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Alcatel / Lucent Technologies Inc. Merger Announcement (ALA, LU)

April 2, 2006, 11:00 AM EST

Executives

Serge Tchuruk - Alcatel - Chairman

Patricia Russo - Lucent - President, CEO

Jean-Pascal Beaufret - Alcatel - CFO

John Kritzmacher - Lucent - CFO

Frank D'Amelio - Lucent - COO

Michael Quigley - Alcatel - COO

Mark Gibbens - Lucent - Treasurer

Analysts

Jeffrey Schlesinger - UBS

Kulbinder Garcha - Credit Suisse

John Anthony - Cowen and Company

Stefan Formier - BSM Radio Station

Tim Daubenspeck - Pacific Crest Securities

Steve Kamman - CIBC

Paras Bhargava - BMO Nesbitt Burns

Inder Singh - Prudential

Roger Cheng - Dow Jones

Eiji Ono - Credit Suisse

Mark Sue - RBC Capital Markets

Sandeep Malhotra - Merrill Lynch

Paul Sagawa - Sanford Bernstein

Presentation

Serge Tchuruk

I am frankly very proud to today announce what is likely to be a major event in our industry. A few hours ago, the boards of the two companies have unanimously approved a merger between our two companies to form not less than the world's leading communication solutions provider.

In my opening remarks, I would like to briefly try to give my answers to three questions. Why merge? Why now? Why Alcatel and Lucent? Let me try on the first one, why merge? There are to date two essential keys for success in today's very competitive market. The first key, to be amongst the best in the capability to innovate in products; not only in products, also solutions and services.

The second key, to be amongst the best of the lower-cost players. In other words, the market is so competitive that even if you have the first key and if you don't have the second key, you cannot open the door. To get those two keys working, obviously scale and size can help. A combination of two very large players which individually have already gone a long way in meeting those two criteria can be a formidable winner.

Now the second question is, why now? Now seems to be the optimum time because this combination gives both companies distinct time to market advantage in a market that is changing significantly. This is the first tier 1 combination in equipment suppliers, which gives us a great start.

Scale and speed to market have become even more critical as the communications landscape changes rapidly, due to competition, consolidation and complexity, three industry forces that now make this combination a logical course for both companies.

The third question, why Alcatel and Lucent. To be frank, that is not a new idea, at least for me. I will certainly remind you that five years ago we went a very long way to get this done, and the discussion broke out in the last minutes, I would say. So I don't know if [Rene Chard] by any chance is listening to the call, but if he is I would remind him of this time and send him my warmest regards.

So why Alcatel and Lucent? Because, you know, this is really creating the true global communication solutions provider. Very deep customer relationships, as you can see on this slide with nearly every major service provider throughout the world; lots of industry-leading R&D platforms; a complete ability to offer integrated, end-to-end solutions and not so many players today can offer end-to-end solutions. Alcatel and Lucent can both and obviously a combination can even do more.

A leader in converged networks. I would say that even if we come from two continents, I have always felt that Alcatel and Lucent shared a common vision and innovation culture which should enable successful execution. In other words, our people understand each other very well, actually, when they talk to each other.

The third thing, geographic fit is absolutely exceptional, and I am sure Pat will talk about that in more detail. It is roughly one-third U.S. and Canada, one-third Europe and one-third the rest of the world, including Asia. One could hardly dream any better.

The fourth thing, it so happens -- and that is not again a discovery -- that bringing together the two companies can achieve significant synergies and should therefore contribute and enhance the financial position of the two companies. We have estimated that something like EUR 1.4 billion in annual pre-tax cost synergies, within three years, can be achieved, with a substantial majority expected to be achieved in the first two years, post-closing. NPV at about EUR 10 billion to EUR 12 billion, actually.

The combined revenues of the two companies are going to be about EUR 21 billion, or $25 billion, with cash in around 10 billion. The combination will be EPS accretive in the first year post-closing, with synergies excluding restructuring charges and amortization of intangible assets. So this sounds to me like an exceptional strategic fit; the right time, the right solution, the right company. We are convinced it will go a long way to enhancing shareholder value.

Going now to the next slide, a few short words about what the transaction is. First of all, the combined market cap of the two companies amount to approximately EUR 30 billion, or $36 billion. The transaction will be a stock for stock merger which is going to be structured as a tax-free exchange of Alcatel's [ADS]s for Lucent shares.

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, which reflects the difference in the capitalization of the companies.

In legal terms, the deal is structured as a reverse triangular merger, after which Lucent will become a subsidiary of Alcatel, and Lucent shareholders will receive a tax-free exchange of Alcatel ADSs for Lucent shares. By the way, these structures are common in mergers of this size, and most mergers involving U.S. public companies are done this way.

The merger will have to go through the regulatory approval process, and we expect the closing should take place between six and 12 months from now. Regulatory approvals are required from the European Union Commission, the U.S.A. Anti-Trust Authorities, and the Exxon-Florio Act.

Now some additional words on what the company is going to look like. It is a new company, given the process which we are adopting, it is going to be incorporated in France with executive offices in Paris. The new company name will be determined at a later date.

North American operations will be based in New Jersey, where Global Bell Labs are headquartered, and will remain headquartered. The leadership will be non-executive Chairman, myself; CEO, Patricia Russo, will be based in Paris. There is going to be an international board including 14 members. Six will be Alcatel current directors -- some of Alcatel's current directors, I should say, including myself; six will be some of Lucent's current directors, including Pat Russo; and two new independent European directors will be mutually reached. We are really trying to leverage the best of the two companies.

Now some additional words, on the next slide, just to complete the growth picture. If I look at adding up some of the numbers, I am frankly quite impressed by what comes out of it. We are without any doubt, and much beyond anyone else, the number one worldwide in wire line at a time where its market picks up again, due to IPT and many other things, network transformations.

We are the number two in worldwide mobility, and we are also the number two in worldwide services. If I look at wire line, everybody knows our combined strength in DSL which reached close to 40% market share. We are big players in optics and we are by far the number one in optics; number one in multi-service; number three in IPS routing and the like.

The wireless, Pat will talk more about it, but overall market share will amount with all standards to something around 18% and we are going to be number two in this market, with a lot of strength. CDMA strength of Lucent, our big strength in emerging world; services, our [SATS] are going to be $5 billion in combined revenues across a number of applications.

So the picture is really, I believe, quite compelling. '05 revenues amount to EUR 25 billion -- $25 billion. We are present in nearly any major carrier throughout the world. We are a leader in IPTV, [MGM], IMS and 3G spectrum and we are in a unique position in service integration.

One word about our customers, who our customers are. I am not going to go through the list, but as I said there is practically no customer, large or small, not being reached by either Alcatel or Lucent.

Now for our customers, what does this mean? I believe the benefits for our customers are quite compelling. What do our customers want? They want us to be both global and local, which seems to be a paradox, but that is the way things are. As to being global, we have a comprehensive R&D portfolio which leverages, among other things, Bell Labs excellence, with 26,000 R&D engineers and 25,000 active patents.

We are the leading end-to-end communication solutions integrator. We are a leader in major areas defining the next generation of networks, and Pat will certainly say much more about this. We are a local partner in every region, and there is not one single country in the word where there is not significant presence today of either us or Lucent. Obviously, this is going to be a long-term strategic partnership.

Now in conclusion, I believe that the combination of Alcatel and Lucent will provide the right answers to the key issues. We are the answers to the ongoing consolidation of the global service providers. We are the answer to the increasing network complexity as convergence requires breadth of products and depth of services expertise. We are the answer for the service providers requiring a long-term reliable partner as major network transformation just begins. We are the answer to the demanding needs for large R&D investment required to maintain leadership for us and our customer.

So in a nutshell, scale and scope will further enhance our competitiveness, and I am very convinced about that. I would like to give the floor to Pat. Pat.

Patricia Russo

Thank you very much. Good morning, good afternoon and good evening to everyone. This is certainly a very exciting day for all of us at Lucent Technologies, with our partners at Alcatel. This is, in my view and Serge has said it very well, a truly compelling combination at a time in the industry where consolidation, competition and complexity are driving a set of needs that this combined company will be better able to meet, we believe, than any of our competitors.

Let me proceed here and talk a little bit about the two companies with a common vision. We share -- I think it is important, because as Serge said, we know each other well. We have worked together and side by side, and also competitively in the industry. But dating back five years, these are two companies who know each other fairly well and we share a common vision of where networks are going and what the expertise is that is required to get them there.

We share a common and deep understanding of what our customers require, and we both share a combined culture of technical excellence and a passion for innovation, and I look forward to leveraging that passion into extending our leadership in the global market.

We bring together a pace and breadth and depth of talent that is unparalleled in the industry, and as Serge noted we have geographical portfolio and a customer fit that is really quite complementary. So we have a shared vision and a uniquely complementary fit to the combination of these companies.

Moving on, just to punctuate the point that Serge made about the leadership that we have in the key and relevant areas that are important to how networks will evolve with respect to the next generation of technologies and the ability to deliver new converged services on behalf of our customers.

If you look at what is happening in the market, clearly the areas that you see on the next chart point to the areas that we believe are most relevant to win in the arena of next generation networks. Certainly, the combination of our companies provides leadership in each of these areas. In the fixed and mobile broadband access area, number one in DSL, number two overall in mobility. I would point out that our combined CMA and UMTS businesses would make us number one in the third generation spectrum technology base, which as you know is the fastest growing mobility segment. In optics, microwave, clear leadership in the traditional transport technologies, but also very well-positioned to help our customers integrate through Ethernet solutions.

Number one in microwave, thanks to Alcatel's industry leading point-to-point solutions, which are really very well-suited for quick and economic deployment of new legs for the network.

In the converged core, and the converged edge area, we would be both number one in both multi-service wide area networks, as well as [IMS] and in the integration and services area, we have the capabilities as you can see on the chart, across many sets of skills that really come together to create for us the number one position in network transformation services.

So the real point here is that in the areas that we believe are relevant to where the growth will be, the combined company will be either number one or number two in each of these areas.

Moving on, I talked about the strong position that the combined companies will have in mobility. We will be a leader in terms of innovation, expertise, deployment services, network migration as well as pure volume.

Lucent, as you may know, is the global leader in 3G CDMA with a 48% global market share and strong relations around the world. Alcatel is very well-positioned for 3G UMTS migration, a strong presence with its GSM base, and in a number of growing markets around the world.

So both companies will have strong positions and large footprints in 2G and 3G networks, and we look forward to leveraging those as third-generation technologies take hole around the world.

Additionally, both companies would be very well positioned for 3G services in China, including relationships with China Unicom and China Mobile, and we are both working with carriers in China as they prefer for the 3G licenses and implementation of those technologies. Lastly, a strong footprint in IMS and Access.

Moving on, I think there is no question that another clear differentiator for the combined companies is our strength and what is known as the triple play of voice, video and data. Together, we will be the most experienced company in terms of its capability, with more than 40 projects underway around the world, including 20 commercial networks.

We see the opportunity with our combined capabilities to really leverage an end-to-end service capability by linking what is happening in the Access network into the next generation IMS core, and enabling exciting and creative new services for our customers. We also enjoy together a very wide ecosystem of partners, as a result of the relationships that both Lucent and Alcatel have established in the industry.

Moving to the next chart, I mentioned our capability in the services and support arena. There is no question in our mind that as the complexity of these networks continues to intensify, our customers needs for integration, migration, professional services, consulting services and that kind of help is growing.

We bring together a deep and broad capability here and see from this significant opportunity, to be able to grow. As Serge noted, the combined services business are EUR 4 billion or $5 billion. They really span not only the traditional service arena, which has been and will continue to be important, but also new service areas: consulting and professional services, as well as hosted applications and services associated with those, which will allow for us to leverage our next generation and IMS positions.

Lastly, we've developed a distinct multi-vendor capability that will enable us to better deliver complex, end-to-end support for our customers.

The last area I'll focus on is to really talk about a leading position in IMS and the network transformation associated with that. As Serge noted, our industry is at the beginning of a major technology transformation to an all-IT network characterized as IP multimedia subsystems, or IMS.

The combined companies bring to this proposition a set of capabilities in the wire line, the mobile and the enterprise arena that we believe give us the greatest capability to integrate and leverage our technical expertise, our technologies, our portfolios to really help our customers create the next generation of converged lifestyle, personalized services that we believe will help them grow their business.

So I think this is an area where, as we go forward, the strength of both companies against an industry that is at the beginning of a major transformation bodes very well for our position in the market, as well as our ability to grow.

Moving on to cover a little bit about the geographic balance -- and Serge noted this -- this is truly a global company. If you look at the geographic balance, it could not be more perfect, quite frankly, when you look at where the spending is in the industry. In 2005 about half of Alcatel's business came from Europe; about 66% of Lucent's business came from North America.

If you look at the combined companies and the calendar year 2005 revenues, what you see is about one-third, one-third and one-third across North America, Europe and then one-third split between the Asia Pacific regions, the Middle East and Africa, and the Caribbean and Latin America region. So a compelling geographic balance, and I would argue the best geographic balance in the industry.

Moving on, the combined companies have clearly an industry-leading R&D capability. When you look at the number of developers and engineers we have around the world combined, we would be 26,000 plus strong with respect to the engineering resources and collective brainpower of those people. From a patent standpoint, we would have 25,000 active patents in our patent portfolio. Combined, an R&D investment capacity of EUR 2.4 billion or $2.9 billion of R&D. So just a tremendous wealth of talent, assets and technical depth that will be at the foundation of this combined company.

I know there has been some speculation about how to handle any work that is done for the U.S. government or for the French government, and I would say that we intend to form a separate U.S. -- independent U.S. subsidiary. Serving contracts with the U.S. Government agencies. This subsidiary would be separately managed by a board which will be composed of three U.S. citizens which will be acceptable to the government. This is a structure that is routinely used to protect certain government programs in the course of mergers that involve non-U.S. parties.

And with regard to Thales the combined company will remain the industrial partner of Thales and a key stakeholder alongside the French state, directors to the Thales board who are nominated by the combined company would be European Union citizens. Serge Tchuruk or a French director or a French corporate executive of the combined company would be the principal liaison.

So structurally and from an oversight standpoint, we've cared for the unique needs of any work that is being done that is sensitive for either the U.S. or the French government.

Let me say a few words about the compelling nature of the cost synergies. As we've said earlier, we would expect to achieve about EUR 1.4 billion or $1.7 billion in annual pre-tax cost synergies. We would expect to achieve these within three years with a substantial majority achieved in the first two years. The net present value of these cost synergies is expected to be EUR 10 billion or $12 billion.

We have, through the teams that have worked together, mutually identified the synergy opportunities and would expect to capture them by the integration and rationalization across a number of areas cited on this chart: corporate functions, our supply chain and procurement practices, any overlap with respect to sales and marketing and the like. As well, we'd also expect to find some synergies with respect to common platforms, consolidating facilities, and those sorts of things.

The next chart really tries to lay out the anticipated timing of these synergies and as I noted earlier, we would expect a significant majority of those to be achieved in the first two years. A lot of work has already been done, there is clearly a lot more work to be done as integration planning proceeds, but this is a compelling set of synergies that are tangible and have been mutually identified and agreed to between the companies.

We have not included in the synergies that we've noted any synergies resulting from potential revenue upsides, and do believe, however, that there are opportunities as a result of the cross-selling that could be done in certain product areas, as noted on this chart. Our portfolios in many ways are complementary and so we see opportunities to incorporate one another's products into a total solution. As well, there is complementarities geographically and from a customer standpoint, so we would expect to capture some pull-through revenue synergies as a result of that.

As I've said, those are not factored into the synergy analysis that has been presented here, but you can rest assured we will be aggressively going after those.

A few more words about restructuring. We would expect, as a result of the work that has been done, that we would see a reduction in the range of about 10% of our worldwide workforce. We are very sensitive obviously, to the concerns of the employees of both companies. We expect to take a fair and balanced approach as we manage our way through this.

We would expect that we would experience EUR 1.4 billion or $1.7 billion in new cash restructuring charges associated with the restructuring that we anticipate being done. Again, as I said, we would expect a substantial majority of the restructuring to be completed within the first 24 months after closing.

Let me say a few words now about Lucent's pension plans and retiree health care, as this often generates questions. First of all, in the area of pensions, Lucent's pension plans remain very well-funded under the current U.S. government guidelines. The company has not been required to make contributions to these plans since their inception in 1996 and currently does not expect to make any contributions through September of 2007. As you can see, the fair value of the plan assets is about $34 billion and the benefit obligation is at approximately $31 billion.

I noted that we don't expect to make any contributions through 2007. We also believe it is unlikely that any required contributions would have to be made before 2010 that would have any material impact on our liquidity.

With respect to retiree health care, we do provide benefits for about 182,000 retirees and their dependents. We have been working with our union partners to seek some legislative changes that would increase our flexibility to use excess pension assets to help fund retiree health care. We take the interests and needs of our retirees very seriously, and we have worked hard to find the right balance between supporting those needs and what the company has been able to afford.

Let me move along to the next chart which speaks to the enhanced financial position of the combined company. As you can see, the combined company will have a strong balance sheet and income statement. As of December 31, 2005 the combined companies had EUR 9 billion in cash and $11 billion which puts the combined company in a net cash position of about EUR 1 billion.

As Serge noted, the combined revenues of the company will be EUR 21 billion, $25 billion, with a combined net income of EUR 2 billion in calendar 2005. The company's overall debt profile will continue to be relatively long-dated with more than 60% of its debt maturing on or after 2010. At the same time, the combined company will also have substantial deferred tax assets.

So in summary -- and I know we've shared an awful lot with you -- but just to recap what Serge said, we are very excited about this combination. We see it as an opportunity to create clear competitive advantage in the marketplace. There is compelling strategic rationale for this merger. The combination of Alcatel and Lucent will create the first truly global communications solutions provider. It is a clear leader in convergence.

We have a shared vision and a culture of innovation that we believe will help ease our transition and benefit both our new and existing customers. Lastly, this provides us a tremendous opportunity to achieve significant financial synergies, enhance our financial position and create significant shareowner value.

So the bottom line is, we believe it is the right time, it is the right combination and the right set of solutions. With that, I will turn it back to Jean-Pascal to moderate questions.

Jean-Pascal Beaufret

Thank you, Patricia. Stacey, if you don't mind to start the Q&A right now, please.

Question-and-Answer Session

Operator

(Operator instructions) Your first question comes from the line of Jeffrey Schlesinger with UBS. Please go ahead.

Jeffrey Schlesinger - UBS

Yes, thank you. Just a couple of financial questions, and then more of a philosophical question on how you managed this transition. You mentioned the view that the deal would be accretive in the first year afterwards, excluding the restructuring charges and amortization of intangibles. What do you expect the increase in the amortization of intangibles to be as a result of this deal, if any at all?

If you could also give us a sense, are any of the convertibles that Lucent has today forced to convert as part of this? Is that increase included in the share count assumption that you've given as part of the exchange?

Lastly on the financial side, on the cost synergies, you gave us good sense on the 1.4 billion in the different areas. Could you give us a sense of how that would split down between cost of sales, SG&A and R&D?

Lastly on the more philosophical question, how do you manage -- after two companies that have gone through significant restructuring over the last several years -- how do you manage the morale going into another major downsizing? As well as handle disruption and focus for the company, obviously in what is still going to be a very competitive environment, despite this added consolidation? Thank you.

Patricia Russo

I don't know where to start -- Jean-Pascal or John Kritzmacher, both of our CFOs are with us. Do either one of you want to take the initial set of questions with respect to the restructuring charges?

Jean-Pascal Beaufret

Just commenting on the first question about the accretion power of the transaction. We let you guys calculate all of the accretion powers. We are saying today we have 1.4 billion cost synergies on year 3 in this transaction. All of that will be factored in the current model and the market model of most companies.

John, would you like to take the question about the convertible and the earnings per share and the fully diluted model we used?

John Kritzmacher

With regard to the conversion features of the convertible debt that we have in the marketplace, there are no triggers that would be affected by the combination of the two companies, so our conversions would be consistent with the practices we have followed in reporting our results over the past several quarters.

With regard to the question related to the amortization of intangibles, back to Jean-Pascal's comments, it is still a bit premature for us to provide an estimate of what those amounts might be, we still have quite a bit of work to do to apply purchase accounting to the transaction. We will go through that exercise and be able to report on that sometime down the road.

Patricia Russo

Did we get all of the financial questions? Let me take a crack and maybe Serge has a comment as well to your more philosophical question. Just a couple of points I would make. I think obviously both companies, the people of both companies, have demonstrated over the past several years tremendous resolve, capacity, resiliency to manage through change.

I think if you look at both of our companies, degree of change and the magnitude of what we have all done is significant. So from a people standpoint, I do believe that our people are up to the task of doing what will need to be done in order to integrate these companies, with an eye toward the future that we create for the combined company and the opportunity to have a platform from which, as we go through the integration, a real platform from which to then grow, compete and win with all of the benefits that are associated with that.

Now having said that, we are not naïve about the challenges associated with the integration planning, the combination, and rationalizations that will be required. We clearly intend to have speed as our bias, with an eye toward very specific and detailed integration plans. We will want to move quickly so that we can get past the through the disruptive dimensions of this onto a level of stability that we will all be aspiring to.

I believe our people are up to the challenge, I believe with the right leadership, the right clarity of responsibility and a rigorous plan, we can in fact get this done. Serge, did you want to add anything to that?

Serge Tchuruk

Pat, just to say that I 100% share your view. Our two companies, in the past, have shown the capability to weather very difficult market conditions and do what was needed in terms of downsizing and the like. To be frank, and to my regret, having been an expert in trying to downsize and streamline, I do believe that the task of achieving what is needed is feasible, with a fair and balanced approach to our people throughout the world. I am very confident we can do this.

Operator

Our next question comes from the line of Kulbinder Garcha from Credit Suisse. Please go ahead.

Kulbinder Garcha - Credit Suisse

Yes, thank you. A question for Pat on the restructuring side. The 1.4 billion cost reduction that you are talking about is, I think more aggressive than even the most optimistic of forecasts. Can you just give us a sense of how that might split down between head count and non- head count?

Also in terms of actually Alcatel/Lucent retaining those benefits, often a significant amount of cost savings pass back to customers in one form or another over time. How confident can we be that Alcatel/Lucent can preserve those cost savings, and really drive the margins in that matter?

Patricia Russo

First of all, I believe as we look at the restructuring, and I will ask my colleagues to provide any additional color here, that if you look at the breakdown of the estimated synergies, about half is related to head count reductions we've talked about, and the other half related to things like leveraging our procurement practices, and consolidation of operations like IT and real estate and those sorts of things. So that is a rough flavor of how these restructuring charges break down.

The second part of your question?

Kulbinder Garcha - Credit Suisse

With respect to cost improvements, what we see in the industry is typically a large part has been passed back to customers as products are simplified, or however those things tend to work. I am just wondering, what is the confidence you can actually retain them and they will go to Alcatel/Lucent's bottom line?

Frank D'Amelio

From my perspective, we have and will continue to do this: every year, we work significant, extensive cost reductions into our products. Clearly, in one way, shape or form we pass that back to our customers. We have done that and will continue to do that.

To the extent that the efforts here assist us to do that further, we will obviously consider that going forward.

Kulbinder Garcha - Credit Suisse

Okay, thanks. Just one final follow-up. My math suggests that if you are having some sales growth, let's say not even a great deal but actually get his 1.4 billion cost synergy, we are talking about a business that should do a clean operating margin in the mid-teens within two to three years.

I guess my question is, given the fragmented nature of standards, is that the kind of number we should be thinking about as a long-term margin for this business?

Patricia Russo

Jean-Pascal, did you want to respond to that?

Jean-Pascal Beaufret

It is absolutely clear that the potential of the increases of the margin at an operating level is quite significant in those transactions. I would say that it will be somewhere in the 10-20%. I will not be more specific than that.

Kulbinder Garcha - Credit Suisse

Okay, thank you, Jean-Pascal.

Operator

Our next question comes from the line of John Anthony with Cowen and Company. Please go ahead.

John Anthony - Cowen and Company

Good afternoon, everybody. A couple of quick questions. Given the history of mega consolidations within the technology segment as a whole, what do you plan on doing differently to avoid some of the pitfalls outside of the other acquisitions we have seen historically that haven't worked out.

Secondly, along the same lines, have you put any sort of retention programs in place to keep key employees throughout both organizations?

Last, is there any sort of break-up fee involved in this deal?

Serge Tchuruk

I can take the first part of the question, Pat. The good thing about this, Alcatel/Lucent combination is the fact that there is not a huge overlap. I mean, there is some overlap otherwise we would not have cost savings, but there is not a huge overlap in the way the two companies are made up.

In other words, we have carefully looked at product lines, our geographic implementation and the like and obviously I am not going to tell you it is very easy to rationalize, but we have a very clear view of what and how you can do it.

Again, this is based on a thorough evaluation which we have conducted. The numbers which we are quoting for synergies are completely based on rather in-depth study.

Now on the rest of the question --

Patricia Russo

I would add to Serge's comment about the clarity we have around the opportunities and the fact that we do not have huge overlaps. I would just say, I think when you think about how do you approach an integration, there are some principles that we will be adopting that I alluded to a bit earlier, right? We will want to move with what I would call prudent speed, so speed will be our bias. Clarity around accountabilities and decision-making must be clear. The integration plan must be detailed, rigorous and very tightly managed, and so the combination of what we have done going into this announcement and our philosophical thinking about how to manage the transition planning and integration team, I believe give us a very good chance for success in this Endeavour.

From a retention standpoint, we will be taking the steps that we need to assure that we are keeping the people that we need in the business to help us get this done.

In terms of a break-up fee, yes there is a break-up fee associated with this transaction of 500 million.

John Anthony - Cowen and Company

A quick follow-up; is that 500 million to both sides? Also, a question Pat for you specifically. How did you weigh, entering into this transaction, against other choices that you had in front of you to create optimal shareholder value for Lucent shareholders? Over what timeframe did you make that judgment?

Patricia Russo

Yes, it is 500 million for both sides. You know, I think Serge said it well when he kicked off this session. As any company, and certainly we, evaluate strategic options, you look at what you are trying to achieve long term and what possible partners are available, what is the fit -- both product, geographic, cultural, technical capabilities -- just as five years ago there were very extensive negotiations, we believe this is absolutely the best combination for us, given the complementarities of all of the things that we described and the ability to create tremendous share owner value.

Next question.

Operator

Thank you. Your next question comes from the line of Mr. Stefan Formier with BSM Radio Station. Please go ahead.

Stefan Formier - BSM Radio Station

Is it possible to get a few words in French from Mr. Tchuruk for the French Radio. Mr. Tchuruk? [Question asked in French]

Serge Tchuruk

[Response provided in French]

Stefan Formier - BSM Radio Station

[Question asked in French]

Serge Tchuruk

[Response provided in French]

Stefan Formier - BSM Radio Station

[Question asked in French]

Serge Tchuruk

[Response provided in French]

Stefan Formier - BSM Radio Station

[Question asked in French]

Serge Tchuruk

[Response provided in French]

Stefan Formier - BSM Radio Station

[Question asked in French]

Serge Tchuruk

[Response provided in French]

Stefan Formier - BSM Radio Station

[Question asked in French]

Serge Tchuruk

[Response provided in French]

Operator

Thank you. Our next question comes from the line of Tim Daubenspeck with Pacific Crest Securities. Please go ahead.

Tim Daubenspeck - Pacific Crest Securities

Thank you very much. Two questions. The first question, I think for a lot of Alcatel investors, we would like to feel comfortable about Michael Quigley's role going forward here. I know he has been named a COO, but the confidence level that Mike was going to stay and be an integral part of this combined entity, we would like some reassurance there.

The second thing, just on the two European board members. Can you just clarify what you mean by European there? Are these going to be previous Alcatel board members who come back? Can you just give us a little more color as to what you mean by the two European board members? Thank you.

Michael Quigley

Tim, let me address the first part. It is Michael Quigley here. You can be 110% confident that I am 120% committed to this venture. Frankly, to me it has been the absolute right fit, as both Pat and Serge have said. We have looked very closely at what this does, principally for our customers, because if it does the right thing for our customers we are going to be successful together. We are absolutely convinced this is the right move for our customers.

We will bring the strength of both companies to bear on bringing end-to-end solutions for our customers. I won't repeat what both Serge and Pat have said about the synergies we will get, not just in cost synergies but in our abilities to bring solutions together.

I would emphasis that I have had an opportunity to get to know both Pat Russo and Frank D'Amelio very well over the course of our negotiations, and I very much look forward to working with both of them. Frank and I in particular have quite complementary roles to play in the new organization, and I think we look forward to be part of the team that supports Pat and Serge as we move forward.

Serge Tchuruk

On the second part, what is Europe? I will leave it to more qualified people to define what is Europe. The only rationale behind this is the fact that our board is international in nature, so the two boards will agree to nominate two additional directors, jointly selected and agreed upon, which will be European in nationality. Europe covers continental Europe, U.K. and the list of 25 countries in the E.U.

Tim Daubenspeck - Pacific Crest Securities

So it is more of a geographic representation as opposed to a control issue on the two new directors?

Serge Tchuruk

It is a geographic representation, not primary control.

Tim Daubenspeck - Pacific Crest Securities

Thank you very much.

Operator

Our next question comes from the line of Steve Kamman from CIBC. Please go ahead.

Steve Kamman - CIBC

Can you hear me?

Operator

We can hear you.

Steve Kamman - CIBC

My one thought as suggestions for the name is either [inaudible].

Patricia Russo

Steve, could you say those again?

Steve Kamman - CIBC

[Inaudible]. Actually, to get on to the serious question, you've got some pretty significant partnerships: Juniper in the optics space as well. Can you just talk to how that is going to flow through as you put the two companies together, competition in the IT space?

And then Pat, any understanding or thoughts in terms of successions? I think that fits to the previous question. Mike and Frank are both very quality people, I'd hate to lose either of them. Any thoughts in terms of how that is going to work?

Patricia Russo

Mike or Serge, feel free to jump in here. I would say, Steve, we both enjoyed -- Lucent and Alcatel -- both enjoy partnerships and as you know as well as I, partnerships in this industry have been increasingly important over the last few years.

We value our partnerships, I think as we progress forward we will be looking at all of those partnerships, we will try to extend and leverage those to the extent that we can, and where in fact we have to get something sorted out, we will sort it out. I think partnerships as a matter of strategy will continue to be important to us as we go forward.

Secondly, your comment about both Mike and Frank. I will tell you I am absolutely delighted at the breadth and depth of talent that the combined companies have with respect to the management team of this company going forward. It would be my goal and objective that we leverage the skills and the capabilities and the relationships that they have established to assure that we are successful as we bring these companies together and go forward.

I think Mike said it well when he said he is looking very forward to working very closely with Frank as we take on the tasks of integrating and combining these companies and competing even more effectively in the marketplace. Serge, anything you want to add to that?

Serge Tchuruk

I fully support what you said. Does anyone here want to add something? No. That is fine, thank you.

Steve Kamman - CIBC

Thank you.

Operator

Our next question comes from the line of Paras Bhargava with BMO Nesbitt Burns. Please go ahead.

Paras Bhargava - BMO Nesbitt Burns

Good day. Just a question, Pat. You gave us a lot of details on your pension issues. We have had the president of the Lucent Retirees Association, Ken [Rashton], say some things. As we look at the Series 420 transfers that are still in front of Congress, what process do you need to follow going forward to deal with both of these constituencies? Is the merger contingent on getting approval from both of these two constituencies? Thanks.

Patricia Russo

First of all, the merger is not contingent on getting approval. We indicated some time ago that we were working with the CWA and IBEW to secure legislation that would be specific to Lucent that would enable us to utilize 420 transfer, really expand the 420 transfer capability. We are continuing to work in a very collaborative way toward that end. That, as you may know, is working its way through Congress as part of the pension legislation that is under consideration.

We've said and continue to say, we take very seriously the relationship with our retirees. We've worked very hard to continue to maintain benefits that both recognize the contributions they have made and that are affordable. We will continue to do that.

Operator

Our next question comes from the line of Inder Singh with Prudential. Please go ahead.

Inder Singh - Prudential

Thank you very much. I wanted to ask a couple of questions. You've obviously looked at the cost synergies quite closely, and I do think that you've come up with a pretty compelling case in terms of the head count as well as the process synergies you might see.

At the same time, I think you are optimistic of getting some revenue synergies. What I would like to know is, have you had a chance to talk to some of your customers, both on the Alcatel side as well as on the Lucent side? Have they said to you or suggested that by integrating the IPTV and VoIP areas, let's say, from Alcatel with IMS, wireless and services from Lucent? That puts together a compelling portfolio they are looking for, which will help you garner more market share?

I mean clearly, you are really putting together a very powerful, $25 billion company. Do you expect that you will be able to derive some of those revenue synergies as well? What gives you that confidence?

Serge Tchuruk

If I may, Pat. Mike, take of this question -- I may add a few words, I am sure Pat may also do so. Go ahead, Mike.

Michael Quigley

If I could start by saying yes, we certainly had some discussions with some of our major customers, as you would expect us to do. I have to say, overall our customers are quite enthusiastic about the combined strength the two companies bring, to bring them end-to-end solutions. Just exactly along the lines that you talked about.

If you think of the strength of the two companies, Alcatel, with what its established in the infrastructure, routing, IPTV and Lucent with what has been done in IMS and [NGN] -- we bring quite a powerful combination which our customers see the potential of, particularly as we move more and more towards the converged world of triple play, which is video, high speed internet, voice and wire line and wireless integration together.

This is a complex equation for even our biggest customers to deal with. They, I think, look forward to having a very, very strong partner who has managed and mastered all of the technologies necessary to make this happen.

As Pat emphasized, not only have all of the technologies, but have the service capability and the integration capability to make this all happen.

Serge Tchuruk

I am frankly impressed by all of the customers who I have talked to recently, not about obviously this merger, but they have all indicated their desire to see our industry consolidate. All are pushing us to participate into it.

Some people would say, maybe the Alcatel/Lucent might be the right combination. Obviously I could not comment on it, but it is a bit paradoxical that customers want suppliers to merge. Customers want to have, in the long term, a partner who will be around and be strong and reliable.

Frank D'Amelio

It's Frank. If I can just echo what Serge and Mike said. We've obviously had extensive discussions with customers as well and really, it is not -- it is more than just, I will call it IPTV or IMS. It is really the wire line portfolio, the mobility portfolio, the services portfolio, the combined assets of each company into each of those areas, really, is being well-received. When you do the one plus one, you get much more than two in each of those areas.

Inder Singh - Prudential

Thank you.

Operator

Our next question comes from the line of Roger Cheng, Dow Jones. Please go ahead.

Roger Cheng - Dow Jones

Hi. I had a quick question on the market value, I noticed it was based on Friday's closing price. The terms are actually below what Lucent was trading at on Friday. I am wondering how, if you could provide more detail as to how the terms were determined.

I guess what you can say to Lucent shareholders who kind of have to sell their stock, or change their stock, for something at lower value than what it was on Friday.

John Kritzmacher

This is John Kritzmacher, the CFO for Lucent. The exchange ratio in our transaction, as we have said previously, the exchange ratio was intended to represent an at-market transaction. As is typical with deals of this nature, we selected a trading interval to average out for the trading ratio that preceded our final signing of an agreement by some small period of time.

The average ratio turned out at the close on Friday to be a very slight discount to Lucent holders. You know, there is going to be some variation in the market as we trade from day to day, but at the end of the day the variance is very minor and in fact it reflects some improvement in Lucent's relative value over the period of time, as news of our combination began to leak.

So we would argue, given the improvement in our share price over the past week, along with the normal practice of an at-market transaction, that in fact this is a very fair and equitable deal for Lucent shareholders and for Alcatel's shareholders.

Roger Cheng - Dow Jones

Thank you.

Operator

Our next question comes from the line of Eiji Ono, Credit Suisse.

Eiji Ono - Credit Suisse

Hi, it is Eiji from Credit Suisse here. Two questions. First, some details on the Lucent pension issues. First, there is about a $5.1 billion unrecognized net loss in terms of the pension side. I am wondering if that has to be recognized in a merger like this?

Second, if you are able to net off the pension benefits and the post-retirement obligations, it still looks like you are going to be in a net deficit of about $2.4 billion.

Can you check if that is correct? If so, is that something that will have to be funded in the future, and how?

A follow-up question for Jean-Pascal. You said in Kulbinder's previous question you expect margins in the 10-20% range to be reasonable in the future. Obviously that is quite a large range. I just want to bring up something that we did go through with Alcatel in the past, I think in 2004 when we were talking about some of the future margin potential and cost-cutting, et cetera.

Some of the back of the envelope numbers we came out to for Alcatel potentially get into margins of 14% or 15%. Obviously, I think the fixed cost reductions came through, but the gross margin benefits did not. If we see a similar progression this time around, again is the 10-20% correct or is it going to be more 10-15% or somewhere within there?

Lastly, just on the diluted shares. Can we get an exact number of what the expected diluted shares are to be, once this transaction is done, including all of the convertibles, et cetera, just so we can get an actual number to work off of. Sorry for all of those different questions, but if we can get some answers on them I would be very appreciative. Thanks.

John Kritzmacher

This is John Kritzmacher. With regard to the matter of pension assets and liabilities, we will do a reconciliation of our balances to reflect the fair value of assets and the present obligation for the liabilities. So there will be an adjustment. We have not decided that precisely and we will not until we approach closing and work through that and other matters related to our purchase accounting. Mark, would you like to address the matter of shares?

Mark Gibbens

We will be able to come out with that in a fairly short period of time, the number of shares that would be outstanding. But as I think was mentioned earlier, this does not require the putting of the convertibles that we currently have outstanding, so you should be able to utilize, for the time being, the number of shares that we normally report on a diluted share count basis. Which in each quarter, roughly tends to be on the order of 5 billion to 5.1 billion shares outstanding, from a Lucent perspective.

Jean-Pascal Beaufret

The pension obligation, I believe that this is true, that reporting the combined companies reporting under ISI standards would probably change the way we account for pension obligations and [other] obligations, but not in a detrimental way for the overall strong balance sheet of the combined companies, this is one point.

The second point, you mentioned the potential of margin improvement which we had said, which we had anticipated to sell them for at a time when the market was quite different. The market proved to be [inaudible] for some tougher, some tough in terms of competition, and we have reacted promptly to that. Both companies have reacted promptly to that and have continued their improvement in margins and their efforts in reducing their costs.

We believe that basically improving the margin will come of the improved purchasing power we will get in this combination. So the range I gave, 10-20% is not specific enough today, because we are not here to guide on the combined company. We are just here to give you the type of advantages of such a combination, which is basically on the gross margin side to gain some purchasing power and negotiation power vis-à-vis the customers.

Serge Tchuruk

If I may add, I think the most powerful product architecture available in the two companies to mechanically increase the margins.

Operator

Our next question comes from the line of Mark Sue with RBC Capital Markets.

Mark Sue - RBC Capital Markets

Is there a term limit for your position, or will you be given the flexibility to execute under the guidance of the board? Have you decided on the final COO and CFO positions? Are there term limits for these positions?

Patricia Russo

I am sorry, I didn't hear the first part of the question.

Mark Sue - RBC Capital Markets

Is there a term limit for the CEO position at the moment, or do you think you will be given the flexibility to execute.

Patricia Russo

A term limit. No, I will be negotiating an employment agreement, as you would expect, for this new position with the combined company and with the board as appropriate. When, in fact, that is concluded I am sure it will be disclosed publicly. The second part of the question was?

Mark Sue - RBC Capital Markets

COO and CFO.

Patricia Russo

COO and CFO.

Mark Sue - RBC Capital Markets

For the combined entity.

Patricia Russo

Yes, I believe we put in the press release today that Mike Quigley is assuming the role of Chief Operating Officer and Jean-Pascal Beaufret is assuming the role of Chief Financial Officer for the combined company.

Mark Sue - RBC Capital Markets

Yes, and is that just for a specific timeframe, or are they also under employment negotiations?

Patricia Russo

There is no stated timeframe at this point in time, those are responsibilities we expect to carry forward. If we end up with some kind of employment agreement, we will make that known.

Mark Sue - RBC Capital Markets

Okay, well thank you and good luck, everybody.

Patricia Russo

Thank you.

Operator

Our next question comes from the line of Sandeep Malhotra with Merrill Lynch. Please go ahead.

Sandeep Malhotra - Merrill Lynch

Thank you. I wanted some clarification on the combined company's position in 3G UMTS. Could you please comment separately on the strength that Lucent and Alcatel bring to the table, and also talk about how the two platforms will be rationalized into one platform going forward?

Michael Quigley

Would you like me to take that one, Pat?

Patricia Russo

Yes, let me start and I think it will probably be a combination of both of us, and Frank is here with me as well. A couple of comments. First of all, as you all know the third generation technology platform is a spread spectrum technology. Lucent is the global leader in CDMA which is the same technology base, if you will, as 3G.

So we, Lucent, start from a place of tremendous depth and breadth around 3G technologies in general, and we have worked to leverage that with respect to technology deployment and platform deployment around UMTS or wideband CDMA.

We have announced two agreements publicly, one being 02 in the U.K. and as well, a very large contract with Cingular here in the United States for their UMTS deployment. I will let Mike comment on the positioning that Alcatel currently has, and then we will come back and let Frank and Mike comment on the work the teams have done with respect to how we see this going forward.

Michael Quigley

Well if I could perhaps start off by saying that one of the clear advantages, if you think about it, of the two companies coming together is just the magnitude of the strength we bring in the R&D. We really have now huge scalability in our R&D investment, and so we have big capacity to pump R&D into this.

Just complementing what Pat has said, on the Alcatel side, we have a very strong 2G footprint which complements what we see with Lucent, obviously, in CDMA. Let's not forget also, as we move toward UMTS wideband CDMA, the expertise that Lucent's technology brings in to CDMA can be a big asset.

We've got a lot of assets we've talked about as well in terms of software-defined radios, we've got I think over 50 networks which are 3G ready today in Alcatel. So when you add the two capacities of the two companies together, I think it is quite formidable.

Frank D'Amelio

The only thing I would add, Pat and Mike really covered most of it, just two comments here. One is the combined embedded base, from both a CDMA and GSN perspective, coupled with the progress we've been making in the UMTS really creates just a huge embedded base and ongoing opportunity for the company.

Most importantly, we will make sure we do the things we need to do to continue to satisfy and delight our customers in this area and the other areas that we do business in.

Sandeep Malhotra - Merrill Lynch

If I could just ask a follow-on question related to cost synergies. The NPV number stated is $12 billion, which is one-third of the combined market cap, $36 billion. In response to an earlier question, I think Pat mentioned that half of the cost synergies would come from head count reduction, which would imply an NPV of $6 billion from head count reduction. Whereas the actual head count reduction mentioned in the presentation that was discussed is 10%.

I am trying to reconcile the two. Should we be expecting a higher number of layoffs than 10%?

Frank D'Amelio

No, you should not be expecting a higher level of layoffs than 10%. 10% is the correct figure. The impact around synergies from head count reductions versus other aspects of the operations was given as a very round figure, that roughly half will come from head count. It will tend to be skewed a little bit more toward head count, it was just intended as a round number. The head count number that was given in terms of 10% reductions is accurate.

Sandeep Malhotra - Merrill Lynch

Thank you.

Operator

Our last question comes from the line of Paul Sagawa with Sanford Bernstein.

Please go ahead.

Paul Sagawa - Sanford Bernstein

A quick one, and then one a little more philosophical in nature. The net loss carryforwards that Lucent has -- and I think Alcatel has some too -- what are the mechanics of how those will get recognized in the combined company? Is there any change in that?

Second of all, if we think about the R&D that Mike has been talking about, and the ability to essentially afford a more comprehensive R&D program levering it against your revenue base, brings up generally speaking, just how much economies of scale there is in this business for those sorts of things.

So if you think about the major growth opportunities, IPTV, IMS, 3G, routing and optical space, what kind of market share does the company need to have in order to afford a competitive R&D program? Certainly your competitor in Canada has mentioned that they think they need to get 20% market share, important markets, in order to be viable. Is that really a fundamental driver of needing to do this deal in order to get yourselves in every major category, to that level?

Against that, how many competitors do you think, long run, can stay with a combined Alcatel/Lucent in these important technology arenas with this kind of an R&D program? I would imagine not many.

John Kritzmacher

This is John Kritzmacher, let me take the matter with regard to NOLs and then I will hand off. With regard to net operating losses, both on Alcatel's ledger as well as Lucent's, we expect that as we combine we will, as we've indicated throughout today's presentation, be more profitable. The generation of those profits will improve our opportunity to utilize those NOLs that we were carrying, in particular we carry large NOLs here in the U.S. and expect to be more profitable here in the U.S.

As we demonstrate that we can take advantage of those NOLs, we will write their value back onto our books and utilize them.

Patricia Russo

Paul, let me just make a comment on the more philosophical part of your question, and then see if Serge or Mike have anything they want to add. I think regardless of whether you come at this as, what market share do you need or what market position do you need in a particular segment, I think at the most fundamental level, this is an industry where size and scale matter. It matters increasingly when you think about the competitive nature of what is going on, the R&D intensity and the complexity of what it is that is happening with respect to networks, and the innovative necessity, if you will, to create differentiating offers.

So what I think is really exciting about this combination and really back to Mike's point in responding to the question on UMTS, in the investment capacity and the R&D capacity that this combined company has, will be unparalleled in the industry. It will give us the capability not only to have the breadth of portfolio we need to deliver end-to-end solutions, but the flexibility to continue to innovate in the arenas that are going to matter with respect to creating new differentiation.

So as we looked at this, there is no question that this is an R&D intensive industry. Competition is increasing and size and scale really matter. So that is one of the compelling aspects of this combination, and I think it will make a huge difference for us in the marketplace.

Serge Tchuruk

If I can add one word to this. To a large extent, the product portfolio of Alcatel and Lucent is sort of overlapping -- not completely, but to a large extent. Adding up to two research teams and shrinking a bit, there is a lot more R&D power, actually, for every unit of sale. That is a basic rule of achieving economies of scale in R&D, by amortizing R&D on a much broader base. That is what it is, actually.

Okay, so I think we have come to the end of this session, Pat, unless you want to say something else?

Patricia Russo

No, Serge.

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Source: Alcatel / Lucent Technologies Inc. Merger Announcement Conference Call Transcript (ALA, LU)
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