AGERE SYSTEMS INC - 10-Q Quarterly Report

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AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON MAY 8, 2003

________________________________________________________________________________

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

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FORM 10-Q

[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934

FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2003

OR

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934

FOR THE TRANSITION PERIOD FROM TO

COMMISSION FILE NUMBER 001-16397

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AGERE SYSTEMS INC.

A DELAWARE I.R.S. EMPLOYER
CORPORATION NO. 22-3746606

1110 AMERICAN PARKWAY NE, ALLENTOWN, PA 18109

Telephone number: 610-712-1000

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Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]

Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes [X] No [ ]

At April 30, 2003, 767,943,138 shares of Class A common stock and
907,994,888 shares of Class B common stock were outstanding.

________________________________________________________________________________

AGERE SYSTEMS INC.

FORM 10-Q
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2003
TABLE OF CONTENTS

1

PART I -- FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

AGERE SYSTEMS INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(DOLLARS IN MILLIONS EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)

See Notes to Condensed Consolidated Financial Statements.

2

AGERE SYSTEMS INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(DOLLARS IN MILLIONS EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)

See Notes to Condensed Consolidated Financial Statements.

3

AGERE SYSTEMS INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN MILLIONS)
(UNAUDITED)

See Notes to Condensed Consolidated Financial Statements.

4

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN MILLIONS EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)

1. BACKGROUND AND BASIS OF PRESENTATION

BACKGROUND

Agere Systems Inc. (the 'Company' or 'Agere') was incorporated in Delaware
as a wholly owned subsidiary of Lucent Technologies Inc. ('Lucent') on August 1,
2000. On February 1, 2001, Lucent transferred to Agere substantially all of the
assets and liabilities related to the Company's business (the 'Separation'). On
April 2, 2001, the Company completed the initial public offering of its Class A
common stock, while Lucent retained all of the Company's outstanding Class B
common stock. On June 1, 2002, Lucent distributed all of the Agere common stock
it then owned to its stockholders (the 'Distribution'). Prior to the
Distribution, Agere was a majority-owned subsidiary and a related party of
Lucent. Revenue from products sold to Lucent prior to the Distribution was $65
and $143 for the three and six months ended March 31, 2002, respectively, of
which $13 and $37, respectively, is recorded within income (loss) from
operations of discontinued operations.

Effective with the first quarter of fiscal 2003, the Company refined its
methodology for allocating shared information technology expenses to its
operating segments and between costs, selling, general and administrative
expenses, and research and development expenses. The Company believes that this
methodology provides a better assignment of these expenses based on additional
information about the components and underlying drivers which has been developed
since the Separation. Historical amounts for all periods presented have been
conformed to the current presentation. As a result of this change, approximately
$18 and $38 of expenses previously reflected in costs were reclassified to
operating expenses for the three and six months ended March 31, 2002,
respectively.

INTERIM FINANCIAL INFORMATION

These condensed financial statements have been prepared in accordance with
the rules of the Securities and Exchange Commission for interim financial
statements and do not include all annual disclosures required by accounting
principles generally accepted in the United States ('U.S.'). These financial
statements should be read in conjunction with the audited consolidated and
combined financial statements and notes thereto included in the Company's
Form 10-K for the fiscal year ended September 30, 2002. The condensed financial
information as of March 31, 2003 and for the three and six months ended
March 31, 2003 and 2002 is unaudited, but includes all adjustments that
management considers necessary for a fair presentation of the Company's
consolidated results of operations, financial position and cash flows. Results
for the three and six months ended March 31, 2003 are not necessarily indicative
of results to be expected for the full fiscal year 2003 or any other future
periods.

2. DISCONTINUED OPERATIONS

On August 14, 2002, the Company announced plans to exit its optoelectronic
components business. The Company had historically reported this business as part
of its Infrastructure Systems segment. The condensed consolidated financial
statements have been reclassified for all periods presented to reflect this
business as discontinued operations. The Company first reflected this business
as discontinued operations in the first quarter of fiscal 2003 when the Company
entered into an agreement to sell a substantial portion of the business and
determined it could sell the remainder of the business. The revenues, costs and
expenses directly associated with this business have been reclassified as
discontinued operations on the condensed consolidated statements of operations.
Corporate expenses such as general corporate overhead and interest have not been
allocated to discontinued operations. Revenue recorded within income (loss) from
operations of discontinued operations was $7 and $62 for the three months ended
March 31, 2003 and 2002, respectively, and $61 and $154 for the six months ended
March 31, 2003 and 2002, respectively. Income (loss) from operations of
discontinued operations before income taxes was $12 and $(269) for the three
months ended March 31, 2003 and 2002, respectively, and $19 and $(337) for the
six months ended March 31, 2003 and 2002, respectively.

5

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(DOLLARS IN MILLIONS EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)

During the three months ended March 31, 2003, the Company sold a substantial
portion of its optoelectronic components business to TriQuint Semiconductor,
Inc. ('TriQuint') for $40 in cash. This transaction included the products,
product warranty liabilities, technology and certain facilities related to this
business; and included lasers, detectors, modulators, passive components,
arrayed waveguide-based components, amplifiers, transmitters, receivers,
transceivers, transponders, and micro electro-mechanical systems. As part of the
sale, the Company's facilities in Breinigsville, Pennsylvania and Matamoros,
Mexico were transferred and approximately 340 of the Company's employees joined
TriQuint. The Company recognized a gain of $22 from the sale which is included
in gain on disposal of discontinued operations.

During the three months ended March 31, 2003, the Company sold the remainder
of its optoelectronic components business that provides cable television
transmission systems, telecom access and satellite communications components to
EMCORE Corporation ('EMCORE') for $25 in cash. The transaction included the
assets, products, product warranty liabilities, technology and intellectual
property related to this business. As part of the sale, approximately 210 of the
Company's employees joined EMCORE. The Company recognized a gain of $19 from the
sale which is included in gain on disposal of discontinued operations.

3. CUMULATIVE EFFECT OF ACCOUNTING CHANGE

Effective October 1, 2002, the Company adopted Statement of Financial
Accounting Standards ('SFAS') No. 143, 'Accounting for Asset Retirement
Obligations' ('SFAS 143'). This standard provides the financial accounting and
reporting requirements for the cost of legal obligations associated with the
retirement of tangible long-lived assets. SFAS 143 requires the Company to
record asset retirement obligations at fair value. The obligation is recorded as
a liability and the associated cost is capitalized as part of the related
long-lived asset and then depreciated over its remaining useful life. The net
assets of $2 that were capitalized upon adoption were related to the restoration
of leased facilities and the associated liability was $7. Changes in the
liability resulting from the passage of time are recognized as operating
expense. The adoption of SFAS 143 as of October 1, 2002, resulted in a
cumulative loss of $5. There were no income taxes provided due to the recording
of a full valuation allowance against U.S. net deferred tax assets. The increase
in net loss represents the depreciation and other operating expenses that would
have been recorded previously if SFAS 143 had been in effect in prior years. The
pro forma effect of retroactive application of SFAS 143 for the three and six
months ended March 31, 2002 would not change the net loss and loss per share, as
reported.

4. RESTRUCTURING AND OTHER CHARGES -- NET

The Company has implemented restructuring and consolidation actions to
improve gross profit, reduce expenses and streamline operations. These actions
include workforce reductions, rationalization and consolidation of manufacturing
capacity, and the exit of the optoelectronic components business. Charges and
credits related to continuing operations are included in restructuring and other
charges -- net, while charges and credits related to discontinued operations are
included in income (loss) from operations of discontinued operations. The
restructuring actions associated with discontinued operations will remain an
obligation of the Company and the Company will retain the associated reserve.

The Company also incurred expenses of $3 and $5 for the three and six months
ended March 31, 2002, respectively, relating to its separation from Lucent that
are classified within restructuring and other charges -- net. There were no
expenses related to the separation from Lucent in the three and six months ended
March 31, 2003.

6

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(DOLLARS IN MILLIONS EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)

THREE AND SIX MONTHS ENDED MARCH 31, 2003

The following table sets forth the Company's restructuring reserves as of
March 31, 2003 and reflects the activity affecting the reserve for the three and
six months ended March 31, 2003:

Workforce Reductions

The Company recorded restructuring charges relating to workforce reductions
of $40 and $47 for the three and six months ended March 31, 2003, respectively.
Reflected in these amounts were cash charges of $15 and $22 for the three and
six months ended March 31, 2003, respectively, principally related to a
workforce reduction of approximately 330 management employees. The remaining
non-cash charge of $25 for both periods consists of: $6 and $7 for curtailment
charges relating to the Company's qualified occupational pension plan and
postretirement medical liability, respectively, as represented employees at the
Company's Orlando manufacturing facility became eligible for retiree benefits
sooner than actuarially anticipated; and $12 for a special pension benefit to
certain U.S. employees, including represented employees covered under the terms
of a collective bargaining agreement, that will be paid from the Company's
pension assets.

The Company recorded restructuring credits of $2 and $14 for the three and
six months ended March 31, 2003, respectively, related to workforce reductions.
The credits are principally due to the reversal of charges associated with the
employees that joined TriQuint and EMCORE, of which $7, for the six months ended
March 31, 2003, is a non-cash credit due to a decrease in the special pension
benefit to be paid from the Company's pension assets.

7

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(DOLLARS IN MILLIONS EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)

As previously announced on August 14, 2002, the Company expects to reduce
its active workforce by a total of approximately 4,000 employees by the end of
December 2003 as part of its plan to exit the optoelectronic components business
and consolidate U. S. manufacturing operations into its Orlando, Florida
facility. As of March 31, 2003, all severance and special pension benefit costs
associated with completing this workforce reduction have been recognized and
approximately 1,600 employees remain to be taken off-roll.

Rationalization of Manufacturing Capacity and Other Charges

The Company recorded restructuring and related charges of $34 and $91 for
the three and six months ended March 31, 2003, respectively, relating to the
rationalization of under-utilized manufacturing facilities, the exit of the
optoelectronic components business and other restructuring-related activities.
The charges for the three months ended March 31, 2003 include $17 for asset
impairments, $9 for facility lease terminations, $5 for increased depreciation,
$2 for operating lease terminations and $1 for other related costs. In addition,
the charges for the six months ended March 31, 2003 include $23 for asset
impairments, including $11 associated with the resizing of Orlando's research
and development and manufacturing operations; $8 for facility lease
terminations, including non-cancelable leases, and facility restoration costs
associated with exiting the optoelectronics components business; $9 for
increased depreciation; $5 for contract terminations; and $12 for other related
costs. Increased depreciation was recognized due to a change in accounting
estimate as a result of shortening the estimated useful lives of certain assets
in connection with the planned closing of certain administrative facilities. The
other related costs were incurred primarily to implement the restructuring
initiatives and include costs for the relocation and training of employees and
for the relocation of equipment.

The Company recorded restructuring credits of $14 and $41 for the three and
six months ended March 31, 2003, respectively. The credits for the three months
ended March 31, 2003 consist of $4 for the reversal of the facility lease
termination reserve associated with the facility in Mexico that was transferred
to TriQuint, $2 for asset impairment adjustments due to realizing more proceeds
than expected from asset dispositions, and $8 principally for the reversal of
reserves associated with prior actions deemed no longer needed, including $6 for
operating lease terminations and $2 related to asset decommissioning. The six
months ended March 31, 2003 also includes credits of $10 for asset impairment
adjustments due to realizing more proceeds than expected from asset dispositions
and $17 for a reversal of reserves associated with the resizing of the research
and development and manufacturing operations in Orlando, including $13 for
operating lease terminations and $4 related to asset decommissioning.

Restructuring Reserve Balances as of March 31, 2003

The Company anticipates that principally all of the $24 restructuring
reserve as of March 31, 2003, relating to workforce reductions, will be paid by
the end of calendar year 2003. The Company also anticipates that the
restructuring reserve of $71 relating to the rationalization of manufacturing
capacity and other charges as of March 31, 2003 will be paid as follows:
approximately two-thirds of the contract terminations of $23 will be paid by
September 30, 2003 with the remainder being paid $1 per quarter thereafter,
facility termination fees and non-cancelable lease obligations of $28 will be
paid over the respective lease terms through 2010 and the majority of the
facility restoration costs and other costs of $20 will be paid by June 30, 2004.
The Company expects to fund these cash outlays with cash on hand.

8

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(DOLLARS IN MILLIONS EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)

THREE AND SIX MONTHS ENDED MARCH 31, 2002

The following table sets forth the Company's restructuring reserves as of
March 31, 2002 and reflects the activity affecting the reserve for the three and
six months ended March 31, 2002:

Workforce Reductions

The Company recorded restructuring charges relating to workforce reductions
of $16 and $56 for the three and six months ended March 31, 2002, respectively.
These charges affected both management and represented employees within the
Company's business operations groups, sales organizations and corporate support
functions located in New Jersey, Pennsylvania and Florida. Of the total
workforce reduction charges, $10 and $23 for the three and six months ended
March 31, 2002, respectively, represents non-cash charges for a special pension
benefit to certain U. S. employees that were funded through pension assets.

In the first half of fiscal 2002, the Company recorded a $20 reversal of the
restructuring reserve associated with workforce reductions, resulting from
severance and benefit cost termination estimates that exceeded amounts paid
during the second half of calendar year 2001. The original reserve included an
estimate for occupational employees that was based on the average rate of pay
and years of service of the occupational employee pool at risk. The Company's
collective bargaining agreements allowed for a period when employees at risk
could opt for positions filled by employees with less seniority. When that
period ended, a series of personnel moves followed that ultimately resulted in
lower payments than originally expected. This was due principally to the
termination of occupational employees with fewer years of service and fewer
weeks of severance entitlement. These personnel moves were substantially

9

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(DOLLARS IN MILLIONS EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)

finished at the end of calendar 2001. There were no reversals associated with
workforce reductions for the three months ended March 31, 2002.

Rationalization of Manufacturing Capacity and Other Charges

The Company recorded restructuring charges of $40 and $121 for the three and
six months ended March 31, 2002, respectively, relating to the rationalization
of under-utilized manufacturing facilities and other activities. The charges
recorded for the second quarter of fiscal 2002 included $36 for asset
impairments and $4 for other related costs. The charges recognized for the first
half of fiscal 2002 included $69 related to asset impairments, $40 for facility
closings, and $12 of other related costs primarily for contract terminations.

The asset impairment charge of $36 for the second quarter of fiscal 2002
resulted principally from the impairment of assets under construction that had
not been placed into service, and the asset impairment charge of $69 for the
first half of fiscal 2002 also includes the impairment of property, plant and
equipment associated with the consolidation of manufacturing and other corporate
facilities. These non-cash impairment charges represent the write-down to fair
value less costs to sell of property, plant and equipment that were disposed of,
held for sale, or removed from operations.

The facility closing charge of $40 for the first half of fiscal 2002
consists principally of a non-cash charge of $35 for the realization of the
cumulative translation adjustment resulting from the Company's decision to
substantially liquidate its investment in the legal entity associated with its
Madrid, Spain manufacturing operations. The $5 balance of the charge related to
the facility closings is primarily for lease terminations and non-cancelable
leases and related costs.

The Company recorded restructuring credits of $35 and $66 for the three and
six months ended March 31, 2002, respectively. The $35 reversal during the
second quarter of fiscal 2002 resulted from adjustments to estimates of $27 for
asset impairments, $2 for facility lease terminations and $6 for contract
terminations. The asset impairment adjustments were due principally to realizing
more proceeds than expected from asset dispositions and from assets that were
placed back into service. The restructuring credits for the first half of fiscal
2002 also include a $25 reversal due to the Company receiving more proceeds from
the sale of the assets associated with the Company's Madrid, Spain manufacturing
operations than originally estimated and a $6 reversal of a restructuring
reserve deemed no longer necessary.

5. DEBT

ACCOUNTS RECEIVABLE SECURITIZATION

Agere Systems Inc. and certain of its subsidiaries amended the accounts
receivable securitization agreement on November 12, 2002. Agere Systems Inc. and
certain of its subsidiaries irrevocably transfer accounts receivable on a daily
basis to a wholly-owned, fully consolidated, bankruptcy-remote subsidiary, Agere
Systems Receivables Funding LLC ('ASRF'). ASRF has entered into a loan agreement
with certain financial institutions, pursuant to which the financial
institutions agreed to make loans to ASRF secured by the accounts receivable.
The financial institutions have commitments under the loan agreement of up to
$200; however the amount the Company can actually borrow at any time depends on
the amount and nature of the accounts receivable that the Company has
transferred to ASRF. The loan agreement expires on November 11, 2003.

As of March 31, 2003, ASRF had borrowings of $115 outstanding under this
agreement. The majority of the Company's accounts receivable are required to be
pledged as security for the outstanding loans even though some of those
receivables may not qualify for borrowings. As of March 31, 2003, $194 of gross
receivables was pledged as security for the outstanding loans. The Company pays
interest on amounts borrowed under the agreement based on one-month LIBOR. The
weighted average annual interest rate on amounts borrowed as of March 31, 2003
was 1.4%. In addition,

10

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(DOLLARS IN MILLIONS EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)

the Company pays an annual commitment fee, which varies depending on its credit
rating, on the $200 total loan commitment. As of March 31, 2003, the commitment
fee was 1.5% per annum. If the Company's credit rating were to decline one or
two levels, the commitment fee would increase to 2% or 3% per annum,
respectively.

ASRF is a separate legal entity with its own separate creditors. Upon
liquidation of ASRF, its assets will be applied to satisfy the claims of its
creditors prior to any value in ASRF becoming available to the Company. The
business of ASRF is limited to the acquisition of receivables from Agere Systems
Inc. and certain of its subsidiaries and related activities.

COLLATERAL INSTALLMENT LOAN

On March 28, 2003, the Company borrowed $20 under an installment note with a
fixed interest rate of 9.45% that is secured by certain Company equipment. The
Company will make 24 monthly installments beginning on May 1, 2003 with a $7
balloon payment due at the end of this period. Assuming certain conditions are
met, the Company has the ability to refinance the balloon payment for an
additional twelve month period. The current portion of this loan is $7 as of
March 31, 2003.

6. SUPPLEMENTARY FINANCIAL INFORMATION

STATEMENT OF OPERATIONS INFORMATION

The Company has recognized increased depreciation due to a change in
accounting estimate as a result of shortening the estimated useful lives of
certain assets in connection with the Company's restructuring activities. The
Company recorded increased depreciation of $29 and $55 for the three and six
months ended March 31, 2003, respectively. Of these amounts $24 and $41 was
recorded in costs and $5 and $14 was recorded in restructuring and other
charges -- net for the three and six months ended March 31, 2003, respectively.
The Company also recorded increased depreciation of $9 for both the three and
six months ended March 31, 2002, of which $8 is recorded in costs and $1 is
recorded in restructuring and other charges -- net. This increased depreciation
is reflected in net loss and resulted in a $0.02 and $0.03 per share increase in
the net loss for the three and six months ended March 31, 2003, respectively,
and a $0.01 per share increase in the net loss for both the three and six months
ended March 31, 2002.

During the three months ended March 31, 2002, the Company realized a $243
gain on the sale of its field-programmable gate array business, which is
reflected in (gain) loss on sale of operating assets -- net.

For the three months ended March 31, 2003, the Company recorded a provision
for income taxes of $30 on a pre-tax loss from continuing operations of $148,
yielding an effective tax rate of (20.4)% due primarily to the provision for
taxes in foreign jurisdictions. No benefit was recognized for U.S. tax purposes
as a full valuation allowance of approximately $72 was recorded against U.S. net
deferred tax assets for the three months ended March 31, 2003. For the three
months ended March 31, 2002, the Company recorded a provision for income taxes
of $20 on pre-tax income from continuing operations of $70, yielding an
effective tax rate of 28.6% due primarily to the provision for taxes in foreign
jurisdictions.

For the six months ended March 31, 2003, the Company recorded a provision
for income taxes of $54 on a pre-tax loss from continuing operations of $272,
yielding an effective tax rate of (20.0)% due primarily to the provision for
taxes in foreign jurisdictions. No benefit was recognized for U.S. tax purposes
as a full valuation allowance of approximately $126 was recorded against U.S.
net deferred tax assets for the six months ended March 31, 2003. For the six
months ended March 31, 2002, the Company recorded a provision for income taxes
of $40 on a pre-tax loss from continuing operations of $217, yielding an
effective tax rate of (18.4)% due primarily to the provision for taxes in
foreign jurisdictions. No benefit was recognized for U.S. tax purposes as a full
valuation allowance of approximately $77 was recorded against U.S. net deferred
tax assets for the six months ended March 31, 2002.

11

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(DOLLARS IN MILLIONS EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)

BALANCE SHEET INFORMATION

7. INVESTMENT IN SILICON MANUFACTURING PARTNERS

In December 1997, the Company entered into a joint venture, called Silicon
Manufacturing Partners Pte Ltd. ('SMP'), with Chartered Semiconductor
Manufacturing Ltd. ('Chartered Semiconductor'), a leading manufacturing foundry
for integrated circuits, to operate a 54,000 square foot integrated circuit
manufacturing facility in Singapore. The Company owns a 51% equity interest in
this joint venture, and Chartered Semiconductor owns the remaining 49% equity
interest. The Company's 51% interest in SMP is accounted for under the equity
method due to Chartered Semiconductor's participatory rights under the joint
venture agreement. Under the joint venture agreement, each partner is entitled
to the margins from sales to customers directed to SMP by that partner, after
deducting their respective share of the overhead costs of SMP. Accordingly,
SMP's net income (loss) is not expected to be shared in the same ratio as equity
ownership. The Company's investment in SMP was $193 and $179 as of March 31,
2003 and September 30, 2002, respectively, and is recorded in other assets.

For the three and six months ended March 31, 2003 the Company recognized
equity earnings, which is recorded in other income -- net, of $10 and $12 from
SMP, respectively, compared to $5 and $26, respectively, in the corresponding
prior year periods. SMP reported net income of $11 and $2 for the three and six
months ended March 31, 2003, respectively, versus a net loss of $4 and net
income of $26, respectively, in the corresponding prior year periods. As of
March 31, 2003, SMP reported total assets of $534 and total liabilities of $304
compared to total assets of $589 and total liabilities of $367 as of September
30, 2002.

8. COMPREHENSIVE INCOME (LOSS)

Total comprehensive loss represents net loss plus the results of certain
equity changes not reflected in the condensed consolidated statements of
operations. The components of other comprehensive income (loss) are shown below.

The foreign currency translation adjustments are not adjusted for income
taxes because they relate to indefinite investments in non-U.S. subsidiaries.
The unrealized gain on cash flow hedges is related to hedging activities by SMP
and there are no income taxes provided as they relate to an equity method
investee. The minimum pension liability adjustment is related to the items
discussed in Note 14 and there are no income taxes provided due to the recording
of a full valuation allowance against U.S. net

12

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(DOLLARS IN MILLIONS EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)

deferred tax assets. The reclassification adjustment for the six months ended
March 31, 2002 is comprised of a reversal of a $30 unrealized gain due to the
realization of a gain from the sale of an available-for-sale investment and a
$35 unrealized foreign currency translation loss due to the realization of the
cumulative translation adjustment resulting from the Company's decision to
substantially liquidate its investment in the legal entity associated with its
Madrid, Spain manufacturing operations.

9. INTANGIBLE ASSETS

Effective October 1, 2002, the Company adopted SFAS No. 142, 'Goodwill and
Other Intangible Assets' ('SFAS 142'). SFAS 142 provides guidance on the
financial accounting and reporting for goodwill and other acquired intangible
assets. Under SFAS 142, goodwill and indefinite lived intangible assets are no
longer amortized. Intangible assets with finite lives will continue to be
amortized over their useful lives, which are no longer limited to a maximum of
forty years. SFAS 142 also requires that goodwill be tested for impairment at
least annually. The adoption of SFAS 142 did not result in the recording of an
impairment charge or any adjustments to previously recorded amounts. There were
also no changes to the classification and useful lives of previously acquired
goodwill and other intangible assets. The following table reflects intangible
assets by major class and the related accumulated amortization:

Intangible asset amortization expense for the three and six months ended
March 31, 2003 was $3 and $5, respectively. Intangible asset amortization
expense for the remainder of fiscal 2003 is estimated to be $4. The amortization
expense for the succeeding two fiscal years is estimated to be $6 and $3,
respectively.

The following table reflects the impact of SFAS 142 on net loss and net loss
per share had SFAS 142 become effective October 1, 2001.

13

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(DOLLARS IN MILLIONS EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)

10. STOCK COMPENSATION PLANS

In December 2002, the Financial Accounting Standards Board ('FASB') issued
SFAS No. 148 'Accounting for Stock-Based Compensation -- Transition and
Disclosure,' ('SFAS 148') which amends the transition and disclosure provisions
of SFAS No. 123 'Accounting for Stock-Based Compensation' ('SFAS 123').
SFAS 148 provides alternative methods of transition for a voluntary change to
the fair value based method of accounting for stock-based employee compensation
and amends the disclosure requirements of SFAS 123 to require more prominent and
more frequent disclosures in financial statements about the effects of
stock-based compensation. The transition provisions are effective for fiscal
years ending after December 15, 2002. The disclosure provisions are effective
for interim periods beginning after December 15, 2002, with early application
encouraged. The Company adopted the interim period disclosure provisions of SFAS
148 beginning with the first quarter of fiscal 2003 and these provisions had no
effect on the Company's financial condition or results of operations. The
Company applies Accounting Principles Board Opinion No. 25, 'Accounting for
Stock Issued to Employees' ('APB 25') and related interpretations in accounting
for its plans, as permitted under SFAS 123. Compensation expense recorded under
APB 25, which uses the intrinsic value method, was $0 and $1 for the three
months ended March 31, 2003 and 2002, respectively, and $1 and $2 for the six
months ended March 31, 2003 and 2002, respectively.

The following table illustrates the effect on net loss and net loss per
share if Agere had applied the fair value recognition provisions of
SFAS No. 123 to its stock option plans and employee stock purchase plan (the
'ESPP'):

- ---------

(1) The pro forma amounts shown above include the fair values of
all Agere stock options including, for the three and six
months ended March 31, 2002, Lucent options held by Agere
employees that were converted to Agere options at the
Distribution date. Also included is the fair value of the
option embedded in Agere shares under the ESPP. The pro
forma impact of applying SFAS No. 123 in the second quarter
of fiscal 2003 and 2002 does not necessarily represent the
pro forma impact in future quarters or years.

Stock options outstanding as of March 31, 2003 were 210,265,357. The Company
granted 65,000,250 stock options from its stock option plans during the six
months ended March 31, 2003. These options were primarily broad based grants
that were part of its annual grant program.

As of March 31, 2003, 77,950,184 shares remained available for purchase
under the ESPP. For the six months ended March 31, 2003, 2,496,764 shares were
purchased under the ESPP.

11. NET LOSS PER COMMON SHARE

Basic and diluted net loss per common share is calculated by dividing net
loss by the weighted average number of common shares outstanding during the
period. As a result of the loss from continuing operations reported for the
three and six months ended March 31, 2003, 210,265,357

14

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(DOLLARS IN MILLIONS EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)

outstanding stock options and 123,960,695 potential common shares related to
convertible notes have been excluded from the diluted per share calculations
because their effect would be anti-dilutive. For the three months ended March
31, 2002, 147,076 potential common shares have been included in the diluted per
share calculations. As a result of the loss from continuing operations reported
for the six months ended March 31, 2002, 132,128,705 outstanding stock options
and 12,500 potential common shares related to other stock units have been
excluded from the diluted per share calculations because their effect would be
anti-dilutive.

12. OPERATING SEGMENTS

The Company's business operations are divided into two market-focused
groups, Client Systems and Infrastructure Systems, that target the consumer
communications and network equipment markets respectively. These two groups
comprise the Company's reportable operating segments. The segments each include
revenue from the licensing of intellectual property assigned to that segment.
There were no intersegment sales.

The Client Systems segment provides integrated circuit solutions for a
variety of end-user applications such as hard disk drives and modems for
computers, Internet-enabled cellular terminals and wireless local area
networking.

The Infrastructure Systems segment provides integrated circuit solutions to
makers of high-speed communications systems. Prior to the reflection of the
Company's optoelectronic components business as discontinued operations, as
discussed in Note 2, the Infrastructure Systems segment also included the
results of operations from this business.

Each segment is managed separately. Disclosure of segment information is on
the same basis used internally for evaluating segment performance and allocating
resources. Performance measurement and resource allocation for the segments are
based on many factors. The primary financial measure used is operating income
(loss), exclusive of amortization of goodwill and other acquired intangibles,
net restructuring and other charges and net gain or loss on the sale of
operating assets.

The Company does not identify or allocate assets by operating segment. In
addition, the Company does not allocate interest income or expense, other income
or expense, or income taxes to the segments. Management does not evaluate
segments based on these criteria. The Company has centralized corporate
functions and uses shared service arrangements to realize economies of scale and
efficient use of resources. The costs of shared services, and other corporate
center operations managed on a common basis, are allocated to the segments based
on usage or other factors based on the nature of the activity.

At the beginning of each fiscal year, the Company updates the allocation of
its shared integrated circuit fabrication costs based on the demand forecasts by
month for the fiscal year from the two operating segments. This essentially
creates a take-or-pay relationship between the Company's manufacturing
facilities and the operating segments. Effective October 1, 2002, with the
update of the demand forecast for fiscal 2003, the costs allocated to the Client
segment have increased by approximately $20 and $45 for the three and six months
ended March 31, 2003, respectively, when compared to the corresponding prior
year period. Accordingly, the costs allocated to the Infrastructure Systems
segment decreased by the same amount. This change in allocation impacts gross
margins at the segment level, but has no effect on the overall gross margin for
the Company.

The Company generates revenues from the sale of one product, integrated
circuits. Integrated circuits are made using semiconductor wafers imprinted with
a network of electronic components. They are designed to perform various
functions such as processing electronic signals, controlling electronic system
functions and processing and storing data.

15

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(DOLLARS IN MILLIONS EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)

REPORTABLE SEGMENTS

RECONCILING ITEMS

A reconciliation of the totals reported for the operating segments to the
significant line items in the condensed consolidated statements of operations is
shown below.

13. FINANCIAL GUARANTEES

In November 2002, the FASB issued Interpretation No. 45 'Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others' ('FIN 45'). FIN 45 is principally a
clarification and elaboration of SFAS No. 5 'Accounting for Contingencies,'
under which companies were required to recognize a liability when it became
likely that the company would have to honor its guarantee. FIN 45 prescribes the
disclosures required by a guarantor about its obligations under certain
guarantees it has issued, including loan guarantees and standby letters of
credit. The disclosure requirements in FIN 45 are effective for annual and
interim periods ending after December 15, 2002. It also requires a guarantor to
recognize a liability, at the inception of a guarantee, for the fair value of
the obligations it has assumed, even if it is not probable that payments will be
required. The initial recognition and measurement provisions of FIN 45 are
required only on a prospective basis for guarantees issued or modified after
December 31, 2002. The Company adopted FIN 45 effective with the first quarter
of fiscal 2003 with no material impact on its financial condition or results of
operations. Set forth below is a discussion of the Company's guarantees as of
March 31, 2003.

A subsidiary of Agere Systems Inc. has guaranteed the payment of $9 of debt
and interest incurred by SMP. As of March 31, 2003, no liability is recorded
since the Company believes it is unlikely that the subsidiary would be required
to make any payments associated with this guarantee.

16

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(DOLLARS IN MILLIONS EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)

Two real estate leases were assigned in connection with the sale of the
Company's wireless local area networking equipment business. The Company remains
secondarily liable for the remaining lease payments in the event of default. The
maximum potential amount of future payments that the Company could be liable for
is $6. As of March 31, 2003, no liability is recorded since the Company believes
it is unlikely that it would be required to make any payments related to these
obligations.

Agere Systems Inc. includes indemnification clauses in its standard terms
and conditions for product sales agreements, which indemnify its customers from
third party intellectual property infringement litigation. Also, the Company's
installment note contains an indemnification clause in which Agere provides
indemnification against any claims, liabilities, losses and costs associated
with the collateral named in the agreement. There are no liabilities recorded as
of March 31, 2003 for indemnification clauses.

The Company's policy is to record a liability, which is reflected within
other current liabilities, for known or potential warranty claims based on
historical experience. The tables below present a reconciliation of the changes
in the Company's aggregate product warranty liability for continuing operations
for the three and six months ended March 31, 2003.

14. BENEFIT OBLIGATIONS

On March 14, 2003, the Company voluntarily contributed 18,750,000 shares of
Agere Class A common stock to the qualified occupational pension plan. The value
of the stock at the time of the contribution was $30. This contribution,
combined with a remeasurement of the qualified occupational pension plan as a
result of the curtailment discussed in Note 4, led to a $20 reduction of the
minimum pension liability from $170 as of September 30, 2002 to $150 as of March
31, 2003.

15. COMMITMENTS AND CONTINGENCIES

In the normal course of business, the Company is involved in proceedings,
lawsuits and other claims, including proceedings under laws and government
regulations related to environmental, tax and other matters. The semiconductor
industry is characterized by substantial litigation concerning patents and other
intellectual property rights. From time to time, the Company may be party to
various inquiries or claims in connection with these rights. In addition, from
time to time the Company is involved in legal proceedings arising in the
ordinary course of business, including unfair labor charges filed by its unions
with the National Labor Relations Board, claims before the U.S. Equal Employment
Opportunity Commission and other employee grievances. These matters are subject
to many uncertainties, and outcomes are not predictable with assurance.
Consequently, the ultimate aggregate amount of monetary liability or financial
impact with respect to these matters as of March 31, 2003

17

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(DOLLARS IN MILLIONS EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)

cannot be ascertained. While these matters could affect the operating results of
any one quarter when resolved in future periods and while there can be no
assurance with respect thereto, management believes that after final
disposition, any monetary liability or financial impact to the Company beyond
that provided for as of March 31, 2003, would not be material to the annual
consolidated financial statements.

LEGAL PROCEEDINGS

On October 17, 2002, the Company filed a patent infringement lawsuit against
Intersil Corporation ('Intersil') in the United States District Court in
Delaware. The Company alleged that Intersil had infringed six of the Company's
patents related to integrated circuits for wireless networking using the IEEE
802.11 standard and is seeking monetary damages for Intersil's infringement of
these patents and an injunction prohibiting Intersil from using the patents in
the future. On November 6, 2002, Intersil filed a counterclaim in this matter,
alleging that ten patents of Intersil are infringed by unspecified Agere
products. Two of the patents relate to system-level circuits, and eight patents
relate to semiconductor processing. The complaint seeks an injunction and
damages. The Company believes that Intersil's claims are without merit.

On October 30, 2002, Choice-Intersil Microsystems, Inc. ('Choice-Intersil'),
filed a lawsuit against the Company in the United States District Court for the
Eastern District of Pennsylvania. The amended complaint alleges misappropriation
of trade secrets and copyrights that were jointly developed and jointly owned by
Digital Ocean, Inc. (which, following several acquisitions and corporate
reorganizations, is now Choice-Intersil) and Lucent. The trade secrets and
copyrights relate to media access controller technology for wireless local area
networks. The complaint seeks an injunction and damages. The Company believes
that Choice-Intersil's claims are without merit.

On November 19, 2002, the Company filed a lawsuit against Choice-Intersil,
Intersil and Intersil Americas Inc. in state court in Delaware. The Company
alleged, among other things, misappropriation of trade secrets and breach of
contract relating to the trade secrets that were jointly developed and
jointly-owned by Digital Ocean, Inc. and Lucent. The Company is seeking an
injunction against further use and disclosure of the trade secrets and damages
for past disclosure and misuse.

The Company intends to vigorously defend itself against the claims of the
Intersil parties.

ENVIRONMENTAL, HEALTH AND SAFETY

The Company is subject to a wide range of U.S. and non-U.S. governmental
requirements relating to employee safety and health, and to the handling and
emission into the environment of various substances used in its operations. The
Company also is subject to environmental laws, including the Comprehensive
Environmental Response, Compensation and Liability Act, also known as Superfund,
that require the cleanup of soil and groundwater contamination at sites
currently or formerly owned or operated by the Company, or at sites where the
Company may have sent waste for disposal. These laws often require parties to
fund remedial action at sites regardless of fault. Agere has responsibility for
remediation costs associated with five Superfund sites, two facilities formerly
owned by Lucent and one current manufacturing facility.

It is often difficult to estimate the future impact of environmental
matters, including potential liabilities. The Company has established financial
reserves to cover environmental liabilities where they are probable and
reasonably estimable. This practice is followed whether the claims are asserted
or unasserted. Management expects that the amounts reserved will be paid out
over the period of remediation for the applicable site, which typically ranges
from five to thirty years. Reserves for estimated losses from environmental
remediation are, depending upon the site, based primarily upon internal or third
party environmental studies, estimates as to the number, participation level and
financial viability of all potentially responsible parties, the extent of the
contamination and the nature of

18

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(DOLLARS IN MILLIONS EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)

required remedial actions. Accruals are adjusted as further information develops
or circumstances change. The amounts provided for in the condensed consolidated
financial statements for environmental reserves are the gross undiscounted
amount of such reserves, without deductions for insurance or third party
indemnity claims. Although the Company believes that its reserves are adequate,
including those covering the Company's potential liabilities at Superfund sites,
there can be no assurance that expenditures which will be required relating to
remedial actions and compliance with applicable environmental laws will not
exceed the amounts reflected in these reserves or will not have a material
adverse impact on the Company's financial condition, results of operations or
cash flows. Any possible loss or range of loss that may be incurred in excess of
that provided for as of March 31, 2003, cannot be estimated.

19

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

The following discussion of our financial condition and results of
operations should be read in conjunction with our unaudited financial statements
for the three and six months ended March 31, 2003 and 2002 and the notes
thereto. This discussion contains forward-looking statements. Please see
'Forward-Looking Statements' and 'Factors Affecting Our Future Performance' for
a discussion of the uncertainties, risks and assumptions associated with these
statements.

OVERVIEW

We provide advanced integrated circuit solutions for wireless data,
high-density storage and multi-service networking applications. These solutions
form the building blocks for a broad range of communications and computing
applications. Integrated circuits are made using semiconductor wafers imprinted
with a network of electronic components. They are designed to perform various
functions such as processing electronic signals, controlling electronic system
functions and processing and storing data.

Our business operations are divided into two market-focused groups, Client
Systems and Infrastructure Systems, that target the consumer communications and
network equipment markets respectively. Each of these two groups is a reportable
operating segment. The segments each include revenue from the licensing of
intellectual property assigned to that segment. The Client Systems segment
provides integrated circuit solutions for a variety of end-user applications
such as hard disk drives and modems for computers, Internet-enabled cellular
terminals and wireless local area networking. The Infrastructure Systems segment
provides integrated circuit solutions to makers of high-speed communications
systems. The Infrastructure Systems segment also provided optoelectronic
components, however, we have sold these operations and have reflected them as
discontinued operations. See 'Sale of Optoelectronic Components Business' for
additional details.

Effective with the first quarter of fiscal 2003, we refined our methodology
for allocating shared information technology expenses to our operating segments
and between costs, selling, general and administrative expenses, and research
and development expenses. We believe that this methodology provides a better
assignment of these expenses based on additional information about the
components and underlying drivers which has been developed since our separation
from Lucent Technologies Inc. in fiscal 2001. Historical amounts for all periods
presented have been conformed to the current presentation. As a result of this
change, approximately $18 million and $38 million of expenses previously
reflected in costs were reclassified to operating expenses for the three and six
months ended March 31, 2002, respectively.

SEPARATION FROM LUCENT

We were incorporated under the laws of the State of Delaware on August 1,
2000, as a wholly owned subsidiary of Lucent. On February 1, 2001, Lucent
transferred to us the assets and liabilities related to our business, other than
pension and postretirement assets and liabilities. In April 2001, we completed
our initial public offering. On June 1, 2002, Lucent completed our spin-off by
distributing all of the Agere common stock it then owned to its stockholders.
Also in June 2002, Lucent transferred to us the pension and postretirement
assets and liabilities related to our employees based on then available census
data. This census data has recently been finalized and our pension plans will be
receiving a final transfer from the Lucent plans in the quarter ending June 30,
2003. Prior to the completion of the spin-off, we were a majority-owned
subsidiary and a related party of Lucent. Revenue from products sold to Lucent
prior to the spin-off was $65 million and $143 million for the three and six
months ended March 31, 2002, respectively, of which $13 million and $37 million,
respectively, is recorded within income (loss) from operations of discontinued
operations.

SALE OF OPTOELECTRONIC COMPONENTS BUSINESS

During the three months ended March 31, 2003, we sold a substantial portion
of our optoelectronic components business to TriQuint Semiconductor, Inc. for
$40 million in cash. The transaction included the products, product warranty
liabilities, technology and certain facilities related to this business; and

20

includes lasers, detectors, modulators, passive components, arrayed
waveguide-based components, amplifiers, transmitters, receivers, transceivers,
transponders, and micro electro-mechanical systems.

During the three months ended March 31, 2003, we also sold the remainder of
our optoelectronic components business that provides cable television
transmission systems, telecom access and satellite communications components to
EMCORE Corporation for $25 million in cash. The transaction included the assets,
products, product warranty liabilities, technology and intellectual property
related to this business.

Our exit from the optoelectronic components business is complete as a result
of these two sales. The condensed consolidated financial statements have been
reclassified for all periods presented to reflect the optoelectronic components
business as discontinued operations. See Note 2 to our financial statements in
Item 1 for additional details.

RESTRUCTURING ACTIVITIES

We have implemented restructuring and consolidation actions to improve gross
profit, reduce expenses and streamline operations. These actions include a
workforce reduction, rationalization and consolidation of manufacturing
capacity, and the exit of our optoelectronic components business. We recorded
net restructuring and related charges for continuing operations of $68 million
and $93 million for the three and six months ended March 31, 2003, respectively,
which are classified within restructuring and other charges -- net. In addition,
within gross margin we recorded $29 million and $54 million of restructuring
related costs during the three and six months ended March 31, 2003,
respectively, of which $24 million and $41 million, respectively, resulted from
increased depreciation. We recorded net restructuring and related charges for
continuing operations of $62 million for the six months ended March 31, 2002,
which are classified within restructuring and other charges -- net. We recorded
no net restructuring and related charges for continuing operations in the three
months ended March 31, 2002. In addition, within gross margin we recorded
approximately $9 million and $10 million of restructuring related costs during
the three and six months ended March 31, 2002, respectively, of which $8 million
resulted from increased depreciation in both periods. The increased depreciation
in all periods is due to the shortening of estimated useful lives of certain
assets in connection with our restructuring actions. For additional details
regarding our restructuring activities, see Note 4 to our financial statements
in Item 1.

The exit from our optoelectronic components business completes a major
portion of our previously announced corporate restructuring. We are still in the
process of consolidating our integrated circuit manufacturing capabilities as
previously planned. To complete and implement our remaining restructuring and
consolidation actions, we estimate we will incur approximately $155 million in
additional charges, of which approximately $105 million will be cash-related and
approximately $50 million will be non-cash related.

RESULTS OF OPERATIONS

THREE MONTHS ENDED MARCH 31, 2003 COMPARED TO THE THREE MONTHS ENDED MARCH 31,
2002

The following table shows the change in revenue, both in dollars and in
percentage terms by segment:

Revenue. Revenue decreased 9% or $46 million, for the three months ended
March 31, 2003, as compared to the same quarter in 2002. The decrease of $9
million within the Client segment was driven

21

primarily by the absence of $21 million in revenues from our wireless local area
network equipment business that was sold in fiscal 2002, partially offset by a
$12 million increase in revenues derived from the licensing of intellectual
property. We also saw strength in the sales of General Packet Radio Service, or
GPRS, solutions used in mobile terminal devices, but experienced pricing
pressures related to wireless local area networking solutions.

The majority of the decrease of $37 million within the Infrastructure
segment was due to the absence of $19 million in revenues from our analog line
card and field programmable gate array businesses which were sold in fiscal
2002. The remaining decrease was caused by decreased volume, which resulted from
lower demand from telecommunications equipment manufacturers as their customers,
communication service providers, reduced capital expenditures.

Gross margin. Gross margin increased 5.5 percentage points to 26.4% for the
three months ended March 31, 2003 from 20.9% for the three months ended March
31, 2002. Gross margin for the Client segment decreased to 14.9% in the current
quarter from 27.1% in the prior year quarter. Gross margin for the
Infrastructure segment increased to 55.1% in the current quarter from 8.5% in
the prior year quarter. The changes in margin on a segment basis were caused in
part by a change in the allocation of certain shared manufacturing costs. At the
beginning of each fiscal year, we update the allocation of our shared integrated
circuit fabrication costs based on the demand forecasts by month for the fiscal
year from our two operating segments. This essentially creates a take-or-pay
relationship between our manufacturing facilities and the operating segments. As
a result, the dramatic decline in the telecommunications markets in fiscal 2002
negatively impacted Infrastructure margins due to un-recovered costs, as sales
volumes were less than we had anticipated. With the update of our demand
forecast for fiscal 2003, effective October 1, 2002, the costs allocated to our
Client segment for the three months ended March 31, 2003 have increased by
approximately $20 million when compared to the prior year quarter. Accordingly,
the costs allocated to the Infrastructure segment decreased by the same amount.
This change in allocation is partly responsible for the decrease in Client
margin and the increase in Infrastructure margin. However, this change in
allocation has no effect on our total gross margin.

In addition to the change in allocation as noted above, the Client segment
margins were also negatively impacted by a $25 million charge taken during the
three months ended March 31, 2003 for restructuring related costs, as well as
the loss of gross margin from our wireless local area network equipment business
which was sold in fiscal 2002. These decreases to margin were partially offset
by improved expense management related to the actions taken under our
restructuring and cost saving initiatives and a $12 million increase in gross
margin derived from the licensing of intellectual property. In addition to the
change in allocation as noted above, the Infrastructure segment margins were
also positively impacted by improved expense management related to the actions
taken under our restructuring and cost saving initiatives and $6 million of
lower inventory provisions in the current quarter.

Selling, general and administrative. Selling, general and administrative
expenses decreased 15% or $14 million, from $92 million in the three months
ended March 31, 2002 to $78 million in the three months ended March 31, 2003.
The decrease was primarily driven by reduced salary, benefit and other
expenditures as a result of our restructuring and cost saving initiatives and
the absence of expenditures related to our analog line card, field programmable
gate array and wireless local area network equipment businesses which were sold
in fiscal 2002. In addition, bad debt expenditures decreased by $7 million while
expenses related to our annual meeting increased by $8 million when compared to
the prior year quarter.

Research and development. Research and development expenses decreased 29% or
$48 million, from $164 million in the three months ended March 31, 2002 to $116
million in the three months ended March 31, 2003. The majority of the decrease
was due to reduced expenditures as we focused our product development efforts
and realized savings from our restructuring and cost saving initiatives.
Additional reductions occurred due to the absence of expenses from the three
businesses that we sold in fiscal 2002.

Amortization of goodwill and other acquired intangibles. Amortization
expense decreased 67% or $6 million from $9 million for the three months ended
March 31, 2002 to $3 million for the three months ended March 31, 2003. The
decrease is due to the absence of amortization of goodwill in the three

22

months ended March 31, 2003. Effective October 1, 2002, we adopted Statement
142, 'Goodwill and Other Intangible Assets' and are no longer permitted to
amortize goodwill. Acquired intangible assets with finite lives are still
amortized.

Restructuring and other charges -- net. Net restructuring and other charges
increased $65 million to $68 million for the three months ended March 31, 2003
from $3 million for the three months ended March 31, 2002. See 'Restructuring
Activities' for additional details.

Operating income (loss). We reported an operating loss of $150 million for
the three months ended March 31, 2003, compared with operating income of $80
million for the three months ended March 31, 2002. The deterioration in
operating income (loss) is primarily attributable to a $243 million gain on the
sale of our field-programmable gate array business in the prior year quarter and
increased restructuring and other charges in the current year quarter. These
amounts more than offset improvements realized as a result of increased expense
reductions and higher gross margin. Although performance measurement and
resource allocation for the reportable segments are based on many factors, the
primary financial measure used is operating income (loss) by segment, exclusive
of amortization of goodwill and other acquired intangibles, net restructuring
and other charges and net (gain) loss on sale of operating assets, which is
shown in the following table.

Other income -- net. Other income -- net was $13 million of income for both
the three months ended March 31, 2003 and 2002. A $5 million increase in income
from our equity investment in Silicon Manufacturing Partners Pte, Ltd during the
current quarter was offset by a $5 million decrease in interest income as a
result of lower average cash balances.

Interest expense. Interest expense decreased 52% or $12 million to $11
million for the three months ended March 31, 2003 from $23 million for the three
months ended March 31, 2002. This decrease is due to having significantly lower
debt in the three months ended March 31, 2003 primarily as a result of
repayments on our credit facility, which matured on September 30, 2002.

Provision for income taxes. For the three months ended March 31, 2003, we
recorded a provision for income taxes of $30 million on a pre-tax loss from
continuing operations of $148 million, yielding an effective tax rate of
(20.4)%. This rate differs from the U.S. statutory rate primarily due to the
recording of a full valuation allowance of approximately $72 million against
U.S. net deferred tax assets and the provision for taxes in foreign
jurisdictions. For the three months ended March 31, 2002, we recorded a
provision for income taxes of $20 million on pre-tax income from continuing
operations of $70 million, yielding an effective tax rate of 28.6%. This rate
differs from the U.S. statutory rate primarily due to the provision for taxes in
foreign jurisdictions.

Income (loss) from discontinued operations. For the three months ended March
31, 2003, income from our discontinued optoelectronics business was $53 million,
or $0.03 per share, and consisted of income from operations of $12 million and a
gain on disposal of $41 million. The income from operations reflects a $10
million net reversal of restructuring charges and a $7 million gain from the
sale of an investment, which were partially offset by losses in the operations
of this business. These losses were lessened by a lack of depreciation and
amortization as all long-lived assets related to discontinued operations were
impaired in fiscal 2002. The gain from disposal reflects a $22 million gain from
the sale to TriQuint and a $19 million gain from the sale to EMCORE. See Note 2
to our financial statements in Item 1 for additional information. For the three
months ended March 31, 2002, loss from discontinued operations was $269 million,
or $0.16 per share.

23

SIX MONTHS ENDED MARCH 31, 2003 COMPARED TO THE SIX MONTHS ENDED MARCH 31, 2002

The following table shows the change in revenue, both in dollars and in
percentage terms by segment:

Revenue. Revenue decreased 6% or $55 million, for the six months ended March
31, 2003, as compared to the same period in 2002. The increase of $17 million
within the Client segment was driven primarily by strength in the sales of
systems on a chip used in hard disk drive applications and GPRS solutions used
in mobile terminal devices, as well as a $17 million increase in revenues
derived from the licensing of intellectual property. These increases were
partially offset by the absence of $38 million in revenues from our wireless
local area network equipment business which was sold in fiscal 2002 and by
pricing pressures related to wireless local area networking solutions.

The majority of the decrease of $72 million within the Infrastructure
segment was due to the absence of $43 million in revenues from our analog line
card and field programmable gate array businesses which were sold in fiscal
2002. The remaining decrease was caused by decreased volume, which resulted from
lower demand from telecommunications equipment manufacturers as their customers,
communication service providers, reduced capital expenditures.

Gross margin. Gross margin increased 6.9 percentage points to 26.2% for the
six months ended March 31, 2003 from 19.3% for the six months ended March 31,
2002. Gross margin for the Client segment decreased to 13.6% in the current
period from 21.4% in the prior year period. Gross margin for the Infrastructure
segment increased to 55.5% in the current period from 15.5% in the prior year
period. The changes in margin on a segment basis were caused in part by the
change in the allocation of certain shared manufacturing costs described above.
The dramatic decline in the telecommunications markets in fiscal 2002 negatively
impacted Infrastructure margins due to un-recovered costs, as sales volumes were
less than we had anticipated. With the update of our cost allocation for fiscal
2003, effective October 1, 2002, the costs allocated to our Client segment for
the six months ended March 31, 2003 have increased by approximately $45 million
when compared to prior year period. Accordingly, the costs allocated to the
Infrastructure segment decreased by the same amount. This change in allocation
is partly responsible for the decrease in Client margin and the increase in
Infrastructure margin. However, this change in allocation has no effect on our
total gross margin.

In addition to the change in allocation as noted above, the Client segment
margins were also negatively impacted by a $45 million charge taken during the
six months ended March 31, 2003 for restructuring related costs, as well as the
loss of gross margin from our wireless local area network equipment business
which was sold in fiscal 2002. These decreases to margin were partially offset
by improved expense management related to the actions taken under our
restructuring and cost saving initiatives and a $16 million increase in gross
margin derived from the licensing of intellectual property. In addition to the
change in allocation as noted above, the Infrastructure segment margins were
also positively impacted by improved expense management related to the actions
taken under our restructuring and cost saving initiatives and $15 million of
lower inventory provisions in the current period.

Selling, general and administrative. Selling, general and administrative
expenses decreased 22% or $42 million, from $193 million in the six months ended
March 31, 2002 to $151 million in the six months ended March 31, 2003. The
overall decrease was primarily driven by reduced salary, benefit and other
expenditures as a result of our restructuring and cost saving initiatives and
the absence of expenditures related to our analog line card, field programmable
gate array and wireless local area network equipment businesses which were sold
in fiscal 2002. In addition, bad debt expenditures decreased by

24

$11 million while expenses related to our annual meeting increased by $11
million when compared to the prior year period.

Research and development. Research and development expenses decreased 29% or
$98 million, from $341 million in the six months ended March 31, 2002 to $243
million in the six months ended March 31, 2003. The majority of the decrease was
due to reduced expenditures as we focused our product development efforts and
realized savings from our restructuring and cost saving initiatives. Additional
reductions occurred due to the absence of expenses from the three businesses
that we sold in fiscal 2002.

Amortization of goodwill and other acquired intangibles. Amortization
expense decreased 71% or $12 million from $17 million for the six months ended
March 31, 2002 to $5 million for the six months ended March 31, 2003. The
decrease is due to the absence of amortization of goodwill in the six months
ended March 31, 2003. Effective October 1, 2002, we adopted Statement 142,
'Goodwill and Other Intangible Assets' and are no longer permitted to amortize
goodwill. Acquired intangible assets with finite lives are still amortized.

Restructuring and other charges -- net. Net restructuring and other charges
increased 39% or $26 million to $93 million for the six months ended March 31,
2003 from $67 million for the six months ended March 31, 2002. See
'Restructuring Activities' for additional details.

Operating loss. We reported an operating loss of $264 million for the six
months ended March 31, 2003, compared with an operating loss of $193 million for
the six months ended March 31, 2002. The increase in operating loss is primarily
attributable to a $243 million gain on the sale of our field-programmable gate
array business in the prior year period and increased restructuring and other
charges in the current year period. These amounts more than offset improvements
realized as a result of increased expense reductions and higher gross margin.
Although performance measurement and resource allocation for the reportable
segments are based on many factors, the primary financial measure used is
operating income (loss) by segment, exclusive of amortization of goodwill and
other acquired intangibles, net restructuring and other charges and net (gain)
loss on sale of operating assets, which is shown in the following table.

Other income -- net. Other income -- net decreased 67% or $33 million to $16
million of income for the six months ended March 31, 2003 compared to $49
million of income for the same period in 2002. The change is primarily due to a
$14 million decrease in income from our equity investment in Silicon
Manufacturing Partners Pte, Ltd during the current period and a $15 million
decrease in interest income as a result of lower average cash balances.

Interest expense. Interest expense decreased 67% or $49 million to $24
million for the six months ended March 31, 2003 from $73 million for the six
months ended March 31, 2002. This decrease is due to having significantly lower
debt in the six months ended March 31, 2003 primarily as a result of repayments
on our credit facility, which matured on September 30, 2002.

Provision for income taxes. For the six months ended March 31, 2003, we
recorded a provision for income taxes of $54 million on a pre-tax loss from
continuing operations of $272 million, yielding an effective tax rate of
(20.0)%. This rate differs from the U.S. statutory rate primarily due to the
recording of a full valuation allowance of approximately $126 million against
U.S. net deferred tax assets and the provision for taxes in foreign
jurisdictions. For the six months ended March 31, 2002, we recorded a provision
for income taxes of $40 million on a pre-tax loss from continuing operations of
$217 million, yielding an effective tax rate of (18.4)%. This rate differs from
the U.S. statutory rate

25

primarily due to the impact of recording a full valuation allowance of
approximately $77 million against U.S. net deferred tax assets and the provision
for taxes in foreign jurisdictions.

Income (loss) from discontinued operations. For the six months ended March
31, 2003, income from our discontinued optoelectronic business was $60 million,
or $0.04 per share, and consisted of income from operations of $19 million and a
gain on disposal of $41 million. The income from operations reflects a $10
million net reversal of restructuring charges and a $7 million gain from the
sale of an investment. The income from operations also benefited from a $24
million take-or-pay settlement, as well as a lack of depreciation and
amortization as all long-lived assets related to discontinued operations were
impaired in fiscal 2002. The gain from disposal reflects a $22 million gain from
the sale to TriQuint and a $19 million gain from the sale to EMCORE. See Note 2
to our financial statements in Item 1 for additional information. For the six
months ended March 31, 2002, loss from discontinued operations was $337 million,
or $0.20 per share.

LIQUIDITY AND CAPITAL RESOURCES

As of March 31, 2003, our cash in excess of short-term debt was $573
million, which reflects $727 million in cash and cash equivalents less $115
million of borrowings under our accounts receivable securitization facility, $32
million from the current portion of our capitalized lease obligations and $7
million from the current portion of an installment note. In addition, we have
$18 million of cash held in trust that primarily supports obligations of our
captive insurance company and is not immediately available to fund on-going
operations. As of March 31, 2003, our long-term debt was $481 million, which
consists of $410 million of convertible subordinated notes due in fiscal 2009,
$58 million from the non-current portion of our capitalized lease obligations
and $13 million from the non-current portion of an installment note.

Net cash used in operating activities from continuing operations was $91
million for the six months ended March 31, 2003 compared with $381 million for
the six months ended March 31, 2002. This improvement in cash used in operating
activities reflects the impact of our steps to streamline our cost structure,
including restructuring and consolidation activities, and the streamlining of
our product portfolio. Net cash used in operating activities from discontinued
operations was $59 million for the six months ended March 31, 2003 compared with
$36 million for the six months ended March 31, 2002.

Net cash provided by investing activities was $29 million for the six months
ended March 31, 2003 compared with $303 million for the six months ended March
31, 2002. The decrease in cash flow from investing activities is primarily due
to $250 million of net proceeds from the sale of our field-programmable gate
array business in the prior year period and a decrease of $101 million in
proceeds from the sale of property, plant and equipment, partially offset by net
proceeds of $64 million from the sale of our optoelectronic components business
to TriQuint and EMCORE in the current period. Capital expenditures decreased by
$11 million during the six months ended March 31, 2002 when compared to the
prior year period.

Net cash used in financing activities was $43 million for the six months
ended March 31, 2003, compared with $1,433 million for the six months ended
March 31, 2002. The current period use of cash primarily reflects the partial
repayment of $48 million related to our accounts receivable securitization
facility and $23 million related to amounts outstanding under capital leases,
offset somewhat by borrowings of $20 million under an installment loan. The
prior year period includes repayments of $1,500 million of outstanding debt on
our credit facility, which was retired on September 30, 2002 and an increase of
$137 of short-term debt under our accounts receivable securitization facility.

On January 24, 2002, Agere Systems Inc. and certain of its subsidiaries
entered into a securitization agreement relating to certain accounts receivable.
As part of the agreement, Agere Systems Inc. and certain of its subsidiaries
irrevocably transfer accounts receivable on a daily basis to a wholly-owned,
fully consolidated subsidiary. The subsidiary has entered into a loan agreement
with certain financial institutions, pursuant to which the financial
institutions agreed to make loans to the subsidiary secured by the accounts
receivable. The financial institutions have commitments under the loan agreement
of up to $200 million; however, the amount that we can actually borrow at any
time depends on the amount and nature of the accounts receivable that we have
transferred to the subsidiary. The loan agreement, as amended on November 12,
2002, expires on November 11, 2003. As of March 31, 2003, $115 million was

26

outstanding under this agreement. We pay interest on amounts borrowed under the
agreement based on one-month LIBOR. We also pay an annual commitment fee, which
varies depending on our credit rating, on the $200 million total loan
commitment. As of March 31, 2003, the commitment fee was 1.5% per annum. If our
credit rating were to decline one or two levels, the commitment fee would
increase to 2% or 3% per annum, respectively. As of March 31, 2003, our credit
ratings were BB- with a negative outlook from Standard & Poor's and B1 from
Moody's.

The loan agreement has financial covenants which require us to (1) achieve a
minimum level of earnings before interest, taxes, and depreciation and
amortization each quarter, (2) maintain a minimum level of net worth each
quarter, and (3) limit our annual capital expenditures. A violation of these
covenants will end our ability to obtain further loans under the agreement, but
will not accelerate payment or require an immediate cash outlay to cover amounts
previously loaned under the accounts receivable securitization.

Our primary source of liquidity is our cash and cash equivalents. We believe
our cash and cash equivalents on hand will be sufficient to meet our projected
cash requirements for the next 12 months and for the foreseeable future
thereafter.

During the three months ended March 31, 2003, we voluntarily contributed
18,750,000 shares of our Class A common stock to our qualified occupational
pension plan. The value of the stock at the time of the contribution was $30
million. This contribution, combined with a remeasurement of the qualified
occupational pension plan as a result of the curtailment caused by restructuring
activities at our Orlando facility, led to a $20 million reduction of our
minimum pension liability from $170 million as of September 30, 2002 to $150
million as of March 31, 2003. As part of the remeasurement, the plan was
revalued as of March 31, 2003 with a discount rate of 6.25%. We do not expect to
make any further contributions to our pension plans in fiscal 2003.

RECENT ACCOUNTING PRONOUNCEMENTS

In November 2002, the Financial Accounting Standards Board issued
Interpretation No. 45 'Guarantor's Accounting and Disclosure Requirements for
Guarantees, Including Indirect Guarantees of Indebtedness of Others.'
Interpretation 45 is principally a clarification and elaboration of Statement of
Financial Accounting Standards No. 5 'Accounting for Contingencies,' under which
companies were required to recognize a liability for guarantees only when it
became likely that the company would have to honor its guarantee. Interpretation
45 prescribes the disclosures required by a guarantor about its obligations
under certain guarantees it has issued, including loan guarantees and standby
letters of credit. It also requires a guarantor to recognize a liability, at the
inception of a guarantee, for the fair value of the obligations it has assumed
under the guarantee, even if it is not probable that payments will be required
under that guarantee. The initial recognition and measurement provisions of
Interpretation 45 are required only on a prospective basis for guarantees issued
or modified after December 31, 2002. Previous accounting for guarantees issued
prior to application of Interpretation 45 will not need to be revised or
restated. The disclosure requirements in Interpretation 45 are effective for
annual and interim periods ending after December 15, 2002. The adoption of the
recognition and measurement provisions of Interpretation 45 did not have a
material impact on our financial condition or results of operations.

In December 2002, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 148 'Accounting for Stock-Based
Compensation -- Transition and Disclosure,' which amends the transition and
disclosure provisions of Statement of Financial Accounting Standards No. 123
'Accounting for Stock-Based Compensation.' Statement 148 provides alternative
methods of transition for a voluntary change to the fair value based method of
accounting for stock-based employee compensation and amends the disclosure
requirements of Statement 123 to require more prominent and more frequent
disclosures in financial statements about the effects of stock-based
compensation. The transition provisions are effective for fiscal years ending
after December 15, 2002. The disclosure provisions are effective for interim
periods beginning after December 15, 2002, with early application encouraged. We
adopted the interim period disclosure provisions of Statement 148 beginning with
the first quarter of fiscal 2003 and will adopt the annual disclosure
requirements effective with the fiscal year ended September 30, 2003. The
adoption of Statement 148 had no effect on our financial condition or results of
operations.

27

In January 2003, the Financial Accounting Standards Board issued
Interpretation No. 46 'Consolidation of Variable Interest Entities,' which
clarifies the application of Accounting Research Bulletin No. 51, 'Consolidated
Financial Statements.' Interpretation 46 requires certain variable interest
entities to be consolidated by the primary beneficiary of the entity if the
equity investors in the entity do not have the characteristics of a controlling
financial interest or do not provide sufficient equity at risk for the entity to
support its activities. Interpretation 46 is effective for all new variable
interest entities created after January 31, 2003. For variable interest entities
acquired or created prior to February 1, 2003, the provisions of Interpretation
46 must be applied to the first interim or annual period beginning after June
15, 2003. We do not expect Interpretation 46 to have an impact on our financial
condition or results of operations since we currently do not have variable
interest entities.

ENVIRONMENTAL, HEALTH AND SAFETY MATTERS

We are subject to a wide range of laws and regulations relating to
protection of the environment and employee safety and health. We are currently
involved in investigations and/or cleanup of known contamination at eight sites
either voluntarily or pursuant to government directives. There are established
reserves for environmental liabilities where they are probable and reasonably
estimable. Reserves for estimated losses from environmental remediation are,
depending on the site, based primarily upon internal or third party
environmental studies, estimates as to the number, participation level and
financial viability of all potential responsible parties, the extent of
contamination and the nature of required remedial actions. Although we believe
that the reserves are adequate to cover known environmental liabilities, it is
often difficult to estimate with certainty the future cost of such matters.
Therefore, there is no assurance that expenditures that will be required
relating to remedial actions and compliance with applicable environmental laws
will not exceed the amount reflected in the reserves for such matters or will
not have a material adverse effect on our consolidated financial condition,
results of operations or cash flows. Any possible loss or range of loss that may
be incurred in excess of that provided for as of March 31, 2003, cannot be
estimated.

LEGAL PROCEEDINGS

On October 17, 2002, we filed a patent infringement lawsuit against Intersil
Corporation in the United States District Court in Delaware. We alleged that
Intersil had infringed six of our patents related to integrated circuits for
wireless networking using the IEEE 802.11 standard and are seeking monetary
damages for Intersil's infringement of these patents and an injunction
prohibiting Intersil from using the patents in the future. On November 6, 2002,
Intersil filed a counterclaim in this matter, alleging that ten patents of
Intersil are infringed by unspecified Agere products. Two of the patents relate
to system-level circuits, and eight patents relate to semiconductor processing.
The complaint seeks an injunction and damages. We believe that Intersil's claims
are without merit.

On October 30, 2002, Choice-Intersil Microsystems, Inc. filed a lawsuit
against us in the United States District Court for the Eastern District of
Pennsylvania. The amended complaint alleges misappropriation of trade secrets
and copyrights that were jointly developed and jointly owned by Digital Ocean,
Inc. (which, following several acquisitions and corporate reorganizations, is
now Choice-Intersil) and Lucent. The trade secrets and copyrights relate to
media access controller technology for wireless local area networks. The
complaint seeks an injunction and damages. We believe that Choice-Intersil's
claims are without merit.

On November 19, 2002, we filed a lawsuit against Choice-Intersil, Intersil
and Intersil Americas Inc. in state court in Delaware. We alleged, among other
things, misappropriation of trade secrets and breach of contract relating to the
trade secrets that were jointly developed and jointly-owned by Digital Ocean and
Lucent. We are seeking an injunction against further use and disclosure of the
trade secrets and damages for past disclosure and misuse.

We intend to vigorously defend our self against the claims of the Intersil
parties.

RISK MANAGEMENT

We are exposed to market risk from changes in foreign currency exchange
rates and interest rates that could impact our results of operations and
financial position. We manage our exposure to these

28

market risks through our regular operating and financing activities and, when
deemed appropriate, through the use of derivative financial instruments. We use
derivative financial instruments as risk management tools and not for
speculative purposes. We use foreign currency forward contracts, and may from
time to time use foreign currency options, to manage the volatility of
non-functional currency cash flows resulting from changes in exchange rates. The
change in fair market value of derivative instruments was recorded in other
income (expense) -- net and was not material for all periods presented.

While we hedge certain foreign currency transactions, a decline in value of
non-U.S. dollar currencies may adversely affect our ability to contract for
product sales in U.S. dollars because our products may become more expensive to
purchase in U.S. dollars for local customers doing business in the countries of
the affected currencies.

FORWARD-LOOKING STATEMENTS

This Management's Discussion and Analysis of Financial Condition and Results
of Operations and other sections of this report contain forward-looking
statements that are based on current expectations, estimates, forecasts and
projections about the industry in which we operate, management's beliefs and
assumptions made by management. Words such as 'expects', 'anticipates',
'intends', 'plans', 'believes', 'seeks', 'estimates', variations of such words
and similar expressions are intended to identify such forward looking
statements. These statements are not guarantees of future performance and
involve risks, uncertainties and assumptions which are difficult to predict.
Therefore, actual outcomes and results may differ materially from what is
expressed or forecasted in such forward-looking statements. Except as required
under the federal securities laws and the rules and regulations of the
Securities and Exchange Commission, we do not have any intention or obligation
to update publicly any forward-looking statements whether as a result of new
information, future events or otherwise.

FACTORS AFFECTING OUR FUTURE PERFORMANCE

The following factors, many of which are discussed in greater detail in our
Annual Report on Form 10-K for the fiscal year ended September 30, 2002, could
affect our future performance and the price of our stock.

RISKS RELATED TO OUR BUSINESS

Our U.S. union agreements expire on May 31, 2003, and we cannot assure you
that we will complete new agreements prior to that time, or that we will not
be competitively disadvantaged if we are unable to do so.

As of March 31, 2003, we had approximately 1,700 U.S. union
represented employees covered by collective bargaining agreements. Most
of these employees are part of our manufacturing operations. Our U.S.
union agreements are with the Communications Workers of America and the
International Brotherhood of Electrical Workers. These agreements expire
on May 31, 2003. We have begun negotiations with the unions on new
contracts. We can provide no assurance that we will be able to complete
new agreements with the unions prior to the expiration of the contracts
or that we will not be competitively disadvantaged if we are unable to do
so.

A widespread outbreak of an illness such as severe acute respiratory
syndrome, or SARS, could negatively affect our manufacturing, assembly and
test, design or other operations, making it more difficult and expensive to
meet our obligations to our customers. Such an outbreak could also reduce
demand from our customers.

A number of countries in the Asia/Pacific region have recently been
experiencing outbreaks of SARS. As a result of these outbreaks,
businesses can be shut down temporarily and individuals can become ill
or quarantined. We have manufacturing and back-office operations in
Singapore, assembly and test and back-office operations in Thailand and
design operations in China, countries where outbreaks of SARS have
been reported.

If our operations are curtailed because of SARS or other health
issues, we may need to seek alternate sources of supply for manufacturing
or other services and alternate sources may

29

be more expensive. Alternate sources may not be available or may result
in delays in shipments to our customers, each of which would reduce our
profitability. In addition, a curtailment of our design operations could
result in delays in the development of new products.

If our customers' businesses were affected by SARS, they might delay
or reduce purchases from us, which could reduce our revenues and
profitability.

If we fail to keep pace with technological advances in our industry or if we
pursue technologies that do not become commercially accepted, customers may
not buy our products and our revenue may decline.

The integrated circuit industry is intensely competitive, and our failure to
compete effectively could result in lower revenue.

Joint ventures and other third-parties manufacture some of our products for
us. If these manufacturers are unable to fill our orders on a timely and
reliable basis, our revenue may be adversely affected.

The demand for components in the communications equipment industry has
recently declined, and we cannot predict the duration or extent of this
trend. Our revenue will depend in part on demand for these types of
components.

If we do not complete our announced restructuring and facility consolidation
activities as expected, or even if we do so, we may not achieve all the
benefits we anticipate.

Our revenue and operating results may fluctuate because we expect to derive
most of our revenue from semiconductor devices and the integrated circuits
industry is highly cyclical, and because of other characteristics of our
business, and these fluctuations may cause our stock price to fall.

Because many of our current and planned products are highly complex, they
may contain defects or errors that are detected only after deployment in
commercial communications applications, and if this occurs, it could harm
our reputation and result in increased expense.

Because our sales are concentrated on a limited number of key customers, our
revenue may materially decline if one or more of our key customers do not
continue to purchase our existing and new products in significant
quantities.

If we fail to attract, hire and retain qualified personnel, we may not be
able to develop, market or sell our products or successfully manage our
business.

Because we are subject to order and shipment uncertainties, any significant
cancellations or deferrals could cause our revenue to decline or fluctuate.

If we do not achieve adequate manufacturing utilization, yields, volumes or
sufficient product reliability, our gross margins will be reduced.

We have relatively high gross margin on the revenue we derive from the
licensing of our intellectual property, and a decline in this revenue would
have a greater impact on our net income than a decline in revenue from our
integrated circuits products.

If our customers do not qualify our products or manufacturing lines or the
manufacturing lines of our third-party suppliers for volume shipments, our
revenue may be delayed or reduced.

We conduct a significant amount of our sales activity and manufacturing
efforts outside the United States, which subjects us to additional business
risks and may adversely affect our results of operations due to increased
costs.

We are subject to environmental, health and safety laws, which could
increase our costs and restrict our operations in the future.

We may be subject to intellectual property litigation and infringement
claims, which could cause us to incur significant expenses or prevent us
from selling our products. If we are unable to protect our intellectual
property rights, our businesses and prospects may be harmed.

30

We believe that financing has recently been difficult to obtain for
companies in our industry and if we need additional cash to fund our
operations or to finance future strategic initiatives, we may not be able to
obtain it on acceptable terms or at all.

Because of differences in voting power and liquidity between the Class A
common stock and the Class B common stock, the market price of the Class A
common stock may be different from the market price of the Class B common
stock.

The development and evolution of markets for our integrated circuits are
dependent on factors over which we have no control. For example, if our
customers adopt new or competing industry standards with which our products
are not compatible or fail to adopt standards with which our products are
compatible, our existing products would become less desirable to our
customers and our sales would suffer.

Class action litigation due to stock price volatility or other factors could
cause us to incur substantial costs and divert our management's attention
and resources.

We may effect a reverse stock split and if we do so, our stock price may
decline after the reverse stock split.

RISKS RELATED TO OUR RECENT SEPARATION FROM LUCENT

We are limited in the amount of stock that we can issue to raise capital
because of potential adverse tax consequences.

Our historical financial information prior to the February 1, 2001
contribution to us of our business from Lucent may not be representative of
our results as a stand-alone company and, therefore, may not be reliable as
an indicator of our historical or future results.

Because Lucent's Bell Laboratories' central research organization
historically performed important research for us, we must continue to
develop our own core research capability. We may not be successful, which
could materially harm our prospects and adversely affect our results of
operations.

We could incur significant tax liabilities and payment obligations if Lucent
fails to pay the tax liabilities attributable to Lucent under our tax
sharing agreement.

Because the Division of Enforcement of the Securities and Exchange
Commission is investigating matters brought to its attention by Lucent, our
business may be affected in a manner we cannot foresee at this time.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We have exposure to foreign exchange and interest rate risk. There have been
no material changes in market risk exposures from those disclosed in our Annual
Report on Form 10-K for the fiscal year ended September 30, 2002. See Item
2 -- 'Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Risk Management' for additional details.

ITEM 4. CONTROLS AND PROCEDURES

Within 90 days prior to the filing of this report, we carried out an
evaluation, under the supervision and with the participation of management,
including the Chief Executive Officer and Chief Financial Officer, of our
disclosure controls and procedures (as defined in Rules 13a-14 and 15d-14 under
the Securities Exchange Act of 1934). Based upon that evaluation, the Chief
Executive Officer and Chief Financial Officer concluded that our disclosure
controls and procedures are effective in timely alerting them to material
information required to be included in periodic filings with the Securities and
Exchange Commission.

There were no significant changes in our internal controls or in other
factors that could significantly affect these internal controls subsequent to
the date of our most recent evaluation.

31

PART II -- OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

See Part I -- 'Management's Discussion and Analysis of Financial Condition
and Results of Operations -- Legal Proceedings'.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

Agere held its Annual Meeting of Stockholders on February 20, 2003. At that
meeting, stockholders elected two individuals as Directors of the Company for
terms that will expire at the Annual Meeting to be held in 2006. In addition,
stockholders approved three Company proposals, each of which provided for an
amendment to Agere's certificate of incorporation to effect a reverse stock
split at the discretion of Agere's Board of Directors. The ratio of the reverse
stock split varied in each proposal. The individuals elected and the results of
the voting are as follows.

There were no broker non-votes on any of the above matters. The following
individuals whose terms expire in either 2004 or 2005 continue to serve as
Directors of the Company: Richard L. Clemmer, John T. Dickson, Krish Prabhu,
Harold A. Wagner and John A. Young.

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

(a) Exhibits

See Exhibit Index.

(b) Reports on Form 8-K

Current Report on Form 8-K filed January 17, 2003 pursuant to Item 2
(Acquisition or Disposition of Assets), Item 5 (Other Events) and Item
7b (Pro Forma Financial Information).

Current Report on Form 8-K filed January 31, 2003 pursuant to Item 2
(Acquisition or Disposition of Assets) and Item 7b (Pro Forma Financial
Information).

32

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.

AGERE SYSTEMS INC.

Date: May 8, 2003 /S/ JOHN W. GAMBLE, JR.
.............................
JOHN W. GAMBLE, JR.
EXECUTIVE VICE PRESIDENT AND
CHIEF FINANCIAL OFFICER

33

CERTIFICATIONS

I, John T. Dickson, certify that:

1. I have reviewed this quarterly report on Form 10-Q of Agere Systems
Inc.;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material
fact necessary to make the statements made, in light of the
circumstances under which such statements were made, not misleading
with respect to the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other
financial information included in this quarterly report, fairly
present in all material respects the financial condition, results
of operations and cash flows of the registrant as of, and for, the
periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible
for establishing and maintaining disclosure controls and procedures
(as defined in Exchange Act Rules 13a-14 and 15d-14) for the
registrant and have:
(a) Designed such disclosure controls and procedures to ensure
that material information relating to the registrant,
including its consolidated subsidiaries, is made known to us
by others within those entities, particularly during the
period in which this quarterly report is being prepared;
(b) Evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to
the filing date of this quarterly report (the 'Evaluation
Date'); and
(c) Presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures
based on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed,
based on our most recent evaluation, to the registrant's auditors
and the audit committee of registrant's board of directors (or
persons performing the equivalent function):
(a) All significant deficiencies in the design or operation of
internal controls which could adversely affect the
registrant's ability to record, process, summarize and
report financial data and have identified for the
registrant's auditors any material weaknesses in internal
controls; and
(b) Any fraud, whether or not material, that involves management
or other employees who have a significant role in the
registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in
this quarterly report whether there were significant changes in
internal controls or in other factors that could significantly
affect internal controls subsequent to the date of our most recent
evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.

Date: May 8, 2003

/s/ JOHN T. DICKSON
.................................
JOHN T. DICKSON
PRESIDENT AND
CHIEF EXECUTIVE OFFICER

34

I, John W. Gamble, Jr., certify that:

1. I have reviewed this quarterly report on Form 10-Q of Agere Systems
Inc.;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material
fact necessary to make the statements made, in light of the
circumstances under which such statements were made, not misleading
with respect to the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other
financial information included in this quarterly report, fairly
present in all material respects the financial condition, results
of operations and cash flows of the registrant as of, and for, the
periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible
for establishing and maintaining disclosure controls and procedures
(as defined in Exchange Act Rules 13a-14 and 15d-14) for the
registrant and have:
(a) Designed such disclosure controls and procedures to ensure
that material information relating to the registrant,
including its consolidated subsidiaries, is made known to us
by others within those entities, particularly during the
period in which this quarterly report is being prepared;
(b) Evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to
the filing date of this quarterly report (the 'Evaluation
Date'); and
(c) Presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures
based on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed,
based on our most recent evaluation, to the registrant's auditors
and the audit committee of registrant's board of directors (or
persons performing the equivalent function):
(a) All significant deficiencies in the design or operation of
internal controls which could adversely affect the
registrant's ability to record, process, summarize and
report financial data and have identified for the
registrant's auditors any material weaknesses in internal
controls; and
(b) Any fraud, whether or not material, that involves management
or other employees who have a significant role in the
registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in
this quarterly report whether there were significant changes in
internal controls or in other factors that could significantly
affect internal controls subsequent to the date of our most recent
evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.

Date: May 8, 2003

/s/ JOHN W. GAMBLE, JR.
.................................
JOHN W. GAMBLE, JR.
EXECUTIVE VICE PRESIDENT AND
CHIEF FINANCIAL OFFICER

35

EXHIBIT INDEX