SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Report of Foreign Private Issuer

FORM 6-K

Pursuant to Rule 13a-16 or 15d-16
of the Securities Exchange Act of 1934

For the month of September, 2006

Commission File Number 1-11130

ALCATEL

54, rue La Boétie
75008 Paris – France
(Address of principal executive offices)

Indicate by check mark whether the registrant files or will file annual reports under cover Form 20-F or Form 40-F.

Form 20-F þ                                                                                                       Form 40-F o

Indicate by check mark if the registrant is submitting the Form 6-K in paper as permitted by Regulation S-T Rule 101(b) (1):                

Indicate by check mark if the registrant is submitting the Form 6-K in paper as permitted by Regulation S-T Rule 101(b) (7):                

Indicate by check mark whether by furnishing the information contained in this Form, the registrant is also thereby furnishing the information to the Commission pursuant to Rule 12g3-2(b) under the Securities Exchange Act of 1934.

Yes o                                                                                                       No þ

If “Yes” is marked, indicate below the file number assigned to the registrant in connection with Rule 12g3-2(b): 82-                    

 

 

TABLE OF CONTENTS

Operating and Financial Review and Prospects as of and for the Period Ended June 30, 2006.

OPERATING AND FINANCIAL REVIEW AND PROSPECTS

UNAUDITED CONDENSED INTERIM CONSOLIDATED INCOME STATEMENTS — IFRS STANDARDS

UNAUDITED CONDENSED INTERIM CONSOLIDATED BALANCE SHEETS — IFRS STANDARDS

UNAUDITED CONDENSED INTERIM CONSOLIDATED STATEMENTS OF CASH FLOWS — IFRS STANDARDS

UNAUDITED CONDENSED INTERIM CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY

NOTES TO UNAUDITED CONDENSED INTERIM CONSOLIDATED FINANCIAL STATEMENTS

SIGNATURE

Operating and Financial Review and Prospects as of and for the Period Ended June 30, 2006.

Forward-looking Information

This discussion of our Operational and Financial Review and Prospects contains forward-looking statements based on beliefs of our management. We use the words “anticipate,” “believe,” “expect,” “may,” “intend,” “should,” “plan,” “project,” or similar expressions to identify forward-looking statements. Such statements reflect our current views with respect to future events and are subject to risks and uncertainties. Many factors could cause the actual results to be materially different, including, among others, changes in general economic and business conditions, changes in currency exchange rates and interest rates, introduction of competing products, lack of acceptance of new products or services and changes in business strategy. Such forward-looking statements include, but are not limited to, the forecasts and targets included in this discussion under the heading “Operating and Financial Review and Prospects as of and for the Period Ended June 30, 2006 — Overall Perspective,” with respect to (i) our expectation that the carrier market will grow in the second half of 2006, (ii) the additional costs associated with our current strategic transactions with Lucent Technologies, Inc. and Thales are in line with our expectations and (iii) the amount we would be required to pay in the future pursuant to our existing contractual obligations and off-balance sheet contingent commitments, included in this discussion under the heading “Contractual obligations and off-balance sheet commitments”.

Presentation of Financial Information

The following discussion of our financial condition and results of operations should be read in conjunction with our unaudited condensed interim consolidated financial statements as of and for the period ended June 30, 2006 (the “unaudited condensed interim consolidated financial statements”) and the related notes presented elsewhere in this document. Our unaudited condensed interim consolidated financial statements have been prepared in accordance with International Financial Reporting Standards as adopted in the European Union (“IFRS”), which differ in certain significant ways from U.S. generally accepted accounting principles (“U.S. GAAP”). The unaudited condensed interim consolidated financial statements are compliant with IAS 34 requirements. The most significant differences that affect the presentation of our financial results relate to the accounting treatment of business combinations before the date of transition to IFRS (January 1, 2004), capitalization of development costs, accounting of post-employment benefits, accounting for share-based payment transactions, accounting of compound financial instruments, accounting for sale and leaseback transactions, accounting for restructuring costs, accounting for inventory write-downs, accounting for income taxes in interim periods and impacts of differences between IFRS and U.S. GAAP on share in net assets of equity affiliates. For a discussion of the significant differences between IFRS and U.S. GAAP as they relate to our unaudited condensed interim consolidated financial statements, and a reconciliation of our net income (loss) for the period ended June 30, 2006 and shareholders’ equity as of that date to U.S. GAAP, please refer to Notes 20 through 23 in our unaudited condensed interim consolidated financial statements included elsewhere in this document.

Changes in Accounting Standards as of January 1, 2006

As a result of the publication of the “Fair Value Option” amendment to IAS 39 “Financial Instruments: Recognition and Measurement”, effective January 1, 2006, certain marketable securities previously included in the category of financial assets at fair value through profit or loss are now designated as financial assets available for sale. The impact of this change, had it been applied in 2005, is presented in Note 7 – Financial income (loss) and in the consolidated statement of changes in shareholders’ equity in our unaudited condensed interim consolidated financial statements included elsewhere in this document.

Critical Accounting Policies

The discussion in “Operating and Financial Review and Prospects” below is based on our unaudited condensed interim consolidated financial statements, which are prepared in accordance with IFRS as described in Note 1 thereto. Some of the accounting methods and policies used in preparing our unaudited condensed interim consolidated financial statements under IFRS and the reconciliation of our net income and shareholders’ equity to U.S. GAAP are based on complex and subjective assessments by our management or on estimates based on past experience and assumptions deemed realistic and reasonable based on the circumstances concerned. The actual value of our assets, liabilities and shareholders’ equity and of our earnings could differ from the value derived from these estimates if conditions changed and these changes had an impact on the assumptions adopted.

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

Valuation allowance for inventories and work in progress

Inventories and work in progress are measured at the lower of cost or net realizable value. Valuation allowances for inventories and work in progress are calculated based on an analysis of foreseeable changes in demand, technology or the market, in order to determine obsolete or excess inventories and work in progress.

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

From 2000 to 2003, significant provisions for write-down of inventories and work in progress were accounted for because of difficult market conditions and the abandonment of certain product lines. The impact of these provisions on our income before tax is a net charge of € 28 million for the first six months of 2006 (a net charge of € 18 million in 2005 and of € 15 million for the first six months of 2005). This amount represented new write-downs taken in the first half of 2006, which more than offset the reversal of existing provisions of € 40 million due to asset sales that occurred in the first half of 2006.

Because of the revival in the telecommunications market, our future results could continue to be positively impacted by the reversal of provisions previously made.

Impairment of customer receivables and loans

An impairment loss is recorded for customer receivables and loans if the present value of the future receipts is below the nominal value. The amount of the impairment loss reflects both the customers’ ability to honor their debts and the age of the debts in question. A higher default rate than estimated or the deterioration of our major customers’ creditworthiness could have an adverse impact on our future results. Impairment losses on customer receivables were € 221 million at June 30, 2006 (€ 228 million at December 31, 2005 and € 260 million at June 30, 2005). The impact of impairment losses for customer receivables and loans on income before tax is a net gain of € 5 million for the first six months of 2006 (a net gain of € 25 million in 2005 and € 28 million for the first six months of 2005).

Impairment losses on customer loans and other financial assets (assets essentially relating to customer financing arrangements) were € 887 million at June 30, 2006 (€897 million at December 31, 2005 and € 918 million at June 30, 2005). The impact of these impairment losses on income before tax is a net gain of € 2 million for the first six months of 2006 (a net gain of € 25 million in 2005 and € 4 million for the first six months of 2005).

Capitalized development costs, goodwill and other intangible assets

The criteria for capitalizing development costs are set out in Note 1f to our unaudited condensed interim consolidated financial statements included elsewhere in this document. Once capitalized, these costs are amortized over the estimated lives of the products concerned.

The Group must therefore evaluate the commercial and technical feasibility of the development projects and estimate the useful lives of the products resulting from the projects. Should a product fail to substantiate these assumptions, the Group may be required to impair or write off some of the capitalized development costs in the future.

The Group also has intangible assets acquired for cash or through business combinations and the goodwill resulting from such combinations.

As indicated in Note 1g to our unaudited condensed interim consolidated financial statements, in addition to the annual goodwill impairment tests, timely impairment tests are carried out in the event of indications of reduction in value of intangible assets held. Possible impairments are based on discounted future cash flows and/or fair values of the assets concerned. A change in the market conditions or the cash flows initially estimated can therefore lead to a review and a change in the impairment loss previously recorded.

Net goodwill is € 3,735 million at June 30, 2006 (€ 3,772 million at December 31, 2005 and € 3,896 million at June 30, 2005). Other intangible assets, net were € 875 million at June 30, 2006 (€ 819 million at December 31, 2005 and € 808 million at June 30, 2005). The annual impairment test for goodwill (Note 1g to our unaudited condensed interim consolidated financial statements) was performed during the second quarter of 2006 and resulted in no goodwill impairment being recorded as of June 30, 2006.

Impairment of property, plant and equipment

In accordance with IAS 36 “Impairment of Assets”, when events or changes in market conditions indicate that tangible or intangible assets may be impaired, such assets are reviewed in detail to determine whether their carrying value is lower than their recoverable value, which could lead to recording an impairment loss (recoverable value is the higher of its value in use and its fair value less costs to sell) (see Note 1g to our unaudited condensed interim consolidated financial statements). Value in use is estimated by calculating the present value of the future cash flows expected to be derived from the asset. Fair value less costs to sell is based on the most reliable information available (market statistics, recent transactions, etc.).

The planned closing of certain facilities, additional reductions in personnel and reductions in market outlooks have been considered impairment triggering events in prior years. No significant impairment losses have been recorded for the first six months of both 2006 and 2005.

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

Provision for warranty costs and other product sales reserves

Provisions for product sales cover probable liabilities arising from past and current sales contracts and are mainly related to claims made by customers for non-fulfillment of contractual obligations, warranty and retrofits, fines and penalties. Provisions are recorded for warranties given to customers on our products or for expected losses and for penalties incurred in the event of failure to meet contractual obligations on construction contracts. These provisions are calculated based on historical return rates and warranty costs expensed as well as on estimates. These provisions and subsequent changes to the provisions are recorded in cost of sales either when revenue is recognized (provision for customer warranties) or, for construction contracts, when revenue and expenses are recognized by reference to the stage of completion of the contract activity. Costs and penalties that will be effectively paid can differ considerably from the amounts initially reserved and could therefore have a significant impact on future results.

Product sales reserves represent € 653 million at June 30, 2006, of which € 151 million relate to construction contracts (see Note 12 to our unaudited condensed interim consolidated financial statements) (€ 753 million and € 173 million respectively at December 31, 2005). For further information on the impact on net income (loss) of the change in these provisions, see consolidated results of operations for the six months ended June 30, 2006 compared to the six months ended June 30, 2005, Income (loss) from operating activities before restructuring, share-based payments, impairment of capitalized development costs and gain on disposal of consolidated entities and Notes 12 and 15 to our unaudited condensed interim consolidated financial statements.

Deferred taxes

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

At June 30, 2006, deferred tax assets were € 1,670 million (of which € 795 million relate to the United States and € 401 million to France). Evaluation of the Group’s capacity to utilize tax loss carry forwards relies on significant judgment. The Group analyzes the positive and negative elements to conclude as to the probability of utilization in the future of these tax loss carry forwards, which also consider the factors indicated in Note 1n to our unaudited condensed interim consolidated financial statements. This analysis is carried out regularly in each tax jurisdiction where significant deferred tax assets are recorded.

If future taxable results are considerably different from those forecast that support recording deferred tax assets, the Group will be obliged to revise downwards or upwards the amount of the deferred tax assets, which could have a significant impact on our balance sheet and net income (loss).

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

As indicated in Note 1k to our unaudited condensed interim consolidated financial statements included elsewhere in this document, the Group participates in defined contribution and defined benefit plans for employees. Furthermore, certain other post-employment benefits, such as life insurance and health insurance (mainly in the United States), are also reserved. All these obligations are measured based on actuarial calculations relying upon assumptions, such as the discount rate, return on plan assets, future salary increases, employee turnover and mortality tables.

These assumptions are generally updated annually. At December 31, 2005, the weighted average discount rate was 3.95%, the weighted average future salary increase was 3.34% and the weighted average expected long-term return on assets was 4.28% (these assumptions are set forth in Note 25 to our consolidated financial statements at December 31, 2005). Using the “corridor” method, only actuarial gains and losses in excess of the greater of 10% of the present value of the defined benefit obligation or 10% of the fair value of any plan assets are recognized over the expected average remaining working lives of the employees participating in the plan. In accordance with the option available under IFRS 1, cumulative actuarial gains and losses at the transition date have been recognized in shareholders’ equity. The corridor method is therefore only applied as from January 1, 2004.

The Group considers that the actuarial assumptions used are appropriate and supportable but changes that will be made to them in the future could have, however, a significant impact on the amount of such obligations and the Group’s net income (loss). An increase of 0.5% in the discount rate at December 31, 2005 (or a reduction of 0.5%) has a positive impact on 2005 net income of € 8 million (or a negative impact of € 8 million on net income). An increase of 0.5% in the assumed rate of return on plan assets for 2005 (or a reduction of 0.5%) has a positive impact on 2005 net income of € 11 million (or a negative impact of € 11 million on net income).

Revenue recognition

As indicated in Note 1o to our unaudited condensed interim consolidated financial statements, revenue is measured at the fair value of the consideration received or to be received when the company has transferred the significant risks and rewards of ownership of a product to the buyer.

For revenues and expenses generated from construction contracts, the Group applies the percentage of completion method of accounting, provided certain specified conditions are met, based either on the achievement of contractually defined milestones or on costs incurred compared with total estimated costs. The determination of the stage of completion and the revenues to be recognized rely on numerous estimations based on costs incurred and acquired experience. Adjustments of initial estimates can, however, occur throughout the life of the contract, which can have significant impacts on future net income (loss).

For arrangements to sell software licenses with services, software license revenue is recognized separately from the related service revenue, provided the transaction adheres to certain criteria (as prescribed by the AICPA’s SOP 97-2), such as the existence of sufficient vendor-specific objective evidence to determine the fair value of the various elements of the arrangement. Determination of the fair value of the various elements of the arrangement relies also on estimates, which if they had to be corrected, would have an impact on revenues and net income (loss).

In the context of the present telecommunications market, it can be difficult to evaluate the Group’s capacity to recover receivables. Such evaluation is based on the customers’ creditworthiness and on the Group’s capacity to sell such receivables without recourse. If, subsequent to revenue recognition, the recoverability of a receivable that had been initially considered as likely becomes doubtful, a provision for an impairment loss is then recorded.

Derecognition of financial assets

A financial asset, as defined under IAS 32 “Financial Instruments: Disclosure and Presentation,” is either totally or partially derecognized (removed from the balance sheet) when (i) we expect that no further cash flow will be generated by it, (ii) we transfer substantially all risks and rewards attached to the asset or (iii) we retain no control of the asset.

With respect to trade receivables, a transfer without recourse in case of payment default by the debtor is regarded as at transfer of substantially all risks and rewards of ownership, thus making such receivables eligible for derecognition, on the basis that risk of late payment is considered marginal. Potential new interpretations in the future of the concept of “substantial transfer of risks and rewards” could lead us to modify our current accounting treatment.

OPERATING AND FINANCIAL REVIEW AND PROSPECTS

Overall Perspective

Overview of the first half of 2006. The first six months of 2006 were characterized by a dynamic and growing telecommunications market. We have seen our revenues increase as a result of this market environment and, in particular, due to our leading position in products and technologies that will help our customers transform their networks to provide voice, data and video at very high speeds to their end users. We call this network transformation “triple play” and our fixed line business, where we supply access, optical, and IP data products, has benefited from this trend. In our wireless business, we have seen revenue growth; however, we have also invested in new technology which has not yet been significantly deployed in our customers’ networks. In addition, we continue to operate in a highly competitive pricing environment. Both the high level of investment and the competitive market environment have impacted our revenue and profitability in the mobile segment. Our private communications business has recorded satisfactory revenue growth, particularly in the rail communications and enterprise activities, partially offset by a continued softness in the satellite sector. During the first six months of 2006 our revenues increased by 12.2% to € 6,451 million. If there had been a constant euro/U.S. dollar exchange rate during the first six months of 2006 as compared to the same period in 2005, our consolidated revenues would have increased by approximately 10.7%. Our income (loss) from operating activities before restructuring, share-based payments, impairment of capitalized development costs and gain on disposal of consolidated entities (we previously referred to this item as operating profit) was € 461 million, or 7.1% of revenues, while our net income (attributable to equity holders of the parent) was € 284 million. Net cash, which is total gross cash and marketable securities less total gross debt as recorded on our balance sheet, amounted to € 980 million.

The first part of the year has been highlighted by a major strategic evolution which has placed Alcatel at the forefront of the much needed industry consolidation. Our pending merger with Lucent Technologies, Inc., which we announced on April 2, 2006, should provide enhanced earnings opportunities for the combined company, thanks to the strong and complementary geographical and technological attributes of both companies. The closing of the deal is expected in the fourth quarter of 2006. Our plan to transfer our satellite and security assets to Thales, which we announced on April 5, 2006, should allow us to reinforce our industrial partnership and open new opportunities for our communications technology in the defense and security markets. Closing for this transaction is expected to occur in the second half of the year.

Outlook for the second half of 2006. Going into the second half of the year we expect to see the carrier market growing in the mid single digit range for full year 2006. As we expect the pending merger with Lucent Technologies to close during the fourth quarter of 2006, we are not providing specific annual guidance.

Our third quarter will be a transition quarter where we expect revenues to grow year over year in the mid single digit range (at the current structure). Income (loss) from operating activities before restructuring, share-based payments, impairment of capitalized development costs and gain on disposal of consolidated entities should be close to the same amount as in the second quarter of 2006, taking into account increased investments in R&D and additional costs associated with the strategic moves underway.

Highlights of recent transactions

Acquisition of Nortel’s UMTS business. On September 1, 2006, we announced the signing of a non-binding memorandum of understanding with Nortel to acquire Nortel’s UMTS radio access business (UTRAN) and related assets for $320 million.

Shareholders’ approval of the merger with Lucent Technologies. On September 7, 2006, our shareholders approved all proposed resolutions related to the merger with Lucent Technologies at our annual and extraordinary general meeting of shareholders.

Highlights of transactions during the six months ended June 30, 2006

Acquisition of equity stake in 2Wire. On January 27, 2006, we acquired a 27.5% stake in 2Wire, a company specializing in home broadband network products, for $122 million.

Merger with Lucent Technologies. On April 2, 2006, we entered into a definitive merger agreement with Lucent Technologies. The boards of directors and the shareholders of both companies have approved the transaction. Under the terms of the agreement, Lucent shareholders will receive 0.1952 of an ADS (American Depositary Share) representing ordinary shares of Alcatel (as the combined company) for every common share of Lucent that they hold. Upon completion of the merger, Alcatel shareholders will own approximately 60% of the combined company and Lucent shareholders will own approximately 40% of the combined company. The combined company’s ordinary shares will continue to be traded on the Euronext Paris and the ADSs, representing ordinary shares, will continue to be traded on The New York Stock Exchange.

The combined company created by this merger will be incorporated in France, with its headquarters located in Paris. The North American operations will be based in New Jersey, U.S.A., where Bell Labs will remain headquartered. The board of directors of the combined company will be composed of 14 members and will have equal representation from each company, including Serge Tchuruk and Patricia Russo, five of Alcatel’s current directors and five of Lucent’s current directors. The board will also include two new independent European directors to be mutually agreed upon.

The combined company intends to form a specific U.S. subsidiary holding certain contracts with U.S. government agencies and will be subject to reinforced confidentiality and security conditions. A board of directors, comprising three independent U.S. citizens acceptable to the U.S. government, will manage this subsidiary separately.

The merger is subject to customary regulatory and governmental reviews in the United States, Europe and elsewhere (many of which have already been obtained) and other customary conditions. The transaction is expected to be completed in the fourth quarter of 2006. Until the merger is completed, both companies will continue to operate their businesses independently.

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

Disposal of satellite subsidiaries, railway signaling, and integration and services activities for mission-critical systems to Thales. On April 5, 2006, we announced that the board of directors of Thales had approved the acquisition in principle of our satellite subsidiaries, railway signalling business and our integration and services activities for mission-critical systems. With this transaction, we would strengthen our position as a significant shareholder in Thales, with a 21.6% stake, while Groupe Industriel Marcel Dassault would keep its 5% share and the French State would remain the majority shareholder with 27.1%.

The transaction primarily consists of the contribution by Alcatel to Thales of the following assets:

1. In the Space sector:

	-		Our 67% stake in the capital of Alcatel Alenia Space (this joint venture company, created in 2005, combined Alcatel’s and Finmeccanica S.p.A.’s industrial space assets, the latter holding a 33% stake).
	-		Our 33% stake in the capital of Telespazio, a worldwide leader in satellite services, whose majority stake of 67% is held by Finmeccanica.

2. In the domain of critical systems for security:

	-		Our Transport Systems activities, which is a worldwide leader in signalling solutions for rail transport and urban metros.
	-		Our Systems Integration activities not dedicated to telecom operators, and covering mainly the transport and energy sectors.

The total revenues of these activities, based on our 2005 consolidated financial statements, amounted to € 2 billion. The workforce represents approximately 11,000 people, mainly in France, Germany, Italy and Canada. All the assets to be included in the contemplated transaction are part of our Private Communications segment.

Thales will pay Alcatel approximately € 0.7 billion in cash upon closing the transaction, subject to adjustment.

As of September 25, 2006, Alcatel and Thales had not entered into a binding contract with regard to this transaction. An amendment to the shareholders agreement between the French State, Alcatel and Dassault regarding the shareholding of Thales must be completed as part of the transaction. The transaction will also be subject to customary regulatory approvals as well as approval from the French State, Lucent and Finmeccanica, our partner in Alcatel Alenia Space and Telespazio.

Highlights of Transactions during 2005

Acquisitions

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

Dispositions

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

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.

Other Transactions

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

Moody’s upgrade of our long-term debt. On April 11, 2005, Moody’s upgraded to Bal from Ba3 the ratings for our long-term debt on the basis of cost savings achieved by us and our balance sheet strength.

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

Exchange of our interest in joint venture with TCL Communication. On July 18, 2005, we exchanged our 45% shareholding in our joint venture for mobile handsets with our partner, which resulted in our owning 4.8% of TCL Communication Technology Holdings Limited.

Consolidated Results of Operations for the Six Months Ended June 30, 2006 Compared to the Six Months ended June 30, 2005

Before January 1, 2005 our consolidated financial statements were prepared in accordance with French GAAP. Effective January 1, 2005, we began preparing our financial statements in accordance with IFRS in order to comply with European Union regulations. For a more detailed explanation of our implementation of these requirements, see “Presentation of Financial Information”, above. The following discussion is based on IFRS accounting standards.

Revenues. Revenues increased by 12.2% to € 6,451 million for the first six months of 2006, as compared to € 5,752 million for the same period last year. Approximately 40% of our revenues are denominated in or linked to the U.S. dollar. When we translate these sales into euros for accounting purposes, there is an exchange rate impact based on the relative value of the U.S. dollar and the euro. During the first six months of 2006, the increase in the value of the U.S. dollar relative to the euro had a positive impact on our

revenues. If there had been a constant euro/U.S. dollar exchange rate during the first six months of 2006 as compared to the same period in 2005 our consolidated revenues would have increased by approximately 10.7%. This is based on applying (i) to our sales made directly in U.S. dollars or currencies linked to U.S. dollars effected during the first half of 2006, the average exchange rate that applied for the same period in 2005, instead of the average exchange rate that applied for such period in 2006, and (ii) to our exports (mainly from Europe) effected during the first half of 2006 which are denominated in U.S. dollars and for which we enter into hedging transactions, our average euro/U.S. dollar hedging rate that applied for the same period in 2005. Our management believes that providing our investors with our consolidated revenues for the first half of 2006 in constant euro/U.S. dollar exchange rates facilitates the comparison of the evolution of our revenues with that of the industry. The table below sets forth our revenues as reported, the conversion and hedging impact of the euro/U.S. dollar and our revenues at a constant rate:

		Six				Six
		months				months
		ending 2006				ending 2005				% of Change
Revenues as reported		€	6,451			€	5,752				12.1	%
Conversion impact euro/U.S. dollar			(78	)			—				(1.2	%)
Hedging impact euro/U.S. dollar			(3	)			—				(0.1	%)
Revenues at constant rate		€	6,369			€	5,752

Within the fixed communications segment, revenues grew in all businesses except for our traditional fixed line voice switching activity, which continues to decline. The revenue increase in our fixed communications segment is due to the transformation of the telecommunications network to an Internet Protocol (IP)-based architecture and the demand for Alcatel’s products in the access, optical, and IP carrier data sectors to build out this new network. The increased revenue in our mobile communications segment, in particular our GSM(2/2.5G) product offering for network infrastructure build-out, came primarily from business in the developing regions of the world. Revenues were strong across all business lines in our mobile communications segment with the exception of our wireless voice switching business, which is declining due to the shift to next generation products. In the private communications segment, increases in both our enterprise and rail communications businesses were slightly offset by the decline in our satellite activities.

Revenue for the first half of 2006 by geographical market (calculated based upon the location of the subsidiary that recorded the revenue) was as follows: revenues in Europe increased by 5.0% to € 2,939 million compared to € 2,800 million in the same period last year; revenues in Asia Pacific increased by 10.7% to € 938 million compared to € 847 million in the same period last year; revenues in North America increased by 50.4% to € 1,238 million compared to € 823 million in the same period last year; revenues in the rest of the world increased by 4.2% to € 1,336 million compared to € 1,282 million in the same period last year. In the first half of 2006, Europe accounted for 45.6% of revenues by geographical market while Asia Pacific, North America, and the rest of the world accounted for 14.5%, 19.2% and 20.7%, respectively. This compares with the following percentages of revenues by geographical market for the first half of 2005: Europe — 48.7%, Asia Pacific — 14.7%, North America — 14.3%, and the rest of the world — 22.3%.

Gross profit. During the first half of 2006, gross profit amounted to 34.2% of revenues or € 2,207 million, compared to 36.0% of revenues or € 2,068 million in the same period last year. The decline in gross profit as a percentage of revenues is due primarily to the increased pricing pressures we experienced in some of our markets. The decrease in both our fixed and variable costs related to cost of sales stemming from our ongoing efforts to streamline our organization were not sufficient to offset the price decreases over the period.

Administrative and selling expenses. For the six months ended June 30, 2006, administrative and selling expenses were stable at € 1,017 million or 15.8% of revenues compared to € 1,013 million or 17.6% of revenues in the same period last year. The decrease in administrative and selling expenses as a percentage of total revenues compared to the first six months of 2005 is primarily attributable to fixed costs reductions across all business activities.

Research and development costs. Research and development costs increased to € 729 million for the first six months of 2006 compared to € 685 million in the same period last year. As a percentage of revenues, R&D costs for the first six months of 2006 decreased slightly to 11.3%, compared to 11.9% in the same period last year.

Income (loss) from operating activities before restructuring, share-based payments, impairment of capitalized development costs and gain on disposal of consolidated entities. Income (loss) from operating activities before restructuring, share-based payments,

impairment of capitalized development costs and gain on disposal of consolidated entities (we previously referred to this item as operating profit) benefited from operating leverage generated by volume, recording significant contributions from the IP data and access businesses in the fixed communications segment. It amounted to € 461 million or 7.1% of revenues for the first six months of 2006 compared to € 370 million for the same period last year, which represented 6.4% of revenues.

Provision reversals impacted income (loss) from operating activities before restructuring, share-based payments, impairment of capitalized development costs and gain on disposal of consolidated entities by € 87 million in the first half of 2006 of which € 83 million related to reversals of product sales reserves (€ 108 million and € 99 million, respectively, in the first half of 2005). Of the € 83 million, € 16 million mainly related to reductions in probable penalties due to contract delays or other contractual issues or in estimated amounts based upon statistical and historical evidence. € 23 million of reversals are related to warranty provisions due to revision of our original estimate for warranty provision regarding warranty period and costs. This revision, in turn, was due mainly to the earlier than expected renewal of products by the customer, as a result of technological obsolescence or to better performance than anticipated. The remaining € 44 million of reversals mainly related to reversals of contract loss provisions, due to lower estimated remaining costs to be incurred.

In the first half of 2006, new product sales reserves of € 153 million were recorded, which did not fully offset product sales reserve reversals of € 83 million that occurred in first half of 2006, causing a net negative impact of € 70 million on income (loss) from operating activities before restructuring, share-based payments, impairment of capitalized development costs and gain on disposal of consolidated entities. In the same period last year, income (loss) was positively impacted by € 1 million from product sales reserves and reversals, representing € 98 million of new product sales reserves, offset by € 99 million of product sales reserve reversals.

Share-based payment (stock option plans). Share-based payments representing expensed employee stock options amounted to € 30 million for the first six months of 2006 compared to € 38 million in the same period of 2005.

Restructuring costs. Restructuring costs were € 31 million for the first six months of 2006, compared to € 49 million for the same period last year. This decrease is due in part to a revaluation of restructuring needs following the leasing of vacant premises during the first six months of 2006. The restructuring costs incurred during the first six months of 2006 relate primarily to restructuring plans in Western Europe, primarily Germany, Italy, and France. Also included within restructuring costs is impairment of goodwill. Impairment of goodwill for the first six months of 2006 amounted to € 4 million due to an assessment of discontinued activities. There was not impairment of goodwill for the same period in 2005.

Income (loss) from operating activities. Income (loss) from operating activities amounted to € 400 million in the first six months of 2006 compared to € 283 million during the same period of 2005 due to higher income (loss) from operating activities before restructuring, share-based payments, impairment of capitalized development costs and gain on disposal of consolidated entities, coupled with lower charges for share-based payments and restructuring costs as discussed above.

Finance costs. Finance costs amounted to € 47 million in the first six months of 2006 compared to € 50 million in the same period of 2005 and included € 107 million of interest paid on our gross financial debt, offset by € 60 million in interest earned on cash, cash equivalents and marketable securities, resulting in a net financial cost of € 47 million. In the same period last year, net financial costs amounted to € 50 million resulting from € 110 million of interest paid on our gross financial debt, offset by € 60 million in interest earned on cash, cash equivalents and marketable securities.

Other financial income (expense). Other financial expense amounted to € 19 million in the first half of 2006 compared to financial income of € 73 million in the same period last year. This decrease is due primarily to the capital gains generated by the disposal of our equity stake in Nexans and Mobilrom during the first six months of 2005.

Share in net income (losses) of equity affiliates. Share in net income of equity affiliates amounted to € 21 million during the first six months of 2006 compared to a loss of € 23 million in the same period last year. The loss during the first six months of 2005 resulted from a loss generated by our handset joint venture with TCL.

Income before tax and discontinued operations. Income before tax and discontinued operations amounted to € 355 million compared to € 283 million in the same period last year,

Income tax expense. We had an income tax expense of € 56 million for the first six months of 2006, compared to an income tax benefit of € 76 million for the same period last year. The expense for the first six months of 2006 is due to changes in provisions for tax litigation and to the increase in countries with respect to which we have no tax loss carry forwards whereas, based on forecasted

tax results of different subsidiaries in the Group, net deferred tax assets of € 87 million were recorded during the first six months of 2005, mainly in Europe and North America.

Income from continuing operations. Income from continuing operations amounted to € 299 million in the first six months of 2006 compared to € 359 million in the same period last year.

Income (loss) from discontinued operations. Income from discontinued operations amounted to € 14 million during the first six months of 2006 compared to a loss of € 15 million in the same period last year. There were no discontinued operations in either 2006 or 2005. However, the initial capital gain (loss) on discontinued operations that were sold in 2004 was adjusted in each of 2006 and 2005 due to developments in ongoing legal proceedings related to these disposals.

Net income attributable to equity holders of parent. Net income after minority interests of € 29 million amounted to € 284 million compared to € 320 million, after minority interests of € 24 million in the same period last year.

Results of Operations by Business Segment for the Six Months Ended June 30, 2006 Compared to the Six Months ended June 30, 2005

The organizational chart below sets forth our three business segments and their principal business activities since January 2005:

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

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

		Fixed				Mobile				Private				Other &				Total
		Communications				Communications				Communications				Eliminations				Group
Six months ended June 30, 2006
Revenues			2,636				1,915				1,939				(39	)			6,451
Income (loss) from operating activities before restructuring, share-based payments, impairment of capitalized development costs and gain on disposal of consolidated entities			243				137				99				(18	)			461
Capital expenditures for tangible assets			26				32				27				20				105
Six months ended June 30, 2005
Revenues			2,211				1,747				1,829				(35	)			5,752
Income (loss) from operating activities before restructuring, share-based payments, impairment of capitalized development costs and gain on disposal of consolidated entities			170				181				93				(74	)			370
Capital expenditures for tangible assets			22				26				27				21				96

Fixed Communications

Revenues in our fixed communications segment increased by 19.2% to € 2,636 million compared to € 2,211 million in the same period last year. This increase is due to the strong customer demand for the transformation of customers’ telecommunications network to an all Internet Protocol (IP) architecture. This new system will transport voice, data, and video services (referred to as “triple play services” in the industry) over the customers’ network. As a result of this network transformation, we are recording revenue increases in our access, optical and IP carrier data product lines, only slightly offset by the continuing decline in our traditional fixed line voice switching activity.

The fixed communications segment’s income (loss) from operating activities before restructuring, share-based payments, impairment of capitalized development costs and gain on disposal of consolidated entities was € 243 million for the first six months of 2006 compared to € 170 million in the same period last year. This increase is due to a significant contribution across all product lines with the exception of our traditional fixed voice switching activity, with a particularly good performance in our access and IP carrier data businesses.

Mobile Communications

Revenues in our mobile communications segment increased by 9.6% to € 1,915 million in the first six months of 2006 compared to € 1,747 million in the same period last year. This increase is primarily due to the continued growth in emerging markets such as Africa, China and the Middle East where operators are building out their wireless infrastructure. We also recorded significant growth in our mobile applications business where we supply products and services for payment, video and music. Our wireless transmission activity, which is primarily microwave transmission, returned to growth with good customer acceptance of its new product portfolio. This increase was offset by the decline in our traditional core wireless voice switching business as the market demand shifts to next generation technologies.

The mobile communications segment’s income (loss) from operating activities before restructuring, share-based payments, impairment of capitalized development costs and gain on disposal of consolidated entities was € 137 million for the first six months of 2006 compared to € 181 million in the same period last year. This decrease is due primarily to increased investment in next generation technologies and an intensely competitive pricing environment.

Private Communications

Revenues in our private communications segment increased by 6.0% to € 1,939 million in the first six months of 2006 compared to € 1,829 million in the same period last year. This increase is due primarily to revenue increases in our enterprise and rail communications business and to a lesser extent, in our integration and services activity. The satellite revenues decreased due to low order backlog.

The private communications segment’s income (loss) from operating activities before restructuring, share-based payments, impairment of capitalized development costs and gain on disposal of consolidated entities was € 99 million in the first six months of 2006 compared to € 93 million in the same period last year. This increase is due primarily to an improvement in our rail communications business.

Liquidity and Capital Resources

Liquidity

Cash Flow for the Six Months Ended June 30, 2006 and 2005

Cash Flow Overview

Cash and cash equivalents decreased by € 729 million during the first six months of 2006 to € 3,781 million at June 30, 2006 compared to the cash and cash equivalents as of December 31, 2005. This decrease was mainly due to net cash used by investing activities of € 362 million, due primarily to capital expenditures amounting to € 306 million, and to cash used by the increase in operating working capital which amounted to € 534 million, which more than offset the net cash provided by operating activities before changes in working capital, interests and taxes, which amounted to € 459 million.

Net Cash Provided (Used) by Operating Activities. Net cash provided by operating activities before changes in working capital, interests and taxes was € 459 million compared to € 242 million for the first six months of 2005. This increase is primarily due to our positive net income before tax and discontinued operations of € 355 million for the first six months of 2006 compared to € 283 million in the same period last year. The € 284 million of net income attributable to the equity holders of the parent is adjusted for financial, tax and non-cash items, primarily depreciation and amortization, net gain on disposal of non-current assets, changes in fair values and share based payments, and adjusted further for cash outflows that had been previously reserved (mainly for ongoing restructuring programs). The net gain on disposal of non-current assets was € 55 million, consisting mainly of real estate assets, compared to a gain of € 136 million in the same period last year, from the sale of our holdings in Nexans and of real estate assets. The cash outflows for restructuring amounted to € 140 million for the first six months of 2006 compared to € 235 million for the first six months of 2005. Net cash used by operating activities was € 171 million for the first six months of 2006 compared to € 192 million during the same

period last year. These amounts take into account the cash used by the increase in operating working capital which amounted to € 534 million for the first six months of 2006 and € 423 million during the same period last year, reflecting our increased revenue performance as well as our expectations for revenue growth in the coming quarters.

Net Cash Provided (Used) by Investing Activities. Net cash used by investing activities was € 362 million for the first six months of 2006 compared to a net cash provided of € 71 million during the same period last year. This increase in net cash used is mainly due to changes in marketable securities which represented net cash outflows of € 93 million for the first six months of 2006 compared to cash proceeds of € 258 million during the same period last year. Capital expenditures amounted to approximately € 300 million for each of the two periods presented. Proceeds from disposal of fixed assets amounted to € 90 million for the first six months of 2006 compared to € 9 million in the same period last year (due mainly to disposal of various real estate assets).

Net Cash Provided (Used) by Financing Activities. Net cash used by financing activities amounted to € 155 million for the first six months of 2006 compared to net cash used of € 298 million in the same period last year. The main reason for this change was the more limited use of cash to decrease our long-term debt ( € 115 million for the first six months of 2006, compared with € 259 million for the first six months of 2005), including by repurchasing debt.

Disposed of or discontinued operations. Disposed of or discontinued operations represented a net cash proceed of € 2 million for the first six months of 2006, compared with € 14 million in the same period last year.

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 € 4,500 million as of June 30, 2006 are sufficient to fund our cash requirements for the next twelve months.

During 2006 we expect to make cash outlays for our restructuring programs of approximately € 250 million and to make capital expenditures, which should be approximately € 700 million, including research and development capitalization. We will also repay our 7.00% bonds maturing in December 2006 that we did not previously repurchase (€ 403 million as of June 30, 2006). In addition, our expected growth in revenues in 2006 compared to 2005 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 our 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 2006 we are continuing our bond repurchase program targeted at short term maturities.

Credit Ratings. As of September 25, 2006, our credit ratings were as follows:

		Long-term		Short-term
Rating Agency		Debt		Debt		Outlook		Last Update
Standard & Poor’s		BB		B		On Credit Watch, negative implication		March 24, 2006
Moody’s		Ba1		Not Prime		On Review, negative implication		April 3, 2006

Standard & Poor’s. On March 10, 2006, Standard & Poor’s changed Alcatel’s long-term debt credit rating (BB) outlook from Outlook Stable to Outlook Positive. However, on March 24, 2006, following Alcatel’s announcement of its discussions with Lucent Technologies of a possible merger of the two companies, Standard & Poor’s placed Alcatel’s credit rating under observation, considering that, if the merger was consummated, a downgrading of the long-term debt rating may be envisaged due to the financial structure of the combined entity. The ratings themselves (BB and B) remain unchanged from the ratings upgrade on November 10, 2004. The rating grid of Standard & Poor’s ranges from AAA (the strongest rating) to D (the weakest rating). Our BB — rating is in the BB category, which also includes BB+ and BB- ratings. Standard & Poor’s gives the following definition to the BB category: “[a]n obligation rated ‘BB’ is less vulnerable to non payment than other speculative issues. However, it faces major ongoing uncertainties or exposure to adverse business, financial, or economic conditions, which could lead to the obligor’s inadequate capacity to meet its financial commitment on the obligation. 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 April 3, 2006, Moody’s put Alcatel’s credit rating under review in view of a possible downgrading of its long-term debt rating (Ba1, Outlook Positive). This action followed Alcatel’s confirmation of discussions with Lucent Technologies regarding a possible merger and was motivated by the strategic and operational changes that Alcatel would have to undergo as a result of the merger. The ratings themselves (Ba1 and NP) remained unchanged from the ratings upgrade on April 11, 2005. 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 Ba1 rating is in the Ba category which also includes Ba2 and Ba3 ratings. Moody’s gives the following definition of its Ba category: “debt which is rated Ba is judged to have speculative elements and is subject to substantial credit risk.”

We can provide no assurances that our credit ratings will not be reduced in the future by Standard & Poor’s, Moody’s or similar rating agencies, especially in light of the pending merger with Lucent. 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 limited access to the commercial paper market.

At June 30, 2006, our total financial debt (excluding interest derivatives accounted for in other assets and liabilities) amounted to € 3,545 million compared to € 3,798 million at December 31, 2005.

Short-term Debt. At June 30, 2006, we had € 1,244 million of short-term financial debt outstanding, which included € 554 million of bonds and € 149 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 June 30, 2006, we had € 2,301 million of long-term financial debt outstanding.

Rating Clauses Affecting our Debt. 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 with both agencies move back to investment grade level. However, since this condition had not been met as of June 30, 2006, we were unable to take advantage of the step down clause during the period.

Syndicated Facility. The availability of our three year, multi-currency syndicated revolving credit facility of € 1,000 million with a maturity of June 2009 does not depend upon our credit ratings. At June 30, 2006, we had not drawn on this facility and it remained undrawn at September 28, 2006. Our ability to draw on this facility is conditioned upon our compliance with a financial covenant linked to the capacity of Alcatel to generate sufficient cash to repay our net debt. We test this covenant every quarter. As the Group had cash and cash equivalents in excess of its gross financial debt at March 31 and June 30, 2006, we were in compliance with this covenant at these dates. We can provide no assurance that we will remain compliant with such covenant in the future.

Contractual obligations and off-balance sheet contingent commitments

Contractual obligations. We have certain contractual obligations that extend beyond 2005. Among these obligations we have long-term debt, capital leases, operating leases, commitments to purchase fixed assets, interest on long-term debt and other unconditional purchase obligations. Our total contractual cash obligations at June 30, 2006 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 unaudited interim consolidated balance sheet included in this document.

		Payment Deadline
						Before
		Before				December 31,
Contractual payment obligations		June 30, 2007				2008				2009-2010				2011 and after				Total
										(in millions)
Financial debt (excluding capital leases)		€	1,190			€	116			€	814			€	1,371			€	3,491
Equity component of Oceane			—				—				—				115				115
Capital lease obligations			54								—				—				54
Subtotal — included in our balance sheet		€	1,244			€	116			€	814			€	1,486			€	3,660
Operating leases			143				277				185				326				931
Commitments to purchase fixed assets			61				—				—				—				61
Interest on long-term debt			137				159				142				93				531
Unconditional purchase obligations(a)			109				11				2				—				122
Sub total — not included in our balance sheet		€	450			€	447			€	329			€	419			€	1,645
Total contractual obligations		€	1,694			€	563			€	1,143			€	1,905			€	5,305

Off-balance sheet commitments and contingencies. On June 30, 2006, our off-balance sheet commitments and contingencies amounted to € 2,749 million, consisting primarily of € 1,881 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 and are routinely provided in long-term supply contracts. If certain events occur subsequent to our including these commitments within our off-balance sheet contingencies, such as the delay in promised delivery or claims related to an alleged failure by us to perform on our long-term contracts, or the failure by one of our customers to meet its payment obligations, we reserve the estimated risk on our consolidated balance sheet under the line item “Reserves for product sales” (see Note 12 and Note 15 to our unaudited condensed interim consolidated financial statements) or in inventory reserves. Not included in the € 2,749 million of off-balance sheet commitments and contingencies is a € 600 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 € 2,749 million is our contingent liability pursuant to the securitization of other accounts receivable and the sale of a carry-back receivable described below.

Off-balance sheet contingent commitments, which for purposes of the table below include only performance guarantees issued by us to financial institutions and exclude our commitment to provide further customer financing (as described below), are as follows:

		June 30, 2006				June 30, 2005
		(in millions)
Guarantees given on contracts made by Group entities and by non-consolidated subsidiaries(1)		€	2,071			€	2,077
Other contingent commitments (2)		€	601			€	721
Sub-total — Contingent commitments(3)		€	2,671			€	2,798
Secured borrowings(4)		€	78			€	124
Total off-balance sheet commitments and secured borrowings(3)		€	2,749			€	2,922

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 do not reflect any amounts that may be recovered under recourse, collateralization 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 unaudited condensed interim consolidated financial statements. Contingent liabilities arising out of litigation, arbitration or regulatory actions are not included in the preceding table either, with the exception of those linked to the guarantees given on our long-term contracts.

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

Guarantees given on third party long-term contracts could require us to make payments to the guaranteed party based on a non-consolidated company’s failure to perform under an agreement. The fair value of these contingent liabilities, corresponding to the premium to be received by the guarantor for issuing the guarantee, was € 2 million as of June 30, 2006.

Customer Financing. Based on standard industry practice, from time to time we extend financing to our customers by granting extended payment terms, making direct loans and providing guarantees to third-party financing sources. As of June 30, 2006, net of reserves, we had provided customer financing of approximately € 348 million. This amount includes € 338 million of customer deferred payments and accounts receivable, and € 10 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 € 122 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.

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 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. Under IFRS the carry-back receivable is not de-recognized but is reported on the asset side of the balance sheet, as an “other non current asset”, at its discounted value using the discount rate applied in the sale transaction by the intervening credit institution, and as a “financial liability” at its discounted value using the French State bonds’ discount rate, on the liability side of the balance sheet.

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

Securitization of accounts receivables. In December 2003, we 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. This special purpose vehicle is fully consolidated under IFRS. The receivables sold at June 30, 2006, which amounted to € 75 million (€ 69 million as of June 30, 2005), are therefore maintained in the consolidated balance sheet. At June 30, 2006, the maximum amount of bank financing that we could obtain through the sale of receivables was € 150 million. The actual amount of such funding for each receivable is a percentage of the amount of the receivable and the percentage varies depending on the quality of the receivables sold. The purpose of this securitization program is to optimize the management and recovery of receivables, in addition to providing extra financing.

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

Although, as discussed above, we engage in a rigorous credit approval process and have taken actions to limit our exposure to customer credit risks, the global downturn and deterioration of the telecommunications industry through 2003 caused certain of our customers to experience financial difficulties and others to file for protection under 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.

Capital Expenditures. We expect our capital expenditures in 2006 to be approximately €700 million, including capitalization of research and development expenses. We believe that our current cash and cash equivalents, cash flows and funding arrangements provide us with adequate flexibility to meet our short-term and long-term financial obligations and to pursue our capital expenditure program as planned. We base this assessment on current and expected future economic and market conditions. Should economic and market conditions deteriorate, we may be required to engage in additional restructuring efforts and seek additional sources of capital, which may be difficult if there is no continued improvement in the market environment and given our limited ability to access the fixed income market at this point. In addition, as mentioned in “Capital Resources” above, if we do not meet the financial covenant contained in our syndicated facility, we may not be able to rely on this funding arrangement to meet our cash needs.

Qualitative and Quantitative Disclosures About Market Risk

At June 30, 2006, our exposure to market risks was not materially different from our exposure at the end of last year, as described in our 2005 Form 20-F.

Research and Development

Costs. In the first half of 2006, our research and development costs, net of the impact of the capitalization of research and development expenses, totaled € 729 million (11.3% of consolidated net sales for the six months ended June 30, 2006) compared to costs of € 685 million in the first six months of 2005 (11.9% of consolidated net sales for the six months ended June 30, 2005).

ALCATEL AND SUBSIDIARIES

Unaudited condensed interim consolidated income statements for the six month periods ended June 30, 2005 and 2006			F-2
Unaudited condensed interim consolidated balance sheets at June 30, 2006 and at December 31, 2005			F-3
Unaudited condensed interim consolidated statements of cash flows for the six month periods ended June 30, 2006 and 2005			F-5
Unaudited condensed interim consolidated statements of changes in shareholders’ equity for the six month periods ended June 30, 2006 and 2005 and for the year ended December 31, 2005			F-6
Notes to unaudited condensed interim consolidated financial statements:
— Summary of accounting policies			F-7
— Principal uncertainties regarding the use of estimates			F-16
— Changes in consolidated companies			F-19
— Information by business segment			F-21
— Information by geographical segment			F-22
— Other			F-22
— Reconciliation to U.S. GAAP			F-44

ALCATEL AND SUBSIDIARIES

UNAUDITED CONDENSED INTERIM CONSOLIDATED INCOME STATEMENT

						Six months ended June 30,
		Note				2006 (a)				2006				2005
						(in millions except per share information)
Revenues			(4	)		$	8,244			€	6,451			€	5,752
Cost of sales							(5 423	)			(4,244	)			(3,684	)
Gross profit							2,820				2,207				2,068
Administrative and selling expenses							(1,300	)			(1,017	)			(1,013	)
Research and development expenses before capitalization of development expenses							(1,011	)			(791	)			(751	)
Impact of capitalization of development expenses							79				62				66
Research and development costs			(5	)			(932	)			(729	)			(685	)
Income (loss) from operating activities before restructuring, share-based payments, impairment of capitalized development costs and gain on disposal of consolidated entities			(4	)			589				461				370
Share-based payment (stock option plans)			(6	)			(38	)			(30	)			(38	)
Restructuring costs			(15	)			(40	)			(31	)			(49	)
Income (loss) from operating activities							511				400				283
Interests relative to gross financial debt							(137	)			(107	)			(110	)
Interests relative to cash, cash equivalents							77				60				60
Finance costs			(7	)			(60	)			(47	)			(50	)
Other financial income (expense)			(7	)			(24	)			(19	)			73
Share in net income (losses) of equity affiliates							27				21				(23	)
Income before tax and discontinued operations							454				355				283
Income tax expense			(9	)			(72	)			(56	)			76
Income (loss) from continuing operations							382				299				359
Income (loss) from discontinued operations			(8	)			18				14				(15	)
Net income (loss)							400				313				344
Attributable to:
— Equity holders of the parent							363				284				320
— Minority interests							37				29				24
Net income (loss) attributable to equity holders of the parent per share (in euros)
— Basic earnings per share			(10	)			0.27				0.21				0.23
— Diluted earnings per share			(10	)			0.27				0.21				0.23
Net income (loss) (before discontinued operations) attributable to equity holders of the parent per share (in euros)
— Basic earnings per share							0.26				0.20				0.24
— Diluted earnings per share							0.26				0.20				0.24
Net income (loss) of discontinued operations per share (in euros)
— Basic earnings (loss) per share							0.01				0.01				(0.01	)
— Diluted earnings (loss) per share							0.01				0.01				(0.01	)

ALCATEL AND SUBSIDIARIES

UNAUDITED CONDENSED INTERIM CONSOLIDATED BALANCE SHEET

														December 31,
		Note				June 30, 2006				June 30, 2006				2005
						(in millions)
ASSETS
Goodwill						$	4,773			€	3,735			€	3,772
Intangible assets, net							1,118				875				819
Goodwill and intangible assets, net							5,891				4,610				4,591
Property, plant and equipment							5,505				4,308				4,557
Depreciation							(4 261	)			(3,334	)			(3,446	)
Property, plant and equipment, net							1,245				974				1,111
Share in net assets of equity affiliates			(13	)			869				680				606
Other non-current financial assets, net							414				324				306
Deferred tax assets							2,134				1,670				1,768
Prepaid pension costs							385				301				294
Other non-current assets			(11	)			204				160				468
TOTAL NON-CURRENT ASSETS							11,142				8,719				9,144
Inventories and work in progress, net			(12	)			2,201				1,722				1,438
Amounts due from customers on construction contracts			(12	)			1,410				1,103				917
Trade receivables and related accounts, net			(12	)			3,682				2,881				3,420
Advances and progress payments			(12	)			161				126				124
Other current assets, net			(11	)			1,072				839				827
Assets held for sale			(8	)			86				67				50
Current income taxes							291				228				45
Marketable securities, net			(16	)			919				719				640
Cash and cash equivalents			(16	)			4,832				3,781				4,510
TOTAL CURRENT ASSETS							14,652				11,466				11,971
TOTAL ASSETS							25,794				20,185				21,115

LIABILITIES AND SHAREHOLDERS’ EQUITY

														December 31,
		Notes				June 30, 2006				June 30, 2006				2005
						(in millions)
Capital stock (€ 2 nominal value: 1,430,777,113 ordinary shares issued as of June 30, 2006 and 1,428,541,640 ordinary shares issued as of December 31, 2005)						$	3,656			€	2,861			€	2,857
Additional paid-in capital							10,670				8,350				8,308
Less treasury stock at cost							(2,005	)			(1,569	)			(1,575	)
Retained earnings, fair value and other reserves							(4,475	)			(3,502	)			(4,460	)
Cumulative translation adjustments							( 49	)			(38	)			174
Net income — attributable to the equity holders of the parent							363				284				930
Shareholders’ equity — Attributable to the equity holders of the parent							8,161				6,386				6,234
Minority interests							612				479				477
TOTAL SHAREHOLDERS’ EQUITY			(14	)			8,773				6,865				6,711
Pensions, retirement indemnities and other post-retirement benefits							1,873				1,466				1,461
Bonds and notes issued, long term			(14),	(16)			2,736				2,141				2,393
Other long term debt			(16	)			204				160				359
Deferred tax liabilities							150				117				162
Other non-current liabilities			(11	)			357				279				295
TOTAL NON-CURRENT LIABILITIES							5,320				4,163				4,670
Provisions			(15	)			1,815				1,420				1,621
Current portion of long term debt			(16	)			1,590				1,244				1,046
Customers’ deposits and advances			(12	)			1,240				970				1,144
Amounts due to customers on construction contracts			(12	)			142				111				138
Trade payables and related accounts			(12	)			4,696				3,675				3,755
Current income taxes liabilities							98				77				99
Other current liabilities			(11	)			2,121				1,660				1,931
TOTAL CURRENT LIABILITIES							11,702				9,157				9,734
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY							25,794				20,185				21,115

UNAUDITED CONDENSED INTERIM CONSOLIDATED STATEMENTS OF CASH FLOWS

						Six months ended June 30,
		Note				2006 (a)				2006				2005
						(in millions)
Cash flows from operating activities
Net income (loss)- Attributable to the equity holders of the parent						$	363			€	284			€	320
Minority interests							37				29				24
Adjustments			(17	)			187				146				(102	)
Net cash provided (used) by operating activities before changes in working capital, interest and taxes			(17	)			587				459				242
— Decrease (increase) in inventories and work in progress			(12	)			(464	)			(363	)			(294	)
— Decrease (increase) in trade receivables and related accounts			(12	)			348				272				(82	)
— Decrease (increase) in advances and progress payments			(12	)			(5	)			(4	)			(10	)
— Increase (decrease) in accounts payable and accrued expenses			(12	)			(5	)			(4	)			(84	)
— Increase (decrease) in customers’ deposits and advances			(12	)			(216	)			(169	)			87
— Change in other assets and liabilities							(340	)			(266	)			(39	)
Cash provided (used) by operating activities before interests and taxes							(96	)			(75	)			(179	)
— Interest received							72				56				59
— Interest (paid)							(134	)			(105	)			(81	)
— Taxes (paid)/received							(60	)			(47	)			9
Net cash provided (used) by operating activities							(219	)			(171	)			(192	)
Cash flows from investing activities:
Proceeds from disposal of tangible and intangible assets							115				90				9
Capital expenditures							(391	)			(306	)			(296	)
Of which impact of capitalization of development costs							(248	)			(194	)			—
Decrease in loans and other non-current financial assets							—				46				80
Cash expenditures for acquisition of consolidated and non-consolidated companies							(158	)			(124	)			(60	)
Cash proceeds from sale of previously consolidated and non-consolidated companies							32				25				80
Decrease/(increase) in marketable securities							(119	)			(93	)			258
Net cash provided (used) by investing activities							(463	)			(362	)			71
Cash flows from financing activities:
Issuance/(repayment) of short-term debt							(72	)			(56	)			(37	)
Repayment/repurchase of long term debt			(16	)			(147	)			(115	)			(259	)
Proceeds from issuance of shares							17				13				6
Proceeds from disposal/(acquisition) of treasury stock							5				4				3
Dividends paid							(1	)			(1	)			(11	)
Net cash provided (used) by financing activities							(198	)			(155	)			(298	)
Net cash (used) by operating activities of discontinued operations							(13	)			(10	)			—
Net cash provided by investing activities of discontinued operations							15				12				14
Net cash provided by financing activities of discontinued operations							—				—				—
Net effect of exchange rate changes							(55	)			(43	)			103
Net increase (decrease) in cash and cash equivalents							(932	)			(729	)			(302	)
Cash and cash equivalents at beginning of period							5,763				4 510				4,611
Cash and cash equivalents at end of period							4,832				3 781	*			4,309	*

UNAUDITED CONDENSED INTERIM CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY

																																		Total
																		Changes in																attributable to the
										Additional				Retained				fair value								Cumulative				Net				equity
		Number				Capital				paid-in				earnings				and other				Treasury				translation				income				holders of
Note		of shares				Stock				capital				(1)				reserves				Stock				adjustments				(loss)				the parent				Minority interests				TOTAL
		(in millions of euros except for number of shares outstanding)
Balance at December 31, 2004 after appropriation			1,365,973,827				2,852				8,226				(4,450	)			82				(1,607	)			(183	)			—				4,920				373				5,293
																			(81	)															(81	)							(81	)
Financial assets available for sale																											256								256				50				306
Cumulative translation adjustments																			(30	)															(30	)							(30	)
Other adjustments			—				—				—				—				(111	)			—				256				—				145				50				195
Net income (loss) changes directly recognized in equity			—				—				—				—				—				—								320				320				24				344
Net income (loss)							—				—				—				(111	)			—				256				320				465				74				539
Total of accounted expenses and revenues			1,107,661				2				7				—				—				—				—				—				9				—				9
Other capital increases							—				38				—				—				—				—				—				38				—				38
Deferred share-based payments			900,062				—				—				(29	)			—				24				—								(5	)			—				(5	)
Net change in treasury stock of shares owned by consolidated subsidiaries			—				—				—				(4	)			—				—				—				—				(4	)			(9	)			(13	)
Other adjustments							—								(6	)																			(6	)			(9	)			(15	)
June 30, 2005			1,367,981,550				2,854				8,271				(4,483	)			(29	)			(1,583	)			73				320				(5,423	)			438				5,861
Financial assets available for sale																			12																12								12
Cumulative translation adjustments																											101								101				22				123
Cash flow hedging																			32																32				—				32
Other adjustments															19																				19				—				19
Net income (loss) changes directly recognized in equity															19				44				—				101				—				164				22				186
Net income (loss)																															610				610				17				627
Total of accounted expenses and revenues															19				44								101				610				774				39				813
Other capital increases			1,197,999				3				6																								9								9
Deferred share-based payments											31																								31								31
Net change in treasury stock of shares owned by consolidated subsidiaries			441,382												(8	)							8												—								—
Other adjustments															(3	)																			(3	)			—				(3	)
December 31, 2005 before appropriation			1,369,620,931				2,857				8,308				(4,475	)			15				(1,575	)			174				930				6,234				477				6,711
Proposed appropriation of net income (loss)															930																(930	)			—								—
Balance at December 31, 2005 after appropriation			1,369,620,931				2,857				8,308				(3,545	)			15				(1,575	)			174				—				6,234				477				6,711
Financial assets available for sale																			14																14								14
Cumulative translation adjustments																											(212	)							(212	)			(29	)			(241	)
Cash flow hedging																			10																10								10
Other adjustments															4																				4								4
Net income (loss) changes directly recognized in equity															4				24								(212	)							(184	)			(29	)			(213	)
Net income (loss)																															284				284				29				313
Total of accounted expenses and revenues															4				24								(212	)			284				100				—				100
Other capital increases			2,235,473				4				12																								16								16
Deferred share-based payments											30																								30								30
Net change in treasury stock of shares owned by consolidated subsidiaries			673,798												(4	)							6												2								2
Other adjustments															4																				4				2				6
June 30, 2006 before appropriation			1,372,530,202				2,861				8,350				(3,541	)			39				(1,569	)			(38	)			284				6,386				479				6,865
Proposed appropriation of net income (loss)															(229	)																			(229	)							(229	)
June 30, 2006 after appropriation			1,372,530,202				2,861				8,350				(3,770	)			39				(1,569	)			(38	)			284				6,157				479				6,636