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<SEC-DOCUMENT>0000950123-01-509126.txt : 20020412
<SEC-HEADER>0000950123-01-509126.hdr.sgml : 20020412
ACCESSION NUMBER: 0000950123-01-509126
CONFORMED SUBMISSION TYPE: 10-K
PUBLIC DOCUMENT COUNT: 6
CONFORMED PERIOD OF REPORT: 20010930
FILED AS OF DATE: 20011210
FILER:
COMPANY DATA:
COMPANY CONFORMED NAME: AGERE SYSTEMS INC
CENTRAL INDEX KEY: 0001129446
STANDARD INDUSTRIAL CLASSIFICATION: SEMICONDUCTORS & RELATED DEVICES [3674]
IRS NUMBER: 223746606
STATE OF INCORPORATION: DE
FISCAL YEAR END: 0930
FILING VALUES:
FORM TYPE: 10-K
SEC ACT: 1934 Act
SEC FILE NUMBER: 001-16397
FILM NUMBER: 1810337
BUSINESS ADDRESS:
STREET 1: 555 UNION BLVD
CITY: ALLENTOWN
STATE: PA
ZIP: 18109
BUSINESS PHONE: 6107124323
MAIL ADDRESS:
STREET 1: 555 UNION BLVD
CITY: ALLENTOWN
STATE: PA
ZIP: 18109
</SEC-HEADER>
<DOCUMENT>
<TYPE>10-K
<SEQUENCE>1
<FILENAME>y55437e10-k.txt
<DESCRIPTION>AGERE SYSTEMS INC.
<TEXT>
<PAGE>
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON DECEMBER 10, 2001
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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
<Table>
<C> <S>
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED SEPTEMBER 30, 2001
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
</Table>
COMMISSION FILE NUMBER 001-16397
AGERE SYSTEMS INC.
(Exact name of registrant as specified in its charter)
<Table>
<S> <C>
DELAWARE 22-3746606
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
555 UNION BOULEVARD 18109
ALLENTOWN, PENNSYLVANIA (Zip Code)
(Address of principal executive offices)
</Table>
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE:
610-712-4323
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
<Table>
<Caption>
TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED
------------------- -----------------------------------------
<S> <C>
Class A Common Stock, $.01 par value New York Stock Exchange
</Table>
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
NONE
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 if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
The aggregate market value of voting common equity held by non-affiliates
of the registrant as of December 1, 2001 was approximately $3.56 billion.
As of December 1, 2001, 727,429,667 shares of Class A common stock, par
value $.01 per share, and 908,100,000 shares of Class B common stock, par value
$.01 per share, were outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Certain information required by Part III of this report (Items 10, 11, 12
and 13) is incorporated by reference from the registrant's proxy statement to be
filed pursuant to Regulation 14A with respect to the registrant's 2002 annual
meeting of stockholders.
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<PAGE>
AGERE SYSTEMS INC.
FORM 10-K
FOR THE YEAR ENDED SEPTEMBER 30, 2001
<Table>
<Caption>
PAGE
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<S> <C> <C>
PART I
Item 1. Business.................................................... 2
Item 2. Properties.................................................. 20
Item 3. Legal Proceedings........................................... 20
Item 4. Submission of Matters to a Vote of Security Holders......... 21
PART II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters......................................... 21
Item 6. Selected Financial Data..................................... 21
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................... 23
Item 7A. Quantitative and Qualitative Disclosures About Market
Risk........................................................ 44
Item 8. Financial Statements and Supplementary Data................. 46
Item 9. Change in and Disagreements with Accountants on Accounting
and Financial Disclosure.................................... 88
PART III
Item 10. Directors and Executive Officers of the Registrant.......... 88
Item 11. Executive Compensation...................................... 89
Item 12. Security Ownership of Certain Beneficial Owners and
Management.................................................. 89
Item 13. Certain Relationships and Related Transactions.............. 89
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form
8-K......................................................... 90
</Table>
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FORWARD-LOOKING STATEMENTS
Certain statements in this Form 10-K are forward-looking statements within
the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A
of the Securities Act of 1933, and Section 21E of the Securities Exchange Act of
1934. The words "estimate," "plan," "intend," "expect," "anticipate," "believe"
and similar expressions are intended to identify forward-looking statements.
These forward-looking statements are found at various places throughout this
Form 10-K and throughout the other documents incorporated herein by reference.
Agere disclaims any intention or obligation to update or revise any
forward-looking statements, whether as a result of new information, future
events or otherwise. Although we believe that our expectations are based on
reasonable assumptions, we can give no assurance that our goals will be
achieved. Important factors that could cause actual results to differ from
estimates or projections contained in the forward-looking statements are
described in the "Factors Affecting Our Future Performance" section contained in
Item 7.
PART I
ITEM 1. BUSINESS
GENERAL
Agere Systems designs, develops and manufactures integrated circuits for
use in a broad range of communications and computer systems and optoelectronic
components for communications networks. We are the world leader in sales of
communications components, which include both integrated circuits and
optoelectronic components. Communications components are basic building blocks
of electronic and photonic products and systems for terrestrial and submarine,
or undersea, communications networks and for communications equipment.
In fiscal 2001, we had two principal businesses: Integrated Circuits and
Optoelectronics. Integrated circuits, or chips, 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 Integrated
Circuits business also includes our wireless local area networking products,
which facilitate the transmission of data and voice signals within a localized
area without cables or wires. Our Optoelectronics business includes our
optoelectronic components operations, including both our active optoelectronic
and our passive optical components. Optoelectronic components transmit, process,
change, amplify and receive light that carries data and voice traffic over
optical networks. The Integrated Circuits and Optoelectronics businesses each
include revenue from the licensing of intellectual property related to that
business.
On July 20, 2000 Lucent Technologies announced that it planned to create a
separate company that comprised its microelectronics business including its
integrated circuits and optoelectronics divisions. We were incorporated in
Delaware on August 1, 2000 to be that company. Our separation from Lucent was
substantially completed, including the transfer of all assets and liabilities
related to these divisions other than pension and postretirement plan assets and
liabilities, which have yet to be transferred, when we completed our initial
public offering in April 2001. As of December 1, 2001, Lucent owned 100% of our
outstanding Class B common stock and 37 million shares of our outstanding Class
A common stock, which represented a majority of the combined voting power of
both classes of our common stock. Lucent has announced that it continues to move
forward with its intention to distribute all shares of our common stock that it
owns to its stockholders in a tax-free distribution, but Lucent's credit
facilities include conditions that must be met before Lucent can distribute its
Agere stock to its stockholders. See "Item 7 -- Overview -- Separation from
Lucent" for further information about our spin off as a fully independent
company.
Our principal executive offices are located at 555 Union Boulevard,
Allentown, Pennsylvania 18109. Our telephone number is (610) 712-4323. Our World
Wide Web site address is www.agere.com.
We sell our products primarily through our direct sales force, but we also
utilize distributors, resellers and electronic commerce. Of our total net
revenue of $4,080 million in the fiscal year ended September 30, 2001,
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$2,869 million or 70% was generated by our Integrated Circuits segment and
$1,211 million or 30% was generated by our Optoelectronics segment.
Approximately 45% of our revenue was generated in the United States and 55%
internationally. See note 17 to our financial statements in Item 8 for further
information about our Integrated Circuits and Optoelectronics segments.
As of September 30, 2001 we employed approximately 14,400 people worldwide.
We have major research and development and manufacturing sites in the United
States, Mexico, Singapore and Thailand.
INTEGRATED CIRCUITS
We offer integrated circuits for use in a broad range of communications
networks and computer systems. Our integrated circuits are used primarily in the
following types of equipment:
- network communications equipment, which facilitates the transmission,
switching and management of data and voice traffic within communications
networks;
- client access and network connectivity devices, such as modems and analog
line cards, which allow computers, servers and other equipment to connect
to communications networks;
- wireless terminals and infrastructure, such as mobile telephones and
cellular base stations, which transmit and receive data and voice
communications through radio waves; and
- hard disk drives, which store data and are found in products such as
personal computers, servers and new consumer devices.
We also sell wireless local area networking products, which facilitate the
transmission of data and voice signals within a localized area without cables or
wires.
STRATEGY
Our integrated solutions combine a number of functions into a single unit.
Because of this integration, we have the ability to deliver products that
interact more effectively and enhance performance. This allows our customers to
meet the requirements of their end customers faster and more cost effectively
than if they purchase a number of separate integrated circuits.
We have dedicated engineering groups that develop core manufacturing
technology, common design methodology and commonly used integrated circuit
design elements for use across our Integrated Circuits segment. By using common
core technologies, we simplify our design methods, create reusable intellectual
property and achieve manufacturing efficiencies.
We believe the primary considerations for customers selecting integrated
circuit products are:
- design capabilities, including the ability to deliver integrated
solutions;
- performance, as measured by speed, power requirements and reliability;
- feature set;
- price;
- flexibility, which refers to the ability to design products using the
manufacturer's own intellectual property, the manufacturer's customers'
intellectual property or a combination of both; and
- compatibility with other products and communications standards used in
communications networks.
We focus our product development and sales efforts to address the customer
considerations listed above. The relative importance of these factors may vary
depending on the product group or the particular customer's requirements. For
example, price may be one of the most important considerations for a customer
selecting many of our client access and network connectivity integrated circuits
because these integrated circuits are used in price sensitive products sold to
consumers. On the other hand, a customer selecting our network
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communications integrated circuits typically will be more focused on design and
performance rather than price because these customers often have specialized
demands that require customized solutions.
PRODUCTS AND APPLICATIONS
Our integrated circuits support five primary applications: network
communications equipment, client access and network connectivity devices,
wireless products, wireless local area networking products, and storage and
analog products.
Network Communications Equipment
We offer integrated circuits that facilitate the transmission and switching
of data and voice signals within communications networks. Our integrated
circuits process signals and transmit the signals to deliver information
throughout the network. Our integrated circuits are key building blocks in both
optical and wireline communications networks.
We sell a complete integrated circuit solution that supports speeds up to
2.5 gigabits per second. This solution consists of physical layer devices,
integrated circuits supporting SONET/SDH communication standards, multi-service
switching fabrics and network processing devices and broadband access devices,
each of which is described below. We have, in various stages of development, 10
gigabits per second products that have either recently been introduced in
commercial quantities or are currently being sampled by one or more customers.
Physical Layer Devices. High-speed physical layer devices are key elements
in the conversion between optical signals and electronic signals, as required by
communications networks. High-speed physical layer devices accept the output
from an optical receiver and convert it into a digital data signal that can be
used in communications switching and processing functions. Our products include
a set of six integrated circuit components for physical layer devices that
provide a complete product offering for 10 gigabits per second transmission. We
offer our customers physical layer device components either separately or
together with optoelectronic components. In particular, we sell a transponder
which combines our physical layer device components together with our
optoelectronic components in a single product.
SONET/SDH Network Devices. Synchronous optical networks, which are
typically referred to as SONET, and synchronous digital hierarchy standard, or
SDH, carry data, voice and video traffic through a network by combining lines
carrying traffic at slower speeds with lines carrying traffic at higher speeds.
This process is known as multiplexing, and involves directing traffic from the
individual lines into designated time slots in the higher speed lines, and those
lines into still higher speed lines. The SONET/SDH equipment that handles the
directing of traffic into slower speed and faster speed lines is the add-drop
multiplexor, or ADM. Add-drop multiplexors handle the addition and removal of
traffic from a SONET/SDH communication transmission. We offer single-chip
integrated circuit solutions, or framers, for add-drop multiplexing of data and
voice traffic. In addition, our framers are used in high-speed routers within an
optical network. A router is an interface, or link, between two networks.
Multi-Service Switching Fabrics and Network Processing Devices. Switching
devices guide data to different local area networks and wide area networks based
on the intended destination. Multi-service switching devices support the
transmission of voice and video signals as well as data. We sell switch fabrics
and network processors to communications equipment manufacturers. A switch
fabric directs the data within a switching device. A network processor is a
component that controls how data is sent over a network or over a switch fabric
such that the data retains its quality of service without interfering with other
data traffic. We also offer supporting software with our switching products. In
addition, our customers sometimes add their own supporting software to switch
fabrics and network processors that they purchase from us to produce complete
switching equipment.
We currently offer switching products for asynchronous transfer mode, or
ATM. We are developing switching products for the Internet protocol standard.
These products are being sampled by some customers but further design work is
required before they will be available for sale in commercial quantities.
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Asynchronous transfer mode and Internet protocol refer to different procedures
for the formatting and timing of data transmission between two pieces of
equipment. Our switching integrated solutions reduce the number of required
integrated circuits needed in a switching device.
Broadband Access Devices. Broadband is a general term which refers to
high-speed data transmission. Our broadband access integrated circuits, or
mappers, support data transport between central offices and enterprise sites by
aggregation and termination. Aggregation refers to the combining of many
low-speed, or tributary, data signals from enterprises into higher speed, or
trunk, data signals for transmission to a central office. Termination refers to
the separation of trunk data signals into lower-speed, tributary data signals.
Our products support data transport for T-carrier data transport in North
America. T-carrier is a digital transmission service from a common carrier. We
support similar services worldwide which are referred to as J-carrier in Japan
and E-carrier in Europe. T-carrier services such as T1 and T3 lines are widely
used to create point-to-point networks for use by enterprises. T1 and T3 lines
refer to different levels of T-carrier service which transmit data at 1.5
megabits per second and 44.7 megabits per second, respectively. A megabit is a
unit of measurement for data and is equal to one million bits.
Customized Solutions. The majority of our revenue from our network
communications products is derived from the manufacture of customized integrated
circuits for our customers. These integrated circuits incorporate our
intellectual property or combine our intellectual property with our customers'
intellectual property to create a customized solution for these customers. For
some customers, we design and manufacture the integrated circuit while the key
intellectual property belongs solely to our customers. We draw our intellectual
property from the various product areas described above in order to meet our
customers' specific requirements.
We also deliver customized solutions with our field-programmable gate
arrays, or FPGAs, or our field-programmable systems-on-a-chip, or FPSCs. Our
field-programmable gate array is a specialized processor of electronic signals
that can be modified by a customer for a number of functions after the
integrated circuit has been deployed in a network. Our field-programmable
system-on-a-chip incorporates several complex functions as well as a
field-programmable gate array on one integrated circuit. On December 7, 2001, we
entered into an agreement with Lattice Semiconductor Corporation to sell our
FPGA and FPSC business for $250 million in cash. We expect this transaction to
be completed in the second quarter of fiscal 2002, subject to regulatory
approval and other customary closing conditions.
Our systems-level knowledge allows us to turn our customers' design
concepts into a systems solution quickly and effectively. Our intellectual
property gives our customers the flexibility to customize their products to meet
their individual cost and performance objectives.
Client Access and Network Connectivity Devices
We sell integrated circuits for use in products that allow users to access
communications networks through a variety of different methods. We offer our
customers solutions that include integrated circuits and software.
Many of our products convert analog signals into digital signals and
digital signals into analog ones. Analog refers to a transmission technique
employing a continuous signal that varies in amplitude, frequency or phase of
the transmission. Digital, on the other hand, refers to a method of storing,
processing and transmitting data that uses distinct electronic or optical pulses
to represent the binary digits 0 and 1.
We sell integrated circuits as part of the following client access and
network connectivity products:
Modem Products. We primarily sell our integrated circuits for modem
products directly to leading manufacturers of personal computers and other
electronic equipment as well as to manufacturers who sell modem solutions to
manufacturers of personal computers.
Input/Output Products. Input/output refers to the transfer of data within
and between computers, peripheral equipment, such as printers, scanners and
digital cameras, and data networks. We sell input/output
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products primarily to manufacturers of computers, peripheral equipment and
communications equipment. A majority of our sales are customized solutions that
combine our intellectual property with that of our customers in the design of
our integrated circuits. Our products support Universal Serial Bus, or USB, and
IEEE-1394 industry standards, which are both established connectivity and
transmission standards. We also are currently developing solutions that utilize
InfiniBand(TM), a new industry standard for high-bandwidth input/output
operations for enterprise computing. We have started to sell our first
InfiniBand product.
Analog Line Card and Analog Telephone Products. Traditional voice
telephone equipment uses technology in which voice communications are
transmitted as analog signals until they reach a network services provider's
central office, where analog line cards are located. Analog line cards convert
analog voice signals into digital signals to be transmitted through the
communications network and convert the digital signal coming from the network
back to analog in order to complete the telephone call. Our customers also use
our products in telephone interfaces, or lines, located closer to an end user in
devices such as television set-top boxes, broadband gateways and integrated
access devices. Broadband gateways and integrated access devices combine a
variety of communications technologies such as analog and digital subscriber
line in the end user's premises onto a single telephone line for transmission to
the network. We sell our analog line card and telephone solutions to
manufacturers of communications equipment for use worldwide.
Traditional Voice Systems. We provide integrated circuits to
telecommunications equipment manufacturers for use in traditional voice
telephone networks and integrated services digital network, or ISDN, systems.
These networks are not as advanced as newer voice and data networks that
manufacturers of communications equipment currently offer. We expect sales for
these systems to decline rapidly over the next several years.
Newly Introduced Products. We have started to sell products in areas for
which, if sufficient demand emerges, we expect to expand our offerings. We have
started to offer integrated circuits and software for use in digital telephony
products. Digital telephony products are solutions that access and interface
with merged voice and data networks. We also have introduced a series of
asynchronous transfer mode interconnect products for use in infrastructure
equipment for digital telephony services. Asynchronous transfer mode, or ATM,
refers to a specific set of procedures for the formatting and timing of data
transmission between two pieces of equipment. We sell our digital telephony
solutions to manufacturers of business telephone equipment.
Wireless Products
We sell integrated circuits for use in digital mobile telephones, cellular
base stations and other wireless data and voice communications products. We also
offer supporting software as part of our comprehensive integrated circuit
wireless product solutions. These solutions include:
- digital signal processors for speech compression and encoding and
transmission of voice and data;
- radio frequency integrated circuits to transmit and receive signals;
- conversion signal processors to convert signals between frequencies used
in digital signal processors and frequencies used for radio transmission;
and
- software that controls the communication process.
We also have started to license hardware and software designs for mobile
telephones that use our integrated circuits.
Most of our wireless products operate on the Global Systems for Mobile
Communications, or GSM, standard. We also sell products that support General
Packet Radio Service, or GPRS, that provide enhanced data transmission
capabilities for GSM mobile phones.
Wireless Infrastructure Products. We sell integrated circuit solutions
used in wireless infrastructure products, which are primarily cellular base
stations and cellular base transceiver stations, and wireless terminals, which
include mobile telephones, pagers and personal digital assistants.
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Wireless Local Area Networking Products
We sell integrated circuits, software and equipment for wireless networks.
We offer our ORiNOCO(TM) products for wireless local area networking and
Bluetooth(TM) products for personal area networking.
ORiNOCO Products. Our ORiNOCO products comprise a complete wireless local
area network system that provides broadband network access through mobile and
fixed data devices. We offer the software and equipment necessary to create and
support wireless local area networks, which are typically referred to as
wireless LANs. Our wireless local area network solution currently supports data
transmission speeds of over 10 megabits per second. We sell a complete solution
for wireless networking that facilitates mobile Internet connectivity to the end
user in an enterprise, home or public space, such as an airport lounge or hotel
lobby.
We sell wireless local area network solutions to network services providers
and to customers that sell to enterprises and home users under the ORiNOCO
brand. We also sell our ORiNOCO products to personal computer manufacturers that
integrate them into their products. Our primary indirect channel into the
enterprise market is Avaya Inc., formerly the enterprise networks group of
Lucent.
Bluetooth Products. We sell integrated circuit solutions and supporting
software for the new market of Bluetooth technology applications. Bluetooth is
an open standard for short-range radio transmission of digital voice and data
that facilitates a wireless personal area network. The Bluetooth technology also
makes it easier for data synchronization of mobile computers, mobile telephones
and handheld devices. Bluetooth uses radio waves that can pass through walls and
other non-metal barriers to create a personal area network.
We have started to sell a two-component Bluetooth solution and supporting
software. Our solution facilitates a wireless personal area network which
supports data transmission speeds of up to 1 megabit per second for devices
within an approximately 30-foot radius. We sell our Bluetooth products to
manufacturers of communications and computer equipment.
Storage and Analog Products
We sell integrated circuits for use in storage devices, commonly referred
to as hard disk drives. As applications used on computers and communications
equipment become more complex, we expect an increased demand for higher storage
capability. We also sell integrated circuits for use in analog signal processing
and control functions within various products. Analog integrated circuits shape
or condition electronic signals and amplify electronic signal strength. They
also regulate voltage levels and provide interfaces between products within an
analog environment. We currently focus on development opportunities in the hard
disk drive product area, the analog communications product area and in the
product area for analog power products, which regulate power.
OPTOELECTRONIC COMPONENTS
Our optoelectronic components are utilized in optical networks. Optical
networks transmit information as pulses of light, or optical signals, through
optical fibers, which are hair-thin glass strands. An optical network utilizes a
number of interdependent active optoelectronic and passive optical components.
An active component is a device that has both optical and electronic properties.
A passive component is a device that functions only in the optical domain. We
primarily offer active optoelectronic components, including:
- lasers, which are devices that produce light suitable for optical
networks;
- modulators, which are devices that turn optical signals on and off to
encode information that travels through a network;
- amplifiers, which are devices that regenerate optical signals after they
suffer loss as a result of traveling long distances within the network;
- transmitters, which are devices that convert electronic signals into
optical signals for transmission;
- receivers, which are devices that convert optical signals back into
electronic form on the receiving end of a communications network;
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- transponders, which are devices that combine both integrated circuits and
optoelectronic components in one unit that transmits and receives optical
signals; and
- micro electro-mechanical systems, or MEMS, which are small mechanical
products that perform a variety of optical functions without converting
an optical signal into electronic form. Our MEMS products are being
sampled by some customers but further design and manufacturing process
development will be required before these products will be available for
sale in commercial quantities.
In addition to our broad portfolio of active optoelectronic components, we have
started to sell passive optical filters and silicon waveguides. Passive optical
filters are devices used in conjunction with active optoelectronic components in
products such as amplifiers. Silicon waveguides are passive optical components
that manipulate optical signals to perform a variety of functions.
We sell our optoelectronic components for use in submarine and terrestrial
optical networks. Submarine networks transmit optical signals undersea, usually
at high speeds and over long distances. Terrestrial networks include high-speed
transport networks, which transmit optical signals at high speeds over long
distances, and metropolitan networks, which transmit optical signals between
central offices of network services providers or between enterprises and central
offices. Terrestrial networks also include cable television networks, which
transmit optical signals between cable system operators and homes, and data
communication networks, which transmit optical signals within a local area
network. A local area network links data devices such as servers, computers and
printers in the same localized area to facilitate Internet access and to share
files and programs.
STRATEGY
We believe the primary considerations for customers selecting
optoelectronic components are:
- performance, as measured by speed, power requirements and reliability;
- price;
- breadth of product line and ability to offer integrated solutions;
- quality and automation of manufacturing processes;
- manufacturing capacity, as measured by ability to satisfy orders; and
- compatibility of products with other products and communications
standards used in communications networks.
Our optoelectronic components are engineered to work together in an optical
network. We sell integrated solutions that combine multiple components into a
single product. We believe our integrated solutions allow our customers to
reduce the size and costs of their optical network equipment and reduce their
time to develop new products. We also believe these solutions allow our
customers to rely on a smaller number of suppliers and improve the performance
of their products.
PRODUCTS AND APPLICATIONS
We have described below our key optoelectronic components and the network
applications for these products.
Key Optoelectronic Components
Lasers. We offer a variety of types of lasers for use in high-speed
transport, metropolitan, cable television and submarine network applications.
Higher power lasers can transmit light greater distances than lower power
lasers. A single laser is required for each channel in a dense wavelength
division multiplexing, or DWDM, system, which is a system that transmits two or
more signals over a single optical fiber. Communications equipment manufacturers
use different types of lasers depending on the needs of the specific network
application.
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Modulators. Modulation can be achieved directly by turning a laser on and
off or by external modulators that transmit or interrupt a continuous optical
signal to achieve the same on and off effect. Long-distance and submarine
networks typically use high power lasers and external modulators, while
short-distance networks use direct modulation. Our lithium niobate modulators
are used in high-speed transport and metropolitan network applications, and our
lithium niobate polarization controllers are used in high-speed transport
network applications.
Amplifiers. During transmission, an optical signal must be periodically
renewed because it loses its strength as it travels within the network. Optical
amplifiers increase the strength of an optical signal without converting it back
into an electronic signal. Optical amplifiers represent a major cost efficiency,
as network services providers can reduce the number of costly
optical-to-electronic-to-optical conversions. We offer erbium doped fiber
amplifiers and raman amplifiers in high-speed transport and metropolitan network
applications.
Transmitters, Receivers and Transceivers. We offer cooled laser
transmitters for high-speed transport, metropolitan and cable television network
applications, uncooled laser transmitters for metropolitan network applications,
and turnable laser transmitters for high-speed transport network applications.
Our positive intrinsic negative, or PIN, receivers are used for high-speed
transport, metropolitan and cable television network applications, and our
avalanche photo detector, or APD, receivers are used for high-speed transport
and metropolitan network applications. Transmitters and receivers are also
sometimes combined into one module, which is called a transceiver.
Transponders. Our transponders offer both integrated circuits and
optoelectronic components in one combined unit, or module. This module combines
a transceiver with a multiplexor/demultiplexor into a unified product. A
multiplexor is an electronic device that allows two or more signals to be
combined for transmission over one communications circuit. A demultiplexor
separates two or more signals previously combined by compatible multiplexing
equipment. Our transponders are capable of multiplexing 16 electronic signals
into one optical signal. Our transponders are also capable of demultiplexing one
optical signal into 16 electronic signals. We have recently begun shipping our
2.5 gigabits per second transponders in commercial quantities to our customers
and we are sampling 10 gigabits per second transponders.
MEMS Devices. We recently introduced optical cross connects and dynamic
gain equalizers, which are our first optical micro electro-mechanical systems,
or MEMS, devices. MEMS are small mechanical products that perform a variety of
optical functions which include optical switching, dynamic gain equalization and
add-drop multiplexing. An optical cross connect is an optical switching device
that maintains the optical signal as light from input to output, without
converting it into electronic form. A dynamic gain equalizer is an optical
device that optimizes transmissions in an optical network by equalizing the
amplitude of specific wavelengths of light within the optical fiber. These
products are being sampled by some customers but further design and
manufacturing process development is required before they will be available for
sale in commercial quantities.
Thin Film Optical Filters. Thin film optical filters are designed to allow
only selected wavelengths of light to pass through them. Our filters are
manufactured by depositing many thin layers on a base of specially made glass.
Thin film optical filters are used in dense wavelength division multiplexing, or
DWDM, systems, which are systems that transmit two or more signals over a single
fiber. They can also be used to correct the amplitude of the signal coming from
an optical amplifier. Our thin film optical filters are generally sold to
optical component manufacturers which package and combine them with active
optoelectronic components.
Silicon Waveguides. We have started to sample optical dynamic gain
equalizers, which are our first silicon waveguide products. We believe our
experience in silicon-based integrated circuit manufacturing processes is an
important factor in our ability to manufacture these products. These
silicon-based processes will permit production of these products in high
volumes. In addition, silicon-based technology allows active components such as
transmitters and receivers to be integrated with silicon waveguides, permitting
reductions in size and cost of integrated modules.
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Network Applications
Submarine. We offer a variety of highly reliable, ultrastable components
designed to withstand the rigors of long-distance undersea transmission.
Customers for our submarine products are manufacturers of undersea
communications equipment.
High-Speed Transport. Our products support transmission of optical signals
at speeds of 2.5 or 10 gigabits per second. We also have 40 gigabits per second
modulators and receivers that are currently being sampled by customers. Our
high-speed transport products can send multiple optical signals for distances up
to 720 kilometers without amplification, and much further when used in
conjunction with optical amplifiers. Customers for our high-speed transport
products are manufacturers of communications equipment who sell to network
services providers that operate long-distance communications networks.
Metropolitan. We sell optoelectronic components that are used in optical
networks in metropolitan areas to carry information between central offices of
network services providers or between large enterprises and central offices. The
information transmitted within these networks is carried for shorter distances,
generally 40 kilometers or less, and at lower speeds than those used in
high-speed transport network applications. We sell products designed for
metropolitan communications networks to manufacturers of communications
equipment, which sell to service providers that operate local exchanges and to
manufacturers of network equipment for enterprises.
Cable Television. Over the past ten years, cable system operators have
upgraded their networks to add optical fiber to their networks. Our cable
television optoelectronic components provide a high-speed return path from the
consumer's home to the cable system operator. This return path allows cable
system operators to offer Internet and telephone services, in direct competition
with network services providers. Customers for our cable television
optoelectronic components are manufacturers of cable television transmission
equipment.
Data Communication. A local area network links data devices such as
servers, computers and printers in the same localized area to facilitate
Internet access and to share files and programs. As bandwidth and transmission
distance requirements of enterprises have increased, it has become more
practical to utilize the superior transmission capabilities of optical networks
to build high-speed local area networks. These networks require transceivers to
convert electronic signals into optical signals and back into electronic signals
at high speeds. Customers for our data communication optoelectronic components
are manufacturers of network equipment for enterprises.
CUSTOMERS, SALES AND DISTRIBUTION
CUSTOMERS
We have a globally diverse base of customers, consisting primarily of
manufacturers of communications and computer equipment. We generally target as
customers the leaders in the market segments in which our products are used as
well as the companies we believe will be future leaders in these segments. In
fiscal 2001, we sold our products directly to approximately 250 end customers
and indirectly, through distributors, to approximately 1,000 end customers. For
some end customers, we deliver the product to, and are paid by, a third party
associated with the customer, such as their contract manufacturer. Our top 20
end customers in fiscal 2001, based on revenue, accounted for approximately 70%
of our revenue and our top 10 end customers in fiscal 2001, based on revenue,
accounted for approximately 53% of our revenue. Our top ten end customers in
fiscal 2001 were:
<Table>
<S> <C>
Apple Computer, Inc. Lucent Technologies Inc.
Alcatel Maxtor Corp.
Avaya Inc. Nortel Networks Corp.
Cisco Systems, Inc. Seagate Technology, Inc.
Globespan Inc. Tycom (US) Inc.
</Table>
All of the customers listed above purchased integrated circuits from us.
Alcatel, Avaya, Cisco Systems, Lucent, Nortel and Tycom also purchased
optoelectronic components from us. Our sales to Lucent
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represented 14.9%, 21.3% and 25.7% of our revenue for fiscal 2001, 2000 and
1999, respectively. No other customer accounted for 10% or more of our revenue
in fiscal 2001, 2000 or 1999.
SALES AND DISTRIBUTION
We have a worldwide sales organization with approximately 500 employees as
of September 30, 2001, located in 24 domestic and 16 international sales
offices. We sell our products globally primarily through our direct sales force.
To complement our direct sales force, we also sell our products through
distributors, which sales in fiscal 2001 represented approximately 8% of our
revenue. During fiscal 2001, we discontinued our prior practice of using
manufacturers' representatives as part of our selling effort.
When selling both our integrated circuits and optoelectronic components, we
aim to have our customers incorporate our products into the end products they
design and develop. Typically, manufacturers of communications and computer
equipment conduct a competitive process to select suppliers for the parts that
they will include in their end products. Our sales, marketing and technical
personnel work with customers to demonstrate our products' ability to satisfy
any specific requirements. We call winning the competitive process a design win.
A design win is important because it allows us to establish a long-term
relationship with the customer, at least through the life-cycle of the product.
We generally do not, however, enter into written agreements with our customers
after achieving a design win. A customer could terminate our relationship or
discontinue developing the product. Most of our revenue originates from sales
that are the result of design wins.
After we achieve a design win and negotiate the terms of the sale, we
deliver our products to our end customers in a number of ways. Our end customers
typically have us ship our products to their facilities directly. In some
instances, however, our customer uses a contract manufacturer to manufacture and
assemble their end product. When our product is being incorporated into an end
product being manufactured by a contract manufacturer, we often ship our product
directly to the contract manufacturer and receive payment from that contract
manufacturer. To determine our sales to particular customers, however, we
recognize this type of transaction as a sale to, and revenue from, the end
customer. Sometimes a customer for which we have achieved a design win will have
us sell that product to a distributor or trading company from which they buy our
product. We recognize these transactions as indirect sales.
MANUFACTURING AND SUPPLIES
MANUFACTURING
Our manufacturing operations are organized in two distinct groups:
integrated circuit and optoelectronic component manufacturing. Due to increasing
overlap of our products and manufacturing processes, we have started to
integrate our manufacturing operations, where appropriate, to improve
operational efficiencies.
INTEGRATED CIRCUIT MANUFACTURING
We had seven facilities located in four countries devoted to manufacturing
integrated circuits as of September 30, 2001. These sites utilized approximately
2.3 million square feet. As part of our announced restructuring activities, we
are in the process of closing approximately 90,000 square feet of this space. As
of September 30, 2001, we had approximately 5,950 employees devoted to
integrated circuit manufacturing. During fiscal 2001, our company-owned and
joint venture wafer fabrication was done in the United States, Spain and
Singapore, while our assembly and test operations were in the United States,
Singapore and Thailand.
Currently, we manufacture most of our integrated circuits in facilities
that we either own or operate through a joint venture. We also have third-party
manufacturing relationships to improve our manufacturing efficiency and
flexibility and to allow us to focus on manufacturing and developing leading
products. We entered into a joint venture with Chartered Semiconductor
Manufacturing Ltd. in December 1997 to open an integrated circuit manufacturing
facility in Singapore. Under the terms of our agreement with Chartered
Semiconductor, we agreed to purchase 51% of the production output from this
facility and Chartered
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Semiconductor agreed to purchase the remaining 49% of the production output. For
more information regarding our joint venture with Chartered Semiconductor,
please see "-- Strategic Relationships -- Manufacturing Relationship." In the
future, we expect to increase the amount of integrated circuits we buy at market
prices, whether through our relationship with Chartered Semiconductor or other
strategic relationships.
We have implemented sophisticated logistics and planning systems and
manufacturing processes that allow us to manufacture and deliver our integrated
circuits more quickly and reliably. The sophisticated internal systems we are
implementing allow us to start manufacturing a customer's specific order for
some integrated circuits within hours of receipt. Today, we believe we are able
to manufacture silicon wafers faster than most of our competitors. However, as
we increase our percentage of wafer fabrication manufactured through strategic
relationships, we may not be able to maintain our manufacturing cycle times. We
assemble, test and ship our integrated circuits, on average, in approximately
two and a half days, which we believe is better than the industry average. We
intend to continue performing these activities for substantially all of our
integrated circuits in the future and to maintain our industry-leading cycle
time.
OPTOELECTRONIC COMPONENT MANUFACTURING
We had six facilities located in the United States and one facility located
in Mexico devoted to manufacturing optoelectronic components as of September 30,
2001. These sites utilized approximately 700,000 square feet. As part of our
announced restructuring activities, we have closed two sites in the United
States. As of September 30, 2001, we had approximately 1,650 employees devoted
to optoelectronic component manufacturing. Currently, we manufacture
substantially all of our optoelectronic components internally. A small
percentage of our components, however, are sent to sub-assembly manufacturers.
These are manufacturers that add some pieces to the unfinished product and send
the unfinished product back to us. In these cases, we complete the manufacturing
of the final product and deliver the product to our customers.
We intend to explore opportunities to increase our manufacturing
capabilities through joint ventures or strategic relationships with third
parties. If we form these ventures or develop these relationships, we will seek
to ensure consistent quality so that neither our customers nor our customers'
end users can differentiate between products that are manufactured in-house and
those that are not. Additionally, we have started to manufacture some of our
silicon-wafer-based optoelectronic components in our integrated circuit
facilities to capture economies of scale. This allows us to apply our extensive
experience in integrated circuit manufacturing to the high-volume manufacturing
of optoelectronic components.
We have automated the manufacturing of core technologies used in our
optoelectronic components. In particular, we have automated our optical
sub-assembly manufacturing process, which is the core technology used in all of
our laser-based optoelectronic products. The benefits of automation include:
- greater volume;
- improved quality and reliability;
- reduced costs; and
- improved speed in responding to customer demands.
SUPPLIES
At times, the integrated circuits and optoelectronic components industries
have been supply constrained, meaning that demand for components is greater than
the ability of most manufacturers of integrated circuit and optoelectronic
components products, including us and our competitors, to supply products. In
early fiscal 2001, we experienced shortages in supplies of parts for our
products and in the equipment needed to increase the capacity of our
manufacturing plants, although by the end of fiscal 2001, we were not
experiencing shortages. Also, there is a limited number of qualified engineers
with the talent to develop and manufacture new products as quickly as desired. A
significant price increase from our suppliers may cause our gross profit to
decline if we could not pass the increase to our customers. The loss of a
significant supplier or the inability
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<PAGE>
of a supplier to meet performance and quality specifications or delivery
schedules may cause our revenue to decline.
We currently purchase several different parts that are used in our
optoelectronic components for which there is only one qualified manufacturer of
each part. Some of these single source suppliers also are competitors of ours.
These parts are included in our optical amplifiers, pump lasers used in
submarine networks, lithium niobate modulators and PIN and APD receivers. The
number of qualified alternative suppliers for our single source parts and
processes is limited and the process of qualifying new suppliers requires a
substantial lead time. Although we have not experienced any significant
difficulties in obtaining the above parts or manufacturing processes, we are
currently looking for alternative sources of these parts and processes, either
through internal development or alternative suppliers.
COMPETITION
We compete in the integrated circuit and optoelectronic component market
segments within the communications component industry. These market segments are
intensely competitive, and are characterized by:
- rapid technological change;
- evolving standards;
- short product life cycles; and
- price erosion.
The number of competitors has risen in the past few years. We expect the
intensity of competition in the market segments we serve to continue to increase
in the future as existing competitors enhance and expand their product offerings
and as new participants enter these market segments. Increased competition may
result in price reductions, reduced revenues and loss of market share. We cannot
assure you that we will be able to compete successfully against existing or
future competitors. Some of our customers and companies with which we have
strategic relationships also are, or may be in the future, competitors of ours.
The size and number of our competitors vary across our product areas, as do
the resources we have allocated to the segments we target. Therefore, many of
our competitors have greater financial, personnel, capacity and other resources
than we have in a particular market segment or overall. Competitors with greater
financial resources may be able to offer lower prices, additional products or
services or other incentives that we cannot match or offer. These competitors
may be in a stronger position to respond quickly to new technologies and may be
able to undertake more extensive marketing campaigns. They also may adopt more
aggressive pricing policies and make more attractive offers to potential
customers, employees and strategic partners. These competitors may make
strategic acquisitions or establish cooperative relationships among themselves
or with third parties to increase their ability to gain market share. Further,
some of our competitors are currently selling commercial quantities of products
that we are sampling to our customers, that are still in the initial stages of
development or that we may develop in the future. By being able to offer these
products in commercial quantities before we do, our competitors can establish
significant market share, acquire design wins in customer equipment programs and
create a market position that we may be unable to overcome once we have
completed development and testing of that product. Because we have a unionized
workforce and many of our main competitors are not unionized to the same extent
or at all, our product costs may be higher. As a result, our competitors may be
more profitable or may be able to compete for customers more effectively based
on price. In the event of a union work stoppage at our facilities, we may be
adversely affected.
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Our primary competitors within our various product areas are listed in the
table below.
<Table>
<Caption>
CLIENT ACCESS
AND WIRELESS
OPTOELECTRONIC NETWORK NETWORK LOCAL AREA
COMPONENTS COMMUNICATIONS CONNECTIVITY WIRELESS PRODUCTS NETWORKING STORAGE AND ANALOG
- -------------- -------------- -------------- ------------------ -------------- ------------------
<S> <C> <C> <C> <C> <C>
Agilent Technologies, Applied Micro Broadcom Corp. Fujitsu Ltd. BreezeCOM Ltd. Analog Devices,
Inc. Circuits Corp. Inc.
Alcatel Broadcom Corp. Conexant Infineon Cisco Systems, Infineon
Systems, Inc. Technologies AG Inc. Technologies AG
Corning Inc. Conexant Infineon Koninklijke Intel Corp. LSI Logic Corp.
Systems, Inc. Technologies Philips
AG Electronics AG
Fujitsu Ltd. IBM Corp. LSI Logic Motorola, Inc. Intersil Marvel
Corp. Holding Corp. Communications
Corp.
Infineon Technologies Infineon Koninklijke NEC Corp. Nokia Corp. STMicroelectronics
AG Technologies Philips N.V.
AG Electronics AG
JDS Uniphase Corp. PMC-Sierra, NEC Corp. QUALCOMM Inc. Nortel Texas Instruments
Inc. Networks Corp. Incorporated
NEC Corp. TranSwitch Texas STMicroelectronics Proxim, Inc.
Corp. Instruments N.V.
Incorporated
Nortel Networks Corp. Vitesse Texas Instruments Symbol
Semiconductor Incorporated Technologies,
Inc.
3Com Corp.
</Table>
While we are the world leader in sales of communications components, our
competitive position varies depending on the market segment and product areas
within these segments. For example, we are number one or two, based on revenue,
in many of our product areas, including the analog modem, baseband integrated
circuits for wireless infrastructure, SONET/SDH integrated circuits and wired
communications integrated circuits. However, our competitive position is not as
strong in the wireless terminal and passive optical component product areas.
While improving our position in many of the product areas where our position is
less well-established is an objective of ours, we cannot assure you that we will
be able to accomplish this goal. Further, because we expect to face increasing
competitive pressures from both current and future competitors in the product
areas we serve, we may not be able to maintain our position in the product areas
in which we are currently a leader.
We believe the following factors are the principal methods of competition
in our industry:
- performance and reliability;
- price;
- compatibility of products with other products and communications
standards used in communications networks;
- product size;
- ability to offer integrated solutions;
- time to market;
- breadth of product line;
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<PAGE>
- logistics and planning systems; and
- quality of manufacturing processes.
While we believe we are competitive on the basis of all the above listed
factors, we believe some of our competitors compete more favorably on the basis
of price and on delivering products to market more quickly. However, we feel we
are particularly strong in offering integrated solutions, our broad product
lines and our logistics and planning systems.
RESEARCH AND DEVELOPMENT
Our research and development personnel focus on product and manufacturing
process development, which provides the technological basis for our commercial
products, and on basic research, which helps provide the scientific advances
which ultimately lead to new products and technology and manufacturing
processes. Our product and process development team is comprised of
approximately 2,700 development engineers and scientists. Approximately
two-thirds of these development engineers and scientists work directly in our
business units to design and implement product solutions. The remaining
one-third work primarily on manufacturing and design technology that spans large
segments of our business, such as the technology for system-on-a-chip and
high-performance optical modules.
Our basic research effort is organized into three areas:
- optoelectronics;
- electronic devices; and
- circuits and systems.
Our researchers perform application-focused research, primarily around
optical communications, semiconductor technology and advanced circuit and
systems development for future communications technologies. Across each of the
areas, we also focus on products that seek to combine our integrated circuit and
optoelectronic capabilities. We believe that the combination of our integrated
circuits and optoelectronic components may offer our customers several benefits,
including improved product performance and reduced product size and costs. This
combination also may allow our customers to decrease time-to-market and reduce
the number of their suppliers.
In addition to our internal research and development team, we also work
closely with universities around the world. We also have entered into joint
research and development initiatives with a number of our customers.
Our research and development expenditures were $951 million, $827 million
and $683 million for fiscal years 2001, 2000 and 1999, respectively. We
anticipate that we will continue to make significant research and development
expenditures to maintain our competitive position with a continuing flow of
innovative products, technology and manufacturing processes, although at lower
levels than in fiscal 2001. We expect to fund our future research and
development expenditures from our operations.
STRATEGIC RELATIONSHIPS
As part of our manufacturing strategy, we have entered into joint ventures
with various partners. We also have developed strategic relationships to augment
our technological capabilities.
MANUFACTURING RELATIONSHIP
In December 1997, we entered into a joint venture, called Silicon
Manufacturing Partners, with Chartered Semiconductor Manufacturing Ltd., a
leading manufacturing foundry for integrated circuits, to operate a 54,000
square foot integrated circuit manufacturing facility in Singapore. We have a
51% equity interest in this joint venture, and Chartered Semiconductor owns the
remaining 49% equity interest. Under the terms of our agreement with Chartered
Semiconductor and Silicon Manufacturing Partners, we agreed to purchase 51% of
the production output from this facility and Chartered Semiconductor agreed to
purchase the
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<PAGE>
remaining 49% of the production output. If we do not purchase all the wafers
allotted to us, we are obligated to reimburse the joint venture for the portion
of fixed costs associated with the unpurchased wafers. Chartered Semiconductor
is similarly obligated with respect to the wafers allotted to it. Chartered
Semiconductor will also have the right of first refusal to the wafers produced
in excess of our requirements. The joint manufacturing venture is currently
operational.
The agreement may be terminated by either party upon two years written
notice, but may not be terminated prior to February 2008. The agreement also may
be terminated for material breach, bankruptcy or insolvency.
TECHNOLOGY RELATIONSHIPS
Our most important technology relationships are described below.
Integrated Circuit Manufacturing Process Technology
In July 2000, we entered into an agreement with Chartered Semiconductor
committing us and Chartered Semiconductor to jointly develop manufacturing
technologies for future generations of integrated circuits targeted at
communications markets. We have agreed to invest up to $350 million over a five
year period. As part of the joint development activities, our two companies will
staff a new research and development team at Chartered Semiconductor's Woodlands
campus in Singapore. These scientists and engineers will work with our teams in
Murray Hill, New Jersey, and Orlando, Florida, as well as with Chartered
Semiconductor's technology development organization.
During the term of the agreement and for five years thereafter, we and
Chartered Semiconductor will be required to update each other, without
compensation, with technical information relating to any corrections or
improvements made to the processes which we have jointly developed. All
intellectual property jointly developed, other than patents, will be jointly
owned by us and Chartered Semiconductor. Jointly made inventions and patents
which issue from these inventions will be equally divided between us and
Chartered Semiconductor, and the non-owning party will receive a nonexclusive,
royalty-free and nontransferable license for each invention or patent. The
agreement may be terminated for breach of material terms upon 30 days notice or
for convenience upon six months notice prior to the planned successful
completion of a development project, in which case the agreement will terminate
upon the actual successful completion of such project.
StarCore
In June 1998, we entered into a Joint Design Center operating agreement
with Motorola, Inc. to develop advanced digital signal processor technologies.
We and Motorola develop these technologies in a joint design center called the
StarCore Technology Center located in Atlanta, Georgia. We and Motorola equally
share the funding of the costs and expenses of operating the center. The board
of advisors comprised of ours and Motorola's representatives will determine, on
a yearly basis, the annual budget for operating the center. The StarCore
Technology Center designs digital signal processor cores and development tools
that we can incorporate in our complete system-on-a-chip solutions for
communications applications. StarCore focuses on digital signal processor
technologies for cellular base stations and the transmission of wireless data
and other applications. The StarCore SC-140 digital signal processor core, the
first core developed by the StarCore Technology Center, was produced in April
1999. We are currently sampling integrated circuit solutions which include this
digital signal processor core.
During the term of the agreement, the items developed within the joint
design center, other than patents, may be licensed to third parties only upon
mutual consent by Motorola and us. All joint patents, which are patents arising
out of inventions made jointly by our employees or consultants and those of
Motorola where such employees or consultants were assigned to the joint design
center, will be jointly owned by us and Motorola. We and Motorola will be free
to use these jointly owned patents for any purpose and to license third parties
under these patents without approval from the other.
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The initial term of the agreement will expire on May 1, 2008, and may be
extended for successive two year periods by mutual agreement. We and Motorola
will review the operations of the joint design center in June 2002 and every two
years thereafter. After any such review either we or Motorola may terminate the
agreement upon one year written notice. The agreement also may be terminated for
breach of material terms, insolvency or bankruptcy.
MEMS
We have entered into a joint design center agreement with Lucent to develop
technology for micro electro-mechanical systems, or MEMS, which are small
mechanical devices that perform a variety of functions. The primary focus of the
joint design center will be the development of optical MEMS. We and Lucent have
both agreed to jointly fund, manage and staff the joint design center over the
following three years to develop this technology. We and Lucent each have a
one-half interest in the MEMS technical information owned by Lucent as of
February 1, 2001. We and Lucent have granted each other a perpetual,
nonexclusive, royalty-free license in our respective patents which issue from
applications having an effective first filing date prior to February 1, 2003 to
make and sell MEMS products. All joint patents, which are patents issued from
any application filed with respect to any invention made jointly by us and
Lucent while working on a joint design center product and conceived or reduced
to practice during performance under the agreement, will be jointly owned by us
and Lucent. We and Lucent will be free to use these jointly owned patents for
any purpose and to license third parties under these patents. Some of these
products may be manufactured exclusively for Lucent, subject to some
restrictions, for a limited period following the first commercial availability
of a product, on a case by case basis. The initial term of the agreement will
expire on January 31, 2004. The agreement may be terminated for breach of
material terms or by prior written notice of either party for convenience.
PATENTS, TRADEMARKS AND OTHER INTELLECTUAL PROPERTY
We own or have rights to a number of patents, trademarks, copyrights, trade
secrets and other intellectual property directly related to and important to our
business. Under the intellectual property agreements we entered into with Lucent
as part of the separation, Lucent has assigned or exclusively licensed to us
approximately 6,000 U.S. patents and patent applications and their corresponding
foreign patents and patent applications. These patents include patents related
to the following technologies:
- integrated circuit and optoelectronic manufacturing processes;
- lasers;
- optical modulators;
- lithium niobate devices;
- optoelectronic receivers; and
- integrated circuits for use in products such as modems, digital signal
processors, wireless communications, network processors and communication
protocols.
In connection with these patents, we have entered into a cross license
agreement with Lucent. In addition, we have received a joint ownership interest
in patents and patent applications relating to optical micro electro-mechanical
systems, or MEMS.
Lucent has also granted us rights and licenses to patents, trademarks,
copyrights, trade secrets and other intellectual property that are not directly
related to our business but help facilitate our business. We also have received
non-exclusive licenses to all other patents retained by Lucent, including
patents in areas such as optical fiber, audio and video coding and
telecommunications systems. In addition, Lucent has conveyed to us numerous
sublicenses under patents of third parties. We derive revenue from licensing our
intellectual property.
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<PAGE>
In addition, Lucent has assigned to us numerous trademarks, both in the
United States and in foreign countries. The primary trademarks used in the sale
of our products have been transferred to us, except for the Lucent name and logo
and the Bell Laboratories name.
The patents described above include patents of all ages ranging from
pending applications, which will have a duration of 20 years from their filing
dates, through patents soon to expire. The agreements do not provide for
termination.
We indemnify our customers for some of the costs and damages of patent
infringement in circumstances where our product is the primary factor creating
the customer's infringement exposure. We generally exclude coverage where
infringement arises out of the combination of our products with products of
others.
We expect to protect our products and processes by asserting our
intellectual property rights where appropriate and prudent. We also will obtain
patents, copyrights, and other intellectual property rights used in connection
with our business when practicable and appropriate.
GOVERNMENT REGULATION
Many of our customers' end products that include our integrated circuits or
optoelectronic components are subject to extensive telecommunications-based
regulation by the United States and foreign laws and international treaties. We
must design and manufacture our products to ensure that our customers are able
to satisfy a variety of regulatory requirements and protocols established to,
among other things, avoid interference among users of radio frequencies and to
permit interconnection of equipment. For example, disk drives that include our
integrated circuits need to satisfy Federal Communications Commission emissions
testing. Cellular base stations that include our integrated solutions must be
qualified by the Federal Communications Commission that they meet radio
frequency spectrum requirements. In addition, some of our equipment products,
such as our wireless local area networking products, must be certified to
safety, electrical noise and communications standards compliance.
Each country has different regulations and a different regulatory process.
In order for our customers' products to be used in some jurisdictions,
regulatory approval and, in some cases, specific country compliance testing and
re-testing may be required. The delays inherent in this regulatory approval
process may force our customers to reschedule, postpone or cancel the
incorporation of our products into their products, which may result in
significant reductions in our sales. The failure to comply with current or
future regulations or changes in the interpretation of existing regulations in a
particular country could result in the suspension or cessation of sales in that
country by us or our customers. It also may require us to incur substantial
costs to modify our products to aid our customers in complying with the
regulations of that country.
We work with consultants, counsel and testing laboratories to support our
compliance efforts as necessary. These individuals work to ensure that our
products comply with the requirements of the Federal Communications Commission
in the United States and with the requirements of the European
Telecommunications Standards Institute in western Europe, as well as with the
various individual regulations of other countries.
The regulatory environment in which we operate is subject to changes due to
political, economic and technical factors. In particular, as use of wireless
technology expands and as national governments continue to develop regulations
for this technology, we may need to comply with new regulatory standards
applicable to our products. Changes in our regulatory environment that generally
result from our expansion into new areas or changes in current regulations could
increase the cost of manufacturing our products because we must continually
modify our products to respond to these changes.
In addition, domestic and international authorities continue to regulate
the allocation and auction of the radio frequency spectrum. These regulations
have a direct impact on us because many of our customers' licensed products can
be marketed only if permitted by suitable frequency allocations, auctions and
regulations. The implementation of these regulations may delay our end-users in
deploying their systems, which could, in turn, lead to delays in orders of our
products by our customers and end users. Further, when we license hardware and
software designs for mobile telephones that use our integrated circuits, we work
with
18
<PAGE>
our customers to help them achieve full certification approval for their mobile
telephones, which is a prerequisite for them to be able to sell their mobile
telephones.
EMPLOYEES
As of September 30, 2001, we employed approximately 14,400 full-time
employees, including approximately 2,700 research and development employees and
7,600 manufacturing employees. During fiscal 2001, we announced a series of
restructuring initiatives that include closing our Madrid manufacturing location
by the end of the calendar year and reducing employment worldwide by
approximately 6,000 positions, of which 4,300 had been eliminated by September
30, 2001. Of our 14,400 employees at September 30, 2001, approximately 7,650
were management and non union-represented employees, and approximately 3,450
were U.S. union-represented employees covered by collective bargaining
agreements. In addition, approximately 200 employees were union-represented
employees located in Mexico and covered by a collective bargaining agreement.
On May 31, 1998, Lucent entered into a collective bargaining agreement with
the Communications Workers of America and into a separate agreement with the
International Brotherhood of Electrical Workers. In connection with our
separation from Lucent, we will assume the obligations under these agreements
with respect to our U.S. union-represented employees. These agreements will be
effective until May 31, 2003, unless the parties to each agreement reach a
mutual agreement to amend the terms. All of our unionized employees in Mexico
are members of the Mexican National Union of Industrial Workers. We entered into
a collective bargaining agreement with this union on January 10, 2000. As is
typical in Mexico, wages are renegotiated every year, while other terms and
conditions of employment are renegotiated every two years. We believe that we
generally have a good relationship with our employees and the unions that
represent them. We are subject from time to time to unfair labor charges filed
by the unions with the National Labor Relations Board. If we are unsuccessful in
resolving these charges, our operations may be disrupted or we may incur
additional costs that may adversely affect our results of operations. If we
experience any work stoppages by our union employees, we believe that we may be
affected to a greater extent than our competitors.
BACKLOG
Our backlog, which represents the aggregate of the sales price of orders
received from customers, but not yet recognized as revenue, was approximately
$769 million and $1.9 billion on September 30, 2001 and September 30, 2000,
respectively. The majority of these orders are fulfilled within three months.
All orders, however, are subject to possible rescheduling by customers. Our
customers often change their order two or three times between initial order and
delivery. Our customers' frequent changes usually relate to quantities or
delivery dates, but sometimes relate to the specifications of the products we
are shipping. Although we believe that the orders included in the backlog are
firm, orders may generally be cancelled by the customer without penalty. We also
may elect to permit cancellation of orders without penalty where management
believes it is in our best interests to do so. For these reasons, we believe
that our backlog at any given date is not a meaningful indicator of future
revenues.
ENVIRONMENTAL, HEALTH AND SAFETY MATTERS
We are subject to a wide range of laws and regulations relating to
protection of the environment and employee health and safety. Most of our
manufacturing facilities have undergone regular internal audits relating to
environmental, health and safety requirements. Most of those facilities also are
regularly audited and certified by an independent and accredited third party
registrar, such as Lloyd's Register Quality Assurance, as conforming to the
internationally recognized ISO 14001 standard relating to environmental
management. In addition, most of our non-U.S. manufacturing facilities conform
to BS 8800, the British standard for occupational health and safety management
systems. Based upon these reviews, we believe that our manufacturing facilities
are in substantial compliance with all applicable environmental, health and
safety requirements.
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<PAGE>
We are 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 us, or at sites where we may have
sent waste for disposal. These laws often require parties to fund remedial
action at sites regardless of fault. Lucent is a potentially responsible party
at numerous Superfund sites and sites otherwise requiring cleanup action. With
some limited exceptions, under the agreement governing our separation from
Lucent, we have assumed all environmental liabilities resulting from our
businesses, which include liabilities for the costs associated with eight of
these sites -- five Superfund sites, two of our former facilities and one of our
current manufacturing facilities.
ORGANIZATIONAL STRUCTURE EFFECTIVE OCTOBER 1, 2001
Effective October 1, 2001, we aligned our products under two new
market-focused groups, Infrastructure Systems and Client Systems, that target
the network equipment and consumer communications markets respectively.
In addition, we have combined the supply chain management and manufacturing
activities of both integrated circuits devices and optoelectronics components
under a new Operations support organization to bring a full-systems perspective
to our manufacturing processes. This group manages manufacturing and the full
supply chain across both the systems groups.
INFRASTRUCTURE SYSTEMS GROUP
We are consolidating research and development, as well as marketing, for
both integrated circuits devices and optoelectronics aimed at communications
systems under the Infrastructure group. This will allow us to design, develop
and deliver complete, interoperable solutions to equipment manufacturers for
advanced enterprise, access, metropolitan, long-haul and undersea applications.
CLIENT SYSTEMS GROUP
The Client Systems group will focus primarily on wireless data and computer
communications applications. The group will deliver semiconductor solutions for
a variety of end-user applications such as modems, Internet-enabled cellular
terminals and hard-disk drives for computers. In addition, the group will offer
semiconductor, software, systems and wireless local area network (LAN) solutions
through the ORiNOCO product family.
ITEM 2. PROPERTIES
As of September 30, 2001, we operated 13 manufacturing facilities and four
warehouse locations in the United States and five other countries. We also
operated an additional 65 facilities, including research and development
facilities and design centers. We operate facilities in a total of 19 countries.
Our principal owned manufacturing facilities were located in the United States,
Mexico, Singapore, Spain and Thailand, although we are in the process of closing
our facility in Spain. We also have a 51% interest in our Silicon Manufacturing
Partners joint venture located in Singapore which is predominantly used as a
manufacturing site. Our facilities had an aggregate floor space of approximately
8.3 million square feet, of which approximately 5.5 million square feet is owned
and approximately 2.8 million square feet is leased. Our lease terms range from
monthly leases to 14 years. We believe that all of our facilities and equipment
are in good condition and are well maintained and able to operate at present
levels.
ITEM 3. LEGAL PROCEEDINGS
The information required by this Item is included in Item 7 of Part II of
this Form 10-K under the heading "Legal Proceedings."
20
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ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
During the fourth quarter of fiscal 2001, no matter was submitted to a vote
of the security holders of Agere.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
PRICE RANGE OF COMMON STOCK
Agere's Class A common stock trades on the New York Stock Exchange under
the symbol "AGR.A." The high and low sale prices for our Class A common stock
for each quarter since our initial public offering on March 27, 2001 are set
forth below:
<Table>
<Caption>
QUARTER ENDED HIGH LOW
------------- ---- ---
<S> <C> <C>
March 31, 2001.............................................. $6.23 $6.01
June 30, 2001............................................... 9.50 4.10
September 30, 2001.......................................... 7.50 3.10
</Table>
As of December 1, 2001 there were approximately 739 holders of record of
the Class A common stock. However, we believe that the number of beneficial
owners is substantially greater than the number of record holders, because a
large portion of the Class A common stock is held of record through brokerage
firms in "street name."
All of Agere's outstanding Class B common stock is held by Lucent. There is
currently no established trading market for our Class B common stock.
DIVIDEND POLICY
We do not anticipate paying any dividends on our common stock in the
foreseeable future. We currently intend to retain our future earnings for use in
the operation and expansion of our business. Under our bank credit facility, we
are not permitted to pay any dividends on our common stock other than dividends
payable solely in additional shares of our common stock and dividends pursuant
to our stockholders' rights plan.
ITEM 6. SELECTED FINANCIAL DATA
The following table sets forth selected financial information for the
company. The financial information for the years ended September 30, 2001, 2000
and 1999 and as of September 30, 2001 and 2000 has been derived from the
company's audited consolidated and combined financial statements included
elsewhere in this report. The financial information for the year ended September
30, 1998 and as of September 30, 1999 has been derived from the company's
audited combined financial statements not included in this report. The financial
information for the year ended September 30, 1997 and as of September 30, 1998
and 1997 has been derived from the company's unaudited combined financial
statements not included in this report. The historical selected financial
information may not be indicative of our future performance as a stand-alone
company and should be read in conjunction with the information contained in
"Management's Discussion and
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<PAGE>
Analysis of Financial Condition and Results of Operations" and the consolidated
and combined financial statements and the related notes included elsewhere in
this report.
<Table>
<Caption>
YEAR ENDED SEPTEMBER 30,
-------------------------------------------------
2001(1) 2000(2) 1999 1998 1997
-------- -------- ------- ------- -------
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS INFORMATION:
Revenue.......................................... $ 4,080 $4,708 $3,714 $3,101 $2,769
Gross profit..................................... 996 2,153 1,765 1,509 1,321
Purchased in-process research and development.... -- 446 17 48 --
Amortization of goodwill and other acquired
intangibles.................................... 415 189 13 3 1
Restructuring and separation..................... 662 -- -- -- --
Impairment of goodwill and other acquired
intangibles.................................... 2,762 -- -- -- --
Income (loss) before cumulative effect of
accounting change.............................. (4,612) (76) 319 303 275
Cumulative effect of accounting change (net of
provision (benefit) for income taxes of $(2) in
2001 and $21 in 1999)(3)....................... (4) -- 32 -- --
Net income (loss)................................ $(4,616) $ (76) $ 351 $ 303 $ 275
BASIC AND DILUTED EARNINGS (LOSS) PER SHARE:(4)
Income (loss) before cumulative effect of
accounting change.............................. $ (3.46) $ (.07) $ .31 $ .29 $ .27
Cumulative effect of accounting change(3)........ -- -- .03 -- --
Net income (loss)................................ $ (3.46) $ (.07) $ .34 $ .29 $ .27
Weighted average shares outstanding -- basic and
diluted (millions)............................. 1,334 1,035 1,035 1,035 1,035
</Table>
<Table>
<Caption>
AT SEPTEMBER 30,
------------------------------------------
2001 2000 1999 1998 1997
------ ------ ------ ------ ------
<S> <C> <C> <C> <C> <C>
BALANCE SHEET INFORMATION:
Working capital................................... $ 156 $ 428 $ 219 $ 409 $ 331
Total assets...................................... 6,562 7,067 3,020 2,481 2,197
Short-term debt................................... 2,516 14 14 -- --
Long-term debt.................................... 33 46 64 -- --
</Table>
- ---------------
(1) During fiscal 2001 we received approximately $3.4 billion of net proceeds
from our initial public offering and recorded a $2.8 billion impairment of
goodwill and other acquired intangibles related to our acquisitions of Ortel
Corporation, Herrmann Technology, Inc., Agere, Inc. and Enable
Semiconductor, Inc. We also assumed $2.5 billion of debt from Lucent
Technologies Inc., consisting of short-term borrowings under a credit
facility provided by financial institutions. We did not receive any of the
proceeds of this short-term debt.
(2) During fiscal 2000 goodwill and other acquired intangibles increased by $3.4
billion due to the acquisitions of Ortel, Herrmann, Agere, Inc. and
substantially all the assets of VTC Inc., whose results of operations are
included from their respective dates of acquisition.
(3) Effective October 1, 2000, we adopted Statement of Financial Accounting
Standards No. 133, "Accounting for Derivative Instruments and Hedging
Activities," as amended.
Effective October 1, 1998, we changed our method for calculating the
market-related value of plan assets used in determining the expected
return-on-asset component of annual net pension and postretirement benefit
costs.
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<PAGE>
(4) Basic and diluted earnings (loss) per common share are calculated by
dividing income (loss) by the weighted average number of common shares
outstanding during the period. The weighted average number of common shares
outstanding on a historical basis includes the retroactive recognition to
October 1, 1996 of the 1,035,000,000 shares owned by Lucent prior to our
initial public offering.
ITEM 7. 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 consolidated and combined
financial statements 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 are the world leader in sales of communication components, which include
integrated circuits and optical components. Communication components are the
basic building blocks of electronic and photonic products and systems for
terrestrial and submarine, or undersea, communications networks and for
communications equipment. We sell our integrated circuits and optoelectronic
components globally to manufacturers of communications and computer equipment.
We report our operations in two segments: Integrated Circuits and
Optoelectronics. Integrated circuits, or chips, 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. The Integrated
Circuits segment includes our wireless local area networking products, which
facilitate the transmission of data and voice signals within a localized area
without cables or wires. The Optoelectronics segment represents our
optoelectronic components operations, including both our active optoelectronic
and our passive optical components. Optoelectronic components transmit, process,
change, amplify and receive light that carries data and voice traffic over
optical networks. The Integrated Circuits and Optoelectronics segments each
include revenue from the licensing of intellectual property related to that
segment.
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. We had no material assets or
activities as a separate corporate entity until the contribution to us by Lucent
of its integrated circuits and optoelectronic components businesses. Lucent
conducted these businesses through various divisions and subsidiaries. On
February 1, 2001, Lucent began the separation of our company by transferring to
us the assets and liabilities related to these businesses. The separation was
substantially completed, including the transfer of all assets and liabilities
other than prepaid pension costs and postretirement liabilities, which have yet
to be transferred, when we completed our initial public offering in April 2001.
As of September 30, 2001, Lucent owned 100% of our outstanding Class B common
stock and 37 million shares of our outstanding Class A common stock, which
represented approximately 58% of the total outstanding common stock and
approximately 84% of the combined voting power of both classes of our common
stock with respect to the election and removal of directors.
Lucent originally announced its intention to distribute all shares of our
common stock it then owned to its shareholders in a tax-free distribution by
September 30, 2001. On August 16, 2001, Lucent amended its credit facilities.
The amended credit facilities modified the conditions that must be met before
Lucent can distribute its Agere stock to its stockholders. The distribution of
Agere stock can occur at Lucent's request if the following terms and conditions,
as defined under Lucent's credit facilities, are met by Lucent:
- no event of default exists under the credit facilities;
- generated positive earnings before interest, taxes, depreciation and
amortization for the fiscal quarter immediately preceding the
distribution;
- meet a minimum current asset ratio;
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<PAGE>
- receipt of $5,000 million in cash from certain non-operating sources; and
- its 364-day $2,000 million credit facility has been terminated and its
$2,000 million credit facility expiring in February 2003 has been reduced
to $1,750 million or less.
On November 30, 2001, Lucent stated it remained committed to completing the
process of separating Agere from Lucent, and that it intended to move forward
with the distribution of the Agere stock it held in a tax-free spin off to its
shareholders. Because Lucent must meet a number of conditions before it can
complete the spin off and because Lucent alone will make the decision about
whether to complete the spin off, even if the conditions were met, we can not
assure you that Lucent will complete the spin off by a particular date or at
all.
In connection with our separation from Lucent, we entered into several
agreements with Lucent regarding, among other things, interim services,
intellectual property and product supply. The interim services agreement sets
forth charges generally intended to allow the providing company to fully recover
the allocated direct costs of providing the services, plus all out-of-pocket
costs and expenses. For more information, see note 19 to our financial
statements in Item 8.
Lucent is our largest customer with purchases in fiscal 2001, 2000 and 1999
representing 14.9%, 21.3% and 25.7%, respectively, of our revenue. We expect
Lucent will continue to represent a significant percentage of our revenue in the
foreseeable future.
Our financial statements include amounts prior to February 1, 2001 that
have been derived from the financial statements and accounting records of Lucent
using the historical results of operations and historical basis of the assets
and liabilities of our businesses. We believe the assumptions underlying our
financial statements are reasonable. However, our financial statements for
periods prior to February 1, 2001 may not necessarily reflect our results of
operations, financial position and cash flows in the future or what our results
of operations, financial position and cash flows would have been had we been a
stand-alone company during the periods presented. Because a direct ownership
relationship did not exist among all the various units comprising Agere,
Lucent's net investment in us is shown in lieu of stockholders' equity in our
financial statements for periods prior to February 1, 2001. For periods prior to
February 1, 2001, our financial statements include allocations of Lucent's
expenses, assets and liabilities, including allocations for general corporate
expenses, basic research, interest expense, pension and postretirement costs,
income taxes and cash and receivables, which are discussed in note 1 to our
financial statements in Item 8.
ACQUISITIONS
During fiscal 1999 and 2000 we completed the acquisitions described below
as part of our efforts to broaden our portfolio of product offerings. We did not
have any significant acquisitions during fiscal 2001.
In June 2000, we acquired Herrmann, a developer and manufacturer of passive
optical filters that can be used in conjunction with active optoelectronic
components in products such as amplifiers. The purchase price was $432 million
in Lucent common stock and options. In connection with this acquisition, certain
former stockholders of Herrmann are entitled to receive up to a total of 677,019
additional shares of Lucent common stock based on retention and the achievement
of specified milestones, which require the production of two products at
improved manufacturing yields within the three-year period following the
acquisition. As of September 30, 2001, 200,000 shares of Lucent common stock had
been released based on the achievement of milestones, resulting in additional
goodwill related to the acquisition. The achievement of additional milestones
may also result in additional goodwill.
In April 2000, we acquired Ortel, a developer and manufacturer of
semiconductor optoelectronic components used in fiber optic systems for cable
television and data communications networks. The purchase price was $2,998
million in Lucent common stock and options.
In April 2000, we acquired Agere, Inc., a developer and supplier of network
processor integrated circuits. Network processors control how data is sent over
a network. The purchase price was $377 million in Lucent common stock and
options.
24
<PAGE>
In March 2000, we acquired substantially all the assets of VTC, a supplier
of integrated circuits to computer hard disk drive manufacturers. The purchase
price was $104 million in cash. In connection with this acquisition,
stockholders of VTC are entitled to receive additional cash consideration of up
to $50 million contingent on the delivery of product at specified manufacturing
yields and the transfer and qualification of process technology to our
manufacturing facilities. As of September 30, 2001, $30 million of the
additional cash consideration had been paid, resulting in additional goodwill
related to the acquisition. Any future contingent cash consideration paid will
also be recorded as additional goodwill.
In March 1999, we acquired Enable, a developer of integrated circuits for
local area network equipment. The purchase price was $51 million in cash.
In February 1999, we acquired Sybarus Technologies ULC, a developer of
integrated circuits for communications networks. The purchase price was $41
million in cash.
During fiscal 2001, we performed impairment evaluations of the goodwill and
other acquired intangibles from recent acquisitions. The assessments were
performed in accordance with Statement of Financial Accounting Standards No.
121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to be Disposed of," as a result of weakening economic conditions and
decreased current and expected future demand for products in the markets in
which we operate. We determined the fair value of the acquired entities using a
discounted cash flow model based on growth rates and margins reflective of the
current decrease in demand for our products, as well as anticipated future
demand. Discount rates used were based upon our weighted average cost of capital
adjusted for business risks. These assumptions were based on management's best
estimate of future results. As a result of the assessments, we determined that
an other than temporary impairment of goodwill and other acquired intangibles
existed. We recorded a charge to reduce goodwill and other acquired intangibles
of $2,762 million during fiscal 2001, consisting of $2,220 million, $275
million, $240 million and $27 million related to Ortel, Herrmann, Agere, Inc.
and Enable, respectively.
OPERATING TRENDS
Order levels and revenues declined significantly in the latter half of
fiscal 2001 and are expected to remain at lower levels in the near-term. We
believe the decreases are due to weakness in our customers' markets and excess
inventory held by our customers. We experienced a higher than normal level of
order cancellations and reschedules during the second half of fiscal 2001.
Although the level of customer order changes has decreased in recent months, our
order backlog is lower than we have experienced in the past. Because of this
reduced backlog and the potential for additional order changes by customers our
ability to forecast future results is limited.
Our costs consist primarily of manufacturing overhead, materials and labor.
Similar to many semiconductor manufacturers, we have relatively high fixed costs
associated with our wafer manufacturing. As a result, our ability to reduce
costs quickly in times of decreased demand is limited, which has an adverse
effect on margins. Because we anticipated higher revenues as we entered fiscal
2001, our cost structure reflected manufacturing capacity and resources greater
than those actually required. In light of the lower revenues we have experienced
in recent quarters, we have taken a number of steps to reduce our cost
structure, including restructuring activities and reductions in capital
spending. We continue to evaluate our cost and expense structure and expect to
announce additional actions during fiscal year 2002 to further reduce our costs,
expenses and break-even point.
RESTRUCTURING AND SEPARATION EXPENSES AND INVENTORY PROVISION
In fiscal 2001, we announced a series of restructuring initiatives to
reduce our cost structure in light of declining revenues. We recorded a
restructuring charge of $563 million in fiscal 2001 classified within
restructuring and separation expenses. These restructuring initiatives include a
worldwide workforce reduction, rationalization of manufacturing capacity and
other activities.
The restructuring initiatives announced in fiscal 2001 will result in a
workforce reduction of approximately 6,000 employees across various business
functions, operating units and geographic regions, and
25
<PAGE>
includes both management and occupational employees. We recorded a restructuring
charge of $177 million in fiscal 2001 related to approximately 5,500 employees,
of which approximately 4,300 employees had been taken off-roll as of September
30, 2001, and expect to record a restructuring charge of approximately $20
million related to the additional 500 employees by the end of the first quarter
of fiscal 2002. Of the $177 million charge, $28 million represents termination
benefits to U.S. management employees that will be funded through Lucent's
pension assets. Severance costs and other exit costs noted above were determined
in accordance with Emerging Issues Task Force No. 94-3, "Liability Recognition
for Certain Employee Termination Benefits and Other Costs to Exit an Activity."
In addition, on December 5, 2001, we announced our intention to further reduce
our workforce by approximately 950 positions. See note 22 to our financial
statements in Item 8 for further information about this reduction.
We recorded a restructuring charge of $386 million in fiscal 2001 relating
to the rationalization of under-utilized manufacturing facilities and other
restructuring-related activities. We have discontinued manufacturing operations
at our chip fabrication plant in Madrid, Spain and have agreed to sell the
facility. We are also rationalizing under-utilized manufacturing capacity at our
facilities in Orlando, Florida, and in Allentown, Breiningsville and Reading,
Pennsylvania. In addition, we are consolidating several satellite-manufacturing
sites, as well as leased corporate offices. The restructuring charge for fiscal
2001 includes $37 million related to facility closings primarily for lease
terminations, non-cancelable leases and related costs. It also includes an asset
impairment charge of $287 million related to property, plant and equipment
associated with the consolidation of manufacturing and other corporate
facilities. This charge was recognized in accordance with the guidance on
impairment of assets in Statement 121. The remaining restructuring charge of $62
million relates primarily to contract terminations.
A summary of restructuring charges is outlined as follows:
<Table>
<Caption>
YEAR ENDED AT SEPTEMBER 30,
SEPTEMBER 30, 2001 2001
----------------------------- ------------------
TOTAL NON CASH CASH RESTRUCTURING
CHARGES CHARGES PAYMENTS RESERVE
------- -------- -------- ------------------
(DOLLARS IN MILLIONS)
<S> <C> <C> <C> <C>
Workforce reduction..................... $177 $ (28) $(57) $ 92
Rationalization of manufacturing
capacity and other charges............ 386 (293) (14) 79
---- ----- ---- ----
Total.............................. $563 $(321) $(71) $171
==== ===== ==== ====
</Table>
We anticipate that the majority of the remaining cash expenditures relating
to workforce reductions will be paid by the end of the first quarter of fiscal
2002 and the majority of the contract termination payments will be paid by the
end of the second quarter of fiscal 2002. Amounts related to non-cancelable
lease obligations due to the consolidation of facilities will be paid over the
respective lease terms through fiscal 2005. We expect to substantially complete
implementation of the announced restructuring program by December 31, 2001. We
currently estimate future annualized pre-tax savings to be approximately $550
million, of which $440 million are cash savings. The full benefit of these
savings will begin to be recognized in the second quarter of fiscal 2002.
We incurred costs, fees and expenses relating to our separation from
Lucent. These costs, fees and expenses were primarily related to legal
separation matters; the establishment of a separate computer and information
technology infrastructure and associated information processing and network
support; marketing relating to building a company brand identity; and,
implementing treasury, real estate, pension and records retention management
services. For fiscal 2001 we incurred $99 million of separation expenses
classified within restructuring and separation expenses. Additional separation
costs that we may incur in future periods are contingent on the form and timing
in which we achieve our full independence from Lucent.
We recorded inventory provisions, classified within cost of sales, of $409
million in fiscal 2001 compared to inventory provisions of $29 million in fiscal
2000. The fiscal 2001 amount, which includes purchase order cancellation
charges, reflects a significant decrease in forecasted revenue and was
calculated in accordance
26
<PAGE>
with our inventory valuation policy, which is based on a review of forecasted
demand compared with existing inventory levels.
REORGANIZATION
Effective October 1, 2001, we have aligned our products under two new
market-focused groups, Infrastructure Systems and Client Systems, that target
the network equipment and consumer communications markets respectively. The
Infrastructure Systems group includes our optoelectronics components business
and portions of our integrated circuits business and will facilitate the
convergence of products from both businesses as we address markets in high-speed
communications systems. The Client Systems group includes our wireless data,
computer communications, storage and wireless terminal solutions products that
address end-user applications markets.
RESULTS OF OPERATIONS
FISCAL YEAR ENDED SEPTEMBER 30, 2001 COMPARED TO FISCAL YEAR ENDED SEPTEMBER
30, 2000
The following table shows the change in revenue by operating segment:
<Table>
<Caption>
YEAR ENDED
SEPTEMBER 30, CHANGE
--------------- -----------
2001 2000 $ %
------ ------ ----- ---
(DOLLARS IN MILLIONS)
<S> <C> <C> <C> <C>
OPERATING SEGMENT:
Integrated Circuits................................. $2,869 $3,507 $(638) (18)%
Optoelectronics..................................... 1,211 1,201 10 1
------ ------ -----
Total............................................ $4,080 $4,708 $(628) (13)%
====== ====== =====
</Table>
Revenue. Revenue decreased 13% or $628 million, to $4,080 million in
fiscal 2001 from $4,708 million in fiscal 2000, primarily due to volume
decreases in the Integrated Circuits segment. The decrease of $638 million
within the Integrated Circuits segment was driven by volume decreases across the
segment, which were partially offset by increased revenues from our wireless
local area networking product offerings. The increase of $10 million within the
Optoelectronics segment was due to increased sales of components used in
submarine network, transponder and access applications, offset by a decrease in
sales of components used in high-speed long haul applications.
During fiscal 2001 revenues decreased sequentially each quarter due to
declining market conditions compared to sequential revenue growth each quarter
in fiscal 2000. Integrated Circuits revenues declined $627 million or 57% to
$469 million in the fourth quarter of fiscal 2001 from the peak quarterly
revenue level of $1,096 million experienced in the fourth quarter of fiscal
2000. Optoelectronic revenues declined $293 million or 69% to $131 million in
the fourth quarter of fiscal 2001 from the peak quarterly revenue level of $424
million experienced in the first quarter of fiscal 2001.
Costs and gross margin. Costs increased 21% or $529 million, to $3,084
million in the current fiscal year from $2,555 million in the prior fiscal year.
Gross margin decreased 21.3 percentage points to 24.4% in fiscal 2001 from 45.7%
in fiscal 2000, primarily due to lower manufacturing capacity utilization and
increased inventory provisions. Gross margin for the Integrated Circuits segment
declined to 30.0% in fiscal 2001 from 44.7% in fiscal 2000 primarily due to
lower manufacturing capacity utilization and increased inventory provisions.
Gross margin for the Optoelectronics segment decreased to 11.1% in fiscal 2001
from 48.7% in fiscal 2000 due to increased inventory provisions, lower
manufacturing capacity utilization and a change in product mix, particularly
from higher margin components of high-speed long haul applications to lower
margin components.
Selling, general and administrative. Selling, general and administrative
expenses increased 12% or $62 million, to $597 million in fiscal 2001 from $535
million in fiscal 2000. This was primarily due to increases
27
<PAGE>
in general and administrative expenses associated with being a stand-alone
company, which were partially offset by lower bonus accruals.
Research and development. Research and development expenses increased 15%
or $124 million, to $951 million in fiscal 2001 from $827 million in fiscal
2000. The increase was due to new and ongoing product development expenses,
including a full year of expenses associated with acquisitions during fiscal
2000, partially offset by lower bonus accruals.
Purchased in-process research and development. Purchased in-process
research and development decreased to zero in fiscal 2001 from $446 million in
fiscal 2000. This is the result of no significant acquisitions being made in
fiscal 2001, while a number of acquisitions were completed in fiscal 2000.
Amortization of goodwill and other acquired intangibles. Amortization
expense increased $226 million to $415 million in fiscal 2001 from $189 million
in fiscal 2000 due to the recognition in fiscal 2001 of amortization associated
with acquisitions completed during fiscal 2000.
Restructuring and separation expenses. Restructuring and separation
expenses of $662 million were incurred in fiscal 2001. We recorded $563 million
of restructuring charges. We also incurred expenses of $99 million in connection
with our separation from Lucent.
Impairment of goodwill and other acquired intangibles. During fiscal 2001,
we determined that an other than temporary impairment of goodwill and other
acquired intangibles existed and recorded a charge of $2,762 million to reduce
goodwill and other acquired intangibles.
Operating income (loss). Operating loss was $4,391 million in fiscal 2001
compared to $156 million of operating income in fiscal 2000. This was driven
primarily by the impairment of goodwill and other acquired intangibles, a
decline in gross profit, restructuring and separation expenses and an increase
in the amortization of goodwill and other acquired intangibles, partially offset
by the absence of purchased in-process research and development costs in fiscal
2001. 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 purchased in-process
research and development costs, amortization of goodwill and other acquired
intangibles, restructuring and separation expenses, and impairment of goodwill
and other acquired intangibles. The following table shows the change in
operating income by segment:
<Table>
<Caption>
YEAR ENDED
SEPTEMBER 30, CHANGE
-------------- --------------
2001 2000 $ %
------ ----- ------- ----
(DOLLARS IN MILLIONS)
<S> <C> <C> <C> <C>
OPERATING SEGMENT:
Integrated Circuits................................ $(282) $434 $ (716) (165)%
Optoelectronics.................................... (270) 357 (627) (176)
----- ---- -------
Total........................................... $(552) $791 $(1,343) (170)%
===== ==== =======
</Table>
Other income-net. Other income-net increased 6% or $2 million, to income
of $35 million in fiscal 2001 from income of $33 million in fiscal 2000. The $35
million in fiscal 2001 was comprised of interest income from our investment of
the proceeds from our initial public offering, income from our equity investment
in Silicon Manufacturing Partners Pte Ltd., the impairment of several
non-consolidated investments and foreign exchange losses. The $33 million in
fiscal 2000 was comprised primarily of gains on sale of investments and foreign
exchange gains.
Interest Expense. Interest expense increased $93 million to $151 million
in fiscal 2001 from $58 million in fiscal 2000. This increase is due to interest
on the $2,500 million of short-term debt we assumed from Lucent in April 2001.
Provision for income taxes. The effective tax rates were (2.3%) and 158.0%
for fiscal 2001 and 2000, respectively. The fiscal 2001 effective tax rate
includes the impact of recording a valuation allowance of approximately $553
million for deferred tax assets, and the effects of non-tax deductible goodwill
amortization
28
<PAGE>
and separation costs. The fiscal 2000 effective tax rate includes the impact of
non-tax deductible goodwill amortization and non-tax deductible purchased
in-process research and development.
FISCAL YEAR ENDED SEPTEMBER 30, 2000 COMPARED TO FISCAL YEAR ENDED SEPTEMBER
30, 1999
The following table shows the change in revenue by operating segment:
<Table>
<Caption>
YEAR ENDED
SEPTEMBER 30, CHANGE
--------------- ----------
2000 1999 $ %
------ ------ ---- ---
(DOLLARS IN MILLIONS)
<S> <C> <C> <C> <C>
OPERATING SEGMENT
Integrated Circuits................................... $3,507 $3,055 $452 15%
Optoelectronics....................................... 1,201 659 542 82
------ ------ ----
Total.............................................. $4,708 $3,714 $994 27%
====== ====== ====
</Table>
Revenue. Revenue increased 27%, or $994 million, to $4,708 million in
fiscal 2000 from $3,714 million in fiscal 1999, primarily due to volume
increases in both the Integrated Circuits and Optoelectronics segments. The
increase of $452 million in the Integrated Circuits segment was driven by
increases across our integrated circuits product offerings except for a decrease
in fiscal 2000 sales of our integrated circuits for wireless terminal devices
due to a missed design win with a large customer in 1999, which resulted in our
not generating sales from a generation of that customer's mobile telephones. The
increase of $542 million in the Optoelectronics segment was driven by increased
sales primarily to existing customers of many of our key optoelectronic
components for high-speed transport and submarine network applications.
Costs and gross margin. Costs increased 31%, or $606 million, to $2,555
million in fiscal 2000 from $1,949 million in fiscal 1999, primarily due to
increased sales volume. Gross margin decreased 1.8 percentage points to 45.7% in
fiscal 2000 from 47.5% in fiscal 1999. Gross margin for the Integrated Circuits
segment was 44.7% in fiscal 2000 and 48.6% in fiscal 1999. The decrease in
Integrated Circuits gross margin was primarily due to lower average revenues per
unit. Gross margin for the Optoelectronics segment increased to 48.7% in fiscal
2000 from 42.5% in fiscal 1999. The increase in Optoelectronics gross margin was
due primarily to the volume growth in the business, which resulted in a more
efficient utilization of manufacturing capacity.
Selling, general and administrative. Selling, general and administrative
expenses decreased 7%, or $38 million, to $535 million in fiscal 2000 from $573
million in fiscal 1999. This decrease was primarily due to lower costs
associated with the implementation of our advanced logistics and planning
systems. These systems were primarily implemented and paid for in fiscal 1999.
Research and development. Research and development expenses increased 21%,
or $144 million, to $827 million in fiscal 2000 from $683 million in fiscal
1999. This increase was primarily due to new and ongoing product development
expenses within the Integrated Circuits and Optoelectronics segments, including
$50 million added during the year as a result of our acquisitions.
Purchased in-process research and development. Purchased in-process
research and development increased $429 million, to $446 million in fiscal 2000
from $17 million in fiscal 1999. This increase was due to the acquisitions of
Ortel, Agere, Inc., Herrmann and substantially all the assets of VTC during
fiscal 2000.
Amortization of goodwill and other acquired intangibles. Amortization
expense increased $176 million, to $189 million in fiscal 2000 from $13 million
in fiscal 1999. This increase reflects amortization of goodwill associated with
the acquisitions of Ortel, Herrmann and Agere, Inc. during fiscal 2000.