As filed with the Securities and Exchange Commission on December 8, 2003

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549



Form 10-K



|[X] |  | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
|--- |  | ------------------------------------------------------------------------------------



For the fiscal year ended September 30,
2003


|[   ] |  | 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.

(Exact name of registrant as specified in its charter)



|Delaware (State or other jurisdiction of incorporation or organization) |  |  |  | 22-3746606 (I.R.S. Employer Identification No.)
|----------------------------------------------------------------------- |  |  |  | -----------------------------------------------
|1110
American Parkway N.E. Allentown, Pennsylvania                      |  |  |  | 18109                                          
|(Address of
principal executive offices)                                |  |  |  | (Zip
Code)                                     

Registrants telephone number, including area code:
610-712-1000

Securities registered pursuant to Section 12(b) of the Act:



|Title of
Each Class                  |  |  |  | Name of Each Exchange on Which Registered
|------------------------------------ |  |  |  | -----------------------------------------
|Class A Common
Stock, $.01 par value |  |  |  | New
York Stock Exchange                  
|Class B Common
Stock, $.01 par value |  |  |  | New
York Stock Exchange                  

Securities registered pursuant to Section 12(g) of the Act:
None.



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




Indicate by check mark if disclosure of delinquent
filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrants knowledge, in
definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.
[X]




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




The aggregate market value of voting common equity
held by non-affiliates of the registrant as of March 31, 2003 was approximately $2.6 billion, based on the reported last sale prices on the New York
Stock Exchange of such equity on such date.




As of December 1, 2003, 791,038,216 shares of Class A
common stock and 907,994,888 shares of Class B common stock were outstanding.


DOCUMENTS INCORPORATED BY REFERENCE



Certain information required by Part III of this
report (Items 10, 11, 12, 13 and 14) is incorporated by reference from the registrants proxy statement to be filed pursuant to Regulation 14A
with respect to the registrants 2004 annual meeting of stockholders.


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Agere Systems Inc. Form 10-K For the Year Ended September 30,
2003

|PART
I   |  |  |  |                                                                                               |  |  |    |  |  | 
|-------- |  |  |  | --------------------------------------------------------------------------------------------- |  |  | -- |  |  | 
|Item
1.  |  |  |  | Business                                                                                      |  |  | 1  | 
|Item 2.  |  |  |  | Properties                                                                                    |  |  | 9  | 
|Item
3.  |  |  |  | Legal Proceedings                                                                             |  |  | 9  | 
|Item
4.  |  |  |  | Submission of Matters to a Vote of Security Holders                                           |  |  | 9  | 
|         |  |  |  | Executive Officers of the Registrant                                                          |  |  | 10 | 
|PART
II  |  |  |  |                                                                                               |  |  |    | 
|Item
5.  |  |  |  | Market for Registrants Common Equity and Related Stockholder Matters                         |  |  | 11 | 
|Item
6.  |  |  |  | Selected Financial Data                                                                       |  |  | 12 | 
|Item
7.  |  |  |  | Managements Discussion and Analysis of Financial Condition and Results of Operations         |  |  | 13 | 
|Item
7A. |  |  |  | Quantitative and Qualitative Disclosures About Market Risk                                    |  |  | 31 | 
|Item
8.  |  |  |  | Financial Statements and Supplementary Data                                                   |  |  | 32 | 
|Item
9.  |  |  |  | Change in and Disagreements with Accountants on Accounting and Financial Disclosure           |  |  | 69 | 
|Item 9A. |  |  |  | Controls and Procedures                                                                       |  |  | 69 | 
|PART
III |  |  |  |                                                                                               |  |  |    | 
|Item 10. |  |  |  | Directors and Executive Officers of the Registrant                                            |  |  | 69 | 
|Item 11. |  |  |  | Executive Compensation                                                                        |  |  | 69 | 
|Item 12. |  |  |  | Security Ownership of Certain Beneficial Owners and Management andRelated Stockholder Matters |  |  | 70 | 
|Item 13. |  |  |  | Certain Relationships and Related Transactions                                                |  |  | 70 | 
|Item 14. |  |  |  | Principal Accountant Fees and Services                                                        |  |  | 70 | 
|PART
IV  |  |  |  |                                                                                               |  |  |    | 
|Item 15. |  |  |  | Exhibits, Financial Statement Schedules, and Reports on Form 8-K                              |  |  | 71 | 

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FORWARD-LOOKING STATEMENTS



Certain statements in this Form 10-K are
forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933, and
Section 21E of the Securities Exchange Act of 1934. The words estimate, plan, intend, expect,
anticipate, believe and similar expressions are intended to identify forward-looking statements. These forward-looking
statements are found at various places throughout this report and in the documents incorporated herein by reference. Agere disclaims any intention or
obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. Although we believe
that our expectations are based on reasonable assumptions, we can give no assurance that our goals will be achieved. Important factors that could cause
our actual results to differ from estimates or projections contained in the forward-looking statements are described under Factors Affecting Our
Future Performance in Item 7.


PART I

Item 1. Business

General



We design, develop, manufacture and sell integrated
circuit solutions for applications such as high-density storage, multiservice networking, wireless data and personal computer connectivity
applications. These solutions form the building blocks for a broad range of computing and communications applications. Some of our solutions include
related software and reference designs. Our customers include manufacturers of hard disk drives, high-speed communications systems, personal computers
and mobile phones.




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. Reference designs are complete specifications for products that a
customer can use to build an end product, including components, board layouts and software. By using a reference design, a customer can reduce the
amount of product design it must perform and the amount of time to introduce a new product into the market.




Our business operations are organized into two
market-focused groups, the Client Systems group, which serves the computing and consumer communications market, and the Infrastructure Systems group,
which serves the networking equipment market. Each of these two groups is a reportable operating segment. Each segment includes revenue
from the licensing of intellectual property.




The Client Systems group delivers integrated
circuits, software and reference designs for applications including storage, wireless data and personal computer connectivity, including hard disk
drives and modems for computers, data-enabled mobile phones and wireless local area networking. The Infrastructure Systems group delivers integrated
circuit solutions for multiservice networking to network equipment customers.




During fiscal 2003, we substantially completed a
restructuring of our business in response to significant declines in our revenue, particularly from our telecommunications network equipment customers.
We believe that these customers were themselves experiencing significant declines in demand from their customers. As part of this restructuring,
we:


| |  | Sold our optoelectronic components business, including the
manufacturing facilities associated with that business;
|- |  | ------------------------------------------------------------------------------------------------------------------

| |  | Reduced our headcount;
|- |  | ----------------------

| |  | Consolidated our operations into fewer facilities;
and
|- |  | ------------------------------------------------------

| |  | Closed two integrated circuit wafer manufacturing
facilities.
|- |  | -------------------------------------------------------------



Of our total revenue of $1.8 billion in the fiscal
year ended September 30, 2003, $1.3 billion, or 72%, was generated by our Client Systems segment and $518 million, or 28%, was generated by our
Infrastructure Systems segment. In fiscal 2003, 20% of our revenue was generated in the United States and 80% outside the United States. Of our total
revenue of $1.9 billion in the fiscal year ended September 30, 2002, $1.3 billion, or 65%, was generated by our Client Systems segment and $664
million, or 35%, was generated by our Infrastructure Systems segment.


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In fiscal 2002, 27% of our revenue was generated in the United States and 73%
outside the United States. See note 19 to our financial statements in Item 8 for additional information about our Client Systems and Infrastructure
Systems segments and We conduct a significant amount of our sales activity and manufacturing efforts outside the United States, which subjects us
to additional business risks and may adversely affect our results of operations due to increased costs. in Item 7.



As of September 30, 2003, we had approximately 6,800
active employees worldwide. We have major research and development and manufacturing sites in the United States, India, Singapore, Thailand and the
United Kingdom.




We were incorporated in Delaware in 2000 as part of
Lucent Technologies Inc.s plan to spin off its microelectronics business to its stockholders. Lucent completed our spin-off on June 1,
2002.




We maintain an Internet website at
http://www.agere.com. We make available free of charge on our website our annual report on Form 10-K, our quarterly reports on Form 10-Q,
current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) of the Securities Exchange Act of 1934 as
soon as practicable after we electronically file such material with, or furnish it to, the Securities and Exchange Commission. Information on our
website is not incorporated by reference into this report.


Client Systems



Through our Client Systems group, we offer
integrated circuits, software and reference designs for a variety of consumer-purchased products such as hard disk drives, personal computers and
mobile phones.




Many of our products convert analog signals into
digital signals and vice versa. Analog refers to a transmission technique employing a continuous signal that varies in amplitude, frequency or phase of
the transmission. Digital refers to a method of transmitting, storing and processing data that uses distinct electronic or optical pulses to represent
the binary digits 0 and 1.




Storage Products




We sell integrated circuits for use in hard disk
drives. Within the storage products area we sell read channels, disk controllers, pre-amplifiers, or preamps, and motor controllers. Read channels
convert an analog signal that is generated by reading the stored data on the hard disk into digital signals. Preamps are used to amplify the initial
signal from the hard disk so the signal can be processed by the read channel. Together, these are key components that are critical to determining the
overall performance of a hard disk drive. We also develop and sell disk drive controllers, which are used to control signal processing and
communications functions within the disk drive. When a read channel and a disk controller are integrated into a single solution, this is referred to as
a system on a chip. We also sell motor controllers, which are used to control functions related to the spinning of the physical storage
media.




Mobile Phones




We sell integrated circuits for use in digital
mobile phones, and other wireless data and voice communications products. We also offer comprehensive integrated circuit wireless product solutions
that include:


| |  | Digital signal processors for speech compression and encoding
and transmission of voice and data;
|- |  | -------------------------------------------------------------------------------------------------

| |  | Conversion signal processors to convert signals between
frequencies used in digital signal processors and frequencies used for radio transmission; and
|- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Software that controls the communication process.
|- |  | -------------------------------------------------



We also license hardware and software designs for
mobile phones that use our integrated circuits.




Most of our mobile phone products support General
Packet Radio Service, or GPRS, and operate on the Global System for Mobile Communications, or GSM, standard. GPRS provides enhanced data transmission
capabilities for GSM mobile phones. We are providing customers with samples of integrated circuits for an extension of GPRS called EDGE and are selling
products that support the wideband CDMA, or 3G, standard.




Computing Connectivity
Devices




Modem Products.    We
sell integrated circuits and associated software for modem products primarily to leading manufacturers of personal computers, modems and other electronic
equipment. We also offer integrated circuits and software for use in digital telephony products. Digital telephony products provide access to merged


2

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voice and data communications networks. We sell our digital telephony solutions to
manufacturers of business telephone equipment.



Input/Output
Products.    Input/output refers to the transfer of data within and between computers; peripheral equipment, such as printers,
scanners and digital cameras; and data networks. We sell input/output products primarily to manufacturers of computers, peripheral equipment and
communications equipment. A majority of our sales are customized solutions that combine our intellectual property with that of our customers in the
design of our integrated circuits. Our products support Universal Serial Bus, or USB, and IEEE-1394 industry standards, which are both established
connectivity and transmission standards.




Wireless Local Area Networking
Products




We sell integrated circuits and network access cards
for wireless networks, along with associated software.




Our network access cards are used primarily to
connect computers, especially laptop computers, with wireless networks. Our customers can use our integrated circuits to build network access cards or
other wireless local area networking equipment of their own design.




Our wireless local area networking solutions
currently support data transmission speeds of up to 54 megabits per second. During fiscal 2003, we entered into an agreement with Infineon Technologies AG to
jointly develop high-speed wireless local area networking products. These products use circuit elements previously designed by us and by Infineon as
well as components jointly designed by both companies.




We sell our wireless local area networking products
to personal computer manufacturers and wireless networking equipment manufacturers who integrate our products into their own products.




Media Connectivity
Devices




We have begun development of integrated circuits and
software to support a variety of media distribution requirements designed for consumer electronics applications. These products will build on our
wireless networking experience and add functionality specifically designed to enable wireless delivery of audio and video between consumer electronics
equipment.


Infrastructure Systems



Through our Infrastructure Systems group, we offer
solutions for high-speed communications systems that encompass integrated circuits, software and reference designs. Our products facilitate the
transmission and switching of voice, video and data signals within communications networks and are used primarily in the following types of
equipment:


| |  | Network communications equipment, which facilitates the
transmission, switching and management of data and voice traffic within communications networks;
|- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Network access equipment, such as data communications equipment,
which allows devices to connect with communications networks;
|- |  | ------------------------------------------------------------------------------------------------------------------------------

| |  | Enterprise networking equipment, which switches and routes data
traffic in businesses local area networks and storage area networks; and
|- |  | -----------------------------------------------------------------------------------------------------------------------------------------

| |  | Wireless infrastructure equipment, such as cellular base
stations, which transmits and receives data and voice communications through radio waves.
|- |  | --------------------------------------------------------------------------------------------------------------------------------------------------



Our Infrastructure Systems product offerings support
three primary applications:


| |  | Enterprise networking;
|- |  | ----------------------

| |  | Wireline communications infrastructure; and
|- |  | -------------------------------------------

| |  | Wireless communications infrastructure.
|- |  | ---------------------------------------



We sell integrated circuit solutions that include
physical layer devices, integrated circuits supporting SONET/SDH communication standards, multiservice switching fabrics and network processing devices
and broadband access devices, each of which is described below.




Enterprise Networking




We sell integrated circuit solutions that are used
in data networking systems. These systems include local area networks for communicating data within businesses. We are also currently designing
products that will be used in storage area networks.


3

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The majority of our revenue from products used in
enterprise networking applications is derived from the sale of integrated circuits that are custom developed for our customers. These integrated
circuits incorporate our intellectual property or combine our intellectual property with the intellectual property of our customers or other third
parties to create a customized solution for these customers. For some customers, we design and manufacture the integrated circuit while the key
intellectual property belongs solely to our customers.




Our systems-level knowledge and integrated circuit
design methodologies allow us to turn our customers design concepts into a systems solution quickly and effectively. Our intellectual property
gives our customers the flexibility to customize their products to meet their individual cost and performance objectives.




We have begun development of a new family of
standard products for high-speed networking applications. Our entry into this product area was made possible through our acquisition of Massana Limited
during fiscal 2003. These products are intended to address both enterprise and client applications for gigabit Ethernet, a high-speed data networking
standard that operates at data rates of one gigabit per second.




Wireline Communications
Infrastructure




We sell products designed for wired communications
infrastructure. These products are used in high-speed transport networks and in the equipment used to access and interconnect these
networks.




Multiservice Switching Fabrics and Network
Processing Devices.    Switching devices guide data to different communications networks based on the intended destination.
Multiservice switching devices support the transmission of voice and video signals as well as data. We sell switch fabrics and programmable network
processors to communications equipment manufacturers. A switch fabric directs the data within a switching device. A network processor is a component
that controls how data is sent over a network or over a switch fabric such that the data retains its quality of service without interfering with other
data traffic. We also offer supporting software with our switching products.




We currently offer switching products for
asynchronous transfer mode, or ATM, and Internet protocol, or IP. Asynchronous transfer mode and Internet protocol refer to different procedures for
the formatting and timing of data transmission between two pieces of equipment. Our switching integrated solutions reduce the number of required
integrated circuits needed in a switching device.




Broadband Access Devices. Broadband is a
general term that refers to high-speed data transmission. Our broadband access integrated circuits, or mappers, support data transport between central
offices and enterprise sites by aggregation and termination. Aggregation refers to the combining of many low-speed, or tributary, data signals from
enterprises into higher speed, or trunk, data signals for transmission to a central office. Termination refers to the separation of trunk data signals
into lower-speed, tributary data signals.




Our products support data transport for T-carrier
data transport in North America. T-carrier is a digital transmission service from a common carrier. We support similar services worldwide. These
services are referred to as J-carrier in Japan and E-carrier in Europe. T-carrier services such as T1 and T3 lines are widely used to create
point-to-point networks for use by enterprises. T1 and T3 lines refer to different levels of T-carrier service that transmit data at 1.5 megabits per
second and 44.7 megabits per second, respectively. A megabit is a unit of measurement for data and is equal to approximately one million
bits.




SONET/SDH Network
Devices.    Synchronous optical networks, which are typically referred to as SONET, and synchronous digital hierarchy standard
networks, or SDH, carry data, voice and video traffic through a network by combining lines carrying traffic at slower speeds with lines carrying
traffic at higher speeds. This process is known as multiplexing, and involves directing traffic from the individual lines into designated time slots in
the higher speed lines, and those lines into still higher speed lines. The SONET/SDH equipment that handles the directing of traffic into slower speed
and faster speed lines is the add-drop multiplexor, or ADM. Add-drop multiplexors handle the addition and removal of traffic from a SONET/SDH
communication transmission. We offer single-chip integrated circuit solutions, or framers, for add-drop multiplexing of data and voice traffic. In
addition, our framers are used in high-speed routers within an optical network. A router is an interface, or link, between two
networks.




Physical Layer
Devices.    High-speed physical layer devices are key elements in the conversion between optical signals and electronic signals
in communications networks. High-speed physical layer devices accept the output from an optical receiver and convert it into a digital data signal that
can be used in communications switching


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and processing functions. Our products include integrated circuit components for
physical layer devices that provide a complete product offering for transmission up to and including 10 gigabits per second.



Wireless Communications
Infrastructure




Wireless Infrastructure
Devices.    We sell integrated circuit solutions used in wireless infrastructure products, which are primarily cellular base
stations and cellular base transceiver stations. These devices include digital signal processors for speech compression and encoding and transmission
of voice and data and networking products that connect cellular equipment to the wired communications network. Some of these products are standard
offerings that are sold to multiple customers and some are customized for a particular customer. The customized offerings may combine our intellectual
property with intellectual property from our customer. Many of the multiservice networking devices used in wireline communications infrastructure,
including network processors and ATM traffic management devices, are also used in wireless infrastructure.




We have also introduced a new family of radio
frequency power products for wireless base station power amplifier applications. These products can be applied to existing and new wireless
communications standards. These products are currently being evaluated by multiple potential customers.


Customers, Sales And Distribution



Customers




We have a globally diverse base of customers,
consisting primarily of manufacturers of computer and communications equipment. We generally target as customers the leaders in the market segments in
which our products are used as well as the companies we believe will be future leaders in these segments. In fiscal 2003, we sold our products directly
to approximately 260 end customers and indirectly, through distributors, to approximately 630 end customers. For some end customers, we deliver the
product to, and are paid by, a third party associated with the customer, such as their contract manufacturer. Our top 20 end customers in fiscal 2003,
based on revenue, accounted for approximately 74% of our revenue and our top 10 end customers in fiscal 2003, based on revenue, accounted for
approximately 60% of our revenue. Our top ten end customers in fiscal 2003 were:







|Apple Computer,
Inc.     |  |  |  | NEC
Corporation              
|------------------------ |  |  |  | -----------------------------
|Cisco Systems,
Inc.      |  |  |  | Nokia Corporation            
|Hewlett
Packard          |  |  |  | Samsung Electronics Co., Ltd.
|Lucent
Technologies Inc. |  |  |  | Seagate Technology, Inc.     
|Maxtor
Corp.             |  |  |  | Western Digital Corp.        



Our sales to Maxtor represented 16% and 14% of our
revenue in fiscal 2003 and 2002. Our sales to Seagate Technology represented 12% of sales in fiscal 2003, and our sales to Lucent represented 15% of
sales in fiscal 2001. No other customer accounted for 10% or more of our revenue in fiscal 2003, 2002 or 2001.




Sales and
Distribution




We have a worldwide sales organization with
approximately 330 employees as of September 30, 2003, located in nine U.S. sales offices and 15 sales offices outside the U.S. We sell our products globally
primarily through our direct sales force. To complement our direct sales force, we also sell our products through distributors, which sales in fiscal
2003 represented approximately 11% of our revenue.




We aim to have our customers incorporate our
products into the end products they design and develop. Typically, manufacturers of computer and communications equipment conduct a competitive process
to select suppliers for the parts that they will include in their end products. Our sales, marketing and technical personnel work with customers to
demonstrate our products ability to satisfy any specific requirements. We call winning the competitive process a design win. A design win is
important because it allows us to establish a long-term relationship with the customer, at least through the life cycle of the product. We generally do
not, however, enter into written agreements with our customers after achieving a design win. A customer could terminate its relationship with us or
discontinue developing the product. Most of our revenue originates from sales that are the result of design wins.




After we achieve a design win and negotiate the
terms of the sale, we deliver our products to our end customers in a number of ways. Our end customers typically have us ship our products to their
facilities directly. In some


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instances, however, our customer uses a contract manufacturer to manufacture and
assemble their end product. When our product is being incorporated into an end product being manufactured by a contract manufacturer, we often ship our
product directly to the contract manufacturer and receive payment from that contract manufacturer. To determine our sales to particular customers,
however, we recognize this type of transaction as a sale to, and revenue from, the end customer. Sometimes a customer for whom we have achieved a
design win will have us sell that product to a distributor or trading company from whom the customer then buys our product. We recognize these
transactions as indirect sales.

Manufacturing



Our operations support organization is responsible
for our supply chain management and manufacturing activities. As of September 30, 2003, we had approximately 3,150 employees devoted to manufacturing
and related support activities.




We had three facilities located in three countries
devoted to manufacturing integrated circuits as of September 30, 2003. These sites utilized approximately 2.1 million square feet of space dedicated to
manufacturing. As of September 30, 2003, our company-owned and joint venture wafer fabrication operations were in the United States and Singapore,
while our assembly and test operations were in Singapore and Thailand. During fiscal 2003, we completed the consolidation of our United States
integrated circuit manufacturing operations to our facility in Orlando, Florida. We are seeking a buyer for that facility.




We have a joint venture, called Silicon
Manufacturing Partners, with Chartered Semiconductor Manufacturing Ltd., that operates an integrated circuit manufacturing facility in Singapore. We
have agreed to purchase 51% of the ventures managed wafer capacity and Chartered Semiconductor has agreed to purchase the remaining 49% of the
managed wafer capacity. Silicon Manufacturing Partners determines its managed wafer capacity each year based on forecasts provided by Agere and
Chartered Semiconductor. If we fail to purchase our commitments, we will be required to pay the joint venture for the fixed costs associated
with the unpurchased wafers. Chartered Semiconductor is similarly obligated with respect to the wafers allotted to it. The joint venture 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 of either party.




Currently, we manufacture most of our integrated
circuits in facilities that we either own or operate through a joint venture. We also have third-party manufacturing relationships to improve our
manufacturing efficiency and flexibility and to allow us to focus on developing leading products. In the future, we expect to increase the amount of
integrated circuits we buy at market prices.


Competition



We sell products designed for communications and
computer equipment manufacturers. Our customers products are sold in market segments that are intensely competitive and characterized
by:


| |  | Rapid technological change;
|- |  | ---------------------------

| |  | Evolving standards;
|- |  | -------------------

| |  | Short product life cycles; and
|- |  | ------------------------------

| |  | Price erosion.
|- |  | --------------



There are many competitors for our products. We
expect the intensity of competition in the market segments we serve to continue to increase in the future as existing competitors enhance and expand
their product offerings and as our customers attempt to limit the number of suppliers from which they buy. Increased competition may result in price
reductions, reduced revenues and loss of market share. We cannot assure you that we will be able to compete successfully against existing or future
competitors. Some of our customers and companies with which we have strategic relationships also are, or may be in the future, competitors of
ours.


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Our primary competitors within our client product
areas are listed in the table below.







|Storage                        |  |  |  | Mobile Phones                        |  | Computing Connectivity               |  | Wireless Local Area Networking
|------------------------------ |  |  |  | ------------------------------------ |  | ------------------------------------ |  | ------------------------------
|Infineon
Technologies AG       |  |  |  | Koninklijke Philips Electronics N.V. |  | Broadcom Corp.                       |  | Broadcom Corp.                
|LSI Logic
Corp.                |  |  |  | Motorola, Inc.                       |  | Conexant Systems, Inc.               |  | GlobespanVirata, Inc.         
|Marvell
Technology Group Ltd.  |  |  |  | QUALCOMM Inc.                        |  | Infineon Technologies AG             |  | Texas Instruments Incorporated
|STMicroelectronics N.V.        |  |  |  | Skyworks Solutions, Inc.             |  | Koninklijke Philips Electronics N.V. |  |                               
|Texas Instruments
Incorporated |  |  |  | STMicroelectronics N.V.              |  | PCTel, Inc.                          |  |                               
|                               |  |  |  | Texas Instruments Incorporated       |  |                                      |  |                               



Our primary competitors within our
infrastructure product areas are listed in the table below.







|Enterprise Networking         |  |  |  | Wireline Communications Infrastructure |  | Wireless Communications Infrastructure
|----------------------------- |  |  |  | -------------------------------------- |  | --------------------------------------
|Broadcom
Corp.                |  |  |  | Applied Micro
Circuits Corp.           |  | Applied Micro
Circuits Corp.          
|IBM Corp.                     |  |  |  | Intel
Corp.                            |  | Intel
Corp.                           
|Intel Corp.                   |  |  |  | Motorola,
Inc.                         |  | PMC-Sierra,
Inc.                      
|LSI Logic
Corp.               |  |  |  | PMC-Sierra,
Inc.                       |  | Texas Instruments
Incorporated        
|Marvell Technology Group Ltd. |  |  |  | Vitesse
Semiconductor Corporation      |  | Vitesse
Semiconductor Corporation     



Our competitive position varies depending
on the market segment and product areas within these segments. For example, we are number one or two, based on revenue, in many of our product areas,
including analog modems, baseband integrated circuits for wireless infrastructure, SONET/SDH integrated circuits and wired communications integrated
circuits. However, our competitive position is not as strong in the mobile phones and network processor product areas. While improving our position in
many of the product areas where our position is less well-established is an objective of ours, we cannot assure you that we will be able to accomplish
this goal. Further, because we expect to face increasing competitive pressures from both current and future competitors in the product areas we serve,
we may not be able to maintain our position in the product areas in which we are currently a leader.




We believe competition in our industry is based on
the following factors:


| |  | Performance and reliability;
|- |  | ----------------------------

| |  | Price;
|- |  | ------

| |  | Compatibility of products with other products and communications
standards used in communications networks;
|- |  | -----------------------------------------------------------------------------------------------------------

| |  | Product size;
|- |  | -------------

| |  | Ability to offer integrated solutions;
|- |  | --------------------------------------

| |  | Time to market;
|- |  | ---------------

| |  | Breadth of product line;
|- |  | ------------------------

| |  | Logistics and planning systems; and
|- |  | -----------------------------------

| |  | Quality of manufacturing processes.
|- |  | -----------------------------------



While we believe we are competitive on the basis of
all the factors listed above, we believe some of our competitors compete more favorably on the basis of price and on delivering products to market more
quickly. However, we feel we are particularly strong in offering integrated solutions, our broad product lines and our logistics and planning
systems.


Research and development



As of September 30, 2003, our product development
team consisted of approximately 2,150 development engineers and scientists. Approximately 85 percent of these development engineers and scientists
design and implement product solutions. The remaining 15 percent work primarily on integrated circuit design methodology and common circuit elements
that can be used in a number of products.


7

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Our research and development expenditures were $467
million, $625 million and $815 million for fiscal 2003, 2002 and 2001, respectively. We anticipate that we will continue to make significant research
and development expenditures to maintain our competitive position with a continuing flow of innovative products and technology.


Patents, Trademarks And Other Intellectual Property



We own or have rights to a number of patents,
trademarks, copyrights, trade secrets and other intellectual property directly related to and important to our business. We have approximately 5,650
U.S. patents and patent applications and their corresponding foreign patents and patent applications. These patents include patents related to the
following technologies:


| |  | Integrated circuit and optoelectronic manufacturing
processes;
|- |  | --------------------------------------------------------------

| |  | Integrated circuits for use in products such as modems, digital
signal processors, wireless communications, network processors and communication protocols; and
|- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Optoelectronic products including lasers, optical modulators,
optical receivers and optical amplifiers.
|- |  | -------------------------------------------------------------------------------------------------------



The patents described above include patents of all
ages ranging from pending applications, which will have a duration of 20 years from their filing dates, through patents soon to
expire.




We indemnify our customers for some of the costs and
damages of patent infringement in circumstances where our product is the primary factor creating the customers infringement exposure. We
generally exclude coverage where infringement arises out of the combination of our products with products of others.




We expect to protect our products and processes by
asserting our intellectual property rights where appropriate and prudent. We also will obtain patents, copyrights and other intellectual property
rights used in connection with our business when practicable and appropriate.


Government Regulation



Many of our customers end products that
include our products are subject to extensive telecommunications-based regulation by the United States and foreign laws and international treaties. We
must design and manufacture our products to ensure that our customers are able to satisfy a variety of regulatory requirements and protocols
established to, among other things, avoid interference among users of radio frequencies and to permit interconnection of equipment.




Each country has different regulations and a
different regulatory process. In order for our customers products to be used in some jurisdictions, regulatory approval and, in some cases,
specific country compliance testing may be required. The delays inherent in this regulatory approval process may force our customers to reschedule,
postpone or cancel the incorporation of our products into their products, which may result in significant reductions in our sales. The failure to
comply with current or future regulations or changes in the interpretation of existing regulations in a particular country could result in the
suspension or cessation of sales in that country by us or our customers. It also may require us to incur substantial costs to modify our products to
aid our customers in complying with the regulations of that country. Changes in our regulatory environment that generally result from our expansion
into new areas or changes in current regulations could increase the cost of manufacturing our products because we must continually modify our products
to respond to these changes.




In addition, domestic and international authorities
continue to regulate the allocation and auction of the radio frequency spectrum. These regulations have a direct impact on us because many of our
customers licensed products can be marketed only if permitted by suitable frequency allocations, auctions and regulations. The implementation of
these regulations may delay our end-users in deploying their systems, which could, in turn, lead to delays in orders of our products by our customers
and end users. Further, when we license hardware and software designs for mobile phones that use our integrated circuits, we work with our customers to
help them achieve full certification approval for their mobile phones, which is a prerequisite for them to be able to sell their mobile
phones.


Employees



As of September 30, 2003, we employed approximately
6,800 active full-time employees, including approximately 6,100 management and non union-represented employees, and approximately 700 U.S.
union-represented employees covered by collective bargaining agreements.


8

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On May 27, 2003, we entered into a collective
bargaining agreement with local unions 1522, 1560, 1898 and 2000 of the International Brotherhood of Electrical Workers. This agreement, which covers
our U.S. union-represented employees, will be effective until May 31, 2006, unless the parties reach a mutual agreement to amend the
terms.




We believe that we generally have good relationships
with our employees and the unions that represent them.


Backlog



Our backlog, which represents the aggregate of the
sales price of orders received from customers for delivery within six months, but not yet recognized as revenue, was approximately $612 million and
$356 million on September 30, 2003 and September 30, 2002, respectively. The majority of these orders are fulfilled within three months. All orders,
however, are subject to possible rescheduling by customers. Our customers often change their orders two or three times between initial order and
delivery. Our customers frequent changes usually relate to quantities or delivery dates, but sometimes relate to the specifications of the
products we are shipping. Although we believe that the orders included in the backlog are firm, generally orders may be cancelled by the customer
without penalty. We also may elect to permit cancellation of orders without penalty where we believe it is in our best interests to do so. For these
reasons, we believe that our backlog at any given date may not be a reliable indicator of future revenues.


Environmental, Health And Safety Matters



We are subject to a wide range of laws and
regulations relating to protection of the environment and employee health and safety. Our manufacturing facilities have undergone regular internal
audits relating to environmental, health and safety requirements. Most of those facilities also are regularly audited and certified by an independent
and accredited third party registrar, such as Lloyds Register Quality Assurance, as conforming to the internationally recognized ISO 14001
standard relating to environmental management. In addition, our non-U.S. manufacturing facilities conform to BS 8800, the British standard for
occupational health and safety management systems. Based upon these reviews, we believe that our manufacturing facilities are in substantial compliance
with all applicable environmental, health and safety requirements.




We are subject to environmental laws, including the
Comprehensive Environmental Response, Compensation and Liability Act, also known as Superfund, that require the cleanup of soil and groundwater
contamination at sites currently or formerly owned or operated by us, or at sites where we may have sent waste for disposal. These laws often require
parties to fund remedial action at sites regardless of fault. We are a potentially responsible party at a number of Superfund sites and sites otherwise
requiring cleanup action. Specifically, we have liabilities for costs associated with five Superfund sites and two facilities formerly owned by
Lucent.


Item 2. Properties



As of September 30, 2003, we operated three
manufacturing facilities and three warehouse locations in the United States and three other countries. We also operated an additional 61 facilities,
including research and development facilities and design centers. We operated facilities in a total of 18 countries. Our manufacturing facilities were
located in the United States, Singapore and Thailand. We also have a 51% interest in our Silicon Manufacturing Partners joint venture located in
Singapore, which is predominantly used as a manufacturing site.




Our facilities have an aggregate floor space of
approximately 6.7 million square feet, of which approximately 4.7 million square feet, including all of our manufacturing facilities other than our
assembly and test facility in Singapore, is owned and approximately 2.0 million square feet is leased. Our lease terms range from monthly leases
to 13 years. We believe that all of our facilities and equipment are in good condition and are well maintained and able to operate at present
levels.


Item 3. Legal Proceedings



The information required by this Item is included in
Item 7 under the heading Legal Proceedings.


Item 4. Submission of Matters to a Vote of Security Holders



During the fourth quarter of fiscal 2003, no matter
was submitted to a vote of our security holders.


9

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Executive Officers of the Registrant



Our executive officers as of December 1, 2003 were
as follows:







|Name                |  |  |  | Age |  | Position                                              
|------------------- |  |  |  | --- |  | ------------------------------------------------------
|John T.
Dickson     |  |  |  | 57  |  | President and Chief Executive Officer                 
|Ronald D.
Black     |  |  |  | 39  |  | Executive Vice President, Client Systems Group        
|John W.
Gamble, Jr. |  |  |  | 40  |  | Executive Vice President and Chief Financial Officer  
|Peter
Kelly         |  |  |  | 46  |  | Executive Vice President, Operations Group            
|Sohail A.
Khan      |  |  |  | 49  |  | Executive Vice President, Infrastructure Systems Group
|Ahmed
Nawaz         |  |  |  | 54  |  | Executive Vice President, Worldwide Sales Group       



John T. Dickson has been our President and
Chief Executive Officer since August 2000. Previously, Mr. Dickson was Executive Vice President and Chief Executive Officer of Lucents
Microelectronics and Communications Technologies Group since October 1999. He joined AT&T in 1993 as Vice President of its Integrated Circuit
business unit, moved to Lucent following its spin-off in 1996, and was named Chief Operating Officer of Lucents Microelectronics Group in 1997.
Before joining AT&T, Mr. Dickson was Chairman and Chief Executive Officer of Shographics from 1992 until 1993, was President and Chief Executive
Officer of Headland Technology Incorporated from 1991 to 1992, held various management positions at ICL plc from 1983 until 1991 and held various
management positions at Texas Instruments from 1969 until 1983. Mr. Dickson is currently a director of the Semiconductor Industry Association, or SIA,
and Mettler-Toledo International Inc. and a member of the board of trustees of Lehigh Valley Health Network.




Ronald D. Black has been our Executive Vice
President, Client Systems Group, since October 2001. Previously, Mr. Black had been Senior Vice President, Strategy and Business Development at Agere
from March 2001 to October 2001. Before joining Agere, Mr. Black was Vice President and General Manager, Next-Generation Networks Business Unit of
Gemplus, a provider of smart card solutions, from 1998 to 2001. Prior to Gemplus, Mr. Black was the General Manager of the Networking and
Communications Systems Division of Motorolas Semiconductor Products Sector.




John W. Gamble, Jr. has been our Executive
Vice President and Chief Financial Officer since February 2003. Between January 2003 and February 2003, Mr. Gamble was our Senior Vice President and
Business Controller and, between January 2001 and January 2003, he was our Senior Vice President and Treasurer. Between 1996 and 2001, Mr. Gamble held
a number of finance positions at Honeywell International (formerly Allied Signal), including vice president and chief financial officer of Honeywell
Industrial Controls, vice president of business planning and analysis and assistant treasurer. Prior to joining Allied Signal, Mr. Gamble held a number
of positions with General Motors, including treasurer of General Motors of Canada and director of international acquisitions and
divestitures.




Peter Kelly has been our Executive Vice
President, Operations Group, since October 2001. Previously, Mr. Kelly had been Ageres Vice President of Operations for Integrated Circuits from
September 2000 to October 2001. Mr. Kelly joined Lucent Microelectronics in September 2000 from Fujitsu-ICL Systems Inc., a joint venture of ICL and
Fujitsu that provided computer systems and services to retailers and banks, where he was Executive Vice President and Chief Operating Officer. Mr.
Kelly had been with Fujitsu-ICL for six years.




Sohail A. Khan has been our Executive Vice
President, Infrastructure Systems Group, since October 2001. Previously, Mr. Khan had been Executive Vice President of Integrated Circuits since March
2001. Mr. Khan was President of the Integrated Circuits business of Lucents Microelectronics and Communications Technologies Group from April
2000 to March 2001. Mr. Khan was the strategy and business development Vice President of Lucents Microelectronics and Communications Technologies
Group from September 1996 to April 2000. From April 1996 to September 1996, Mr. Khan was Vice President of Marketing for MMC Networks, a developer and
supplier of network processing platforms and services. Mr. Khan joined AT&T in 1990 as the director of marketing and applications engineering for
the digital signal processing product line and moved to Lucent following its spin-off in 1996. While at AT&T, he held a variety of positions,
including Vice President and General Manager of the Wireless and Multimedia business unit of AT&T from February 1994 to April
1996.




Ahmed Nawaz has been our Executive Vice
President, Worldwide Sales Group, since March 2001. Mr. Nawaz was President of Worldwide Sales, Strategy and Business Development, from April 2000 to
March 2001, and President, Integrated Circuits Division, from July 1998 to April 2000, of Lucents Microelectronics and Communications
Technologies Group. He joined AT&T in 1992 and moved to Lucent following its spin-off in 1996. Mr. Nawaz was Vice President of Lucents
Network Communications business unit from January 1996 to July 1998.


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While at AT&T, he was Vice President of the Applications business unit from
1994 to 1995. Prior to joining AT&T, Mr. Nawaz was at Texas Instruments, where he was responsible for the personal computer business unit from 1990
to 1992 and also held various marketing and product management positions.



Officers are not elected for a fixed term of office
but hold office until their successors have been elected.


PART II

Item 5. Market for Registrants Common Equity and Related Stockholder
Matters



Price Range of Common
Stock




Our Class A common stock trades on the New York
Stock Exchange under the symbol AGR.A. The high and low sale prices for our Class A common stock for each quarter during our last two full
fiscal years are set forth below, as reported in the consolidated transaction reporting system:







|Fiscal 2002                      |  |  |  | High |      | Low
|-------------------------------- |  |  |  | ---- | ---- | ---
|Quarter Ended
December 31, 2001  |  |  |  | $    | 6.30 |    
|Quarter ended
March 31, 2002     |  |  |  | $    | 6.10 |    
|Quarter ended
June 30, 2002      |  |  |  | $    | 4.49 |    
|Quarter ended
September 30, 2002 |  |  |  | $    | 2.70 |    






|Fiscal 2003                      |  |  | 
|-------------------------------- |  |  | 
|Quarter ended
December 31, 2002  |  |  | 
|Quarter ended
March 31, 2003     |  |  | 
|Quarter ended
June 30, 2003      |  |  | 
|Quarter ended
September 30, 2003 |  |  | 



All of our outstanding Class B common stock was held
by Lucent until June 1, 2002, when Lucent completed our spin-off, distributing to its stockholders all of our Class A common stock and Class B common
stock that it held on that date.




Our Class B common stock has traded on the New York
Stock Exchange under the symbol AGR.B since June 3, 2002. The following table sets forth, for the indicated periods, the quarterly high and
low sale prices of our Class B common stock, as reported in the consolidated transaction reporting system:







|Fiscal 2002                                               |  |  |  | High |      | Low
|--------------------------------------------------------- |  |  |  | ---- | ---- | ---
|Quarter ended
June 30, 2002  (trading began June 3, 2002) |  |  |  | $    | 3.32 |    
|Quarter ended
September 30, 2002                          |  |  |  | $    | 2.72 |    






|Fiscal 2003                      |  |  |  |   |     
|-------------------------------- |  |  |  | - | ----
|Quarter ended
December 31, 2002  |  |  |  | $ | 1.74
|Quarter ended
March 31, 2003     |  |  |  | $ | 2.01
|Quarter ended
June 30, 2003      |  |  |  | $ | 2.60
|Quarter ended
September 30, 2003 |  |  |  | $ | 3.52



As of December 1, 2003, there were 652,124 holders of record of the Class A common stock and
 1,330,634 holders of record of the Class B common stock. We believe that the number of beneficial owners is substantially greater than the
number of record holders, because a large portion of our common stock is held of record through brokerage firms in street
name.




Dividend Policy




We do not anticipate paying any dividends on our
common stock in the foreseeable future. We currently intend to retain our future earnings for use in the operation and expansion of our
business.




Unregistered Sales of Common
Stock




On August 22, 2003, we acquired Massana Limited, a
developer of Gigabit Ethernet-over-copper physical layer device technologies. As part of the acquisition, we issued 9,108,125 shares of Class A common
stock to the Massana stockholders in exchange for all the outstanding shares of Massana. The shares were issued in a private, directly


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negotiated transaction not involving a public offering in reliance on the exemption
from registration provided by Section 4(2) of the Securities Act of 1933. Our reliance on this exemption was based in principal part on certain factual
representations received from the former Massana stockholders who received the shares.



See Item 12 for information about our equity
compensation plans.


Item 6. Selected Financial Data



The following table sets forth selected financial
information for our company. The financial information for the years ended September 30, 2003, 2002, and 2001, and as of September 30, 2003 and 2002,
has been derived from our audited financial statements included elsewhere in this report. The financial information as of September 30, 2001, 2000 and
1999 has been derived from our audited financial statements not included in this report. The financial information for the years ended September 30,
2000 and 1999 has been reclassified to reflect our former optoelectronic components business as discontinued operations and was derived from our
unaudited financial statements not included in this report. The historical selected financial information may not be indicative of our future
performance and should be read in conjunction with the information contained in Managements Discussion and Analysis of Financial Condition
and Results of Operations and the consolidated and combined financial statements and the related notes included in Items 7 and 8, respectively.







|                                                                   |  |  |  | Year Ended September 30, |      
|------------------------------------------------------------------ |  |  |  | ------------------------ | -----
|
|
|Statement
of operations information:                               |  |  |  |                          |      
|Revenue                                                            |  |  |  | $                        | 1,839
|Gross
profit                                                       |  |  |  |                          | 579  
|Income (loss)
from continuing operations                           |  |  |  |                          | (371 
|Basic and
diluted earnings (loss) per share: (4)                   |  |  |  |                          |      
|Income (loss)
from continuing operations                           |  |  |  | $                        | (0.22
|Weighted
average shares outstanding  basic and diluted (millions) |  |  |  |                          | 1,667






|                           |  |  |  | September 30, |      
|-------------------------- |  |  |  | ------------- | -----
|
|Balance
sheet information: |  |  |  |               |      
|Total
assets               |  |  |  |               | 2,388
|Short-term
debt            |  |  |  |               | 195  
|Long-term
debt             |  |  |  |               | 451  

---

|(1) |  | During fiscal 2002, our short-term debt decreased significantly
as we repaid $2.5 billion of borrowings under a credit facility. Also, our total assets decreased significantly as we used $1.6 billion of cash on
hand to repay the credit facility and recorded significant impairments of property, plant and equipment, as well as goodwill and other acquired
intangibles.
|--- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(2) |  | During fiscal 2001, we received approximately $3.4 billion of net
proceeds from our initial public offering and recorded a $2.8 billion impairment of goodwill and other acquired intangibles. We also assumed $2.5
billion of debt from Lucent, consisting of short-term borrowings under a credit facility provided by financial institutions. We did not receive any of
the proceeds of this short-term debt.
|--- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(3) |  | During fiscal 2000, goodwill and other acquired intangibles
increased by $3.4 billion due to the acquisitions of Ortel Corporation, Herrmann Technology Inc., Agere, Inc. and substantially all the assets of VTC
Inc.
|--- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(4) |  | Basic and diluted earnings (loss) per common share are calculated
by dividing income (loss) by the weighted average number of common shares outstanding during the period. The weighted average number of common shares
outstanding on a historical basis includes the retroactive recognition to October 1, 1998 of the 1,035,100,000 shares owned by Lucent prior to our
initial public offering.
|--- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

12

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Item 7. Managements Discussion and Analysis of Financial Condition and
Results of Operations



The following discussion of our financial
condition and results of operations should be read in conjunction with our financial statements and the related notes in Item 8. This discussion
contains forward-looking statements. Please see Forward-Looking Statements and Factors Affecting Our Future Performance for a
discussion of the uncertainties, risks and assumptions associated with these statements.


Overview



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




Our business operations are divided into two
market-focused groups, Client Systems and Infrastructure Systems. The Client segment targets the computer and consumer communications market and the
Infrastructure segment targets the network equipment market. Each of these two groups is a reportable operating segment. The segments each include
revenue from the licensing of intellectual property. The Client segment provides integrated circuit solutions for a variety of end-user applications
such as hard disk drives and modems for computers, data-enabled mobile phones and wireless local area networking. The Infrastructure segment provides
integrated circuit solutions to makers of high-speed communications systems. In addition, the Infrastructure segment formerly provided optoelectronic
components; however, we have sold those operations and have reflected them as discontinued operations for all periods presented. See Sale of
Optoelectronic Components Business for additional details.




In fiscal 2003, we refined our methodology for
allocating shared information technology expenses to our operating segments and between costs, selling, general and administrative expenses, and
research and development expenses. We believe that this methodology provides a better assignment of these expenses based on additional information
about the components and underlying drivers which has been developed since our separation from Lucent Technologies Inc. in fiscal 2001. We have
conformed historical amounts for all periods presented to the current presentation. As a result of this change, we reclassified $58 million and $39
million of expenses previously reflected in costs to operating expenses for fiscal 2002 and 2001, respectively.




Separation from
Lucent




We were incorporated under the laws of the State of
Delaware on August 1, 2000, as a wholly owned subsidiary of Lucent. On February 1, 2001, Lucent transferred to us the assets and liabilities related to
our business, other than pension and postretirement assets and liabilities, which have subsequently been transferred. In April 2001, we completed our
initial public offering. On June 1, 2002, Lucent completed our spin-off by distributing all of the Agere common stock it then owned to its
stockholders.




Prior to the completion of the spin-off on June 1,
2002, we were a majority-owned subsidiary and a related party of Lucent. Revenue from products sold to Lucent during fiscal 2002, prior to the
spin-off, was $162 million, of which $43 million is recorded within income (loss) from operations of discontinued business. Revenue from products sold
to Lucent for fiscal 2001 was $606 million, of which $165 million is recorded within income (loss) from operations of discontinued
business.




Our financial statements include amounts prior to
February 1, 2001 that have been derived from the financial statements and accounting records of Lucent using the historical results of operations and
historical basis of the assets and liabilities of our businesses. We believe the assumptions underlying our financial statements are reasonable.
However, our financial statements that were derived from Lucents financial records may not necessarily reflect what our results of operations,
financial position and cash flows would have been had we been a stand-alone company. Because a direct ownership relationship did not exist among all
the various units comprising Agere, Lucents net investment in us is shown in lieu of stockholders equity in our financial statements for
periods prior to February 1, 2001. We began accumulating retained earnings (losses) on February 1, 2001, the date on which Lucent transferred to us
substantially all the assets and liabilities of our business. For periods prior to February 1, 2001, our financial statements include allocations of
Lucents expenses, assets and liabilities.


13

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Sale of Optoelectronic Components
Business




During the second quarter of fiscal 2003, we sold a
substantial portion of our optoelectronic components business to TriQuint Semiconductor, Inc. for $40 million in cash. The transaction included the
products, product warranty liabilities, technology and certain facilities related to this business; and included lasers, detectors, modulators, passive
components, arrayed waveguide-based components, amplifiers, transmitters, receivers, transceivers, transponders and micro electro-mechanical
systems.




During the second quarter of fiscal 2003, we also
sold the remainder of our optoelectronic components business, which provided cable television transmission systems, telecom access and satellite
communications components, to EMCORE Corporation for $25 million in cash. The transaction included the assets, products, product warranty liabilities,
technology and intellectual property related to this business.




Our exit from the optoelectronic components business
was completed as a result of these two sales. The consolidated financial statements have been reclassified for all periods presented to reflect the
optoelectronic components business as discontinued operations. See Note 4 to our financial statements in Item 8 for additional
details.




Operating Environment




In fiscal 2001 and 2002, we saw significant declines
in our revenue, particularly from our telecommunications equipment manufacturing customers. We believe that these customers were themselves
experiencing significant declines in demand from their customers. As our revenue declined, we determined on several occasions that we needed to reduce
our cost structure. As a result, we implemented programs to reduce our headcount, consolidate our operations into fewer facilities and reduce our owned
manufacturing capacity, including exiting our optoelectronic components business, selling several non-core businesses and reducing our capital
spending.




We have now substantially completed our planned
restructuring activities, including headcount reductions and facility consolidations. We have also ceased operations at our integrated circuit
manufacturing facilities located in Allentown and Reading, Pennsylvania. Our remaining restructuring activities, primarily the decommissioning of these
manufacturing facilities, will take several more quarters to complete.




Our revenue has increased in each of the last three
quarters, after reaching a low-point in the first quarter of fiscal 2003. As a result of our actions to reduce costs and expenses and our stabilizing
revenue, we have seen improvements in our gross profit and net income (loss) in each of the last three quarters.




Our business depends in large part on demand for
personal computers and associated equipment, wireless communications equipment such as mobile phones and wireless local area networking equipment and
telecommunications infrastructure equipment. Our revenues can be affected by changes in demand for any of these types of products. These markets are
competitive and rapidly changing and significant technological changes, new customer requirements, changes in customer buying behavior or the emergence
of competitive products with new capabilities or technologies could adversely affect revenues and operating results. Also, portions of our revenues
have been derived from customers that individually accounted for greater than 10% of our revenues. In fiscal 2003, sales to Maxtor and Seagate
represented 16% and 12%, respectively, of our revenue. In fiscal 2002, sales to Maxtor represented 14% of our revenue and in fiscal 2001, sales to
Lucent represented 15% of our revenue. Maxtor and Seagate are customers of our Client segment and Lucent is a customer of our Infrastructure
segment.




Restructuring
Activities




As a result of our restructuring activities, we
recorded net restructuring and related charges within continuing operations of $131 million, $503 million and $486 million for fiscal 2003, 2002 and
2001, respectively, which are classified within restructuring and other charges  net. For additional details regarding our net restructuring and
other charges, see Note 5 to our financial statements in Item 8.




We also recorded restructuring related costs within
continuing operations within gross profit of $103 million and $59 million for fiscal 2003 and 2002, respectively, of which $71 million and $34 million,
respectively, resulted from increased depreciation. The increased depreciation is due to the shortening of estimated useful lives of certain
manufacturing assets in connection with our restructuring activities. There were no restructuring related costs recorded within gross profit for fiscal
2001.




To complete our remaining restructuring and
consolidation actions, we estimate we will incur additional expenses of approximately $40 to $50 million in the first quarter of fiscal 2004, primarily
for the decommissioning


14

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of our manufacturing sites in Allentown and Reading. We also expect to spend
approximately $20 million for capital expenditures in fiscal 2004 and fiscal 2005 related to our restructuring and consolidation actions. These are
expected to be the last major expenditures under our previously announced restructuring initiatives.



Application of Critical Accounting Policies
and Estimates




The preparation of financial statements and related
disclosures in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and
revenues and expenses during the period reported. The following accounting policies involve a critical accounting estimate because they are
particularly dependent on estimates and assumptions made by management about matters that are highly uncertain at the time the accounting estimates are
made. In addition, while we have used our best estimates based on facts and circumstances available to us at the time, different estimates reasonably
could have been used in the current period, and changes in the accounting estimates we used are reasonably likely to occur from period to period which
may have a material impact on the presentation of our financial condition and results of operations. We review these estimates and assumptions
periodically and reflect the effects of revisions in the period that they are determined to be necessary. We have reviewed our critical accounting
policies with our audit committee.




Property, Plant and
Equipment




Property, plant and equipment that is held and used
is generally reflected in our financial statements at historical cost less an allocation for depreciation that may not be reflective of its fair market
value. However, we have impaired property, plant and equipment in connection with our restructuring initiatives. Property, plant and equipment is
reviewed for impairment whenever events such as a significant industry downturn, product discontinuance, plant closures, product dispositions,
technological obsolescence or other changes in circumstances indicate that their carrying amount may not be recoverable. We perform impairment tests on
groups of assets that are related and have separately identifiable cash flows. In some cases, it may not be practical to measure the cash flows
associated with a group of assets due to the integrated nature of our production process. As a result, we may need to shorten the useful lives related
to these assets, which would cause us to recognize increased depreciation. If separate identifiable cash flows can be identified, we compare the
carrying amount of the assets to their undiscounted expected future cash flows. If an impairment exists, assets classified as held and used are
written-down to fair value and assets classified as held for sale are written-down to fair value less costs to sell. It is reasonably likely that the
actual fair value may differ from our current estimate, in which case we may under- or over-value our property, plant and equipment and under- or over-
value the related impairment charge.




Tax Valuation Allowance




A tax valuation allowance is established, as needed,
to reduce net deferred tax assets to the amount for which recovery is probable. Commencing with the quarter ended June 30, 2001, we established a full
valuation allowance against our U.S. net deferred tax assets because our lack of history as an independent company, recent losses and the uncertainty
of the timing of the recovery of our industry, cause our long term financial forecast to have enough uncertainty that we do not meet the standard of
more likely than not that is required for measuring the likelihood of realization of net deferred tax assets. In the event it becomes more
likely than not that some or all of the deferred tax assets will be realized, we will adjust our valuation allowance. Depending on the amount and
timing of taxable income we ultimately generate in the future, as well as other factors, we could recognize no benefit from our deferred tax assets, in
accordance with our current estimate, or we could recognize their full value.




Tax Contingencies




Tax contingencies are recorded to address potential
exposures involving tax positions we have taken that could be challenged by taxing authorities. These potential exposures result from the varying
application of statutes, rules, regulations and interpretations. Our estimate of the value of our tax contingencies contains assumptions based on past
experiences and judgments about potential actions by taxing jurisdictions. The majority of our tax contingencies were transferred to us from Lucent as
part of the separation transaction and reflect our potential exposures under the tax sharing agreement. We believe these tax contingencies are
reasonable. It is likely that the ultimate resolution of these matters may be greater or less than the amount that we have accrued.


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Retirement Benefits




Postretirement liabilities are for benefits that we
expect to pay to eligible former employees who are retired. We consider various factors in determining our postretirement liability, including the
number of employees who will receive benefits, the type and length of benefits they will receive, trends in health care costs and other actuarial
assumptions. If the actual postretirement benefits paid differ from our current estimate we may be over- or under-accrued.




We also have pension plans covering substantially
all U.S. employees, excluding management employees hired after June 30, 2003. We consider various factors in determining our pension liability,
including the number of employees who be will paid, their salary levels and years of service, the expected return on plan assets, the discount rate
used to determine the benefit obligation, the timing of the payment of benefits, and other actuarial assumptions. If the actual results and events of
our pension plan differ from our current assumptions, our benefit obligations may be over- or under-valued.




We reassess our retirement benefit plan assumptions
on a regular basis. The three key benefit plan assumptions are the discount rate, salary increase assumptions and the expected rate of return on plan
assets. The discount rate we use reflects the prevailing market rate of a portfolio of fixed-income debt instruments rated AA or better and with
maturities matching the expected maturities of the benefit obligations. During the latter part of fiscal 2003, we recorded a curtailment as a result of
actions taken under our recent restructuring related initiatives. This caused us to re-evaluate our assumptions and we changed the discount rate to
6.25% from 6.75% for our U.S. retirement benefit plans. We base our salary increase assumptions on historical experience and future expectations. The
expected rate of return for our retirement benefit plans represents the average rate of return expected to be earned on plan assets over the period the
benefits included in the benefit obligation are expected to be paid. In developing the expected rate of return, we consider long-term compound
annualized returns based on historical market data as well as historical and expected returns on the various categories of plan assets. For fiscal
2003, the weighted-average long-term rate of return on assets assumption remains at 8% for our U.S. retirement benefit plans. The target investment
portfolio allocation for our U.S. pension plans is 40% in equities and 60% in fixed income investments. The portfolios equity weighting is
consistent with the long-term nature of the plans benefit obligation.




Actuarial assumptions are based upon
managements best estimates and judgment. Material changes may occur in retirement benefit costs in the future if these assumptions differ from
actual events or experience. Each change of 25 basis points in the discount rate assumption would have an estimated $0.5 million impact on net
retirement benefit costs and a $44 million impact on benefit obligations. Each change of 25 basis points in the expected rate of return assumption
would have an estimated $3.2 million annual impact on net retirement benefit costs.


Results of Operations



Fiscal year ended September 30, 2003 compared
to fiscal year ended September 30, 2002




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







|                       |  |  |  | Year Ended September 30, |       | Change | 
|---------------------- |  |  |  | ------------------------ | ----- | ------ | 
|
|
|Operating
Segment:     |  |  |  |                          |       |        | 
|Client
Systems         |  |  |  | $                        | 1,321 |        | 
|Infrastructure Systems |  |  |  |                          | 518   |        | 
|Total
Revenue          |  |  |  | $                        | 1,839 |        | 



Revenue.    Revenue
decreased 4% or $84 million, to $1,839 million in fiscal 2003 from $1,923 million in fiscal 2002. The increase of $62 million within the Client segment
reflects strength in the sales of GPRS solutions used in mobile phones and system-on-a-chip solutions used in hard disk drives, as well as a $37
million increase in intellectual property licensing revenues. These increases were partially offset by the absence of $62 million in revenues from our
wireless local area network equipment business which we sold in fiscal 2002. Also offsetting the increase was a decline in revenues related to our
wireless local area networking solutions as we experienced price pressures and a transition from a board-based to a chipset-based
solution.




The decrease of $146 million within the
Infrastructure segment reflects the absence of $66 million in revenues from our analog line card and field-programmable gate array businesses which we
sold in fiscal 2002, as well as


16

---

a $25 million decrease in intellectual property licensing revenues. The remaining
decrease was caused by decreased volume, which resulted from lower demand from telecommunications equipment manufacturers as their customers,
communication service providers, reduced capital expenditures.



Costs and gross
margin.    Costs decreased 12%, or $169 million, to $1,260 million in fiscal 2003 from $1,429 million in fiscal 2002. Gross
margin increased 5.8 percentage points to 31.5% in fiscal 2003 from 25.7% in fiscal 2002. Gross margin for the Client segment decreased to 21.3% in
fiscal 2003 from 29.3% in fiscal 2002. Gross margin for the Infrastructure segment increased to 57.3% in fiscal 2003 from 18.8% in fiscal 2002. The
changes in gross margin on a segment basis were caused in part by a change in the allocation of certain shared manufacturing costs. We update at the
beginning of each fiscal year the allocation of our shared integrated circuit fabrication costs based on the demand forecasts by month from our two
operating segments. This essentially creates a take-or-pay relationship between our manufacturing facilities and the operating segments. As a result,
the dramatic decline in the telecommunications markets in fiscal 2002 negatively impacted Infrastructure gross margin due to excess manufacturing
capacity, as sales volumes were less than we had anticipated. With the update of our demand forecast for fiscal 2003, the costs allocated to our Client
segment for fiscal 2003 increased by approximately $80 million when compared to fiscal 2002. Accordingly, the costs allocated to the Infrastructure
segment decreased by the same amount. This change in allocation is partly responsible for the decrease in Client gross margin and the increase in
Infrastructure gross margin, although it has no effect on our total gross margin.




In addition to the change in allocation described
above, the Client segment gross margin was negatively impacted by a $79 million increase in restructuring related costs, as well as the absence of
gross margin from our wireless local area network equipment business which we sold in fiscal 2002. These decreases to gross margin were partially
offset by a $34 million increase in gross margin from the licensing of intellectual property and improved expense management related to the actions
taken under our restructuring and cost saving initiatives. In addition to the change in allocation described above, the Infrastructure segment gross
margin was positively impacted by improved expense management related to the actions taken under our restructuring and cost saving initiatives, a $35
million decrease in restructuring related costs, $22 million of lower inventory provisions in fiscal 2003 and the sale of our analog line card business
in fiscal 2002, offset in part by lower sales volumes and a $20 million decrease in gross margin from the licensing of intellectual
property.




Selling, general and
administrative.    Selling, general and administrative expenses decreased 10% or $32 million from $326 million in fiscal 2002
to $294 million in fiscal 2003. The decrease was primarily driven by reduced salary, benefit and other expenditures as a result of our restructuring
and cost saving initiatives and the absence of expenditures related to our analog line card, field-programmable gate array and wireless local area
network equipment businesses which we sold in fiscal 2002. The decrease was partially offset by $16 million related to annual meeting expenses, as
there was a significant increase in the number of Agere stockholders as a result of the distribution of Agere common stock by Lucent to its
stockholders on June 1, 2002.




Research and
development.    Research and development expenses decreased 25% or $158 million from $625 million in fiscal 2002 to $467
million in fiscal 2003. The majority of the decrease was due to reduced expenditures as we focused our product development efforts and realized savings
from our restructuring and cost saving initiatives. We also reduced our research and development efforts related to silicon fabrication research and
other manufacturing processes as we transition to a fab-lite model, which resulted in a decrease of approximately $45 million. In addition,
approximately $26 million of the decrease is due to the absence of expenses from the three businesses that we sold in fiscal 2002.




Amortization of goodwill and other acquired
intangibles.    Amortization expense decreased 76% or $26 million from $34 million in fiscal 2002 to $8 million in fiscal 2003,
primarily due to the absence of amortization of goodwill in fiscal 2003. Effective October 1, 2002, we adopted Statement 142, Goodwill and Other
Intangible Assets, and are no longer permitted to amortize goodwill. We continue to amortize acquired intangible assets with finite lives over
their useful life.




Restructuring and other charges 
net.    Net restructuring and other charges decreased 74% or $372 million to $131 million in fiscal 2003 from $503 million in
fiscal 2002. See Restructuring Activities for additional details.




(Gain) loss on sale of operating assets 
net.    (Gain) loss on sale of operating assets  net decreased $278 million from a gain of $299 million in fiscal 2002 to
a gain of $21 million in fiscal 2003. The fiscal 2002 gain consists principally of a $243 million gain on the sale of our field-programmable gate array
business and a


17

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$58 million gain on the sale of our wireless local area network equipment business,
while the fiscal 2003 gain consists principally of the recognition of a $16 million gain on the sale of the analog line card business, which had
previously been deferred. See Note 9 to our financial statements in Item 8 for additional information.



Operating loss.    We
reported an operating loss of $300 million in fiscal 2003, compared with an operating loss of $695 million in fiscal 2002. The improvement in operating
loss is primarily attributable to lower expenses and a higher gross margin in the current year, partially offset by lower gains on the sale of
operating assets in the current year. Although performance measurement and resource allocation for the reportable segments are based on many factors,
the primary financial measure used is operating income (loss) by segment, exclusive of amortization of goodwill and other acquired intangibles, net
restructuring and other charges and (gain) loss on sale of operating assets  net, which is shown in the following table:







|                                |  |  |  | Year Ended September 30, |      | Change | 
|------------------------------- |  |  |  | ------------------------ | ---- | ------ | 
|
|
|Operating
Segment: (1)          |  |  |  |                          |      |        | 
|Client
Systems                  |  |  |  | $                        | (148 | )      | 
|Infrastructure Systems          |  |  |  |                          | (34  | )      | 
|Total
Operating Loss by Segment |  |  |  | $                        | (182 | )      | 



|(1) |  | A reconciliation of operating loss by segment to total operating
loss is provided in Note 19 to our financial statements in Item 8.
|--- |  | -----------------------------------------------------------------------------------------------------------------------------------



Other income 
net.    Other incomenet decreased 71% or $54 million to $22 million in fiscal 2003 compared to $76 million in the prior
year. The change is primarily due to a $27 million decrease in income from our equity investment in Silicon Manufacturing Partners Pte, Ltd. and a $20
million decrease in interest income as a result of lower average cash balances.




Interest
expense.    Interest expense decreased 61% or $74 million to $47 million in fiscal 2003 from $121 million in fiscal 2002. This
decrease is due to having significantly lower debt in fiscal 2003 primarily as a result of repayments on our credit facility, which matured on
September 30, 2002, partially offset by interest incurred on our convertible subordinated notes.




Provision for income
taxes.    For fiscal 2003, we recorded a provision for income taxes of $46 million on a pre-tax loss from continuing operations
of $325 million, yielding an effective tax rate of (14.2)%. This rate differs from the U.S. statutory rate primarily due to the recording of a full
valuation allowance of $91 million against U.S. net deferred tax assets and the tax effect of non-U.S. operations. For fiscal 2002, we recorded a
provision for income taxes of $63 million on a pre-tax loss from continuing operations of $740 million, yielding an effective tax rate of (8.5)%. This
rate differs from the U.S. statutory rate primarily due to the impact of recording a full valuation allowance of $259 million against U.S. net deferred
tax assets and the tax effect of non-U.S. operations.




Income (loss) from discontinued
operations.    For fiscal 2003, income from discontinued operations was $38 million, or $0.02 per share, and consisted of
income from operations of $8 million and a gain on disposal of $30 million. The gain from disposal reflects an $11 million gain from the sale to
TriQuint and a $19 million gain from the sale to EMCORE. For fiscal 2002, loss from discontinued operations was $1,008 million, or $0.62 per
share.




Fiscal year ended September 30, 2002 compared
to fiscal year ended September 30, 2001




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







|                       |  |  |  | Year Ended September 30, |       | Change | 
|---------------------- |  |  |  | ------------------------ | ----- | ------ | 
|
|
|Operating
Segment:     |  |  |  |                          |       |        | 
|Client
Systems         |  |  |  | $                        | 1,259 |        | 
|Infrastructure Systems |  |  |  |                          | 664   |        | 
|Total
Revenue          |  |  |  | $                        | 1,923 |        | 



Revenue.    Revenue
decreased 33%, or $963 million, to $1,923 million in fiscal 2002 from $2,886 million in fiscal 2001 due primarily to volume decreases. The decrease of
$147 million within the Client segment was driven


18

---

by price erosion across the entire segment, particularly in the wireless local
area networking market, and volume decreases across the majority of the segment, except for the hard disk drive market
which experienced substantial volume growth. The decrease of $816 million within the Infrastructure segment was due to depressed market conditions and
reduced expenditures by communication service providers and communication equipment manufacturers, which drove volume decreases across the entire
segment.



Costs and gross
margin.    Costs decreased 27%, or $542 million, to $1,429 million in fiscal 2002 from $1,971 million in fiscal 2001. Gross
margin decreased to 25.7% in fiscal 2002 from 31.7% in fiscal 2001, a decrease of 6.0 percentage points. Gross margin for the Client segment increased
to 29.3% in fiscal 2002 from 24.7% in fiscal 2001. This increase was primarily due to improved manufacturing capacity utilization as a result of
actions taken under our restructuring and cost saving initiatives and lower inventory provisions of $22 million, partially offset by the effects of
product price reductions. Gross margin for the Infrastructure segment decreased to 18.8% in fiscal 2002 from 38.4% in fiscal 2001. The decrease was due
to excess manufacturing capacity as a result of the decline in sales volume, which was partially offset by lower inventory provisions of $30
million.




Selling, general and
administrative.    Selling, general and administrative expenses decreased 38%, or $197 million, from $523 million in fiscal
2001 to $326 million in fiscal 2002. The decrease was primarily due to reduced salary, benefit and other expenditures as a result of our restructuring
and cost saving initiatives.




Research and
development.    Research and development expenses decreased 23%, or $190 million, from $815 million in fiscal 2001 to $625
million in fiscal 2002. The decrease was primarily due to reduced expenditures as we focused our product development efforts and realized savings from
our restructuring and cost saving initiatives.




Amortization of goodwill and other acquired
intangibles.    Amortization expense decreased 55%, or $42 million, from $76 million in fiscal 2001 to $34 million in fiscal
2002. The decrease is principally due to an impairment of goodwill and other acquired intangibles of $267 million recognized in the second half of
fiscal 2001. This impairment reduced our goodwill and other acquired intangibles and therefore, fiscal 2002 amortization.




Restructuring and other charges 
net.    Net restructuring and other charges increased 3%, or $17 million, to $503 million in fiscal 2002 from $486 million in
fiscal 2001. Net restructuring and related expenses increased 28%, or $109 million, to $496 million in fiscal 2002 from $387 million in the prior
fiscal year. Expenses associated with the separation from Lucent decreased 93%, or $92 million, to $7 million in fiscal 2002 from $99 million in fiscal
2001, as the separation was mostly completed in fiscal 2001.




Impairment of goodwill and other acquired
intangibles.    Prior to the adoption in fiscal 2003 of Statement 142, we reviewed our long-lived assets for impairment in
accordance with Statement 121. Statement 121 required that a long-lived asset be assessed for impairment whenever events or changes in circumstances
indicated the carrying amount of the asset may not be fully recoverable. We performed assessments because of weakening economic conditions and
decreased current and expected future demand for products in the markets in which we operate. As a result of these assessments, we determined that an
impairment of goodwill and other acquired intangibles existed related to certain of our acquisitions. During fiscal 2001, we recorded a charge of $267
million to reduce goodwill and other acquired intangibles, consisting of $240 million and $27 million related to Agere, Inc. and Enable Semiconductor
Inc., respectively. There were no impairment charges for goodwill and other acquired intangibles related to continuing operations in fiscal
2002.




(Gain) loss on sale of operating assets 
net.    (Gain) loss on sale of operating assets  net increased $301 million, to a gain of $299 million in fiscal 2002
from a loss of $2 million in fiscal 2001. The fiscal 2002 amount consists principally of a $243 million gain related to the sale of our
field-programmable gate array business and a $58 million gain related to the sale of our wireless local area network equipment
business.




Operating loss.    We
reported an operating loss of $695 million for fiscal 2002 compared to an operating loss of $1,254 million for fiscal 2001. The improvement in
operating loss is primarily attributable to expense reductions, gains on sale of operating assets and a reduction in the impairment of goodwill and
other acquired intangibles, partially offset by a decrease in gross profit. Although performance measurement and resource allocation for the reportable
segments are based on many factors, the primary financial measure used is operating income (loss) by segment, exclusive of amortization of goodwill and
other acquired intangibles, restructuring and other charges 


19

---

net, the impairment of goodwill and other acquired intangibles, and (gain) loss on
sale of operating assets  net, which is shown in the following table:






|                                |  |  |  | Year Ended September 30, |      | Change | 
|------------------------------- |  |  |  | ------------------------ | ---- | ------ | 
|
|
|Operating
Segment: (1)          |  |  |  |                          |      |        | 
|Client
Systems                  |  |  |  | $                        | (73  | )      | 
|Infrastructure Systems          |  |  |  |                          | (384 | )      | 
|Total
Operating Loss by Segment |  |  |  | $                        | (457 | )      | 



|(1) |  | A reconciliation of operating loss by segment to total operating
loss is provided in Note 19 to our financial statements in Item 8.
|--- |  | -----------------------------------------------------------------------------------------------------------------------------------



Other income 
net.    Other income  net increased 23% or $14 million to $76 million in fiscal 2002 from $62 million in fiscal 2001. The
$76 million in fiscal 2002 was comprised primarily of $40 million of income from our equity investment in Silicon Manufacturing Partners Pte, Ltd., $30
million of interest income and $6 million of other miscellaneous income. The $62 million in fiscal 2001 was comprised primarily of $69 million of
interest income and $42 million of income from our equity investment, partially offset by $22 million for impairments of non-consolidated investments,
$14 million of foreign exchange losses and $13 million of other miscellaneous losses.




Interest
expense.    Interest expense decreased 20%, or $30 million, from $151 million in fiscal 2001 to $121 million in fiscal 2002.
During fiscal 2002, our interest expense was principally related to our credit facility, which we significantly reduced throughout the year and fully
repaid by the end of the fiscal year and the convertible notes we issued in June of 2002. During fiscal 2001, our interest expense primarily reflects
four months of allocations from Lucent and interest on the $2,500 million credit facility we assumed from Lucent in April 2001.




Provision for income
taxes.    For fiscal 2002, we recorded a provision for income taxes of $63 million on a pre-tax loss from continuing
operations of $740 million, yielding an effective tax rate of (8.5)%. This rate differs from the U.S. statutory rate primarily due to the recording of
a full valuation allowance of $259 million against U.S. net deferred tax assets and the tax effect of non-U.S. operations. For fiscal 2001, we recorded
a provision for income taxes of $111 million on a pre-tax loss from continuing operations of $1,343 million, yielding an effective tax rate of (8.3)%.
This rate differs from the U.S. statutory rate primarily due to the impact of recording a full valuation allowance of $412 million against U.S. net
deferred tax assets and the tax effect of non-U.S. operations.




Income (loss) from discontinued
operations.    For fiscal 2002, loss from discontinued operations was $1,008 million, or $0.62 per share, and included $475
million of restructuring charges and a $220 million impairment for goodwill and other acquired intangibles. For fiscal 2001, loss from discontinued
operations was $3,158 million, or $2.37 per share, and included a $2,495 million impairment for goodwill and other acquired
intangibles.


Liquidity and Capital Resources



On September 30, 2003, our cash in excess of
short-term debt was $549 million, which reflects $744 million in cash and cash equivalents less $154 million of borrowings under our accounts
receivable securitization facility, $34 million from the current portion of our capitalized lease obligations and $7 million from the current portion
of our installment note. In addition, we have $21 million of cash held in trust that primarily supports obligations of our captive insurance company
and is not immediately available to fund on-going operations. On September 30, 2003, our long-term debt was $451 million, which consists of $410
million of convertible subordinated notes due December 15, 2009, $31 million from the non-current portion of our capitalized lease obligations and $10
million from the non-current portion of our installment note.




Net cash used in operating activities from
continuing operations was $23 million in fiscal 2003 compared with $428 million in fiscal 2002. This improvement in cash used in operating activities
reflects the impact of our steps to reduce our cost structure, including restructuring and consolidation actions, and the streamlining of our product
portfolio. Net cash used in operating activities from discontinued operations was $86 million in fiscal 2003 compared with $232 million in fiscal
2002.




Net cash used in operating activities from
continuing operations was $428 million in fiscal 2002 compared with net cash provided by operating activities of $228 million in fiscal 2001. Although
cash used for costs and operating expenses decreased in fiscal 2002 when compared to fiscal 2001, this was more than offset by lower revenues in fiscal
2002 when compared to fiscal 2001. Net cash used in operating activities from discontinued


20

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operations was $232 million in fiscal 2002 compared with net cash provided by
discontinued operations of $41 million in fiscal 2001.



Investing activities used net cash of $11 million in
fiscal 2003 compared to net cash provided of $368 million in fiscal 2002, and net cash used of $723 million in fiscal 2001. The decrease in cash flow
from investing activities in fiscal 2003 versus fiscal 2002 is primarily due to lower proceeds from the disposition of businesses and sales of assets.
In fiscal 2003, we received $64 million from the sale of our optoelectronic components business and $38 million from the sale of property, plant and
equipment. In fiscal 2002, we received $382 million from the sale of the field-programmable gate array, wireless local area networking equipment and
analog line card businesses, $142 million from the sale of property, plant and equipment and $55 million from the sale of investments. In addition,
capital expenditures decreased by $79 million to $116 million in fiscal 2003 from $195 million in fiscal 2002. Prior to fiscal 2002, capital
expenditures had historically been the primary component of our investing activities and were $723 million in fiscal 2001. However, in response to
adverse market conditions that began in fiscal 2001, we significantly reduced our capital expenditures and we expect them to continue at current
levels.




Financing activities used net cash of $28 million
and $1,970 million in fiscal 2003 and 2002, respectively, and provided net cash of $3,607 million in fiscal 2001. The fiscal 2003 use of cash primarily
reflects the repayment of $65 million in long-term debt, the majority of which is related to capital leases, and the net repayment of $9 million under
our accounts receivable securitization facility, partially offset by borrowings of $20 million under an installment note and proceeds of $26 million
from the issuance of common stock. The fiscal 2002 use of cash includes the repayment of $2,500 million under our credit facility, partially offset by
$396 million of net proceeds from the issuance of convertible subordinated notes and $163 million of net short-term borrowings under our accounts
receivable securitization facility. The fiscal 2001 proceeds primarily reflect $3,448 million of net cash proceeds from the sale of our common stock in
our initial public offering. Prior to our initial public offering, we relied on Lucent to provide financing for our operations.




We have entered into a securitization transaction with certain
financial institutions, pursuant to which the financial institutions agreed to make loans secured by certain of our accounts receivable. The financial
institutions have commitments under the related loan agreement of up to $200 million; however, the amount that can be borrowed at any time depends on
the amount and nature of our accounts receivable. The loan agreement expires on October 1, 2004. As of September 30, 2003, $154 million was outstanding
under this agreement. See Note 7 to our financial statements in Item 8 for a description of the structure of the transaction and additional details.




The majority of our accounts receivable are required
to be pledged as security for the outstanding loans even though some of those receivables may not qualify for borrowings. As of September 30, 2003,
$228 million of gross receivables was pledged as security for the outstanding loans. We pay interest on amounts borrowed under the agreement based on
one-month LIBOR. In addition, we pay an annual commitment fee, which varies depending on our credit rating, on the $200 million total loan commitment.
As of November 5, 2003, our credit ratings were BB- from Standard & Poors and B1 from Moodys, both with a stable
outlook.




The loan agreement has a financial covenant which
requires us to achieve a minimum level of earnings before interest, taxes, and depreciation and amortization each quarter. A violation of this covenant
will end our ability to obtain further loans under the agreement, but will not accelerate payment or require an immediate cash outlay to cover amounts
previously loaned under the accounts receivable securitization.




On June 19, 2002, we issued $410 million of 6.5%
Convertible Subordinated Notes due December 15, 2009 and received net proceeds of $396 million. Interest on the notes accrues at the rate of 6.5% per
annum and is payable semi-annually on June 15 and December 15 of each year, beginning on December 15, 2002. Investors can convert the notes into shares
of Class A common stock at an initial price of $3.3075 per share, subject to adjustment in certain events, at any time prior to maturity, unless
previously redeemed or repurchased by us. We may redeem the notes in whole or in part at any time on or after June 20, 2007. In addition, upon a
fundamental change in our company, we may be required to repurchase the notes at a price equal to 100% of the principal amount of the notes plus any
accrued and unpaid interest.




We have pension plans covering substantially all
U.S. employees hired prior to July 1, 2003. The funding requirements related to our pension plans are dependent on many factors, including actuarial
assumptions and the actual performance of our plan assets. On March 14, 2003, we voluntarily contributed 18,750,000 shares of our Class A common stock
to our pension plan for represented employees. The value of the stock at the time of the contribution was $30 million. We do not expect that we will be
required to make any contributions to our pension plans in fiscal 2004.


21

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Our primary source of liquidity is our cash and cash
equivalents. We believe our cash and cash equivalents will be sufficient to meet our projected cash requirements for at least the next 12
months.




Contractual
Obligations




The following table summarizes the payments due for
specific contractual obligations. These amounts are as of September 30, 2003, with the exception of the accounts receivable securitization, which has
been adjusted to reflect the extended maturity of that facility to October 1, 2004.







|                                   |  |  |  | Fiscal Years |      
|---------------------------------- |  |  |  | ------------ | -----
|
|
|Contractual
obligations:           |  |  |  |              |      
|Convertible
subordinated notes     |  |  |  | $            | 410  
|Accounts
receivable securitization |  |  |  |              | 154  
|Installment
note                   |  |  |  |              | 17   
|Capital
leases                     |  |  |  |              | 76   
|Operating
leases                   |  |  |  |              | 204  
|Purchase
obligations (1)           |  |  |  |              | 182  
|Other
long-term liabilities (2)    |  |  |  |              | 10   
|Total                              |  |  |  | $            | 1,053

---

|(1) |  | Purchase obligations are defined as agreements to purchase goods
or services that are enforceable and legally binding and that specify all significant terms, including: fixed or minimum quantities to be purchased;
fixed, minimum or variable pricing provisions; and the approximate timing of the transactions. These obligations primarily relate to software licenses
and services, wafer production and equipment maintenance services. The amounts are based on our contractual commitments; however, it is possible we may
be able to negotiate lower payments if we choose to exit these contracts earlier.
|--- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(2) |  | Other long-term liabilities consist of miscellaneous
taxes.
|--- |  | -----------------------------------------------------------



Our material contractual obligations also include a
commitment with Silicon Manufacturing Partners Pte, Ltd., or SMP, a joint venture with Chartered Semiconductor, a leading manufacturing foundry for
integrated circuits. SMP operates a 54,000 square foot integrated circuit manufacturing facility in Singapore. We own a 51% equity interest in this
joint venture, and Chartered Semiconductor owns the remaining 49% equity interest. We have an agreement with SMP under which we have agreed to purchase
51% of the managed wafer capacity and Chartered Semiconductor has agreed to purchase the remaining 49% of the managed wafer capacity. SMP determines
its managed wafer capacity each year based on forecasts provided by Agere and Chartered Semiconductor. If we fail to purchase our commitments, we will
be required to pay SMP for the fixed costs associated with the unpurchased wafers. Chartered Semiconductor is similarly obligated with respect to the
wafers allotted to it. The agreement may be terminated after February 2008 by either party upon two years written notice. The agreement may also
be terminated for material breach, bankruptcy or insolvency of either party. Based on forecasted demand, we believe it is unlikely that we would have
to pay any significant amounts for underutilization in the near future. However, if our purchases under this agreement are less than anticipated, our
cash obligation to SMP may be significant.


Recent Pronouncements



In November 2002, the Financial Accounting Standards
Board issued Interpretation No. 45 Guarantors Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others. Interpretation 45 is principally a clarification and elaboration of Statement of Financial Accounting Standards No. 5
Accounting for Contingencies, under which companies were required to recognize a liability for guarantees only when it became likely that
the company would have to honor its guarantee. Interpretation 45 prescribes the disclosures required by a guarantor about its obligations under certain
guarantees it has issued, including loan guarantees and standby letters of credit. It also requires a guarantor to recognize a liability, at the
inception of a guarantee, for the fair value of the obligations it has assumed under the
guarantee, even if it is not probable that payments will be required under that guarantee. The initial recognition and measurement provisions of
Interpretation


22

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45 are required only on a prospective basis for guarantees issued or modified after December 31, 2002. Previous accounting for
guarantees issued prior to application of Interpretation 45 will not need to be revised or restated. The disclosure requirements in Interpretation 45
are effective for annual and interim periods ending after December 15, 2002. The adoption of the recognition and measurement provisions of
Interpretation 45 did not have an impact on our financial condition or results of operations.



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




In January 2003, the Financial Accounting Standards
Board issued Interpretation No. 46 Consolidation of Variable Interest Entities, which clarifies the application of Accounting Research
Bulletin No. 51, Consolidated Financial Statements. Interpretation 46 requires certain variable interest entities to be consolidated by the
primary beneficiary of the entity if the equity investors in the entity do not have the characteristics of a controlling financial interest or do not
provide sufficient equity at risk for the entity to support its activities. Interpretation 46 is effective for all new variable interest entities
acquired or created after January 31, 2003. For variable interest entities acquired or created prior to February 1, 2003, the provisions of
Interpretation 46 were required to be applied to the first interim or annual period beginning after June 15, 2003. That effective date was subsequently
deferred until the first interim or annual period ending after December 15, 2003. We early adopted Interpretation 46 and this adoption had no effect on
our financial condition or results of operations since we currently do not have any financial interests in variable interest entities.


Environmental, Health and Safety Matters



We are 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
our operations. We are also subject to environmental laws, including the Comprehensive Environmental Response, Compensation and Liability Act, also
known as Superfund, that require the cleanup of soil and groundwater contamination at sites currently or formerly owned or operated by us, or at sites
where we may have sent waste for disposal. These laws often require parties to fund remedial action at sites regardless of fault. We are a potentially
responsible party at a number of Superfund sites and sites otherwise requiring cleanup action. Specifically, we have liabilities for costs associated
with five Superfund sites and two facilities formerly owned by Lucent.




It is often difficult to estimate the future impact
of environmental matters, including potential liabilities. We have established financial reserves to cover environmental liabilities where they are
probable and reasonably estimable. This practice is followed whether the claims are asserted or unasserted. Management expects that the amounts
reserved will be paid out over the period of remediation for the applicable site, which typically ranges from five to thirty years. Reserves for
estimated losses from environmental remediation are, depending upon the site, based primarily upon internal or third party environmental studies,
estimates as to the number, participation level and financial viability of all potentially responsible parties, the extent of the contamination and the
nature of required remedial actions. Accruals are adjusted as further information develops or circumstances change. The amounts provided for in our
financial statements for environmental reserves are the gross undiscounted amount of such reserves, without deductions for insurance or third party
indemnity claims. Although we believe that our reserves are adequate, including those covering our potential liabilities at Superfund sites, there can
be no assurance that expenditures which will be required relating to remedial actions and compliance with applicable environmental laws will not exceed
the amounts reflected in these reserves or will not have a material adverse impact on our financial condition, results of operations or cash flows. Any
possible loss or range of loss that may be incurred in excess of that provided for as of September 30, 2003, cannot be estimated.


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Legal Proceedings



On October 17, 2002, we filed a patent infringement
lawsuit against Intersil Corporation in the United States District Court in Delaware. We alleged that Intersil had infringed six of our patents related
to integrated circuits for wireless networking using the IEEE 802.11 standard and are seeking monetary damages for Intersils infringement of
these patents and an injunction prohibiting Intersil from using the patents in the future. On November 6, 2002, Intersil filed a counterclaim in this
matter, alleging that ten patents of Intersil are infringed by unspecified Agere products. Two of the patents relate to system-level circuits, and
eight patents relate to semiconductor processing. The complaint seeks an injunction and damages. On July 22, 2003, we filed a second patent
infringement lawsuit against Intersil in the United States District Court in Delaware, alleging that Intersil had infringed four additional patents
 three covering semiconductor processing and one covering integrated circuits for wireless networking. We are seeking an injunction and damages.
Intersil counterclaimed with four additional patents relating to semiconductor processing. We believe that Intersils claims are without
merit.




On October 30, 2002, Choice-Intersil Microsystems,
Inc., filed a lawsuit against us in the United States District Court for the Eastern District of Pennsylvania. The amended complaint alleges
misappropriation of trade secrets and copyrights that were jointly developed and jointly owned by Digital Ocean, Inc. (which, following several
acquisitions and corporate reorganizations, is now Choice-Intersil) and Lucent. The trade secrets and copyrights relate to media access controller
technology for wireless local area networks. The complaint seeks an injunction and damages. We counterclaimed for misappropriation of trade secrets and
breach of contract. On September 2, 2003, the court issued a decision denying Choice-Intersils motion for a preliminary injunction and holding
that we had lawfully obtained the trade secrets and copyrights alleged to have been infringed. Choice-Intersil has appealed. We believe that
Choice-Intersils claims are without merit.




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




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




On August 28, 2003, GlobespanVirata, Inc. acquired
Intersils wireless networking product group.


Factors Affecting Our Future Performance



Set forth below and elsewhere in this report and in
other documents we file with the Securities and Exchange Commission are risks and uncertainties that could cause our actual results to differ
materially from the results contemplated by the forward-looking statements contained in this report and other public statements we
make.




Risks Related To Our
Business


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



The demand for our products can change quickly and
in ways we may not anticipate because our industry is generally characterized by:


| |  | Rapid, and sometimes disruptive, technological
developments;
|- |  | ------------------------------------------------------------

| |  | Evolving industry standards;
|- |  | ----------------------------

| |  | Changes in customer requirements;
|- |  | ---------------------------------

| |  | Limited ability to accurately forecast future customer
orders;
|- |  | --------------------------------------------------------------

| |  | Frequent new product introductions and enhancements;
and
|- |  | --------------------------------------------------------

| |  | Short product life cycles with declining prices over the life
cycle of the product.
|- |  | -----------------------------------------------------------------------------------



If we fail to make sufficient investments in
research and development programs in order to develop new and enhanced products and solutions, or if we focus on technologies that do not become widely
adopted, new


24

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technologies could render our current and planned products obsolete, resulting in
the need to change the focus of our research and development and product strategies and disrupting our business significantly.

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



The market for integrated circuits is intensely
competitive and subject to rapid and disruptive technological change. We expect the intensity of competition to continue to increase as existing
competitors enhance and expand their product offerings and as new participants enter the market. Increased competition may result in price reductions,
reduced gross margins and loss of market share. We may not be able to compete successfully against existing or future competitors, which may hurt our
revenue.




The size and number of our competitors vary across
our product areas, as do the resources we have allocated to the segments we target. Therefore, many of our competitors have greater financial,
personnel, production capacity and other resources than we have in a particular market segment or overall. Competitors with greater financial resources
may be able to offer lower prices, additional products or services or other incentives that we cannot match or offer. These competitors may be in a
stronger position to respond quickly to new technologies and may be able to undertake more extensive marketing campaigns. They also may adopt more
aggressive pricing policies and make more attractive offers to potential customers, employees and strategic partners. These competitors may make
strategic acquisitions or establish cooperative relationships among themselves or with third parties to increase their ability to gain market
share.




Further, some of our competitors are currently
selling commercial quantities of products that we are sampling to our customers, that are still in the initial stages of development or that we may
develop in the future. By being able to offer these products in commercial quantities before we do, our competitors can establish significant market
share, acquire design wins in customer equipment programs and create a market position that we may be unable to overcome once we have completed
development and testing of that product.


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



We currently manufacture our integrated circuits
through a combination of internal capability, joint ventures and external
sourcing with contract manufacturers. The integrated circuit manufacturing
industry has a history of developing new manufacturing processes. We
believe that the costs associated with implementing new processes, including
acquiring the necessary equipment and building appropriate facilities, are
increasing with each generation of manufacturing processes. Because we do not want
to make the financial investments necessary for future processes, we plan to rely on
third-party contract manufacturers to make integrated circuits for us using any
manufacturing processes that we do not currently use internally. In fiscal 2003,
approximately 46% of our revenue was derived from integrated circuits
manufactured at joint ventures or through other external sourcing arrangements,
and we expect this percentage to increase over time. To the extent we rely on
joint ventures and third-party manufacturing relationships, we face the
following risks:


| |  | That they may not be able to develop manufacturing methods
appropriate for our products;
|- |  | ----------------------------------------------------------------------------------------

| |  | That manufacturing costs will be higher than
planned;
|- |  | -----------------------------------------------------

| |  | That reliability of our products will decline;
|- |  | ----------------------------------------------

| |  | That they may be unwilling to devote adequate capacity to
produce our products;
|- |  | -------------------------------------------------------------------------------

| |  | That they may not be able to maintain continuing relationships
with our suppliers; and
|- |  | --------------------------------------------------------------------------------------

| |  | That we may have reduced control over delivery schedules and
costs of our products.
|- |  | -----------------------------------------------------------------------------------



If any of these risks were to be realized, we could
experience an interruption in supply or an increase in costs, which could adversely affect our results of operations.




We have recently reduced our owned manufacturing
capacity. In the event of an increase in demand, failure to increase our manufacturing volumes or obtain capabilities from third parties may result in
our not being able to meet customer demand for our products, which could hurt our relationships with our customers and result in our recording lower
revenues than would be the case if we had greater manufacturing capacity.


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



A widespread outbreak of an illness could adversely
affect our operations as well as demand from our customers. A number of countries in the Asia/Pacific region have experienced outbreaks of SARS. As a
result of outbreaks such as these, businesses can be shut down temporarily and individuals can become ill or quarantined.


We have manufacturing and back-office operations in Singapore, assembly and test
and back-office operations in Thailand and design operations in China, countries where outbreaks of SARS have occurred. If our operations are curtailed
because of SARS or other health issues, we may need to seek alternate sources of supply for manufacturing or other services and alternate sources can
be more expensive. Alternate sources may not be available or may result in delays in shipments to our customers, each of which would adversely affect
our results of operations. In addition, a curtailment of our design operations could result in delays in the development of new products. If our
customers businesses are affected by SARS, they might delay or reduce purchases from us, which could adversely affect our results of
operations.

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



We expect to derive most of our revenue from the
sale of integrated circuits. Because the integrated circuits market segment is highly cyclical, we may experience declines in our revenue that are
primarily related to industry conditions and not our products. This industry has experienced significant downturns, often in connection with, or in
anticipation of, excess manufacturing capacity worldwide, maturing product cycles and declines in general economic conditions.




We focus primarily on winning competitive selection
processes to develop products for use in our customers equipment. These selection processes can be lengthy. After winning and beginning a product
design for a customer, that customer may not begin volume production of their equipment for a period of up to two years, if at all. Due to this lengthy
design and development cycle, we may experience delays from the time we begin incurring expenses until the time we generate revenue from our products.
We have no assurances that our customers will ultimately market and sell their equipment or that such efforts by our customers will be successful.
Thus, we may never generate any revenue from our products after incurring significant design and development expenditures.




If we are not selected by a customer to provide a
product, we may experience significantly lower revenue later, as compared to prior periods with more revenue from earlier design wins. In addition,
sales of our products for specific customer projects often begin and end abruptly, so revenue may increase rapidly and later decrease just as quickly.
The relative timing of the beginning and end of our sales and design processes can make our revenues less predictable.




Fluctuations in our revenue or operating results
could cause our stock price to decline, even if our results meet expectations. Further, stock prices in our industry have recently been highly volatile
for reasons that sometimes are unrelated to the performance of the companies in the industry. These broad fluctuations could adversely affect our stock
price.


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 applications, and if this occurs, it could harm our reputation and
result in reduced revenues or increased expenses.



Our products are highly complex and may contain
undetected defects, errors or failures. These products can only be fully tested when deployed in commercial applications and other equipment.
Consequently, our customers may discover errors after the products have been deployed. The occurrence of any defects, errors or failures could result
in:


| |  | Cancellation of orders;
|- |  | -----------------------

| |  | Product returns, repairs or replacements;
|- |  | -----------------------------------------

| |  | Diversion of our resources;
|- |  | ---------------------------

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| |  | Legal actions by our customers or our customers
end-users;
|- |  | -----------------------------------------------------------

| |  | Increased insurance costs; and
|- |  | ------------------------------

| |  | Other losses to us or to our customers or end-users.
|- |  | ----------------------------------------------------



Any of these occurrences could also result in the
loss of or delay in market acceptance of our products and loss of sales, which would harm our business and adversely affect our results of operations.
We have from time to time experienced defects and expect to experience defects in the future. Because
the trend in our industry is moving toward even more complex products in the future, this risk will intensify over time and may result in increased
expenses.


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



Our customer base is highly concentrated. Our top 10
end-customers accounted for approximately 60% of our revenue in fiscal 2003. If any one of our key customers decides to purchase
significantly less from us or to terminate its relationship with us, our revenue may materially decline. Because our strategy has generally been to
develop long-term relationships with a few key customers in the product areas in which we focus and we have a long product design and development cycle
for most of our products, we may be unable to replace these customers quickly or at all. We could lose our key customers or significant sales to our
key customers because of factors beyond our control, such as a significant disruption in our customers businesses generally or in a specific
product line.


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



We derive, and expect to continue to derive, a
significant portion of our revenue from the sale of integrated circuits used in communications networks. Communications equipment makers are purchasing
significantly less components for their products, including the components we sell, than they did before 2001. If demand for these components declines
further, our results of operations may be adversely affected.


We are
expanding, and may seek in the future to expand, into new areas, and if  we are not
successful, our results of operations may be adversely affected.



We are currently developing products in new areas,
including wireless communications infrastructure, high-speed networking and consumer electronics. We may seek to expand into additional areas in the
future. We may expand through internal development efforts, through acquisitions of companies or technologies, or a combination of these
methods.




Our efforts may not result in sales that are
sufficient for us to recoup our investment, and we may experience higher costs than we anticipated. For example, we may not be able to manufacture our
product at a competitive cost, may need to rely on new suppliers or may find that the development efforts are more costly or timing consuming than we
had anticipated. Our products may support protocols that are not widely adopted. Where we choose to develop capabilities by acquiring another company,
we may not be able to integrate the other company successfully into our operations, which may mean that we have difficulty retaining employees from the
acquired company or integrating its technology into our products. We may have difficulties entering markets where competitors have strong market
positions.


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.



In some of our fields of operation, there are only a
limited number of people in the job market who possess the requisite skills. In the past we have experienced difficulty in identifying and hiring
sufficient numbers of qualified engineers in many areas of our business as well as in retaining employees. The loss of the services of any key
personnel or our inability to hire new personnel with the requisite skills could restrict our ability to develop new products or enhance existing
products in a timely manner, sell products to our customers or manage our business effectively.


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



We generally sell products pursuant to purchase
orders that customers may cancel or defer on short notice without incurring a significant penalty. Cancellations or deferrals could cause us to hold
excess inventory, which could adversely affect our results of operations. If a customer cancels or defers product shipments, we may incur unanticipated
reductions or delays in our revenue. If a customer refuses to accept shipped products or does not pay for these products in a timely manner, we could incur significant charges against
our income, which could materially and adversely affect our results of operations.


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



Because the manufacturing costs at our owned and
joint venture manufacturing facilities are relatively fixed, efficient utilization of manufacturing facilities and manufacturing yields are critical to
our results of operations. If we do not experience adequate utilization of our manufacturing facilities, our results of operations may be adversely
affected. Lower than expected manufacturing yields could adversely affect our results of operations and delay product shipments.




The manufacture of our products involves highly
complex and precise processes, requiring production in highly controlled and clean environments. Changes in our manufacturing processes or those of our
suppliers or contractors, or their inadvertent use of defective or contaminated materials, could significantly reduce our manufacturing yields and
product reliability.


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



The revenue we generate from the licensing of our
intellectual property has a higher gross margin compared to the revenue we generate from the sale of our integrated circuits products. Although we have
derived less than 7% of our total revenue in recent years from the licensing of intellectual property, a decline in this licensing revenue would have a
greater impact on our profitability than a similar decline in revenues from the sale of our integrated circuits products.


If our
customers do not qualify our products or manufacturing lines or the  manufacturing lines
of our third-party suppliers for volume shipments, our results of operations may be
adversely affected.



Some customers will not purchase any of our
products, other than limited numbers of evaluation units, until they qualify the manufacturing line for the product. We may not always be able to
satisfy the qualifications. Delays in qualification may cause a customer to discontinue use of our products and result in a significant loss of
revenue.


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



In fiscal 2003, we derived approximately 80% of our
revenue from sales of our products shipped to locations outside the United States. We also manufacture a significant portion of our products outside
the United States and are dependent on non-U.S. suppliers for many of our parts. We intend to continue to pursue growth opportunities in both sales and
manufacturing outside the United States. Operations outside the United States are subject to a number of risks and potential costs, which could
adversely affect our revenue and results of operations, including:


| |  | Our brand may not be locally recognized, which may cause us to
spend significant amounts of time and money to build a brand identity;
|- |  | -------------------------------------------------------------------------------------------------------------------------------------

| |  | Unexpected changes in regulatory requirements;
|- |  | ----------------------------------------------

| |  | Inadequate protection of intellectual property in some countries
outside of the United States;
|- |  | ----------------------------------------------------------------------------------------------

| |  | Currency exchange rate fluctuations;
|- |  | ------------------------------------

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| |  | International trade disputes;
|- |  | -----------------------------

| |  | Political and economic instability; and
|- |  | ---------------------------------------

| |  | Disruptions in international air transport systems.
|- |  | ---------------------------------------------------

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



We are subject to a variety of laws relating to the
use, disposal, clean-up of, and human exposure to, hazardous chemicals. Any failure by us to comply with present and future environmental, health and
safety requirements could subject us to future liabilities or the suspension of production. In addition, compliance with these or future
laws could restrict our ability to expand our facilities or require us to acquire costly
pollution control equipment, incur other significant expenses or modify our manufacturing processes. If additional contaminants are discovered or
additional cleanup obligations imposed at these or other sites, we could be adversely affected.


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



Like other companies in the semiconductor industry,
we are frequently involved in litigation regarding patent and other intellectual property rights. From time to time, we receive notices from third
parties of potential infringement and receive claims of potential infringement when we attempt to license our intellectual property to others.
Defending these claims could be costly and time consuming and would divert the attention of management and key personnel from other business issues.
The complexity of the technology involved and the uncertainty of intellectual property litigation increase these risks. Claims of intellectual property
infringement also might require us to enter into costly royalty or license agreements. However, we may be unable to obtain royalty or license
agreements on terms acceptable to us or at all. In addition, third parties may attempt to appropriate the confidential information and proprietary
technologies and processes used in our business, which we may be unable to prevent and which would harm our business and prospects.


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



We believe that lenders have at times been less
willing to extend credit to companies in the telecommunications and semiconductor industries, making debt financing difficult to obtain. As described
below under Risks Related to Our Separation from Lucent Technologieswe are limited in the amount of stock that we can issue to raise
capital because of potential adverse tax consequences, in connection with our spin-off from Lucent Technologies, we are restricted in our ability
to issue stock in order to raise capital.




If we are not able to obtain sufficient funds on
acceptable terms, we may not have sufficient funds to take advantage of market opportunities or to finance future strategic initiatives.


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



The Class B common stock has greater voting power
per share for the election and removal of directors than the Class A common stock, and, as a result, some investors may prefer the Class B common stock
as a means of investing in our company. The greater potential voting power may cause the Class B common stock to trade at a higher market price than
the Class A common stock. On the other hand, the Class A common stock has historically had a higher daily trading volume than the Class B common stock.
As a result, the Class A common stock may be more liquid than the Class B common stock and more attractive to investors, which may cause the price of
the Class A common stock to be higher than the price of the Class B common stock.


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



The emergence of markets for our integrated circuits
is affected by a variety of factors beyond our control. In particular, our products are designed to conform to current specific industry standards. Our
customers may not


29

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adopt or
continue to follow these standards, which would make our products less desirable to our
customers and reduce our sales.  Also, competing standards may emerge that are preferred
by our customers, which could reduce our sales and require us to make significant
expenditures  to develop new products. To the extent that we are not able to effectively
and expeditiously adapt to new standards, our business will  suffer.

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



In the past, securities class action litigation
often has been brought against a company following periods of volatility in the market price of its securities. Companies in the integrated circuit
industry and other technology industries are particularly vulnerable to this kind of litigation due to the high
volatility of their stock prices. Accordingly, we may in the future be the target of securities litigation. Any securities litigation could result in
substantial costs and could divert the attention and resources of our management.


Risks
Related to Our Separation From Lucent  Technologies

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



In June 2002, Lucent Technologies completed our
spin-off by distributing to its stockholders all of our common stock it then owned. Under Section 355(e) of the Internal Revenue Code, Lucent will
recognize a taxable gain on that distribution if there are one or more acquisitions of our stock representing 50% or more of our stock (by vote or
value) and the stock acquisitions are part of a plan or series of related transactions that includes the spin-off. Any shares of our stock acquired
within two years before or after the spin-off are presumed to be part of such a plan unless we can rebut that presumption. If an issuance of our stock
causes the distribution to be taxable to Lucent under Section 355(e), we would be required to indemnify Lucent against that tax under our tax sharing
agreement with Lucent.




The shares of our Class A common stock issued in our
initial public offering are considered to be part of a plan that includes the spin-off, and the shares of our Class A common stock that may be issued
upon the conversion of our 6.5% convertible subordinated notes may also be considered to be part of a plan that includes the spin-off. Assuming that
all of the convertible notes were converted, approximately 45% of our outstanding shares may be treated as acquired as part of such a
plan.




Treasury Regulations issued in April 2002 provide
safe harbors that may be used to rebut the presumption that shares issued less than two years after the spin-off are part of a plan that includes the
spin-off. However, the application of the safe harbors is not clear in many respects, and they might not be available to us for future share issuances.
As a result, Section 355(e) limits our ability to issue shares to raise capital for at least two years after the spin-off. However, the safe harbors in
these new Treasury Regulations generally provide that issuances of our stock pursuant to ordinary course employee compensation arrangements (such as
employee stock purchase plans) will not be treated as acquisitions of our stock pursuant to a plan that includes the spin-off.


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



We have entered into a tax sharing agreement with
Lucent that allocates responsibility for tax liabilities between them and us. Under U.S. federal income tax laws, Lucent and we are jointly and
severally liable for Lucents federal income taxes attributable to periods prior to and including Lucents taxable year ended September 30,
2001. This means that if Lucent were to fail to pay the taxes attributable to it under the tax sharing agreement for those periods, we may be liable
for all or any part of these liabilities.


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



In late 2000, Lucent brought to the attention of the
staff of the U.S. Securities and Exchange Commission matters relating to its recognition of revenue. Although Lucent has informed us that it has no
reason to believe that the investigation by the Division of Enforcement of the Securities and Exchange Commission into these matters concerns our
business and we are not aware of any reason why the investigation would affect us, it is possible that


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the results of the investigation may have an
impact on us. Although the investigation could result in no action being taken by the Securities and Exchange Commission, if an action were taken and
the investigation were found to concern our business, the action could result in monetary fines or changes in some of our financial and other practices
and procedures that we are unable to foresee at this time. In February 2003, Lucent announced that it had reached a tentative settlement with the
Securities and Exchange Commission regarding these revenue recognition issues. To date, we believe that a final settlement agreement has not been
executed, and there can be no assurances that a final settlement will be reached.

Item 7A. Quantitative and Qualitative Disclosures About Market
Risk

Risk Management



We are exposed to market risk from changes in
foreign currency exchange rates and interest rates that could impact our results of operations and financial position. We manage our exposure to these
market risks through our regular operating and financing activities and, when deemed appropriate, through the use of derivative financial instruments.
We use derivative financial instruments as risk management tools and not for speculative purposes. In addition, derivative financial instruments are
entered into with a diversified group of major financial institutions in order to manage our exposure to nonperformance on such instruments. Our risk
management objective is to minimize the effects of volatility on our cash flows by identifying the recognized assets and liabilities or forecasted
transactions exposed to these risks and appropriately hedging the risks.




We may use foreign currency forward contracts 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 services. The use of these derivative financial instruments allows us to reduce
our 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. As of September 30, 2003, no foreign currency forward contracts were outstanding.




While we hedge certain foreign currency
transactions, any decline in value of non-U.S. dollar currencies may, if not reversed, adversely affect our ability to contract for product sales in
U.S. dollars because our products may become more expensive to purchase in U.S. dollars for local customers doing business in the countries of the
affected currencies.




As of September 30, 2003, we had $154 million of
short-term variable rate debt outstanding. To manage the cash flow risk associated with this debt, we may from time to time enter into interest rate
swap agreements. We had no interest rate swap agreements in effect during fiscal 2003 or fiscal 2002. As of September 30, 2003, a variation of 100
basis points in the interest rate charged on the short-term debt would result in a change of approximately $2 million in annual interest
expense.




As of September 30, 2003, we had outstanding $410
million of fixed rate long-term convertible notes. Interest rate changes and changes in the value of our Class A common stock would likely result in
changes in the market value of these notes. The fair value of these notes was $537 million at September 30, 2003. We perform a sensitivity analysis on
our fixed rate long-term convertible debt to assess the risk of changes in fair value. The model to determine interest rate sensitivity assumes a
hypothetical 150 basis point shift in interest rates, while keeping the price of our Class A common stock constant. At September 30, 2003, assuming a
150 basis point increase in interest rates, the fair value of the notes would decrease by $8 million. Conversely, a 150 basis point decrease in
interest rates at September 30, 2003, would increase the fair value of the notes by $10 million. The model to determine equity price sensitivity
assumes a hypothetical 10% change in the price of our Class A common stock, while keeping the interest rate constant. At September 30, 2003, assuming a
10% increase in the price of our Class A common stock, the fair value of the notes would increase by $34 million. Conversely, a 10% decrease in the
price of our Class A common stock would result in the fair value of the notes decreasing by $33 million.


31

---

Item 8. Financial Statements and Supplementary Data

INDEX TO FINANCIAL STATEMENTS AND FINANCIAL STATEMENT
SCHEDULE






|Consolidated and Combined Financial Statements:                                                                                                                            |  |  |  |  |    | 
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  |  |  |  | -- | 
|Report of
Independent Auditors                                                                                                                                             |  |  |  |  | 33 | 
|Consolidated
and Combined Statements of Operations for the years ended September 30, 2003, 2002 and 2001                                                                   |  |  |  |  | 34 | 
|Consolidated
Balance Sheets as of September 30, 2003 and 2002                                                                                                              |  |  |  |  | 35 | 
|Consolidated
and Combined Statements of Changes in Stockholders Equity/Invested Equity and Total Comprehensive Loss for the years ended September 30,
2003, 2002 and 2001 |  |  |  |  | 36 | 
|Consolidated
and Combined Statements of Cash Flows for the years ended September 30, 2003, 2002 and 2001                                                                   |  |  |  |  | 37 | 
|Notes to
Consolidated and Combined Financial Statements                                                                                                                    |  |  |  |  | 38 | 
|Financial
Statement Schedule:                                                                                                                                              |  |  |  |  |    | 
|Schedule
IIValuation and Qualifying Accounts for the years ended September 30, 2003,2002 and 2001                                                                         |  |  |  |  | 68 | 

32

---

Report of Independent Auditors

To the Board of Directors and Stockholders of Agere Systems
Inc.:



In our opinion, the consolidated and combined
financial statements listed in the accompanying index present fairly, in all material respects, the financial position of Agere Systems Inc. and its
subsidiaries at September 30, 2003 and 2002, and the results of their operations and their cash flows for each of the three years in the period ended
September 30, 2003 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the
financial statement schedule listed in the accompanying index presents fairly, in all material respects, the information set forth therein when read in
conjunction with the related consolidated and combined financial statements. These financial statements and financial statement schedule are the
responsibility of the Companys management; our responsibility is to express an opinion on these financial statements and financial statement
schedule based on our audits. We conducted our audits of these statements in accordance with auditing standards generally accepted in the United States
of America, which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that
our audits provide a reasonable basis for our opinion.




Prior to its separation from Lucent Technologies
Inc. (Lucent) on February 1, 2001 the Company was comprised of businesses which were integrated with the businesses of Lucent;
consequently, as indicated in Note 1, the financial statement amounts prior to this date have been derived from the consolidated financial statements
and accounting records of Lucent, and reflect significant assumptions and allocations. Moreover, as indicated in Note 1, the Company relied on Lucent
and its other businesses for administrative, management, research and other services. Accordingly, the financial statements for the year ended September 30, 2001,
do not necessarily
reflect the results of operations and cash flows of the Company had it been a stand-alone company.




As discussed in Notes 3, 5 and 17 to the
consolidated and combined financial statements, the Company has changed certain of its accounting methods as required upon the adoption of promulgated
accounting principles.


PricewaterhouseCoopers LLPFlorham Park, New Jersey October 28,
2003

33

---



AGERE SYSTEMS INC. AND SUBSIDIARIES  CONSOLIDATED AND COMBINED
STATEMENTS OF OPERATIONS (dollars in millions except per share amounts)






|                                                                                                                                                    |  |  |  | Year Ended September 30, |      
|--------------------------------------------------------------------------------------------------------------------------------------------------- |  |  |  | ------------------------ | -----
|
|REVENUE                                                                                                                                             |  |  |  | $                        | 1,839
|COSTS                                                                                                                                               |  |  |  |                          | 1,260
|GROSS
PROFIT                                                                                                                                        |  |  |  |                          | 579  
|OPERATING
EXPENSES:                                                                                                                                 |  |  |  |                          |      
|Selling,
general and administrative                                                                                                                 |  |  |  |                          | 294  
|Research and
development                                                                                                                            |  |  |  |                          | 467  
|Amortization
of goodwill and other acquired intangibles                                                                                             |  |  |  |                          | 8    
|Restructuring
and other charges  net                                                                                                               |  |  |  |                          | 131  
|(Gain) loss
on sale of operating assets  net                                                                                                       |  |  |  |                          | (21  
|Impairment of
goodwill and other acquired intangibles                                                                                               |  |  |  |                          |     
|TOTAL
OPERATING EXPENSES                                                                                                                            |  |  |  |                          | 879  
|OPERATING
LOSS                                                                                                                                      |  |  |  |                          | (300 
|Other income
 net                                                                                                                                  |  |  |  |                          | 22   
|Interest
expense                                                                                                                                    |  |  |  |                          | 47   
|Loss from
continuing operations before provision for income taxes                                                                                   |  |  |  |                          | (325 
|Provision for
income taxes                                                                                                                          |  |  |  |                          | 46   
|Loss from
continuing operations                                                                                                                     |  |  |  |                          | (371 
|Discontinued
operations:                                                                                                                            |  |  |  |                          |      
|Income (loss)
from operations of discontinued business (net of taxes)                                                                               |  |  |  |                          | 8    
|Gain on
disposal of discontinued business (net of taxes)                                                                                            |  |  |  |                          | 30   
|Income (loss)
from discontinued operations                                                                                                          |  |  |  |                          | 38   
|Loss before
cumulative effect of accounting change                                                                                                  |  |  |  |                          | (333 
|Cumulative
effect of accounting change (net of benefit for income taxes of $0 and $2 for the years ended September 30, 2003 and 2001,
respectively) |  |  |  |                          | (5   
|NET
LOSS                                                                                                                                            |  |  |  | $                        | (338 
|Basic and
diluted income (loss) per share information:                                                                                              |  |  |  |                          |      
|Loss from
continuing operations                                                                                                                     |  |  |  | $                        | (0.22
|Income (loss)
from discontinued operations                                                                                                          |  |  |  |                          | 0.02 
|Loss before
cumulative effect of accounting change                                                                                                  |  |  |  |                          | (0.20
|Cumulative
effect of accounting change                                                                                                              |  |  |  |                          |     
|Net
loss                                                                                                                                            |  |  |  | $                        | (0.20
|Weighted
average shares outstanding  basic and diluted (in millions)                                                                               |  |  |  |                          | 1,667

See Notes to Consolidated and Combined Financial Statements.

34

---

AGERE SYSTEMS INC. AND SUBSIDIARIES  CONSOLIDATED BALANCE
SHEETS (dollars in millions except per share amounts)






|                                                                                                                                                                                                                                                                                                                       |  |  |  | September 30, |       
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  |  |  | ------------- | ------
|
|ASSETS                                                                                                                                                                                                                                                                                                                 |  |  |  |               |       
|Cash and cash
equivalents                                                                                                                                                                                                                                                                                              |  |  |  | $             | 744   
|Cash held in
trust                                                                                                                                                                                                                                                                                                     |  |  |  |               | 21    
|Trade
receivables, less allowances of $6 and $9 at September 30, 2003 and 2002, respectively                                                                                                                                                                                                                           |  |  |  |               | 265   
|Inventories                                                                                                                                                                                                                                                                                                            |  |  |  |               | 122   
|Other current
assets                                                                                                                                                                                                                                                                                                   |  |  |  |               | 52    
|TOTAL CURRENT
ASSETS                                                                                                                                                                                                                                                                                                   |  |  |  |               | 1,204 
|Property,
plant and equipment  net                                                                                                                                                                                                                                                                                    |  |  |  |               | 778   
|Goodwill                                                                                                                                                                                                                                                                                                               |  |  |  |               | 109   
|Other
acquired intangibles  net of accumulated amortization                                                                                                                                                                                                                                                           |  |  |  |               | 13    
|Other
assets                                                                                                                                                                                                                                                                                                           |  |  |  |               | 284   
|TOTAL
ASSETS                                                                                                                                                                                                                                                                                                           |  |  |  | $             | 2,388 
|LIABILITIES                                                                                                                                                                                                                                                                                                            |  |  |  |               |       
|Accounts
payable                                                                                                                                                                                                                                                                                                       |  |  |  | $             | 245   
|Payroll and
related benefits                                                                                                                                                                                                                                                                                           |  |  |  |               | 109   
|Short-term
debt                                                                                                                                                                                                                                                                                                        |  |  |  |               | 195   
|Income taxes
payable                                                                                                                                                                                                                                                                                                   |  |  |  |               | 328   
|Restructuring
reserve                                                                                                                                                                                                                                                                                                  |  |  |  |               | 47    
|Other current
liabilities                                                                                                                                                                                                                                                                                              |  |  |  |               | 98    
|TOTAL CURRENT
LIABILITIES                                                                                                                                                                                                                                                                                              |  |  |  |               | 1,022 
|Pension and
postretirement benefits                                                                                                                                                                                                                                                                                    |  |  |  |               | 288   
|Long-term
debt                                                                                                                                                                                                                                                                                                         |  |  |  |               | 451   
|Other
liabilities                                                                                                                                                                                                                                                                                                      |  |  |  |               | 116   
|TOTAL
LIABILITIES                                                                                                                                                                                                                                                                                                      |  |  |  |               | 1,877 
|Commitments
and contingencies                                                                                                                                                                                                                                                                                          |  |  |  |               |       
|STOCKHOLDERS 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 785,090,755 shares issued and outstanding as of September 30, 2003, after deducting 4,281 shares
in treasury and 734,785,226 shares issued and outstanding  as of September 30,
2002, after deducting 4,248 shares in treasury    |  |  |  |               | 8     
|Class B
common stock, par value $0.01 per share, 5,000,000,000 shares authorized and 907,994,888 shares issued and outstanding as of September 30, 2003, after deducting 105,112
shares in treasury and 907,995,677 shares issued and outstanding as of
September 30, 2002, after deducting 104,323 shares in treasury |  |  |  |               | 9     
|Additional
paid-in capital                                                                                                                                                                                                                                                                                             |  |  |  |               | 7,337 
|Accumulated
deficit                                                                                                                                                                                                                                                                                                    |  |  |  |               | (6,691
|Accumulated
other comprehensive loss                                                                                                                                                                                                                                                                                   |  |  |  |               | (152  
|TOTAL
STOCKHOLDERS EQUITY                                                                                                                                                                                                                                                                                             |  |  |  |               | 511   
|TOTAL
LIABILITIES AND STOCKHOLDERS EQUITY                                                                                                                                                                                                                                                                             |  |  |  | $             | 2,388 

See Notes to Consolidated and Combined Financial Statements.

35

---

AGERE SYSTEMS INC. AND SUBSIDIARIES  CONSOLIDATED AND COMBINED
STATEMENTS OF CHANGES INSTOCKHOLDERS EQUITY/INVESTED EQUITY ANDTOTAL COMPREHENSIVE LOSS (dollars in millions)






|                                                                             |  |  |  | Year Ended September 30, |       
|---------------------------------------------------------------------------- |  |  |  | ------------------------ | ------
|
|CLASS A
COMMON STOCK                                                         |  |  |  |                          |       
|Beginning
balance                                                            |  |  |  | $                        | 7     
|Issuance of
Class A common stock                                             |  |  |  |                          | 1     
|Conversion of
Class B to Class A common stock                                |  |  |  |                          |      
|Ending
balance                                                               |  |  |  |                          | 8     
|CLASS B
COMMON STOCK                                                         |  |  |  |                          |       
|Beginning
balance                                                            |  |  |  |                          | 9     
|Conversion of
Class B to Class A common stock                                |  |  |  |                          |      
|Ending
balance                                                               |  |  |  |                          | 9     
|OWNERS NET INVESTMENT                                                       |  |  |  |                          |       
|Beginning
balance                                                            |  |  |  |                          |      
|Net loss
prior to February 1, 2001                                           |  |  |  |                          |      
|Transfers to
Lucent Technologies Inc.                                        |  |  |  |                          |      
|Transfers
from Lucent Technologies Inc.                                      |  |  |  |                          |      
|Transfer to
additional paid-in capital                                       |  |  |  |                          |      
|Ending
balance                                                               |  |  |  |                          |      
|ADDITIONAL
PAID-IN CAPITAL                                                   |  |  |  |                          |       
|Beginning
balance                                                            |  |  |  |                          | 7,243 
|Transfer from
owners net investment                                         |  |  |  |                          |      
|Transfers to
Lucent Technologies Inc.                                        |  |  |  |                          |      
|Transfers
from Lucent Technologies Inc.                                      |  |  |  |                          |      
|Debt
transferred from Lucent Technologies Inc.                               |  |  |  |                          |      
|Issuance of
common stock  Massana Limited acquisition                       |  |  |  |                          | 26    
|Issuance of
common stock  pension plan                                      |  |  |  |                          | 30    
|Issuance of
common stock  net of expense                                    |  |  |  |                          | 24    
|Equity-based
compensation                                                    |  |  |  |                          | 14    
|Ending
balance                                                               |  |  |  |                          | 7,337 
|ACCUMULATED DEFICIT                                                          |  |  |  |                          |       
|Beginning
balance                                                            |  |  |  |                          | (6,353
|Net
loss                                                                     |  |  |  |                          | (338  
|Net loss from
February 1, 2001                                               |  |  |  |                          |      
|Ending
balance                                                               |  |  |  |                          | (6,691
|ACCUMULATED OTHER COMPREHENSIVE LOSS                                         |  |  |  |                          |       
|Beginning
balance                                                            |  |  |  |                          | (174  
|Minimum
pension liability adjustment                                         |  |  |  |                          | 18    
|Foreign
currency translations                                                |  |  |  |                          |      
|Reclassification adjustment for realized foreign currency translation losses |  |  |  |                          |      
|Unrealized
gain (loss) on cash flow hedges                                   |  |  |  |                          | 4     
|Unrealized
holding gains                                                     |  |  |  |                          |      
|Reclassification adjustment for realized holding gains                       |  |  |  |                          |      
|Ending
balance                                                               |  |  |  |                          | (152  
|TOTAL
STOCKHOLDERS EQUITY/INVESTED EQUITY                                   |  |  |  | $                        | 511   
|TOTAL
COMPREHENSIVE LOSS                                                     |  |  |  |                          |       
|Net
loss                                                                     |  |  |  | $                        | (338  
|Other
comprehensive income (loss)                                            |  |  |  |                          | 22    
|TOTAL
COMPREHENSIVE LOSS                                                     |  |  |  | $                        | (316  

See Notes to Consolidated and Combined Financial Statements.

36

---

AGERE SYSTEMS INC. AND SUBSIDIARIES  CONSOLIDATED AND COMBINED
STATEMENTS OF CASH FLOWS (dollars in millions)






|                                                                                                                                                                                        |  |  |  | Year Ended September 30, |     
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  |  |  | ------------------------ | ----
|
|OPERATING
ACTIVITIES                                                                                                                                                                    |  |  |  |                          |     
|Net
loss                                                                                                                                                                                |  |  |  | $                        | (338
|Less: Income
(loss) from discontinued operations                                                                                                                                        |  |  |  |                          | 38  
|Cumulative
effect of accounting change                                                                                                                                                  |  |  |  |                          | (5  
|Loss from
continuing operations                                                                                                                                                         |  |  |  |                          | (371
|Adjustments
to reconcile loss from continuing operations to net cash (used) provided by operating activities from continuing operations, net of effects for
acquisitions of businesses: |  |  |  |                          |     
|Restructuring
expense  net of cash payments                                                                                                                                            |  |  |  |                          | 12  
|Provision for
inventory write-downs                                                                                                                                                     |  |  |  |                          |    
|Depreciation
and amortization                                                                                                                                                           |  |  |  |                          | 329 
|(Benefit)
provision for uncollectibles                                                                                                                                                  |  |  |  |                          |    
|Provision for
deferred income taxes                                                                                                                                                     |  |  |  |                          | 17  
|Impairment of
non-consolidated investments                                                                                                                                              |  |  |  |                          |    
|Impairment of
goodwill and other acquired intangibles                                                                                                                                   |  |  |  |                          |    
|Equity
earnings from investments                                                                                                                                                        |  |  |  |                          | (13 
|Gain on sales
of investments                                                                                                                                                            |  |  |  |                          |    
|Gain on
disposition of businesses                                                                                                                                                       |  |  |  |                          | (16 
|Amortization
of debt issuance costs                                                                                                                                                     |  |  |  |                          | 2   
|(Increase)
decrease in receivables                                                                                                                                                      |  |  |  |                          | (18 
|Decrease
(increase) in inventories                                                                                                                                                      |  |  |  |                          | 43  
|(Decrease)
increase in accounts payable                                                                                                                                                 |  |  |  |                          | (4  
|Increase
(decrease) in payroll and benefit liabilities                                                                                                                                  |  |  |  |                          | 26  
|Changes in
other operating assets and liabilities                                                                                                                                       |  |  |  |                          | (27 
|Other
adjustments for non-cash items  net                                                                                                                                              |  |  |  |                          | (3  
|Net cash
(used) provided by operating activities from continuing operations                                                                                                             |  |  |  |                          | (23 
|Net cash
(used) provided by operating activities from discontinued operations                                                                                                           |  |  |  |                          | (86 
|NET CASH
(USED) PROVIDED BY OPERATING ACTIVITIES                                                                                                                                        |  |  |  |                          | (109
|INVESTING
ACTIVITIES                                                                                                                                                                    |  |  |  |                          |     
|Capital
expenditures                                                                                                                                                                    |  |  |  |                          | (116
|Proceeds from
the sale or disposal of property, plant and equipment                                                                                                                     |  |  |  |                          | 38  
|Sales of
investments                                                                                                                                                                    |  |  |  |                          | 9   
|Net proceeds
from disposition of businesses                                                                                                                                             |  |  |  |                          | 64  
|Acquisitions
of businesses  net of cash acquired                                                                                                                                       |  |  |  |                          | (1  
|Cash
designated as held in trust                                                                                                                                                        |  |  |  |                          | (5  
|Other
investing activities  net                                                                                                                                                        |  |  |  |                          |    
|NET CASH
(USED) PROVIDED BY INVESTING ACTIVITIES                                                                                                                                        |  |  |  |                          | (11 
|FINANCING
ACTIVITIES                                                                                                                                                                    |  |  |  |                          |     
|Transfers
from Lucent Technologies Inc.                                                                                                                                                 |  |  |  |                          |    
|Payment of
credit facility fees                                                                                                                                                         |  |  |  |                          |    
|Proceeds from
the issuance of long-term debt  net of expenses                                                                                                                          |  |  |  |                          | 20  
|Net
(repayments) proceeds from short-term debt                                                                                                                                          |  |  |  |                          | (9  
|Principal
repayments of credit facility                                                                                                                                                 |  |  |  |                          |    
|Principal
repayments on long-term debt                                                                                                                                                  |  |  |  |                          | (65 
|Proceeds from
issuance of stock  net of expense                                                                                                                                        |  |  |  |                          | 26  
|NET CASH
(USED) PROVIDED BY FINANCING ACTIVITIES                                                                                                                                        |  |  |  |                          | (28 
|Effect of
exchange rate changes on cash                                                                                                                                                 |  |  |  |                          | 1   
|Net
(decrease) increase in cash and cash equivalents                                                                                                                                    |  |  |  |                          | (147
|Cash and
cash equivalents at beginning of year                                                                                                                                          |  |  |  |                          | 891 
|Cash and
cash equivalents at end of year                                                                                                                                                |  |  |  | $                        | 744 

See Notes to Consolidated and Combined Financial Statements.

37

---

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS(dollars in
millions except per share amounts)



1.    Background and Basis of
Presentation

Background



Agere Systems Inc. (the Company or
Agere) provides integrated circuit solutions for applications such as high-density storage, multiservice networking, wireless data and
personal computer connectivity and its customers include manufacturers of hard-disk drives, high speed communications systems, personal computers and
mobile phones.




Agere was incorporated in Delaware as a wholly owned
subsidiary of Lucent Technologies Inc. (Lucent) on August 1, 2000 and on that date 1,000 shares of common stock were issued, authorized and
outstanding. On February 1, 2001, Lucent transferred to Agere substantially all of the assets and liabilities related to the Companys business
(the Separation) other than pension and postretirement assets and liabilities, which were transferred in June of 2002. On March 14, 2001,
the Company changed and reclassified its 1,000 outstanding shares of common stock into 1,035,100,000 shares of Class B common stock (the
Recapitalization). On April 2, 2001, the Company issued 600,000,000 shares of Class A common stock in an initial public offering (the
IPO) for $6 per share less underwriting discounts and commissions of $0.23 per share. In addition, on April 2, 2001, the Company assumed
from Lucent $2,500 of short-term debt. 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. 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. On June 1, 2002, Lucent
distributed all of the Agere common stock it then owned to its stockholders (the Distribution). Prior to June 1, 2002, Agere was a
majority-owned subsidiary of Lucent.




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 as if it had occurred at the beginning of the earliest period presented.


Basis of Presentation



The consolidated and 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 the assets and liabilities transferred to the Company. Management believes the assumptions
underlying the consolidated and combined financial statements are reasonable. However, the consolidated and combined financial statements that were
derived from Lucents financial records may not necessarily reflect the Companys results of operations and cash flows
had the Company been a stand-alone company. 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.
On February 1, 2001, following the Separation, the Company began accumulating retained earnings (losses). The consolidated and combined financial
statements include allocations of certain Lucent expenses, assets and liabilities, including the items described below.




Prior to February 1, 2001, general corporate
expenses were allocated from Lucent based on revenue. These allocations are 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 allocations were primarily for cash
management, legal, accounting, tax, insurance, public relations, advertising, human resources and data services. These allocations amounted to $60 for
fiscal 2001. Management believes these costs are a reasonable representation of the costs that would have been incurred if the Company had performed
these functions as a stand-alone company.




Prior to February 1, 2001, research and development
expenses included 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 $23 for fiscal 2001. Management believes these costs are a reasonable representation of the costs
that would have been incurred if the Company had performed this research as a stand-alone company.


38

---

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL
STATEMENTS(Continued)(dollars in millions except per share amounts)



Prior to February 1, 2001, interest expense was
allocated from Lucent as Lucent provided financing to the Company and incurred debt at the parent level. This allocation was based on the ratio of the
Companys net assets, excluding debt, to Lucents total net assets, excluding debt. The allocation amounted to $32 for fiscal 2001. Interest
expense also includes interest expense related to the Companys capitalized lease obligations.




Prior to the IPO, the Companys income taxes
were calculated on a separate tax return basis. This reflects Lucents tax strategies and is not necessarily reflective of the tax strategies that
the Company would have followed or follows as a stand-alone company.




During fiscal 2003, the Company sold its
optoelectronic components business. The Company had historically reported this business as part of its Infrastructure Systems segment. The consolidated
and combined financial statements have been reclassified for all periods presented to reflect this business as discontinued operations. See Note 4
Discontinued Operations.


2.    Summary of Significant Accounting
Policies

Principles of Consolidation and Combination



The consolidated financial statements include all
majority-owned subsidiaries in which the Company exercises control. Investments in which the Company exercises significant influence, but which it does
not control (generally a 20% to 50% ownership interest), are accounted for under the equity method of accounting. Investments in which the Company does
not exercise significant influence are recorded at cost (generally less than a 20% interest). All material intercompany transactions and balances have
been eliminated.


Use of Estimates



The preparation of financial statements and related
disclosures in conformity with accounting principles generally accepted in the United States of America (the U.S.) requires management to
make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the
date of the financial statements, and revenue and expenses during the period reported. These estimates include assessing the collectability of accounts
receivable, the use and recoverability of inventory, the realization of deferred tax assets, tax contingencies, pension and other employee benefits,
restructuring reserves, useful lives for depreciation and amortization periods of tangible and intangible assets, long-lived asset impairments and
allocation of costs by Lucent among others. The markets for the Companys products are characterized by intense competition, rapid technological
development, evolving standards, short product life cycles and price erosion, all of which could impact the future realizability of the Companys
assets. Estimates and assumptions are reviewed periodically and the effects of revisions are reflected in the period that they are determined to be
necessary. Actual results could differ from those estimates.


Revenue Recognition



Revenue is derived from sales of products and
licensing of intellectual property. Revenue is recognized when persuasive evidence of an arrangement exists, the product has been delivered and title
and risk of loss have been transferred, the sales price is fixed or determinable and collection of the resulting receivable is reasonably assured. The
Company recognizes revenue from product sales to distributors when the distributor sells the product to the end customer. Revenue from licensing
intellectual property is recognized over the license term if the license grants a right to use patents and technology developed in the future. If the
license does not grant a right to use patents and technology developed in the future, licensing revenue is recognized at the beginning of the license
term if the collection of the resulting receivable is reasonably assured.


Research and Development Costs



Research and development costs are charged to
expense as incurred.


Income Taxes



The asset and liability approach is used to
recognize deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the carrying amounts and the
tax bases of assets and liabilities. A valuation allowance is established, as needed, to reduce net deferred tax assets to the amount for which
recovery is more likely than not.


39

---

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL
STATEMENTS(Continued)(dollars in millions except per share amounts)

Loss Per Share



Basic and diluted loss per common share for all
periods following the IPO is calculated by dividing net loss by the weighted average number of outstanding common shares. Due to the Companys net
losses, the effect of potentially dilutive securities or common stock equivalents that could be issued was excluded from the diluted loss per share
calculation due to its anti-dilutive effect. Prior to the IPO, basic and diluted loss per common share is calculated by dividing net loss by
1,035,100,000, which is the number of shares issued to Lucent on August 1, 2000, as retroactively adjusted for the Recapitalization.


Other Comprehensive Income (Loss)



Total comprehensive loss includes, in addition to
net loss, changes in equity that are excluded from the consolidated and combined statements of operations and are recorded directly into a separate
section of stockholders equity/invested equity on the consolidated balance sheets. The Companys accumulated other comprehensive loss shown
on the consolidated balance sheets consists of minimum pension liability adjustments, foreign currency translation adjustments and unrealized gains and
losses on cash flow hedges and investment holdings.


Foreign Currency Translation



Balance sheet accounts of the Companys foreign
operations for which the local currency is the functional currency are translated into U.S. dollars at period-end exchange rates, while income,
expenses and cash flows are translated at average exchange rates during the period. Translation gains or losses related to net assets of such
operations are shown as a component of accumulated other comprehensive loss in stockholders equity/invested equity. Gains and losses resulting
from foreign currency transactions, which are transactions denominated in a currency other than the entitys functional currency, are included in
the consolidated and combined statements of operations.


Cash and Cash Equivalents



The Company considers all liquid investments with
original maturities of ninety days or less to be cash equivalents.


Inventories



Inventories are stated at the lower of cost,
determined on a first-in, first-out basis, or market. The Company records inventory provisions, classified within costs, based on a review of
forecasted demand compared with existing inventory levels.


Property, Plant and Equipment



Property, plant and equipment are stated at cost
less accumulated depreciation. Depreciation and amortization is determined using the straight-line method over the estimated useful lives of the
various asset classes. Equipment leases qualifying as capital leases are also included in property, plant and equipment.




Estimated useful lives range from three to five
years for machinery, electronic and other equipment, and up to forty years for buildings. Major renewals and improvements are capitalized and minor
replacements, maintenance, and repairs are charged to current operations as incurred. Upon retirement or disposal of assets, the cost and related
accumulated depreciation are removed from the consolidated balance sheets and any gain or loss is reflected in the consolidated and combined statements
of operations.


Impairment of Property, Plant and Equipment



Property, plant and equipment is reviewed for
impairment whenever events such as a significant industry downturn, product discontinuance, plant closures, product dispositions, technological
obsolescence or other changes in circumstances indicate that the carrying amount may not be recoverable. When such events occur, the Company compares
the carrying amount of the assets to the undiscounted expected future cash flows. If this comparison


40

---

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL
STATEMENTS(Continued)(dollars in millions except per share amounts)

indicates that there is an impairment, assets classified as held and used are
written-down to fair value and assets classified as held for sale are written-down to fair value less cost to sell.

Internal Use Software



Certain costs of computer software developed or
obtained for internal use are capitalized and amortized on a straight-line basis over three years. Costs for general and administrative, overhead,
maintenance and training, as well as the cost of software that does not add functionality to the existing system, are expensed as
incurred.


Goodwill and Other Acquired Intangibles



Goodwill is the excess of the purchase price over
the fair value of identifiable net assets acquired in business combinations accounted for as purchases. Goodwill is not amortized, but is tested for
impairment annually, or more frequently if events and circumstances indicate an impairment may exist. Intangible assets with finite lives are amortized
over their estimated useful lives. The Company does not have any indefinite lived intangible assets. See Note 6 Impairment of Goodwill and Other
Acquired Intangibles.


Investments



Investments in marketable securities that are
available for sale are recorded at fair value. Fair value is based upon market prices quoted on the last day of the fiscal year. Unrealized gains and
losses related to these securities are excluded from earnings and are included as a separate component of other comprehensive income (loss) until such
gains or losses are realized or such losses are determined to be other than temporary. Minority equity investments in non-publicly traded companies are
generally carried at cost. The Company monitors these investments for impairment and makes appropriate reductions in carrying values when
necessary.


Reclassifications



In fiscal 2003, the Company refined its methodology
for allocating shared information technology expenses to its operating segments and between costs, selling, general and administrative expenses, and
research and development expenses. The Company believes that this methodology provides a better assignment of these expenses based on additional
information about the components and underlying drivers which has been developed since the Separation. Historical amounts for all periods presented
have been conformed to the current presentation. As a result of this change, $58 and $39 of expenses previously reflected in costs were reclassified to
operating expenses for fiscal 2002 and 2001, respectively. Other prior year amounts have also been reclassified to conform to the fiscal 2003
presentation.


Stock Compensation Plans



At September 30, 2003, the Company had various
stock-based compensation plans for employees and outside directors, which are described more fully in Note 14 Stock Compensation Plans. The
Company accounts for those plans under the recognition and measurement principles of Accounting Principles Board Opinion (APB) No. 25,
Accounting for Stock Issued to Employees, and related interpretations.




Compensation expense recorded under APB No. 25,
which uses the intrinsic value method, was $2, $3 and $4 for the years ended September 30, 2003, 2002 and 2001, respectively. If the Company had
elected to adopt the optional fair value recognition provisions of Statement of Financial Accounting Standards (SFAS) No. 123,
Accounting for Stock-Based Compensation (SFAS 123), as amended by SFAS No. 148 Accounting for Stock-Based
Compensation  Transition and Disclosure (SFAS 148), for its stock option plans and Employee Stock


41

---

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL
STATEMENTS(Continued)(dollars in millions except per share amounts)

Purchase Plan (the ESPP), the net loss and net loss per share as
reported would have increased to the pro forma amounts indicated below:






|                                                                                                             |  |  |  | Year Ended September 30, |      
|------------------------------------------------------------------------------------------------------------ |  |  |  | ------------------------ | -----
|
|NET
LOSS:                                                                                                    |  |  |  |                          |      
|As
reported                                                                                                  |  |  |  | $                        | (338 
|Add: Total
stock-based employee compensation expense determined under fair value based method for all awards |  |  |  |                          | (136 
|Pro forma
(1)                                                                                                |  |  |  | $                        | (474 
|BASIC AND
DILUTED LOSS PER SHARE:                                                                            |  |  |  |                          |      
|As
reported                                                                                                  |  |  |  | $                        | (0.20
|Pro forma
(1)                                                                                                |  |  |  | $                        | (0.28

---

|(1) |  | The pro forma amounts shown above include the compensation
expense determined under the fair value method of all Agere stock options, including Lucent options that were converted to Agere options at the
Distribution date. Also included is the compensation expense determined under the fair value method of the options embedded in the Agere shares under
the ESPP.
|--- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Of the $136 of stock-based employee compensation
expense determined under the fair value based method in fiscal 2003, $47 represents expense related to Lucent options that were converted at the
Distribution date and $69 represents expense related to Agere options granted in fiscal 2001, the majority of which were granted at the time of the
IPO.




The fair value of each stock option grant is
estimated on the grant date using the Black-Scholes option-pricing model with the following weighted average assumptions:







|                                   |  |  |  | Year Ended September 30, |     
|---------------------------------- |  |  |  | ------------------------ | ----
|
|AGERE:                             |  |  |  |                          |     
|Dividend
yield                     |  |  |  |                          | 0.00
|Volatility                         |  |  |  |                          | 95.0
|Risk-free
interest rate            |  |  |  |                          | 2.29
|Expected
holding period (in years) |  |  |  |                          | 2.8 
|LUCENT:                            |  |  |  |                          |     
|Dividend
yield                     |  |  |  |                          | n/a 
|Volatility                         |  |  |  |                          | n/a 
|Risk-free
interest rate            |  |  |  |                          | n/a 
|Expected
holding period (in years) |  |  |  |                          | n/a 

---

n/a  not applicable

3.    Accounting Changes



Effective October 1, 2002, the Company adopted SFAS
No. 143, Accounting for Asset Retirement Obligations (SFAS 143). This standard provides the financial accounting and
reporting requirements for the cost of legal obligations associated with the retirement of tangible long-lived assets. SFAS 143 requires the Company to
record asset retirement obligations at fair value. The obligation is recorded as a liability and the associated cost is capitalized as part of the
related long-lived asset and then depreciated over its remaining useful life. Changes in the liability resulting from the passage of time are
recognized as operating expense. The adoption of SFAS 143 as of October 1, 2002 resulted in capitalizing a net long-lived asset of $2, related to the
restoration of leased facilities, recording an associated liability of $7 and a cumulative loss of $5. The cumulative loss represents the depreciation
and other operating expenses that would have been recorded previously if SFAS 143 had been in effect in prior years. There were no income taxes
provided due to the recording of a full valuation allowance against U.S. net


42

---

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL
STATEMENTS(Continued)(dollars in millions except per share amounts)

deferred tax assets. The pro forma effect of retroactive application of SFAS 143
for fiscal 2002 and 2001 would not change the net loss and loss per share, as reported.



Effective October 1, 2000, the Company adopted SFAS
No. 133, Accounting for Derivative Instruments and Hedging Activities (SFAS 133), and its corresponding amendments under
SFAS No. 138, Accounting for Certain Derivative Instruments and Certain Hedging Activities  an Amendment of FAS 133
(SFAS 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 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, the effective portions of changes in fair value of the derivative are
reported in other comprehensive income (loss) 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 increase in net loss of $4 (net of a tax benefit of $2). The
increase in net loss is primarily due to derivatives not designated as hedging instruments. For fiscal 2003, 2002 and 2001, the change in fair market
value of derivative instruments was recorded in other income  net and was not material.


4.    Discontinued Operations



On August 14, 2002, the Company announced plans to
exit its optoelectronic components business. The Company had historically reported this business as part of its Infrastructure Systems segment. The
consolidated and combined financial statements have been reclassified for all periods presented to reflect this business as discontinued operations.
The Company reflected this business as discontinued operations beginning in fiscal 2003 when the Company entered into an agreement to sell a
substantial portion of the business and determined it could sell the remainder of the business. The revenues, costs and expenses directly associated
with this business have been reclassified as discontinued operations on the consolidated and combined statements of operations. Corporate expenses such
as general corporate overhead and interest have not been allocated to discontinued operations. Revenue recorded within income (loss) from operations of
discontinued business was $60, $254 and $1,194 for fiscal 2003, 2002 and 2001, respectively. Income (loss) from operations of discontinued business
before income taxes was income of $8 for fiscal 2003 and a loss of $1,007 and $3,164 for fiscal 2002 and 2001, respectively.




During the second quarter of fiscal 2003, the
Company sold a substantial portion of its optoelectronic components business to TriQuint Semiconductor, Inc. (TriQuint) for $40 in cash.
This transaction included the products, product warranty liabilities, technology and certain facilities related to this business; and included lasers,
detectors, modulators, passive components, arrayed waveguide-based components, amplifiers, transmitters, receivers, transceivers, transponders and
micro electro-mechanical systems. As part of the sale, the Companys facilities in Breinigsville, Pennsylvania and Matamoros, Mexico were
transferred and approximately 340 of the Companys employees joined TriQuint. The Company recognized a net gain of $11 from the sale, which is
included in gain on disposal of discontinued business (net of taxes) for fiscal 2003.




During the second quarter of fiscal 2003, the
Company sold the remainder of its optoelectronic components business, which provided cable television transmission systems, telecom access and
satellite communications components, to EMCORE Corporation (EMCORE) for $25 in cash. The transaction included the assets, products, product
warranty liabilities, technology and intellectual property related to this business. As part of the sale, approximately 210 of the Companys
employees joined EMCORE. The Company recognized a net gain of $19 from the sale, which is included in gain on disposal of discontinued business (net of
taxes) for fiscal 2003.


5.    Restructuring and Other Charges 
Net

Restructuring and Related Expenses



The Company has implemented restructuring and
consolidation actions to improve gross profit, reduce expenses and streamline operations. These actions include workforce reductions, rationalization
and consolidation of manufacturing capacity and the exit of the optoelectronic components business. Charges and credits related to continuing
operations are included in restructuring and other charges  net, while charges and credits related to


43

---

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL
STATEMENTS(Continued)(dollars in millions except per share amounts)

discontinued operations are included in income (loss) from operations of
discontinued business (net of taxes). The restructuring actions associated with discontinued operations remain an obligation of the Company and are
reflected in the restructuring reserve.



Effective October 1, 2002, the Company adopted SFAS
No. 146, Accounting for Costs Associated with Exit or Disposal Activities (SFAS 146), which applies to all exit or
disposal activities initiated after December 31, 2002. SFAS 146 requires that a liability for a cost associated with an exit or disposal activity be
recognized and measured initially at fair value only when the liability is incurred. The adoption of SFAS 146 did not have a material impact on the
Companys financial condition or results of operations.




Year Ended September 30,
2003




The following table sets forth the Companys
restructuring reserves as of September 30, 2003, and the activity affecting the reserve for fiscal 2003:







|                                                            |  |  |  |   |     | Year Ended September 30, 2003 |  |   |    
|----------------------------------------------------------- |  |  |  | - | --- | ----------------------------- |  | - | ---
|
|
|Workforce
reductions                                        |  |  |  | $ | 60  |                               |  | $ | 84 
|Rationalization of manufacturing capacity and other charges |  |  |  |   | 102 |                               |  |   | 101
|Total                                                       |  |  |  | $ | 162 |                               |  | $ | 185
|Continuing
operations                                       |  |  |  |   |     |                               |  | $ | 174
|Discontinued
operations                                     |  |  |  |   |     |                               |  |   | 11 
|Total                                                       |  |  |  |   |     |                               |  | $ | 185



Workforce Reductions




The Company recorded restructuring charges of $84
relating to workforce reductions in fiscal 2003. Of the total workforce reduction charges, $62 represents non-cash charges that consist of the
following: $25 for curtailment charges relating to an acceleration of the prior service cost of the Companys qualified pension plans as employees
are retiring earlier than actuarially anticipated, $14 for settlement charges of an unrecognized loss related to employees taking a lump sum
distribution from the pension plans upon termination of employment, thereby eliminating any future pension obligation to those employees, $9 for
increased charges to the postretirement medical liability as employees were eligible for retiree health benefits sooner than actuarially anticipated,
and $14 for special retirement benefits to certain U.S. employees, including occupational employees covered under the terms of a collective bargaining
agreement. The charges for fiscal 2003 also include $22 of cash charges, principally related to a workforce reduction of approximately 330 management
employees.




The Company recorded restructuring credits relating
to workforce reductions of $24 in fiscal 2003. These credits consist of $14 due to the reversal of charges associated with the employees that joined
TriQuint and EMCORE, of which $7 are non-cash credits due to a decrease in special retirement benefits. The restructuring credits also include $10 for
non-cash postemployment benefit adjustments principally associated with the closing of international facilities.




As announced on August 14, 2002, the Company
expected to reduce its active workforce by a total of approximately 4,000 employees by the end of December 2003 as part of its plan to exit the
optoelectronic components business and consolidate U.S. manufacturing operations into its Orlando, Florida facility. As of September 30, 2003, all
severance and special retirement benefit costs associated with completing this workforce reduction have been recognized and approximately 100 employees
remain to be taken off-roll.




Rationalization of Manufacturing Capacity and
Other Charges




The Company recorded restructuring and related
charges of $101 in fiscal 2003 relating to the rationalization of under-utilized manufacturing facilities, the exit of the optoelectronic components
business and other restructuring-related activities. These charges consist of: $42 for asset impairments, including $11 associated
with


44

---

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL
STATEMENTS(Continued)(dollars in millions except per share amounts)

the resizing of research and development and manufacturing operations at the
Companys Orlando facility; $19 for facility lease terminations, including non-cancelable facility leases; $15 for increased depreciation; $7 for
contract terminations; and $18 for other related costs. Increased depreciation was recognized due to a change in accounting estimate as a result of
shortening the estimated useful lives of certain assets in connection with the planned closing of certain administrative facilities. The other related
costs were incurred primarily to implement the restructuring initiatives and include costs for the relocation and training of employees and for the
relocation of equipment.



The Company recorded restructuring and related
credits of $46 in fiscal 2003, which consist of $17 for a reversal of reserves associated with the resizing of the research and development and
manufacturing operations in Orlando, including $13 for operating lease terminations and $4 related to asset decommissioning; $15 for asset impairment
adjustments due to realizing more proceeds than expected from asset dispositions; $4 for the reversal of a facility lease termination reserve
associated with a facility in Mexico that was transferred to TriQuint; and $10 principally for the reversal of reserves associated with actions deemed
no longer necessary.




Restructuring Reserve Balances as of September
30, 2003




The Company anticipates that the majority of the $11
restructuring reserve as of September 30, 2003 relating to workforce reductions will be paid by December 31, 2003. The Company also anticipates that
the restructuring reserve of $36 relating to the rationalization of manufacturing capacity and other charges as of September 30, 2003 will be paid as
follows: the contract terminations of $7 will be paid $1 per quarter through the second quarter of fiscal 2005, facility lease terminations and
facility restoration and other costs of $29 will be paid over the respective lease terms through 2010. The Company expects to fund these cash payments
with cash on hand.




Year Ended September 30,
2002




The following table sets forth the Companys
restructuring reserves as of September 30, 2002 and the activity affecting the reserve for fiscal 2002:







|                                                            |  |  |  |   |     | Year Ended September 30, 2002 |  |   |      
|----------------------------------------------------------- |  |  |  | - | --- | ----------------------------- |  | - | -----
|
|
|Workforce
reductions                                        |  |  |  | $ | 92  |                               |  | $ | 402  
|Rationalization of manufacturing capacity and other charges |  |  |  |   | 79  |                               |  |   | 696  
|Total                                                       |  |  |  | $ | 171 |                               |  | $ | 1,098
|Continuing
operations                                       |  |  |  |   |     |                               |  | $ | 586  
|Discontinued
operations                                     |  |  |  |   |     |                               |  |   | 512  
|Total                                                       |  |  |  |   |     |                               |  | $ | 1,098



Workforce Reductions




During fiscal 2002, the Company recorded
restructuring charges of $402 related to workforce reductions of approximately 5,000 employees. Of the total workforce reduction charges, $316
represented non-cash charges that consisted of the following: $268 for special retirement benefits to certain U. S. employees, including occupational
employees covered under the terms of a collective bargaining agreement, $32 for increased charges to the postretirement medical liability as employees
were eligible for retiree health benefits sooner than actuarially anticipated, and $16 for curtailment charges relating to an acceleration of the prior
service cost of the Companys qualified pension plan as employees retired earlier than actuarially anticipated. Of the $268 special retirement
benefits, $103 represented charges incurred as the result of actions of the Company prior to June 1, 2002 that were paid from Lucents pension
assets while $165 represented charges subsequent to June 1, 2002 that were paid from the Companys pension assets. The charges for fiscal 2002
also include $86 of cash charges.




In fiscal 2002, the Company recorded workforce
related restructuring credits of $39. Of this amount, $20 represented a reversal of the restructuring reserve associated with workforce reductions,
resulting from severance


45

---

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL
STATEMENTS(Continued)(dollars in millions except per share amounts)



and benefit cost estimates that exceeded amounts paid during the second half of calendar 2001. The original reserve included an estimate of termination
pay and benefits for occupational employees that was based on the average rate of pay and years of service of the occupational employee pool at risk.
The Companys collective bargaining agreements allowed for a period when employees at risk could opt for positions filled by employees with less
seniority. When that period ended, a series of personnel moves followed that ultimately resulted in lower severance and benefit payments than
originally expected. This was due principally to the termination of occupational employees with fewer years of service and fewer weeks of severance
entitlement. These personnel moves were substantially finished at the end of calendar 2001. The balance of $19 represented a non-cash credit for the
decrease in the actuarially calculated severance liability because of the population decrease resulting from the various restructuring initiatives.
Severance costs and other exit costs were determined in accordance with EITF 94-3. The postretirement charge was determined in accordance with SFAS No.
106, Employers Accounting for Postretirement Benefits Other Than Pensions and the actuarially calculated severance liability
credit was determined in accordance with SFAS No. 112, Employers Accounting for Postemployment Benefits.




By September 30, 2002, the Company had taken
approximately 7,200 people off roll as a result of workforce reductions announced in fiscal 2001 and the first half of fiscal 2002. As announced on
August 14, 2002, the Company expected to reduce its active workforce by approximately 4,000 additional employees by the end of December 2003 as part of
its plan to exit the optoelectronic components business and consolidate U.S. manufacturing operations into its Orlando facility.




Rationalization of Manufacturing Capacity and
Other Charges




The Company recorded restructuring and related
charges of $696 in fiscal 2002 relating to the rationalization of under-utilized manufacturing facilities, the exit of the optoelectronics business and
other restructuring related activities. Of the charges recorded for fiscal 2002, $520 was for asset impairments, $76 for facility closings, $51 for
contract terminations, $9 for increased depreciation and $40 for other related costs. The increased depreciation charges were recognized due to a
change in accounting estimate as a result of shortening of estimated useful lives of certain assets in connection with the planned closing of certain
administrative facilities. The other related costs are for the implementation and integration of the initiatives and include costs for the relocation
and training of employees and for relocation of equipment.




Of the asset impairment charges of $520 in fiscal
2002, $353 resulted from actions associated with the Companys exit of the optoelectronic components business. Of the remaining $167, $75 was
related to ceasing operations at Reading, Pennsylvania, $76 was for resizing Orlandos research and development and manufacturing operations, and
$16 was for all other impairments related to the rationalization of under-utilized manufacturing facilities. All affected assets were classified as held
and used. In accordance with SFAS 144, the carrying amounts of all held and used asset groups were compared to the undiscounted future cash flows
expected to be generated over their estimated remaining useful lives. Cash flows were projected based upon historical results and estimates of future
performance. In cases where the expected future cash flows were less than the carrying amounts of the assets, those assets were considered impaired and
were written down to fair value which was determined using the present value of estimated future cash flows. The impaired assets that were disposed of
other than by sale were written-down to fair value, less costs of disposal.




The facility closing charges of $76 in fiscal 2002
consisted of $41 due to facility lease terminations, including non-cancelable leases, and facility restoration costs of which $20 was associated with
the exiting of the optoelectronic components business and $21 was associated with the consolidation of the Pennsylvania and New Jersey facilities and
the consolidation of the majority of the U.S. integrated circuit manufacturing operations into the Orlando facility. The balance of $35 was a non-cash
charge for the realization of the cumulative translation adjustment resulting from the substantial liquidation of the Companys investment in the
legal entity associated with its Madrid, Spain manufacturing operations, which were sold in fiscal 2002. This charge was recognized in accordance with
EITF Issue No. 01-5, Issue Summary No. 1, Application of SFAS No. 52, and Foreign Currency Translation, to an Investment Being Evaluated for
Impairment That Will Be Disposed Of.




The contract termination charges of $51, including a
non-cash charge of $5 for the write-off of prepaid operating lease costs, were principally due to operating lease termination fees and non-cancelable
asset leases associated with the consolidation of the Pennsylvania and New Jersey facilities and the consolidation of the majority of the U.S.
integrated circuit manufacturing operations into the Orlando facility.


46

---

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL
STATEMENTS(Continued)(dollars in millions except per share amounts)



The Company recorded restructuring credits of $88 in
fiscal 2002. These credits consisted of $69 for asset impairment adjustments, $6 for facility lease terminations and facility restoration, $7 for
contract terminations and $6 for a reversal of a reserve that was no longer needed. The asset impairment adjustments were due to realizing $40 more
proceeds than expected from asset dispositions, including $25 from the sale of assets associated with the Madrid, Spain facility. The impairment
adjustments also included $20 due to the redeployment of assets and $9 from the reversal of a reserve that was not needed. The facility lease and
restoration reversals, as well as the contract termination reversals, resulted from favorable lease and contract termination negotiations and lower
facility restoration costs than previously reserved.




Separation Expenses




The Company incurred costs, fees and expenses
relating to the Separation. These costs, fees and expenses were primarily related to legal separation matters, designing and constructing the
Companys 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. The Company incurred $7 and $99 of separation expenses in fiscal
2002 and 2001, respectively, which are included in restructuring and other charges  net. There were no separation expenses in fiscal 2003, since
the Separation was completed.


6.    Impairment of Goodwill and Other Acquired
Intangibles



Prior to the adoption of SFAS No. 142,
Goodwill and Other Intangible Assets (SFAS 142) on October 1, 2002, the Company reviewed its long-lived assets for
impairment whenever events or changes in circumstances indicated the carrying amount of the asset may not be fully recoverable. Goodwill and other
acquired intangibles associated with acquisitions were evaluated for impairment in the period in which the Company became aware of events or
occurrences that indicated an impairment may exist. Impairment assessments were performed because of weakened economic conditions and decreased current
and expected future demand for products in the markets in which the Company operated. Fair value of the acquired entities was determined using a
discounted cash flow model based on growth rates and margins reflective of lower demand for the Companys products, as well as anticipated future
demand. Discount rates used were based upon the Companys weighted average cost of capital adjusted for business risks. These amounts were based
on managements best estimate of future results.




As a result of these assessments, the Company
determined that an impairment of goodwill and other acquired intangibles existed related to certain of the Companys acquisitions. During fiscal
2002, the Company recorded a charge of $220, all of which is recorded in discontinued operations, comprised of $113 related to Ortel Corporation
(Ortel) and $107 related to Herrmann Technology, Inc. (Herrmann). During fiscal 2001, the Company recorded a charge of $2,762,
of which $267 is recorded in impairment of goodwill and other acquired intangibles and comprised of $240 related to Agere, Inc. and $27 related to
Enable Semiconductor Inc. The remaining $2,495 is recorded in discontinued operations and is comprised of $2,220 related to Ortel and $275 related to
Herrmann. There were no impairment charges for goodwill and other acquired intangibles in fiscal 2003.


7.    Debt

Accounts Receivable Securitization



On January 22, 2002, Agere Systems Inc. and certain
of its subsidiaries entered into a securitization transaction relating to certain accounts receivable. On November 12, 2002, this agreement was amended
to extend the expiration date of the loan agreement to November 11, 2003. Agere Systems Inc. and certain of its subsidiaries irrevocably transfer
accounts receivable on a daily basis to a wholly-owned, fully consolidated, bankruptcy-remote subsidiary, Agere Systems Receivables Funding LLC
(ASRF). ASRF has entered into a loan agreement with certain financial institutions, pursuant to which the financial institutions agreed to
make loans to ASRF secured by the accounts receivable. The financial institutions have commitments under the loan agreement of up to $200; however the
amount the Company can actually borrow at any time depends on the amount and nature of the accounts receivable that the Company has transferred to
ASRF. See Note 24 Subsequent Events.


47

---

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL
STATEMENTS(Continued)(dollars in millions except per share amounts)



As of September 30, 2003, ASRF had borrowings of
$154 outstanding under this agreement. The majority of the Companys accounts receivables are required to be pledged as security for the
outstanding loans even though some of those receivables may not qualify for borrowings. As of September 30, 2003, $228 of gross receivables was pledged
as security for the outstanding loans. The Company pays interest on amounts borrowed under the agreement based on one-month LIBOR. The weighted average
annual interest rate on amounts borrowed as of September 30, 2003 was 1.1%. In addition, the Company pays an annual commitment fee, which varies
depending on its credit rating, on the $200 total loan commitment. As of September 30, 2003, the commitment fee was 1.5% per annum. If the
Companys credit rating were to decline one or two levels, the commitment fee would increase to 2% or 3% per annum, respectively.




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


Convertible Subordinated Notes



On June 19, 2002, the Company issued $410 of 6.5%
Convertible Subordinated Notes due December 15, 2009 (the Notes). The Company received proceeds of $396 in connection with this offering,
net of $14 in underwriting fees and other expenses, which have been deferred and will be amortized to interest expense over the term of the
Notes.




Interest on the Notes accrues at the rate of 6.5%
per annum and is payable semi-annually on June 15 and December 15 of each year, beginning on December 15, 2002. The Notes can be converted into shares
of Class A common stock at an initial price of $3.3075 per share, subject to adjustment in certain events, at any time prior to maturity, unless
previously redeemed or repurchased by the Company. The Company may redeem the Notes in whole or in part at any time on or after June 20, 2007. In
addition, upon a fundamental change in the Company, the Company may be required to repurchase the Notes at a price equal to 100% of the principal
amount of the Notes plus any accrued and unpaid interest. The Notes are unsecured subordinated obligations and will be subordinated in right of payment
to all the Companys existing and future senior debt.


Collateral Installment Loan



On March 28, 2003, the Company borrowed $20 under an
installment note with a fixed interest rate of 9.45% that is secured by certain Company equipment. On May 1, 2003, the Company began paying 24 monthly
installments, with a $7 balloon payment due at the end of this period. Assuming certain conditions are met, the Company has the ability to refinance
the balloon payment for an additional twelve month period. As of September 30, 2003, $17 is outstanding under this installment loan, of which the
current portion is $7.


Other Debt



The remainder of the Companys debt relates to
obligations under capitalized leases. See Note 22 Commitments and Contingences  Leases for information regarding the future minimum
lease payments under non-cancelable leases.


8.    Acquisition of Massana Limited



On August 22, 2003, the Company acquired Massana
Limited (Massana), a developer of Gigabit Ethernet-over-copper physical layer device technologies, for approximately $28. The Company
issued 9,108,125 shares of Class A common stock in exchange for all the outstanding shares of Massana, of which 1,768,034 shares are being held in
escrow to satisfy potential liabilities, if any resulting from claims for breaches of representations and warranties under the purchase agreement. If
no claims are made, these shares will be released in three annual installments of 589,345 shares, beginning on August 23, 2004.




The acquisition of Massana was accounted for under
the purchase method of accounting. The purchase price, including acquisition costs, was allocated to the net assets acquired based on fair market
values. The consolidated and combined financial statements include the results of operations for Massana from the date of acquisition.
The


48

---

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL
STATEMENTS(Continued)(dollars in millions except per share amounts)

allocation of the purchase price by major balance sheet line item is provided
below. The final allocation of the purchase price is contingent on the revision of estimates. The Company does not expect the final allocations to
differ materially from the preliminary allocation.






|Current
assets                |  |  |  | $ | 1  | 
|----------------------------- |  |  |  | - | -- | 
|Property,
plant and equipment |  |  |  |   | 1  | 
|Goodwill                      |  |  |  |   | 26 | 
|Other
acquired intangibles    |  |  |  |   | 4  | 
|Current
liabilities           |  |  |  |   | 4  | 
|Total                         |  |  |  | $ | 28 | 



The acquired intangible asset consists of existing
technology, which will be amortized over a 5-year period. The goodwill has been assigned to the Infrastructure segment and is not deductible for tax
purposes.


9.    Divestitures of Businesses

Sale of FPGA Business



On January 18, 2002, the Company completed the sale
of certain assets and liabilities related to the field-programmable gate array (FPGA) business of the Infrastructure Systems segment to
Lattice Semiconductor Corporation (Lattice) for $250 in cash. The transaction included the Companys general-purpose ORCA® FPGA
product portfolio, field-programmable system chip product portfolio and related software design tools. As part of the transaction, approximately 100
employees transferred to Lattice. The Company recognized a gain in fiscal 2002 of $243 from the sale, which is included in (gain) loss on sale of
operating assets  net.


Sale of Wireless Local Area Network Equipment Business



On August 5, 2002, the Company completed the sale of
certain assets and liabilities of the 802.11 wireless local area network equipment business of the Client Systems segment, including its ORiNOCO®
product family, to Proxim Corporation (Proxim) for $65 in cash. As part of the sale, approximately 150 employees transferred to Proxim. In
addition, the Company and Proxim entered into a three-year strategic supply agreement under which the Company provides chips, modules and cards to
Proxim as needed, a license agreement for Agere technology used in the ORiNOCO business and a patent cross-license agreement for their respective
patent portfolios which resulted in the dismissal of patent-related litigation between the two companies. The Company recognized a gain in fiscal 2002
of $58 from the sale, which is included in (gain) loss on sale of operating assets  net.


Sale of Analog Line Card Business



On September 30, 2002, the Company completed the
sale of certain assets and liabilities of the analog line card business of the Infrastructure Systems segment to Legerity, Inc. (Legerity)
for $70 in cash. The sale consists of certain products, technology, intellectual property and equipment related to the analog line card business, which
provides integrated circuits used in telephone network equipment. As part of the transaction, approximately 40 employees transferred to Legerity. At
the time of the sale, the Company was obligated to supply integrated circuits to Legerity into fiscal 2003 and the gain on the sale was deferred.
During fiscal 2003, the Company substantially satisfied its obligations to Legerity and recognized a gain on the sale of $16, which is reflected in
(gain) loss on sale of operating assets  net.


10.    Investment in Silicon Manufacturing
Partners



In December 1997, the Company entered into a joint
venture, called Silicon Manufacturing Partners Pte, Ltd. (SMP), with Chartered Semiconductor Manufacturing Ltd. (Chartered
Semiconductor), a leading manufacturing foundry for integrated circuits, to operate a 54,000 square foot integrated circuit manufacturing
facility in Singapore. The Company owns a 51% equity interest in this joint venture, and Chartered Semiconductor owns the remaining 49% equity
interest. The Companys 51% interest in SMP is accounted for under the equity method due to Chartered Semiconductors participatory rights
under the joint venture agreement. Under the joint venture agreement, each partner is entitled to the margins from sales to themselves or customers
that are directed to SMP by that partner, after deducting their respective share of the overhead costs of SMP. Accordingly, SMPs


49

---

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL
STATEMENTS(Continued)(dollars in millions except per share amounts)

net income is not shared in the same ratio as equity ownership. The Company
recognized equity earnings of $13, $40 and $54 in fiscal 2003, 2002 and 2001, respectively.



The following table shows the condensed balance
sheets and statements of operations of SMP:







|                       |  |  |  | September 30, |     |  | 
|---------------------- |  |  |  | ------------- | --- |  | 
|
|Assets                 |  |  |  |               |     |  | 
|Current
assets         |  |  |  | $             | 181 |  | 
|Noncurrent
assets      |  |  |  |               | 308 |  | 
|Liabilities            |  |  |  |               |     |  | 
|Current
liabilities    |  |  |  | $             | 162 |  | 
|Noncurrent
liabilities |  |  |  |               | 85  |  | 






|                                  |  |  |  | Year Ended September 30, |     |  | 
|--------------------------------- |  |  |  | ------------------------ | --- |  | 
|
|Revenue                           |  |  |  | $                        | 301 |  | 
|Gross
profit                      |  |  |  |                          | 24  |  | 
|Income from
continuing operations |  |  |  |                          | 10  |  | 
|Net
income                        |  |  |  | $                        | 10  |  | 



SMP has entered into interest rate swaps, which have
been designated as cash flow hedges, to manage interest rate risk from its floating interest rate debt and has recorded the unrealized gain or loss
from these hedges as a separate component of other comprehensive income (loss). The Company has a 51% equity interest in these transactions and, as a
result, recorded an unrealized gain of $4 and $3 and an unrealized loss of $13 in other comprehensive income (loss) in fiscal 2003, 2002 and 2001,
respectively. The Companys investment in SMP was $197 and $179 at September 30, 2003 and 2002, respectively, and is recorded in other
assets.


11.    Supplementary Financial
Information

Statement of Operations Information



The Company recorded inventory provisions classified
within costs of $31 and $83 in fiscal 2002 and 2001, respectively. There were no inventory provisions recorded within costs during fiscal 2003. These
amounts were calculated in accordance with the Companys inventory valuation policy, which is based on a review of forecasted demand compared with
existing inventory levels.




The Company has recognized increased depreciation
due to a change in accounting estimate as a result of shortening the estimated useful lives of certain assets in connection with the Companys
restructuring activities. The Company recorded increased depreciation of $86 and $69 for fiscal 2003 and 2002, respectively. Of these amounts $71 and
$34 were recorded in costs, $15 and $9 were recorded in restructuring and other charges  net, and $0 and $26 were recorded in discontinued
operations for fiscal 2003 and 2002, respectively. This increased depreciation is reflected in net loss and resulted in a $0.05 and $0.04 per share
increase in the net loss for fiscal 2003 and 2002, respectively. There was no increased depreciation in fiscal 2001.







|                                                               |  |  |  | Year Ended September 30, |    
|-------------------------------------------------------------- |  |  |  | ------------------------ | ---
|
|INCLUDED IN
COSTS AND OPERATING EXPENSES:                      |  |  |  |                          |    
|Depreciation
and amortization of property, plant and equipment |  |  |  | $                        | 308
|OTHER INCOME
 NET:                                            |  |  |  |                          |    
|Interest
income                                                |  |  |  | $                        | 10 
|Equity
earnings from investments                               |  |  |  |                          | 13 
|Gain (loss)
on foreign currency transactions                   |  |  |  |                          | (3 
|Impairment of
non-consolidated investments                     |  |  |  |                          |   
|Other income
(loss)                                            |  |  |  |                          | 2  
|Other income
 net                                             |  |  |  | $                        | 22 

50

---

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL
STATEMENTS(Continued)(dollars in millions except per share amounts)

Balance Sheet Information



The Company had $21 and $16 of cash held in trust as
of September 30, 2003 and 2002, respectively, primarily in support of obligations of the Companys captive insurance company.







|                                                |  |  |  | September 30, |       
|----------------------------------------------- |  |  |  | ------------- | ------
|
|INVENTORIES                                     |  |  |  |               |       
|Finished
goods                                  |  |  |  | $             | 38    
|Work in
process                                 |  |  |  |               | 77    
|Raw
materials                                   |  |  |  |               | 7     
|Inventories                                     |  |  |  | $             | 122   
|PROPERTY,
PLANT AND EQUIPMENT  NET             |  |  |  |               |       
|Land and
improvements                           |  |  |  | $             | 35    
|Buildings and
improvements                      |  |  |  |               | 431   
|Machinery,
electronic and other equipment       |  |  |  |               | 1,659 
|Total
property, plant and equipment             |  |  |  |               | 2,125 
|Less:
accumulated depreciation and amortization |  |  |  |               | (1,347
|Property,
plant and equipment  net             |  |  |  | $             | 778   

Cash Flow Information



Prior to the Separation, interest and income taxes
were 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.
Following the Separation, the Company began to pay interest and income tax expenses. Cash paid for interest was $40, $71 and $84 for fiscal 2003, 2002
and 2001, respectively. Cash paid for income taxes was $10, $38 and $52 for fiscal 2003, 2002 and 2001, respectively.




In fiscal 2003, the Company acquired Massana by
issuing 9,108,125 shares of Class A common stock valued at $26 in exchange for all the outstanding shares of Massana. See Note 8 Acquisition of
Massana Limited.




Non-cash transactions in fiscal 2002 with Lucent
resulted in a net increase to additional paid-in capital of $227. The increase is primarily the result of activity related to pension and
postretirement benefits. In fiscal 2001, transfers from Lucent included a $2,500 decrease to additional paid-in capital to reflect the transfer of a
credit facility from Lucent. Agere did not receive any of the proceeds.




Capital lease obligations of $19 and $80 were
entered into in fiscal 2003 and 2002, respectively, primarily for the lease of semiconductor manufacturing equipment and other assets. No capital
leases were entered into in fiscal 2001.


51

---

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL
STATEMENTS(Continued)(dollars in millions except per share amounts)

12.    Income Taxes



The following table presents the principal reasons
for the difference between the effective tax rate and the U.S. federal statutory income tax rate based on loss from continuing
operations.







|                                                                  |  |  |  | Year Ended September 30, |      
|----------------------------------------------------------------- |  |  |  | ------------------------ | -----
|
|U.S. federal
statutory income tax rate                            |  |  |  |                          | 35.0 
|State and
local income taxes, net of federal income tax effect    |  |  |  |                          | 0.6  
|Effect of
non-U.S. earnings                                       |  |  |  |                          | (19.7
|Research
credits                                                  |  |  |  |                          |     
|Foreign sales
corporation                                         |  |  |  |                          |     
|Valuation
allowance                                               |  |  |  |                          | (27.9
|Other
differencesnet                                             |  |  |  |                          | (2.2 
|Effective
income tax rate excluding acquisition related costs (1) |  |  |  |                          | (14.2
|Acquisition
related costs (1)                                     |  |  |  |                          |     
|Effective
income tax rate                                         |  |  |  |                          | (14.2

---

|(1) |  | Non-tax deductible in-process research and development and
amortization of goodwill.
|--- |  | ------------------------------------------------------------------------------------



The fiscal 2003 and 2002 rates include the impact of
recording a charge of approximately $91 and $259, respectively, to increase the valuation allowance for deferred tax assets. A full valuation allowance
has been recorded for fiscal 2003 and 2002 on U.S. net deferred tax assets.




The following table presents the U.S. and foreign
components of loss from continuing operations before income taxes and the provision for income taxes.







|                           |  |  |  | Year Ended September 30, |     
|-------------------------- |  |  |  | ------------------------ | ----
|
|LOSS BEFORE
INCOME TAXES   |  |  |  |                          |     
|United
States              |  |  |  | $                        | (222
|Non-U.S                    |  |  |  |                          | (103
|Loss before
income taxes   |  |  |  | $                        | (325
|PROVISION FOR
INCOME TAXES |  |  |  |                          |     
|Current                    |  |  |  |                          |     
|Federal                    |  |  |  | $                        | 20  
|State and
local            |  |  |  |                          | 1   
|Non-U.S                    |  |  |  |                          | 8   
|Sub-total                  |  |  |  |                          | 29  
|Deferred                   |  |  |  |                          |     
|Federal                    |  |  |  |                          | 11  
|State and
local            |  |  |  |                          | 1   
|Non-U.S                    |  |  |  |                          | 5   
|Sub-total                  |  |  |  |                          | 17  
|Provision for
income taxes |  |  |  | $                        | 46  



As of September 30, 2003, the Company had total
federal and state net operating loss carryforwards (tax-effected) of approximately $805, and federal and state research and development credit
carryforwards of approximately $28, the majority of which begin to expire at the end of fiscal 2021 through fiscal 2023.


52

---

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL
STATEMENTS(Continued)(dollars in millions except per share amounts)



Net deferred tax assets are reflected within other
assets. The components of deferred tax assets and liabilities at September 30, 2003 and 2002 are as follows:







|                                        |  |  |  | September 30, |       
|--------------------------------------- |  |  |  | ------------- | ------
|
|Deferred
Tax Assets                     |  |  |  |               |       
|Benefit
obligations                     |  |  |  | $             | 137   
|Reserves and
allowances                 |  |  |  |               | 87    
|Net operating
loss/credit carryforwards |  |  |  |               | 833   
|Valuation
allowance                     |  |  |  |               | (1,087
|Property,
plant and equipment           |  |  |  |               | 4     
|Intangibles                             |  |  |  |               | 21    
|Other                                   |  |  |  |               | 9     
|Total
deferred tax assets:              |  |  |  | $             | 4     
|Deferred
Tax Liabilities                |  |  |  |               |       
|Property,
plant, and equipment          |  |  |  | $             |      
|Total
deferred tax liabilities:         |  |  |  | $             |      



The Company has not provided for U.S. deferred
income taxes or foreign withholding taxes on $254 and $355 of undistributed earnings of its non-U.S. subsidiaries as of September 30, 2003 and 2002,
respectively, because these earnings are intended to be reinvested indefinitely.


13.    Comprehensive Income (Loss)



Total comprehensive loss represents net loss plus
the results of certain equity changes not reflected in the consolidated and combined statements of operations. The components of accumulated other
comprehensive loss are shown below.







|                                  |  |  |  | Foreign Currency Translation |     | Unrealized Holding Gains |  | Unrealized Gains (Losses) on Cash Flow Hedges |     | Minimum Pension Liability Adjustment |  | Total Accumulated Other Comprehensive Income (Loss)
|--------------------------------- |  |  |  | ---------------------------- | --- | ------------------------ |  | --------------------------------------------- | --- | ------------------------------------ |  | ---------------------------------------------------
|Ending
balance September 30, 2000 |  |  |  | $                            | (52 | )                        |  | $                                             |    |                                      |  | $                                                  
|Fiscal 2001
change                |  |  |  |                              | 26  |                          |  |                                               | 30  |                                      |  |                                                    
|Ending
balance September 30, 2001 |  |  |  |                              | (26 | )                        |  |                                               | 30  |                                      |  |                                                    
|Fiscal 2002
change                |  |  |  |                              | 32  |                          |  |                                               | (30 | )                                    |  |                                                    
|Ending
balance September 30, 2002 |  |  |  |                              | 6   |                          |  |                                               |    |                                      |  |                                                    
|Fiscal 2003
change                |  |  |  |                              |    |                          |  |                                               |    |                                      |  |                                                    
|Ending
balance September 30, 2003 |  |  |  | $                            | 6   |                          |  | $                                             |    |                                      |  | $                                                  



The foreign currency translation adjustments are not
currently adjusted for income taxes because they relate to indefinite investments in non-U.S. subsidiaries. The unrealized gains (losses) on cash flow
hedges are related to hedging activities by SMP and there are no income taxes provided as they relate to an equity method investee. There were also no
income taxes provided for the unrealized holding gains on investments and the minimum pension liability adjustment due to the recording of a full
valuation allowance against U.S. net deferred tax assets.


53

---

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL
STATEMENTS(Continued)(dollars in millions except per share amounts)

14.    Stock Compensation Plans



Agere has stock-based compensation plans under which
employees and outside directors receive stock options and other equity-based awards. The plans provide for the granting of stock options, performance
awards, restricted stock awards, cash awards, stock appreciation rights and other stock unit awards. At September 30, 2003, awards relating to
193,106,093 shares were outstanding and 168,893,907 shares remain available for the grant of awards under these plans. These shares can be either Class
A or Class B common stock. All awards granted through September 30, 2003 under the stock-based compensation plans were related to Class A common stock.
During fiscal 2003, 2002 and 2001, employees of the Company were granted stock options and other equity-based awards under Ageres 2001 Long Term
Incentive Plan. Agere stock options are granted with an exercise price equal to 100% of the market value of a share of common stock on the date of the
grant, generally have seven-year terms, and vest no later than four years from the date of grant.




Employees of the Company were also granted stock
options and other equity-based awards under Lucent stock-based compensation plans, generally before the IPO. In connection with certain of the
Companys acquisitions, outstanding stock options held by employees of acquired companies became exercisable, according to their terms, for
Lucents common stock effective at the acquisition date. On June 1, 2002, at the time of the Distribution, awards outstanding under Lucents
stock-based compensation plans and held by Company employees were converted to Company stock-based awards. The pre-converted Lucent stock options
generally were granted with an exercise price equal to 100% of the market value of a share of common stock on the date of grant, had two to ten year
terms and vested no later than four years from the date of grant. The Company stock options and other awards, as converted or adjusted, have the same
vesting provisions, option periods, and other terms and conditions as the Lucent stock options and awards they replaced. The number of shares covered
by, and the exercise prices of each stock option were adjusted so that immediately following conversion, each option had the same ratio of the exercise
price per share to the market value per share, and the same aggregate difference between market value and exercise price as the Lucent stock options
immediately prior to the conversion. No new measurement date occurred upon conversion of the stock options. In connection with the Distribution, Lucent
stock options held by Company employees were converted into Agere stock options for a total of 57,138,106 shares of Class A common
stock.




Agere maintains an ESPP, which has consecutive
offering periods, each consisting of four purchase periods of approximately six months in length. The first offering period commenced on March 27, 2001
and ended April 30, 2003. The second offering period began on May 1, 2003 and will end on April 30, 2005. Subsequent offering periods will run
generally for 24 months beginning May 1 of every other year. Under the terms of the ESPP, participating employees may have up to 10% of eligible
compensation (subject to certain limitations on the number of shares and fair market value of shares that may be acquired each purchase period)
deducted from their pay to purchase the Companys common stock. The per share purchase price is equal to 85% of the lower of either the market
price on the employees entry date for the current offering period, or the last trading day of each purchase period. Through September 30, 2003,
8,859,157 shares had been purchased under the ESPP and 76,140,843 shares remained available for purchase.




In December 2002, the FASB issued SFAS 148, which
amends the transition and disclosure provisions of SFAS 123. SFAS 148 provides alternative methods of transition for a voluntary change to the fair
value based method of accounting for stock-based employee compensation and amends the disclosure requirements of SFAS 123 to require more prominent and
more frequent disclosures in financial statements about the effects of stock-based compensation. The transition provisions are effective for fiscal
years ending after December 15, 2002. The disclosure provisions are effective for interim periods beginning after December 15, 2002, with early
application encouraged. The Company early adopted the interim period disclosure provisions of SFAS 148 beginning with the first quarter of fiscal 2003
and these provisions had no effect on the Companys financial condition or results of operations.


54

---

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL
STATEMENTS(Continued)(dollars in millions except per share amounts)



Presented below is a summary of the status of the
Lucent stock options held by Company employees prior to the Distribution and the related transactions for the eight months ended May 31, 2002 and the
year ended September 30, 2001. Also presented below is a summary of the status of Agere stock options and related transactions for fiscal years 2003,
2002 and 2001. The Lucent stock option activity is not necessarily indicative of what the activity would have been had Agere been a separate
stand-alone company during the periods presented.







|                                                                          |  |  |  | Shares (000s) |         | Weighted Average Exercise Price
|------------------------------------------------------------------------- |  |  |  | -------------- | ------- | -------------------------------
|LUCENT
OPTIONS OUTSTANDING AT SEPTEMBER 30, 2000                          |  |  |  |                | 42,073  |                                
|Granted or
Assumed (1)                                                    |  |  |  |                | 9,526   |                                
|Exercised                                                                 |  |  |  |                | (2,033  | )                              
|Forfeited or
Expired                                                      |  |  |  |                | (4,086  | )                              
|LUCENT
OPTIONS OUTSTANDING AT SEPTEMBER 30, 2001                          |  |  |  |                | 45,480  |                                
|Granted                                                                   |  |  |  |                |        |                                
|Exercised                                                                 |  |  |  |                | (1,890  | )                              
|Forfeited or
Expired                                                      |  |  |  |                | (5,368  | )                              
|LUCENT
OPTIONS OUTSTANDING AT MAY 31, 2002                                |  |  |  |                | 38,222  |                                
|Agere
spin-off adjustments (2)                                            |  |  |  |                | 18,916  |                                
|AGERE OPTIONS
SUBSTITUTED FOR LUCENT OPTIONS, OUTSTANDING AT JUNE 1, 2002 |  |  |  |                | 57,138  |                                
|AGERE OPTIONS
OUTSTANDING AT SEPTEMBER 30, 2000                           |  |  |  |                |        |                                
|Granted                                                                   |  |  |  |                | 151,763 |                                
|Exercised                                                                 |  |  |  |                |        |                                
|Forfeited or
Expired                                                      |  |  |  |                | (9,013  | )                              
|AGERE OPTIONS
OUTSTANDNG AT SEPTEMBER 30, 2001                            |  |  |  |                | 142,750 |                                
|Granted                                                                   |  |  |  |                | 5,649   |                                
|Agere options
substituted for Lucent options (2)                          |  |  |  |                | 57,138  |                                
|Exercised                                                                 |  |  |  |                | (41     | )                              
|Forfeited or
Expired                                                      |  |  |  |                | (32,050 | )                              
|AGERE OPTIONS
OUTSTANDING AT SEPTEMBER 30, 2002                           |  |  |  |                | 173,446 |                                
|Granted                                                                   |  |  |  |                | 67,185  |                                
|Exercised                                                                 |  |  |  |                | (738    | )                              
|Forfeited or
Expired                                                      |  |  |  |                | (46,787 | )                              
|AGERE OPTIONS
OUTSTANDING AT SEPTEMBER 30, 2003                           |  |  |  |                | 193,106 |                                

---

|(1) |  | Includes options converted in acquisitions.
|--- |  | -------------------------------------------

|(2) |  | Effective with the Distribution on June 1, 2002, the outstanding
Lucent options were converted to Agere options. The number of Agere shares covered by substituted options was adjusted and all exercise prices were
decreased immediately following the Distribution to preserve the economic values of the options that existed prior to the Distribution.
|--- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

55

---

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL
STATEMENTS(Continued)(dollars in millions except per share amounts)



The weighted average fair value of the Agere stock
options, and Lucent stock options held by Agere employees prior to the Distribution, was calculated using the Black-Scholes option-pricing model. The
weighted average fair value of Agere stock options granted during fiscal 2003, 2002 and 2001 was $0.83, $2.17 and $2.43 per share, respectively. The
weighted average fair value of stock options granted by Lucent during fiscal 2001 was $7.36 per share, respectively. See Note 2 Summary of
Significant Accounting Policies  Stock Compensation Plans.




The following table summarizes the status of Agere
stock options outstanding at September 30, 2003:







|                 |  |  |  | Stock Options Outstanding |         | Stock Options Exercisable | 
|---------------- |  |  |  | ------------------------- | ------- | ------------------------- | 
|
|$0.08 to
$2.00   |  |  |  |                           | 61,613  |                           | 
|$2.01 to
$5.15   |  |  |  |                           | 6,292   |                           | 
|$5.16 to
$5.85   |  |  |  |                           | 42,813  |                           | 
|$5.86 to
$6.00   |  |  |  |                           | 48,082  |                           | 
|$6.01 to
$10.30  |  |  |  |                           | 5,326   |                           | 
|$10.31 to
$15.50 |  |  |  |                           | 9,001   |                           | 
|$15.51 to
$36.00 |  |  |  |                           | 10,641  |                           | 
|$36.01 to
$51.56 |  |  |  |                           | 9,338   |                           | 
|Total            |  |  |  |                           | 193,106 |                           | 



Other stock unit awards are granted under certain
award plans. The following table presents the total number of shares of common stock represented by awards granted to Company
employees.







|                                                                      |  |  |  | Year Ended September 30, |    
|--------------------------------------------------------------------- |  |  |  | ------------------------ | ---
|
|Agere other
stock unit awards granted (000s)                         |  |  |  |                          |   
|Weighted
average market value of shares granted during the period     |  |  |  |                          | n/a
|Lucent other
stock unit awards granted (000s) (1)                    |  |  |  |                          |   
|Weighted
average market value of shares granted during the period (1) |  |  |  |                          | n/a

---

|(1) |  | Following the Distribution, the remaining 434 Lucent other stock
unit awards were converted to 649 Agere other stock unit awards, with a weighted average market value at grant date of $11.73.
|--- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

15.    Loss Per Common Share



Basic and diluted loss per common share is
calculated by dividing net loss by the weighted average number of outstanding common shares. As a result of the net loss reported for each of the years
presented, the following potential common shares have been excluded from the calculation of diluted loss per share because their effect would be
anti-dilutive: 123,960,695 and 35,076,790 related to the convertible notes for fiscal 2003 and 2002, respectively, and 2,229 potential common shares
related to other stock units for fiscal 2001. For fiscal 2003, 2002 and 2001, 193,106,093, 173,446,189 and 142,750,376 outstanding stock options,
respectively, were excluded from the computation of loss per share because their effect would be anti-dilutive.


56

---

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL
STATEMENTS(Continued)(dollars in millions except per share amounts)

16.    Benefit Obligations



The Company has pension plans covering substantially
all U.S. employees, excluding management employees hired after June 30, 2003. Retirement benefits are offered under a defined benefit plan and are
based on either a career pay or dollar per month formula or on a cash balance plan which is based on pay, age and interest earned on existing balances.
The cash balance plan covers certain employees of companies acquired since 1996 and management employees hired after January 1, 1999 and before July 1,
2003. The Company also has postretirement benefit plans that include healthcare benefits and life insurance coverage. Participants in the cash balance
plan and management employees hired after June 30, 2003 are not entitled to Company paid benefits under the postretirement benefit
plan.




Prior to the Distribution, most of the
Companys U.S. management and occupational employees participated in Lucents pension and postretirement plans. Effective June 1, 2002, the
Company assumed responsibility for all pension and postretirement benefits covering active employees of the Company, as well as employees who retired
or were terminated subsequent to the IPO. During June 2002, Lucent transferred to the Company, a substantial portion of the total estimated pension and
postretirement assets, and all of the obligations related to these employees based on then available census data. Obligations related to retired and
terminated vested employees prior to the IPO are the responsibility of Lucent. In fiscal 2003, the final asset transfer occurred as a result of the
finalization of the census data and the completion of the actuarial calculations.




Lucent managed its employee benefit plans on a
consolidated basis and separate Company information is not available for the periods prior to June 1, 2002. The consolidated and combined statements of
operations include an allocation of the costs (credits) of the employee pension and postretirement plans. These costs (credits) were allocated based on
the Companys active employee population for each period presented prior to June 1, 2002.







|                                               |  |  |  | Eight Months Ended June 1, |   | Year Ended September 30,
|---------------------------------------------- |  |  |  | -------------------------- | - | ------------------------
|
|Net
Periodic Benefit Cost (Credit) from Lucent |  |  |  |                            |   |                         
|Pension
benefits                               |  |  |  | $                          |  |                         
|Postretirement benefits                        |  |  |  |                            | 7 |                         






|                                     |  |  |  | Year Ended September 30, 2003 |     | Four Months Ended September 30, 2002 | 
|------------------------------------ |  |  |  | ----------------------------- | --- | ------------------------------------ | 
|
|Agere
Net Periodic Benefit Cost      |  |  |  |                               |     |                                      | 
|Service
cost                         |  |  |  | $                             | 24  |                                      | 
|Interest
cost                        |  |  |  |                               | 73  |                                      | 
|Expected
return on plan assets       |  |  |  |                               | (96 | )                                    | 
|Amortization
of prior service cost   |  |  |  |                               | 3   |                                      | 
|Recognized
net actuarial loss (gain) |  |  |  |                               |    |                                      | 
|Transition
asset                     |  |  |  |                               |    |                                      | 
|Net periodic
benefit cost (credit)   |  |  |  |                               | 4   |                                      | 
|Special
retirement benefits          |  |  |  |                               | 7   |                                      | 
|Curtailment
charges                  |  |  |  |                               | 25  |                                      | 
|Settlement
charge                    |  |  |  |                               | 14  |                                      | 
|Total benefit
cost                   |  |  |  | $                             | 50  |                                      | 

57

---

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL
STATEMENTS(Continued)(dollars in millions except per share amounts)



The following table sets forth the combined status
of the plans as recognized in the consolidated balance sheets:







|                                                 |  |  |  | Year Ended September 30, 2003 |       | Four Months Ended September 30, 2002 | 
|------------------------------------------------ |  |  |  | ----------------------------- | ----- | ------------------------------------ | 
|
|Change in
benefit obligation                     |  |  |  |                               |       |                                      | 
|Benefit
obligation at beginning of period        |  |  |  | $                             | 1,198 |                                      | 
|Service
cost                                     |  |  |  |                               | 24    |                                      | 
|Interest
cost                                    |  |  |  |                               | 73    |                                      | 
|Amendments                                       |  |  |  |                               | 1     |                                      | 
|Actuarial
(gain)/loss                            |  |  |  |                               | 69    |                                      | 
|Benefits
paid                                    |  |  |  |                               | (223  | )                                    | 
|Special
retirement benefits                      |  |  |  |                               | 7     |                                      | 
|Curtailment
charges                              |  |  |  |                               | 19    |                                      | 
|Benefit
obligation at September 30               |  |  |  | $                             | 1,168 |                                      | 
|Change in
plan assets                            |  |  |  |                               |       |                                      | 
|Fair value of
plan assets at beginning of period |  |  |  | $                             | 1,010 |                                      | 
|Actual
gain/(loss) on plan assets                |  |  |  |                               | 170   |                                      | 
|Employer
contributions                           |  |  |  |                               | 31    |                                      | 
|Benefits
paid                                    |  |  |  |                               | (223  | )                                    | 
|Fair value of
plan assets at September 30        |  |  |  | $                             | 988   |                                      | 
|Funded status
of the plan                        |  |  |  | $                             | (180  | )                                    | 
|Unrecognized
net actuarial loss                  |  |  |  |                               | 189   |                                      | 
|Unrecognized
prior service cost                  |  |  |  |                               | 9     |                                      | 
|Net amount
recognized                            |  |  |  | $                             | 18    |                                      | 



The pension benefit obligation as of September 30,
2003 and 2002 includes $5 and $4, respectively for the Companys international plans. The fair value of plan assets as of September 30, 2003 and
2002 each include $1 for the Companys international pension plan assets.




The projected benefit obligation, accumulated
benefit obligation and fair value of plan assets for the pension plans with accumulated benefit obligations in excess of plan assets were $1,168,
$1,130 and $988, respectively, as of September 30, 2003 and $1,198, $1,153 and $1,010, respectively, as of September 30, 2002.




The special retirement benefits are separation
payments made to employees and are included in restructuring and other charges  net. The curtailment charges reflect an increase in the
recognized liabilities of the plans as employees are retiring sooner than originally anticipated, primarily due to the restructuring activities. The
settlement charges are for previously unrecognized losses related to employees taking a lump-sum distribution from the pension plans upon termination
of employment, thereby eliminating the Companys pension obligations. Benefits paid reflect all special and normal retiree benefit
payments.




On March 14, 2003 the Company voluntarily
contributed 18,750,000 shares of its Class A common stock to the pension plan for represented employees. The value of the stock at the time of the
contribution was $30. In addition, $1 in cash was contributed to the non-qualified pension plan in fiscal 2003.




Amounts recognized in the consolidated balance sheet
consist of:







|                                     |  |  |  | September 30, 2003 |      | September 30, 2002 | 
|------------------------------------ |  |  |  | ------------------ | ---- | ------------------ | 
|
|Accrued
benefit liability            |  |  |  | $                  | (143 | )                  | 
|Intangible
asset                     |  |  |  |                    | 9    |                    | 
|Accumulated
other comprehensive loss |  |  |  |                    | 152  |                    | 
|Net amount
recognized                |  |  |  | $                  | 18   |                    | 

58

---

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL
STATEMENTS(Continued)(dollars in millions except per share amounts)



Prior to June 1, 2002, the costs and benefit
obligations of the Companys retirement benefit plans were reported on a consolidated basis in Lucents financial statements. Actuarial
assumptions used by Lucent to determine costs and benefit obligations for the principal pension plans and the postretirement benefit obligations up to
June 1, 2002 were a discount rate of 7.0%, an expected rate of return on plan assets of 9.0% and a rate of compensation increase of 4.5% (applicable
only to pension benefits and life insurance). In June 2002, a substantial portion of the pension and postretirement assets and all of the obligations
of the Company were transferred from Lucent. The actuarial assumptions used by the Company for the period June 1, 2002 to September 30, 2002 were a
discount rate of 6.75%, an expected rate of return on plan assets of 8.0% and a rate of compensation increase of 4.0% (applicable only to pension
benefits and life insurance).




The Company reassesses its benefit plan assumptions
on a regular basis. The actuarial assumptions for the principal pension and postretirement plans for fiscal 2003 were a discount rate of 6.25%,
expected average rate of return on plan assets of 8.0% and a rate of compensation increase of 4.0% (applicable only to pension benefits and life
insurance).




For fiscal 2002, the assumed health care cost trend
rates were 10% for participants under age 65 and 11% for participants age 65 or older. For dental care, for all ages, the trend rate was 4%. The
actuarial assumptions on health care cost trends, and claims were changed for fiscal 2003. A 12% annual rate of increase in the per capita cost of
covered health care benefits was assumed for fiscal 2002, decreasing gradually to 5% for 2007 and remaining constant at that level thereafter. The per
capita cost increase for dental care benefits was assumed to be 4% for all years. A one percent annual change in the assumed cost trend rate would have
a minimal effect on the total service and interest cost components and on the postretirement benefit obligation.


Savings Plans



The Company established savings plans for its
employees effective January 1, 2002. The majority of the Companys employees are eligible to participate in these plans. Prior to January 1, 2002,
the employees participated in similar plans sponsored by Lucent. The plans allow employees to contribute a portion of their compensation on a pre-tax
and/or after-tax basis in accordance with specified guidelines. The Company matches a percentage of employee contributions up to certain limits. The
Companys contribution to savings plans was $12 and $17 in fiscal 2003 and 2002, respectively. The Companys contribution related to the
Lucent plans was $25 in fiscal 2001.




Effective April 1, 2002, the Company began funding
the employer match for U.S. employees with newly issued Class A common stock. Through September 30, 2002, the Companys matching contributions to
the savings plan consisted of 3,130,588 shares. During fiscal 2003, the Companys matching contributions to the savings plan consisted of
6,620,332 shares.


17.    Intangible Assets



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


59

---

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL
STATEMENTS(Continued)(dollars in millions except per share amounts)

useful lives of previously acquired goodwill and other intangible assets. The
following table reflects intangible assets by major class and the related accumulated amortization:






|                                   |  |  |  | September 30, 2003 |     | September 30, 2002
|---------------------------------- |  |  |  | ------------------ | --- | ------------------
|Unamortized
intangible assets:     |  |  |  |                    |     |                   
|Goodwill:                          |  |  |  |                    |     |                   
|Client
Systems segment             |  |  |  | $                  | 79  |                   
|Infrastructure Systems segment (1) |  |  |  |                    | 30  |                   
|Total
goodwill                     |  |  |  | $                  | 109 |                   
|Amortized
intangible assets:       |  |  |  |                    |     |                   
|Other
acquired intangibles  net:  |  |  |  |                    |     |                   
|Existing
technology                |  |  |  | $                  | 34  |                   
|Less:
accumulated amortization     |  |  |  |                    | 21  |                   
|Other
acquired intangibles  net   |  |  |  | $                  | 13  |                   

---

|(1) |  | During fiscal 2003, Infrastructure Systems segment goodwill
increased by $26 due to the acquisition of Massana.
|--- |  | ---------------------------------------------------------------------------------------------------------------



Intangible asset amortization expense for
fiscal 2003, 2002 and 2001 was $8, $10 and $10, respectively. Intangible assets have an estimated useful life of 5 years. The Company does not have any
intangibles with indefinite lives. The amortization expense for future fiscal years is estimated to be:







|                     |  |  |  | 2004 |   | 2005 |  | 2006 |   | 2007 |  | 2008
|-------------------- |  |  |  | ---- | - | ---- |  | ---- | - | ---- |  | ----
|Amortization
expense |  |  |  | $    | 7 |      |  | $    | 3 |      |  | $   



The following table reflects the impact of SFAS 142
on net loss and net loss per share had SFAS 142 become effective October 1, 2000. Goodwill amortization includes amounts recorded in continuing and
discontinued operations:







|                                  |  |  |  | Year Ended September 30, |      
|--------------------------------- |  |  |  | ------------------------ | -----
|
|Net
loss:                         |  |  |  |                          |      
|Net loss
 reported               |  |  |  | $                        | (338 
|Add back
goodwill amortization    |  |  |  |                          |     
|Net loss
 as adjusted            |  |  |  | $                        | (338 
|Basic and
diluted loss per share: |  |  |  |                          |      
|Net loss
 reported               |  |  |  | $                        | (0.20
|Add back
goodwill amortization    |  |  |  |                          |     
|Net loss
 as adjusted            |  |  |  | $                        | (0.20

18.    Financial Guarantees



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


60

---

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL
STATEMENTS(Continued)(dollars in millions except per share amounts)

effective with the first quarter of fiscal 2003 with no material impact on its
financial condition or results of operations. Set forth below is a discussion of the Companys guarantees as of September 30, 2003.



A subsidiary of Agere Systems Inc. has guaranteed $9
of debt and interest incurred by SMP. As of September 30, 2003, no liability is recorded since the Company entered into the guarantee prior to December
31, 2002 and believes it is unlikely that the subsidiary would be required to make any payments associated with this guarantee.




Two real estate leases were assigned in connection
with the sale of the Companys wireless local area networking equipment business. The Company remains secondarily liable for the remaining lease
payments in the event of a default. The maximum potential amount of future payments that the Company could be liable for is $6 as of September 20,
2003. As of September 30, 2003, no liability is recorded since the Company entered into the guarantee prior to December 31, 2002 and believes it is
unlikely that it would be required to make any payments related to these obligations.




Agere Systems Inc. includes indemnification clauses
in its standard terms and conditions for product sales agreements, which indemnify its customers from third party intellectual property infringement
litigation. Also, the Companys installment note contains an indemnification clause in which Agere provides indemnification against any claims,
liabilities, losses and costs associated with the collateral named in the agreement. There are no liabilities recorded as of September 30, 2003 for
indemnification clauses since the fair value of potential obligations cannot be estimated.




The Companys policy is to record a liability,
which is reflected within other current liabilities, for known or potential warranty claims based on historical experience. The table below presents a
reconciliation of the changes in the Companys aggregate product warranty liability for continuing operations for the year ended September 30,
2003:







|                                                                              |  |  |  | Year Ended September 30, 2003
|----------------------------------------------------------------------------- |  |  |  | -----------------------------
|Balance as of
October 1, 2002                                                 |  |  |  | $                            
|Accruals for
new and pre-existing warranties (including changes in estimates) |  |  |  |                              
|Settlements
made (in cash or in kind) during the period                       |  |  |  |                              
|Balance as of
September 30, 2003                                              |  |  |  | $                            

19.    Operating Segments



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




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




The Infrastructure Systems segment provides
integrated circuit solutions to makers of high-speed communications systems. Prior to the reflection of the Companys optoelectronic components
business as discontinued operations, as discussed in Note 4, the Infrastructure Systems segment also included the results of operations from this
business.




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




The Company does not identify or allocate assets by
operating segment. In addition, the Company does not allocate interest income or expense, other income or expense, or income taxes to the segments.
Management does not evaluate segments based on these criteria. The Company has centralized corporate functions and uses shared service arrangements to
realize economies of scale and efficient use of resources. The costs of shared services, and


61

---

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL
STATEMENTS(Continued)(dollars in millions except per share amounts)

other corporate center operations managed on a common basis, are allocated to the
segments based on usage or other factors based on the nature of the activity.



At the beginning of each fiscal year, the Company
updates the allocation of its shared integrated circuit fabrication costs based on the demand forecasts by month from the two operating segments. This
essentially creates a take-or-pay relationship between the Companys manufacturing facilities and the operating segments. The dramatic decline in
the telecommunications markets in fiscal 2002 negatively impacted Infrastructure Systems gross margin due to excess manufacturing capacity, as
sales volumes were less than the Company had anticipated. With the update of the demand forecast for fiscal 2003, the costs allocated to the Client
Systems segment increased by approximately $80 for fiscal 2003, when compared to fiscal 2002. Accordingly, the costs allocated to the Infrastructure
Systems segment decreased by the same amount. This change in allocation impacts gross margin at the segment level, but has no effect on the overall
gross margin for the Company.




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


Reportable Segments






|                                                                                                                                                                                                                                  |  |  |  | Year Ended September 30, |      
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  |  |  | ------------------------ | -----
|
|Revenue                                                                                                                                                                                                                           |  |  |  |                          |      
|Client
Systems                                                                                                                                                                                                                    |  |  |  | $                        | 1,321
|Infrastructure Systems                                                                                                                                                                                                            |  |  |  |                          | 518  
|Total                                                                                                                                                                                                                             |  |  |  | $                        | 1,839
|Operating
loss (excluding amortization of goodwill and other acquired intangibles, net restructuring and other charges, impairment of goodwill and other acquired
intangibles, and (gain) loss on sale of operating assets  net) |  |  |  |                          |      
|Client
Systems                                                                                                                                                                                                                    |  |  |  | $                        | (148 
|Infrastructure Systems                                                                                                                                                                                                            |  |  |  |                          | (34  
|Total                                                                                                                                                                                                                             |  |  |  | $                        | (182 

Reconciling Items



A reconciliation of the totals reported for the
operating segments to the significant line items in the financial statements is shown below:







|                                                        |  |  |  | Year Ended September 30, |     
|------------------------------------------------------- |  |  |  | ------------------------ | ----
|
|Reportable
segment operating loss                       |  |  |  | $                        | (182
|Less:                                                   |  |  |  |                          |     
|Amortization
of goodwill and other acquired intangibles |  |  |  |                          | 8   
|Restructuring
and other charges  net                   |  |  |  |                          | 131 
|Impairment of
goodwill and other acquired intangibles   |  |  |  |                          |    
|(Gain) loss
on the sale of operating assets  net       |  |  |  |                          | (21 
|Total
operating loss                                    |  |  |  | $                        | (300

62

---

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL
STATEMENTS(Continued)(dollars in millions except per share amounts)

Geographic Information






|                                          |  |  |  | Revenue (1) Year Ended September 30, |       | Long-lived Assets (2) September 30, | 
|----------------------------------------- |  |  |  | ------------------------------------ | ----- | ----------------------------------- | 
|
|U.S.                                      |  |  |  | $                                    | 375   |                                     | 
|Foreign
Regions                           |  |  |  |                                      |       |                                     | 
|Asia/Pacific
& Pacific Rim (3) (4)        |  |  |  |                                      | 1,287 |                                     | 
|Europe,
Middle East & Africa              |  |  |  |                                      | 121   |                                     | 
|Caribbean,
Canada, Mexico & Latin America |  |  |  |                                      | 56    |                                     | 
|Totals                                    |  |  |  | $                                    | 1,839 |                                     | 

---

|(1) |  | Revenue is attributed to geographic areas based on the
customers shipped-to location, except for intellectual property license revenue which is attributed to the U.S. operations.
|--- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(2) |  | Represents property, plant and equipment-net, goodwill and other
acquired intangibles-net.
|--- |  | ------------------------------------------------------------------------------------------

|(3) |  | Individual countries that had revenue greater than 10% of the
Companys revenues were Singapore and Taiwan. Singapore accounted for $372 and $349 of revenue in fiscal 2003 and 2002, respectively. Taiwan
accounted for $186 and $204 of revenue in fiscal 2003 and 2002, respectively.
|--- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(4) |  | Singapore accounted for $100 and $118 of long-lived assets as of
September 30, 2003 and 2002, respectively, which was greater than 10% of the Companys long-lived assets.
|--- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Concentrations



The Companys business depends in large part on
demand for personal computers and associated equipment, wireless communications equipment such as wireless handsets and wireless local area networking
equipment and telecommunications infrastructure equipment. The Companys revenues can be affected by changes in demand for these types of
products. These markets are competitive and rapidly changing and significant technological changes, new customer requirements, changes in customer
buying behavior or the emergence of competitive products with new capabilities or technologies could adversely affect revenues and operating results.
Also, portions of the Companys revenues are derived from customers that individually accounted for greater than 10% of the Companys
revenues for the years presented. In fiscal 2003, sales to Maxtor Corporation (Maxtor) and Seagate Technology, Inc. (Seagate)
represented 16% and 12%, respectively, of consolidated revenue. In fiscal 2002, sales to Maxtor represented 14% of consolidated revenue and in fiscal
2001, sales to Lucent represented 15% of consolidated revenue. Maxtor and Seagate are customers of the Client Systems segment and Lucent is a customer
of the Infrastructure Systems segment.


20.    Financial Instruments

Fair Values



The carrying values and estimated fair values of
cash and cash equivalents, investments, receivables, payables and debt maturing within one year contained in the consolidated and combined balance
sheets approximate fair value. The carrying value and the fair value of the Notes at September 30, 2003 was $410 and $537, respectively. The fair value
of the Notes was determined using quoted market rates.


Credit and Market Risk



By their nature, all financial instruments involve
risk, including credit risk for non-performance by counterparties. The Company seeks to reduce credit risk on financial instruments by dealing only
with financially secure counterparties and establishes reserves for losses when deemed necessary. The Company seeks to limit its exposure to credit
risks in any single country or region. All financial instruments inherently expose the holders to market risk, including changes in currency and
interest rates. Agere manages its exposure to these market risks through its regular operating and financing activities and when appropriate, through
the use of derivative financial instruments.


63

---

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL
STATEMENTS(Continued)(dollars in millions except per share amounts)

Letters of Credit



The Company is a party to letters of credit that
represent purchased guarantees ensuring the Companys performance or payment to third parties in accordance with specified terms and conditions
which amounted to approximately $10 and $8 as of September 30, 2003 and 2002, respectively, and are included in cash held in trust or other assets,
depending upon the terms. The estimated fair value of these letters of credit was $0 as of September 30, 2003 and 2002, which is based on fees paid to
obtain the obligations.


21.    Transactions with Lucent



Lucent was the majority stockholder and a related
party of the Company until the Distribution, which occurred on June 1, 2002. Revenue from products sold to Lucent in fiscal 2002 prior to the
Distribution was $162, of which $43 is recorded within income (loss) from operations of discontinued business. Revenue from products sold to Lucent for
fiscal 2001 was $606, of which $165 is recorded within income (loss) from operations of discontinued business. There were no material purchases of
products from Lucent in fiscal 2002 prior to the Distribution. Products purchased from Lucent for fiscal 2001 were $22.




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. This agreement also provided for the replication and transfer of
designated computer systems. The costs associated with this agreement amounted to $7 and $73 for fiscal 2002 and 2001, respectively. Lucent also billed
the Company $23 in fiscal 2001 for specific research and development projects.


22.    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 inquiries or claims in connection with these rights. In addition, from time to time the Company is involved in legal
proceedings arising in the ordinary course of business, including unfair labor charges filed by its unions with the National Labor Relations Board,
claims before the U.S. Equal Employment Opportunity Commission and other employee grievances. These matters are subject to many uncertainties, and
outcomes are not predictable with assurance. Consequently, the ultimate aggregate amount of monetary liability or financial impact with respect to
these matters at September 30, 2003 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 September 30, 2003, would not be material to the annual consolidated financial
statements.




The Company has an agreement with SMP under which it
has agreed to purchase 51% of the managed wafer capacity from SMPs integrated circuit manufacturing facility and Chartered Semiconductor agreed
to purchase the remaining 49% of the managed wafer capacity. SMP determines its managed wafer capacity each year based on forecasts provided by Agere
and Chartered Semiconductor. If the Company fails to purchase its commitments, it will be required to pay SMP for the fixed costs associated
with the unpurchased wafers. Chartered Semiconductor is similarly obligated with respect to the wafers allotted to it. 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 of either party. Based on forecasted demand, the Company believes it is unlikely that it would have to pay any significant amounts for
underutilization in the near future. However, if the Companys purchases under this agreement are less than anticipated, the Companys cash
obligation to SMP may be significant.


Legal Proceedings



On October 17, 2002, the Company filed a patent
infringement lawsuit against Intersil Corporation (Intersil) in the United States District Court in Delaware. The Company alleged that
Intersil had infringed six of the Companys patents related to integrated circuits for wireless networking using the IEEE 802.11 standard and is
seeking monetary


64

---

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL
STATEMENTS(Continued)(dollars in millions except per share amounts)

damages for Intersils infringement of these patents and an injunction
prohibiting Intersil from using the patents in the future. On November 6, 2002, Intersil filed a counterclaim in this matter, alleging that ten patents
of Intersil are infringed by unspecified Agere products. Two of the patents relate to system-level circuits, and eight patents relate to semiconductor
processing. The complaint seeks an injunction and damages. On July 22, 2003, the Company filed a second patent infringement lawsuit against Intersil in
the United States District Court in Delaware, alleging that Intersil had infringed four additional Company patents  three covering semiconductor processing and one covering integrated
circuits for wireless networking. The Company is seeking an injunction and damages. Intersil counterclaimed with four
additional patents relating to semiconductor processing. The Company believes that Intersils claims are without merit.



On October 30, 2002, Choice-Intersil Microsystems,
Inc. (Choice-Intersil), filed a lawsuit against the Company in the United States District Court for the Eastern District of Pennsylvania.
The amended complaint alleges misappropriation of trade secrets and copyrights that were jointly developed and jointly owned by Digital Ocean, Inc.
(which, following several acquisitions and corporate reorganizations, is now Choice-Intersil) and Lucent. The trade secrets and copyrights relate to
media access controller technology for wireless local area networks. The complaint seeks an injunction and damages. The Company counterclaimed for
misappropriation of trade secrets and breach of contract. On September 2, 2003, the court issued a decision denying Choice-Intersils motion for a
preliminary injunction and holding that the Company had lawfully obtained the trade secrets and copyrights alleged to have been infringed.
Choice-Intersil has appealed. The Company believes that Choice-Intersils claims are without merit.




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




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




On August 28, 2003, GlobespanVirata, Inc. acquired
Intersils wireless networking product group.


Environmental, Health and Safety



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




It is often difficult to estimate the future impact
of environmental matters, including potential liabilities. The Company has established financial reserves to cover environmental liabilities where they
are probable and reasonably estimable. This practice is followed whether the claims are asserted or unasserted. Management expects that the amounts
reserved will be paid out over the period of remediation for the applicable site, which typically ranges from five to thirty years. Reserves for
estimated losses from environmental remediation are, depending upon the site, based primarily upon internal or third party environmental studies,
estimates as to the number, participation level and financial viability of all potentially responsible parties, the extent of the contamination and the
nature of required remedial actions. Accruals are adjusted as further information develops or circumstances change. The amounts provided for in the
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 impact on the
Companys financial condition, results of operations or cash flows. Any possible loss or range of loss that may be incurred in excess of that
provided for as of September 30, 2003, cannot be estimated.


65

---

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL
STATEMENTS(Continued)(dollars in millions except per share amounts)

Leases



The Company leases land, buildings and equipment
under agreements that expire in various years through 2015. Rental expense under operating leases was $89, $125 and $133 for fiscal 2003, 2002 and
2001, respectively. Rental expense under operating leases is net of sublease rentals of $4 in fiscal 2003. The table below shows the future minimum
lease payments due under non-cancelable leases as of September 30, 2003. Such payments total $204 for operating leases and have not been reduced by
minimum sublease rentals of $5 due in the future under noncancelable subleases. The net present value of such payments on the capital lease obligations
was $65 after deducting imputed interest of $11.







|                 |  |  |  | Year Ended September 30, |    
|---------------- |  |  |  | ------------------------ | ---
|
|Operating
leases |  |  |  | $                        | 79 
|Capital
leases   |  |  |  |                          | 42 
|Total            |  |  |  | $                        | 121

23.    Quarterly Information (Unaudited)






|                                                                      |  |  |  | Fiscal Quarters |      
|--------------------------------------------------------------------- |  |  |  | --------------- | -----
|
|YEAR ENDED
SEPTEMBER 30, 2003                                         |  |  |  |                 |      
|Revenue                                                               |  |  |  | $               | 436  
|Gross
profit                                                          |  |  |  |                 | 113  
|Income (loss)
from continuing operations                              |  |  |  |                 | (148 
|Income (loss)
before cumulative effect of accounting change           |  |  |  |                 | (141 
|Cumulative
effect of accounting change                                |  |  |  |                 | (5   
|Net income
(loss)                                                     |  |  |  | $               | (146 
|Basic and
diluted income (loss) per share:                            |  |  |  |                 |      
|Income (loss)
from continuing operations                              |  |  |  | $               | (0.09
|Income (loss)
before cumulative effect ofaccounting change            |  |  |  |                 | (0.09
|Cumulative
effect of accounting change                                |  |  |  |                 |     
|Net income
(loss)                                                     |  |  |  | $               | (0.09
|Weighted
average shares outstanding  basic (in millions)             |  |  |  |                 | 1,648
|Weighted
average shares outstanding  diluted (in millions) (1)       |  |  |  |                 | 1,648
|YEAR ENDED
SEPTEMBER 30, 2002                                         |  |  |  |                 |      
|Revenue                                                               |  |  |  | $               | 445  
|Gross
profit                                                          |  |  |  |                 | 78   
|Income (loss)
from continuing operations                              |  |  |  |                 | (307 
|Net
loss                                                              |  |  |  | $               | (375 
|Basic and
diluted loss per share:                                     |  |  |  |                 |      
|Income (loss)
from continuing operations                              |  |  |  | $               | (0.19
|Net
loss                                                              |  |  |  | $               | (0.23
|Weighted
average shares outstanding  basic and diluted (in millions) |  |  |  |                 | 1,635

---

|(1) |  | 20,817,356 potential common shares related to stock options and
13,350 potential common shares related to other stock units were included in the weighted average shares outstanding  diluted calculation for the
fourth fiscal quarter of 2003.
|--- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

66

---

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL
STATEMENTS(Continued)(dollars in millions except per share amounts)

24.    Subsequent Events

Amendment of the Accounts Receivable Securitization



On October 3, 2003, Agere Systems Inc. and certain
of its subsidiaries amended the accounts receivable securitization agreement. In connection with the amendment, the expiration of the agreement was
extended from November 11, 2003 to October 1, 2004. The overall committed amount under the loan agreement of $200 remains unchanged.


Restructuring Activities



In October of 2003, the Company began the
decommissioning of its manufacturing sites in Allentown and Reading, Pennsylvania. The Company will record charges that are expected to be
approximately $40 to $50 in the first quarter of fiscal 2004, primarily related to the decommissioning of these sites.


67

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AGERE SYSTEMS INC. SCHEDULE II  VALUATION AND QUALIFYING
ACCOUNTS (dollars in millions)






|Column A                               |  |  |  | Column B |     | Column C |  | Column D |     | Column E | 
|-------------------------------------- |  |  |  | -------- | --- | -------- |  | -------- | --- | -------- | 
|
|
|Fiscal
2003                            |  |  |  |          |     |          |  |          |     |          | 
|Allowance for
doubtful accounts        |  |  |  |          | 9   |          |  |          | (1  | )        | 
|Deferred tax
asset valuation allowance |  |  |  |          | 997 |          |  |          | 90  |          | 
|Fiscal
2002                            |  |  |  |          |     |          |  |          |     |          | 
|Allowance for
doubtful accounts        |  |  |  |          | 33  |          |  |          | (4  | )        | 
|Deferred tax
asset valuation allowance |  |  |  |          | 537 |          |  |          | 630 |          | 
|Fiscal
2001                            |  |  |  |          |     |          |  |          |     |          | 
|Allowance for
doubtful accounts        |  |  |  |          | 17  |          |  |          | 26  |          | 
|Deferred tax
asset valuation allowance |  |  |  |          |    |          |  |          | 553 |          | 

---

|(a) |  | Amounts written off as uncollectible, payments or
recoveries.
|--- |  | -------------------------------------------------------------

|(b) |  | Amount offsets deferred tax asset associated with future tax
deductions upon payment of pension liabilities.
|--- |  | ------------------------------------------------------------------------------------------------------------

|(c) |  | Amounts represent (additions) deductions to prior year valuation
allowance based on tax return filings.
|--- |  | -------------------------------------------------------------------------------------------------------

|(d) |  | Amount offsets deferred tax liability associated with the
potential future gain on the sale of available-for-sale securities.
|--- |  | -----------------------------------------------------------------------------------------------------------------------------

|(e) |  | Amount offsets decrease in deferred tax asset associated with
future tax deductions upon payment of pension liabilities.
|--- |  | ------------------------------------------------------------------------------------------------------------------------

68

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Item 9. Changes in and Disagreements With Accountants on Accounting and
Financial Disclosure



None.


Item 9A. Controls and Procedures



With the participation of our Chief Executive
Officer and Chief Financial Officer, management has carried out an evaluation of the effectiveness of our disclosure controls and procedures (as
defined in Rule 13a-15(e) under the Securities Exchange Act of 1934). Based on that evaluation, the Chief Executive Officer and Chief Financial Officer
concluded that our disclosure controls and procedures were effective as of September 30, 2003.




There were no changes in our internal control over
financial reporting (as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934) during the fourth quarter of fiscal 2003 that materially
affected, or are reasonably likely to materially affect, our internal control over financial reporting.


PART III

Item 10. Directors and Executive Officers of the Registrant



We have a code of conduct that applies to all
Directors, officers and employees, including our principal executive officer and principal financial officer (who is also our principal accounting
officer). You can find our code of conduct on our website by going to the following address: http://www.agere.com/governance, and clicking on the link
for our code of conduct. We will post any amendments to
the code of conduct, as well as any waivers that are required to be disclosed by the rules of either the Securities and Exchange Commission or the New
York Stock Exchange, on our website.




Our Board of Directors has adopted Corporate
Governance Guidelines and charters for the Audit and Finance, Compensation and Nominating/Governance Committees of the Board of Directors. You can find
these documents on our website by going to the following address: http://www.agere.com/governance, and clicking on the appropriate link.




You can also obtain a printed copy of any of the
materials referred to above by contacting us at the following address:


| |  | Agere Systems Inc. c/o The Bank of New York P. O. Box
11082 Church Street Station New York, New York 10286-1082 Telephone: 1-866-AGEREIR (1-866-243-7347)
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------



The Audit and Finance Committee of our Board of
Directors is an audit committee for purposes of Section 3(a)(58) of the Securities Exchange Act of 1934. The members of that committee are:
Richard L. Clemmer (Chair), Rajiv L. Gupta, Harold A. Wagner and John A. Young.




Apart from certain information concerning our
executive officers which is set forth in Part I of this report, the other information required by this Item is incorporated herein by reference to the
applicable information in the proxy statement for our 2004 annual meeting, including the information set forth under the captions Election of
Directors, Section 16(a) Beneficial Ownership Reporting Compliance and Governance of the Company  Audit and Finance
Committee  Audit Committee Financial Expert.


Item 11. Executive Compensation



The information required by this Item is
incorporated herein by reference to the applicable information in the proxy statement for our 2004 annual meeting, including the information set forth
under the captions Executive Compensation, Compensation of Directors and Compensation Committee Interlocks and Insider
Participation.


69

---

Item 12. Security Ownership of Certain Beneficial Owners and Management and
Related Stockholder Matters

EQUITY COMPENSATION PLAN INFORMATION



The following table summarizes information about our
equity compensation plans as of September 30, 2003. All outstanding awards relate to our Class A common stock. For additional information about our
equity compensation plans, see note 14 to our financial statements in Item 8.







|Plan Category                                                  |  |  |  | Number of securities to be issued upon exercise of outstanding
options, warrants and rights (1) |             | Weighted-average exercise price of outstanding options,
warrants and rights |  | Number of securities remaining available for future issuance
under equity compensation plans (excluding securities reflected in column (a))
|-------------------------------------------------------------- |  |  |  | ----------------------------------------------------------------------------------------------- | ----------- | --------------------------------------------------------------------------- |  | -------------------------------------------------------------------------------------------------------------------------------------------
|
|Equity
compensation plans approved by security holders         |  |  |  |                                                                                                 | 167,411,045 |                                                                             |  | $                                                                                                                                          
|Equity
compensation plans not approved by security holders (3) |  |  |  |                                                                                                 | 23,177,812  |                                                                             |  | $                                                                                                                                          
|Total                                                          |  |  |  |                                                                                                 | 190,588,857 |                                                                             |  | $                                                                                                                                          

---

|(1) |  | In connection with our spin-off from Lucent, we assumed stock
options that had originally been granted by Lucent or AT&T or companies that Lucent had acquired. The table does not include information for equity
compensation plans assumed by Lucent in connection with acquisitions of the companies that originally established those plans. At September 30, 2003,
2,517,236 shares were issuable upon exercise of outstanding options, with a weighted-average exercise price of $6.0597 per share, under these plans.
Since the spin-off we have not granted, and we will not grant in the future, any additional options under these plans.
|--- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(2) |  | Includes 202,144,573 shares available for issuance under our
2001 Long Term Incentive Plan in connection with stock options, stock appreciation rights, restricted stock awards, performance shares and units,
dividend equivalents and other stock unit awards. Under that plan, 39,975,000 shares remain available for the grant of stock appreciation rights,
restricted stock, performance shares and other stock unit awards.
|--- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(3) |  | All of the shares reported in this row were stock options
granted prior to our spin-off by Lucent under Lucent plans that had not been approved by Lucents stockholders and that we assumed in connection
with the spin-off. Since the spin-off, we have not granted, and we will not grant in the future, any further awards under these plans.
|--- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



The other information required by this Item is
incorporated by reference to the applicable information in the proxy statement for our 2004 annual meeting, including the information set forth under
the caption Beneficial Ownership of Agere Common Stock.


Item 13. Certain Relationships and Related Transactions



The information required by this Item is
incorporated by reference to the applicable information in the proxy statement for our 2004 annual meeting, including the information set forth under
the caption Other Arrangements with Executives.


Item 14. Principal Accountant Fees and Services



The information required by this Item is
incorporated by reference to the applicable information in the proxy statement for our 2004 annual meeting, including the information set forth under
the caption Our Relationship with Our Independent Auditors.


70

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PART IV

Item 15. Exhibits, Financial Statement Schedules, and Reports on Form
8-K

(a)(1) Financial Statements



The information required by this Item is included in
Item 8 of Part II of this report.


(a)(2) Financial Statement Schedule



The information required by this Item is included in
Item 8 of Part II of this report.


(a)(3) Exhibits



See Item 15(c) below.


(b) Reports on Form 8-K



Current Report on Form 8-K furnished July 23, 2003
pursuant to Items 7 (Exhibits), 9 (Regulation FD disclosure) and 12 (Results of Operations and Financial Condition).




Current Report on Form 8-K furnished September 5,
2003 pursuant to Item 12 (Results of Operations and Financial Condition).


(c) Exhibits:






|2    |  |  |  | Separation and Distribution Agreement (incorporated by reference to Exhibit 2 to our Registration Statement on Form S-1, File No.
333-51594)                                                  
|---- |  |  |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|3.1  |  |  |  | Certificate of Incorporation (incorporated by reference to Exhibit 4.1 to our Registration Statement on Form S-8, File No.
333-58324)                                                         
|3.2  |  |  |  | By-laws of Agere Systems Inc. (incorporated by reference to Exhibit 3.2 to our Registration Statement on Form S-1, File No.
333-51594)                                                        
|4.1  |  |  |  | Specimen Class A Common Stock certificate (incorporated by reference to Exhibit 4.1 to our Registration Statement on Form S-1, File No.
333-51594)                                            
|4.2  |  |  |  | Specimen Class B Common Stock certificate (incorporated by reference to Exhibit 4.2 to our Annual Report on Form 10-K, filed December 12,
2002)                                               
|4.3  |  |  |  | Certificate of Incorporation (filed as Exhibit 3.1 hereto)                                                                                                                                    
|4.4  |  |  |  | By-laws of Agere Systems Inc. (filed as Exhibit 3.2 hereto)                                                                                                                                   
|4.5  |  |  |  | Rights Agreement between Agere Systems Inc. and The Bank of New York, as Rights Agent (incorporated by reference to Exhibit 4.2 to our
Registration Statement on Form S-8, File No. 333-58324)
|4.6  |  |  |  | Form
of Rights Certificate (attached as Exhibit B to the Rights Agreement filed as Exhibit 4.4 hereto)                                                                                        
|4.7  |  |  |  | Indenture for $410,000,000 Convertible Subordinated Notes (incorporated by reference to Exhibit 10.1 to our Quarterly Report on Form 10-Q,
filed August 9, 2002)                              
|10.1 |  |  |  | Separation and Distribution Agreement (filed as Exhibit 2 hereto)                                                                                                                             
|10.2 |  |  |  | Tax
Sharing Agreement (incorporated by reference to Exhibit 10.4 to our Registration Statement on Form S-1, File No. 333-51594)                                                               
|10.3 |  |  |  | Letter Agreement amending the Tax Sharing Agreement (incorporated by reference to Exhibit 10.29 to our Registration Statement on Form S-1,
File No. 333-81632, filed March 11, 2002)          
|10.4 |  |  |  | Patent and Technology License Agreement (incorporated by reference to Exhibit 10.12 to our Registration Statement on Form S-1, File No.
333-51594)                                            

71

---

|10.5  |  |  |  | Technology Assignment and Joint Ownership Agreement (incorporated by reference to Exhibit 10.14 to our Registration Statement on Form S-1,
File No. 333-51594)                                   
|----- |  |  |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|10.6  |  |  |  | Microelectronics Product Purchase Agreement (incorporated by reference to Exhibit 10.17 to our Registration Statement on Form S-1, File No.
333-51594)                                           
|10.7  |  |  |  | Amendment to Microelectronics Product Purchase Agreement (incorporated by reference to Exhibit 99.1 to our Report on Form 8-K, filed July 18,
2002)                                              
|10.8  |  |  |  | Joint
Venture Agreement with Chartered Semiconductor Manufacturing Ltd. (incorporated by reference to Exhibit 10.19 to our Registration Statement on Form
S-1, File No. 333-51594)               
|10.9  |  |  |  | Receivables Loan Agreement (incorporated by reference to Exhibit 10 of our Registration Statement on Form S-3, File No. 333-81632, filed May
21, 2002)                                           
|10.10 |  |  |  | Amendment No. 1 to Receivables Loan Agreement (incorporated by reference to Exhibit 10.16 to our Annual Report on Form 10-K, filed December
12, 2002)                                            
|10.11 |  |  |  | Amendment No. 2 to Receivables Loan Agreement (incorporated by reference to Exhibit 10.17 to our Annual Report on Form 10-K, filed December
12, 2002)                                            
|10.12 |  |  |  | Amendment No. 3 to Receivables Loan Agreement*                                                                                                                                                   
|10.13 |  |  |  | Agere
Systems Inc. Short Term Incentive Plan (incorporated by reference to Exhibit 10.5 to our Registration Statement on Form S-1, File No. 333-81632, filed
March 11, 2002)                    
|10.14 |  |  |  | Agere
Systems Inc. 2001 Long Term Incentive Plan (incorporated by reference to Exhibit 10.6 to our Registration Statement on Form S-1, File No. 333-81632,
filed March 11, 2002)                
|10.15 |  |  |  | Agere
Systems Inc. 2001 Long Term Incentive Plan Restricted Stock Unit Award Agreement (incorporated by reference to Exhibit 10.7 to our Registration
Statement on Form S-1, File No. 333-51594)
|10.16 |  |  |  | Agere
Systems Inc. 2001 Long Term Incentive Plan Nonstatutory Stock Option Agreement (incorporated by reference to Exhibit 10.8 to our Registration Statement
on Form S-1, File No. 333-51594)  
|10.17 |  |  |  | Agere
Systems Inc. Non-Employee Director Stock Plan (incorporated by reference to Exhibit 10.20 to our Registration Statement on Form S-1, File No.
333-51594)                                  
|10.18 |  |  |  | Agere
Systems Inc. 2001 Employee Stock Purchase Plan (incorporated by reference to Exhibit 10.21 to our Registration Statement on Form S-1, File No.
333-51594)                                 
|10.19 |  |  |  | Agere
Systems Inc. Deferred Compensation Plan (incorporated by reference to Exhibit 10.9 to our Registration Statement on Form S-1, File No.
333-51594)                                         
|10.20 |  |  |  | Agere
Systems Inc. Supplemental Pension Plan (incorporated by reference to Exhibit 10.10 to our Registration Statement on Form S-1, File No.
333-51594)                                         
|10.21 |  |  |  | Agere
Systems Inc. Officer Severance Policy (incorporated by reference to Exhibit 10.26 to our Annual Report on Form 10-K, filed December 12,
2002)                                             
|10.22 |  |  |  | Agere
Systems Inc. Medium-Term Incentive Plan (incorporated by reference to Exhibit 10.27 to our Annual Report on Form 10-K, filed December 12,
2002)                                           
|10.23 |  |  |  | Agere
Systems Inc. 2004-2005 Medium-Term Incentive Plan*                                                                                                                                        
|10.24 |  |  |  | 1996
Lucent Long Term Incentive Program For Agere Employees (incorporated by reference to Exhibit 10.28 to our Annual Report on Form 10-K, filed
December 12, 2002)                             
|10.25 |  |  |  | 1997
Lucent Long Term Incentive Plan For Agere Employees (incorporated by reference to Exhibit 10.29 to our Annual Report on Form 10-K, filed December
12, 2002)                                
|10.26 |  |  |  | 1998
Global Stock Option Plan For Agere Employees (incorporated by reference to Exhibit 10.30 to our Annual Report on Form 10-K, filed December 12,
2002)                                       

72

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|10.27 |  |  |  | Founders Grant Stock Option Plan For Agere Employees (incorporated by reference to Exhibit 10.31 to our Annual Report on Form 10-K,
filed December 12, 2002)     
|----- |  |  |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------
|10.28 |  |  |  | AT&T 1987 Long Term Incentive Program For Agere Employees (incorporated by reference to Exhibit 10.32 to our Annual Report on Form
10-K, filed December 12, 2002)
|12    |  |  |  | Computation of Ratio of Earnings to Fixed Charges*                                                                                                                
|21    |  |  |  | List
of Subsidiaries of Agere Systems Inc.*                                                                                                                       
|23    |  |  |  | Consent of PricewaterhouseCoopers LLP*                                                                                                                            
|24    |  |  |  | Powers of Attorney*                                                                                                                                               
|31.1  |  |  |  | Certification of Chief Executive Officer pursuant to Rule 13a-14(a)*                                                                                              
|31.2  |  |  |  | Certification of Chief Financial Officer pursuant to Rule 13a-14(a)*                                                                                              
|32.1  |  |  |  | Certification of Chief Executive Officer pursuant to 18 U.S.C. 1350*                                                                                              
|32.2  |  |  |  | Certification of Chief Financial Officer pursuant to 18 U.S.C. 1350*                                                                                              



| |  | Exhibit represents a management contract or compensatory plan or
arrangement.
|- |  | -----------------------------------------------------------------------------

|* |  | Filed herewith.
|- |  | ---------------

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SIGNATURES



Pursuant to the requirements of Section 13 or 15(d)
of the Securities Exchange Act of 1934, this Report has been signed on behalf of the Registrant by the undersigned, thereunto duly authorized, in the
City of Allentown, Commonwealth of Pennsylvania, on the 5th day of December, 2003.




AGERE SYSTEMS INC.


|By: /s/ |  | John W. Gamble, Jr. John W. Gamble, Jr. Executive Vice President and Chief Financial Officer
|------- |  | --------------------------------------------------------------------------------------------



Pursuant to the requirements of the Securities
Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates
indicated.







|Signature                                  |  |  |  | Title                                                                                                               |  | Date            
|------------------------------------------ |  |  |  | ------------------------------------------------------------------------------------------------------------------- |  | ----------------
|/s/ John T.
DicksonJohn T. Dickson         |  |  |  | President, Chief Executive Officer and Director (Principal Executive Officer)                                       |  | December
5, 2003
|/s/ John W.
Gamble, Jr.John W. Gamble, Jr. |  |  |  | Executive Vice President and Chief Financial Officer (Principal Financial Officer and Principal Accounting
Officer) |  | December
5, 2003
|*Richard L. Clemmer                        |  |  |  | Director                                                                                                            |  |                 
|*Rajiv L. Gupta                            |  |  |  | Director                                                                                                            |  |                 
|*Richard S. Hill                           |  |  |  | Director                                                                                                            |  |                 
|*Krish A. Prabhu                           |  |  |  | Director                                                                                                            |  |                 
|*Thomas P. Salice                          |  |  |  | Director                                                                                                            |  |                 
|*Rae F. Sedel                              |  |  |  | Director                                                                                                            |  |                 
|*Harold A. Wagner                          |  |  |  | Chairman of the Board                                                                                               |  |                 
|*John A. Young                             |  |  |  | Director                                                                                                            |  |                 

|* |  | By:    /s/ John W. Gamble, Jr. (Attorney in Fact) December 5, 2003
|- |  | ------------------------------------------------------------------

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