Agere Systems Q3 2006 Earnings Conference Call Transcript (AGR)

Jul.25.06 | About: Agere Systems (AGR-OLD)

Agere Systems Inc (AGR-OLD) Q3 2006 Earnings Conference Call July 25, 2006 7:00 AM ET

Executives:

Sujal Shah, Vice President of Investor Relations and Corporate Communications

Richard Clemmer, President, Chief Executive Officer

Peter Kelly, Executive Vice President, Chief Financial Officer

Analysts:

Ross Seymore, Deutsche Bank

Bill Lewis, JP Morgan

Srini Pajjuri, Merrill Lynch

Allan Mishan, CIBC World Markets

Charlie Glavin, Needham & Company

(Shuglee Shurafi?)

Mark Edelstone, Morgan Stanley

(Raj Iyer?)

(Jenny Shu?)

Paul O’Neill(?)

Operator

Ladies and Gentlemen: thank you for standing by. Welcome to the Agere Systems investor relations conference call. Operator instructions. I’d like to turn the call over to your host, Sujal Shah, Vice President of Investor Relations and Corporate Communications at Agere Systems. Please go ahead.

Sujal Shah, Vice President of Investor Relations and Corporate Communications

Good morning and thank you for joining us. With me today are Rick Clemmer, President and Chief Executive Officer; and Peter Kelly, Executive Vice President and Chief Financial Officer. They will discuss highlights of Agere’s results for Q3 FY 2006 and then we will open the call for questions. Copies of our press release and other supporting financial data are available on our website. All income statement measures on this call with the exception of revenues will be non-GAAP measures unless we indicate otherwise. Today’s earnings release describes the differences between our non-GAAP and GAAP reporting. You can find reconciliations of our non-GAAP financial measures to corresponding GAAP amounts on our website at www.agere.com/webcast. A replay of today’s call will be available on our website. I also want to remind you that today’s remarks will include forward-looking statements. Our actual results could differ materially from those suggested by the statements made today. Information about factors that could affect our future results is contained in our annual report on Form 10-K for the fiscal year ended September 30, 2005 and our Form 10-Q for the quarter ended March 31, 2006. Now I will turn the call over to Rick Clemmer.

Richard Clemmer, President, Chief Executive Officer

Good morning and welcome. Overall, we turned in a strong Q3 and we are particularly pleased with our progress in improving operating income and driving profitability, which are the corner stones of Phase II of our turnaround plan. In Q3, we reported EPS of $0.22, above our April guidance of $0.13-0.18 per share. On a GAAP basis, we delivered net income of $47 million or $0.27 per share. This far exceeded our guidance of $0.00-0.05 per share, even after taking into account a one-time tax benefit of $27 million. Our operating margin came in at a healthy 11% with gross margin over 50%. At the same time, we’re doing a solid job of expense control. Our focus in this area enabled us to achieve our quarterly operating expense target of $155 million, one quarter ahead of plan and we believe that our focus on expenses control will continue to be a positive for the business. Revenues in total, however, fell short of expectations for the quarter, while Networking performed better than expected and Mobility came in at the high end of guidance, our Storage business was lower than expected.

Two factors accounted for the softness in storage. First, although we expected near term plus intakes in our business as Seagate worked through the Maxtor product transitions, we did not accurately predict the short-term impact this would have on our June quarter results. Second, because the majority of our storage revenue is driven by desktop shipments, we were impacted by weaker than expected end customer demand in desktop units and industry conditions reported by TrendFOCUS in its July report. Despite the softness in storage in the quarter, the combination of Seagate and Maxtor offers excellent opportunities for Agere. In the June quarter, through a joint development effort between the alliance and Seagate, we sampled the first ARM-based SOC which will be used in the production platform. In addition we have recently been awarded another ARM-based SOC by this customers. These design wins further solidify our relationship with Seagate and build on our significant experience in developing and delivering ARM-based cores and storage, which are also leveraged throughout our other businesses.

In addition, our SOCs are currently shipping into Seagate’s 2.5 EDGE and other mainstream platforms, representing growth opportunities for us. Overall, we are making good progress and have successfully completed Phase I of our three-phase turnaround plan. We have established a clear plan for growth for each of our businesses and have developed an overall strategy for Agere. I will talk more about our strategy later in the call. We’re now solidly in Phase II of our plan and have demonstrated our ability to drive earnings growth. We have built a strong foundation to support our efforts to achieve our business model of 15% operating margin. At this point I’ll turn the call over to Peter to take you through our results and guidance.

Peter Kelly, Executive Vice President, Chief Financial Officer

Thanks, Rick. This morning we reported quarterly net income of $37 million or $0.22 per share, exceeding the guidance range we provided in April. Our revenues were $382 million, with Seagate and Samsung as 10% customers. Storage revenues were $135 million, down $36 million from the March quarter. In April, we indicated that our storage revenues would be flat to down single digits. Assumed in that guidance was growth in SOC revenues with Seagate, growth in pre-amp revenues and an approximate 50% decrease in revenues from Maxtor platforms. While we correctly anticipated a decline in shipments associated with the Maxtor platforms, shipments to our lead customer were lower than expected. However as Rick noted, we are confident that the Seagate and Maxtor combination presents a strong opportunity for Agere.

Turning to mobility, revenues were $105 million, an increase of 11% over the $95 million reported for the March quarter with EDGE solutions representing nearly half of our handset revenues. Networking revenues were $142 million, an increase of 8% over the $131 million reported for the March quarter, driven by strength in computing, wireline and wireless access. In the June quarter, our total revenue from licensing intellectual property was $32 million. The breakdown of IP revenues in our operating segments was $11 million in Storage, $8 million in Mobility and $13 million in Networking. Our gross profit as a percent of sales was 51.6%, at the high end of our guidance range due to favorable product mix and manufacturing cost reduction. Our operating expenses were $155 million in the June quarter, significantly better than the guidance given in April. We continue to execute on our process to reduce operating expenses and are pleased that we have met our Q4 targets in the June quarter, one quarter ahead of our goal. Our operating profit of $42 million was 11%.

We remain committed to achieving 15% operating margin and are pleased with the earnings leverage we have implemented in our business. We believe we will hit our 15% goal at revenue levels of approximately $425 million. In the quarter, taxes were $4 million, interest expense was $6 million and other income was $5 million. On a GAAP basis, we delivered net income of $47 million or $0.27 per share, far exceeding our guidance of $0.00-0.05 per share. Included in the $47 million of GAAP net income was a $27 million tax benefit, associated with an $85 million reduction in our pension liability arising from our restructuring activities. During the quarter, we recorded $8 million of GAAP restructuring charges and related costs. The majority of those charges were related to the ongoing decommissioning of Orlando and additional depreciation of our Union Boulevard facility.

Turning now to the balance sheet, our working capital management continues to be very strong. Inventory closed at $135 million, receivables were $215 million and accounts payable were $171 million. In the June quarter, our cash balance decreased by $130 million to $490 million. During the quarter, we purchased over 6.2 million shares for a total price of $100 million. We also had $35 million of voluntary pension contributions, $26 million associated with restructuring, $22 million of capital expenditures, $12 million of interest payments and repurchased $10 million of our convertible debt. Our total debt all of which is convertible notes due in 2009 now stands at $362 million. We’ve completed the stock repurchase authorized by our Board of Directors in October 2005 and have purchase approximately 14 million shares for a total of $200 million. We continue to believe that our stock is undervalued and I’m pleased to announce that our Board has authorized an additional $200 million stock repurchase program.

Depreciation and amortization expense for the June quarter was $28 million, of which $25 million was related to ongoing operations. The $3 million was additional depreciation related to the consolidation of our Allentown office base. GAAP expense related to equity compensation was $10 million for the June quarter.

I’d now like to turn to our guidance for the September quarter. Our total revenue is expected to be in the range of $375-400 million. In Storage, we expect revenues to be flat to up slightly, we expect our mobility business to be roughly flat in the September quarter, with increases in handset revenues offset by declines in satellite radio shipments. Networking revenues are expected to be flat to down slightly with growth in our investment areas offset by decreases in shipments of mature products. IP licensing revenues for the September quarter are expected to be $25-35 million. Previously I expected that IP revenues would decline gradually over time. However, following a complete review of our portfolio, we now expect IP revenues to increase, beginning in 2008, driven by our strong 802.11 portfolio and a more aggressive approach toward litigation and contract enforcement. This is a significant change in how we view the revenue potential of our IP portfolio. We expect gross margins to be approximately 49-51%. We continue to be pleased with our performance on operating expenses and now expect the September quarter to approach $150 million. Our focus on operating expenses has led to additional savings beyond what we projected in April.

We now believe that operating expenses in FY 2007 will be in a range of $600-620 million. In the September quarter, we expect to post net income in the range of $0.21-0.26 per share. Our GAAP net income results are expected to be in the range of $0.08-0.13 per share. The net restructuring charges and related costs excluded from non-GAAP net income are expected to be approximately $10-13 million. The majority of these restructuring charges are related to the ongoing decommissioning work at our Orlando facility and the Allentown office consolidation. We expect equity compensation expenses to be approximately $11 million. Excluding any purchase of Agere stock or voluntary pension contributions, we expect our total cash balance to increase by $15-25 million in the quarter. We expect capital spending in the September quarter to be approximately$10-15 million and estimate restructuring related payments of approximately $15 million.

We expect taxes to be approximately $5 million, interest expense should be about $6 million and we expect other income to be about $6 million. Clearly we are very pleased with the progress we’re making in getting to competitive levels of profitability. With over $0.20 of quarterly EPS now sustainable, we are executing strongly in the second phase of our turnaround plan. The third phase of our plan, revenue growth, is critical in taking our earnings to the next level. Rick will now cover how our strategy will drive revenue growth in the second half of FY 2007. Let me turn the call back to Rick.

Richard Clemmer, President, Chief Executive Officer

Thank you, Peter. Since October the leadership team has been focused on executing against our turnaround plan and developing a unifying strategy for Agere that defines who we are and how we will compete. Our strategy addresses exactly what we must accomplish to position Agere for growth and ensure each of our three businesses is investing to drive long-term success. First and foremost, we must lead in our core markets of Storage, Mobility and Networking, through system wide silicon and software solutions. To succeed beyond the opportunities in those core markets, we will leverage the combined strengths of our businesses to grow in adjacent and new markets. For example, our capabilities DSPs and traffic management are enabling us to explore growth areas in mobile consumer, home and business and access networking applications. It’s also critical that we focus our investments to drive innovation and create unique, sustainable value. We are committed to industry-leading performance in rechannels, cellular baseband and packet processing. Recognizing the diversity and speed of our markets, we will partner both as a supplier and a customer to accelerate time to market and enhance and promote our total systems offerings. Underpinning everything we do, we will continue to innovate, to exceed customer expectations through superior execution, operational excellence and support. We have truly made a great deal of progress in the last several months. However, we know we have more work to do to achieve the levels of leadership and growth called for in our strategy.

That pursuit of continuous improvement is driving everyone at Agere today and is the basis for our corporate vision. ‘Perfecting the Connected Lifestyle.’ By this, we mean that we will work to transform the performance of networks and consumer electronics to enable people to stay connected, more reliably, in more places, and more often than ever before. Although we are talking about our strategy for the first time today, we have been laying the foundation for some time. You will see this as I recap the progress of our three businesses in the June quarter. In our networking business, we will fully leverage our unmatched ability to deliver and manage real time multimedia services, to and within the home and businesses and to mobile users. Our expertise in high speed packet processing and transmission will enable us to provide unique, scaleable solutions for high-end gateway, wireless access, wireline access and storage area network markets. This is a superior core competency that clearly differentiates Agere from our competitors in offering the best quality of experience to the end user. During the quarter, we launched the TrueONE portfolio. These scaleable turnkey solutions are based on our packet processing, switching, digital processing and system software capabilities.

These solutions enabled the delivery of carrier class voice, data, IPTV and HDTV services over a single, converged broadband network, enabling us to provide solutions for the market. By targeting the market in this manner, the networking business has increased its addressable market with refocused R&D spending and scaleable platform solutions. Over the past several quarters, we have increased the rate of design wins and shortened time to revenue by offering our customers complete software and hardware solutions based on our existing rich product portfolio. We expect these wins to make meaningful contributions to revenue in FY 2007. For example, leveraging TrueONE, we have secured wins with Nortel for business gateway solutions, the system level solution leverages our packet processing expertise and incorporates 12 components from Agere with accompanying software from which we drive our revenue stream. The silicon content includes a network processor, network attached storage, voice and connectivity components. At the same time, we continue to take advantage of our core competencies to expand our customer base. Ericsson selected our packet processing technology for its DSLAM equipment. NEC chose Agere solutions for its third generation wireless infrastructure Node B platform.

Abaya(?) selected us for its enterprise and remote office IP telephony platform and 3Com and Lenovo chose Agere’s Ethernet solutions for enterprise switching applications. In storage area networking, our strong CIRTES(?) capability enabled us to secure a design win with a leading fiber channel switching vendor. These wins build on our momentum in the (SAN space?) following our multiple design wins with QLogic. Turning to mobility, Agere delivered platform solutions for Samsungs ultra-thin X820 model, promoted as the world’s slimmest mobile phone. This trend setting feature-rich phone offers a 2 megapixel digital video camera, document viewer and TV output function and bluetooth capability. It has been widely advertised in USA Today, the New York Times and the Wall Street Journal. In addition, we were pleased to be designed into Samsung’s flagship E900 GPRS EDGE mobile phone which is packed with multimedia features and business functions.

In EDGE, the number of handsets using our chipsets continues to grow. We have 50 models either shipping or currently in development. As we noted last quarter, we expect to begin shipping into mass markets 3G handsets for Samsung during the last calendar quarter of 2006 and we expect 3G to be a revenue driver in the second half of FY 2007. As I mentioned, our strategy calls for us to broaden our collaborative initiatives to offer customers timely solutions. Our goal is to leverage our strong base band solutions, to expand our silicon offerings to include high attach rate features, for example, we just finalized an agreement with u-Nav Microelectronics, a best-in-class provider of Global Positioning System (NYSE:GPS) solutions. This agreement gives Agere the capability to offer proven GPS solutions in addition to our baseband solutions to enable value-added functionality like Location Based Services and satisfy future regulatory requirements for E-911 emergency services. Overall, by collaborating with other technology providers like u-Nav, we will be able to accelerate time to market while minimizing R&D expenses. This approach will also allow us to integrate market proven solutions with our own technology, providing maximum flexibility.

Moving to storage, we have made excellent progress expanding our customer base. Last quarter, we mentioned a 1.8 inch SOC win with a major Asian HDD provider. Now I’m pleased to report that we are in the final qualification stages with another major Asian HDD provider for an SOC for 160GB desktop PC platform. This will begin shipping in the first half of FY 2007. Separately, in line with our strategy we also collaborated with this customer on a design for its new 2.5 inch HDD flash combo drive, beating a major competitor. In pre-amplifiers, our ongoing investment has produced consistent share growth highlighted over the last several quarters. We see a clear path to becoming number one in pre-amps as we continue to provide solutions across multiple platforms and all major HDD customers. Also we are increasing R&D investments in storage to ensure industry leading re-channel technology. In summary, we have strong opportunities across our three businesses that will drive revenue growth in the second half of FY 2007. In Storage, we expect continued growth in pre-amps, continued success at Seagate and customer expansion for SOCs. In mobility, we expect to see the ramp of 3G mass market phones, low cost 2.5G and EDGE. In networking, we will leverage our TrueONE portfolio of existing products to provide quick time to market solutions and increase our addressable market. I would like to conclude today’s call by emphasizing that Agere’s turnaround is well underway as demonstrated by our strong earnings growth and the improvement in operating margin. We have a clear strategy that will enable us to build on our strengths as we develop new products and solutions, to expand into new markets. Our mission now is to execute on that strategy. I’d like to now turn the call over to Sujal.

Sujal Shah

Thank you, Rick. At this point we will begin the Q&A portion of the call. Shirley, will you please give the instructions for the Q&A session?

Questions and Answers

Operator

Operator instructions. Our first question comes from Ross Seymore, you may ask your question.

Q – Ross Seymore, Deutsche Bank

First of all, congratulations on the nice EPS showing there. A strategic question on the opex side of things: you’ve done a great job of bringing that down even faster that we thought. Does there come a level where you believe you need to spend a certain amount to invest to deliver the growth as we go into 2007? And opex will either flatten out or start to rise? I know, Peter, you did give the FY 2007 number, but how did the linearity of that go through the year?

A - Peter Kelly

Well I guess what we were trying to do is give you some general direction rather than specific guidance. It’s difficult to give you exactly what you asked for. I think one of the important things to note is Rick did talk, towards the end there, about the fact that we are beginning to invest more in our storage business, particularly in our re-channel. We’ll do that by basically reducing our investments in our support costs. We’re looking really to make sure that we invest in the things that generate revenue and minimize the cost of doing business.

A - Richard Clemmer

The only thing I’d add to that is we’ve also refocused our investments. Clearly on the networking side we’re refocused on packet processing, giving us the ability to drive true leadership. As we laid up over the last couple of quarters, we’ve chosen to try to focus our investments in areas where we can lead, where we can be number one or number two in the market and focus on those areas, and in fact reduce our investments in other areas.

Q – Ross Seymore, Deutsche Bank

As my one follow up, on the storage side of things, your guidance for flat to slightly up there after a little bit weaker than expected quarter – can you give us an idea of what you’re seeing from an end demand perspective and then maybe a little bit of color on the Maxtor business versus the remainder of your business as we look into the September quarter, please?

A - Richard Clemmer

Yes. I think we’re at the point where, you know, now it’s part of Seagate and we have to talk about it in total. I think we’d laid out our expectations for how we thought that transition would happen with Maxtor and I think that’s consistent. We don’t see anything really changing. I think in the end markets, you know TrendFOCUS put out a report relative to last quarter, talking about a little bit of softness in the desktop space. So clearly we can point to that and we saw the same thing. I think our overall position in the HDD market continues to be very solid. The position with Seagate with the Alliance continues to be strong. We continue to expand our customer base in the HDD area, so I think the opportunity in HDD is just as consistent as what we said in the past and we continue to be very optimistic about the opportunities as we move forward.

Operator

Our next question comes from Bill Lewis. You may ask your question.

Q – Bill Lewis, JP Morgan

I guess following up on Ross’s questions, maybe I’ll ask it a slightly different way. I think we all area a little concerned about the outlook for the PC market. As you identified, you have a lot of share in desktop PCs. Could you maybe just share with us what your thoughts are on the outlook for that market? Relative to your guidance of flat to up slightly after the down quarter? I’m just trying to get at, you know, do you think the market is much less of a seasonal increase this September quarter than in prior years or is it more that there are still some (inaudible) with some consolidation in your customers and some of the new programs that are not ramping just yet?

A - Richard Clemmer

Well, Bill, I think it’s consistent with both of those. I think there’s multiple factors. There’s probably a little more confusion in the disk drive markets, this seasonal pattern because of the combination or Seagate’s integration of Maxtor. But I think if you look at the fundamentals and you look out over the next reasonable period of time, one of the key factors that’s really going to drive the so-called desktop growth is really going to be in the consumer market. As those applications get spread into a much broader space. So you know, while clearly I think there are some implications near term associated with what is going on in the overall PC market, which you can read from any of the reports, and certainly we don’t really have anything to add to those, I think the real advantage for the disk drive industry is the opportunity to expand just the PC market and the real significant growth factor is going to be in the consumer applications, which is going to grow at a factor of two to three times what the overall market will. And you know, the desktop market will be relatively flat as we look out over the future periods while that consumer growth is going to drive the overall disk drive market. So I think we are going through a transition in the disk drive industry and we’re well underway with that, but as far as the PC portion of that, the desktop portion of that itself? You know I think you can read those reports and I don’t think we have anything that would be any different than what you hear in most of those reports.

Q – Bill Lewis, JP Morgan

Okay. As a follow up on your opex outlook, does this new FY 2007 target which is basically flat to up from here, does this preclude further operating expense cuts? Should we think of the cuts as mostly being complete and now you’re going to stabilize and grow a little bit? And does it also include anything on your more aggressive approach to your patent portfolio? Are there additional costs that would need to come on top of that, or are those de minimus in the outlook?

A - Peter Kelly

We’ve said on the last call, Bill, that we’d really gotten through the majority of our cost programs in this last quarter. No, we don’t expect to implement further programs. As regards the VIP portfolio, the actions that we have at this point in time are already included in that number.

A - Richard Clemmer

I think what you’ll see us continue to do, Bill, is we’ll do some trimming as we really focus on operational execution and support in all the corporate areas, as Peter talked about earlier, and refocusing our opex levels on areas that will ensure that we drive significant revenue growth. You’ll see clearly a significant change underpinning our total, but I think Peter’s comments in total address what we expect associated with the opex levels.

Operator

Your next question comes from Srini Pajjuri, you may ask your question.

Q - Srini Pajjuri, Merrill Lynch

Thank you, good morning. A couple of quick clarifications. Peter, the gross margins you saw a nice upside. How sustainable do you think that is? I’m wondering if you’re going to change your 50% target model

A - Peter Kelly

Not at this stage. We think 50% is a reasonable medium term model to go with. You know, we’ve always said that we’ll have some pluses and minuses off that, which is why we give the guidance of 49-51%. This quarter, it worked out quite well for us. Our manufacturing cost reduction came in a little faster than we expected. Our mix was quite rich. We think 49-51% is a good range really.

Q - Srini Pajjuri, Merrill Lynch

Okay, and then in terms of the IP revenues, what magnitude are you talking about when you say it’s going to grow, starting next year?

A - Peter Kelly

We’re talking about 2008, it’s difficult to assess that. I think previously I’d said it would fall by about $10 million a year. I would expect it to increase at least by that. But the reality is given the approach that we’re taking on IP, I think you may see it be a little bit more lumpy in future than you have in the past.

Q - Srini Pajjuri, Merrill Lynch

Okay, then on the storage side, Rick, you mentioned you have new design wins with some Asian customers. Could you give us a little bit more specificity on what kind of revenue ramps you’d expect here and when?

A - Richard Clemmer

We talked about that in the call, actually, at the time of the ramp taking place in the first half of 2007. We can’t talk about the specifics of it but it is significantly one of the fastest growing HDD suppliers that we have been working with for some time and that we’re well positioned with. So we think it’s a significant opportunity for us to expand our customer base and we’re in a unique position, working through that, where we’ll be sole source on that specific platform.

A - Peter Kelly

If I can add something there, I think if you look at 2006, outside of Seagate and Maxtor we only had one customer where the revenue was higher than $10 million. As we go into 2007, outside of Seagate we’ll have five customers who have a revenue of more than $10 million. So it’s quite a big change.

Q - Srini Pajjuri, Merrill Lynch

Okay, because I mean we have heard this from Agere in the past about future design wins that never really materialized. I’m just wondering, what kind of visibility do we have here to say that, you know, the ramps are going to start in the first half of 2007?

A - Richard Clemmer

We’re in final qualification with the plans to ship. I don’t know – we’re not talking about it until we get to the final qualification phase. We’re not talking about it in a conceptual phase or an engagement phase. We’re talking about with the final product prepared in the final qualification, with shipments beginning imminently.

Q - Srini Pajjuri, Merrill Lynch

Then finally, given what you’re seeing in storage, is there an impact on pricing? Are you having to renegotiate pricing at this point?

A - Richard Clemmer

Nothing significant, nothing material associated with it. You know, as we have been successful in defending our beach head associated with Seagate, you know, we’ve had to be sure that we were very competitive in that process. But there’s not anything that’s significantly out of the ordinary there.

Operator

Our next question comes from Allan Mishan. You may ask your question.

Q - Allan Mishan, CIBC World Markets

Hey guys. Nice job with the expenses. On the Maxtor business, I guess it was down in line with your expectations about 50%. What are you expecting in the September quarter for Maxtor?

A - Richard Clemmer

Well Maxtor is a company that doesn’t exist any more. It’s part of Seagate now and so I think that we’ll go through – Seagate has talked about the fact that they’ll go end of life, those platforms, by the end of the calendar year for sure. They’re working through a transition associated with those but as we talk about it, it’s just combined with our overall outlook now.

Q - Allan Mishan, CIBC World Markets

Okay, but the specific platforms that used to be Maxtor – I mean, is it a fair assumption they’ll take another big drop and then there’s very little left over in the December quarter?

A - Richard Clemmer

I think that’s probably a pretty good assumption.

Q - Allan Mishan, CIBC World Markets

Great. Then the pre-amp business – what was the sequential increase? Did it meet your targets for share gains there?

A - Richard Clemmer

The pre-amp business on the design win side continues to be extremely strong, but just like we talked about on the desktop SOCs, we saw some of the same characteristics associated with pre-amps in the current quarter. That’s a near term thing, it’s not anything significant for the business. We continue to be well positioned with design wins that we’ve been talking about and we continue to win and continue to position ourselves very well in pre-amp.

Q - Allan Mishan, CIBC World Markets

So the revenue continues to grow?

A - Richard Clemmer

Yes.

Operator

Our next question comes from Charlie Glavin, you may ask your question.

Q - Charlie Glavin, Needham & Company

Drilling down into this a little bit, given the visibility on several large wins, are you guys willing to indicate where you think storage may be next year, that we will see absolute year over year growth in storage? Or some sort of gauge? Then I have a follow up.

A - Richard Clemmer

Charlie, we don’t talk about next year. I think we’re talking about increased customer expansion, the current existing design wins that we have, we have confirmed we’ll continue to be shipping in most cases throughout that period of time. Obviously with the exception of Maxtor where Seagate is going through an end of life associated with that. But we are expanding our customer base and you know, we expect to see the overall disk drive industry in terms of volume grow at the mid-teen level. The increase that we see associated with our pre-amp business with additional customers as well as increased design wins facilitates and supports that customer expansion. You know, we continue to be well-positioned with Seagate and we would expect to continue to do well as Seagate does well.

Q - Charlie Glavin, Needham & Company

Speaking of (TDA and the ARM-based?) design within Barracuda, and I know you can’t talk about the specific products, but have those design win activities been part of your alliance with (FC Micro?) And if so, how long have you been working on an ARM-based solution? Because it would seem as if, if you are in the Barracuda, that would also extend beyond Seagate and also into OEMs.

A - Richard Clemmer

I think as you point out, we can’t talk about specific platforms. The key for us is being in final qualification with our first ARM-based SOC with a second follow on design underway and continued expansion. That really kind of builds on the capability that we have throughout our businesses. ARM-based cores are a key part of our Mobility and Networking business as well. This is not anything new or an exception for us. It just builds on the experience we’ve had in the past. It’s just a different form of controller associated with it.

Q - Charlie Glavin, Needham & Company

But it is fair to say that you’ve been working on an ARM-based solution for some time now, correct?

A - Richard Clemmer

Really, if we’re in final qualification, we’ve been working on it for quarters.

Q - Charlie Glavin, Needham & Company

You mentioned satellites being done. I’m a little curious. Given that the GEN35s(?) were supposed to come up, why the particular weakness for the September quarter given the transition? I would have thought it would have been flat, rather than down.

A - Peter Kelly

I think it’s just the phasing of how their procurement works. We’ve seen a similar thing over the last couple of years, actually.

Operator

Your next question comes from (Shuglee Shurafi?) you may ask your question.

Q – (Shuglee Shurafi?)

I guess building on some prior questions, I’m a little bit confused about the guidance for storage. I think that backward looking it was definitely weak but forward looking, some are saying that because of Intel’s price cuts, the Intel (conra shipping and marome?) and back to school, that PC shipments will pick up. I’m curious whether you’re just simply being conservative with your storage guidance, or whether you think that because of the changes taking place to Seagate Maxtor, that there are more disruptions nearer term that cause you to be cautious?

A - Richard Clemmer

I think we’re well positioned with Seagate so I don’t think that anything changes relative to the fundamentals of your disk drive business. I think that as we look out at the outlook, we are trying to be somewhat cautious, but it’s based on our expectations associated with what we expect. As we all know, the volatility of the PC market creates some plus intakes and then the continuing integration of Maxtor by Seagate will create, for another quarter or so, some plus intakes associated with it. But the contribution and the help that provides for the overall industry and specifically for Agere we think is very positive going forward.

Q – (Shuglee Shurafi?)

As far as the Asian OEM for drives that you mentioned is going to ramp in Fiscal H1 2007, what are your chances of landing another Tier One OEM for Storage in the near term? Next year?

A - Richard Clemmer

I think it’s important to note that this will be the next generation of 160GB drive counts. Seagate had a distinct advantage in technology on the 160 GB level now 12 months in advance of anybody basically using our technology and the technology of the Alliance. So that’s been very positive as we move forward. You know, we think that most of the disk drive companies are looking at how they replicate the electronic supply chain that Seagate has. Seagate has talked about that being a strategic advantage bar. We would be hopeful, but you know, we’ll comment on those as we can talk about them. Nothing that we could talk about – if we were to talk about this platform with the Asian customer, we waited for a point where we got in qualification before we talked about it, to be able to confirm our ability to deliver to our shareholders associated with that.

Operator

Your next question comes from Mark Edelstone, you may ask your question.

Q - Mark Edelstone, Morgan Stanley

Good morning guys. Nice job on the expense controls. A question I guess first off on the cellular business. Obviously you’ve got some good programs working with Samsung. Can you just break out a little bit what kind of growth you expect here in the September quarter for the cellular piece of mobility?

A - Peter Kelly

We’re not going to do that. We do expect it to increase, Mark. But we’re not going to go into the details of it.

Q - Mark Edelstone, Morgan Stanley

Then maybe can you talk a little bit more about the intellectual property side of the business? I understand the guidance here for the current quarter but when you look at FY 2007, what type of range should we expect there? Then also, what are the costs involved in becoming more aggressive in litigation?

A - Richard Clemmer

Mark, we don’t think that it’s a significant operating expense cost. There’ll be some costs associated with it, but it’s not like it creates a significant step function. It’s really how we ensure we’ll get fair value for the intellectual property we have. As we transition through over future years, as Peter talked about before, anticipating a nominal decline as we go out on an annual basis, we’re now feeling very comfortable that in fact we’ll begin to see a nominal increase as we go forward, associated with the strength of that portfolio and our ability to exert our IP. So you know, I think we feel positive about the outlook associated with it and I think the significant difference is our perspective about an opportunity to see that grow nominally as opposed to decline nominally. But I don’t think it increases our overall expense level significantly.

A - Peter Kelly

To be clear, any costs are included in the 600-620 guidance that we discussed.

Q - Mark Edelstone, Morgan Stanley

And you had highlighted that wireless LAN was sort of the driver behind that. Are there more patents and what not that you’re going to be more aggressive on, or was it really just tied to wireless LAN?

A - Peter Kelly

I think at this point, Mark, it doesn’t really help to go into a lot more detail. The wireless LAN was the one that we particularly wanted to call out, but that’s about all we’d like to say about that point. Although, of course, we do have an awful lot of patents. What’s the latest number?

A - Sujal Shah

I think north of 6,000.

A - Peter Kelly

North of 6,000, so clearly we have lots of opportunities.

A - Richard Clemmer

Yes, and we try and ensure fair value for our intellectual property portfolio.

Q - Mark Edelstone, Morgan Stanley

When you’ve lots of put intakes when you go through the business, but it would seem like a lot of the issues regarding legacy revenues have flown through the P&L. So when you look at $375?400 million in revenues as a quarterly run rate here for September, and look out beyond that, is it your sense that becomes kind of a revenue trough and that you should be able to get real growth for the company beyond that?

A - Richard Clemmer

If you look at it, for the last several years we’ve had a little bit of an unusual pattern that we go through for the December quarter or our first fiscal quarter, a little bit of downtick. And we would expect that to continue next year as well. But then I think we’ve established a solid base and a strong position of growth. We spent a lot of time talking in the past externally about our disk drive business and the opportunities there, which we confirm and still feel very good about. The opportunity that we have in mobility, I think if we really now roll out our strategy associated with networking in the near term opportunities that creates for us, that’s one thing that will drive more near term revenue potential than what we’ve had historically. If you look at most of our businesses, when you’ve had a new design win you have to go through the design process to be able to achieve SOC or Silicon on a Chip. In fact, what we’re doing in the networking business, which we tried to talk about in the conference call, is based on the rich product portfolio we have today and how we integrate those solutions together with some overlaying software that provides our customers and our customers’ customers with a unique solution that they can take to the marketplace in a much more rapid time to revenue. So we’re really encouraged about that and the opportunity to increase our revenue, measured in terms of month as opposed to quarters as you would with a normal SOC basis. So I think that we will go through a seasonal pattern again in our fiscal Q1 level, very similar to what we have over the last several years, but it will establish a very solid base of growth for us with the design wins that we’ve already one, moving into the second half of FY 2007 which is really the June quarter.

Operator

Our next question comes from (Raj Iyer?) you may ask your question.

Q – (Raj Iyer?)

My question has been answered, thank you.

Operator

Your next question comes from (Jenny Shu?), you may ask your question.

Q – (Jenny Shu?)

Just a couple of questions on the mobility segments. I was wondering if you could talk about traction with your 3G and also the EDGE handsets beyond Samsung? I think in the past you’ve mentioned Sony Ericsson with their PC cards?

A - Richard Clemmer

We continue to work with Sony Ericsson on the PC cards. That’s a smaller business than the handsets and not as significant from a volume viewpoint. We’ve talked about, we had been working with Chimai(?), Chimai(?) actually has a 3G handset that is completed that they are beginning to engage with a tier one handset provider such that they can have a design win. We’re working with them and supporting them. Clearly, the outlook and the projections we’ve established are based with the customer engagements that we have today and we can count on, but we’re working with a number of other customers to see how we expand our customer base on the mobility side.

Q – (Jenny Shu?)

On the partnership that you announced this morning with u-Nav, could you talk about would this go into low end or into current Samsung handsets or other customers outside of Samsung?

A - Richard Clemmer

We’re currently engaging with Samsung. We met with Samsung last week to talk about what handsets the carriers will be driving LBS on. There is a lot of activity around the carriers to look at Location Based Services and how they increase their revenue stream potentially by adding additional functionality to the normal home-going cell phone business. By being in a position to establish that technology early to market, as that market begins to develop, we think we’re well positioned toward Samsung and toward their business with carriers as well as our other handset providers – more in China and Location Based Services we would anticipate could be like some of the other functionality associated with cell phones, where it might grow more rapidly on an international or Asian basis than it actually does in the US. But a lot of discussion by the carriers as they look at location-based services, clearly there’s a regulatory requirement for E-911 emergency services and being able to have that in conjunction with the technology is a critical component. But we’re just in the early phase of actually working with Samsung on what platforms that might be implemented in.

Operator

Our last question comes from Paul O’Neill. You may ask your question.

Q – Paul O’Neill(?)

Good quarter on the other segments, I guess people are focusing on disk drives so I’ll give it one more shot. Part of your conservative guidance and the issues with inventory – not your inventory but maybe inventory in the channel – we’re hearing two customers at $10 million going to five, a lot of good design wins, good cost controls, mobility doing well etc. So what’s your take on the channel of disk drives out there?

A - Richard Clemmer

I don’t think that we have seen anything that’s disproportionate associated with channel inventory at this point in time, Paul, so you know, we think that it’s in pretty healthy shape, obviously, as the disk drive companies themselves report, we’ll have to make sure that we can confirm that. But all indications we have at this point in time is we’re not aware of any problems in the channel associated with disk drives.

Q – Paul O’Neill(?)

So if we just go back three months ago and look at your guidance, were you more correct on the Maxtor – did Maxtor come in – again maybe you’ve answered this but I’ll say it again. Did Maxtor come in as you expected, and it was more – the PC slowdown that has caused the shortfall and I guess what people think will continue probably until this ships? Is that where the issue was, do you think?

A - Richard Clemmer

I think again, Maxtor is part of Seagate now so it’s hard to break that out. But basically, those platforms as they went forward were pretty much in line with what we anticipated and expected. So but I think we should leave that up to our customers to really comment on the specifics of what happened in their individual businesses. I think all we can really talk about is our shipments into the business itself, Paul.

Sujal Shah

I would like to thank all of you for joining us this morning. If you have any additional questions, please call Investor Relations at Agere Systems. Thank you and have a nice day.

Operator

Ladies and Gentlemen: this conference will be available for replay starting today at 10am and running through midnight on August 1st. You may access the replay by dialing 1800-685-0305. International participants may dial 203-369-3406. The call is also available via webcast replay at http://www.agere.com/webcast. That does conclude today’s conference. Thank you for your participation. You may now disconnect your lines.

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