In addition, notes mandatorily redeemable for new or existing Alcatel shares have not been taken into account in the calculation of the diluted earnings per share amount due to their anti-dilutive effect.

Note 37 — Summary of differences between accounting principles followed by Alcatel and U.S. GAAP

Alcatel’s accounting policies comply with generally accepted accounting principles in France (“French GAAP”) (see note 1). Elements of Alcatel’s accounting policies which differ significantly from generally accepted accounting principles in the United States (“U.S. GAAP”) are described below:

(a) Differences in accounting for business combinations

Adoption of French “pooling of interests” accounting method for stock-for-stock business combinations under French GAAP

From January 1, 1999, in connection with the change in French accounting principles, Alcatel accounted for its acquisition of DSC Communications Corporation (“DSC”) under the French pooling of interests accounting method: assets and liabilities of DSC Communications Corporation were accounted for on a carryover basis at the acquisition date, adjusted to Alcatel’s accounting method. The difference resulting from the application of the pooling of interests accounting method remained in shareholders’ equity.

The two stock-for-stock acquisitions made during the first half of 2000, Genesys Telecommunications Laboratories (“Genesys”) and Newbridge Networks Corporation (“Newbridge”), the stock-for-stock acquisition of Kymata made during the second half of 2001, the stock-for-stock acquisition of Astral Point and Telera made during 2002 and the stock-for-stock acquisition of TiMetra made during 2003 have been accounted for using the pooling of interests accounting method under French GAAP.

Under U.S. GAAP, the DSC, Genesys, Newbridge, Kymata, Astral Point and Telera acquisitions have been recorded under the purchase accounting method. TiMetra being a development stage-company when acquired, the difference between the fair value of net assets acquired and the purchase price was accounted for in operating expenses.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

The purchase prices were mainly allocated to acquired technology, in-process research and development, fair value of investments, deferred compensation and deferred tax liabilities resulting in goodwill of:


	Date of
	acquisition		Currency		Goodwill

	(in millions)
DSC		1998		USD		2,613
Genesys		2000		USD		1,471
Newbridge		2000		CAD		6,968
Kymata		2001		GBP		57
Astral Point		2002		USD		138
Telera		2002		USD		47
TiMetra		2003		USD		114	^(a)


(a)	As TiMetra does not meet the definition of a business under U.S. GAAP, goodwill was written off.

As part of the changeover to IFRS on and after January 1, 2005, the French “pooling of interest” method of accounting for business combinations occurring in 2004 has been abandoned on and after January 1, 2004 by the Group (see note 1 and note 10).

Intangible assets and SFAS 144

In connection with the acquisitions described above, the Group allocated part of the purchase prices to acquired technologies. The amounts recorded at the acquisition dates were: USD 256 million for DSC, USD 59 million for Genesys, CAD 694 million for Newbridge, GBP 10 million for Kymata, USD 8 million for Astral Point, USD 27 million for Telera and USD 40 million for TiMetra. Those intangible assets are amortized over their estimated useful life (three-seven years) and are tested for impairment in compliance with Statement of Financial Accounting Standards (“SFAS”) No.144 “Accounting for the Impairment or Disposal of Long-Lived Assets” (“SFAS 144”).

Allocation of the purchase price to in-process research and development projects


	DSC

In connection with the acquisition of DSC, the Group allocated USD 1,096 million of the purchase price to in-process research and development projects. At the acquisition date, DSC was conducting design, development, engineering and testing activities associated with the completion of hundreds of projects aimed at developing next-generation technologies that were expected to address emerging market demands for the telecommunication equipment market. The allocation of USD 1,096 million of the purchase price to these in-process research and development projects represented their estimated fair values. More specifically, the development, engineering and testing activities associated with the following technologies were allocated as portions of the purchase price: Access (USD 600 million), Switching (USD 400 million), and Transmission (USD 100 million).

The estimated costs to be incurred to complete the purchased in-process technology into commercially viable products were approximately USD 195 million in the aggregate over the two years — USD 100 million for switching, USD 72 million for access, and USD 23 million for transmission.

At the acquisition date, it was estimated that total revenues from the acquired in-process technology would peak in the years 2002 to 2005 and steadily decline thereafter as other new products and technologies were expected to be introduced by Alcatel.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

The estimated costs of goods sold and operating expenses as a percentage of revenues were expected to be lower than those of DSC on a stand-alone basis primarily due to production efficiencies expected to be achieved through economies of scale of the combined operations. As a result of these savings, the combined company was expected to benefit from higher profit margins in future periods.


	Newbridge

In connection with the acquisition of Newbridge, the Group allocated USD 750 million of the purchase price to in-process research and development projects.

At the acquisition date, Newbridge was conducting design, development, engineering and testing activities associated with the completion of numerous projects aimed at developing next-generation technologies that were expected to address emerging market demands for the telecommunication equipment market. The allocation of USD 750 million of the purchase price to these in-process research and development projects represented their estimated fair value. More specifically, the development, engineering and testing activities associated with the following technologies were allocated portions of the purchase price: Switching and Routing (USD 505 million) and Access (USD 245 million).

Approximately USD 135 million had been spent on the research and development projects as of the valuation date. Costs to complete the projects were estimated at approximately USD 100 million over the 12 to 18 months following the acquisition. Management estimated that the aforementioned projects were in various stages of development, ranging from 50% to 80% complete based on development costs.

At the acquisition date, it was estimated that total revenues from the acquired in-process technology would peak in the years 2004 to 2005 and steadily decline thereafter as other new products and technologies were expected to be introduced by Alcatel.

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


	Genesys

At the acquisition date, Genesys was conducting design, development, engineering and testing activities associated with the completion of several projects related to Genesys release 6. The allocation of $ 100 million of the purchase price to the in-process research and development projects represented their estimated fair values.

Approximately USD 22 million had been spent on research and development projects as of the valuation date. Costs to complete the projects were estimated at approximately USD 25 million over the ten months following the acquisition. Management estimated that the aforementioned projects were in various stages of development and were approximately 50% complete, in the aggregate, based on development costs.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

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

A discount rate of 18% was used for determining the value of in-process research and development. This rate is higher than the implied weighted average cost of capital for the acquisition due to the inherent uncertainties surrounding the successful development of the purchased in-process technology, the useful life of such technology, the profitability levels of such technology, and the uncertainty of technological advances that were unknown at this time.


	TiMetra

At the acquisition date, TiMetra was developing routers to handle data traffic at what is known as the network edge, the part of the data network that links offices, homes and other buildings to the long distance “core” network. In June 2003, TiMetra introduced its first product, for next generation carrier networks, designed to fit multiple applications. The allocation of USD 5.5 million of the purchase price to the in-process research and development projects represented their estimated fair values using the methodology described above.

Approximately USD 42 million had been spent on research and development projects as of the valuation date. Costs to complete the projects were estimated at approximately USD 9 million over 24 months following the acquisition. Management estimated that the aforementioned projects were in various stages of development and were approximately 80% complete, in the aggregate, based on development costs.

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


	Spatial

At the acquisition time, Spatial Wireless was developing a UMTS project qualified as in-process research and development project. This UMTS project, represents a major engineering effort to integrate UMTS (Universal Mobile Telecommunications System) and support for Wi-Fi handset access into the Alcatel’s wireless Softswitch technology. The allocation of USD 10 million of the purchase price to the in-process research and development projects represented their estimated fair values using the methodology described below.

Approximately USD 4 million had been spent since June 2003 on this in-process research and development project as of the acquisition date. Management estimated that the aforementioned project was approximately 80% complete, therefore, costs to complete the project were estimated at approximately USD 1 million over 5 months following the acquisition.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Estimated total revenues from the acquired in-process technology were expected to peak in 2006 to 2010 and steadily decline thereafter as other new products and technologies were expected to be introduced by Alcatel.

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

A discount rate of 30% was used for determining the value of the in-process research and development. This rate is higher than the implied weighted average cost of capital for the acquisition due to inherent uncertainties surrounding the successful development of the purchased in-process technology, the lifetime of such technology, the profitability levels of such technology, and the likelihood of technological evolutions unknown at that time.

Accounting for pre-existing stock option plans in business combinations

In connection with purchase transactions, outstanding options to purchase shares of the acquired company become exercisable into options to purchase Alcatel shares. Alcatel records the fair value of the outstanding options as a liability of the acquired company.

Under U.S. GAAP, in accordance with FASB Interpretation (“FIN”) No. 44 “Accounting for Certain Transactions involving Stock Compensation” (“FIN 44”), Alcatel credits the fair value of the vested options exchanged to shareholders’ equity, with the debit included as part of the acquisition cost.

The unvested part of the option for which services are to be rendered is recorded at its intrinsic value over the remaining vesting period.


(b)	Amortization and impairment of acquisition goodwill

Under French GAAP, goodwill is generally amortized over its estimated life, not to exceed 20 years.

In order to conform to the new criteria in SFAS No. 141 “Business Combinations” (“SFAS 141”), effective as of January 1, 2002, the Group evaluated its existing goodwill relating to prior business combinations and determinated that an adjustment or reclassification to intangible assets as of January 1, 2002 was not required.

Beginning January 1, 2002, for the purpose of preparing the U.S. GAAP reconciliation, Alcatel adopted SFAS No. 142 “Goodwill and Other Intangible Assets” (“SFAS 142”). Goodwill is no longer amortized but rather tested for impairment at the adoption date and on an annual basis or whenever indicators of impairment arise. The goodwill impairment test, which is based on fair value, is performed at the reporting unit level (one level below the operating segment).

Additionally, goodwill on equity method investments is no longer amortized. However, it is still to be tested for impairment in accordance with Accounting Principles Board Opinion (“APB”) No. 18, “The Equity Method of Accounting for Investments in Common Stock” (“APB 18”).


(c)	Derivative instruments and hedging activities

The Group uses financial instruments to manage and reduce its exposure to fluctuations in interest rates, foreign currency and exchange rates. When these contracts qualify as hedges, gains and losses on such contracts are accounted for in the same period as the item being hedged; otherwise, changes in the market value of these instruments are recognized in the period of change.

Beginning January 1, 2001, for purposes of the U.S. GAAP reconciliation, Alcatel adopted SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities” (“SFAS 133”), as amended by

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ALCATEL AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

SFAS No. 137 and SFAS No. 138. SFAS 133, as so amended and interpreted, establishes accounting and reporting standards for derivative instruments (including certain derivative instruments embedded in other contracts) and for hedging activities. All derivatives, whether designated in hedging relationships or not, are recorded in the balance sheet at fair value and changes in fair value are recognized immediately in earnings, unless the derivatives qualify as hedges of future cash flows. For derivatives qualifying as hedges of future cash flows, the effective portion of changes in fair value is recorded temporarily in equity (Other Comprehensive Income), then recognized in earnings along with the related effects of the hedged items. Any ineffective portion of hedges is reported in earnings as it occurs. For derivatives qualifying as fair value hedges, changes in fair value of both the derivative and the hedged item are recognized in earnings. SFAS 133 defines new requirements for designation and documentation of hedging relationships, as well as ongoing effectiveness assessments in order to use hedge accounting.


(d)	Liability recognition for certain employee termination benefits and other costs

The main difference between French and U.S. GAAP relates to the accounting method for post-employment benefits in early retirement programs. Under SFAS 112, only benefits attributable to employees’ services already rendered have to be provided for at the balance sheet date, other benefits have to be accrued over the future period from the commitment date until termination. Under French GAAP, except in certain cases, post-employment benefits relating to early retirement programs are considered attributable to past services and therefore provided for at the commitment date. Under SFAS 146, a liability for a cost associated with exit or disposal activities should be recognized at fair value when the liability is incurred. Under French GAAP, the liability could be accounted for at the date of a commitment to an exit or disposal plan.


(e)	Other comprehensive income

SFAS No. 130 “Other Comprehensive Income”, effective for financial periods beginning after December 15, 1997, requires retroactive reporting of comprehensive income and its components, displayed as prominently as other financial statements. Comprehensive income may be defined for U.S. GAAP purposes as the change in equity of a business enterprise from transactions and other events and circumstances from non-owner sources. French GAAP does not require separate disclosure of all such changes in equity during a fiscal period.


(f)	Pension and post-retirement benefits other than pension plans

U.S. GAAP requires recognition of a minimum liability adjustment, which is not required under French GAAP.

To comply with U.S. GAAP, the Group applies the SFAS No. 106 “Employers’ Accounting for Post-retirement Benefits other than Pensions”. These post-retirement benefits, primarily life insurance and health care, cover most of Alcatel’s U.S. Group employees.

Starting January 1, 2004, Alcatel decided to apply the Conseil National de la Comptabilité (CNC)’s recommendation 2003-R.01 relating to standards of accounting for, and measurement of, employee retirement and other similar benefits, in order to anticipate application of the accounting principles set forth in IAS 19 (Employee Benefits). The actuarial gains and losses linked to experience adjustments and to the effects of changes in actuarial assumptions that were recorded at December 31, 2003, have been recorded in shareholders’ equity (see note 1(i) and note 24(b)). Under U.S. GAAP those actuarial gains and losses will be recognized over the expected average remaining working lives of the employees.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


(g)	Accounting for marketable securities and marketable equity securities

Alcatel accounts for its investments at the lower of historical cost or fair value, assessed investment by investment. Under U.S. GAAP, certain investments in equity securities are stated at fair value. Changes in fair value relating to trading securities are included in net income while those relating to available-for-sale securities are included directly in shareholders’ equity.


(h)	Accounting for stock options plans

Accounting for stock option plans under French GAAP generally does not lead to recognition of a compensation expense. Under U.S. GAAP, Alcatel accounts for those plans under the recognition and measurement principles of APB opinion No. 25, “Accounting For Stock Issued To Employees” (“APB 25”), and related interpretations. Stock-based employee compensation cost is reflected in net income.

The effect on net income and earnings per share, if Alcatel had applied the fair value recognition provisions of SFAS No. 123, “Accounting for Stock-Based Compensation” (“SFAS 123”), is presented in note 40(2).


(i)	Sale-leaseback transactions

SFAS 13 “Accounting for leases” requires that in a sale-leaseback transaction with a lease classified as an operating lease, any profit or loss on the sale shall be deferred and amortized in proportion to the rental payments over the period of time that the asset is expected to be used. Under French GAAP, the profit corresponding to the disposal of the asset is not deferred if the transaction was made with a selling price and rental payments that correspond to the market conditions at the time of the transaction.


(j)	Accounting for transfers and servicing of financial assets

SFAS 140 “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities” is applicable for sales that occurred after March 31, 2001.

As the SVF trust did not meet the criteria of a “qualified special purpose entity” under SFAS 140, under U.S. GAAP the SVF trust was consolidated in Alcatel’s consolidated balance sheet at December 31, 2003, leading to an increase of other investments and short-term financial debt amounting to € 212 million compared to French GAAP. In accordance with new French financial regulations, which are applicable from the first financial accounting year beginning after August 2, 2003, the SVF trust is consolidated since January 1, 2004. Since this date, there is no remaining accounting difference concerning this program. Moreover, this program was cancelled in April 2004 (see note 31(b)).

In May 2002, Alcatel sold to a credit institution a carry-back receivable with a face value of € 200 million resulting from the option to carry back tax losses from prior years. The cash received from this sale amounted to € 149 million, corresponding to the discounted value of this receivable, that matures in five years. Alcatel is required to indemnify the purchaser in case of any error or inaccuracy concerning the amount or nature of the carry-back receivable sold. The transferor (Alcatel) has the ability to retroactively cancel the sale in case of future taxable profit during the next five years following the disposal. Due to the existence of an agreement to reacquire the receivable and in accordance with SFAS 140 (paragraph 9 c), the sale of Alcatel’s carry back receivable transaction was accounted for as a secured financing and is therefore included in financial debt under U.S. GAAP.


(k)	Income taxes

Since January 1, 1998, Alcatel has been applying U.S. GAAP for the recognition of deferred taxes in its French GAAP financial statements. Consequently, no adjustment is required to reconcile Alcatel’s

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ALCATEL AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

consolidated financial statements under French GAAP to U.S. GAAP, except for the tax effect of other adjustments and the tax on undistributed earnings on equity affiliates. For undistributed earnings of foreign subsidiaries, no provision has been recorded for the French and foreign taxes that could result from the remittance of such undistributed earnings since the earnings are permanently reinvested and it is not practicable to estimate the amount of such taxes.


(l)	Presentation of Consolidated Financial Statements

The classification of certain items in, and the format of, Alcatel’s Consolidated Financial Statements vary to some extent from U.S. GAAP.

The most significant reporting and presentation practices followed by Alcatel that differ from U.S. GAAP are described in the following paragraphs:

In its balance sheet, Alcatel reports advance payments on long-term contracts received from customers as a liability. We do not offset liabilities with work in progress or recognized income not yet billed.

A balance sheet is presented under French GAAP by nature of assets and liabilities or order of liquidity. Accrued interest, short-term borrowings, bank overdrafts and short-term portion of other debt are included in debt. The long-term portion of debt is specified on the balance sheet. Under U.S. GAAP, the portion of debt maturing within one year would be classified as a current liability (€ 1,037 million at December 31, 2004, € 883 million at December 31, 2003 and € 1,096 million at December 31, 2002).

The short-term portion of accrued contract costs and other reserves would be shown as current liabilities under U.S. GAAP (€ 1,621 million at December 31, 2004, € 2,493 million at December 31, 2003 and € 2,678 million at December 31, 2002). Additionally, U.S. GAAP would require the long-term portion of other payables to be shown as long-term liabilities (€ 202 million at December 31, 2004, € 273 million at December 31, 2003 and € 716 million at December 31, 2002) and the long-term portion of other debtors to be shown as non-current assets (€ 1,409 million at December 31, 2004, € 1,659 million at December 31, 2003 and € 1,775 million at December 31, 2002).

Deferred income tax assets are recorded in the consolidated balance sheet if it is more likely than not that the tax benefit will be realized. Deferred income tax assets are recorded at their full amount and a valuation allowance is accounted for, if necessary.

Under U.S. GAAP, income statement presentation (see note 39), restructuring costs, other revenues (expenses) detailed in note 7, amortization of goodwill and in process research and development have been presented as a deduction from or an addition to operating income, except for gains on sale of shares in subsidiaries which have been presented in a separate line item below the operating income.

In its statement of cash flows, Alcatel presents the items “net cash provided (used) by operating activities before changes in working capital” and “net cash flows after investment”, these items would not be shown under a U.S. GAAP statement of cash flows presentation.


(m)	Discontinued operations

In April 2004, Alcatel and TCL Communication Technology Holdings Limited announced the execution of a memorandum of understanding to form a joint venture mobile handset company. The joint venture company officially started operations on August 31, 2004 and is 55% owned by TCL and 45% owned by Alcatel. The mobile phone business of Alcatel is no longer considered to be under Alcatel’s control as of December 31, 2003 and therefore the results and financial position of this business have been accounted for in discontinued operations under French GAAP. This transaction could not be considered as a discontinued activity under U.S. GAAP due to our 45% interest in TCL & Alcatel Mobile Phone Ltd at year end. Under U.S. GAAP, the mobile phone business results from January 1, 2004 to August 30, 2004 have been

F-86

ALCATEL AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

consolidated in our consolidated financial statements and not accounted for in the specific income (loss) from discontinued operation line item.

In May 2004, Alcatel announced that it had entered into a binding agreement with Draka to combine their respective global optical fiber and communication cable businesses. This transaction was completed on July 1, 2004. Draka owns 50.1% and Alcatel 49.9% of the new company Draka Comteq BV. The optical fiber business of Alcatel is no longer considered to be under Alcatel’s control as of December 31, 2003 and therefore the results and financial position of this business have been accounted for in discontinued operations under French GAAP. This transaction could not be considered as a discontinued activity under U.S. GAAP due to our 49.9% interest in Draka Comteq BV at year end. Under U.S. GAAP, the optical fiber business results from January 1, 2004 to June 30, 2004 have been consolidated in our consolidated financial statements and not accounted for in the specific income (loss) from discontinued operation line item.

In September 2004, Alcatel signed an agreement with a private equity firm, Ripplewood, to divest all of its electrical power system activities (Saft Power Systems). The closing of this sale, subject to regulatory approvals, took place on January 25, 2005. The results of this business were recorded as a discontinued operation in 2004 under French GAAP and under U.S. GAAP. Under French GAAP, net assets of this business were accounted for in the caption “share in net assets of equity affiliates and net assets and liabilities of disposed of or discontinued operations” whereas they have been reclassified as assets and liabilities held for sale under U.S. GAAP.

In May 2003, Alcatel announced that it had entered into a binding agreement with Avanex to divest our optical components business (the Optronics division). This transaction was completed on August 1, 2003. As part of this transaction, Avanex also acquired certain assets of Corning Incorporated’s photonics activities. In consideration for the assets contributed, Alcatel received 28% of the capital of Avanex. Since Optronics France and Optronics UK (formerly Kymata), were disposed of as part of this agreement, they were no longer considered to be under Alcatel’s control as of December 31, 2002, and therefore the results and financial position of these two companies were accounted for in discontinued operations under French GAAP for 2003. This transaction could not be considered as discontinued activity under U.S. GAAP due to our 26.2% interest in Avanex at year end. Under U.S. GAAP, Optronics France an Optronics UK results from January 1, 2003 to July 31, 2003 have been consolidated in our consolidated financial statements and not accounted for in the specific income (loss) from discontinued operation line item.


(n)	Disposal of battery business

As the net assets of the battery business were higher under U.S. GAAP than under French GAAP, mainly due to differences in accounting goodwill (see note 37(b)), the gain from the disposal was adjusted in our U.S. GAAP reconciliation.

Note 38 — Reconciliation to U.S. GAAP

The following is a summary of the estimated adjustments to the Consolidated Income Statements for the years 2004, 2003 and 2002 and Alcatel shareholders’ equity at December 31, 2004, 2003 and 2002, which would be required if U.S. GAAP had been applied instead of French GAAP.

F-87

ALCATEL AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(a) Net income


	Note			2004^(a)			2004			2003			2002

				(in millions)
Net income (loss) as reported in the Consolidated Income Statements				$	380		€	281		€	(1,944	)	€	(4,745	)
Amortization and impairment of acquisition goodwill		37(b	)		528			390			466			(3,547	)
Accounting for investments in securities		37(g	)		10			7			(3	)		(7	)
Restructuring plans		37(d	)		(165	)		(122	)		168			(317	)
Sale and lease-back transaction		37(i	)		31			23			(195	)		—
Purchased in-process research and development		37(a	)		(11	)		(8	)		(5	)		(13	)
Adjustment of French pooling of interests accounting method^(b)		37(a	)		(42	)		(31	)		(174	)		(556	)
Derivative instruments and hedging activities		37(c	)		(64	)		(47	)		(60	)		411
Compensation expenses		37(h	)		—			—			(39	)		(56	)
Discontinued and disposed of operations		37(m	)		(51	)		(38	)		68			—
		37(n	)
Pensions and other post-retirement benefits		37(f	)		41			30
Other adjustments					59			44			29			68
Tax effect of the above adjustments					28			21			(32	)		57
Cumulative effect of adoption of SFAS 142, net of tax					—			—			—			(2,806	)

Net income (loss) according to U.S. GAAP					744			550			(1,721	)		(11,511	)


(a)	Translation of amounts from € into $ has been made merely for the convenience of the reader at the Noon Buying Rate of € 1 = $1.3538 on December 31, 2004.

(b)	For 2004, represents amortization of acquired technology booked in connection with the allocation of purchase prices of acquisitions accounted for using the pooling of interests accounting method for French GAAP purposes and accounted for using the purchase accounting method for U.S. GAAP reconciliation purposes.


	For 2003, represents impact of TiMetra acquisition for which assets were written off, disposal of Kymata and amortization of acquired technology recorded in connection with the allocation of purchase prices of acquisitions accounted for using pooling of interests accounting method for French GAAP purposes and restated for U.S. GAAP reconciliation purposes.

	For 2002, represents amortization and impairment of acquired technology booked in connection with the allocation of purchase prices of acquisitions accounted for using the pooling of interests accounting method for French GAAP purposes and accounted for using the purchase accounting method for U.S. GAAP reconciliation purposes.

F-88

ALCATEL AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(b) Shareholders’ equity


	Note			2004^(a)			2004			2003			2002

				(in millions)
Shareholders’ equity as reported in the Consolidated Balance Sheets, after appropriation				$	4,560		€	3,368		€	3,030		€	5,007
Amortization and impairment of acquisition goodwill		37(b	)		(4,165	)		(3,077	)		(3,780	)		(1,886	)
Accounting for investments in securities		37(g	)		121			89			56			23
Restructuring plans		37(d	)		108			80			204			40
Sale and lease back transaction		37(i	)		(261	)		(193	)		(216	)		—
Accounting for pre-existing stock option plans in business combinations		37(a	)		107			79			245			360
Adjustment of French pooling of interests accounting method		37(a	)		8,910			6,581			7,121			7,672
Pensions and other post-retirement benefits		37(f	)		(417	)		(308	)		(448	)		(452	)
Derivative instruments and hedging activities		37(c	)		181			133			181			240
Other adjustments					171			126			82			36
Tax effect of the above adjustments					(23	)		(17	)		(61	)		(50	)
Cumulative effect of adoption of SFAS 142, net of tax					—			—			—			(2,806	)

Shareholders’ equity according to U.S. GAAP				$	9,292		€	6,864		€	6,414		€	8,184


(a)	Translation of amounts from € into $ has been made merely for the convenience of the reader at the Noon Buying Rate of € 1 = $1.3538 on December 31, 2004.

F-89

ALCATEL AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Note 39 — Summarized U.S. GAAP Consolidated Financial Statements

(1) Summarized U.S. GAAP Consolidated Income Statements

Under U.S. GAAP, the following information would be set forth in the consolidated financial statements for the years ended December 31, 2004, 2003 and 2002 as either a separate statement or as a component of the consolidated statements of changes in shareholder’s equity and minority interests.


	2004^(a)			2004			2003			2002

	(in millions)
Net sales	$	17,143		€	12,663		€	12,528		€	16,549
Cost of sales		(10,956	)		(8,092	)		(8,865	)		(13,869	)
Administrative and selling expenses		(2,713	)		(2,004	)		(2,178	)		(2,869	)
Research and development expenses		(2,130	)		(1,573	)		(1,631	)		(2,233	)
Purchased in-process R&D		(12	)		(9	)		(5	)		(13	)
Restructuring costs		(583	)		(431	)		(1,132	)		(1,731	)
Amortization and impairment of goodwill and other operating expenses		(5	)		(4	)		(66	)		(4,134	)

Income (loss) from operations		744			550			(1,349	)		(8,300	)
Interest expense on notes mandatorily redeemable for shares		(60	)		(44	)		(47	)		(1	)
Other interest expense		(259	)		(191	)		(259	)		(745	)
Interest income and other financial income, net		174			128			176			111
Other income (expense), net		—			—			10			15
Gain on sale of stock in subsidiaries		299			221			(131	)		254

Income (loss) from continuing operations before taxes		898			664			(1,600	)		(8,666	)
Share in net income of equity affiliates		(45	)		(33	)		(37	)		(77	)
Provision for income tax		(12	)		(9	)		(112	)		91
Minority interests		(89	)		(66	)		(19	)		(21	)

Net income (loss) from continuing operations		752			556			(1,768	)		(8,673	)

Income (loss) from discontinued operations		(8	)		(6	)		47			(32	)
Cumulative effect of adoption of SFAS 142, net of tax (of which tax effect € 0 million)		—			—			—			(2,806	)

Net income (loss)	$	744		€	550		€	(1,721	)	€	(11,511	)


(a)	Translation of amounts from € into $ has been made merely for the convenience of the reader at the Noon Buying Rate of € 1 = $ 1.3538 on December 31, 2004.

(2) Earnings per Share under U.S. GAAP:

Earnings per share presented below are calculated in accordance with SFAS 128. The number of shares to be issued upon conversion of notes mandatorily redeemable for new or existing shares (ORANE) is excluded of the calculation of basic earnings per share.

F-90

ALCATEL AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Earnings per share for 2003 and 2002 has been restated to take into account the conversion of class O shares into ordinary shares, on a one-for-one basis, as approved at the shareholders’ meeting on April 17, 2003.


	2004^(a)		2004		2003			2002

Ordinary shares
Basic earnings per share:
Net income (loss) before cumulative effect of adoption of new standards	$	0.61	€	0.45	€	(1.42	)	€	(7.31	)
Net income (loss)	$	0.61	€	0.45	€	(1.42	)	€	(9.67	)
Diluted earnings per share:
Net income (loss) before cumulative effect of adoption of new accounting standards	$	0.58	€	0.42	€	(1.42	)	€	(7.31	)
Net income (loss)	$	0.58	€	0.42	€	(1.42	)	€	(9.67	)


(a)	Translation of amounts from € into $ has been made merely for the convenience of the reader at the Noon Buying Rate of € 1 = $ 1.3538 on December 31, 2004.

The following tables present a reconciliation of the basic earnings per share and diluted earnings per share for each year disclosed.


	Ordinary shares

			Number of		Per share
2004	Net income (loss)		shares		amount

	(in millions of euros)
Basic earnings per share		550		1,228,745,770	€	0.45
Stock option plans		—		14,133,029		—
Notes mandatorily redeemable for shares (ORANE)		29		120,782,388		—
Diluted earnings per share		579		1,363,661,187	€	0.42


	Ordinary shares

				Number of		Per share
2003	Net income (loss)			shares		Amount

	(in millions of euros)
Basic earnings per share		(1,721	)		1,211,579,968	€	(1.42	)
Stock option plans		—			—		—
Convertible bonds and notes mandatorily redeemable for shares		—			—		—
Diluted earnings per share		(1,721	)		1,211,579,968	€	(1.42	)

The number of stock options not exercised as of December 31, 2003 amounted to 119,425,586 shares. These potential shares were not taken into account for the calculation of the diluted earnings per share because of their anti-dilutive effect.

F-91

ALCATEL AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


	Ordinary shares

				Number of		Per share
2002	Net income (loss)			shares		amount

	(in millions of euros)
Basic earnings per share		(11,511	)		1,190,067,515	€	(9.67	)
Stock option plans		—			—		—
Convertible bonds and notes mandatorily redeemable for shares		—			—		—
Diluted earnings per share		(11,511	)		1,190,067,515	€	(9.67	)

The number of stock options not exercised as of December 31, 2002 amounted to 101,011,736 shares. These potential shares were not taken into account for the calculation of the diluted earnings per share because of their anti-dilutive effect.

(3) Statement of comprehensive income

Under U.S. GAAP, the following information would be set forth in the consolidated financial statements for the years ended December 31, 2004, 2003 and 2002 as either a separate statement or as a component of the consolidated statement of changes in shareholders’ equity and minority interests.


	2004^(a)			2004			2003			2002

	(in millions)
Net income (loss) under U.S. GAAP	$	744			€ 550			€ (1,721	)		€ (11,511	)
Other comprehensive income:
— Foreign currency translation adjustments		(355	)		(262	)		(311	)		(950	)
— Unrealized gains (losses) on securities		53			39			36			(250	)
— Minimum pension liability adjustments		(139	)		(103	)		(10	)		(117	)
— Tax effect on the above adjustments		(22	)		(16	)		(10	)		96

Comprehensive income (loss) according to U.S. GAAP	$	281			€ 208			€ (2,016	)		€ (12,732	)


(a)	Translation of amounts from € into $ has been made merely for the convenience of the reader at the Noon Buying Rate of € 1 = $ 1.3538 on December 31, 2004.

If Alcatel were to present consolidated financial statements in accordance with U.S. GAAP, the accumulated balances for minimum pension liability adjustments, foreign currency translation adjustments and unrealized gains (losses) on available-for-sale securities would be disclosed either on the face of the consolidated balance sheets, in the statements of changes in shareholders’ equity and minority interests, or in the notes to the financial statements. The following table presents the accumulated balances, net of tax, of each of these classifications.

F-92

ALCATEL AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


	Minimum			Foreign			Unrealized
	pension			currency			gains
	liability			translation			(losses) on
	adjustments			adjustments			securities

	(in millions of euros)
2004
Balance beginning of the year		(244	)		(854	)		43
Current period change		(119	)		(262	)		39

Balance end of the year		(363	)		(1,116	)		82

2003
Balance beginning of the year		(232	)		(543	)		15
Current period change		(12	)		(311	)		28

Balance end of the year		(244	)		(854	)		43

2002
Balance beginning of the year		(157	)		407			211
Current period change		(75	)		(950	)		(196	)

Balance end of the year		(232	)		(543	)		15

F-93

ALCATEL AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(4) Classified balance sheet as of December 31:


	2004			2003			2002

	(in millions of euros)
ASSETS
Cash		2,608			4,645			5,407
Marketable securities		2,003			1,588			473
Short-term investments		551			94			258
Other debtors		1,895			2,073			2,432
Trade receivables and related accounts		3,494			3,262			4,639
Inventories, net		1,502			1,432			2,329
Assets held for sale		118			282			—

TOTAL CURRENT ASSETS		12,171			13,376			15,538

Other investments & other non current assets, net		2,396			3,132			4,143
Equity in net assets of affiliates		708			679			553

Investments and other non-current assets		3,104			3,811			4,696

Property, plant and equipment, at cost		4,910			6,378			8,308
Less: accumulated depreciation		(3,692	)		(4,817	)		(5,732	)

Property, plant and equipment, net		1,218			1,561			2,576

Acquisition goodwill, net		6,829			6,831			7,225
Other intangible assets, net		566			419			399

Intangible assets, net		7,395			7,250			7,625

TOTAL NON-CURRENT ASSETS		11,717			12,622			14,897

TOTAL ASSETS		23,888			25,998			30,435

LIABILITIES AND SHAREHOLDERS’ EQUITY
Other current liabilities		2,553			3,018			3,320
Trade payables and related accounts		3,356			3,605			4,164
Accrued contract costs & other accrued liabilities		1,573			2,301			2,603
Customers deposits and advances		1,164			1,181			1,482
Short-term financial debt		1,053			1,091			1,413
Liabilities held for sale		100			264			—
TOTAL CURRENT LIABILITIES		9,799			11,460			12,982

Other long-term liabilities		381			381			1,117
Other long-term financial debt		388			357			472
Bonds and notes issued		3,240			4,356			4,598

Long-term financial debt		3,628			4,713			5,070

Other reserves		639			619			688
Accrued pensions and retirement obligations		1,557			1,384			1,366

Total reserves		2,196			2,003			2,054

TOTAL NON-CURRENT LIABILITIES		6,205			7,097			8,241

Notes mandatorily redeemable for shares		645			645			645

MINORITY INTERESTS		375			382			383

Capital stock		2,611			2,569			2,529
Additional paid-in capital		21,214			21,266			21,243
Retained earnings		(14,241	)		(14,801	)		(13,245	)
Unrealized holding gains		82			43			15
Cumulative translation adjustments		(1,116	)		(854	)		(543	)
Less treasury stock, at cost		(1,686	)		(1,809	)		(1,815	)

SHAREHOLDERS’ EQUITY		6,864			6,414			8,184

TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY		23,888			25,998			30,435

F-94

ALCATEL AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(5) Statement of changes in shareholders’ equity


			Additional						Minimum			Unrealized		Cumulative			Treasury			Net
	Capital		paid-in			Retained			liability			holding		translation			Stock at			income			Shareholders’
	stock		capital			earnings			adjustment			gains/(losses)		adjustment			cost			(loss)			equity

	(in millions of euros)
Balance at December 31, 2003 after appropriation		2,569		21,266			(14,557	)		(244	)		43		(854	)		(1,809	)		—			6,414
Capital increase		6		20																				26
Net change in treasury stock Ordinary shares owned by consolidated subsidiaries				(90	)		2											123						35
Net changes in unrealized holding gains/(losses)													39											39
Minimum liability adjustment										(119	)													(119	)
Accounting for pre-existing stock option plans in business combinations				(158	)		134																	(24	)
Capital increase linked to the acquisition of Spatial		36		176			2																	214
Translation adjustment															(262	)								(262	)
Other changes							(9	)																(9	)
Net income (loss)																					550			550

Balance at December 31, 2004 before appropriation		2,611		21,214			(14,428	)		(363	)		82		(1,116	)		(1,686	)		550			6,864

Proposed appropriation of net income (loss)							550														(550	)

Balance at December 31, 2004 after appropriation		2,611		21,214			(13,878	)		(363	)		82		(1,116	)		(1,686	)		—			6,864

F-95

ALCATEL AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Note 40 — Specific U.S. GAAP disclosures

(1) Impairment of goodwill (Disclosure SFAS 142)

The changes during 2004 in the carrying value of goodwill per segment are presented in the table below:


	Fixed			Mobile			Private						Total
	Communications			Communications			Communications			Other			Group

	(in millions of euros)
Balance as of January 1, 2003		4,152			405			2,619			49			7,225

Goodwill acquired during year		4			1			29			—			34
Goodwill adjusted during allocation period		(9	)		—			—			—			(9	)
Impairment losses		—			—			—			—			—
Goodwill written off related to sale of business		(57	)					(98	)					(155	)
Currency translation adjustments		(64	)		(5	)		(166	)		(19	)		(264	)

Balance as of January 1, 2004		4,026			401			2,384			20			6,831

Goodwill acquired during year					183			29						212
Goodwill adjusted during allocation period					1									1
Impairment losses								(1	)		(3	)		(4	)
Goodwill written off related to sale or discontinuance of business		(10	)					(7	)					(17	)
Currency translation adjustments		(112	)		(16	)		(64	)		(2	)		(194	)

Balance as of December 31, 2004		3,904			569			2,341			15			6,829

Amortization of identifiable intangible assets acquired

Entities acquired during the year


	Gross carrying		Accumulated
	amount		amortization

	(in millions of euros)
Amortized intangible assets		57		(8	)
— Acquired technology and in process research and development		57		(8	)
— Other		—		—
Unamortized intangible assets		—		—

The amortization expense of entities acquired during the year was € 8 million. Amortization expense of intangible assets is expected to be € 10 million in 2005, 2006, 2007 and 2008, and € 9 million in 2009.

Alcatel Group


	Gross carrying		Accumulated
	amount		amortization

	(in millions of euros)
Amortized intangible assets		1,198		(632	)
— Acquired technology		157		(55	)
— Other^(a)		1,041		(577	)
Unamortized intangible assets		—		—

F-96

ALCATEL AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


(a)	mainly software development costs and also including € 44 million of intangible assets related to the application of SFAS 87 (see note 40(5) a))

The amortization expense for the year ended December 31, 2004 was € 165 million. Amortization expense of intangible assets excluding intangibles assets related to the application of SFAS 87 is expected to be € 216 million in 2005, € 140 million in 2006, € 109 million in 2007, € 39 million in 2008, € 13 million in 2009 and € 4 million in 2010.

(2) Stock-based compensation (disclosure SFAS 123 and SFAS 148)

From 1996 to 2004, Alcatel adopted stock option incentive plans (see note 21).

The following information is disclosed according to the Statement of Financial Accounting Standard No. 123 Accounting for Stock-Based Compensation (“SFAS 123”) and relates to the plans adopted in 1996 through 2004:

Since 2004, the fair value at grant date of options has been determined using a binomial method; this lattice model takes into account the vesting period and the exercises by grantees. The fair values at grant date of options granted during the years 2003, 2002, 1999 and 1998 have been estimated using the Black Scholes model and a stochastic model for the 2000 and 2001 plans, each with the following characteristics:


	2004		2003		2002		2001			2000			1999			1998		1997

Interest rate		3.91%		3.62%		3.80%		5%			5%			6%^(a	⁾		3.68%		5%
Expected life		3-8 years		3-8 years		3-8 years		3-9 years			5-10 years			5 years			5 years		5 years
Expected volatility		40%		60%		60%		^(c	⁾		^(b	⁾		39%			35%		32.5%
Expected dividends		1%		1%		1%		1%			1%			1%			2%		2.25%


(a)	USD rates, concern mainly U.S. plans

(b)	73% for Alcatel Class O shares, 64% for Class A shares, 51% for ADS.

(c)	50% for Alcatel Class O shares, 46% for Class A shares, 46% for ADS.

The models used to calculate option values were developed to estimate the fair value of freely tradable, fully transferable options without vesting restrictions, which significantly differ from the Group’s stock option awards. These models are very sensitive as to the stock price volatility assumptions. Accordingly, management believes that these valuation models do not necessarily provide a reliable single measure of the fair value of the Group’s stock option awards.

The Group continues to apply the accounting method prescribed by APB Opinion No. 25 “Accounting for Stock Issued to Employees”.

F-97

ALCATEL AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

The following table sets forth the pro forma net income and earnings per share, as if the fair value based accounting method had been used to account for stock-based compensation cost:


	2004			2003			2002

	(in millions of euros
	except per share data)
Net income (loss) as reported		550			(1,721	)		(11,511	)
Stock-based employee compensation expense included in reported net income, net of tax		—			39			56
Stock-based employee compensation expense determined under fair value based method for all awards, net of tax		(350	)		(470	)		(572	)

Proforma net income (loss)		200			(2,152	)		(12,027	)

Basic earnings per ordinary share as reported		0.45			(1.42	)		(9.67	)
Basic earnings per ordinary share proforma		0.16			(1.78	)		(10.11	)
Diluted earnings per ordinary share as reported		0.42			(1.42	)		(9.67	)
Diluted earnings per ordinary share proforma		0.16			(1.78	)		(10.11	)

(3) Derivative Instruments and Hedging Activities:

Beginning January 1, 2001, for purposes of the U.S. GAAP reconciliation, Alcatel adopted SFAS 133 which establishes accounting and reporting standards that require every derivative instrument (including certain derivative instruments embedded in other contracts) to be recorded in the balance sheet as either an asset or liability, measured at its fair value. SFAS 133 also requires that changes in the derivative instrument’s fair value be recognized currently in earnings unless specific hedge accounting criteria are met. Special accounting for qualifying hedges allows a derivative instrument’s gains or losses to offset related results on the hedged item in the income statement. However, a company must formally document, designate the relationship between the hedging instrument and the hedged underlying transaction, and assess the effectiveness of transactions that receive hedge accounting.

The Group uses derivative financial instruments with off balance sheet risks primarily to manage and reduce its exposure to fluctuations in interest rates and foreign currency exchange rates. Derivative financial instruments held or issued at year-end are mostly hedges of existing or anticipated financial or commercial transactions or are backed to issued debt.

As a consequence, according to SFAS 133, the greatest part of the Group’s derivative instruments are considered as hedging. However, the Group has considered that some instruments, which are economic hedges such as currency options used to hedge commercial bids, did not perfectly comply with the hedging requirements of SFAS 133 and the Group has therefore considered them as non hedging.

Foreign currency risk

As a multinational group, certain of the Group’s commercial transactions are denominated in non-euro currencies. The Group uses derivative instruments to reduce its exposure to the effects of currency fluctuations. Alcatel decided to separate commercial bids from binding transactions.

Only hedging of firm commitments qualifies for hedge accounting under SFAS 133. There must be a relationship between the hedging instrument and the hedged underlying transaction.

For commercial transactions, each derivative instrument (only forward exchange contracts) is clearly related to a firm commercial contract.

F-98

ALCATEL AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

A commercial underlying contract is measured at fair value in order to offset the mark-to-market of the derivative hedging instrument. Changes in the derivative instrument’s fair value and its related results on the hedged item are recognized in the income statement.

According to SFAS 133, a firm commitment hedge is classified as a fair value hedge.

Derivative instruments used to cover commercial bids are economic hedges but they do not qualify for hedge accounting under SFAS 133, because the realization of the underlying commitment is not certain enough.

Therefore, derivative instruments used to hedge commercial bids (mainly options) are marked to market without offset against the underlying commitment.


	Interest rate risk

Since Alcatel is a borrower, derivative instruments are used to reduce its exposure to interest rate fluctuations. Derivative instruments (interest rate swaps, cross currency swaps, caps, floors, forward rate agreements) used by the Group to cover its debt are economic hedges but they do not qualify for hedge accounting under SFAS 133.

For long-term debt, each derivative instrument is related to a long-term issue or a medium-term note. The fair value of the long-term debt offsets the fair value of the related financial derivative. The difference is recorded in the income statement. These derivatives qualify as fair value hedges under SFAS 133.

In all other cases, derivative instruments used by Alcatel do not qualify for hedge accounting, because they do not satisfy SFAS 133 hedge criteria.


	Fair value hedges

The ineffective portion of changes in Alcatel’s fair value hedges was not material in the income statement at December 31, 2004 and December 31, 2003. At December 31, 2002 the ineffective portion of changes in fair value hedges of € 17 million was both due to mismatches in amounts and maturities.

The Group did not have any amount excluded from the measure of effectiveness.

There was no impact of contract cancellations on the income statement at December 31, 2004 and 2003. This impact was € 32.8 million at December 31, 2002.


	Net investment hedges

The Group has stopped investment hedges in foreign subsidiaries. At December 31, 2004 and 2003, there were no derivatives that qualified as investment hedge.

The portion of the derivatives that does not qualify as a hedge in 2003 and 2002 had been recorded in the income statement and had generated a loss of € 17 million at December 31, 2003 and a € 219 million gain at December 31, 2002.


(4)	Restructuring

Under French GAAP, as disclosed in note 1(j) and starting January 1, 2002 (first application of the regulation No. 00-06, regulation on liabilities), the Group records restructuring reserves when the restructuring programs have been finalized and approved by the Group’s management and have been announced before the balance sheet date of the Group’s financial statements. Until December 31, 2001, the Group recorded restructuring reserves when the restructuring programs had been finalized and approved by Group

F-99

ALCATEL AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

management and had been announced before approval of the financial statements. Under U.S. GAAP, the Group records restructuring as disclosed in note 37(d).

The impact of this U.S. GAAP adjustment for the years ended December 31, 2004, 2003 and 2002 respectively is as follows:

2004:


										Cumulative
				Current						translation
				year						adjustments
	2003			expense			Utilization			and others			2004

	(in millions of euros)
French GAAP reserve		1,068			304			(606	)		(104	)		662
Consolidation of discontinued activities					3			(37	)		34
Cost to relocate employees to another site		(8	)		(3	)								(11	)
Moving costs		(8	)		2									(6	)
Other direct costs		(31	)		25						1			(5	)
Lay-off costs in excess of legal obligation		(157	)		100						(1	)		(58	)
Total U.S. GAAP adjustment		(204	)		127			(37	)		34			(80	)

U.S. GAAP restructuring reserve		864			431			(643	)		(70	)		582

Of which related to plan initiated after December 31, 2002 (see detail in SFAS 146 disclosure)		409			349			(384	)		5			379

The current year expense recorded in 2004 includes the following major actions:


	2004

— Lay-off costs in Alcatel-CIT (France)		144
— Lay-off costs in Alcatel Espana S.A. (Spain)		36
— Lay-off costs in other European units (UK, Belgium, Portugal, AT Nordics)		31
— Lay-off costs in Germany and closure of Stuttgart plant		65
— Closure of Illkirch		43
— Reorganization, outsourcing and termination costs in North American plants (U.S. and Canada)		38
— Other plans in the world		74

Total		431

The reserve at the end of 2004 is analyzed below:


	2004

	(in millions
	of euros)
Employee termination benefits		405
Other costs		177

Total		582

F-100

ALCATEL AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

The remaining € 405 million reserve for employee termination benefits at December 31, 2004 includes approximately 3,627 employees representing:


	Number of
	employees

— Lay-off costs in Alcatel-CIT (France)		583
— Downsizing of Submarine Networks Division		138
— Lay-off costs in Alcatel Espana S.A. (Spain)		124
— Reorganization of Space Division: lay-offs mainly in France and Belgium		443
— Lay-off costs in other European units (UK, Belgium, Portugal, AT Nordics)		299
— Lay-off costs in Germany and closure of Stuttgart plant		925
— Closure of Illkirch		293
— Reorganization, outsourcing and termination costs in North American plants (U.S. and Canada)		365
— Other plans in the world		457

Total		3,627

SFAS 146 disclosure related to plans initiated after December 31, 2002:

The evolution of the restructuring reserve under U.S. GAAP during the year ended December 31, 2004 for the plans initiated after December 31, 2002, is as follows:


						Costs paid
	December 31,		Charged to			or settled			CTA and			December 31,
	2003		expense			(utilization)			other			2004

	(in millions of euro)
Alcatel-CIT		67		139			(121	)		9			94
Alcatel Espana S.A. (Spain)		20		36			(32	)					24
Submarine Networks Division		78		(1	)		(42	)		8			42
Space division		34		6			(24	)		(5	)		10
Germany		61		28			(7	)		9			90
Illkirch		51		48			(63	)		9			45
Other (no individual amount higher than € 50 million)		98		93			(95	)		(25	)		73

Total		409		349			(384	)		5			379

Of which:
Termination benefits		313		259			(306	)		(4	)		262
Contract terminations		64		29			(37	)		(34	)		22
Other associated costs		32		61			(41	)		43			95

F-101

ALCATEL AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

The major type of costs associated with the exit or disposal activities initiated after December 31, 2002 and the information by reportable segment are the following:


					Cumulative
					amount
			Amount		incurred as of
	Total amount		incurred in		December 31,
Plans initiated in 2004	expected		2004		2004

Termination benefits		82		74		74
Contract terminations		11		32		32
Other associated costs		24		6		6

Total		117		111		111

Of which:
Fixed Communications Group		31		27		27
Mobile Communications Group		4		4		4
Private Communications Group		16		14		14
Other		66		66		66

The major exit activities initiated during 2004 are the following:


	• Alcatel España S.A. (Spain) restructuring plan

In order to further reduce its fixed costs basis, Alcatel España S.A decided in the fourth quarter to extend the 2003 collective plan (see below). This extension was focused on employees with high compensation costs and affects 130 employees.


					Cumulative
					amount
			Amount		incurred as of
	Total amount		incurred in		December 31,
	expected		2004		2004

Termination benefits		25		25		25
Contract terminations		—		—		—
Other associated costs		—		—		—

Total		25		25		25

Of which:
Fixed Communications Group		5		5		5
Mobile Communications Group
Private Communications Group		1		1		1
Other		19		19		19


	• Alcatel USA exit activities

Due to a shift in the Access market, Alcatel USA engaged in a plan to discontinue the 7201 product line. The discontinuation of this activity resulted in costs related to unused fixed assets, contract manufacturing liabilities and the closure of part of the Petaluma, CA facility.

F-102

ALCATEL AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


					Cumulative
					amount
			Amount		incurred as of
	Total amount		incurred in		December 31,
	expected		2004		2004

Termination benefits
Contract terminations		11		11		11
Other associated costs		6		6		6

Total		17		17		17

Of which:
Fixed Communications Group		13		13		13
Mobile Communications Group		—		—		—
Private Communications Group		3		3		3
Other		1		1		1


								Cumulative
								amount
			Amount		Amount			incurred as of
	Total amount		incurred in		incurred in			December 31,
Plans initiated in 2003	expected		2003		2004			2004

	(in millions of euros)
Termination benefits		912		690		185			875
Contract terminations		60		58		(3	)		55
Other associated costs		85		66		55			121

Total		1,057		814		237			1,051

Of which:
Fixed Communications Group		595		497		46			543
Mobile Communications Group		127		77		65			142
Private Communications Group		245		202		68			270
Other		90		38		58			96

The figures in the above table do not include plans initiated in 2003 for companies that are no longer consolidated.

The major exit activities initiated during 2003 and their impact in 2003 and 2004 are as follows:


	• Alcatel-CIT restructuring Plan

Due to the downturn in the telecom market, and more specifically, the domestic French market, Alcatel CIT had to reduce its cost base to remain competitive. In January 2003, Alcatel CIT management signed an agreement with French unions called “accord de méthode”, corresponding to the overcapacity of more than 1,000 people.

CIT had to reduce its resources in Fixed networks, given on the one hand, the maturity of “voice” activities and reduction of new functionalities requested by operators, and on the other hand, the reduced R&D efforts and necessary resources. Reduction in Wireline Transmission was due to decreased activities mostly related to reduced SDH business (high capacity transmission). Terrestrial Transmission was hit by the

F-103

ALCATEL AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

drop in sales as a consequence of the overall market downturn, impacting mostly marketing and operation resources. The research division was penalized by a sharp activity downturn, particularly in Optics.


							Cumulative
							amount
			Amount		Amount		incurred as of
	Total amount		incurred in		incurred in		December 31,
	expected		2003		2004		2004

Termination benefits		431		262		134		397
Contract terminations		2		1		5		6
Other associated costs		—		—		—		—

Total		433		264		139		403

Of which:
Fixed Communications Group		243		168		44		211
Mobile Communications Group		117		62		65		127
Private Communications Group		47		30		15		44
Other		26		5		16		21


•	Alcatel España S.A. (Spain) restructuring plan:

Due to the overall downsizing of the market affecting Europe and the local competition in prices (particularly fixed networks products), Alcatel España had to reduce its cost base to remain competitive in the local environment.

Starting mid 2002, the production of wireline access products at the Toledo site was outsourced in order to address the general downturn in the telecommunication market and to allow more flexibility. In addition, Alcatel management decided to concentrate the production of switching products since several production sites were operated in Europe below their critical mass. The switching production at the Villaverde site was stopped and the remaining volume was transferred to Germany.

In March 2003, a new plan was launched with the goal of centralizing functions of the entire Alcatel España organization. This plan has eliminated much duplication in several functions and has allowed a greater use of the resources. As a consequence, the Villaverde site was closed and all the employees working at this site were moved to the central office in Ramirez del Prado. In total, approximately 460 persons were covered under this re-organization and restructuring plan.

F-104

ALCATEL AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

In November 2003, an extension to the collective plan was negotiated with the unions to cover a downsizing of the activities of the Integration and Service Division.


							Cumulative
							amount
			Amount		Amount		incurred as of
	Total amount		incurred in		incurred in		December 31,
	expected		2003		2004		2004

Termination benefits		86		84		8		92
Contract terminations		2		—		3		3
Other associated costs		9		8		—		8

Total		97		92		11		103

Of which:
Fixed Communications Group		60		66		3		69
Mobile Communications Group		3		6				6
Private Communications Group		11		20		5		25
Other		23				3		3


•	Submarine Networks Division restructuring plan

After two years of strong growth within the submarine industry, the market totally collapsed in 2001. Alcatel’s submarine worldwide sales decreased from € 1.8 billion in 2001 to € 0.5 billion in 2002 and € 0.2 billion in 2003. Most of the operators in the submarine market filed for Chapter-11 protection, suspended payments, cancelled their contracts or asked for re-negotiation of the contract terms.

In order to face this very difficult situation, the French locations were re-organized and a social plan was implemented with a specific announcement in 2003. Given strong product synergies with terrestrial optical systems, the production for new generation submarine systems were made in the factories for optical terrestrial systems. The production of cables in France was significantly recast to the future market requirements.

Due to a general overcapacity on the wet maintenance market and accelerated by contract terminations, a restructuring plan of the maintenance fleet was decided by management in the second half 2003 aiming at reducing the vessel fleet from eight to six. The restructuring covers mainly the termination of the charter of one of the vessels as well as a write-off of another vessel.

F-105

ALCATEL AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


								Cumulative
								amount
			Amount		Amount			incurred as of
	Total amount		incurred in		incurred in			December 31,
	expected		2003		2004			2004

Termination benefits		78		66		9			75
Contract terminations		10		14		(4	)		10
Other associated costs		20		20		—			20

Total		108		100		5			105

Of which:
Fixed Communications Group		108		100		5			105
Mobile Communications Group		—		—		—			—
Private Communications Group		—		—		—			—
Other		—		—		—			—

• Reorganization of Space Division:

In 2001 and 2002, the satellite market suffered from a large market downturn, which led to over-capacities in Alcatel Space and other main competitors in this industry.

Starting 2003, collective social plans were launched in France and in Belgium.

To further resolve the overcapacity issues, it was also decided to close the Norway and Denmark subsidiaries and to transfer the workload to France.


							Cumulative
							amount
			Amount		Amount		incurred as of
	Total amount		incurred in		incurred in		December 31,
	expected		2003		2004		2004

Termination benefits		54		54		—		54
Contract terminations		10		10		—		10
Other associated costs		—		—		3		3

Total		64		64		3		67

Of which:
Fixed Communications Group
Mobile Communications Group
Private Communications Group		64		64		3		67
Other

• Restructuring plan in Germany:

Due to considerable technological changes and a serious reduction in the digital switching market, employment levels in Switching (particularly in installation/ deployment) were sharply decreasing in 2002 and 2003. Besides, due to a worldwide flat demand in Optical transmission systems from 2001 onwards, the Optics factory in Stuttgart could no longer be sustained for economic reasons. Voluntary leave and a reduction in working time in the first three quarters in 2003 were not sufficient as restructuring measures.

F-106

ALCATEL AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

In the end November 2003, a new restructuring plan was launched. Main activities impacted were Switching (where Germany is one of the production units), Optical Transmission Systems (mainly manufacturing activities) and general administration.


							Cumulative
							amount
			Amount		Amount		incurred as of
	Total amount		incurred in		incurred in		December 31,
	expected		2003		2004		2004

Termination benefits		62		54		—		54
Contract terminations		—		—		—		—
Other associated costs		17		11		28		39

Total		69		65		28		93

Of which:
Fixed Communications Group		69		65		28		93
Mobile Communications Group		—		—		—		—
Private Communications Group		—		—		—		—
Other		—		—		—		—

• Closure of Illkirch industrial activity:

Since July 2001, Alcatel has been restructuring its industrial activities related to the production of GSM terminals at the Illkirch site. At first, the site was converted to the manufacture of opto-electronic components. However, when the components market collapsed, Alcatel opted to seek industrial work outside its own activities (Intraprise project).

As no significant workload could be found, Alcatel management announced in November 2003 the closing of the Illkirch Industries Division.


							Cumulative
							amount
			Amount		Amount		incurred as of
	Total amount		incurred in		incurred in		December 31,
	expected		2003		2004		2004

Termination benefits		88		68		20		88
Contract terminations		—		—		—		—
Other associated costs		16		—		16		16

Total		104		68		36		104

Of which:
Fixed Communications Group		—		—		—		—
Mobile Communications Group		—		—		—		—
Private Communications Group		104		68		36		104
Other		—		—		—		—

F-107

ALCATEL AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

2003:

The impact of the U.S. GAAP adjustment for the year ended December 31, 2003 was as follows:


										Cumulative
				Current						translation
				year						adjustments
	2002			expense^(a)			Utilization			and others			2003

	(in millions of euros)
French GAAP reserve		919			1,160			(980	)		(31	)		1,068
Cost to relocate employees to another site		(3	)		(5	)		—			(1	)		(8	)
Moving costs		(6	)		(8	)		—			2			(8	)
Other direct costs		(15	)		(21	)		—			3			(31	)
Lay-off costs in excess of legal obligation		(16	)		(73	)		(68	)		—			(157	)

Total U.S. GAAP adjustment		(40	)		(107	)		(61	)		4			(204	)

U.S. GAAP restructuring reserve		879			1,053			(1,041	)		(27	)		864

Of which related to plan initiated after December 31, 2002 (see detail in SFAS 146 disclosure)		—			898			(483	)		(6	)		409


(a)	Restructuring costs as indicated in the consolidated U.S. GAAP income statement (see note 39(1)) amount to € 1,132 million of which € 1,053 million, related to the restructuring reserve and € 79 million related to impairment of fixed assets.

The current year expense recorded in 2003 included the following major actions:


	2003

	(in millions of euros)
— Lay-off costs in Alcatel-CIT (France)		(269	)
— Downsizing of Submarine Networks Division: mainly lay-off costs in France (ASN France), rental termination cost of vessel		(116	)
— Lay-off costs in Alcatel Espana S.A. (Spain)		(92	)
— Reorganization of Space Division: transfer of part of the activity from Norway to France and lay-offs mainly in France		(80	)
— Lay-off costs in other European units (UK, Belgium, Portugal, AT Nordics)		(74	)
— Lay-off costs in Germany and closure of Stuttgart plant		(58	)
— Closure of Illkirch		(59	)
— Reorganization, outsourcing and termination costs in North American plants (US and Canada)		(54	)
— Lay-off costs in Optronics Division (France and UK) before disposal of the activity on July 31, 2003		(51	)
— Ongoing reorganization and downsizing of Optical Fiber Division mothballing of Claremont site (US) and reduced activity in Conflans (France) and in Mönchengladbach (Germany)		(33	)
— Lay-off costs in Italia		(18	)
— Other plans in the world		(149	)

Total		(1,053	)

F-108

ALCATEL AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

The reserve at the end of 2003 is analyzed below:


	2003

	(in millions
	of euros)
Employee termination benefits		603
Other costs		261

Total		864

The remaining € 603 million reserve for employee termination benefits at December 31, 2003 included approximately 7,930 employees representing:


	Number
	of employees

— Lay-off costs in Alcatel-CIT (France)		977
— Downsizing of Submarine Networks Division		449
— Lay-off costs in Alcatel Espana S.A. (Spain)		109
— Reorganization of Space Division: transfer of part of the activity from Norway to France and lay-offs mainly in France		288
— Lay-off costs in other European units (UK, Belgium, Portugal, AT Nordics)		1,811
— Lay-off costs in Germany and closure of Stuttgart plant		1,239
— Closure of Illkirch		503
— Reorganization, outsourcing and termination costs in North American plants (US and Canada)		648
— Ongoing reorganization and downsizing of Optical Fiber Division		346
— Lay-off costs in Italia		444
— Other plans in the world		1,116

Total		7,930

F-109

ALCATEL AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

SFAS 146 disclosure related to plans initiated after December 31, 2002:

The evolution of the restructuring reserve under U.S. GAAP during year ended December 31, 2003 for the plans initiated after December 31, 2002, was the following:


					Costs paid
	December 31,		Charged to		or settled					CTA and			December 31,
	2002		expense		(utilization)			Adjustments		other			2003

	(in millions of euros)
Alcatel-CIT		—		263		(196	)		—		—			67
Alcatel Espana S.A. (Spain)		—		92		(72	)		—		—			20
Submarine Networks Division		—		101		(23	)		—		—			78
Space division		—		64		(30	)		—		—			34
Germany		—		65		(4	)		—		—			61
Illkirch		—		68		(17	)		—		—			51
Optronics Division		—		51		(51	)		—		—			—
Other (no individual amount higher than € 50 million)		—		194		(90	)		—		(6	)		98

Total		—		898		(483	)		—		(6	)		409

Of which:
Termination benefits		—		770		(453	)		—		(4	)		313
Contract terminations		—		74		(9	)		—		(1	)		64
Other associated costs		—		54		(21	)		—		(1	)		32

2002

The impact of the U.S. GAAP adjustment for the year ended December 31, 2002 was as follows:


										Cumulative
				Current						translation
				year						adjustments
	2001			expense			Utilization			and others			2002

	(in millions of euros)
French GAAP reserve		1,113			1,081			(1,105	)		(170	)		919
Cost to relocate employees outside		(9	)		5			1			—			(3	)
Moving costs		(10	)		(16	)		20			—			(6	)
Other direct costs		(133	)		74			16			28			(15	)
Lay-off costs in excess of legal obligation/early retirement programs		(258	)		201			37			4			(16	)

Total U.S. GAAP adjustment		(410	)		264			74			32			(40	)

Restructuring reserve and asset write-downs		703			1,345			(1,031	)		(138	)		879
Write-down of assets		88			—			—			(88	)		—

U.S. GAAP restructuring reserve		615			1,345			(1,031	)		(50	)		879

F-110

ALCATEL AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

The current year expense recorded in 2002 included the following major actions:


	2002

	(in millions
	of euros)
— Lay-off and outplacement costs in Stuttgart (Germany)		261
— Costs of ongoing early retirement program and negotiated departures in CIT (France)		173
— Closure of Ghent site (Belgium) and termination costs at other Belgian sites		118
— Lay-off costs in other European units (Spain, Italy, Netherlands, Nordic countries)		261
— Reorganization, outsourcing and termination costs in North American plants (U.S. and Canada)		229
— Reorganization and downsizing of Optical Fiber Division: closure of Conflans site (France) and High River site (Canada) and reduced activity at Douvrin site (France), Claremont site (U.S.) and Mönchengladbach (Germany)		107
— Reorganization of Space Division: conversion of Valence site (France) and early retirement program and negotiated departures at other sites		65
— Reorganization of Optronics Division: closure of Gatineau site (Canada), outsourcing of the U.S activity, early retirement and voluntary terminations at other sites (France and Scotland)		23
— Other restructuring plans		108

Total		1,345

The reserve at the end of 2002 is analyzed below:


	2002

	(in millions
	of euros)
Employee termination benefits		604
Other costs		275

Total		879

The remaining € 604 million reserve for employee termination benefits at December 31, 2002 included approximately 7,452 employees to be terminated representing:


	Number of
	employees

— Negotiated departures relating to reorganization and outsourcing in North America		1,536
— Early retirement and negotiated departures in Stuttgart (Germany)		1,342
— Early retirement and lay-offs in Ghent (Belgium) and other Belgian sites		1,101
— On going early retirement program and negotiated departures in CIT (France)		741
— Negotiated departures in other European countries (Netherlands, Nordic countries, Slovakia) and other French units		918
— Early retirement and lay-offs in Space Division		427
— Departures relating to reorganization and downsizing of Optical Fiber and Optronics Divisions		486
— Other restructuring plans		901

Total		7,452

(5) Pension and post-retirement benefits other than pension plans

In accordance with the laws and customs of each country, the Group provides to its employees pensions plans, medical insurance and reimbursement of medical expenses. In France, Group employees benefit from a

F-111

ALCATEL AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

retirement indemnity plan. In other countries, the plans depend upon local legislation, the business and the historical practice of the subsidiary concerned.

Disclosures in accordance with SFAS 132 are as follows:

(a) Pensions and retirement indemnities

Pensions and retirement obligations are determined in accordance with the accounting principles presented in note 1(i).

Assumptions for the calculation

Discount rates are determined by reference to risk-free rates on bonds issued by the highest-rated companies, and possibly government securities when no such issuers exist, of appropriate duration at the measurement date of each plan. Expected returns on assets are based on the expected rate of return on plan assets (calculated taking into account historic returns, asset allocation and expected future returns). They are both defined centrally to achieve consistency in same monetary areas. Each company within Alcatel has the responsibility of determining its set of local assumptions such as withdrawal rate and salary increase rates to take into account specific local conditions. The assumptions for 2004, 2003 and 2002 are as follows (the rates indicated are weighted average rates):

Year ended

December 31,

2004

2003

2002

Discount rate

4.46

4.81

5.75

Future salary increases

3.52

3.55

3.72

Average residual active life

15-27 years

Amortization period of transition obligation

15 years


	Fiscal year			Fiscal year			Fiscal year
	2004			2003			2002

Expected long-term return on assets		4.70	%		4.50	%		4.47	%

Split between Domestic and foreign is as follows:


	Year ended						Year ended						Year ended
	December 31, 2004						December 31, 2003						December 31, 2002

	Domestic			Foreign			Domestic			Foreign			Domestic			Foreign

Discount rate		4.32	%		4.47	%		4.30	%		4.86	%		5.50	%		5.76	%
Future salary increase		2.82	%		3.57	%		2.25	%		3.70	%		2.57	%		3.88	%


	Fiscal year					Fiscal year					Fiscal year
	2004					2003					2002

Expected long-term return on assets		4.73	%	4.70	%		3.42	%	4.50	%		5.00	%	4.47	%

The assumptions used for the calculation of the Projected Benefit Obligation as of the measurement date (December 31st) of the preceding fiscal year are used to determine the calculation of interest rate and service cost of the following year.

F-112

ALCATEL AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Pensions obligation and funded status

A detailed reconciliation of the changes in the PBO for fiscal year 2004, 2003 and 2002 is provided in the following table:


	Pension benefits

	2004									2003									2002

	Total			Domestic			Foreign			Total			Domestic			Foreign			Total			Domestic			Foreign

	(in millions of euros)
Benefit obligation at beginning of year		3,282			306			2,976			3,270			344			2,926			3,305			349			2,956
Service cost		72			10			62			96			15			81			138			26			112
Interest cost		145			10			135			153			15			138			180			17			163
Plan participants’ contributions		4			—			4			5			—			5			8			—			8
Amendments		(46	)		1			(47	)		23			—			23			27			—			27
Reclassification		—			—			—			—			—			—			74	^(a)		—			74	^(a)
Business combinations		—			—			—			—			1			(1	)		1			—			1
Disposals		(72	)		(14	)		(58	)		(36	)		(26	)		(10	)		(157	)		(35	)		(122	)
Curtailments		(14	)		(7	)		(7	)		(73	)		(37	)		(36	)		(73	)		(29	)		(44	)
Settlements		(19	)		(4	)		(15	)		(65	)		—			(65	)		(44	)		—			(44	)
Special termination benefits		—			—			—			1			—			1			(1	)		(1	)		—
Actuarial loss/(gain)		38			(88	)		126			211			(1	)		212			139			24			115
Benefits paid		(162	)		(3	)		(159	)		(186	)		(5	)		(181	)		(250	)		(7	)		(243	)
Other (foreign currency translation)		(18	)		—			(18	)		(117	)		—			(117	)		(77	)		—			(77	)

Benefit obligation at end of year		3,210			211			2,999			3,282			306			2,976			3,270			344			2,926


(a)	net amount of the pension benefit obligation and fair value of plan assets presented in other non current assets before 2002.


	Pension benefits

	2004						2003						2002

	Total		Domestic		Foreign		Total		Domestic		Foreign		Total		Domestic		Foreign

	(in millions of euros)
Accumulated benefit obligation		2,869		191		2,678		2,825		262		2,563		2,852		320		2,532
Effect of salary increase		341		20		321		457		44		413		418		24		394

Benefit obligation at end of year		3,210		211		2,999		3,282		306		2,976		3,270		344		2,926

F-113

ALCATEL AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

The following table shows for fiscal year 2004, 2003 and 2002 the change in plan assets:


	Pension benefits

	2004									2003									2002

	Total			Domestic			Foreign			Total			Domestic			Foreign			Total			Domestic			Foreign

	(in millions of euros)
Fair value of plan assets at beginning of year		2,050			58			1,992			2,137			46			2,091			2,281			54			2,227
Actual return on plan assets		143			2			141			91			3			88			(36	)		(12	)		(24	)
Employers’ contribution		80			6			74			68			10			58			103			4			99
Plan participants’ contributions		4			—			4			5			—			5			8			—			8
Amendments		(56	)		(15	)		(41	)		4			5			(1	)		—			—			—
Reclassification		—			—			—			—			—			—			78	^(a)		—			78	^(a)
Business combinations		—			—			—			—			—			—			19			—			19
Disposals		(10	)		—			(10	)		(5	)		(5	)		—			(71	)		—			(71	)
Curtailments		—			—			—			(3	)		—			(3	)		—			—			—
Settlements		(15	)		—			(15	)		(61	)		—			(61	)		(83	)		—			(83	)
Special termination benefits/ benefits paid		(104	)		(3	)		(101	)		(108	)		(1	)		(107	)		(129	)		—			(129	)
Other (foreign currency translation)		(8	)		—			(8	)		(78	)		—			(78	)		(33	)		—			(33	)

Fair value of plan assets at end of year		2,084			48			2,036			2,050			58			1,992			2,137			46			2,091


(a)	Net amount of the pension benefit obligation and fair value of plan assets presented in other non current assets before 2002.

A reconciliation of the funded status of pension benefit plans is:


	Pension benefits

	2004									2003									2002

	Total			Domestic			Foreign			Total			Domestic			Foreign			Total			Domestic			Foreign

	(in millions of euros)
Funded status		(1,126	)		(163	)		(963	)		(1,232	)		(248	)		(984	)		(1,133	)		(298	)		(835	)
Unrecognized actuarial loss/(gain)		158			(15	)		173			162			80			82			45			117			(72	)
Unrecognized transition obligation		(2	)		(2	)		(0	)		(3	)		(2	)		(1	)		2			(3	)		5
Unrecognized prior service cost		57			0			57			63			0			63			70			(0	)		70

Net amount recognized		(913	)		(180	)		(733	)		(1,010	)		(170	)		(840	)		(1,016	)		(184	)		(832	)

Amounts recognized in the statement of financial position consist of:


	Pension benefits

	2004									2003									2002

	Total			Domestic			Foreign			Total			Domestic			Foreign			Total			Domestic			Foreign

	(in millions of euros)
Accrued		(1,491	)		(198	)		(1,293	)		(1,484	)		(214	)		(1,270	)		(1,504	)		(279	)		(1,225	)
Prepaid		61			—			61			62			—			62			124			—			124
Intangible assets		44			—			44			50			—			50			—			—			—
Accumulated other comprehensive loss		473			18			455			362			44			318			364			95			269

Net amount accrued for in consolidated financial statements		(913	)		(180	)		(733	)		(1,010	)		(170	)		(840	)		(1,016	)		(184	)		(832	)

F-114

ALCATEL AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

For fiscal year 2004, 2003 and 2002, the PBO, ABO and fair value of plan assets whose ABO exceeded the fair value of plan assets at the measurement date were as follows:


	Pension benefits

	2004									2003									2002

	Total			Domestic			Foreign			Total			Domestic			Foreign			Total			Domestic			Foreign

	(in millions of euros)
Projected Benefit Obligation		(2,485	)		(211	)		(2,274	)		(2,453	)		(306	)		(2,147	)		(2,263	)		(344	)		(1,919	)
Accumulated Benefit Obligation		(2,374	)		(191	)		(2,183	)		(2,323	)		(262	)		(2,061	)		(2,163	)		(320	)		(1,843	)
Fair value of plan assets		962			48			914			948			58			890			798			46			752

Underfunding of accumulated benefit obligation		(1,412	)		(143	)		(1,269	)		(1,375	)		(204	)		(1,171	)		(1,365	)		(274	)		(1,091	)


	Components of net periodic pension cost


	Pension benefits

	2004									2003									2002

	Total			Domestic			Foreign			Total			Domestic			Foreign			Total			Domestic			Foreign

	(in millions of euros)
Components of net periodic cost
Service cost		72			10			62			96			15			81			138			26			112
Interest cost		145			10			135			153			15			138			180			17			163
Expected return on plan assets		(97	)		(2	)		(95	)		(95	)		(3	)		(92	)		(110	)		(4	)		(106	)
Amortization of transition obligation		(2	)		(0	)		(2	)		(2	)		0			(2	)		(2	)		(0	)		(2	)
Amortization of prior service cost		5			0			5			5			0			5			5			(0	)		5
Amortization of recognized actuarial gain/loss		(14	)		(1	)		(13	)		(19	)		3			(22	)		(11	)		6			(17	)
Effect of curtailments		(39	)		(4	)		(35	)		(55	)		(24	)		(31	)		(35	)		(21	)		(14	)
Effect of settlements		6			—			6			23			—			23			23			—			23
Special termination benefits		—			—			—			1			—			1			(1	)		(1	)		—

Net periodic benefit cost		76			13			63			107			6			101			187			23			164

Annual cost under French GAAP for pension benefits plans is € 104 million, € 107 million and € 187 million for the years ended December 31, 2004, 2003 and 2002, respectively. Since January 1, 2004, liabilities and prepaid expenses are determined under French GAAP in accordance with International Accounting Standards No. 19. Therefore, annual costs under French GAAP and U.S. GAAP are different beginning in 2004.

F-115

ALCATEL AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


	Plan assets information

Plan assets are invested as follows:


							Cash and
	Private and						cash			Property
	public bonds			Equity			equivalent			assets			Total

	(in millions of euros and percentage)
2002
Domestic		11	24%		34	74%		1	2%		—	—		46	100%
Foreign		941	45%		563	27%		389	19%		198	9%		2,091	100%

Total		952	45%		597	28%		390	18%		198	9%		2,137	100%

2003
Domestic		23	40%		34	58%		1	2%		—	—		58	100%
Foreign		822	41%		512	26%		371	19%		287	14%		1,992	100%

Total		845	41%		546	27%		372	18%		287	14%		2,050	100%

2004
Domestic		21	54%		18	46%		—	—		—	—		39	100%
Foreign		823	41%		537	26%		373	18%		312	15%		2,045	100%

Total		844	40%		555	27%		373	18%		312	15%		2,084	100%

The investment policy relating to plan assets within the Group depends upon local practices. In all cases, the proportion of equity cannot exceed 80% of plan assets and no individual shares may represent more than 5% of total equity within the plan. The shares held by the plan must be listed on a recognized exchange. The bonds held by the plan must have a minimum “A” rating according to Standard & Poor’s or Moody’s rating criteria.

Moreover, for fiscal year 2005, we expect to contribute € 76 million to pension funds.

(b) Other post-retirement benefits

These post-retirement benefits only relate to American employees for medical insurance and life insurance. Therefore, foreign amounts are equal to total amounts and domestic amounts are nil.

The assumptions for 2004, 2003 and 2002 are as follows (the rates indicated are weighted average rates). They are equal to pension plan assumptions for American companies:


	2004			2003			2002

General inflation		3.00	%		3.00	%		3.00	%
Discount rate		5.27	%		5.25	%		6.50	%
Post-retirement cost trend rate		5.00	%		5.00	%		5.00	%

F-116

ALCATEL AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Other post-retirement obligation and funded status:


	Other post-retirement
	benefits

	2004			2003			2002

	(in millions of euros)
Change in benefit obligation
Benefit obligation at beginning of year		17			106			110
Service cost		0			1			2
Interest cost		1			6			8
Plan participants’ contributions		—			—			—
Amendments		—			(116	)		1
Business combinations		—			—			—
Disposals		—			—			—
Curtailments		—			—			(9	)
Settlements		—			—			—
Special termination benefits		—			—			—
Actuarial loss/(gain)		3			35			20
Benefits paid		(4	)		(6	)		(7	)
Other (foreign currency translation)		(0	)		(9	)		(19	)

Benefit obligation at end of year		17			17			106

The main American medical and life insurance plan was amended in 2003. After 2006, Alcatel will no longer participate in this plan.


	Other post-retirement
	benefits

	2004			2003		2002

	(in millions of euros)
Change in plan assets
Fair value of plan assets at beginning of year		—			—		—
Actual return on plan assets		—			—		—
Employers’ contributions		4			—		—
Plan participants’ contributions		—			—		—
Amendments		—			—		—
Business combinations		—			—		—
Disposals		—			—		—
Curtailments		—			—		—
Settlements		—			—		—
Special termination benefits/ benefits paid		(4	)		—		—
Other (foreign currency translation)		—			—		—

Fair value of plan assets at end of year		—			—		—

F-117

ALCATEL AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


	Other post-retirement
	benefits

	2004			2003			2002

	(in millions of euros)
Funded status		(17	)		(17	)		(106	)
Unrecognized actuarial loss/(gain)		37			41			16
Unrecognized transition obligation		0			0			2
Unrecognized prior service cost		(88	)		(102	)		—

Net amount recognized		(67	)		(78	)		(88	)


	Components of net periodic pension cost:


	Other post-retirement
	benefits

	2004			2003			2002

	(in millions of euros)
Components of net periodic cost
Service cost		0			1			2
Interest cost		1			6			8
Expected return on plan assets		—			—			—
Amortization of transition obligation		0			0			1
Amortization of prior service cost		(6	)		(1	)		—
Amortization of recognized actuarial (gain)/loss		3			4			—
Effect of curtailments		—			1			7
Effect of settlements		—			—			—
Special termination benefits		—			—			—

Net periodic benefit cost		(2	)		11			18


	Amounts recognized in the statement of financial position:


	Other post-retirement
	benefits

	2004			2003			2002

	(in millions of euros)
Accrued benefit liability		(67	)		(78	)		(88	)
Prepaid benefit cost		—			—			—

Net amount accrued for under U.S. GAAP		(67	)		(78	)		(88	)

Regarding the other benefit plans, a one-percentage point change in assumed health care cost trend rates would have the following effects:


	1 Percentage			1 Percentage
	Point increase			Point decrease

Effect on total of service and interest cost components:		5.8	%		(0.5	%)
Effect on the post-retirement benefit obligation:		2.6	%		(1.8	%)

F-118

ALCATEL AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(6) Income taxes

(a) Deferred tax balances:


	2004			2003			2002

	(in millions of euros)
Deferred tax assets		6,301			6,346			6,343
Less valuation allowance^(a)		(4,636	)		(4,306	)		(4,128	)

Net deferred tax assets		1,665			2,040			2,215
Deferred tax liabilities		(109	)		(11	)		(221	)

Net deferred taxes		1,556			2,029			1,994


(a)	Of which € 62 million at December 31, 2004 (€ 62 million at December 31, 2003 and € 85 million at December 31, 2002) will be allocated to reduce goodwill.

Major temporary differences giving rise to deferred taxes at December 31 are as follows:


		2004			2003			2002

		(in millions of euros)
Tax effect of temporary differences related to:
	Accounting for long-term contracts		(16	)		(11	)		(81	)
	Depreciation of property, plant and equipment		—			—			—
	Other		(93	)		—			(140	)

Deferred tax liabilities			(109	)		(11	)		(221	)

Tax losses carried forward			4,858			4,483			4,292
Accrued pension and retirement obligation			111			62			277
Other reserves			217			304			238
Other			1,115			1,497			1,536

Deferred tax assets			6,301			6,346			6,343
Less: Valuation allowance			(4,636	)		(4,306	)		(4,128	)

Deferred tax assets, net			1,665			2,040			2,215

Total deferred tax assets (liabilities), net			1,556			2,029			1,994

Deferred tax balances are analyzed as follows:


At December 31, 2004	Current			Non-current			Total

	(in millions of euros)
Deferred tax assets (net of valuation allowance)		235			1,430			1,665
Deferred tax liabilities		(33	)		(76	)		(109	)

Total		202			1,354			1,556


At December 31, 2003	Current			Non-current		Total

	(in millions of euros)
Deferred tax assets (net of valuation allowance)		406			1,634		2,040
Deferred tax liabilities		(11	)		—		(11	)

Total		395			1,364		2,029

F-119

ALCATEL AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


At December 31, 2002	Current			Non-current			Total

	(in millions of euros)
Deferred tax assets (net of valuation allowance)		568			1,647			2,215
Deferred tax liabilities		(73	)		(148	)		(221	)

Total		495			1,499			1,994

(b) Analysis of income tax (expense) benefit:


	2004			2003			2002

	(in millions of euros)
Current tax (expense) benefit		82			(62	)		283
Tax benefit of operating losses carried forward		110			534			1,860
Net change in valuation allowance		(10	)		(575	)		(1,903	)
Other deferred tax (expense) benefit		(191	)		(9	)		(149	)

Income tax (expense) benefit		(9	)		(112	)		91

(c) Effective income tax rate


	2004			2003			2002

	(in millions of euros)
Income (loss) before taxes, share in net income of equity affiliates, purchased research and development, amortization of goodwill, minority interests and extraordinary items		678			(1,591	)		(4,540	)
Average income tax rate		28.4	%		32.6	%		35.1	%

Expected tax (charge) benefit		(193	)		518			1,594
Impact of:
— reduced taxation of certain revenues		2			12			5
— net change in valuation allowance		(10	)		(575	)		(1,903	)
— tax credits		14			(3	)		31
— other		178			(64	)		364

Actual income tax (charge) benefit		(9	)		(112	)		91
Effective tax rate		1.4	%		(7.1	)%		2.0	%


(d)	Income (loss) before taxes, share in net income of equity affiliates, purchased research and development, minority interests and extraordinary items by geographical origin:


	2004		2003			2002

	(in millions of euros)
France		84		(995	)		(1,690	)
Foreign		590		(600	)		(6,962	)

Income (loss) before tax		674		(1,595	)		(8,652	)

(7) FIN 45 Disclosure

The recognition provisions of FASB Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others” (“FIN 45”), were adopted on January 1, 2003. FIN 45 requires recognition of an initial liability for the fair value of an obligation assumed by issuing a guarantee and is applied on a prospective basis to all guarantees issued or

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

modified after December 31, 2002. The adoption of FIN 45 did not have a material effect on the audited consolidated financial statements.

Through our normal course of business, we have entered into guarantees and indemnifications which mainly arose from the following situations:


	•	Business sale agreements

	•	Intellectual property indemnification obligations

	•	Lease agreements

	•	Third-party debt agreements

	•	Indemnification of lenders and agents under our credit and support facilities and security arrangements

	•	Indemnification of counterparties in receivables securitization transactions

	•	Other indemnification agreements

Guarantees and indemnification agreements are mainly disclosed in note 31 with:


	—	“debt guarantees” for third-party debt agreements, indemnification of lenders and agents under our credit and support facilities and security arrangements and indemnification of counterparties in receivables securitization transactions;

	—	and “other contingent commitments”.

Regarding business sale agreements, the Group is unable to reasonably estimate the maximum amount that could be payable under these arrangements because the exposures are not capped and because of the conditional nature of the Group’s obligations and the unique facts and circumstances involved in each agreement.

The Group records a liability for product warranties corresponding to the estimated amount of future repair and replacement costs for products still under warranty at the balance sheet date. The liability is included in the reserves for product sales disclosed in note 25. The reserve is calculated based on historical experience concerning the costs and frequency of repairs or replacements.

Change of product warranty reserve during fiscal 2003 and 2004:


	2003

	(in millions of euros)
As of January 1, 2003		751

Additional reserves		259
Used		(205	)
Changes in estimates of pre-existing warranties		(162	)
Change in consolidated companies		(18	)
Exchange differences and other		(51	)

As of December 31, 2003		574

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


	2004

	(in millions of euros)
As of January 1, 2004		574

Additional reserves		123
Used		(139	)
Changes in estimates of pre-existing warranties		(141	)
Change in consolidated companies		(49	)
Exchange differences and other		12

As of December 31, 2004		380

Disclosures related to guarantees given are set forth in note 31.


(8)	Combined information concerning subsidiaries consolidated using the proportionate consolidation method

In accordance with regulations of the U.S. Securities and Exchange Commission with respect to the use of proportionate consolidation method, summarized financial information about the Group’s share of assets, liabilities, revenues, expenses and cash flows included in the financial statements and related to investments in operating entities accounted for using the proportionate consolidation method (Evolium and Alda Marine in 2004, 2003 and 2002 and Europe*Star only in 2002) have been prepared for the three years ended December 31, 2004, 2003 and 2002.


	Year ended December 31,

	2004			2003			2002

	(in millions of euros)
Balance Sheet data
Non-current assets		160			153			234
Current assets		25			56			18
Non-current liabilities		96			102			187
Current liabilities		89			49			68
Income statement data
Net sales		2			1			10
Cost of sales		65	^(a)		(32	)		(38	)
Income (loss) from operations		2			(34	)		(50	)
Net income		1			(45	)		(185	)
Cash flow data
Cash flow from operating activities		53			(14	)		5
Cash flow from investing activities		(46	)		(31	)		(46	)
Cash flow from financing activities		(10	)		42			46


(a)	including operating grants received from other fully owned subsidiaries of the Group.

(9) Other information on affiliates

Market value of Alcatel’s stake in listed equity affiliates at December 31, 2004:


	% interest			Net value		Market value

	(in millions of euros)
Thales		9.5	%		392		575

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

In addition, dividends received in 2004 from equity affiliates amounted to € 20 million (€ 13 million for 2003 and € 81 million for 2002).

(10) Other information (schedule II) — based on French GAAP information


	Balance at		Charged to						Balance at
	beginning		costs and			Other			end
	of period		expenses			movements			of period

	(in millions of euros)
Valuation and qualifying accounts deducted from the related accounts
2004
Other investments and miscellaneous		1,549		(39	)		(181	)		1,329
Inventories		978		(22	)		(461	)		495
Trade receivables and related accounts		437		(42	)		(111	)		284
Other accounts receivable		34		4			16			54
2003
Other investments and miscellaneous		2,008		(311	)		(148	)		1,549
Inventories		1,394		67			(483	)		978
Trade receivables and related accounts		1,092		(253	)		(402	)		437
Other accounts receivable		36		(13	)		11			34
2002
Other investments and miscellaneous		1,493		710			(195	)		2,008
Inventories		1,588		562			(756	)		1,394
Trade receivables and related accounts		928		279			(115	)		1,092
Other accounts receivable		17		6			13			36
Accrued contract costs and other reserves
2004
Accrued pensions and retirement obligations		1,010		104			30			1,144
Estimated losses on long-term contracts		155		162			(122	)		195
Other contract costs		1,048		(33	)		(282	)		733
Other reserves		779		(21	)		(70	)		688
2003
Accrued pensions and retirement obligations		1,016		132			(138	)		1,010
Estimated losses on long-term contracts		112		85			(42	)		155
Other contract costs		1,377		66			(395	)		1,048
Other reserves		893		185			(299	)		779
2002
Accrued pensions and retirement obligations		1,120		187			(291	)		1,016
Estimated losses on long-term contracts		343		(14	)		(217	)		112
Other contract costs		1,475		336			(434	)		1,377
Other reserves		1,223		107			(437	)		893


(11)	Recently issued U.S. Accounting Standards

FIN 46 Consolidation of Variable Interest Entities was effective for Alcatel starting January 1, 2004. The Group has concluded that this had no impact on the consolidated financial statements.

In March 2004, the EITF reached consensus on Issue No. 03-01, “The Meaning of Other-Than-Temporary Impairment and its Application to Certain Investments” (“EITF 03-01”). EITF 03-01 provides guidance on other-than-temporary impairment models for marketable debt and equity securities and non-

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

marketable securities accounted for under the cost method. On September 30,2004, the FASB issued FSP 03-01-1, Effective Date of Paragraphs 10-20 of EITF Issue 03-01, The Meaning of Other-Than-Temporary Impairment and its Application to Certain Investments, delaying the effective date for the recognition and measurement guidance in EITF 03-01, until certain implementation issues are addressed and a final FSP is issued. The disclosure requirements in EITF 03-01 remain effective. The Group has concluded that this had no impact on the consolidated financial statements.

In November 2004, the FASB issued FASB Statement No. 151, Inventory Costs, an amendment of ARB No. 43, Chapter 4, clarifying the existing requirements in ARB No. 43 by adopting language similar to that used in IAS 2. The guidance is effective for inventory costs incurred during fiscal years beginning after June 15, 2005. The adoption of FAS 151 will not have an impact on the Group’s consolidated results of operation or financial position, since the key elements are already utilized in the Group’s IFRS and U.S. GAAP consolidated financial statements.

In December 2004, the FASB published FASB Statement No. 123 (revised 2004), Share-Based Payments. This standard provides guidance on how companies must recognize the compensation cost relating to share-based payment transactions in their financial statements. It will require companies to recognize a compensation cost for the value of options granted in exchange for employee services, based on the grant date fair value of those instruments. FASB No. 123 (revised) is effective for public entities as of the beginning of the first interim or annual reporting period that begins after June 15, 2005, however early application is possible. The Group is in the process of assessing what impact the pronouncement will have on its consolidated financial statements.

In December 2004, the FASB published FASB Statement No. 153, Exchanges of Non Monetary Assets an amendment of APB Opinion No. 29. This statement addresses the measurement of exchanges of non monetary assets. It eliminates the exception from fair value measurement for non monetary exchanges of similar productive assets in paragraph 21(b) of APB Opinion 29, and replaces it with an exception for exchanges that do not have commercial substance. This statement specifies that a non monetary exchange has commercial substance if the future cash flows of the entity are expected to change significantly as a result of the exchange. FASB No. 143 is effective for non monetary asset exchanges occurring in fiscal periods beginning after June 15, 2005, however early adoption is possible.


Note 41 —	Subsequent events

On January 28, 2005, Alcatel announced the signature of final agreements to merge its space activities with those of Finmeccanica and the creation of two joint venture companies, to which both partners will contribute their respective satellite industrial and service activities.

On February 24, 2005, Moody’s placed Alcatel’s debt ratings outlook under review for possible upgrade.

On March 15, 2005, Alcatel announced that it has successfully completed the amendment of its existing undrawn € 1.3 billion syndicated 3-year revolving credit facility to benefit from the attractive conditions prevailing in the loan market. The amendment consisted in lengthening the maturity of the facility from June 2007 to June 2009 with a possible extension until 2011, cancelling one of the two financial covenants and reducing the cost of the facility. Alcatel decided to reduce its overall amount to € 1 billion.

On March 16, 2005, Alcatel announced that it has initiated the disposal of 3,476,388 Nexans shares (i.e. 15% of the share capital), corresponding to its entire shareholding, currently accounted for as marketable securities. The transaction takes the form of a private placement executed via an accelerated bookbuilding process.

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