1
As Filed with the SEC on May 10, 2001
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
---
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2001
OR
---- TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from _____________to _____________
Commission file number 001-16397
AGERE SYSTEMS INC.
A Delaware I.R.S. Employer
Corporation No. 22-3746606
555 Union Boulevard, Allentown, Pennsylvania 18109
Telephone - Area Code 610-712-4323
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 No X
At May 1, 2001, 727,000,000 shares of Class A common stock and 908,100,000
shares of Class B common stock were outstanding.
2
2 Form 10-Q - Part I
PART 1 - Financial Information
Item 1. Financial Statements
AGERE SYSTEMS INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED AND COMBINED STATEMENTS OF OPERATIONS
(Dollars in Millions Except Per Share Amounts)
(Unaudited)
Three Six
Months Ended Months Ended
March 31, March 31,
2001 2000 2001 2000
Revenue (includes $174 and $239 for
the three months ended March 31,
2001 and 2000 respectively, and
$405 and $456 for the six months
ended March 31, 2001 and 2000
respectively, from Lucent
Technologies Inc.) ..................... $ 1,191 $ 1,067 $ 2,553 $ 2,033
Costs .................................... 750 613 1,532 1,115
Gross profit ............................. 441 454 1,021 918
Operating Expenses:
Selling, general and
administrative ......................... 179 132 336 242
Research and development ................. 261 190 537 363
Purchased in-process research
and development ......................... -- 11 -- 11
Amortization of goodwill and other
acquired intangibles ................... 112 5 223 10
Restructuring and separation ............. 36 -- 47 --
Total operating expenses ................. 588 338 1,143 626
Operating income(loss) ................... (147) 116 (122) 292
Other income(expense) - net .............. 16 (2) 37 (6)
Interest expense ......................... 10 14 34 28
Income(loss) before provision for
income taxes ........................... (141) 100 (119) 258
Provision for income taxes ............... 7 35 29 99
Income(loss) before cumulative effect
of accounting change .................... (148) 65 (148) 159
Cumulative effect of accounting change
(net of benefit for income taxes of
$2) .................................... -- -- (4) --
Net income(loss) ......................... $ (148) $ 65 $ (152) $ 159
Earnings(loss) per share -
basic and diluted ...................... $ (0.15) $ 0.06 $ (0.15) $ 0.15
Average shares outstanding - basic and
Diluted (millions) .................... 1,035 1,035 1,035 1,035
See Notes to Condensed Consolidated and Combined Financial Statements.
3
3 Form 10-Q - Part I
AGERE SYSTEMS INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED AND COMBINED BALANCE SHEETS
(Dollars in Millions Except Per Share Amounts)
(Unaudited)
March 31, September 30,
2001 2000
ASSETS
Cash and cash equivalents .................. $ 72 $ --
Trade receivables, less allowances
of $29 at March 31, 2001
and $17 at September 30, 2000 ............. 600 699
Receivables due from Lucent Technologies
Inc. ..................................... 37 122
Inventories - net .......................... 629 380
Deferred income taxes - net ................ 72 69
Prepaid expenses ........................... 64 68
Other current assets ....................... 79 66
Total current assets ....................... 1,553 1,404
Property, plant and equipment - net ........ 2,134 1,883
Goodwill and other acquired intangibles,
net of accumulated amortization of $257
at March 31, 2001 and $210 at
September 30, 2000 ....................... 3,285 3,491
Deferred income taxes - net ................ 35 55
Other assets ............................... 292 234
Total assets ............................... $7,299 $7,067
See Notes to Condensed Consolidated and Combined Financial Statements.
(CONT'D)
4
4 Form 10-Q - Part I
AGERE SYSTEMS INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED AND COMBINED BALANCE SHEETS (CONT'D)
(Dollars in Millions Except Per Share Amounts)
(Unaudited)
March 31, September 30,
2001 2000
LIABILITIES
Accounts payable ........................... $ 464 $ 267
Payroll and benefit-related
liabilities .............................. 191 193
Capitalized lease obligation ............... 16 14
Income taxes payable ....................... 320 289
Other current liabilities .................. 191 213
Total current liabilities .................. 1,182 976
Postemployment benefit liabilities ......... 94 95
Capitalized lease obligation ............... 42 46
Deferred income taxes - net ................ 97 103
Other liabilities .......................... 107 66
Total liabilities .......................... 1,522 1,286
Commitments and contingencies
SHAREHOLDER'S EQUITY/INVESTED EQUITY
Preferred stock, par value $1.00 per share,
250,000,000 shares authorized and no
shares issued and outstanding
Class A common stock, par value $0.01 per
share, 5,000,000,000 shares authorized
and no shares issued and outstanding
Class B common stock, par value $0.01 per
share, 5,000,000,000 shares authorized
and 1,035,100,000 shares issued and
outstanding at March 31, 2001 and
September 30, 2000 ....................... 10 10
Additional paid-in capital ................. 5,889 --
Owner's net investment ..................... -- 5,823
Accumulated deficit ........................ (78) --
Accumulated other comprehensive
loss ...................................... (44) (52)
Total shareholder's equity/invested equity . 5,777 5,781
Total liabilities and shareholder's
equity/invested equity .................... $ 7,299 $ 7,067
See Notes to Condensed Consolidated and Combined Financial Statements.
5
5 Form 10-Q - Part I
AGERE SYSTEMS INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED AND COMBINED STATEMENTS OF CHANGES IN STOCKHOLDER'S
EQUITY/INVESTED EQUITY AND TOTAL COMPREHENSIVE INCOME (LOSS)
(Dollars in Millions Except Per Share Amounts)
(Unaudited)
Three Six
Months Ended Months Ended
March 31, March 31,
2001 2000 2001 2000
Class B Common Stock beginning and
ending balance................................. $ 10 $ 10 $ 10 $ 10
Owner's net investment
Beginning balance .............................. 5,915 2,180 5,823 1,969
Net income (loss) .............................. (70) 65 (74) 159
Transfers to Lucent Technologies ............... -- (990) (1,405) (2,077)
Transfers from Lucent Technologies ............. -- 1,067 1,501 2,271
Transfer to additional paid in capital ......... (5,845) (5,845)
Ending balance ................................. -- 2,322 -- 2,322
Additional paid in capital
Beginning balance .............................. -- -- -- --
Transfer from owner's net investment ........... 5,845 -- 5,845 --
Transfers to Lucent Technologies ............... (1,318) -- (1,318) --
Transfers from Lucent Technologies ............. 1,362 -- 1,362 --
Ending balance ................................. 5,889 -- 5,889 --
Retained earnings
Beginning balance .............................. -- -- -- --
Net loss from February 1, 2001 ................. (78) -- (78) --
Ending balance ................................. (78) -- (78) --
Accumulated other comprehensive income (loss)
Beginning balance .............................. (33) (25) (52) (17)
Foreign currency translations .................. (11) (13) 8 (21)
Ending balance ................................. (44) (38) (44) (38)
Total shareholder's equity/invested
equity ending balance........................ $ 5,777 $ 2,294 $ 5,777 $ 2,294
Total comprehensive income (loss)
Net income (loss) .............................. $ (148) $ 65 $ (152) $ 159
Other comprehensive income (loss) .............. (11) (13) 8 (21)
Total comprehensive income(loss) ............... $ (159) $ 52 $ (144) $ 138
See Notes to Condensed Consolidated and Combined Financial Statements.
6
6 Form 10-Q - Part I
AGERE SYSTEMS INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED AND COMBINED STATEMENTS OF CASH FLOWS
(Dollars in Millions)
(Unaudited)
Six Months
Ended March 31,
2001 2000
Operating Activities
Net income(loss) ................................. $(152) $ 159
Adjustments to reconcile net income(loss)
to net cash provided by operating activities,
net of effects of acquisitions of businesses:
Cumulative effect of accounting
change ....................................... 4 --
Depreciation and amortization ................. 442 233
Provision for uncollectibles .................. 14 2
Provision for deferred income taxes ........... (4) (1)
Purchased in-process research and
development ................................. -- 11
Equity (earnings)loss from investments ........ (40) 6
Decrease in receivables ....................... 169 42
Increase in inventories ....................... (249) (6)
Increase(decrease) in accounts
payable ..................................... 197 (43)
Changes in other operating assets
and liabilities ............................. (18) (124)
Other adjustments for non-cash
items - net ................................. 6 --
Net cash provided by operating activities ........ 369 279
Investing Activities
Capital expenditures ............................. (485) (333)
Proceeds from the sale or disposal of
property, plant and equipment .................. -- 1
Purchases of investments ......................... -- (28)
Acquisitions of businesses,
net of cash acquired ........................... (1) (104)
Other investing activities - net ................. -- (5)
Net cash used in investing activities ............ (486) (469)
See Notes to Condensed Consolidated and Combined Financial Statements.
(CONT'D)
7
7 Form 10-Q - Part I
AGERE SYSTEMS INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED AND COMBINED STATEMENTS OF CASH FLOWS (CONT'D)
(Dollars in Millions)
(Unaudited)
Six Months
Ended March 31,
2001 2000
Financing Activities
Transfers from Lucent Technologies Inc. .... 189 193
Principal payments of capital lease
obligation ................................. (3) (4)
Net cash provided by financing
Activities ................................. 186 189
Effect of exchange rate
changes on cash .......................... 3 1
Net increase in cash and
cash equivalents ......................... 72 --
Cash and cash equivalents
at beginning of year ..................... -- --
Cash and cash equivalents
at end of period ......................... $ 72 $ --
See Notes to Condensed Consolidated and Combined Financial Statements.
8
8 Form 10-Q - Part I
NOTES TO CONDENSED CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS
(Dollars in Millions Except Per Share Amounts)
(Unaudited)
1. BACKGROUND AND BASIS OF PRESENTATION
BACKGROUND
On July 20, 2000, Lucent Technologies Inc. ("Lucent") announced its intention to
spin off its optoelectronic components and integrated circuits businesses
(collectively, the "Company's Businesses") that now comprise Agere Systems Inc.
(the "Company" or "Agere"). Lucent also has announced that it intends to
distribute all shares of the Company's common stock it then owns to its
stockholders in a tax free distribution by the end of Lucent's current fiscal
year, which will occur on September 30, 2001 (the "Distribution"), following the
Initial Public Offering ("IPO") of the Company's Class A common stock, which was
completed in April 2001 (see Footnote 12 - Subsequent Events). The Distribution
is subject to certain conditions, and may not occur by the contemplated time or
at all.
On August 1, 2000, the Company was incorporated in Delaware as a wholly owned
subsidiary of Lucent. On this date, 1,000 shares of the Company's common stock,
par value $0.01 per share, were issued, authorized and outstanding. Effective
February 1, 2001, Lucent transferred to the Company substantially all of the
assets and liabilities of the Company's Businesses (the "Separation") except for
short-term debt and related fees which were transferred at the IPO closing date,
and prepaid pension costs and post retirement liabilities which will be
transferred at the Distribution.
On March 14, 2001, the Company amended its certificate of incorporation to
authorize shares of Class A and Class B common stock and changed and
reclassified its 1,000 outstanding shares of common stock into 1,035,100,000
shares of Class B common stock (the "Recapitalization"). The ownership rights of
Class A and Class B common stockholders are the same except that each share of
Class B common stock has four votes for the election and removal of directors
while each share of Class A common stock has one vote for such matters. All
Company share and per share data has been retroactively adjusted to reflect the
Recapitalization.
BASIS OF PRESENTATION
The condensed combined financial statements include amounts prior to February 1,
2001 that have been derived from the consolidated financial statements and
accounting records of Lucent using the historical results of operations and
historical basis of assets and liabilities of the Company's Businesses.
Management believes the assumptions underlying the combined financial statements
are reasonable. However, the combined financial statements included herein may
not necessarily reflect the Company's results of operations, financial position
and cash flows in the future or what its results of operations, financial
position and cash flows would have been had the Company been a stand-alone
company during the periods presented. Because a direct ownership relationship
did not exist among all the various units comprising the Company, Lucent's net
investment in the Company is shown in lieu of stockholders' equity in the
combined financial statements prior to the Separation. The Company began
accumulating retained earnings on February 1, 2001, the date on which Lucent
began transferring to the Company the assets and liabilities of the Company's
Businesses. The formation of the Company and the transfers of assets and
liabilities from Lucent has been accounted for as a reorganization of entities
under common control in a manner similar to a pooling of interests. Beginning
February 1, 2001, the Company's consolidated financial statements include
certain majority owned subsidiaries and assets and liabilities of the Company.
Investments in which the Company exercises significant influence, but which it
does not control are accounted for under the equity method of accounting.
Investments in which the Company does not exercise significant influence are
recorded at cost. All material intercompany transactions and balances between
and among the Company's Businesses have been eliminated.
9
9 Form 10-Q - Part I
NOTES TO CONDENSED CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS
(Dollars in Millions Except Per Share Amounts)
(Unaudited)
GENERAL CORPORATE EXPENSES
Lucent allocated general corporate expenses prior to February 1, 2001. These
allocations are based on revenue for each fiscal year and reflected in the
selling, general and administrative, costs and research and development line
items in the consolidated and combined statements of operations. The general
corporate expense allocation was primarily for cash management, legal,
accounting, tax, insurance, public relations, advertising, human resources and
data services. After the Separation, the Company and Lucent entered into
agreements for Lucent to provide certain general corporate services. The
consolidated and combined financial statements for the three months ended March
31, 2001 and 2000 include amounts for these services of $27 and $45,
respectively, and $72 and $83 for the six months ended March 31, 2001 and 2000,
respectively.
BASIC RESEARCH
Prior to February 1, 2001, research and development expenses in the consolidated
and combined statements of operations include an allocation from Lucent to fund
a portion of the costs of basic research conducted by Lucent's Bell
Laboratories. This allocation was based on the number of individuals conducting
basic research who were transferred from Lucent's Bell Laboratories to the
Company as part of the Separation. This allocation amounted to $6 and $17 for
the three months ended March 31, 2001 and 2000, respectively, and $23 and $34
for the six months ended March 31, 2001 and 2000. Management believes the costs
of this research charged to the Company are a reasonable representation of the
costs that would have been incurred if the Company had performed this research
as a stand-alone company.
INTEREST EXPENSE
Prior to the Separation, Lucent provided financing to the Company and incurred
debt at the parent level. The consolidated and combined balance sheets do not
include debt other than a capitalized lease obligation. The consolidated and
combined statements of operations, however, include an allocation of interest
expense totaling $9 and $12 for the three months ended March 31, 2001 and 2000,
respectively, and $32 and $24 for the six months ended March 31, 2001 and 2000,
respectively. This allocation was based on the ratio of the Company's net
assets, excluding debt, to Lucent's total net assets, excluding debt. The
Company's interest expense as a stand-alone company may be higher or lower than
those reflected in the consolidated and combined statements of operations.
Interest expense also includes interest expense related to the Company's lease
obligation.
PENSION AND POSTRETIREMENT COSTS
At the Distribution, the Company will become responsible for pension and
postretirement benefits for the United States ("U.S.") active employees of the
Company. Obligations related to retired and terminated vested U.S. employees as
of the IPO will remain the responsibility of Lucent. Until the Distribution, the
Company's U.S. employees will be participants in most of Lucent's employee
benefit plans. At the Distribution, the Company will become responsible for
pension and postretirement benefits for the Company's U.S. employees who retire
or terminate after the IPO, and Lucent will transfer to the Company the pension
and postretirement assets related to those employees. Lucent has managed its
U.S. employee benefit plans on a consolidated basis and separate Company
information is not readily available. Therefore, the Company's share of the
Lucent U.S. plans' assets and liabilities is not included in the consolidated
and combined balance sheets. The consolidated and combined statements of
operations include, however, an allocation of the costs of the
10
10 Form 10-Q - Part I
NOTES TO CONDENSED CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS
(Dollars in Millions Except Per Share Amounts)
(Unaudited)
U.S. employee benefit plans. These costs were allocated based on the Company's
U.S. active employee population for each of the periods presented. In relation
to the Lucent plans, the Company recorded pension expense of $1 and $7 for the
three months ended March 31, 2001 and 2000, respectively, and $3 and $14 for the
six months ended March ended 31, 2001 and 2000, respectively, and postretirement
benefit expense of $3 and $4 for the three months ended March 31, 2001 and 2000,
respectively, and $6 and $8 for the six months ended March 31, 2001 and 2000,
respectively. The Company is responsible for the pension and postretirement
benefits of its non-U.S. employees. The assets and liabilities of the various
country-specific plans for these employees are reflected in the consolidated and
combined financial statements and were not material for the periods presented.
INTERIM FINANCIAL INFORMATION
These condensed financial statements have been prepared in accordance with the
rules of the Securities and Exchange Commission for interim financial statements
and do not include all disclosures required by generally accepted accounting
principles. These financial statements should be read in conjunction with the
audited combined financial statements and notes thereto included in the
Company's Form S-1. The condensed financial information as of March 31, 2001 and
for the three and six months ended March 31, 2001 and 2000 is unaudited, but
includes all adjustments that management considers necessary for a fair
presentation of the Company's consolidated and combined results of operations,
financial position and cash flows. Results for the three and six months ended
March 31, 2001 are not necessarily indicative of results to be expected for the
full fiscal year 2001 or any other future periods.
RESTRUCTURING AND SEPARATION EXPENSES
Restructuring and separation expenses include restructuring expenses such as the
cost of certain lease terminations, as well as incremental spending associated
with the Company's separation from Lucent such as the establishment of a
separate computer and information technology infrastructure and associated
information processing and network support.
INCOME TAXES
For the three months ended March 31, 2001 and 2000 the effective tax rates were
(5.6%) and 34.9%, respectively. The effective tax rates were (24.9%) and 38.4%,
respectively, for the six months ended March 31, 2001 and 2000. The 2001 rates
include the impact of non-tax deductible goodwill amortization associated with
acquisitions, and separation related costs.
CASH AND RECEIVABLES
Lucent uses a centralized approach to cash management and the financing of its
operations. Prior to the IPO, cash deposits from the Company's Businesses were
transferred to Lucent on a regular basis and were netted against the owner's net
investment account. On March 31, 2001, $43 of the trade receivables due from
Lucent in the U.S. were settled through equity.
2. RECENT PRONOUNCEMENTS
SAB 101
In December 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin 101, "Revenue Recognition in Financial Statements" ("SAB
101"). SAB 101 provides guidance on the recognition, presentation and disclosure
of revenue in financial statements and requires adoption no later than the
fourth quarter of
11
11 Form 10-Q - Part I
NOTES TO CONDENSED CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS
(Dollars in Millions Except Per Share Amounts)
(Unaudited)
fiscal 2001. The Company plans to adopt SAB 101 in the fourth fiscal quarter,
and does not believe the impact of adoption of SAB 101 will be material to its
consolidated financial position and results of operations.
3. ACCOUNTING CHANGE
Effective October 1, 2000, the Company adopted Statement of Financial Accounting
Standards ("SFAS") No. 133, "Accounting for Derivative Instruments and Hedging
Activities" ("SFAS 133"), and its corresponding amendments under SFAS No. 138.
SFAS 133 requires the Company to measure all derivatives, including certain
derivatives embedded in other contracts, at fair value and to recognize them in
the consolidated balance sheet as an asset or liability, depending on the
Company's rights or obligations under the applicable derivative contract. For
derivatives designated as fair value hedges, the changes in the fair value of
both the derivative instrument and the hedged item are recorded in earnings. For
derivatives designated as cash flow hedges, changes in fair value of the
effective portions of the derivative are reported in other comprehensive income
and are subsequently reclassified into earnings when the hedged item affects
earnings. Changes in fair value of derivative instruments not designated as
hedging instruments and ineffective portions of hedges are recognized in
earnings in the current period. The adoption of SFAS 133 as of October 1, 2000,
resulted in a cumulative after-tax decrease to results from operations of $4
(net of a tax benefit of $2) in the six months ended March 31, 2001. The
decrease in results from operations is primarily due to derivatives not
designated as hedging instruments. For the three and six months ended March 31,
2001, the change in fair market value of derivative instruments was recorded in
other income (expense) and was not material.
FOREIGN CURRENCY RISK
The Company conducts its business on a multinational basis in a variety of
foreign currencies. To manage this risk, the Company enters into various foreign
exchange forward contracts to manage its exposure to changes in those foreign
exchange rates. Alternatively, the Company may hedge foreign exchange risk in
certain sales and purchase contracts by embedding terms in the contracts that
affect the ultimate amount of cash flows under the contract. Principal
currencies hedged are Euros, Singapore dollars and British Pounds Sterling.
The Company hedges foreign currency risk to preserve the economic cash flows of
the Company in accordance with corporate risk management policies, but generally
does not expect to designate related derivative instruments as hedges for
cost/benefit reasons. Accordingly, the changes in fair value of these
undesignated freestanding foreign currency derivative instruments are recorded
in earnings in the period of change and have not been material to the Company
due to the short maturities of these instruments.
4. SUPPLEMENTARY FINANCIAL INFORMATION
BALANCE SHEET INFORMATION
March 31, September 30,
2001 2000
---- ----
INVENTORIES
Completed goods ................................ $121 $119
Work in process and raw materials .............. 508 261
---- ----
$629 $380
==== ====
12
12 Form 10-Q - Part I
NOTES TO CONDENSED CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS
(Dollars in Millions Except Per Share Amounts)
(Unaudited)
CASH FLOW INFORMATION
Interest and income taxes historically have been paid by Lucent on behalf of the
Company and do not necessarily reflect what the Company would have paid had it
been a stand-alone company.
5. COMPREHENSIVE INCOME (LOSS)
Total comprehensive income (loss) represents net income (loss) plus the results
of certain equity changes not reflected in the condensed consolidated and
combined statements of operations.
The after-tax components of accumulated other comprehensive income (loss) are
shown below.
Three Months Ended Six Months Ended
March 31, March 31,
2001 2000 2001 2000
---- ---- ---- ----
Net income (loss) .................... $(148) $ 65 $(152) $ 159
Other comprehensive income (loss):
Foreign currency translation
adjustments ................. (11) (13) 8 (21)
----- ----- ----- -----
Other comprehensive income (loss) .... $(159) $ 52 $(144) $ 138
===== ===== ===== =====
The foreign currency translation adjustments are not currently adjusted for
income taxes because they relate to indefinite investments in non-U.S.
subsidiaries.
6. EARNINGS PER COMMON SHARE
Basic earnings (loss) per common share is calculated by dividing net income
(loss) by the weighted average number of common shares outstanding during the
period. Diluted earnings (loss) per share is calculated by dividing net income
(loss) by the sum of the weighted average number of common shares outstanding
plus all additional common shares that would have been outstanding if
potentially dilutive common shares had been issued. As a result of the net loss
reported for the three and six months ended March 31, 2001, approximately 33,820
and 16,724, respectively, potential common shares, have been excluded from the
calculation of diluted loss per share because their effect would be
anti-dilutive. In addition, at March 31, 2001, Agere employees held stock-based
awards covering approximately 48 million shares of Lucent common stock that will
be converted to Agere stock-based awards at the time of the Distribution. The
number of shares of Agere common stock subject to substituted awards cannot be
determined at this time since the conversion ratio will be determined at the
Distribution based on the per share value of the Company's common stock in
relation to that of Lucent's common stock.
13
13 Form 10-Q - Part I
NOTES TO CONDENSED CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS
(Dollars in Millions Except Per Share Amounts)
(Unaudited)
The following table shows the basic and diluted earnings per share information
for the three and six months ended March 31, 2001 and 2000:
Three Months Ended Six Months Ended
March 31, March 31,
2001 2000 2001 2000
---- ---- ---- ----
Net income(loss) ......................... $ (148) $ 65 $ (152) $ 159
Income (loss) per common share - basic
and diluted:
Net income(loss) before cumulative
effect of accounting change .......... $ (0.15) $ 0.06 $ (0.15) $ 0.15
Cumulative effect of accounting
change ............................... -- -- -- --
Net income(loss) ....................... $ (0.15) $ 0.06 $ (0.15) $ 0.15
Average shares outstanding - basic
and diluted (millions) ................. 1,035 1,035 1,035 1,035
7. OPERATING SEGMENTS
The Company has two reportable segments: Optoelectronics and Integrated
Circuits. The Optoelectronics segment represents the Company's optoelectronic
components operations, including both active optoelectronic components and
passive components. Optoelectronic components transmit, process, change, amplify
and receive light that carries data and voice traffic over optical networks. The
Integrated Circuits segment represents the Company's integrated circuits
operations. 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 also includes the Company's wireless local area networking products,
which facilitate the transmission of data and voice signals within a localized
area without cables or wires. The Optoelectronics and Integrated Circuits
segments each include revenue from the licensing of intellectual property
related to that segment. There were no intersegment sales during the periods
presented.
Each segment is managed separately. Disclosure of segment information is on the
same basis as is used internally for evaluating segment performance and for
deciding how to allocate resources.
The Company has centralized corporate functions and uses shared service
arrangements to realize economies of scale and efficient use of resources. The
costs of shared services, and other corporate center operations managed on a
common basis, are allocated to the segments based on usage or other factors
based on the nature of the activity.
Performance measurement and resource allocation for the reportable operating
segments are based on many factors. The primary financial measure used is
operating income, exclusive of the amortization of goodwill and other acquired
intangibles, purchased in-process research and development("IPRD") and
restructuring and separation expenses.
14
14 Form 10-Q - Part I
NOTES TO CONDENSED CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS
(Dollars in Millions Except Per Share Amounts)
(Unaudited)
REPORTABLE SEGMENTS
Three Months Ended Six Months Ended
March 31, March 31,
2001 2000 2001 2000
---- ---- ---- ----
INTEGRATED CIRCUITS
Revenue .......................................... $812 $801 $1,750 $1,563
Operating income(loss) - excluding amortization
of goodwill and other acquired
intangibles, IPRD and restructuring
and separation expenses ....................... (46) 49 13 179
OPTOELECTRONICS
Revenue .......................................... $379 $266 $803 $470
Operating income - excluding amortization
of goodwill and other acquired
intangibles, IPRD and restructuring
and separation expenses ....................... 47 83 135 134
RECONCILING ITEMS
A reconciliation of the totals reported for the operating segments to the
significant line items in the condensed financial statements is shown below.
Three Months Ended Six Months Ended
March 31, March 31,
2001 2000 2001 2000
---- ---- ---- ----
OPERATING INCOME
Total reportable segments................... $ 1 $132 $148 $313
Amortization of goodwill and other acquired
intangibles.............................. (112) (5) (223) (10)
IPRD........................................ - (11) - (11)
Restructuring and separation expenses....... (36) - (47) -
------ ---- ------ ----
Total operating income (loss)....... $(147) $116 $(122) $292
====== ==== ====== ====
8. STOCK COMPENSATION PLANS
In March 2001, the Company adopted a long-term incentive plan that provides for
the granting of stock-based awards to employees, and also adopted a stock option
plan for non-employee directors. Under these plans, the exercise price per share
under an option may not be less than the fair market value of a share on the
date of grant. The options for employees become exercisable over a four-year
period, while options for non-employee directors become vested and exercisable
generally on the first anniversary of the date of grant. The Company has
reserved 182,000,000 shares for issuance under these plans and, concurrent with
its IPO, granted options to purchase 79,665,675 shares of its common stock at
the IPO price of $6 per share.
The Company has established an Employee Stock Purchase Plan ("ESPP") that will
be implemented by consecutive offering periods with the first offering period
commencing March 27, 2001 and ending April 30, 2003, and with subsequent
offering periods generally running for 24 months beginning May 1 of every other
year. Each offering period will consist of four purchase periods with the first
purchase period commencing March 27, 2001 and subsequent purchase periods
generally beginning on either May 1 or November 1 and lasting six months. Under
the terms of the ESPP,
15
15 Form 10-Q - Part I
NOTES TO CONDENSED CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS
(Dollars in Millions Except Per Share Amounts)
(Unaudited)
eligible employees may have up to 10% of eligible compensation (subject to
certain limitations) deducted from their pay to purchase shares of the Company's
common stock at a price equal to 85% of the lower of the price on the employee's
entry date for the current offering period or the last trading day of each
purchase period. A maximum of 85,000,000 shares are authorized for issuance
under the ESPP.
9. TRANSACTIONS WITH LUCENT
For the three months ended March 31, 2001 and 2000, the Company had $174 and
$239, respectively, of revenue for products sold to Lucent, and $405 and $456
for the six months ended March 31, 2001 and 2000, respectively. Included in
these transactions were sales to Avaya Inc., formerly the enterprise networks
business of Lucent, of $14 and $30 for the three and six months ended March 31,
2000, respectively. As a result of Lucent's spin-off of Avaya Inc. on September
30, 2000, the Company's sales to Avaya Inc. are not transactions with Lucent
since that date. Products purchased from Lucent were $6 and $5 for the three
months ended March 31, 2001 and 2000, respectively, and $15 and $8 for the six
months ended March 31, 2001 and 2000, respectively. Prior to the Separation,
certain other costs were billed directly to the Company by Lucent for specific
research and development projects related to the Company's Businesses. This
amounted to $6 and $16 for the three months ended March 31, 2001 and 2000,
respectively, and $23 and $31 for the six months ended March 31, 2001 and 2000,
respectively.
Following the Separation, the Company and Lucent entered into an Interim Service
and Systems Replication Agreement to provide each other, on an interim,
transitional basis, with various data processing services, telecommunications
services and corporate support services, including: accounting, financial
management, information systems management, tax, payroll, legal, human resources
administration, procurement and other general support.
The Interim Service and Systems Replication Agreement also provides for the
replication and transfer of designated computer systems used for administrative
support or used in the Company's Businesses or Lucent's other businesses. The
systems include specified hardware, software, data storage or maintenance and
support components. Costs and expenses of purchasing hardware or obtaining
software are borne by the party purchasing the hardware or licensing the
software. These costs and services amounted to $20 for both the three and six
months ended March 31, 2001.
10. COMMITMENTS AND CONTINGENCIES
In the normal course of business, the Company is involved in proceedings,
lawsuits and other claims, including proceedings under laws and government
regulations related to environmental, tax and other matters. The semiconductor
industry is characterized by substantial litigation concerning patents and other
intellectual property rights. From time to time, the Company may be party to
various inquiries or claims in connection with these rights. These matters are
subject to many uncertainties, and outcomes are not predictable with assurance.
Consequently, the ultimate aggregate amount of monetary liability or financial
impact with respect to these matters at March 31, 2001 cannot be ascertained.
While these matters could affect the operating results of any one quarter when
resolved in future periods and while there can be no assurance with respect
thereto, management believes that after final disposition, any monetary
liability or financial impact to the Company beyond that provided for at March
31, 2001, would not be material to the annual consolidated financial statements.
16
16 Form 10-Q - Part I
NOTES TO CONDENSED CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS
(Dollars in Millions Except Per Share Amounts)
(Unaudited)
In December 1997, the Company entered into a joint venture, called Silicon
Manufacturing Partners Pte Ltd., with Chartered Semiconductor Manufacturing Ltd.
("Chartered Semiconductor"), a leading manufacturing foundry for integrated
circuits, to operate a 54,000 square foot integrated circuit manufacturing
facility in Singapore. The Company owns a 51% equity interest in this joint
venture, and Chartered Semiconductor owns the remaining 49% equity interest. The
Company has an agreement with Silicon Manufacturing Partners to purchase 51% of
the production output from this facility and Chartered Semiconductor agreed to
purchase the remaining 49% of the production output. If the Company fails to
purchase its required commitments, it will be required to pay Silicon
Manufacturing Partners for the fixed costs associated with the unpurchased
wafers. Chartered Semiconductor is similarly obligated with respect to the
wafers allotted to it. The agreement also provides that Chartered Semiconductor
will have the right of first refusal to purchase integrated circuits produced in
excess of the Company's requirements. The agreement may be terminated by either
party upon two years written notice, but may not be terminated prior to February
2008. The agreement may also be terminated for material breach, bankruptcy or
insolvency.
In July 2000, the Company and Chartered Semiconductor entered into an agreement
committing the Company and Chartered Semiconductor to jointly develop
manufacturing technologies for future generations of integrated circuits
targeted at high-growth communications markets. The Company has agreed to invest
up to $350 over a five year period. As part of the joint development activities,
the 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 Company teams in Murray Hill, New Jersey, and Orlando, Florida,
as well as with Chartered Semiconductor's technology development organization,
to create a 600-person research and development team. This relationship is in
the early stages of development. 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 that
project.
RISKS AND UNCERTAINTIES
The Company has a limited history operating as a stand-alone company, and it may
be unable to make the changes necessary to operate as a stand-alone company, or
it may incur greater costs as a stand-alone company that may cause its
profitability to decline. Until recently, the Company's Businesses were operated
by Lucent as a segment of its broader corporate organization rather than as a
separate stand-alone company. Lucent assisted the Company by performing various
corporate functions, including public relations, employee relations, investor
relations, finance, legal and tax functions. Lucent continues to provide some of
these functions to the Company on an interim basis pursuant to the Interim
Services and Systems Replication Agreement. If the Company does not have in
place its own systems and business functions or if it does not have agreements
with other providers of these services once the Interim Services and Systems
Replication Agreement with Lucent expires, the Company may not be able to
effectively operate its business and its profitability may decline.
LEGAL PROCEEDINGS
From time to time the Company is involved in legal proceedings arising in the
ordinary course of business, including unfair labor charges filed by its unions
with the National Labor Relations Board, claims before the U.S. Equal Employment
Opportunity Commission and other employee grievances. The Company also may be
subject to intellectual property litigation and infringement claims, which could
cause it to incur significant expenses or prevent it from selling its products.
17
17 Form 10-Q - Part I
NOTES TO CONDENSED CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS
(Dollars in Millions Except Per Share Amounts)
(Unaudited)
A patent infringement lawsuit has been filed against Lucent, among other
optoelectronic components manufacturers, by Litton Systems, Inc. and The Board
of Trustees of the Leland Stanford Junior University in the United States
District Court for the Central District of California (Western Division) on
October 3, 2000. The Company anticipates that it may be named a defendant in the
suit. The complaint alleges that each of the defendants is infringing a patent
related to the manufacture of erbium-doped optical amplifiers. The patent is
owned by Stanford University and is exclusively licensed to Litton. The
complaint seeks, among other remedies, unspecified monetary damages, counsel
fees and injunctive relief. This matter is in its early stages.
Another patent infringement lawsuit has been filed against Lucent, among other
semiconductors manufacturers, by Lemelson Medical, Education & Research
Foundation, LP, in the United States District Court, District of Arizona on June
15, 1999. The Company anticipates that it may be named a defendant in the suit.
The complaint alleges infringement of 16 patents, 14 of which relate to machine
vision and bar code readers, and the other two relate to semiconductor
processing technology. The action has been stayed with respect to the 14 patents
relating to machine vision and bar code readers, pending a request by the
equipment manufacturers to join the suit and assume responsibility for the
litigation. The complaint alleges infringement of the two patents related to
semiconductor processing based on the manufacture and sale of semiconductor
devices. The complaint seeks unspecified monetary damages, counsel fees and
injunctive relief. All of the Company's integrated circuit products are subject
to this complaint. This matter is in its early stages.
If the Company is unsuccessful in resolving these proceedings, as they relate to
the Company, its operations may be disrupted or it may incur additional costs
that may decrease its profitability. Other than as described above, the Company
does not believe there is any litigation pending that should have, individually
or in the aggregate, a material adverse effect on its financial position,
results of operations or cash flows.
ENVIRONMENTAL, HEALTH AND SAFETY
The Company is subject to a wide range of U.S. and non-U.S. governmental
requirements relating to employee safety and health and to the handling and
emission into the environment of various substances used in its operations. The
Company also is subject to environmental laws, including the Comprehensive
Environmental Response, Compensation and Liability Act, also known as Superfund,
that require the cleanup of soil and groundwater contamination at sites
currently or formerly owned or operated by the Company, or at sites where the
Company may have sent waste for disposal. These laws often require parties to
fund remedial action at sites regardless of fault. Lucent is a potentially
responsible party at numerous Superfund sites and sites otherwise requiring
cleanup action. With some limited exceptions, under the Separation and
Distribution Agreement with Lucent, the Company has assumed all environmental
liabilities resulting from the Company's Businesses, which include liabilities
for the costs associated with eight of these sites--five Superfund sites, two of
the Company's former facilities and one of the Company's current manufacturing
facilities.
It is often difficult to estimate the future impact of environmental matters,
including potential liabilities. The Company has established financial reserves
to cover environmental liabilities where they are probable and reasonably
estimable. This practice is followed whether the claims are asserted or
unasserted. Management expects that the amounts reserved will be paid out over
the period of remediation for the applicable site, which typically ranges from
five to thirty years. Reserves for
18
18 Form 10-Q - Part I
NOTES TO CONDENSED CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS
(Dollars in Millions Except Per Share Amounts)
(Unaudited)
estimated losses from environmental remediation are, depending upon the site,
based primarily upon internal or third party environmental studies, estimates as
to the number, participation level and financial viability of all potentially
responsible parties, the extent of the contamination and the nature of required
remedial actions. Accruals will be adjusted as further information develops or
circumstances change. The amounts provided for in the condensed consolidated and
combined financial statements for environmental reserves are the gross
undiscounted amount of such reserves, without deductions for insurance or third
party indemnity claims. Although the Company believes that its reserves are
adequate, including those covering the Company's potential liabilities at
Superfund sites, there can be no assurance that expenditures which will be
required relating to remedial actions and compliance with applicable
environmental laws will not exceed the amounts reflected in these reserves or
will not have a material adverse effect on the Company's financial condition,
results of operations or cash flows.
11. INVESTMENT IN SILICON MANUFACTURING PARTNERS PTE LTD.
The Company owns a 51% interest in Silicon Manufacturing Partners ("SMP"), a
joint venture with Chartered Semiconductor Manufacturing Ltd., which operates a
54,000 square foot integrated circuit manufacturing facility in Singapore. The
investment is accounted for under the equity method due to Chartered
Semiconductor's participatory rights under the joint venture agreement. Under
the joint venture agreement, each partner is entitled to the margins from sales
to respective customers directed to SMP by that partner, after deducting their
respective share of the overhead costs of SMP. Accordingly, SMP's net income is
not expected to be shared in the same ratio as equity ownership. For the three
and six months ended March 31, 2001 the Company recognized equity earnings in
SMP of $20 and $40, an increase of $22 and $47 respectively, from the prior year
periods. SMP reported a net loss of $1 and net income of $27 for the three and
six months ended March 31, 2001 versus a net loss of $4 and $14 for the same
periods in 2000. As of March 31, 2001, SMP reported total assets of $669 and
total liabilities of $482 compared to total assets of $629 and total liabilities
of $447 as of September 30, 2000.
12. SUBSEQUENT EVENTS
IPO AND OTHER STOCK TRANSACTIONS
On April 2, 2001, the Company issued 600,000,000 shares of Class A common stock
in the IPO for $6 per share less underwriting discounts and commissions of $.23
per share. In addition, on April 2, 2001, Morgan Stanley exercised its
overallotment option and, as a result, on April 4, 2001, Lucent converted
90,000,000 shares of Class B common stock into Class A common stock and
exchanged those shares for outstanding Lucent debt with Morgan Stanley pursuant
to the overallotment option granted in connection with the IPO. After completion
of the IPO, inclusive of the overallotment option, Lucent owned approximately
58% of the aggregate number of outstanding shares of Class A and B common stock.
Also, on April 2, 2001, the Company assumed from Lucent $2,500 of short-term
debt under a credit facility that is secured by substantially all of the
Company's assets. On May 1, 2001, Lucent elected to convert 37,000,000 of its
shares in the Company from Class B common stock to Class A common stock. The
unaudited pro forma condensed balance sheet as of March 31, 2001 below has been
prepared assuming the IPO, the debt assumption and certain other transactions
described below occurred on March 31, 2001, but does not purport to project the
Company's financial position for any future date. The unaudited pro forma
condensed balance sheet is based upon available information and certain
assumptions the Company believes are reasonable.
19
19 Form 10-Q - Part I
NOTES TO CONDENSED CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS
(Dollars in Millions Except Per Share Amounts)
(Unaudited)
Historical Adjustments Pro Forma
ASSETS
Cash and cash equivalents ...................................................... $ 72 $ 3,440 (A) $ 3,512
Trade receivables, less allowances ............................................. 600 600
Receivables due from Lucent Technologies Inc ................................... 37 37
Inventories .................................................................... 629 629
Other current assets ........................................................... 215 55 (B) 270
Total current assets .............................................. 1,553 3,495 5,048
Property, plant and equipment - net ........................................... 2,134 2,134
Goodwill and other acquired intangibles, net ................................... 3,285 3,285
Prepaid pension costs .......................................................... -- 128 (C) 128
Other assets ................................................................... 327 (20)(A) 307
Total assets ...................................................... $ 7,299 $ 3,603 $10,902
LIABILITIES
Current Liabilities ............................................................ $ 1,182 $ (20)(A) $ 1,162
Short-term debt ................................................................ -- 2,500 (D) 2,500
Total current liabilities ......................................... 1,182 2,480 3,662
Post-employment benefit liabilities ............................................ 94 94
Other liabilities .............................................................. 246 74 (C)
21 (C) 341
Total liabilities ................................................. 1,522 2,575 4,097
INVESTED EQUITY/STOCKHOLDERS' EQUITY
Preferred stock, par value $1.00 per share, 250,000,000 shares
Authorized and no shares issued and outstanding pro forma
Class A common stock, par value $0.01 per share,
5,000,000,000 shares authorized and 727,000,000 shares ..................... -- 6 (A)
Issued and outstanding pro forma ........................................... -- 1 (E) 7
Class B common stock, par value $0.01 per share,
5,000,000,000 shares authorized
and 908,100,000 shares
Issued and outstanding pro forma ........................................... 10 (1)(E) 9
Additional paid in capital ..................................................... 5,889 3,434 (A)
............................................................................... 55 (B)
............................................................................... 33 (C)
............................................................................... (2,500)(D) 6,911
Accumulated deficit ............................................................ (78) (78)
Accumulated other comprehensive loss ........................................... (44) (44)
Total invested equity/stockholder's equity ........................ 5,777 1,028 6,805
Total liabilities and invested equity/
stockholder's equity .......................................... $ 7,299 $ 3,603 $10,902
20
20 Form 10-Q - Part I
NOTES TO CONDENSED CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS
(Dollars in Millions Except Per Share Amounts)
(Unaudited)
Notes to the Pro Forma Condensed Financial Statements
(A) Reflects the receipt of the proceeds net of underwriting discounts and
commissions and other IPO related expenses from the sale of 600,000,000
shares of the Class A common stock in the IPO and payment of estimated
offering expenses.
(B) Reflects the transfer from Lucent of the unamortized fees related to the
$2,500 of short-term debt assumed upon completion of the IPO amounting to
$55.
(C) Reflects the projected prepaid pension asset $128 and postretirement
liability $74 and the associated deferred taxes $21 using a statutory rate
of 39.0%, as of September 30, 2001 associated with various existing Lucent
pension and other employee benefit plans related to the employees of the
Company.
(D) Reflects the assumption of $2,500 of short-term debt upon completion of the
IPO. The short-term debt consists of short-term borrowings under a credit
facility that is secured by substantially all of the Company's assets. The
Company did not receive any of the proceeds of this short-term debt. The
$2,500 facility is comprised of term loans and revolving credit loans.
Upon the repayment of $1,500 of the debt, and if the Company has
credit ratings of BBB- with a stable outlook from Standard & Poors and Baa3
with a stable outlook from Moody's Investor Services, the debt will become
unsecured. The current ratings are BBB- from Standard & Poors with a
negative outlook and Baa3 from Moody's Investor Services with a stable
outlook. Upon the repayment of $1,500, the remaining debt outstanding
under this facility would consist of revolving credit loans. The credit
facility will mature on February 21, 2002, which is 364 days from the date
Lucent initially entered into the facility. The debt is not convertible
into any other securities of the Company.
(E) Reflects the exchange by Lucent of 90,000,000 shares of Class B common
stock for an equal number of shares of Class A common stock in connection
with the overallotment option granted in the IPO and the conversion by
Lucent on May 1, 2001 of an additional 37,000,000 shares of Class B common
stock to Class A common stock.
BUSINESS RESTRUCTURING
On April 24, 2001 the Company announced a restructuring plan to reduce its
workforce by approximately 2,000 employees. The workforce reduction was
undertaken to align manufacturing capacity with customer demand and cut costs
and expenses. The majority of the positions affected are based in the Company's
manufacturing facilities in Allentown, Breinigsville and Reading, PA; Irwindale,
CA and Orlando, FL. The Company expects a significant portion of the workforce
reduction to be completed in the third fiscal quarter. It is anticipated that
the balance will be completed in the following quarter. In connection with the
plan, a pre-tax restructuring charge of less than $45 is expected to be
recognized in the third fiscal quarter. Approximately half of this charge, for
termination benefits to certain U.S. management employees, is expected to be
funded through the assets of the Lucent pension plan.
21
21 Form 10-Q - Part I
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION
Overview
Agere Systems Inc. (the "Company") is the world leader in sales of
communications semiconductors, which include both our optoelectronic components
and integrated circuits. Communications semiconductors are the basic building
blocks of electronic and photonic products and systems for terrestrial and
submarine, or undersea, communications networks and for communications
equipment. The Company sells its optoelectronic components and integrated
circuits globally to manufacturers of communications and computer equipment.
The Company reports its operations in two segments: Optoelectronics and
Integrated Circuits. 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 segment represents our integrated circuits operations.
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 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. The Optoelectronics and Integrated Circuits segments each include revenue
from the licensing of intellectual property related to that segment.
The Company reported a net loss of $148 million and $152 million for the three
and six months ended March 31, 2001 respectively compared to net income of $65
million and $159 million for the three and six months ended March 31, 2000. The
primary reason for the decline in earnings is an increase in operating expenses
as a result of goodwill resulting from acquisitions, increases in research and
development and expenses associated with restructuring and separation from
Lucent.
Separation From Lucent
The Company was incorporated under the laws of the State of Delaware on August
1, 2000, as a wholly owned subsidiary of Lucent. The Company had no material
assets or activities as a separate corporate entity until the contribution to
the Company by Lucent of its optoelectronic components and integrated circuits
businesses (the "Separation"). Lucent conducted such businesses through various
divisions and subsidiaries. On February 1, 2001, Lucent began effecting the
Separation by transferring to the Company the assets and liabilities related to
such businesses. The Separation was substantially completed, including the
transfer of all assets and liabilities, by the Initial Public Offering ("IPO")
closing date, except for the prepaid pension costs and the postretirement
liability. As a result, upon completion of the IPO inclusive of the shares sold
in the overallotment option, Lucent owned 100% of our outstanding Class B common
stock, which represented approximately 58% of the total outstanding common stock
and approximately 85% of the combined voting power of both classes of our voting
stock with respect to the election and removal of directors.
Lucent has announced its intention to distribute through a spin-off all of the
shares of the Company's common stock it then owns to its stockholders by the end
of Lucent's current fiscal year, which will occur on September 30, 2001. There
can be no assurance that the Distribution will occur by that date or at all.
The condensed combined financial statements of the Company include amounts that
have been carved out from the financial statements of Lucent using the
historical results of operations and historical basis of the assets and
liabilities of such businesses.
22
22 Form 10-Q - Part I
Additionally, the combined financial statements of the Company include certain
assets, liabilities, revenues and expenses which were not historically recorded
at the level of, but are primarily associated with the Company's businesses. The
consolidated financial statements of the Company reflect the results of the
operations, financial position and cash flows of the businesses transferred to
the Company from Lucent in the Separation. Management believes the assumptions
underlying the financial statements to be reasonable.
The financial statements included herein may not necessarily reflect the results
of operations, financial position and cash flows of the Company in the future or
what the results of operations, financial position and cash flows would have
been had the Company been a separate, stand-alone entity during the periods
presented. The financial information included herein does not reflect the
changes that may occur in the funding and operations of the Company as a result
of the Separation and the IPO.
Restructuring and Separation Expenses
As discussed below under "Operating Trends," the Company is currently
experiencing a softening of demand for products. As a result of market
conditions, on April 24, 2001 the Company announced a restructuring plan to
reduce its workforce by approximately 2,000 employees. The workforce reduction
was undertaken to align manufacturing capacity with customer demand and cut
costs and expenses. The Company expects a significant portion of the workforce
reduction to be completed in the third fiscal quarter. It is anticipated the
balance will be completed in the following quarter. In connection with the plan,
a pre-tax restructuring charge of less than $45 million is expected to be
recognized in the third fiscal quarter. Approximately half of this charge, for
termination benefits to certain U.S. management employees, is expected to be
funded through the assets of Lucent's pension plans. After completion of the
workforce reductions, annualized pre-tax savings associated with these actions
is expected to be approximately $110 million. The Company continues to evaluate
its cost and expense structure and may take additional actions to reduce costs
and expenses.
The Company is expected to incur additional costs, fees and expenses relating to
the separation from Lucent and the IPO of approximately $105 million. These
costs, fees and expenses will be primarily related to legal separation matters,
designing and constructing our computer infrastructure, information and data
storage systems, marketing expenses relating to building a company brand
identity and implementing treasury, real estate, pension and records retention
management services. Except for the anticipated $105 million of costs, fees and
expenses, the Company does not currently anticipate that the changes as a result
of the Separation will materially impact the cost structure as reflected in the
historical results.
Operating Trends
Recently, the Company has experienced a higher than normal level of order
reschedules and cancellations and the level of orders received is generally
lower than previously anticipated. The Company believes this softening of demand
from customers is in response to weakness in the customers' markets as a result
of current economic conditions. As a result of these economic conditions, a
number of customers have placed fewer orders and may have excess inventories of
the Company's products.
The Company cannot predict the extent to which this softening of demand from the
customers will continue. The Company has taken action to reduce capital
expenditures, costs and expenses in response to these trends.
23
23 Form 10-Q - Part I
RESULTS OF OPERATIONS
Three months ended March 31, 2001 compared to three months ended March 31, 2000
The following table shows the change in revenue, both in dollars and in
percentage terms:
Three Months Ended Change
March 31,
2001 2000 $ %
---- ----
(dollars in millions)
Operating Segment:
Optoelectronics $ 379 $ 266 $ 113 42%
Integrated Circuits 812 801 11 1
------ ------ -----
Total $1,191 $1,067 $ 124 12%
====== ====== =====
Revenue. Revenue increased 12% or $124 million, for the three months ended March
31, 2001 as compared to the same period in 2000, due primarily to volume
increases in the Optoelectronics segment. The increase of $113 million in the
current quarter within the Optoelectronics segment was led by increased sales in
the metro, submarine network, and transponder product lines. The increase of $11
million in the current quarter within the Integrated Circuits segment was driven
by volume increases in the wireless local area networking and
network-communication products, partially offset by decreases in the remainder
of the segment's lines.
Costs and gross margin. Costs increased 22% or $137 million, from $613 million
in the prior year quarter to $750 million for the three months ended March 31,
2001. Gross margin decreased approximately 5.5 percentage points from 42.5% to
37.0% for the three months ended March 31, 2001 as compared to the same period
in 2000 due to lower manufacturing capacity utilization and increased inventory
reserves. Gross margin for the Integrated Circuits segment was 34% for the
current quarter, and 40.0% for the prior year quarter. The decrease in
Integrated Circuits gross margin was due primarily to lower manufacturing
capacity utilization and increased inventory reserves. Gross margin for the
Optoelectronics segment was 43.6% for the current quarter, and 49.6% for the
prior year quarter. The decrease in Optoelectronics gross margin was due to
increased inventory reserves and changes in product mix.
Selling, general and administrative. Selling, general and administrative
expenses increased 36% or $47 million, from $132 million in the prior year
quarter to $179 million for the three months ended March 31, 2001. The increase
for the three months ended March 31, 2001 was due to expenses associated with
being a standalone company and an increase in allowance for doubtful accounts.
Research and development. Research and development expenses increased 37% or $71
million, from $190 million for the three months ended March 31, 2000 to $261
million for the three months ended March 31, 2001. The increase was due to new
and ongoing product development expenses within the Integrated Circuits and
Optoelectronics segments, including $21 million for development projects
associated with acquisitions during fiscal 2000.
Amortization of goodwill and other acquired intangibles. Amortization expense
increased $107 million from $5 million for the three months ended March 31, 2000
to $112 million for the three months ended March 31, 2001 due to the
amortization of goodwill associated with acquisitions during fiscal 2000.
24
24 Form 10-Q - Part I
Restructuring and separation expenses. In connection with our separation from
Lucent, we incurred $36 million of expenses during the current fiscal quarter.
These charges included restructuring expenses such as the cost of certain lease
terminations, as well as expenses associated with the Company's Separation from
Lucent such as the establishment of a separate computer and information
technology infrastructure and associated information processing and network
support.
Operating income (loss). Operating income decreased $263 million, from $116
million for the three months ended March 31, 2000 to a loss of $147 million for
the same period in 2001. Operating income includes amortization of goodwill and
other acquired intangibles. The Optoelectronics segment operating loss was $46
million for the three months ended March 31, 2001 compared to operating income
of $83 million for the same period in 2000. The results for the three months
ended March 31, 2001 included $93 million of amortization of goodwill and other
acquired intangibles, and zero in the prior year quarter. The Integrated
Circuits segment operating loss was $65 million for the three months ended March
31, 2001 compared to income of $44 million for the same period in 2000. The
results for the three months ended March 31, 2001 included $19 million of
amortization of goodwill and other acquired intangibles compared to $5 million
in the prior year quarter. The reported segments do not include $36 million of
restructuring and separation expense for the quarter ended March 31, 2001, and
approximately $11 million of costs related to purchased in-process research and
development ("IPRD") for the quarter ended March 31, 2000.
The following table shows the change in operating income (loss), excluding IPRD,
amortization of goodwill and other acquired intangibles, and restructuring and
separation expenses both in dollars and in percentage terms:
Three Months Ended Change
March 31,
2001 2000 $ %
---- ----
(dollars in millions)
Operating Segment:
Optoelectronics $ 47 $ 83 $ (36) (43%)
Integrated Circuits (46) 49 (95) (194)
----- ----- -----
Total $ 1 $ 132 $(131) (99%)
===== ===== =====
Other income(expense)-net. Other income(expense)-net increased $18 million, from
a net loss of $2 million for the three months ended March 31, 2000 to $16
million of income for the same period in 2001. The increase was attributed
primarily to a higher level of income from the equity investment in Silicon
Manufacturing Partners Pte Ltd.
Provision for income taxes. For the second fiscal quarter of 2001, the Company
recorded a provision for income taxes of $7 million on a pre-tax loss of $141
million, yielding an effective tax rate of (5.6%). This rate is higher than the
U.S. statutory rate primarily due to the impact of non-tax deductible goodwill
amortization and separation costs partially offset by research and development
tax credits.
For the second fiscal quarter of 2000, the Company recorded a provision for
income taxes of $35 million on pre-tax income of $100 million, yielding an
effective tax rate of 34.9%. This rate approximates the U.S. statutory rate as
the research and development tax credits and the tax impact of non-U.S. activity
were offset by non-tax deductible goodwill amortization.
25
25 Form 10-Q - Part I
RESULTS OF OPERATIONS
Six months ended March 31, 2001 compared to six months ended March 31, 2000
The following table shows the change in revenue, both in dollars and in
percentage terms:
Six Months Ended Change
March 31,
2001 2000 $ %
---- ----
(dollars in millions)
Operating Segment:
Optoelectronics $ 803 $ 470 $ 333 71%
Integrated Circuits 1,750 1,563 187 12
------ ------ -----
Total $2,553 $2,033 $ 520 26%
====== ====== =====
Revenue. Revenue increased 26% or $520 million, for the six months ended March
31, 2001 as compared to the same period in 2000, due to volume increases in both
the Optoelectronics and Integrated Circuits segments. The increase of $333
million in the current period within the Optoelectronics segment was led by
increased sales of optoelectronic components for high-speed transport, submarine
network, and access applications. The increase of $187 million in the current
year within the Integrated Circuits segment was driven by volume increases in
the network communication and wireless local area networking products, partially
offset by decreases in our wireless terminal devices.
Costs and gross margin. Costs increased 37% or $417 million, from $1,115 million
in the prior year to $1,532 million for the six months ended March 31, 2001.
Gross margin decreased approximately 5 percentage points from 45% to 40% for the
six months ended March 31, 2001 as compared to the same period in 2000 due
primarily to lower manufacturing capacity and increased inventory reserves.
Gross margin for the Integrated Circuits segment was 38% for the six months
ended March 31, 2001, and 44% for the same period in 2000. The decrease in
Integrated Circuits gross margin was due primarily to lower manufacturing
capacity utilization and increased inventory reserves. Gross margin for the
Optoelectronics segment was 45% for the six months ended March 31, 2001, and 48%
for the same period in 2000. The decrease in Optoelectronics gross margin was
due primarily to increased inventory reserves.
Selling, general and administrative. Selling, general and administrative
expenses increased 39% or $94 million, from $242 million in the six months ended
March 31, 2000 to $336 million for the same period in 2001. The increase for the
six months ended March 31, 2001 was due to expenses associated with being a
standalone company and an increase in our allowance for doubtful accounts.
Research and development. Research and development expenses increased 48% or
$174 million, from $363 million for the six months ended March 31, 2000 to $537
million for the six months ended March 31, 2001. The increase was due to new and
ongoing product development expenses within the Integrated Circuits and
Optoelectronics segments, including $53 million for development projects
associated with acquisitions during fiscal 2000.
Amortization of goodwill and other acquired intangibles. Amortization expense
increased $213 million from $10 million for the six months ended March 31, 2000
to $223 million for the six months ended March 31, 2001 due to the amortization
of goodwill associated with acquisitions in fiscal 2000.
26
26 Form 10-Q - Part I
Restructuring and separation expenses. In connection with restructuring and
separation from Lucent, the Company incurred $47 million of expenses during the
current fiscal year-to-date. These charges included restructuring expenses such
as the cost of certain lease terminations, as well as expenses associated with
the Company's Separation from Lucent such as the establishment of a separate
computer and information technology infrastructure and associated information
processing and network support.
Operating income(loss). Operating income decreased $414 million, from $292
million for the six months ended March 31, 2000 to a loss of $122 million for
the same period in 2001. Operating income includes amortization of goodwill and
other acquired intangibles. The Optoelectronics segment operating loss was $49
million for the six months ended March 31, 2001 compared to operating income of
$134 million for the same period in 2000. The results for the six months ended
March 31, 2001 included $184 million of amortization of goodwill and other
acquired intangibles, as compared to zero in the prior year period. The
Integrated Circuits segment operating loss was $26 million for the six months
ended March 31, 2001 compared to operating income of $169 million for the same
period in 2000. The results for the six months ended March 31, 2001 included $39
million of amortization of goodwill and other acquired intangibles compared to
$10 million in the prior year period. The reported segments do not include $47
million of restructuring and separation for the six months ended March 31, 2001,
and $11 of costs related to purchased in-process research and development for
the six months ended March 31, 2000.
The following table shows the change in operating income (loss), excluding IPRD,
amortization of goodwill and other acquired intangibles, and restructuring and
separation expenses both in dollars and in percentage terms:
Six Months Ended Change
March 31,
2001 2000 $ %
---- ----
(dollars in millions)
Operating Segment:
Optoelectronics $135 $134 $ 1 1%
Integrated Circuits 13 179 (166) (93)
---- ---- -----
Total $148 $313 $(165) (53%)
==== ==== =====
Other income(expense)-net. Other income(expense)-net increased $43 million, from
a net loss of $6 million for the six months ended March 31, 2000 to $37 million
of income for the same period in 2001. The increase was attributed primarily to
a higher level of income from the equity investment in Silicon Manufacturing
Partners Pte Ltd.
Provision for income taxes. For the first six months of fiscal 2001, the Company
recorded a provision for income taxes of $29 million on a pre-tax loss of $119
million, yielding an effective tax rate of (24.9%). This rate is higher than the
U.S. statutory rate primarily due to the impact of non-tax deductible goodwill
amortization and separation costs partially offset by research and development
tax credits.
For the first six months of fiscal 2000, the Company recorded a provision for
income taxes of $99 million on pre-tax income of $258 million, yielding an
effective tax rate of 38.4%. This rate is higher than the U.S. statutory rate
primarily due to non-tax deductible goodwill amortization.
27
27 Form 10-Q - Part I
LIQUIDITY AND CAPITAL RESOURCES
Cash flow generated from operations was $369 million for the six months ended
March 31, 2001, compared with $279 million for the six months ended March 31,
2000. The improvement in the cash flow from operations for the six months ended
March 31, 2001, compared with the same period last year, was primarily the
result of decreases in accounts receivables of $169 million and increases in
accounts payables of $197 million, offset by an increase in inventory of $249
million, primarily in our Optoelectronics segment. On March 31, 2001, $43
million of trade receivables due from Lucent in the U.S. was settled through
equity.
Cash used in investing activities was $486 million for the six months ended
March 31, 2001 compared with $469 million for the six months ended March 31,
2000. Capital expenditures and acquisitions of businesses are the primary
components of the investing activities. Capital expenditures were $485 million
for the six months ended March 31, 2001, compared with $333 million for the six
months ended March 31, 2000. The Company's capital spending is used primarily in
support of manufacturing facilities. This includes expansion of manufacturing
capacity and enhancement of existing capacity for the manufacture of newer
technologies. Capital is also used to purchase equipment to improve yield,
increase automation, and increase manufacturing productivity. Additional capital
in fiscal 2001 is being spent on establishing an information technology
infrastructure, including computer servers and networking capability.
Net cash provided by financing activities was $186 million for the six months
ended March 31, 2001 compared with $189 million for the six months ended March
31, 2000. Prior to the IPO, the Company relied on Lucent to provide financing
for its operating and investing needs.
On April 2, 2001, the Company received approximately $3.4 billion in proceeds
from the IPO. Following the completion of the IPO, Lucent no longer provides
funds to finance operations. The $2.5 billion of debt the Company assumed from
Lucent consists of short-term borrowings under a credit facility provided by
financial institutions. The Company did not receive any of the proceeds of this
short-term debt.
The credit facility is secured by substantially all of our assets. The $2.5
billion facility is comprised of term loans and revolving credit loans. Upon the
repayment of $1.5 billion of the debt, and if the Company has credit ratings of
BBB- with a stable outlook from Standard & Poors and Baa3 with a stable outlook
from Moody's Investor Services, the debt will become unsecured. The current
ratings are BBB- from Standard & Poors with a negative outlook and Baa3 from
Moody's Investor Services with a stable outlook. Upon the repayment of $1.5
billion, the remaining debt outstanding under this facility would consist of
revolving credit loans. The credit facility will mature on February 21, 2002,
which is 364 days from the date Lucent initially entered into the facility. The
debt is not convertible into any other securities of the Company.
The only periodic debt service obligation under the credit facility is to make
quarterly interest payments. Interest rates on borrowings under the credit
facility are based on the applicable LIBOR rate, or at the Company's election
the prime rate, in each case plus a spread that will vary depending on the
Company's credit rating and whether or not $1.5 billion of the debt is repaid,
as described below. For a short-term debt balance of $2.5 billion outstanding
for an entire year, a one percentage point increase in the average interest rate
on the obligations, also effective for an entire year, would increase pre-tax
interest expense, and reduce pre-tax income, by $25 million. For the current
ratings of BBB- from Standard & Poor's and Baa3 from Moody's, the applicable
interest rate would be the applicable LIBOR rate plus 250 basis points. In
addition, prior to any repayment of $1.5 billion of the debt, the interest rate
will increase 25 basis points every ninety days from February 22, 2001. Upon any
repayment of $1.5 billion of the debt, the interest rates on the borrowings,
assuming the credit rating remains the same, would return to the applicable
LIBOR rate plus 250 basis points.
28
28 Form 10-Q - Part I
The Company does not anticipate making a $1.5 billion prepayment under the
credit facility prior to its maturity unless funds are raised in a debt capital
market transaction or other type of new financing. There is no assurance that
such additional financing will be available on acceptable terms, with lower
interest rates than the credit facility, or at all. If no prepayments are made
prior to the maturity of the credit facility, our interest expense during the
term of the credit facility, as a result of the 25 basis point increase each
quarter over the term of the facility, will increase by an aggregate of $9.4
million.
The credit facility contains customary restrictions, covenants and events of
default for this type of secured financing. These covenants include a maximum
ratio of debt to earnings before interest, taxes, depreciation and amortization
and a minimum ratio of earnings before interest, taxes, depreciation and
amortization to interest expense. The Company does not expect compliance with
the covenants to materially affect operations.
The primary future recurring cash needs will be working capital, capital
expenditures and debt service. The Company also anticipates incurring in the
first twelve months after the IPO, separation costs, fees and expenses, as
described above. The Company believes that cash flows from operations, together
with the net proceeds from the sale of shares in the IPO, will be sufficient to
meet cash needs for working capital, capital expenditures and debt service
during the twelve month period after the IPO and the foreseeable future
thereafter, although there can be no assurance that this will be the case. If
cash flows from operations are less than expected, the Company may need to incur
additional debt. The Company has not yet decided whether, or to what extent, the
$2.5 billion in debt assumed from Lucent will be refinanced or retired. The
Company may from time to time incur additional debt.
Environmental, Health and Safety Matters
The Company is subject to a wide range of laws and regulations relating to
protection of the environment and employee safety and health. The Company is
currently involved in investigations and/or cleanup of known contamination at
eight sites either voluntarily or pursuant to government directives. There are
established reserves for environmental liabilities where they are probable and
reasonably estimable. Reserves for estimated losses from environmental
remediation are, depending on the site, based primarily upon internal or third
party environmental studies, estimates as to the number, participation level and
financial viability of all potential responsible parties, the extent of
contamination and the nature of required remedial actions. Although the Company
believes that the reserves are adequate to cover known environmental
liabilities, it is often difficult to estimate with certainty the future cost of
such matters. Therefore, there is no assurance that expenditures that will be
required relating to remedial actions and compliance with applicable
environmental laws will not exceed the amount reflected in the reserves for such
matters or will not have a material adverse effect on the Company's financial
condition, results of operations or cash flows.
Legal Proceedings
From time to time the Company is involved in legal proceedings arising in the
ordinary course of business, including unfair labor charges filed by its unions
with the National Labor Relations Board, claims before the U.S. Equal Employment
Opportunity Commission and other employee grievances. The Company also may be
subject to intellectual property litigation and infringement claims, which could
cause it to incur significant expenses or prevent it from selling its products.
A patent infringement lawsuit has been filed against Lucent, among other
optoelectronic components manufacturers, by Litton Systems, Inc. and The Board
of Trustees of the Leland Stanford Junior University in the United States
District Court for the Central District of California (Western Division) on
October 3, 2000. The
29
29 Form 10-Q - Part I
Company anticipates that it may be named a defendant in the suit. The complaint
alleges that each of the defendants is infringing a patent related to the
manufacture of erbium-doped optical amplifiers. The patent is owned by Stanford
University and is exclusively licensed to Litton. The complaint seeks, among
other remedies, unspecified monetary damages, counsel fees and injunctive
relief. This matter is in its early stages.
Another patent infringement lawsuit has been filed against Lucent, among other
semiconductors manufacturers, by Lemelson Medical, Education & Research
Foundation, LP, in the United States District Court, District of Arizona on June
15, 1999. The Company anticipates that it may be named a defendant in the
suit. The complaint alleges infringement of 16 patents, 14 of which relate to
machine vision and bar code readers, and the other two relate to semiconductor
processing technology. The action has been stayed with respect to the 14 patents
relating to machine vision and bar code readers, pending a request by the
equipment manufacturers to join the suit and assume responsibility for the
litigation. The complaint alleges infringement of the two patents related to
semiconductor processing based on the manufacture and sale of semiconductor
devices. The complaint seeks unspecified monetary damages, counsel fees and
injunctive relief. All of the Company's integrated circuit products are subject
to this complaint. This matter is in its early stages.
If the Company is unsuccessful in resolving these proceedings, as they relate to
the Company, its operations may be disrupted or it may incur additional costs
that may decrease its profitability. Other than as described above, the Company
does not believe there is any litigation pending that should have, individually
or in the aggregate, a material adverse effect on its financial position,
results of operations or cash flows.
Risk Management
The Company is exposed to market risk from changes in foreign currency exchange
rates that could impact the Company's results of operations and financial
position. The exposure to these market risks is managed through regular
operating and financing activities and, when deemed appropriate, through the use
of derivative financial instruments. Derivative financial instruments are used
as risk management tools and not for speculative purposes. In addition,
derivative financial instruments are entered into with a diversified group of
major financial institutions in order to manage the exposure to nonperformance
on such instruments.
Foreign currency forward contracts, and to a lesser extent from time to time
foreign currency options, are used to manage the volatility of non-functional
currency cash flows resulting from changes in exchange rates. Foreign currency
exchange contracts are designated for recorded, firmly committed or anticipated
purchases and sales. The use of these derivative financial instruments reduces
the Company's overall exposure to exchange rate movements, since the gains and
losses on these contracts substantially offset losses and gains on the assets,
liabilities and transactions being hedged.
Effective October 1, 2000, the Company adopted Statement of Financial Accounting
Standards ("SFAS") No. 133, "Accounting for Derivative Instruments and Hedging
Activities" ("SFAS 133""), and its corresponding amendments under SFAS No. 138.
The adoption of SFAS 133 as of October 1, 2000, resulted in a cumulative
after-tax decrease to results from operations of $4 (net of a tax benefit of $2)
in the six months ended March 31, 2001. The decrease to results from operations
is primarily due to derivatives not designated as hedging instruments. For the
three and six months ended March 31, 2001, the change in fair market value of
derivative instruments was recorded in other income (expense) and was not
material.
While the Company hedges many foreign currency transactions, the decline in
value of non-U.S. dollar currencies may, if not reversed, adversely affect the
Company's
30
30 Form 10-Q - Part I
ability to contract for product sales in U.S. dollars because our products may
become more expensive to purchase in U.S. dollars for local customers doing
business in the countries of the affected currencies.
As the Company becomes a stand-alone company, interest rate swap agreements may
be entered into to manage the risk between fixed, floating and variable interest
rates and long-term and short-term maturity debt instruments. There were no
interest rate swap agreements in effect during fiscal 2000 and 2001.
European Monetary Union--EURO
Several member countries of the European Union have established fixed conversion
rates between their existing sovereign currencies and the Euro, and have adopted
the Euro as their new single legal currency. The legacy currencies will remain
legal tender in the participating countries for a transition period between
January 1, 1999 and January 1, 2002. During the transition period, cash-less
payments can be made in the Euro. Between January 1, 2002 and February 28, 2002,
the participating countries will introduce Euro notes and coins and withdraw all
legacy currencies so that they will no longer be available. The Euro conversion
may affect cross-border competition by creating cross-border price transparency.
The Company will continue to evaluate issues involving introduction of the Euro
as further accounting, tax and governmental legal and regulatory guidance is
available. Based on current information and our current assessment, it is not
expected that the Euro conversion will have a material adverse effect on the
Company's business or financial condition.
FORWARD-LOOKING STATEMENTS
This Management's Discussion and Analysis of Results of Operations and Financial
Condition and other sections of this report contain forward-looking statements
that are based on current expectations, estimates, forecasts and projections
about the industry in which the Company operates, management's beliefs and
assumptions made by management. Words such as "expects", "anticipates",
"intends", "plans", "believes", "seeks", "estimates", variations of such words
and similar expressions are intended to identify such forward looking
statements. These statements are not guarantees of future performance and
involve risks, uncertainties and assumptions which are difficult to predict.
Therefore, actual outcomes and results may differ materially from what is
expressed or forecasted in such forward-looking statements. Except as required
under the federal securities laws and the rules and regulations of the
Securities and Exchange Commission, we do not have any intention or obligation
to update publicly any forward-looking statements whether as a result of new
information, future events or otherwise.
FACTORS AFFECTING OUR FUTURE PERFORMANCE
The following is a list of factors that could affect our future performance and
the price of our stock.
RISKS RELATED TO OUR SEPARATION FROM LUCENT
- Our historical financial information may not be representative of our results
as a stand-alone company and, therefore, may not be reliable as an indicator of
our historical or future results.
- We have no history operating as a stand-alone company, and we may be unable to
make the changes necessary to operate as a stand-alone company, or we may incur
greater costs as a stand-alone company that may cause our profitability to
decline.
- We have a significant amount of debt, which will subject us to various
restrictions and higher interest costs and decrease our profitability, and we
may substantially increase our debt in the future.
31
31 Form 10-Q - Part I
- We will be controlled by Lucent as long as it owns a majority of our common
stock, and our other stockholders will be unable to affect the outcome of
stockholder voting during that time.
- We may have potential business conflicts of interest with Lucent with respect
to our past and ongoing relationships and, because of Lucent's controlling
ownership, the resolution of these conflicts may not be on the most favorable
terms to us.
- Because Lucent's Bell Laboratories central research organization historically
performed important research for us, we will need to develop our own core
research capability. We may not be successful, which could materially harm our
prospects and profitability.
- Because the distribution is subject to conditions, Lucent has various
termination rights and Lucent's indebtedness may prohibit the distribution, the
distribution may not occur and we may not achieve many of the expected benefits
of our separation, we may lose many of our employees and our business may
suffer.
- Many of our executive officers and some of our directors may have conflicts of
interest because of their ownership of Lucent common stock and other ties to
Lucent.
- We could incur significant tax liability if Lucent fails to pay the tax
liabilities attributable to Lucent under our tax sharing agreement, which could
require us to pay a substantial amount of money.
- Because the Division of Enforcement of the Securities and Exchange Commission
is investigating matters brought to its attention by Lucent, our business or
stock price may be affected in a manner we cannot foresee at this time.
RISKS RELATED TO OUR BUSINESS
- Because sales of our optoelectronic components and integrated circuits are
dependent on the growth of communications networks, as market demand for these
networks declines, particularly for optical networks, our revenue and
profitability are likely to decline.
- If we fail to keep pace with technological advances in our industry or if we
pursue technologies that do not become commercially accepted, customers may not
buy our products and our revenue and profitability may decline.
- Because our sales are concentrated on Lucent and a few other customers, our
revenue and profitability may materially decline if one or more of our key
customers do not continue to purchase our existing and new products in
significant quantities.
- If we fail to attract, hire and retain qualified personnel, we may not be able
to develop, market or sell our products or successfully manage our business.
- Our products and technologies typically have lengthy design and development
cycles. A customer may decide to cancel or change its product plans, which could
cause us to generate no revenue from a product and result in a decline in our
profitability.
- Because we are subject to order and shipment uncertainties, any significant
cancellations or deferrals could cause our revenue and profitability to decline
or fluctuate.
- We depend on some single sources of supply, particularly for our
optoelectronic components, and interruptions affecting these and other suppliers
could disrupt our production, compromise our product quality and cause our
revenue and profitability to decline.
32
32 Form 10-Q - Part I
- Because we expect to continue to derive a majority of our revenue from
integrated circuits and the integrated circuits industry is highly cyclical, our
revenue and profitability may fluctuate and may cause our stock price to
fluctuate.
- If we do not achieve adequate manufacturing volumes, yields or sufficient
product reliability, our gross margins and profitability may decline.
- If we are unable to commit sufficient resources to make the necessary capital
expenditures for manufacturing equipment or facilities, our gross margins and
profitability may decline.
- We depend on joint ventures or other third-party strategic relationships for
the manufacture of some of our products. If these manufacturers are unable to
fill our orders on a timely and reliable basis, our revenue and profitability
may decline.
- If our customers do not qualify our manufacturing lines for volume shipments,
our revenue may be delayed or reduced.
- Because optoelectronic component and integrated circuit average selling prices
in particular product areas are declining and some of our older products are
becoming obsolete, our profitability may decline.
- If we do not complete our recently announced headcount reductions as
anticipated, we may not achieve the expense reductions we anticipate.
- We conduct a significant amount of our sales activity and manufacturing
efforts outside the United States, which subjects us to additional business
risks and may cause our profitability to decline due to increased costs.
- We are subject to environmental, health and safety laws, which could increase
our costs and restrict our operations in the future.
- Because many of our current and planned products are highly complex, they may
contain defects or errors that are detected only after deployment in commercial
communications networks and if this occurs, then it could harm our reputation
and result in a decrease in our revenue.
- The communications semiconductor industry is intensely competitive, and our
failure to compete effectively could hurt our revenue and reduce our gross
margins and profitability.
- If we are unable to protect our intellectual property rights, our businesses
and prospects may be harmed.
- We may be subject to intellectual property litigation and infringement claims,
which could cause us to incur significant expenses or prevent us from selling
our products.
- If we cannot maintain our strategic relationships or if our strategic
relationships fail to meet their goals of developing technologies or processes,
we will lose our investment and may fail to keep pace with the rapid
technological developments in our industry.
- We may not have financing for future strategic acquisitions or be successful
in completing acquisitions, and we may be limited in the amount of equity we can
issue in acquisitions, which may prevent us from addressing gaps in our product
offerings, improving our technology or increasing our manufacturing capacity.
- We may acquire other businesses or form joint ventures that could negatively
affect our profitability, increase our debt and dilute existing stockholders'
ownership of our company.
33
33 Form 10-Q - Part I
- Because we have changed our name, our potential customers may not recognize
our new brand, which may cause our revenue and profitability to decline.
- Because we recorded a significant amount of goodwill and other acquired
intangibles in connection with our acquisitions in fiscal 2000, we expect our
amortization of goodwill and other acquired intangibles to significantly reduce
our net income in future periods and these assets could become impaired.
- Because we have manufacturing facilities located in California, we face the
risk that an earthquake could damage these facilities, which would cause a
reduction in our revenue and profitability.
- Because our Class A common stock has a limited trading history and our stock
may be considered a technology stock, the market price and trading volume of our
Class A common stock may be volatile.
- Because our quarterly revenue and operating results are likely to vary
significantly in future periods, our stock price may decline.
- Because of differences in voting power and liquidity between the Class A
common stock and the Class B common stock, the market price of the Class A
common stock may be less than the market price of the Class B common stock
following Lucent's distribution of the Class B common stock.
- A number of our shares are or will be eligible for future sale or
distribution, including as a result of the planned distribution by Lucent, which
may cause our stock price to decline.
- The terms of our separation from Lucent, anti-takeover provisions of our
certificate of incorporation and by-laws, our rights agreement and provisions of
Delaware law could delay or prevent a change of control that you may favor.
34
34 Form 10-Q - Part II
Part II - Other Information
Item 2. Changes in Securities and Use of Proceeds
The effective date of the Registration Statement on Form S-1 (File NO.
333-51594) for the Company's initial public offering, filed under the Securities
Act of 1933, as amended, was March 27, 2001. Pursuant to the Registration
Statement, 600,000,000 shares Class A of common stock were offered and sold by
the Company on March 27, 2001 at a price of $6.00 per share, or $3.6 billion in
the aggregate, before underwriting discounts, and 90,000,000 shares of Class A
common stock were sold by Lucent pursuant to an overallotment option, also at a
price of $6.00 per share, or $540 million in the aggregate, before underwriting
discounts. The initial public offering was completed in early April 2001 and all
securities registered have been sold.
The managing underwriters were Morgan Stanley & Co. Incorporated, Bear Stearns &
Co. Inc., J.P. Morgan Securities Inc., Salomon Smith Barney Inc., Deutsche Banc
Alex. Brown Inc., ABN AMRO Rothschild LLC, SG Cowen Securities Corporation and
Blaylock & Partners, L.P. The Company incurred expenses estimated to be
approximately $160 million, of which $ 140 million represented underwriting
discounts and commissions and $20 million represented other expenses expected to
be paid to unaffiliated third parties. The net proceeds to the Company after
total expenses were $3.4 billion.
Item 4. Submission of Matters to a Vote of Security Holders
On March 26, 2001, Lucent, as the Company's sole stockholder approved the Agere
Systems Inc. 2001 Employee Stock Purchase Plan, the Agere Systems Inc. 2001 Long
Term Incentive Plan and the Agere Systems Inc. Non-Employee Director Stock Plan.
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits
Exhibit No. Description
3.1 Certificate of Incorporation (incorporated by
reference to Exhibit 4.1 of registration statement on
Form S-8 (File No. 333-58324))
4.1 Rights Agreement between Agere Systems Inc. and The
Bank of New York, as rights agent, dated as of March
26, 2001 (incorporated by reference to Exhibit 4.2 of
registration statement on Form S-8 (File No.
333-58324))
(b) Reports on Form 8-K
No reports on Form 8-K were filed during the quarter for which this
report is filed.
35
35 Form 10-Q
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Agere Systems Inc.
Date May 10, 2001 /s/ Mark T. Greenquist
------------------------------
Mark T. Greenquist
Executive Vice President and
Chief Financial Officer