L U C E N T T E C H N O L O G I E S 2 0 0 3 A N N U A L R E P O R T N O T I C E O F 2 0 0 4 A N N U A L M E E T I N G A N D P R O X Y S T A T E M E N T L U C E N T T E C H N O L O G I E S Lucent Technologies designs and delivers the systems, services and software that drive next-generation communications networks. Backed by Bell Labs research and development, Lucent uses its strengths in mobility, optical, software, data and voice networking technologies, as well as services, to create new revenue-generating opportunities for its customers, while enabling them to quickly deploy and better manage their networks. Lucent’s customer base includes communications service providers, governments and enterprises worldwide. 2003 FINANCIAL HIGHLIGHTS YearEnded YearEnded (dollarsinmillions,exceptpershareamounts;unaudited) September30, September30, OPERATIONS 2003 2002 Change Revenues $ 8,470 $12,321 $ (3,851) Grossmargin 2,652 1,552 1,100 Selling,generalandadministrative 1,509 3,969 (2,460) Researchanddevelopment 1,488 2,310 (822) Businessrestructuringcharges(reversals)andassetimpairments,net (158) 1,426 (1,584) Goodwillimpairment 35 826 (791) Operatingloss (222) (6,979) 6,757 Provision(benefit)forincometaxes (233) 4,757(a) (4,990) Lossfromcontinuingoperations (770) (11,826) 11,056 Losspercommonsharefromcontinuingoperations $ (0.29) $ (3.51) $ 3.22 FINANCIALPOSITION Cash,cashequivalentsandshort-terminvestments $ 4,507 $ 4,420 $ 87 Totalassets 15,765 17,791 (2,026) Totaldebt(b) 5,980 5,106 874 8%redeemableconvertiblepreferredstock 868 1,680 (812) Shareowners’deficit $(4,239) $ (4,734) $ 495 OTHERINFORMATION Netcashusedinoperatingactivitiesfromcontinuingoperations $ (948) $ (756) $ (192) Headcount 34,500 47,000 (12,500) Stockprice $ 2.16 $ 0.76 $ 1.40 (a)Includeschargesrelatedtoestablishingafullvaluationallowanceonthecompany’snetdeferredtaxassets. (b)Includescompany-obligated7.75%mandatorilyredeemableconvertiblepreferredsecuritiesofsubsidiary trustof$1,152and$1,750fortheyearsendedSeptember30,2003and2002,respectively. LETTER TO OUR SHAREOWNERS TO OUR SHAREOWNERS: Fiscal 2003 was another challenging year for the global telecommunications market as capital spending by service providers continued to decline before beginning to stabilize toward the end of the year. Despite market difficulties, we managed to reduce our year-over-year losses substantially and end the year on a strong positive note — reporting a profitable quarter for the first time since March 2000 and generating positive operating cash flow for the first time since June 2002. Reporting a profitable fourth fiscal quarter was a significant milestone for the company and it was an important step for- ward in our drive toward sustained profitability, which we intend to achieve during fiscal 2004. This achievement, how- ever, wasn’t the result of one quarter of effort. Rather, it was the culmination of three years of hard work and dedication on the part of the entire Lucent team. We’ve had to make a PATRICIAF. RUSSO number of difficult decisions in such areas as resizing our Chairman and Chief Executive Officer work force and reducing subsidies for employee and retiree healthcare. We’ve reduced costs, rationalized our product portfolio, and streamlined our supply chain, while at the same At the same time, our customer satisfaction survey results time improving our performance in meeting the needs of our are the highest they have been in five years, surpassing the customers. competitive average. While we clearly have more work to do on our path to sus- These accomplishments — in the face of a challenging tained profitability, we have dramatically improved the telecommunications market — are a clear testament to our fundamental operations of the business. Notwithstanding the employees’resolve and determination. fact that our year-over-year results include some significant FINANCIALSUMMARY items, compared with fiscal 2002, we: • Improved gross margin by 18 points. For the year ended September 30, 2003, revenues declined • Reduced our operating loss by $6.8 billion. about 31 percent compared with the prior year, from $12.3 bil- • Reduced our net loss from $11.8 billion to $770 million. lion to $8.5 billion. We reduced our loss per share from $3.49 • Decreased our working capital by $600 million. for fiscal 2002 to $0.29 for fiscal 2003. • Reduced our total expenses by $5.6 billion. On a segment basis, revenues in Integrated Network We also made progress in other strategic areas. During the Solutions decreased 32 percent, to $4.2 billion, compared with fiscal year we: fiscal 2002, and Mobility Solutions’revenues declined 28 per- • Penetrated new markets such as Managed Services with cent to $4 billion, compared with the previous year. about $250 million in new contracts. Despite industrywide cuts in capital spending, we announced • Established a leadership position in metro optical. nearly 90 contract wins in 2003. We had wins in all segments • Established strategic relationships with Juniper Networks of the telecom networking sector — from access to core net- and Cisco Systems and extended our relationships with works, in wireline and wireless networks, and in software and Sun Microsystems and IBM. services. • Introduced new products, including At this point, we have essentially completed our restructuring —the 5E-XC™high-capacity switch being deployed by initiatives. In the current challenging environment, it’s likely SBC. that we’ll still have some ups and downs on our path to —the iGen™Compact Switch, a cost-effective multiservice sustained profitability. Like any business, there will still be switch that can reduce operating expenses up to 90 adjustments as we respond to the market. We will continue to percent for small switch applications. manage our cost and expense profile, while also increasing —the Lucent Flexent®Modular Cell 4.0 CDMA2000 base our investment in certain new product areas. station, built using Lucent’s OneBTS®digital base sta- tion platform for 3G spread-spectrum technologies. POCKETS OF OPPORTUNITY —Metropolis®DMXplore Access Multiplexer, which While we remain focused on generating sustainable profitable extends the reach of SONETnetworks to small- and momentum in 2004, we also are focused on longer-term medium-sized enterprises. 1 LETTER TO OUR SHAREOWNERS challenges in terms of the opportunities they present. We have capacity of parts of its network and to offer a wide variety identified pockets of opportunity that could drive near-term of high-speed services to its customers. growth in markets such as voice over Internet protocol • AT&Tselected our Metropolis DMX Access Multiplexer and (VoIP) and softswitch, metro optical, broadband access, high- the Metropolis DMXtend Access Multiplexer as part of its speed wireless data and services. Our product portfolio is next-generation intelligent optical network to increase well-positioned to capitalize on these opportunities. capacity and enable new revenue-generating services in We also have implemented plans to broaden our revenue metropolitan areas. base into areas such as Managed and Professional Services, • BellSouth chose the Lucent Metropolis DMX Access government and certain other markets outside the United Multiplexer to increase the network capacity of its optical States. In addition, we’re expanding our reach with about 200 networks covering their Southeast markets. partners in 50 countries around the world. Through our Global As more and more customers deploy the DMX to build next- Business Partners program, in 2003 we won several optical generation optical networks, they will need an optical and VoIPcontracts in Europe, as well as contracts for our switch/cross-connect product such as our LambdaUnite to optical products in China. bridge the increasingly sophisticated traffic across metro opti- cal networks or connect it with a long-haul network. We have INTEGRATED NETWORK SOLUTIONS already deployed LambdaUnite with Deutsche Telekom; We see opportunities in the VoIPand softswitch markets, even Shandong Unicom, Zheijiang Telecom, and GEFC in China; though they are in their early stages, and we expect these Telkom Indonesia; and ICE in Costa Rica. markets will grow and evolve over many years. To address Broadband Access these opportunities, we recently unveiled our Accelerate™ portfolio to help our customers deploy VoIPservices and net- We believe our broadband access portfolio of products is works. Anchored by our newly launched 5E-XC switch, which well-positioned to capitalize on that market opportunity. And triples the capacity of the existing 5ESS®switch, Accelerate is many of our contract wins in this area reflect this opportunity, all about speed. These solutions put our customers on an including accelerated path to an all-IPnetwork by rapidly enabling rev- • Bell Canada deployed the AnyMedia®Access System to enue-generating services that can help fund next-generation expand its Digital Subscriber Line (DSL) Internet service network builds. and wireline voice networks. SBC announced it would deploy the 5E-XC to more cost- • Sprint LTD selected Lucent’s Stinger®DSLAccess concen- effectively support voice and data calls that enter and exit its trators, for broadband access, one of the largest contracts local network. ever for the Stinger product. Our new unified Softswitch — a platform that supports both • Brasil Telecom installed 100,000 Stinger DSLAccess wireline and wireless applications — is another key compo- Concentrators. nent of our Accelerate portfolio. While the softswitch market • Telekomunikacja Polska deployed the new Stinger Micro- is in its early stages, we have enjoyed some successes. For Remote Terminal 48, which supports high-speed services instance, we have announced a wireline trial of the new in space-constrained areas such as street cabinets or Lucent Softswitch with China Unicom, and we have another multitenant buildings. trial under way in Europe. And we continue to support eight In May 2003, we formed a three-year strategic relationship wireline softswitch customers in live network applications. with Juniper Networks to deliver unified solutions to help With each trial, we learn more about how our customers can service providers evolve today’s networks to tomorrow’s make the most of our VoIPtechnology. And as the market next-generation infrastructure. We are leveraging complemen- develops and customers decide to invest, we’ll be there. tary networking strengths in ATM/Frame Relay, IP/MPLS, optical, voice, network services and software to create a set of Metro Optical market-ready “unified offers” that solve the toughest chal- We also have strategically pursued the opportunity and lenges our service provider customers face. Since the momentum in the metro optical space. As a result, we now relationship was established, we’ve made significant progress. have more than 80 customers for our Metropolis DMX portfo- We released the first Navis®-integrated solution, the IPVPN lio, including Solution, and announced the development of a capability to • Verizon, which deployed our Metropolis DMX portfolio of deliver ATM services with guaranteed quality of service over optical networking products and the LambdaUnite® MPLS networks. MultiService Switch (MSS) to dramatically increase the 2 LETTER TO OUR SHAREOWNERS MOBILITY service providers. This reflects our strategy to focus on our core strengths while partnering with other industry leaders We remain the global leader in spread-spectrum technology — when it makes sense. Lucent’s industry-leading expertise in shipping more than 90,000 spread-spectrum base stations wireless networking and Cisco’s IPnetworking leadership will worldwide, more than 50,000 of them supporting third genera- allow our customers to quickly tap into the new revenue tion (3G) CDMA2000 1X services. We continue to have strong streams being created by the explosive demand for high- relationships with the world’s leading service providers, and speed mobile data. world-class knowledge of spread-spectrum technology — all of which positions us well to capitalize on the 3G market as it SERVICES evolves and matures. There are areas of opportunity where mobile operators Lucent Worldwide Services (LWS) has combined talented continue to upgrade, expand and deploy 3G networks. For people with network know-how and Bell Labs-developed algo- instance, we signed a new $1 billion multiyear agreement with rithms, skills and methodologies to become the industry’s Sprint to enhance and upgrade the largest high-speed wireless leading network integrator. network in the United States with additional 3G equipment from Going forward, we see the biggest growth opportunities for Lucent. We also announced agreements valued at more than LWS in Managed Services and Professional Services, which $600 million with China Unicom for Phase II and Phase III help service providers increase their revenues, reduce their CDMAexpansion. operating costs and increase the reliability and security of their And we’ve announced contract wins with major service networks. We’re beginning to get traction in these two areas. providers around the world, including Reliance Infocomm in In fact, this year alone, we signed Managed Services con- India, KTF in Korea, Moscow Cellular, CODETELin the tracts in North America, Australia, New Zealand, South Dominican Republic, VIVO — a joint venture of Telefonica America and Europe. Moviles and Portugal Telecom — in Brazil, and Cingular in the Our Professional Services offers are based on Bell Labs United States. research and innovations to help service providers increase network reliability, efficiency and security. Most recently, we New High-Capacity Base Station announced a suite of wireless in-building Professional Services that will enable mobile operators and enterprises to In addition, we unveiled our new, compact, cost-effective base improve voice and data coverage in high-traffic areas such as station, Flexent Modular Cell 4.0 Compact, a high-capacity corporate buildings, shopping malls, multitenant buildings, CDMA2000 base station and the newest addition to Lucent’s manufacturing facilities and airports. Bell Labs-developed OneBTS family of base stations. It’s an This year we secured several Professional Services con- ideal solution for mobile operators with networks that require a tracts with international carriers, including KTF in Korea and base station that takes up less space. And China Unicom is O2 in the United Kingdom, with whom we signed a three-year deploying the 4.0 Compact as part of its Phase III expansion. agreement to assess and analyze the performance of its GSM Verizon Wireless announced the commercial launch of a and GPRS networks in Europe. super-fast mobile data network in Washington, D.C., that pro- We are also focusing our efforts in the government market vides businesses and consumers with broadband access data where we provide systems integration, consulting and a host services at speeds of up to 2.4 Mbps. Lucent supplied equip- of Professional Services solutions, ranging from network opti- ment, software and services for this 3G CDMA2000 1xEV-DO mization, planning and design to network security. And we’ve network. already had some successes in this area. Lucent was award- And more recently we announced that we are working with ed the first communications infrastructure contract in Iraq — a AT&TWireless to deploy a 3G W-CDMA(Wideband Code $25 million subcontract awarded by Bechtel for emergency Division Multiple Access) trial network in the greater Miami repair and rehabilitation of the Iraqi network. And in the area to evaluate mobile voice and high-speed data services. fourth fiscal quarter alone, we won more than a half dozen This trial network will be the first W-CDMA, also known as Professional Services contracts with other large government Universal Mobile Telecommunications System (UMTS), contractors. deployment for Lucent in North America, and gives both We also see a large growth opportunity in helping service Lucent and AT&TWireless the opportunity to explore the providers manage their multivendor networks. In fact, we man- range of services that 3G W-CDMAcan make available for age about 30 service provider and enterprise networks from customers. our three global network centers. In January, we announced a partnership with Cisco Systems to resell select Cisco data networking products as part of Lucent’s mobile networking product portfolio for wireless 3 LETTER TO OUR SHAREOWNERS BELLLABS BUILDING FOR THE FUTURE Bell Labs, the innovation engine that powers Lucent While the current environment for telecommunications equip- Technologies, is taking the lead in shaping tomorrow’s broad- ment continues to be challenging, we are now seeing some band networks for service providers. Spread across the globe, signs of stability in the overall market. Although analysts the more than 9,500 scientists and engineers that make up expect little change in service provider capital expenditures in Bell Labs serve a dual mission for Lucent. The bulk of the Bell 2004 from 2003, we are no longer fighting the double-digit Labs community is focused on developing new communica- capital expenditure cuts that plagued the telecom market over tions products and services for Lucent, and researching the past three years. The worst seems to be clearly behind us, real-world technical issues such as network security, reliability and our focus has shifted accordingly. and efficiency. Many Bell Labs researchers and developers Telecommunications is the backbone of the global economy, also work directly with Lucent’s service provider customers and the inherent need for communications is a key component worldwide in an ongoing effort to improve such things as of the global economic recovery. Our industry, therefore, is a quality of service and network optimization. critically important one and will ultimately stabilize and return Bell Labs scientists and engineers are constantly pushing to growth. It’s not a question of if, but when, as Internet con- the frontiers of science and technology, while defining the nections become the next generation’s dial-tone, as the need vision and setting the pace of innovation for the communica- for high-speed wireless data and new applications increases, tions industry and beyond. as the world’s focus turns more and more to network security and reliability issues during times of crisis, and as the world’s Innovation Central embedded network infrastructures evolve to more IP-based Bell Labs also maintains a long-term basic research program and wireless architectures. that allows its researchers to explore fields such as theoretical Over the past year, Lucent’s senior leaders have developed computer science, materials science and bioengineering — a five-year strategic plan aimed at growing our business for fields in which Bell Labs continues to make seminal contribu- the long term. We looked at where we want to be in 2008 tions. Just this year, Bell Labs scientists made a surprising and what it will take to get there. We have defined a set of discovery that a deep-sea sponge constructs optical fiber that aggressive strategic outcomes, set some stakes in the ground is remarkably similar to the optical fiber found in state-of-the- and are in the process of engaging all of the people of Lucent art telecommunications networks. These biological fibers in this important work. present a number of technological advantages over telecom Our strategy supports our new stated purpose: creating fiber, such as more flexibility, and could lead to better fiber- new possibilities to enhance people’s lives by transform- optic networks in the future. ing the way the world communicates. It leverages our On March 10, 2003, Bell Labs was granted its 30,000th legacy of innovation, and it says that, going forward, we intend United States patent, a testament to the continuing feverish to create new ways to communicate and continue to develop pace of innovation at Bell Labs. This milestone patent covers technology that will make a difference in the way people work the mechanisms for guaranteeing quality of service in Internet and live. The plan draws on our expertise in software, net- protocol networks, which should help make packet-based net- working and services. We’ll be looking to new markets and works as reliable as today’s telephone networks. new geographies to drive our growth. We’ll tap deeper into our The R&D Council of New Jersey honored three Bell Labs innovation engine, Bell Labs, and continue to expand partner- scientists with the 2003 Thomas Alva Edison patent award for ships and alliances. Our aim is to be the leading network their software verification technology, an innovation that has integrator worldwide and the No. 1 network solutions provider replaced the slow and flawed manual process that was often in the world. used to test software for errors. We invite you to track our progress during the coming year Bell Labs scientists also are involved in steering the course by logging on to www.lucent.com. of nanotechnology, which involves manipulating and designing materials at the scale of individual atoms or molecules. Bell Labs is now directly managing the New Jersey Nanotechnology Consortium, located at our headquarters in Murray Hill, N.J. We have a world-class nanofabrication lab and an electron beam lithography lab up and running, staffed by a team of leading scientists and engineering experts. The Patricia F. Russo work being done here is focused on commercialization, with Chairman and Chief Executive Officer several contracts already in place with customers in areas such as defense, biotech and aerospace. December 12, 2003 4 LUCENT TECHNOLOGIES INC. 600 MountainAvenue Murray Hill, New Jersey 07974 NOTICE OF 2004ANNUAL MEETING OF SHAREOWNERS TIME . . . . . . . . . . . . . . . . . . 9:00 a.m. EST Wednesday, February 18, 2004 PLACE . . . . . . . . . . . . . . . . The DuPontTheatre 10th and Market Streets Wilmington, Delaware 19801 ITEMS OF BUSINESS . . . . . (1) To elect members of the Board of Directors, whose terms are described in the proxy statement. (2) To approve an amendment to the Restated Certificate of Incorporation to declassify the Board of Directors and to allow for the removal of directors without cause. (3) To approve the Lucent Technologies Inc. 2004 Equity Compensation Plan for Non-Employee Directors. (4) To amend the Restated Certificate of Incorporation authorizing the BoardofDirectorstoeffectareversestocksplitatoneoffourratios. (5) To transact such other business, including consideration of shareownerproposal(s),asmayproperlycomebeforethemeeting and any adjournment thereof. RECORD DATE . . . . . . . . . . Holders of Lucent common stock of record at the close of business on December 22, 2003 are entitled to vote at the meeting. ANNUALREPORT . . . . . . . . The company’s 2003 annual report, which is not a part of the proxy soliciting materials, is included as part of this document. PROXYVOTING . . . . . . . . . It is important that your shares be represented and voted at the meeting. You can vote your shares by completing and returning the proxy card sent to you. Most shareowners can also vote their shares over the Internet or by telephone. If Internet or telephone voting is availabletoyou,votinginstructionsareprintedontheproxycardsentto you. You can revoke a proxy at any time prior to its exercise at the meeting by following the instructions in the accompanying proxy statement. RICHARD J. RAWSON Senior Vice President, December 22, 2003 General Counsel and Secretary LUCENT TECHNOLOGIES FINANCIAL REVIEW 2003 Page Management’s Discussion and Analysis of Financial Condition and Results of Operations F-2 Forward-Looking Statements F-2 Overview F-2 Application of Critical Accounting Estimates F-4 Results of Operations F-9 Liquidity and Capital Resources F-21 Quantitative and Qualitative Disclosures About Market Risk F-26 Five-Year Summary of Selected Financial Data F-29 Report of Management F-30 Report of Independent Auditors F-31 Consolidated Financial Statements F-32 Consolidated Statements of Operations F-32 Consolidated Balance Sheets F-33 Consolidated Statements of Changes in Shareowners’ (Deficit) Equity F-34 Consolidated Statements of Cash Flows F-35 Notes to Consolidated Financial Statements F-36 1. Summary of Significant Accounting Policies F-36 2. Business Restructuring Charges, Reversals and Asset Impairments F-41 3. Discontinued Operations F-45 4. Business Dispositions and Acquisitions F-46 5. Supplementary Financial Information F-47 6. Loss Per Common Share F-48 7. Comprehensive Income (Loss) F-49 8. Income Taxes F-49 9. Debt Obligations F-52 10. Mandatorily Redeemable Convertible Preferred Stock F-54 11. Retirements of Convertible Preferred Securities and Debt Obligations F-55 12. Employee Benefit Plans F-55 13. Stock Compensation Plans F-58 14. Operating Segments F-60 15. Financial Instruments F-63 16. Securitizations and Transfers of Financial Instruments F-66 17. Accounting Changes F-67 18. Commitments and Contingencies F-67 19. Quarterly Information (Unaudited) F-74 F-1 MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS FORWARD-LOOKING STATEMENTS This Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) contains forward-looking statements that are based on current expectations, estimates, forecasts and projections about us, our future performance, the industries in which we operate, our beliefs and our management's assumptions. In addition, other written or oral statements that constitute forward-looking statements may be made by us or on our behalf. Words such as “expects,” “anticipates,” “targets,” “goals,” “projects,” “intends,” “plans,” “believes,” “seeks,” “estimates,” variations of such words and similar expressions are intended to identify such forward-looking statements. These statements are not guarantees of future performance and involve certain risks, uncertainties and assumptions that are difficult to assess. Therefore, actual outcomes and results may differ materially from what is expressed or forecasted in such forward-looking statements. These risks and uncertainties include the failure of the telecommunications market to improve or to improve at the pace we anticipate; continued net losses and negative operating cash flow that may affect our ability to satisfy our cash requirements; our ability to realize the benefits we expect from our strategic direction and restructuring program; our ability to secure additional sources of funds on reasonable terms; our credit ratings; our ability to compete effectively; our reliance on a limited number of key customers; our exposure to the credit risk of our customers; our reliance on third parties to manufacture most of our products; the cost and other risks inherent in our long-term sales agreements; our product portfolio and ability to keep pace with technological advances in our industry; the complexity of our products; our ability to retain and recruit key personnel; existing and future litigation; our ability to protect our intellectual property rights and the expenses we may incur in defending such rights; changes in environmental health and safety law; changes to existing regulations or technical standards; the social, political and economic risks of our foreign operations; and the costs and risks associated with our pension and postretirement benefit obligations. For a more complete list and description of such risks and uncertainties, see the reports filed by us with the Securities and Exchange Commission. Except as required under the federal securities laws and the rules and regulations of the SEC, we do not have any intention or obligation to update publicly any forward-looking statements after the distribution of this MD&A, whether as a result of new information, future events, changes in assumptions or otherwise. OVERVIEW We design and deliver networks for the world’s largest communications service providers. Backed by Bell Labs research and development, we rely on our strengths in mobility, optical, data and voice networking technologies, as well as in software and services, to develop next-generation networks. Our systems, services and software are designed to help customers quickly deploy and better manage their networks and create new revenue-generating services that help businesses and consumers. Beginning in fiscal 2001, the global telecommunications market deteriorated, reflecting a significant decrease in the competitive local exchange carrier market and a significant reduction in capital spending by established service providers. This trend intensified during fiscal 2002 and continued into fiscal 2003. Reasons for the market deterioration included the general economic slowdown, network overcapacity, customer bankruptcies, network build-out delays and limited availability of capital. As a result, our sales and results of operations have been and may continue to be adversely affected. The significant slowdown in capital spending in our target markets has created uncertainty as to the level of demand, which can change quickly and can vary over short periods of time, including from month to month. As a result of this uncertainty, accurate forecasting of near- and long-term results, earnings and cash flow remains difficult. In addition, since a limited number of customers account for a significant amount of our revenue, our results are subject to volatility from changes in spending by one or more of these significant customers. F-2 As discussed in more detail throughout our MD&A: • Our results of operations during the past three years were adversely affected by the rapid and sustained deterioration of the telecommunications market. After several years of significant growth, our revenues declined by 31%, 42% and 26% during fiscal 2003, 2002 and 2001, respectively, compared with the respective prior fiscal year. The significant reduction in capital spending by service providers, among other factors, contributed to this decline. The impact of product rationalizations and discontinuances under our restructuring program did not have a significant effect on the overall reduction in our revenues during the past three fiscal years, although certain product rationalization initiatives, such as our decision to exit GSM, have reduced our total available market opportunities. • Our gross margin rate was 31%, 13% and 10% during fiscal 2003, 2002 and 2001, respectively. The improvement in fiscal 2003 primarily resulted from lower inventory-related charges and continued focus on cost reductions. For fiscal 2002 and 2001, product line discontinuances and the significant and rapid declines in revenues led to significant inventory charges and high- unabsorbed fixed costs, which adversely affected our gross margin rate. • We continued to reduce our operating expenses through restructuring actions. However, these actions resulted in net business restructuring and asset impairment charges of $2.3 billion and $11.4 billion during fiscal 2002 and 2001, respectively. During fiscal 2003, net reversals of $149 million were required due to lower than estimated actual costs for prior year plans. These reversals were particularly related to the true-up of termination benefits. • We had net recoveries of bad debt and customer financings of $223 million in fiscal 2003, primarily due to the favorable settlement of certain fully-reserved notes receivable and accounts receivable. We recognized significant provisions for bad debts and customer financings of $1.3 billion and $2.2 billion during fiscal 2002 and 2001, respectively, as a result of the significant deterioration of the financial health of certain customers. Most of these provisions were related to commitments made and loans drawn under our customer-financing program during prior years. • We recognized a charge of $481 million during fiscal 2003 in connection with the settlement of purported class action securities lawsuits and other related lawsuits against us and certain of our current and former directors and officers for alleged violations of federal securities laws, ERISA and related claims. • We continued to maintain a full valuation allowance on our net deferred tax assets during fiscal 2003, which primarily originated in fiscal 2002. However, we recognized an income tax benefit of $233 million during fiscal 2003, which included several discrete items that were partially offset by current tax expense related to certain non-U.S. operations. The discrete items included tax benefits from the realization of certain fully-reserved net operating losses as a result of carryback claims for taxes paid in prior years, plus additional benefits from the expected favorable resolution of certain tax audit matters. Fiscal 2002 included a tax provision of $4.8 billion despite a pre-tax loss from continuing operations of $7.1 billion due to the requirement for a full valuation allowance. We have two segments, each organized around a separate customer set to which it sells products or services. The Integrated Network Solutions segment (“INS”) sells to global wireline service providers, including long-distance carriers, traditional local telephone companies and Internet service providers. It offers a broad range of software, equipment and services primarily related to voice networking (offerings primarily consisting of switching products, which we sometimes referred to as convergence solutions, and voice messaging products), data and network management (offerings primarily consisting of access and data networking equipment and operating support software) and optical networking. The Mobility segment sells to global wireless service providers and offers software, equipment and services to support the needs of its customers for radio access and core networks. We support these two segments through a number of central organizations, including our services organization and corporate headquarters. F-3