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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
 
 FORM 10-Q [ X ]
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
 For the quarterly period ended March 31, 2004* OR [    ]
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
 Commission file number: 000-24923 CONEXANT SYSTEMS, INC.  Delaware
(State of incorporation)
    
    25-1799439
(I.R.S. Employer Identification No.)
 100 Schulz Drive
Red Bank, New Jersey 07701
(Address of principal executive offices) (Zip code) (732) 345-7500
(Registrants telephone number, including area code) Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes [ X ] No [    ] Indicate by check mark whether the registrant is an accelerated filer (as
defined by Rule 12b-2 of the Exchange Act).
Yes [ X ] No [    ] Number of shares of registrants common stock outstanding as of April 30, 2004
was 463,324,125.   *
    
    For presentation purposes of this Form 10-Q, references made to the March
31, 2004 period relate to the actual fiscal second quarter ended April 2,
2004.




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CAUTIONARY STATEMENT This Quarterly Report contains statements relating to future results of
Conexant Systems, Inc. (including certain projections and business trends) that
are forward-looking statements within the meaning of Section 27A of the
Securities Act of 1933, as amended, and Section 21E of the Securities Exchange
Act of 1934, as amended, and are subject to the safe harbor created by those
sections. Our actual results may differ materially from those projected as a
result of certain risks and uncertainties. These risks and uncertainties
include, but are not limited to: the cyclical nature of the semiconductor
industry and the markets addressed by our products and our customers products;
demand for and market acceptance of new and existing products; successful
development of new products; the timing of new product introductions; the
availability of manufacturing capacity; pricing pressures and other competitive
factors; changes in product mix; product obsolescence; our ability to develop
and implement new technologies and to obtain protection of the related
intellectual property; the uncertainties of litigation; and the risk that the
businesses of Conexant and GlobespanVirata will not be integrated successfully,
as well as other risks and uncertainties, including those set forth herein and
those detailed from time to time in our filings with the Securities and
Exchange Commission. These forward-looking statements are made only as of the
date hereof, and we undertake no obligation to update or revise the
forward-looking statements, whether as a result of new information, future
events or otherwise. 2




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CONEXANT SYSTEMS,
INC. INDEX PAGEPART I. FINANCIAL INFORMATIONItem 1. Financial Statements (unaudited):Consolidated Condensed Balance Sheets  March 31, 2004 and September 30, 2003
    
    
    4Consolidated Condensed Statements of Operations  Three and Three Months Ended March 31, 2004 and 2003
    
    
    5Consolidated Condensed Statements of Cash Flows  Six Months Ended March 31, 2004 and 2003
    
    
    6Notes to Consolidated Condensed Financial Statements
    
    
    7Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    22Item 3. Quantitative and Qualitative Disclosures About Market Risk
    
    
    42Item 4. Controls and Procedures
    
    
    43PART II. OTHER INFORMATIONItem 2. Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities
    
    
    44Item 4. Submissions of Matters to a Vote of Security Holders
    
    
    44Item 5. Other Information
    
    
    45Item 6. Exhibits and Reports on Form 8-K
    
    
    46Signature
    
    
    48EXHIBIT 3.a.1EXHIBIT 3.a.2EXHIBIT 3.b.1EXHIBIT 3.b.2EXHIBIT 4.2EXHIBIT 10.1EXHIBIT 10.2EXHIBIT 31.1EXHIBIT 31.2EXHIBIT 32
  3




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PART I. FINANCIAL INFORMATION 
 ITEM 1. FINANCIAL STATEMENTS CONEXANT SYSTEMS, INC. 
 Consolidated Condensed Balance Sheets
(unaudited, in thousands, except per share amounts)
 March 31,
    
    September 30,2004
    
    2003ASSETSCurrent assets:Cash and cash equivalents
    
    $
    134,756
    
    
    $
    76,186Short-term investments
    
    
    76,227
    
    
    
    99,283Receivables, net of allowance of $1,588 and $1,547 at
March 31, 2004 and September 30, 2003, respectively
    
    
    190,324
    
    
    
    79,557Inventories
    
    
    123,201
    
    
    
    59,548Deferred income taxes
    
    
    13,644
    
    
    
    13,600Mindspeed warrant-current portion
    
    
    20,900
    
    
    
    Other current assets
    
    
    23,987
    
    
    
    26,524Total current assets
    
    
    583,039
    
    
    
    354,698Property, plant and equipment, net
    
    
    85,018
    
    
    
    36,310Goodwill
    
    
    692,126
    
    
    
    56,865Intangible assets, net
    
    
    146,323
    
    
    
    12,506Deferred income taxes
    
    
    242,449
    
    
    
    241,260Mindspeed warrant
    
    
    120,875
    
    
    
    119,230Marketable securities
    
    
    191,724
    
    
    
    Other assets
    
    
    143,923
    
    
    
    110,838Total assets
    
    $
    2,205,477
    
    
    $
    931,707LIABILITIES AND SHAREHOLDERS EQUITYCurrent liabilities:Accounts payable
    
    $
    129,973
    
    
    $
    55,909Accrued compensation and benefits
    
    
    43,471
    
    
    
    28,865Restructuring and reorganization liabilities
    
    
    23,436
    
    
    
    12,091Other current liabilities
    
    
    62,264
    
    
    
    24,816Total current liabilities
    
    
    259,144
    
    
    
    121,681Convertible subordinated notes
    
    
    711,825
    
    
    
    581,825Other liabilities
    
    
    78,276
    
    
    
    61,435Total liabilities
    
    
    1,049,245
    
    
    
    764,941Commitments and contingencies
    

    
    
    
    
    
    Shareholders equity:Preferred and junior preferred stock
    
    
    
    
    
    
    Common stock, $0.01 par value: 1,000,000 shares
authorized; 463,986 and 276,134 shares issued,
and 462,736 shares and 276,134 shares outstanding
at March 31, 2004 and September 30, 2003,
respectively
    
    
    4,640
    
    
    
    2,761Treasury stock: 1,250 shares at cost
    
    
    (9,188
    )
    
    
    Additional paid-in capital
    
    
    4,634,802
    
    
    
    3,506,070Accumulated deficit
    
    
    (3,435,259
    )
    
    
    (3,332,527
    )Accumulated other comprehensive loss
    
    
    (6,570
    )
    
    
    (9,496
    )Notes receivable from stock sales
    
    
    (2,388
    )
    
    
    Unearned compensation
    
    
    (29,805
    )
    
    
    (42
    )Total shareholders equity
    
    
    1,156,232
    
    
    
    166,766Total liabilities and shareholders equity
    
    $
    2,205,477
    
    
    $
    931,707
 See accompanying notes to consolidated condensed financial statements. 4




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CONEXANT SYSTEMS, INC. 
 Consolidated Condensed Statements of Operations
(unaudited, in thousands, except per share amounts)
 Three months ended
    
    Six months endedMarch 31,
    
    March 31,2004
    
    2003
    
    2004
    
    2003Net revenues
    
    $
    243,781
    
    
    $
    140,123
    
    
    $
    421,114
    
    
    $
    284,324Cost of goods sold (including $812 for the three and six
months ended March 31, 2004 related to restructuring
actions in the merger-Notes 3 and 7)
    
    
    142,116
    
    
    
    78,107
    
    
    
    240,312
    
    
    
    159,569Gross margin
    
    
    101,665
    
    
    
    62,016
    
    
    
    180,802
    
    
    
    124,755Operating expenses:Research and development (including non-cash
compensation of $871 and $894 for the three and six
months ended March 31, 2004, respectively, and ($69) and
$399 for the three and six months ended March 31, 2003,
respectively)
    
    
    53,734
    
    
    
    38,741
    
    
    
    92,888
    
    
    
    78,978Selling, general and administrative (including non-cash
compensation of $286 for the three and six months ended
March 31, 2004, and $927 and $1,272 for the three and
six months ended March 31, 2003, respectively)
    
    
    30,602
    
    
    
    23,777
    
    
    
    53,411
    
    
    
    46,556Amortization of intangible assets
    
    
    3,653
    

    
    
    799
    
    
    
    4,608
    
    
    
    1,598In-process research and development
    
    
    160,818
    
    
    
    
    
    
    
    160,818
    
    
    
    Special charges
    
    
    5,514
    
    
    
    285
    
    
    
    6,119
    
    
    
    7,059Total operating expenses
    
    
    254,321
    
    
    
    63,602
    
    
    
    317,844
    
    
    
    134,191Operating loss
    
    
    (152,656
    )
    
    
    (1,586
    )
    
    
    (137,042
    )
    
    
    (9,436
    )Gain on extinguishment of debt
    
    
    
    
    
    
    (34,645
    )
    
    
    
    
    
    
    (34,645
    )Other (income) expense, net
    
    
    (9,736
    )
    
    
    44,732
    
    
    
    (35,017
    )
    
    
    41,329Loss before income taxes
    
    
    (142,920
    )
    
    
    (11,673
    )
    
    
    (102,025
    )
    
    
    (16,120
    )Provision for income taxes
    
    
    459
    
    
    
    381
    
    
    
    707
    
    
    
    697Loss from continuing operations
    
    
    (143,379
    )
    
    
    (12,054
    )
    
    
    (102,732
    )
    
    
    (16,817
    )Loss from discontinued operations, net of income taxes
    
    
    
    
    
    
    (55,970
    )
    
    
    
    
    
    
    (676,580
    )Net loss
    
    $
    (143,379
    )
    
    $
    (68,024
    )
    
    $
    (102,732
    )
    
    $
    (693,397
    )Loss per share, basic and diluted:Continuing operations
    
    $
    (0.41
    )
    
    $
    (0.05
    )
    
    $
    (0.33
    )
    
    $
    (0.06
    )Discontinued operations
    
    
    
    
    
    
    (0.21
    )
    
    
    
    
    
    
    (2.55
    )Net loss
    
    $
    (0.41
    )
    
    $
    (0.26
    )
    
    $
    (0.33
    )
    
    $
    (2.61
    )Number of shares used in per share computation
    
    
    349,968
    
    
    
    266,543
    
    
    
    313,580
    
    
    
    266,129
 See accompanying notes to consolidated condensed financial statements. 5




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CONEXANT SYSTEMS, INC. 
 Consolidated Condensed Statements of Cash Flows
(unaudited, in thousands)
 Six months ended March 31,2004
    
    2003Cash flows from operating activities:Loss from continuing operations
    
    $
    (102,732
    )
    
    $
    (16,817
    )Adjustments to reconcile loss from continuing
operations to net cash provided by (used in)
operating activities, net of effects of disposition
of business and acquisition:Depreciation
    
    
    6,825
    
    
    
    9,928Amortization of intangible assets
    
    
    4,608
    
    
    
    1,598In-process research and development
    
    
    160,818
    
    
    
    Asset impairments
    
    
    2,026
    
    
    
    2,481Provision for losses on accounts receivable
    
    
    
    
    
    
    (3,412
    )Inventory provisions
    
    
    3,129
    
    
    
    8,842Change in fair value of Skyworks note and
Mindspeed warrant
    
    
    (34,090
    )
    
    
    1,756Write-down of non-marketable investments
    
    
    600
    
    
    
    34,402Equity in (earnings) losses of equity method
investees
    
    
    (10,816
    )
    
    
    810Gain of extinguishment of debt
    
    
    
    
    
    
    (34,645
    )Other non-cash items, net
    
    
    3,728
    
    
    
    3,293Changes in assets and liabilities:Receivables
    
    
    (19,508
    )
    
    
    3,007Inventories
    
    
    6,605
    
    
    
    (11,063
    )Accounts payable
    
    
    30,855
    
    
    
    (20,311
    )Accrued expenses and other current liabilities
    
    
    (19,569
    )
    
    
    (3,360
    )Other
    
    
    (6,355
    )
    
    
    2,398Net cash provided by (used in) operating activities
    
    
    26,124
    
    
    
    (21,093
    )Cash flows from investing activities:Cash received in acquisition of GlobespanVirata
    
    
    58,563
    
    
    
    Payment of acquisition related costs
    
    
    (13,204
    )
    
    
    Advances to Skyworks
    
    
    
    
    
    
    (35,000
    )Repayment of Term Notes and advances by Skyworks
    
    
    
    
    
    
    170,000Purchase of marketable securities
    
    
    (41,711
    )
    
    
    (36,508
    )Sale of marketable securities
    
    
    26,816
    
    
    
    28,270Capital expenditures
    
    
    (9,902
    )
    
    
    (8,358
    )Proceeds from sales of assets
    
    
    269
    
    
    
    2,113Payment of deferred purchase consideration
    
    
    (4,000
    )
    
    
    Investments in and advances to businesses
    
    
    (1,571
    )
    
    
    (1,500
    )Net cash provided by investing activities
    
    
    15,260
    
    
    
    119,017Cash flows from financing activities:Proceeds from exercise of stock options
    
    
    17,186
    
    
    
    1,176Repurchase of convertible subordinated notes
    
    
    
    
    
    
    (44,238
    )Net cash provided by (used in) financing activities
    
    
    17,186
    
    
    
    (43,062
    )Net cash used in discontinued operations
    
    
    
    
    
    
    (66,211
    )Net increase (decrease) in cash and cash equivalents
    
    
    58,570
    
    
    
    (11,349
    )Cash and cash equivalents at beginning of period
    
    
    76,186
    
    
    
    161,088Cash and cash equivalents at end of period
    
    $
    134,756
    
    
    $
    149,739
 See accompanying notes to consolidated condensed financial statements. 6




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CONEXANT SYSTEMS, INC. 
 NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(unaudited)
 1. Basis of Presentation and Significant Accounting Policies Conexant Systems, Inc. (Conexant or the Company) designs, develops and sells
semiconductor system solutions, comprised of semiconductor devices, software
and reference designs, for use in broadband communications applications that
enable high-speed transmission, processing and distribution of audio, video,
voice and data to and throughout homes and business enterprises worldwide. The
Companys access solutions connect people through personal communications
access products such as personal computers (PCs), set-top boxes and game
consoles to audio, video, voice and data services over wireless and wire line
broadband connections as well as over dial-up Internet connections. The
Companys central office solutions are used by service providers to deliver
high-speed audio, video, voice and data services over copper telephone lines to
homes and businesses around the globe. In addition, the Companys media
processing products enable the capture, display, storage, playback and transfer
of audio and video content in applications throughout home and small office
environments. The Company operates in one segment. On February 27, 2004, Conexant completed its merger with GlobespanVirata, Inc.
(GlobespanVirata), a provider of broadband communications solutions for
consumer, enterprise and service provider markets. Following the merger,
GlobespanVirata is a wholly-owned subsidiary of Conexant. In the merger,
GlobespanVirata shareholders received 1.198 shares of Conexant common stock for
each share of GlobespanVirata common stock and Conexant issued approximately
180.6 million shares. In addition, the outstanding and unexercised common
stock options of GlobespanVirata were adjusted and converted into options to
purchase 43.6 million shares of Conexant common stock. See Note 2 for further
information. On June 27, 2003, Conexant completed the distribution to Conexant shareholders
of all outstanding shares of Mindspeed Technologies, Inc. (Mindspeed), a
wholly owned subsidiary of Conexant to which Conexant contributed its Internet
infrastructure business, including the stock of certain subsidiaries, and
certain other assets and liabilities, including approximately $100.0 million in
cash (hereinafter, the Mindspeed Spin). In the Mindspeed Spin, Conexant
shareholders received one share of Mindspeed common stock for every three
Conexant shares held and the Conexant shareholders continued to hold their
Conexant shares. Mindspeed issued to Conexant a warrant to purchase 30 million
shares of Mindspeed common stock, representing approximately 20 percent of
Mindspeeds outstanding common stock on a fully diluted basis. The warrant is
exercisable for a period of ten years, commencing one year after the completion
of the Mindspeed Spin, at an exercise price of $3.408 per share (the fair
market value on the date of grant). The warrant is recorded as an asset on the
consolidated condensed balance sheet (see Note 3). Additionally, Conexant
entered into a senior secured revolving credit facility pursuant to which
Mindspeed may borrow up to $50.0 million for working capital and general
corporate purposes. See Note 10 for further information. The operating results of the discontinued Mindspeed Technologies Internet
infrastructure business (through June 27, 2003) included in the accompanying
unaudited consolidated condensed statements of operations were as follows (in
thousands): Three months
    
    Six monthsended
    
    endedMarch 31,
    
    March 31,2003
    
    2003Net revenues
    
    $
    18,311
    
    
    $
    38,566Loss before income taxes
    
    $
    (55,830
    )
    
    $
    (103,136
    )Provision for income taxes
    
    
    140
    
    
    
    260Cumulative effect of change in accounting for goodwill
    
    
    
    
    
    
    (573,184
    )Loss from discontinued operations
    
    $
    (55,970
    )
    
    $
    (676,580
    )
 In the opinion of management, the accompanying unaudited consolidated condensed
financial statements contain all adjustments, consisting of adjustments of a
normal recurring nature, as well as the special charges, necessary to present
fairly the Companys financial position, results of operations and cash flows.
The results of operations for interim periods are not necessarily indicative of
the results that may be expected for a full year. These statements 7




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CONEXANT SYSTEMS, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(unaudited) should be read in conjunction with the consolidated financial statements and
notes thereto included in the Companys Annual Report on Form 10-K for the
fiscal year ended September 30, 2003. Fiscal PeriodsFor presentation purposes, references made to the periods
ended March 31, 2004 and 2003 relate to the actual fiscal 2004 second quarter
ended April 2, 2004 and the actual fiscal 2003 second quarter ended March 28,
2003, respectively. Supplemental Cash Flow Information Cash paid for interest was $11.8 million
and $14.0 million for the six months ended March 31, 2004 and 2003,
respectively. Cash paid (received) for income taxes for the six months ended
March 31, 2004 and 2003 was $(0.3) million and $0.8 million, respectively.
See Note 2 for a discussion of the common stock and options issued and net
assets acquired in the acquisition of GlobespanVirata. Loss Per Share Basic loss per share is based on the weighted-average number
of shares of common stock outstanding during the period. Diluted loss per share
also includes the effect of stock options and other common stock equivalents
outstanding during the period, and assumes the conversion of the Companys and
GlobespanViratas convertible subordinated notes for the period of time such
notes were outstanding, if such stock options and convertible notes are
dilutive. In periods of a net loss position, basic and diluted weighted
average shares are the same. The potential dilutive effect of the common stock equivalents shown below was
not included in the denominator for the computation of diluted earnings per
share for the respective periods, as the effect of these securities was
antidilutive: Three months ended
    
    Six months endedMarch 31,
    
    March 31,(weighted-average number of shares, in thousands)
    
    2004
    
    2003
    
    2004
    
    2003Stock options and warrant (under the treasury stock method)
    
    
    28,009
    
    
    
    294
    
    
    
    25,490
    
    
    
    3174.25% Convertible Subordinated Notes due 2006
    
    
    7,364
    
    
    
    5,897
    
    
    
    7,364
    
    
    
    5,8974% Convertible Subordinated Notes due 2007
    
    
    12,137
    
    
    
    11,228
    
    
    
    12,137
    
    
    
    11,4185.25% Convertible Subordinated Notes due 2006
    
    
    2,246
    
    
    
    
    
    
    
    1,123
    
    
    
    Restricted stock
    
    
    16
    
    
    
    72
    
    
    
    17
    
    
    
    90
 Stock-Based Compensation The Company accounts for employee stock-based
compensation in accordance with the provisions of Accounting Principles Board
Opinion No. 25, Accounting for Stock Issued to Employees (APB 25) and
therefore no compensation expense has been recognized for fixed stock option
plans as options are granted at fair market value on the date of grant. The
Company also has an employee stock purchase plan for all eligible employees.
The Company has adopted the pro forma disclosure provisions of Statement of
Financial Accounting Standards (SFAS) No. 123, Accounting for Stock-Based
Compensation, as amended by SFAS No. 148, Accounting for Stock-Based
Compensation  Transition and Disclosure. Had stock-based compensation been determined based on the fair value at the
grant date for awards consistent with the provisions of SFAS No. 123, the
Companys pro forma loss from continuing operations and pro forma loss from
continuing operations per share would have been the amounts indicated below (in
thousands, except per share amounts): Three months ended
    
    Six months endedMarch 31,
    
    March 31,2004
    
    2003
    
    2004
    
    2003Loss from continuing operations, as
reported
    
    $
    (143,379
    )
    
    $
    (12,054
    )
    
    $
    (102,732
    )
    
    $
    (16,817
    )Add: expense determined under fair value
accounting included in loss from
continuing operations, as reported
    
    
    1,157
    
    
    
    858
    
    
    
    1,180
    
    
    
    1,671Deduct: total expense determined under
fair value accounting for all
awards
    
    
    (11,248
    )
    
    
    (12,026
    )
    
    
    (24,378
    )
    
    
    (35,479
    )Pro forma loss from continuing operations
    
    $
    (153,470
    )
    
    $
    (23,222
    )
    
    $
    (125,930
    )
    
    $
    (50,625
    )Loss from continuing operations per share
 basic and diluted, as reported
    
    $
    (0.41
    )
    
    $
    (0.05
    )
    
    $
    (0.33
    )
    
    $
    (0.06
    )Pro forma loss from continuing
operations per share  basic and diluted
    
    $
    (0.44
    )
    
    $
    (0.09
    )
    
    $
    (0.40
    )
    
    $
    (0.19
    )
 8




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CONEXANT SYSTEMS, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(unaudited) For purposes of pro forma disclosures under SFAS No. 123, the estimated fair
value of the stock-based awards is assumed to be amortized to expense over the
instruments vesting period. The fair value has been estimated at the date of
grant using the Black-Scholes option valuation model with the following
assumptions: Three months ended
    
    Six months endedMarch 31,
    
    March 31,2004
    
    2003
    
    2004
    
    2003Risk-free interest rate
    
    
    2.79
    %
    
    
    3.18
    %
    
    
    3.03
    %
    
    
    3.18
    %Expected volatility
    
    
    97
    %
    
    
    97
    %
    
    
    97
    %
    
    
    97
    %Dividend yield
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Expected life (years)
    
    
    2.5  4.5
    
    
    
    4.5
    
    
    
    2.5  4.5
    
    
    
    4.5Weighted-average fair value
of options granted
    
    $
    5.08
    
    
    $
    1.51
    
    
    $
    5.08
    
    
    $
    1.76
 The Black-Scholes option valuation model was developed for use in estimating
the fair value of traded options that have no vesting restrictions and are
fully transferable. In addition, option valuation models require the input of
highly subjective assumptions, including the expected stock price volatility.
Because awards held by employees and directors have characteristics
significantly different from those of traded options, and because changes in
the subjective input assumptions can materially affect the fair value estimate,
in the opinion of management, the existing models do not necessarily provide a
reliable single measure of the fair value of these options. Investments  marketable securitiesShort-term marketable securities consist
of debt securities with original maturity dates between ninety days and one
year. Long-term marketable securities consist of debt securities with original
maturity dates greater than one year. The Companys investments are classified
as available-for-sale, and are reported at fair value at the balance sheet
date. The unrealized gains and losses are reported as a component of
accumulated other comprehensive income. Management determines the appropriate
classification of debt securities at the time of purchase and reassesses the
classification at each reporting date. Gains and losses on the sale of
available-for-sale investments are determined using the specific-identification
method. For all investment securities, unrealized losses that are other than temporary
are recognized in net income. The Company does not hold these securities for
speculative or trading purposes. ReclassificationsCertain prior year amounts have been reclassified to
conform to the current year presentation. Recent Accounting StandardsIn January 2003, the Financial Accounting
Standards Board (FASB) issued FASB Interpretation No. (FIN) 46, Consolidation
of Variable Interest Entities, which was amended in December 2003. The
Company adopted FIN 46 in the second quarter ended March 31, 2004 with no
impact on its financial position or results of operations. 2. Merger with GlobespanVirata, Inc. On February 27, 2004, the Company completed its merger with GlobespanVirata,
with GlobespanVirata becoming a wholly-owned subsidiary of the Company. The
transaction was accounted for under the purchase method of accounting with the
Company as the acquiror for accounting purposes. In exchange for 100% of the
outstanding shares of common stock of GlobespanVirata (approximately 150.7
million shares), the Company issued 1.198 shares of Conexant common stock for
each share of GlobespanVirata common stock outstanding and each outstanding
option and warrant to purchase GlobespanVirata common stock was adjusted and
converted into an option or warrant to purchase Conexant common stock based on
the 1.198 merger ratio. The purchase consideration is summarized as follows
(in thousands): Fair market value of Conexant common stock issued
    
    $
    1,027,342Fair value of Conexant common stock options issued
    
    
    81,011Transaction costs
    
    
    13,700Total purchase consideration
    
    $
    1,122,053
 The fair value of Conexant common stock and stock options issued of $1.1
billion has been allocated to common 9




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CONEXANT SYSTEMS, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(unaudited) stock and additional paid in capital. The fair market value of the 180.6
million shares of common stock issued was determined using a per share price of
$5.69 (the average of the closing market prices of Conexant common stock on the
day of the announcement of the merger, November 3, 2003, and on the three
business days before and after the announcement date). In accordance with FASB
Interpretation No. 44 Accounting for Certain Transactions Involving Stock
Compensation, the $111.9 million fair value of the 43.6 million Conexant
common stock options granted to replace the then outstanding GlobespanVirata
common stock options was determined using a Black-Scholes option pricing model
with the following assumptions: market price of $5.69 per share, volatility of
97%, risk-free rate of return of 3.2%, expected lives of 4.5 years and no
dividend yield. Approximately $30.9 million in intrinsic value associated with
the unvested stock options has been allocated to unearned compensation and will
be amortized to expense over the average remaining vesting period of
approximately 2.6 years. A total of $1.1 million of this unearned compensation
was recognized as an expense in the quarter ended March 31, 2004. In connection with the merger with GlobespanVirata, the Company began to
formulate a reorganization and restructuring plan (the Reorganization Plan).
As a result of the Reorganization Plan, the Company recorded restructuring and
asset impairment charges related to Conexants operations of $2.7 million
during the three months ended March 31, 2004. These charges are included in
Special Charges and Cost of Sales in the accompanying consolidated condensed
statement of operations. Additionally, the Company recognized $14.8 million as
liabilities assumed in the purchase business combination related to
restructuring liabilities for estimated costs related to GlobespanVirata
facilities consolidation and the related impact on GlobespanVirata outstanding
real estate leases and GlobespanVirata involuntary employee terminations.
These liabilities were included in the allocation of the purchase price in
accordance with SFAS No. 141 entitled Business Combinations and EITF 95-3
entitled Recognition of Liabilities in Connection with a Purchase Business
Combination. Execution of the Reorganization Plan is in its early stages and
further actions may be taken such as additional or different facilities
impairments, workforce reductions or relocations and/or product related
decisions with respect to duplicate technology licenses, duplicate maintenance
contracts, production masks and inventory of goods for which there will no
longer be an active market for the combined company. These actions are
expected to be completed by the end of fiscal 2004, and when taken, additional
charges will be recorded as an adjustment to goodwill. Any actions relating to
the acquiring corporation will be charged to earnings. See Note 7 for a
further description of the Companys reorganization and restructuring plans. The following sets forth the Companys estimates of the fair values of the
assets acquired and liabilities assumed in the merger as of February 27, 2004
(in thousands). Such amounts may change as a result of the preliminary
Reorganization Plan described above. Cash and cash equivalents
    
    $
    58,563Short-term and long-term investments
    
    
    140,871Accounts receivable
    
    
    91,259Inventories
    
    
    73,281Prepaids and other current assets
    
    
    5,446Property and equipment
    
    
    46,883Other long-term assets
    
    
    15,390Identifiable intangible assets
    
    
    137,931In-process research and development
    
    
    160,818Goodwill
    
    
    635,261Accounts payable
    
    
    (43,100
    )Accrued expenses
    
    
    (75,062
    )Accrued restructuring and reorganization liabilities
    
    
    (14,809
    )Long-term debt
    
    
    (130,000
    )Other long-term liabilities
    
    
    (23,284
    )Treasury stock
    
    
    9,188Notes receivable from stock sales
    
    
    2,469Unearned compensation
    
    
    30,948Net assets acquired
    
    $
    1,122,053
 10




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CONEXANT SYSTEMS, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(unaudited) The excess of the purchase price over the fair value of the net tangible assets
acquired has been reflected as identifiable intangible assets and goodwill.
The identifiable intangible assets and respective useful lives are as follows
(in thousands): Product licenses (7 years)
    
    $
    10,964Trademark (7 years)
    
    
    2,006Developed technologies (2  5 years)
    
    
    124,961Total identifiable intangible assets
    
    $
    137,931
 The identifiable intangible assets were valued using the income approach and a
discount rate of 18%. The developed technologies consist of eight products in
the DSL and wireless LAN categories. Under the income approach, the fair value
reflects the present value of the projected cash flows that are expected to be
generated by the products incorporating the current technology. The type of
income approach utilized for the trademark was the relief from royalty
methodology, under which an estimate is made as to the appropriate royalty
income that would be negotiated in an arms length transaction if the subject
intangible asset were licensed from an independent third party owner. These
assets are being amortized on a straight-line basis over their estimated useful
lives ranging from 2 to 7 years, with a weighted average life of approximately
5 years. Amortization expense for these intangible assets was $2.7 million for
the quarter ended March 31, 2004. The amount recorded as goodwill of $635.3
million is not deductible for tax purposes. The amount allocated to in process research and development (IPR&D) of $160.8
million was expensed upon completion of the merger (as a charge not deductible
for tax purposes) as it was determined that the underlying products had not
reached technological feasibility, had no alternative uses and successful
development was uncertain. The Company identified and valued two IPR&D
projects relating to the development of DSL and wireless LAN products. The DSL
project represented 70% of the total IPR&D acquired. Both projects were
approximately 87% complete at the date of the merger. The estimated costs to
complete for the DSL and wireless LAN projects were approximately
$14.1 million
and $6.2 million, respectively. These projects will be completed in fiscal
2005. The fair values assigned to these projects were based on the income
approach and used projected cash flows which were discounted at a rate of 19%.
The discount rate was derived from a weighted-average cost of capital analysis,
adjusted upwards to reflect additional risks inherent in the development
process, including the probability of achieving technological success and
market acceptance. Each of the IPR&D projects was analyzed considering
technological innovations, the existence and utilization of core technology,
the complexity, costs and time to complete the remaining development efforts,
and stage of completion. The discount rate reflects the stage of completion
and other risks inherent in the projects. The material risks associated with
the incomplete projects are the ability to complete the items within the
outlined timeframes and within the allocated cost guidelines, and ultimately to
sell the products to end-users. Management is responsible for the amounts determined for IPR&D as well as
developed technologies and believes that amounts are representative of
fair values. The treasury stock of $9.2 million represents the value of the 1.25 million
shares of Conexant common stock held by iCompression, a subsidiary of
GlobespanVirata, which were effectively repurchased at the acquisition date of
February 27, 2004. The merger was accounted for as a purchase and has been included in the
Companys operations from the closing date. The following unaudited pro forma
information represents a summary of the results of operations as if the merger
occurred at the beginning of each period presented and includes amortization of
identifiable intangibles and unearned compensation from that date. Six months ended March 31,(in thousands, except per share amounts)
    
    2004
    
    2003Net revenues
    
    $
    607,890
    
    
    $
    404,134Net loss
    
    
    (126,958
    )
    
    
    (740,676
    )Net loss per common share  basic and diluted
    
    
    (0.26
    )
    
    
    (1.66
    )
 11




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CONEXANT SYSTEMS, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(unaudited) The pro forma results are based on various assumptions and are not necessarily
indicative of what would have occurred had the merger closed on October 1, 2003
and 2002, respectively. 3. Supplemental Financial Statement Data Marketable Securities
Marketable securities consist of short-term investments and long-term
investments, all of which are classified as available-for-sale securities as
follows: Gross
    
    GrossUnrealized
    
    UnrealizedAmortized
    
    Holding
    
    Holding
    
    FairShort- term investments (in thousands):

    
    Cost
    
    Gains
    
    Losses
    
    ValueMarch 31, 2004:Skyworks 15% convertible senior subordinated notes
    
    $
    47,294
    
    
    $
    20,570
    
    
    $
    
    
    
    $
    67,864Foreign government securities
    
    
    510
    
    
    
    
    
    
    
    
    
    
    
    510Corporate debt securities
    
    
    1,577
    
    
    
    
    
    
    
    (5
    )
    
    
    1,572Equity securities
    
    
    2,321
    
    
    
    3,960
    
    
    
    
    
    
    
    6,281$
    51,702
    
    
    $
    24,530
    
    
    $
    (5
    )
    
    $
    76,227September 30, 2003:Skyworks 15% convertible senior subordinated notes
    
    $
    46,542
    
    
    $
    9,024
    
    
    $
    
    
    
    $
    55,566U.S. government agencies
    
    
    14,640
    
    
    
    25
    
    
    
    (18
    )
    
    
    14,647Foreign government securities
    
    
    2,044
    
    
    
    15
    
    
    
    
    
    
    
    2,059Corporate debt securities
    
    
    21,625
    
    
    
    74
    
    
    
    (59
    )
    
    
    21,640Equity securities
    
    
    2,320
    
    
    
    3,051
    
    
    
    
    
    
    
    5,371$
    87,171
    
    
    $
    12,189
    
    
    $
    (77
    )
    
    $
    99,283
 The Company accounts for the Skyworks 15% convertible senior subordinated notes
as available-for-sale securities carried at their fair value. Unrealized gains
or losses resulting from changes in the fair value of the underlying debt are
included in other comprehensive income. The right to convert the Skyworks 15%
convertible senior subordinated notes into shares of Skyworks common stock is,
for financial accounting purposes, an embedded derivative instrument. Changes
in the fair value of the Skyworks 15% convertible senior subordinated notes
resulting from changes in the value of the conversion right are included in
other (income) expense, net each period. Gross
    
    GrossUnrealized
    
    UnrealizedAmortized
    
    Holding
    
    Holding
    
    FairLong- term investments (in thousands):

    
    Cost
    
    Gains
    
    Losses
    
    ValueMarch 31, 2004:U.S. government agencies
    
    $
    162,722
    
    
    $
    31
    
    
    $
    (220
    )
    
    $
    162,533Foreign government securities
    
    
    1,011
    
    
    
    3
    
    
    
    
    
    
    
    1,014Corporate debt securities
    
    
    28,188
    
    
    
    36
    
    
    
    (47
    )
    
    
    28,177$
    191,921
    
    
    $
    70
    
    
    $
    (267
    )
    
    $
    191,724
 The Companys long-term marketable securities principally have original
contractual maturities from one year to three years. Inventories Inventories consist of the following (in thousands): March 31,
    
    September 30,2004
    
    2003Work-in-process
    
    $
    69,872
    
    
    $
    42,662Finished goods
    
    
    53,329
    
    
    
    16,886$
    123,201
    
    
    $
    59,548
 In the quarter ended March 31, 2004, as a result of strategic decisions made at
the time of the merger with GlobespanVirata, the Company wrote down $0.8
million of on-hand inventory products which will no longer be actively marketed
or sold. This amount was charged to cost of goods sold. 12




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##### Table of Contents



CONEXANT SYSTEMS, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(unaudited) Goodwill During the first six months of fiscal 2004, goodwill was adjusted as follows
(in thousands): Goodwill, September 30, 2003
    
    $
    56,865Merger with GlobespanVirata
    
    
    635,261Goodwill, March 31, 2004
    
    $
    692,126
 Intangible Assets Intangible assets consist of the following (in thousands): March 31, 2004
    
    September 30, 2003Gross
    
    Accumulated
    
    
    
    
    
    Gross
    
    AccumulatedAsset
    
    Amortization
    
    Net
    
    Asset
    
    Amortization
    
    NetDeveloped technology
    
    $
    140,865
    
    
    $
    (11,019
    )
    
    $
    129,846
    
    
    $
    15,904
    
    
    $
    (7,456
    )
    
    $
    8,448Customer base
    
    
    2,050
    
    
    
    (602
    )
    
    
    1,448
    
    
    
    2,050
    
    
    
    (358
    )
    
    
    1,692Other intangible assets
    
    
    20,908
    
    
    
    (5,879
    )
    
    
    15,029
    
    
    
    7,443
    
    
    
    (5,077
    )
    
    
    2,366$
    163,823
    
    
    $
    (17,500
    )
    
    $
    146,323
    
    
    $
    25,397
    
    
    $
    (12,891
    )
    
    $
    12,506
 Intangible assets are amortized over a weighted-average period of approximately
five years. Annual amortization expense is expected to be as follows (in
thousands): Remainder of2004
    
    2005
    
    2006
    
    2007
    
    2008
    
    ThereafterAmortization expense
    
    $
    15,853
    
    
    $
    30,508
    
    
    $
    28,765
    
    
    $
    28,142
    
    
    $
    27,874
    
    
    $
    15,181
 Mindspeed Warrant The Company accounts for the Mindspeed warrant as a derivative instrument, and
changes in the fair value of the warrant are included in other (income)
expense, net each period. At March 31, 2004, the fair value of the Mindspeed
warrant included on the accompanying consolidated condensed balance sheet was
$141.8 million. The current portion of $20.9 million was determined using
current pricing data, and the remaining portion was valued using a
Black-Scholes model with terms for portions of the warrant varying from 1 to 5
years, volatility of 90%, a risk-free interest rate of 3.2%, and no dividend
yield. It is the Companys intent to liquidate the portion of this warrant
classified as current in the next twelve months. Convertible Subordinated Notes The Company and its consolidated subsidiaries have three issues of convertible
subordinated notes, including the 5.25% convertible subordinated notes due May
2006 which were acquired in the GlobespanVirata merger. At March 31, 2004, the
components of convertible subordinated notes are as follows (in thousands): 4.0% Convertible Subordinated Notes due February 2007 with a
conversion price of $42.43
    
    $
    515,0004.25% Convertible Subordinated Notes due May 2006 with a
conversion price of $9.08
    
    
    66,8255.25% Convertible Subordinated Notes due May 2006 with a
conversion price of $22.26
    
    
    130,000Total convertible subordinated notes
    
    $
    711,825
 The significant terms of the 5.25% convertible subordinated notes acquired by
the Company in the GlobespanVirata merger in February 2004 are as follows: The
5.25% convertible subordinated notes are unsecured obligations of
GlobespanVirata, are contractually subordinated in right of payment to all
senior indebtedness of GlobespanVirata, and mature on May 15, 2006. The
holders may convert the notes into shares of Conexant common stock at any time
prior to maturity at a conversion price of $22.262 per share, subject to
adjustment. On and after May 20, 2004, GlobespanVirata may redeem the notes at
any time at GlobespanViratas option, in whole or in part, at the redemption
price shown in the notes, plus accrued interest, if any. 13




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CONEXANT SYSTEMS, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(unaudited) Other (Income) Expense, Net Other (income) expense, net consists of the following (in thousands): Three months ended
    
    Six months endedMarch 31,
    
    March 31,2004
    
    2003
    
    2004
    
    2003Investment and interest income
    
    $
    (2,802
    )
    
    $
    (3,900
    )
    
    $
    (5,299
    )
    
    $
    (9,549
    )Change in fair value of Skyworks 15% convertible
senior subordinated notes
    
    
    (16,456
    )
    
    
    5,785
    
    
    
    (11,545
    )
    
    
    1,756Change in fair value of the Mindspeed warrant
    
    
    2,085
    
    
    
    
    
    
    
    (22,545
    )
    
    
    Interest expense
    
    
    7,260
    
    
    
    7,582
    
    
    
    13,949
    
    
    
    15,170Equity in (earnings) losses of equity method investees
    
    
    (651
    )
    
    
    2,113
    
    
    
    (10,816
    )
    
    
    810Write down of non-marketable investments
    
    
    600
    
    
    
    34,402
    
    
    
    600
    
    
    
    34,402Other
    
    
    228
    
    
    
    (1,250
    )
    
    
    639
    
    
    
    (1,260
    )$
    (9,736
    )
    
    $
    44,732
    
    
    $
    (35,017
    )
    
    $
    41,329
 During the quarter ended December 31, 2003, an unrelated party repaid a $30.0
million note issued in connection with a previous equity investment in an
entity in which the Company owns a 38% interest. In accordance with Staff
Accounting Bulletin No. 51, the Company recognized an $11.4 million gain upon
the payment of this note, which is included in equity in earnings of equity
method investees. 4. Skyworks Notes In November 2002, the Company restructured its previous financing agreements
with Skyworks whereby Skyworks repaid $105.0 million of the principal amount
and all accrued interest owed to the Company under the $150.0 million
promissory notes issued by Skyworks and certain Skyworks subsidiaries and
collateralized by substantially all of the assets of Skyworks (the Term Notes),
and the remaining principal amount of the Term Notes was exchanged for $45.0
million principal amount of the Skyworks 15% convertible senior subordinated
notes with a maturity date of June 30, 2005. Skyworks also repaid all amounts
outstanding under the previous credit facility, the credit facility was
cancelled and the Company released all security interests in Skyworks assets
and properties. Skyworks may redeem the 15% convertible senior subordinated notes at any time
on or after May 12, 2004, subject to a redemption premium of 3% of the
outstanding principal amount. The Company may, at its option, convert the
outstanding principal amount of the 15% convertible senior subordinated notes
into shares of Skyworks common stock based upon the conversion price (initially
$7.87 per share, subject to adjustment under certain circumstances). At
maturity, Skyworks must pay the outstanding principal amount by delivery of a
number of shares of its common stock based upon the conversion price. Skyworks
has granted the Company certain registration rights relating to the 15%
convertible senior subordinated notes and the shares of Skyworks common stock
underlying the 15% convertible senior subordinated notes. As of March 31, 2004, the 15% convertible senior subordinated notes are carried
at their fair value of $67.9 million (including the $23.0 million fair value of
the related conversion right) and are included in short-term investments in the
accompanying consolidated condensed balance sheet because the Company has the
ability and intent to liquidate the 15% convertible senior subordinated notes
or shares underlying the notes within the next twelve months. The Company received a notice dated April 22, 2004 from Skyworks advising that
Skyworks would redeem in full on May 12, 2004 the 15% convertible senior
subordinated notes held by the Company. The Company exercised its right to
convert all of the notes into 5,717,916 shares of Skyworks common stock prior to the
scheduled redemption date at a conversion price of $7.87 per share. 5. Commitments and Contingencies Certain claims have been asserted against the Company, including claims
alleging the use of the intellectual property rights of others in certain of
the Companys products. The resolution of these matters may entail the
negotiation of a license agreement, a settlement, or the resolution of such
claims through arbitration or litigation. In connection with 14




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CONEXANT SYSTEMS, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(unaudited) its spin-off from Rockwell International Corporation, now named Rockwell
Automation, Inc. (Rockwell), Conexant assumed responsibility for all contingent
liabilities and current and future litigation (including environmental and
intellectual property proceedings) against Rockwell or its subsidiaries in
respect of the semiconductor systems business of Rockwell. Texas Instruments, Inc.The Companys GlobespanVirata subsidiary has been
involved in a dispute with Texas Instruments, Inc. (Texas Instruments) over a
group of patents (and related foreign patents) that Texas Instruments alleges
are essential to certain industry standards for implementing ADSL technology.
On June 12, 2003, GlobespanVirata filed a complaint against Texas Instruments,
Stanford University and its Board of Trustees, and Stanford University OTL, LLC
(collectively, the Defendants) in the U.S. District Court of New Jersey. The
complaint asserts, among other things, that the Defendants have violated the
antitrust laws by creating an illegal patent pool, by manipulating the patent
process and by abusing the process for setting industry standards related to
ADSL technology. The complaint also asserts that the Defendants patents
relating to ADSL are unenforceable, invalid and/or not infringed by
GlobespanVirata products. GlobespanVirata is seeking, among other things, (i)
a finding that the Defendants have violated the federal antitrust laws and
treble damages based upon such a finding, (ii) an injunction prohibiting the
Defendants from engaging in anticompetitive practices, (iii) a declaratory
judgment that the claims of the Defendants ADSL patents are invalid,
unenforceable, void, and/or not infringed by GlobespanVirata and (iv) an
injunction prohibiting the Defendants from pursuing patent litigation against
GlobespanVirata and its customers. On August 11, 2003 and September 9, 2003,
the Defendants answered the complaint, denied GlobespanViratas claims and
filed counterclaims alleging that GlobespanVirata has infringed certain of
their ADSL patents. In addition to other relief, the Defendants are seeking to
collect damages from alleged past infringement and to enjoin GlobespanVirata
from continuing to use the Defendants ADSL patents. Although the Company
believes that GlobespanVirata has strong arguments in favor of its position in
this dispute, it can give no assurance that GlobespanVirata will prevail on any
of these grounds in litigation. If any such litigation is adversely resolved,
GlobespanVirata could be held responsible for the payment of damages and/or
have the sale of certain of GlobespanVirata products stopped by an injunction,
which could have a material adverse effect on the Companys business, financial
condition and results of operations. Agere Systems, Inc. On October 17, 2002, Agere Systems, Inc. (Agere) filed
suit against Intersil Corporation (Intersil) in the U.S. District Court of
Delaware. Agere alleges that Intersil infringes certain of its U.S. patents.
Intersil has counterclaimed against Agere for infringement of certain patents,
some of which are now owned by the Companys GlobespanVirata subsidiary and
licensed to Intersil for purposes of the suit. The parties have filed a
stipulated order adding GlobespanVirata as a party to the suit. On July 22,
2003, Agere filed a separate suit against Intersil in the U.S. District Court
of Delaware alleging that Intersil infringes certain additional U.S. patents.
GlobespanVirata has also been added as a party to this action. GlobespanVirata
has the benefit of an indemnity from Intersil limiting its liability for
monetary damages related to these suits, but the possibility exists that the
court could issue an injunction against future sales of affected wireless
products. The Company believes that this litigation will not have a material
adverse effect on its business, financial condition, or results of operations. On October 30, 2002, Intersil and certain of its affiliated companies filed a
suit against Agere in the U.S. District Court for the District of Philadelphia
alleging that Agere misappropriated certain Media Access Control Wireless Local
Area Network technology. This action seeks an injunction to prevent Agere,
either alone or in cooperation with others, from developing, making, and/or
selling products that use that technology. Agere has made similar
counterclaims against GlobespanVirata and its affiliated companies and Intersil
and its affiliated companies. As a result of the acquisition of Intersils
WLAN Products Group and its Choice-Intersil Microsystems, Inc. subsidiary,
which is a party to this suit and the only remaining plaintiff, GlobespanVirata
has become involved in this suit. GlobespanVirata has the benefit of an
indemnity from Intersil limiting its liability for monetary damages, but the
possibility exists that the court could issue an injunction against future
sales of affected wireless products. The Company believes that this litigation
will not have a material adverse effect on its business, financial condition,
or results of operations. IPO Litigation.In November 2001, Collegeware Asset Management, LP, on behalf
of itself and a putative class of persons who purchased GlobespanViratas
common stock between June 23, 1999 and December 6, 2000, filed a complaint in
the U. S. District Court for the Southern District of New York alleging
violations of federal securities laws by the underwriters of GlobespanViratas
initial and secondary public offerings as well as certain 15




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CONEXANT SYSTEMS, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(unaudited) GlobespanVirata officers and directors. The complaint alleges that the
defendants violated federal securities laws by issuing and selling
GlobespanViratas common stock in the initial and secondary offerings without
disclosing to investors that the underwriters had (1) solicited and received
undisclosed and excessive commissions or other compensation and (2) entered
into agreements requiring certain of their customers to purchase the stock in
the aftermarket at escalating prices. The complaint seeks unspecified damages.
The complaint was consolidated with approximately 300 other actions making
similar allegations regarding the public offerings of hundreds of other
companies during 1998 through 2000. In June 2003, the issuers, the individual
defendants and plaintiffs reached a tentative settlement agreement that would,
among other things, result in the dismissal with prejudice of all claims
against GlobespanViratas officers and directors. The settlement remains
subject to a number of conditions, including class certification and approval
of the settlement by the court. It is possible that the parties will not reach
agreement on the final settlement or that the settlement will not be approved.
Even if the settlement is approved, individual class members will have an
opportunity to opt out of the class and to file their own lawsuits, and some
may do so. In either event, the Company believes that the GlobespanVirata
officers and directors have meritorious defenses to the plaintiffs claims and
expects that those defendants will defend themselves vigorously. The Company
also believes that it has sufficient insurance coverage to cover any
indemnification obligations to the directors and officers related to this
litigation. The outcome of litigation cannot be predicted with certainty and some lawsuits,
claims or proceedings may be disposed of unfavorably to the Company. Many
intellectual property disputes have a risk of injunctive relief and there can
be no assurance that a license will be granted. Injunctive relief could have a
material adverse effect on the financial condition or results of operations of
the Company. Based on its evaluation of matters which are pending or asserted
and taking into account the Companys reserves for such matters, management
believes the disposition of such matters will not have a material adverse
effect on the financial condition or results of operations of the Company. The Company has been designated as a potentially responsible party and is
engaged in groundwater remediation at one Superfund site located at a former
silicon wafer manufacturing facility and steel fabrication plant in Parker
Ford, Pennsylvania formerly occupied by the Company. In addition, the Company
is engaged in remediation of groundwater contamination at its former Newport
Beach, California wafer fabrication facility. Management currently estimates
the aggregate remaining costs for these remediations to be approximately $3.1
million and has accrued for these costs as of March 31, 2004. The Company leases certain facilities and equipment under non-cancelable
operating leases which expire at various dates through 2021 and contain various
provisions for rental adjustments including, in certain cases, adjustments
based on increases in the Consumer Price Index. The leases generally contain
renewal provisions for varying periods of time. Rental expense under operating
leases was approximately $9.7 million and $8.4 million for the six months ended
March 31, 2004 and 2003, respectively. At March 31, 2004, future minimum lease payments under operating leases were as
follows (in thousands): Fiscal Year2004 remaining 6 months
    
    $
    12,7412005
    
    
    23,3702006
    
    
    18,5632007
    
    
    14,8762008
    
    
    11,059Thereafter
    
    
    63,431Total future minimum lease payments
    
    $
    144,040
 The summary of future minimum lease payments includes an aggregate of $21.6
million of lease obligations that principally expire through fiscal 2011, which
have been accrued for in connection with the Companys restructuring actions
(see Note 7). The Company purchases a substantial portion of its requirements for
silicon-based semiconductor products from Jazz Semiconductor, Inc. (Jazz).
During the first two years of the long-term supply arrangement entered into
with 16




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CONEXANT SYSTEMS, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(unaudited) Jazz in March 2002, the Companys cost of wafers was an amount which
approximated its historical cost. Thereafter, the cost of wafers is based on
market prices. Additionally, the Company is obligated to purchase certain
minimum annual volumes of wafers during the first three years of the
arrangement. In the event the Companys actual wafer purchases are less than
the required minimum volumes, it will be required to make additional payments
to Jazz. The Companys expected minimum purchase obligations under the
long-term supply agreement with Jazz, net of a portion of the wafer purchase
obligations assumed by a third party, will be approximately $13.1 million for
the remainder of fiscal year 2004 and $13.1 million in fiscal 2005. Additionally, the Company entered into a long-term supply agreement with
Skyworks in June 2002, under which Skyworks provides semiconductor assembly and
test services at the Companys former Mexicali, Mexico facility. Under this
supply agreement, the Company is obligated to purchase certain minimum amounts
of assembly and test services for the remainder of fiscal 2004 and for fiscal
2005 in the amounts of $11.7 million and $10.9 million, respectively. In the
event the Companys purchases of assembly and test services are less than the
required minimum amounts, it will be required to make additional payments to
Skyworks. The Company currently anticipates meeting each of the annual minimum purchase
obligations under the long-term supply agreements with Jazz and Skyworks. At March 31, 2004, the Company is contingently liable for approximately $31.3
million in operating lease commitments on facility leases that were assigned to
Mindspeed and Skyworks at the time of their separation from the Company. In connection with certain non-marketable equity investments, the Company may
be required to invest up to an additional $8.0 million as of March 31, 2004. 6. Comprehensive Loss Comprehensive loss is as follows (in thousands): Three months ended
    
    Six months endedMarch 31,
    
    March 31,2004
    
    2003
    
    2004
    
    2003Net loss
    
    $
    (143,379
    )
    
    $
    (68,024
    )
    
    $
    (102,732
    )
    
    $
    (693,397
    )Other comprehensive income (loss):Foreign currency translation adjustments
    
    
    444
    
    
    
    (1,412
    )
    
    
    902
    
    
    
    723Change in unrealized gains on
available-for-sale securities, net of
tax
    
    
    2,130
    
    
    
    (1,445
    )
    
    
    1,851
    
    
    
    603Minimum pension liability adjustments
    
    
    87
    
    
    
    33
    
    
    
    173
    
    
    
    1,595Other comprehensive income (loss)
    
    
    2,661
    
    
    
    (2,824
    )
    
    
    2,926
    
    
    
    2,921Comprehensive loss
    
    $
    (140,718
    )
    
    $
    (70,848
    )
    
    $
    (99,806
    )
    
    $
    (690,476
    )
 The components of accumulated other comprehensive loss are as follows (in
thousands): March 31,
    
    September 30,2004
    
    2003Foreign currency translation adjustments
    
    $
    (2,121
    )
    
    $
    (3,023
    )Unrealized gains on available-for-sale securities, net of tax
    
    
    3,758
    
    
    
    1,907Minimum pension liability adjustments
    
    
    (8,207
    )
    
    
    (8,380
    )Accumulated other comprehensive loss
    
    $
    (6,570
    )
    
    $
    (9,496
    )
 17




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CONEXANT SYSTEMS, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(unaudited) 7. Special Charges Special charges consist of the following (in thousands): Three months ended
    
    Six months endedMarch 31,
    
    March 31,2004
    
    2003
    
    2004
    
    2003Asset impairments
    
    $
    1,873
    
    
    $
    285
    
    
    $
    2,026
    
    
    $
    2,481Restructuring charges
    
    
    
    
    
    
    
    
    
    
    448
    
    
    
    1,904Integration charges
    
    
    2,599
    
    
    
    
    
    
    
    2,603
    
    
    
    Other special charges
    
    
    1,042
    
    
    
    
    
    
    
    1,042
    
    
    
    2,674$
    5,514
    
    
    $
    285
    
    
    $
    6,119
    
    
    $
    7,059
 Asset Impairments During the first six months of 2003, the Company recorded asset impairment
charges of $2.5 million, related to leasehold improvements associated with
properties no longer occupied by the Company and other assets that management
determined to abandon or scrap. During the second fiscal quarter of 2004 in connection with the GlobespanVirata
merger, the Company recorded asset impairment charges of $1.9 million related
to various Conexant operating assets which were determined to be redundant and
no longer required as a result of the merger. These assets have been
abandoned. Restructuring Charges In fiscal 2001 and continuing into fiscal 2003, the Company implemented a
number of cost reduction initiatives to improve its operating cost structure.
The cost reduction initiatives included workforce reductions, temporary
shutdowns of the Companys manufacturing facilities, significant reductions in
capital spending, the closure or consolidation of certain facilities and salary
reductions for the senior management team until the Company returned to
profitability. In the second quarter of fiscal 2004 in connection with the
GlobespanVirata merger, the Company implemented further workforce reductions
and facility consolidations. The costs and expenses associated with the
restructuring activities are included in special charges in the accompanying
consolidated condensed statements of operations. 2002 Corporate and Manufacturing Restructuring Plan During fiscal 2002, the
Company initiated a further reduction of its workforce throughout its
operations primarily as a result of the divestiture of its Newport Beach wafer
fabrication operations and the spin-off of its former wireless communications
division. In connection with the fiscal 2002 corporate and manufacturing
restructuring actions, the Company terminated approximately 120 employees and
recorded charges aggregating $2.4 million based upon estimates of the cost of
severance benefits for the affected employees. The Company completed these
actions in fiscal 2002. In addition, the Company recorded restructuring
charges of $12.5 million for costs associated with the consolidation of certain
facilities and commitments under license obligations that management determined
would not be used in the future. As part of the 2002 Corporate and Manufacturing Restructuring Plan, during the
first quarter of fiscal 2003, the Company initiated a further workforce
reduction affecting 58 employees and recorded additional charges of $1.9
million based upon estimates of the cost of severance benefits for the affected
employees. During the third quarter of fiscal 2003, the Company revised its
estimate of liabilities for severance benefits and facility costs due to
unfavorable sublease experience to date, and charged an additional $1.5 million
to restructuring expense. In the fourth quarter of 2003, the Company reversed
$1.1 million of the estimated cost to settle the remaining commitment under a
license obligation after its favorable resolution, and increased the estimate
of remaining facility costs due to unfavorable sublease experience. 18




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CONEXANT SYSTEMS, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(unaudited) Activity and liability balances related to the 2002 Corporate and Manufacturing
Restructuring Plan through March 31, 2004 were as follows (in thousands): Workforce
    
    Facilityreductions
    
    and other
    
    TotalCharged to costs and expenses
    
    $
    2,437
    
    
    $
    12,519
    
    
    $
    14,956Cash payments
    
    
    (1,664
    )
    
    
    (431
    )
    
    
    (2,095
    )Restructuring balance, September 30, 2002
    
    
    773
    
    
    
    12,088
    
    
    
    12,861Charged to costs and expenses
    
    
    2,898
    
    
    
    888
    
    
    
    3,786Expense reversal
    
    
    
    
    
    
    (1,100
    )
    
    
    (1,100
    )Cash payments
    
    
    (3,173
    )
    
    
    (3,930
    )
    
    
    (7,103
    )Restructuring balance, September 30, 2003
    
    
    498
    
    
    
    7,946
    
    
    
    8,444Cash payments
    
    
    (266
    )
    
    
    (2,111
    )
    
    
    (2,377
    )Restructuring balance, March 31, 2004
    
    $
    232
    
    
    $
    5,835
    
    
    $
    6,067
 2003 Corporate Restructuring Plan In the fourth quarter of fiscal 2003, the
Company initiated another workforce reduction, closed a design center and
consolidated some facilities. The Company involuntarily terminated
approximately 35 employees in the sales and administration areas and recorded
charges aggregating $1.2 million based upon estimates of the cost of severance
benefits for the affected employees. The Company also recorded restructuring
costs of $2.8 million relating to the consolidation of certain facilities under
non-cancelable leases which were vacated. In the first quarter of fiscal 2004,
as a continuation of the 2003 Corporate Restructuring Plan, the Company vacated
an additional facility and involuntarily terminated additional employees which
resulted in an additional $0.4 million in restructuring expense. Activity and liability balances related to the 2003 Corporate Restructuring
Plan through March 31, 2004 were as follows (in thousands): Workforce
    
    Facilityreductions
    
    and other
    
    TotalCharged to costs and expenses
    
    $
    1,181
    
    
    $
    2,830
    
    
    $
    4,011Cash payments
    
    
    (364
    )
    
    
    
    
    
    
    (364
    )Restructuring balance, September 30, 2003
    
    
    817
    
    
    
    2,830
    
    
    
    3,647Charged to costs and expenses
    
    
    350
    
    
    
    98
    
    
    
    448Cash payments
    
    
    (849
    )
    
    
    (597
    )
    
    
    (1,446
    )Restructuring balance, March 31, 2004
    
    $
    318
    
    
    $
    2,331
    
    
    $
    2,649
 2004 Merger Restructuring and Reorganization Plan In connection with the
GlobespanVirata merger, in order to achieve operational efficiencies, the
Company intends to implement workforce reductions and facilities consolidation
actions through December 2004 and will charge such amounts to restructuring
expense in the period when the required actions are taken. There were no
charges related to the Company in the quarter ended March 31, 2004. As the
restructuring progresses, approximately 200 employees of the Company, including
approximately 55 employees of GlobespanVirata in the 2004 Reorganization Plan
described below, will be impacted by the action. The Company expects to record
charges against earnings of approximately $4 million by the end of the fiscal
year as the actions are completed. In connection with the GlobespanVirata merger, the Company also began to
formulate the 2004 Reorganization Plan, which consisted primarily of workforce
reductions to eliminate redundant positions and consolidation of the worldwide
facilities of GlobespanVirata. In accordance with EITF 95-3 and SFAS No. 141,
the estimated costs of $14.8 million related to these actions were accrued as
liabilities as part of the purchase price allocation (see Note 2). As a result of the 2004 Reorganization Plan, approximately 55 employees of
GlobespanVirata will be part of an involuntary workforce reduction. These
employees are primarily located in the United States in sales and
administrative functions. The workforce related charges of $1.3 million were
based upon estimates of the severance and fringe benefits for the affected
employees. The plan for consolidation of worldwide facilities consisted of
vacating or impairing properties and leases. This resulted in a charge of
$13.5 million and included assumptions regarding sublease rates and time
periods and other costs to prepare and sublease those spaces. Additionally,
there has been a decline in the real estate market in certain geographic
regions in which GlobespanVirata has lease facilities. A portion of the
facilities-related charges represent adjustments to fair market value rates of
those leases. 19




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CONEXANT SYSTEMS, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(unaudited) These non-cancelable lease commitments range from near term to 17 years in
length. Future adjustments to the 2004 Reorganization Plan as currently
intended, whether favorable or unfavorable, will be recorded as an adjustment
to the purchase price allocation. Activity and liability balances related to the 2004 Reorganization Plan through
March 31, 2004 were as follows (in thousands): Workforce
    
    Facilityreductions
    
    and other
    
    TotalRecorded in purchase price allocation
    
    $
    1,300
    
    
    $
    13,509
    
    
    $
    14,809Cash payments
    
    
    
    
    
    
    (89
    )
    
    
    (89
    )Restructuring balance, March 31, 2004
    
    $
    1,300
    
    
    $
    13,420
    
    
    $
    14,720
 At March 31, 2004, the Company has a remaining accrued restructuring and
reorganization liability balance of $23.4 million. The Company expects to pay
the amounts accrued for the workforce reductions during fiscal 2004 and expects
to pay the obligations for the non-cancelable lease and other commitments over
their respective terms, which expire through fiscal 2021. Cash payments to
complete the restructuring and reorganization actions will be funded from
available cash reserves and funds from product sales, and are not expected to
significantly impact the Companys liquidity. Integration Charges In the second fiscal quarter of 2004, the Company incurred $2.6 million of
costs related to the integration efforts of the employees, customers,
operations and other business aspects of the newly combined businesses of
Conexant and GlobespanVirata. Other Special Charges Other special charges in the first six months of 2003 principally consist of a
$2.7 million loss on the sale of certain semiconductor test equipment. Other
special charges in the second fiscal quarter of 2004 of $1.0 million
principally consist of one-time executive bonuses. 8. Segment Information The Company operates and tracks its results in one segment (see Note 1). Net revenues by geographic area, based upon country of destination, are as
follows (in thousands): Three months ended
    
    Six months endedMarch 31,
    
    March 31,2004
    
    2003
    
    2004
    
    2003Americas
    
    $
    25,542
    
    
    $
    15,796
    
    
    $
    47,943
    
    
    $
    35,028Asia-Pacific
    
    
    198,298
    
    
    
    113,862
    
    
    
    338,660
    
    
    
    226,975Europe, Middle East and Africa
    
    
    19,941
    
    
    
    10,465
    
    
    
    34,511
    
    
    
    22,321$
    243,781
    
    
    $
    140,123
    
    
    $
    421,114
    
    
    $
    284,324
 The Company believes a substantial portion of the products sold to original
equipment manufacturers (OEMs) and third-party manufacturing service providers
in the Asia-Pacific region are ultimately shipped to end-markets in the
Americas and Europe. For the three and six months ended March 31, 2004, no
customer accounted for 10% of net revenues. For each of the three and six
months ended March 31, 2003, one customer (a foreign reseller) accounted for
13% of net revenues. No other customer accounted for 10% or more of the
Companys net revenues for the three or six months ended March 31, 2003. 20




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CONEXANT SYSTEMS, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(unaudited) 9. Guarantees The Company has made guarantees and indemnities, under which it may be required
to make payments to a guaranteed or indemnified party, in relation to certain
transactions. In connection with the Companys spin-off from Rockwell, the
Company assumed responsibility for all contingent liabilities and then current
and future litigation (including environmental and intellectual property
proceedings) against Rockwell or its subsidiaries in respect of the operations
of the semiconductor systems business of Rockwell. In connection with the
Companys contribution of certain of its manufacturing operations to Jazz
Semiconductor, Inc. (Jazz), the Company agreed to indemnify Jazz for certain
environmental matters and other customary divestiture-related matters. In
connection with the sales of its products, the Company provides intellectual
property indemnities to its customers. In connection with certain facility
leases, the Company has indemnified its lessors for certain claims arising from
the facility or the lease. The Company indemnifies its directors and officers
to the maximum extent permitted under the laws of the State of Delaware. The
duration of the guarantees and indemnities varies, and in many cases is
indefinite. The guarantees and indemnities to customers in connection with
product sales generally are subject to limits based upon the amount of the
related product sales. The majority of other guarantees and indemnities do not
provide for any limitation of the maximum potential future payments the Company
could be obligated to make. The Company has not recorded any liability for
these guarantees and indemnities in the accompanying consolidated balance
sheets. Product warranty costs are not significant. 10. Mindspeed Credit Facility In connection with the Mindspeed Spin, the Company entered into a senior
secured revolving credit facility pursuant to which Mindspeed may borrow up to
$50.0 million for working capital and general corporate purposes. Mindspeed
may borrow under the credit facility only to restore its cash balance to $25.0
million. Borrowings accrue interest at 10% per annum, payable at maturity, and
are collateralized by substantially all the assets of Mindspeed. The credit
facility expires on June 29, 2007. As of March 31, 2004, no amounts were
outstanding under the credit facility. In connection with the credit facility, Mindspeed issued to the Company
warrants to purchase up to approximately 8.3 million shares of Mindspeed common
stock. The number of shares that may be acquired under the warrants will
depend on the level of borrowings under the credit facility, increasing pro
rata as the principal balance of Mindspeeds borrowings increases. The
warrants will be exercisable for a period of ten years after the Mindspeed Spin
at a price per share equal to the fair market value of a share of Mindspeed
common stock at the time of issuance of the warrants or at the time of the
borrowing that entitles the Company to acquire shares thereunder, whichever is
lower. 11. Subsequent Events On April 22, 2004 SiRF Technology Holdings, Inc. (SiRF) commenced its initial
public offering of shares of its common stock at a public offering price of
$12.00 per share. Prior to the offering the Company owned approximately 8.4
million shares of SiRF common stock. The Company sold approximately 2.5
million shares in the SiRF offering for net proceeds of $28.2 million and will
record a related gain of approximately $26.5 million. After the offering the
Company will continue to hold approximately 5.9 million shares of SiRF common
stock representing approximately 13.5% of SiRFs outstanding shares. The
investment will be classified as a short-term investment and changes in market
value will be reported in other comprehensive income. SiRF common stock trades
on the Nasdaq National Market under the symbol SIRF. The Company received a notice dated April 22, 2004 from Skyworks advising that
Skyworks would redeem in full on May 12, 2004 the 15% convertible senior
subordinated notes held by the Company. The Company exercised its right to
convert all of the notes into 5,717,916 shares of Skyworks common stock prior to the
scheduled redemption date at a conversion price of $7.87 per share. 21




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ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS This information should be read in conjunction with our unaudited consolidated
condensed financial statements and the notes thereto included in this Quarterly
Report, and our audited consolidated financial statements and notes thereto and
Managements Discussion and Analysis of Financial Condition and Results of
Operations contained in our Annual Report on Form 10-K for the fiscal year
ended September 30, 2003. Overview Except where otherwise noted, this discussion of our financial condition and
results of operations represents our continuing operations, excluding our
discontinued Mindspeed Technologies business which we spun off in June 2003.
See Note 1 of Notes to Consolidated Condensed Financial Statements for further
information on this transaction. We are a leading provider of integrated circuits and software for broadband
communications solutions addressing consumer, business enterprise and service
provider markets. Our expertise in mixed-signal processing allows us to deliver
semiconductor devices and complete integrated systems that connect the client,
or end-customer, side of personal communications access products such as PCs,
set-top boxes, residential gateways and game consoles to audio, video, voice
and data services over broadband wire line communications networks, including
virtually all varieties of digital subscriber line (DSL), cable and Ethernet
networks, over wireless local area networks and over direct broadcast
satellite, terrestrial and fixed wireless systems. We also deliver highly
integrated, system-level solutions for telephone company central office
equipment, such as digital subscriber line access multiplexers (DSLAMs) used in
the provisioning of broadband audio, video, voice and data services. Our
dial-up access products include a broad portfolio of modem chipsets and
software for desktop and notebook PC applications as well as embedded equipment
applications including fax machines, multifunction peripherals (MFPs),
point-of-sale (POS) terminals, set-top boxes, gaming consoles and Internet
terminals. Our wide variety of wireless networking chip sets and reference
designs enable wireless connectivity in notebooks, PDAs, digital cameras, MP3
players and other handheld networking appliances in the home and business
enterprise environments. And our media processing solutions include silicon
tuners, demodulators and a variety of broadcast audio and video decoder and
encoder devices that enable the capture, display, storage, playback and
transfer of audio and video content in consumer-oriented products such as PCs,
set-top boxes, gaming consoles, personal video recorders and digital versatile
disk (DVD) applications. We operate in one business segment. We market and sell our semiconductor products and system solutions directly to
leading original equipment manufacturers (OEMs) of communication electronics
products, and indirectly through electronic components distributors. We also
sell our products to third-party electronic manufacturing service providers,
who manufacture products incorporating our semiconductor products for OEMs.
Sales to distributors and other resellers accounted for approximately 38% of net revenues in the
first six months of fiscal 2004. No customer accounted for 10% of our net
revenues in the first six months of fiscal 2004. Our top 20 customers
accounted for approximately 73% of net revenues for the first six months of
fiscal 2004. Revenues derived from customers located in the Americas, Europe
and the Asia-Pacific region were 11%, 8% and 81%, respectively, of our net
revenues for the first six months of fiscal 2004. We believe a substantial
portion of the products we sell to OEMs and third-party manufacturing service
providers in the Asia-Pacific region are ultimately shipped to end-markets in
the Americas and Europe. Merger with GlobespanVirata, Inc. On February 27, 2004, we completed our merger with GlobespanVirata, Inc.
(GlobespanVirata), a provider of broadband communications solutions for
consumer, enterprise and service provider markets. The transaction was
accounted for under the purchase method of accounting with Conexant as the
acquiror for accounting purposes. In exchange for 100% of the outstanding
shares of common stock of GlobespanVirata (approximately 150.7 million shares),
we issued 1.198 shares of our common stock (or a total of approximately 180.6
million shares) for each share of GlobespanVirata common stock outstanding, and
each outstanding option to purchase GlobespanVirata common stock was adjusted
and converted into an option to purchase our common stock based on the 1.198
merger ratio (or options to purchase a total of approximately 43.6 million
shares of our common stock). Total purchase 22




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##### Table of Contents



consideration was approximately $1.1 billion. See Note 2 of Notes to
Consolidated Condensed Financial Statements for further information. The
results of operations of GlobespanVirata have been included in our consolidated
results commencing February 28, 2004. The merger with GlobespanVirata added
net revenues of $83.2 million, gross margin of $32.2 million, research and
development expenses of $11.2 million, and selling, general and administrative
expenses of $6.6 million. These amounts, which represent five weeks of
activity at the end of our second fiscal quarter, are not necessarily
indicative of future quarterly results, as the timing of revenues and expenses
may occur unevenly during a fiscal quarter. Results of Operations Net Revenues We recognize revenues from
product sales upon shipment and transfer of title, in accordance with
the shipping terms specified in the arrangement with the direct customer,
distributor, or other reseller. Revenue recognition is deferred in
all instances where the earnings process is incomplete. We sell a
portion of our products to electronic component distributors under
agreements allowing for a right to return unsold products. We defer
the recognition of revenue on all sales to these distributors until
the products are sold by the distributors to a third party. We record
a reserve for sales returns and allowances for direct customers and
other resellers based on historical experience or specific
identification of an event necessitating a reserve. Development
revenue is recognized when services are performed and was not
significant for any of the periods presented. The following table
summarizes our net revenues: Three months endedChange from
    
    Change fromMarch 31,
    
    Dec. 31,
    
    March 31,
    
    Dec. 2003
    
    March 2003(in millions)
    
    2004
    
    2003
    
    2003
    
    Quarter
    
    QuarterNet revenues
    
    $
    243.8
    
    
    $
    177.3
    
    
    $
    140.1
    
    
    
    37
    %
    
    
    74
    %Six months ended March 31,2004
    
    2003
    
    ChangeNet revenues
    
    $
    421.1
    
    
    $
    284.3
    
    
    
    48
    %
 Net revenues for the three months ended March 31, 2004, which included
GlobespanVirata from February 28, 2004, increased $103.7 million or 74% over
the comparable period in 2003. The increase is attributable to increased
volumes of DSL and wireless LAN products associated with the GlobespanVirata
merger, as well as increases in satellite set-top box solutions, convergence
video products using MPEG codec technology, higher speed document imaging
products and soft modem revenues from products acquired from PCTEL in the third
quarter of fiscal 2003. Net revenues for the six months ended March 31, 2004 increased $136.8 million
or 48% over the comparable period in 2003. This increase is associated with
increased unit shipments of our DSL and wireless LAN products associated with
the GlobespanVirata merger, as well as satellite set-top box solutions,
convergence video products using MPEG codec technology, higher speed document
imaging products, embedded modem solutions and soft modem revenues from
products acquired from PCTEL in the third quarter of fiscal 2003. Net revenues for the three months ended March 31, 2004 increased $66.4 million
or 37% sequentially from the previous quarter. The increase was driven by
increased volume shipments of DSL and wireless LAN products associated with the
GlobespanVirata merger, partially offset by seasonal declines of our universal
access modems and our MPEG codec products. 23




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##### Table of Contents



Gross Margin


Three months endedChange from
    
    Change fromMarch 31,
    
    Dec. 31,
    
    March 31,
    
    Dec. 2003
    
    March 2003(in millions)
    
    2004
    
    2003
    
    2003
    
    Quarter
    
    QuarterGross margin
    
    $
    101.7
    
    
    $
    79.1
    
    
    $
    62.0

    
    
    
    28
    %
    
    
    64
    %Percent of net revenues
    
    
    42
    %
    
    
    45
    %
    
    
    44
    %Six months ended March 31,2004
    
    2003
    
    ChangeGross margin
    
    $
    180.8
    
    
    $
    124.8
    
    
    
    45
    %Percent of net revenues
    
    
    43
    %
    
    
    44
    % Gross margin represents net revenues less cost of goods sold. As a fabless
semiconductor company, we use third parties for wafer production, assembly and
test services. Our cost of goods sold consists predominantly of purchased
finished wafers, assembly and test services, royalty and other intellectual
property costs and labor and overhead associated with product procurement. Our gross margin for the second quarter of fiscal 2004 was 42% compared with
the similar period of fiscal 2003 gross margin of 44%. Gross margin would have
been 42% in the 2003 period excluding the sales of inventory previously written
down to zero cost. Consequently the gross margin percentage remained
consistent year over year as the effect of additional revenues of lower margin
products were offset by cost reduction actions. Our gross margin for the first six months of fiscal 2004 was 43% compared with
the similar period of fiscal 2003 gross margin of 44%. Gross margin would have
been 40% in the 2003 period excluding the sales of inventory previously written
down to zero cost. The increase from year to year in gross margin percentage
reflects the additional revenues from our higher margin universal access and
convergence video products, as well as reductions in vendor inventory prices. When compared with the immediately preceding quarter, our gross margins for the
second quarter of fiscal 2004 decreased to 42% from 45% of net revenues. This
decrease is primarily due to additional revenues of lower margin DSL and
wireless LAN products associated with the GlobespanVirata merger combined with
reduced revenues of higher margin universal access and convergence video
products after the seasonally strong December quarter. Manufacturing cost
reductions and lower royalty costs helped to offset a portion of the negative
impact. Our products are used by communications electronics OEMs that have designed our
products into communications equipment. For many of our products, we gain these
design wins through a lengthy sales cycle, which often includes providing
technical support to the OEM customer. Moreover, once a customer has designed a
particular suppliers components into a product, substituting another
suppliers components often requires substantial design changes which involve
significant cost, time, effort and risk. In the event of the loss of business
from existing OEM customers, we may be unable to secure new customers for our
existing products without first achieving new design wins. When the quantities
of inventory on hand exceed foreseeable demand from existing OEM customers into
whose products our products have been designed, we generally will be unable to
sell our excess inventories to others, and the estimated realizable value of
such inventories to us is generally zero. Once established, these write-downs
are considered permanent adjustments to the cost basis of the excess inventory.
Permanent write-downs are typically a consequence of specific events. For
example during 2001, we experienced sharply reduced end-customer demand when
the overall communication semiconductor market declined swiftly and
dramatically, resulting in a significant number of order cancellations and a
decline in the volume of new orders. These events triggered a permanent
impairment of certain of our inventory. Our gross margin for the second quarter and the first six months of fiscal 2003
benefited from the sale of inventories with an original cost of $3.8 million
and $10.9 million, respectively, that we had written down to a zero cost basis
during fiscal year 2001. These sales resulted from renewed demand for certain
products that was not anticipated at the time of the write-downs. The
previously written-down inventories were generally sold at prices which
exceeded their original cost. Had we not previously written down the cost basis
of these goods, our cost of goods sold would include the original cost of such
goods, and our gross margin for the second quarter and first six
months of fiscal 2003 24




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##### Table of Contents



would have been $58.2 million (42% of our net revenues) and $113.9
million (40% of our net revenues), respectively. As of June 30, 2003, all such
inventories had been scrapped or sold. On an operational basis and unrelated to any significant single event we assess
the recoverability of our inventories at least quarterly through a review of
inventory levels in relation to foreseeable demand (generally over six to
twelve months). Foreseeable demand is based upon all available information,
including sales backlog and forecasts, product marketing plans and product life
cycles. When the inventory on hand exceeds the foreseeable demand, we reserve
for the excess which, at the time of our review, we expect to be unable to
sell. The amount of the inventory reserve is the excess of historical cost over
estimated realizable value. We base our assessment of the recoverability of our inventories, and the
amounts of any reserves, on currently available information and assumptions
about future demand and market conditions. Demand for our products may
fluctuate significantly over time, and actual demand and market conditions may
be more or less favorable than those projected by management. In the event that actual demand is lower than
originally projected, additional inventory reserves may be required. Under our long-term supply arrangement with Jazz Semiconductor, Inc. (Jazz), we
are obligated to purchase certain minimum annual volumes of wafers through
March 2005. Additionally, under a long-term supply agreement with Skyworks, we
are obligated to purchase certain minimum amounts of assembly and test services
during fiscal years 2004 and 2005. In the event our actual purchases under
these arrangements are less than the required minimum volumes, we will be
required to make additional payments, which would adversely affect our gross
margin. We currently anticipate meeting each of the annual minimum purchase
obligations under the long-term supply agreements with Jazz and Skyworks. Research and Development Three months endedChange from
    
    Change fromMarch 31,
    
    Dec. 31,
    
    March 31,
    
    Dec. 2003
    
    March 2003(in millions)
    
    2004
    
    2003
    
    2003
    
    Quarter
    
    QuarterResearch and development
    
    $
    53.7
    
    
    $
    39.2
    
    
    $
    38.7
    
    
    
    37
    %
    
    
    39
    %Percent of net revenues
    
    
    22
    %
    
    
    22
    %
    
    
    28
    %Six months ended March 31,2004
    
    2003
    
    ChangeResearch and development
    
    $
    92.9
    
    
    $
    79.0
    
    
    
    18
    %Percent of net revenues
    
    
    22
    %
    
    
    28
    %
 Our research and development (R&D) expenses consist principally of direct
personnel costs to develop new communications and semiconductor products,
photomask and other costs for pre-production evaluation and testing of new
devices and design and test tool costs. Our R&D expenses also include the costs
for design automation and advanced package development. The $15.0 million increase in R&D expenses for the second quarter of fiscal
2004 compared to the similar period of fiscal 2003 primarily reflects
additional development costs associated with DSL and wireless LAN products as a
result of our merger with GlobespanVirata, and to a much lesser extent,
increased R&D project costs associated with increases in labor, purchased R&D
and electronic design automation tools. The $13.9 million increase in R&D expenses for the six months ended March 31,
2004 compared to the similar period of fiscal 2003 primarily reflects
additional headcount to support the development of DSL and wireless LAN
products as a result of our merger with GlobespanVirata, and to a much lesser
extent, increased R&D project costs associated with labor, purchased R&D,
electronic design automation tools and recruiting. When compared to the immediately preceding quarter, R&D increased $14.5 million
to $53.7 million from $39.2 million. This increase reflects additional
development costs associated with DSL and wireless LAN products as a result of
our merger with GlobespanVirata. In addition, R&D project costs also increased
as labor, photomask and electronic design automation tool costs were slightly
higher. 25




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##### Table of Contents



Selling, General and Administrative Three months endedChange from
    
    Change fromMarch 31,
    
    Dec. 31,
    
    March 31,
    
    Dec. 2003
    
    March 2003(in millions)
    
    2004
    
    2003
    
    2003
    
    Quarter
    
    QuarterSelling, general and administrative
    
    $
    30.6
    
    
    $
    22.8
    
    
    $
    23.8
    
    
    
    34
    %
    
    
    29
    %Percent of net revenues
    
    
    13
    %
    
    
    13
    %
    
    
    17
    %Six months ended March 31,2004
    
    2003
    
    ChangeSelling, general and administrative
    
    $
    53.4
    
    
    $
    46.6
    
    
    
    15
    %Percent of net revenues
    
    
    13
    %
    
    
    16
    %
 Our selling, general and administrative (SG&A) expenses include personnel
costs, sales representative commissions, advertising and other marketing costs.
Our SG&A expenses also include costs of corporate functions including legal,
accounting, treasury, human resources, real estate, information systems,
customer service, sales, marketing, field application engineering and other
services. The $6.8 and $6.9 million increases in SG&A expense for the three and six
months ended March 31, 2004, respectively, compared to the same periods of
fiscal 2003 are attributable to SG&A costs of GlobespanVirata as a result of
our merger and reductions in bad debt charges in the quarter ended March 31,
2003 associated with improving collections experience at that time, partially
offset by a 13% decline in SG&A headcount associated with restructuring
activities. When compared to the immediately preceding quarter, SG&A increased $7.8 million
to $30.6 million from $22.8 million. This increase reflects additional SG&A
costs of GlobespanVirata as a result of our merger, as well as additional
expenses for labor and travel. Amortization of Intangible Assets Three months ended March 31,
    
    Six months ended March 31,(in millions)
    
    2004
    
    Change
    
    2003
    
    2004
    
    Change
    
    2003Amortization of intangible assets
    
    $
    3.7
    
    
    nm
    
    $
    0.8
    
    
    $
    4.6
    
    
    nm
    
    $
    1.6Percent of net revenues
    
    nm
    
    
    
    
    
    nm
    
    nm
    
    
    
    
    
    nm
 nm= not meaningful Amortization expense is recorded for intangible assets other than goodwill
pursuant to SFAS Nos. 141 and 142. SFAS No. 141 requires that all business
combinations be accounted for using the purchase method and provides new
criteria for recording intangible assets separately from goodwill. Goodwill
must be tested at least annually for impairment and written down when impaired. The increased amortization expense in the three and six months ended March 31,
2004 compared to the three and six months ended March 31, 2003 is attributable
to additional intangibles acquired in an acquisition in the latter half of
fiscal 2003 and the GlobespanVirata merger completed on February 27, 2004. See
Note 2 of Notes to Consolidated Condensed Financial Statements for further
information. We expect that amortization of intangible assets will be
approximately $15.9 million for the remainder of fiscal 2004. 26




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##### Table of Contents



In-Process Research and Development Three months ended March 31,
    
    Six months ended March 31,(in millions)

    
    2004
    
    Change
    
    2003
    
    2004
    
    Change
    
    2003In-process research and development
    
    $
    160.8
    
    
    nm
    
    $
    
    
    
    $
    160.8
    
    
    nm
    
    $
    Percent of net revenues
    
    nm
    
    
    
    
    
    nm
    
    nm
    
    
    
    
    
    nm
 nm= not meaningful The in-process research and development (IPR&D) charge of $160.8 million in the
quarter ended March 31, 2004 is related to the GlobespanVirata merger completed
on February 27, 2004. See Note 2 of Notes to Consolidated Condensed Financial
Statements for a discussion of the IPR&D. Special Charges Special charges consist of the following: Three months ended March 31,
    
    Six months ended March 31,(in millions)

    
    2004
    
    Change
    
    2003
    
    2004
    
    Change
    
    2003Restructuring charges
    
    $
    
    
    
    nm
    
    $
    
    
    
    $
    0.5
    
    
    nm
    
    $
    1.9Asset impairment charges
    
    
    1.9
    
    
    nm
    
    
    0.3
    
    
    
    2.0
    
    
    nm
    
    
    2.5Integration charges
    
    
    2.6
    
    
    nm
    
    
    
    
    
    
    2.6
    
    
    nm
    
    
    Other special charges
    
    
    1.0
    
    
    nm
    
    
    
    
    
    
    1.0
    
    
    nm
    
    
    2.7$
    5.5
    
    
    
    
    
    
    $
    0.3
    
    
    $
    6.1
    
    
    
    
    
    
    $
    7.1
 nm= not meaningful See Note 7 of Notes to Consolidated Condensed Financial Statements for a
discussion of asset impairment charges, restructuring charges, integration
charges and other special charges. Other (Income) Expense, Net Three months ended March 31,
    
    Six months ended March 31,(in millions)

    
    2004
    
    Change
    
    2003
    
    2004
    
    Change
    
    2003Other (income) expense, net
    
    $
    (9.7
    )
    
    nm
    
    $
    44.7
    
    
    $
    (35.0
    )
    
    nm
    
    $
    41.3Percent of net revenues
    
    nm
    
    
    
    
    
    nm
    
    nm
    
    
    
    
    
    nm
 nm= not meaningful Other (income) expense, net for the first six months of fiscal 2004 was
comprised of a $22.5 million increase in the fair value of the Mindspeed
warrant, a $11.5 million increase in the fair value of the conversion right
under the Skyworks 15% convertible senior subordinated note, $10.8 million of
income in our equity method investments (including a $11.4 million gain in
accordance with Staff Accounting Bulletin No. 51 for the realization of an
additional investment made by another party in Jazz Semiconductor) and $5.3
million of investment and interest income on invested cash balances, offset by
$13.9 million of interest expense on our convertible subordinated notes, and
impairments of non-marketable investments of $0.6 million. The $11.4 million
gain in our investment in Jazz Semiconductor is the result of our ownership in
Jazz decreasing from 45% to approximately 38% when the additional favorable
investment was realized. Due to variations in the fair values of the common
stock underlying the Skyworks 15% convertible senior subordinated notes and the
Mindspeed warrant, we expect that other (income) expense may fluctuate
significantly in future periods until these derivative instruments are
liquidated. Other (income) expense, net for the first six months of the previous year was
comprised of $9.5 million of investment and interest income on invested cash
balances, offset by $1.8 million decrease in the fair value of the conversion
right under the Skyworks 15% convertible senior subordinated notes, $0.8
million of losses in our equity method investments, $15.2 million of interest
expense on our convertible subordinated notes, and impairments of
non-marketable investments of $34.4 million. 27




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##### Table of Contents



As a result of the acquisition of $130.0 million of the 5.25% convertible
subordinated notes in the GlobespanVirata merger, we expect that our interest
expense will be higher in future quarters by approximately $1.7 million per
quarter. Additionally, as a result of the acquisition of approximately $199.4
million in cash, short-term and long-term investments in the merger, we expect
that our investment and interest income will be higher in future quarters. The carrying values of non-marketable investments are at cost, or their
estimated fair values, if lower. These investments consist of equity interests
in early stage technology companies which we had accounted for under the cost
method. We estimate the fair value of these investments based upon available
financial and other information, including the then-current and projected
business prospects for the subject companies, and when we determine that the
decline in the fair value of these investments is other than temporary, they
are written down to fair value. Provision for Income Taxes We recorded income tax expense of $0.7 million for each of the six months ended
March 31, 2004 and 2003, primarily reflecting taxes imposed on our foreign
subsidiaries. No federal income tax expense was recorded with respect to the
results for both periods as they will be offset by net operating loss
carryovers that have not been previously recognized. Except to the extent of
the federal alternative minimum tax, we expect this will continue for the
foreseeable future. As of September 30, 2003, Conexant had generated $668 million of deferred tax
assets and as of December 31, 2003 GlobespanVirata had $338 million of fully
reserved deferred tax assets, both of which are available to offset future tax
obligations subject to limitations imposed by section 382 of the Internal
Revenue Code. We had a valuation allowance of approximately $413.0 million for
the generated deferred tax assets that we do not expect to realize through the
reduction of future income tax payments. We believe the remaining portion of
our deferred tax assets will be realized based on our current expectations of
future earnings and tax planning strategies available to us. We evaluate the
realizability of our deferred tax assets quarterly and in the event that we
determine that we will not be able to realize all or part of our generated
deferred tax assets in the future, an adjustment to the deferred tax assets
would be charged or credited to income in the period such determination is
made. To the extent the we realize a benefit from the acquired deferred tax
assets, the benefit will be credited to goodwill. Liquidity and Capital Resources Our cash and cash equivalents increased by $58.6 million during the first six
months of fiscal 2004. Cash provided by operating activities was $26.1 million
for the first six months of fiscal 2004, compared to cash used in operating
activities of $21.1 million for the comparable period in fiscal 2003. Operating
cash flows for the first six months of fiscal 2004 reflect our loss from
continuing operations of $102.7 million, offset by non-cash charges of $136.8
million and a net increase in the components of working capital of $8.0
million. Non-cash charges consists of IPR&D of $160.8 million, depreciation
and amortization of $11.4 million, and other non-cash charges of $9.5 million,
offset by a net increase in fair value of the Mindspeed warrant and the
Skyworks note of $34.1 million, and a net increase in equity in earnings of
equity method investees of $10.8 million. The working capital increase
principally consists of a $19.5 million increase in accounts receivable offset
by a $11.3 million increase in accounts payable and accrued expenses, both
attributable to the increased size of our business and the timing of sales and
purchases at quarter end. Inventories have decreased by $6.6 million. Cash provided by investing activities of $15.3 million for the first six months
of fiscal 2004 includes cash and cash equivalents acquired in the
GlobespanVirata merger of $58.6 million, capital expenditures of $9.9 million,
net purchases of marketable securities of $14.9 million, payment of deferred
purchase consideration of $4.0 million, payment of acquisition costs of $13.2
million and investments of $1.6 million. Cash provided by investing activities
of $119.0 million in the first six months of fiscal 2003 principally consisted
of the repayment of the Skyworks note (net of the credit facility of $35.0
million), $2.1 million in proceeds from the sale of assets, partially offset by
$8.2 million of net purchases of marketable securities, capital expenditures of
$8.4 million and payments for investments of $1.5 million. Cash provided by financing activities of $17.2 million for the first six months
of fiscal 2004 consisted of proceeds from the exercise of stock options, and
cash used by financing activities in the first six months of fiscal 2003 28




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##### Table of Contents



consisted of $44.2 million in repurchases of convertible subordinated notes
offset by $1.2 million from the exercise of stock options. At March 31, 2004, we held $45.0 million principal amount of the Skyworks 15%
convertible senior subordinated notes with a maturity date of June 30, 2005.
Skyworks may redeem the 15% convertible senior subordinated notes at any time
after May 12, 2004, subject to a redemption premium of 3% of the outstanding
principal amount. We may, at our option, convert the outstanding principal
amount of the 15% convertible senior subordinated notes into shares of Skyworks
common stock based upon the conversion price (initially $7.87 per share,
subject to adjustment under certain circumstances). At maturity, Skyworks must
pay the outstanding principal amount by delivering to us a number of shares of
its common stock based upon the conversion price. Skyworks has granted us
certain registration rights relating to the 15% convertible senior subordinated
notes and the shares of Skyworks common stock underlying the 15% convertible
senior subordinated notes. As of March 31, 2004 the estimated fair value of the
15% convertible senior subordinated notes was approximately $67.9 million. We have the ability and
intent to sell all or part of the 15% convertible senior subordinated notes or
shares underlying the notes within the next twelve months. We
received a notice dated April 22, 2004 from Skyworks advising that Skyworks
would redeem in full on May 12, 2004 the 15% convertible senior subordinated
notes held by us. We exercised our right to convert all of the notes into
5,717,916 shares of Skyworks common stock prior to the scheduled redemption date at a
conversion price of $7.87 per share. As of March 31, 2004, our principal sources of liquidity are our existing cash
reserves and short-term investments (including the Skyworks 15% convertible
senior subordinated notes), the current portion of the Mindspeed warrant and
cash generated from product sales. Combined cash and cash equivalents,
short-term investments and Skyworks 15% convertible senior subordinated notes
at March 31, 2004 totaled $211.0 million compared to $175.5 million at
September 30, 2003. The current portion of the Mindspeed warrant at March 31,
2004 was $20.9 million. Our working capital at March 31, 2004 was $323.9
million compared to $233.0 million at September 30, 2003. In addition, at March
31, 2004, we held $191.7 million in long-term marketable securities which we
could liquidate to fund operations and/or future acquisitions. In connection with the Mindspeed Spin in June 2003, we entered into a senior
secured revolving credit facility with Mindspeed, pursuant to which Mindspeed
may borrow up to $50.0 million from us for working capital and general
corporate purposes. Mindspeed may borrow under the credit facility only to
restore its cash balance to $25.0 million. The credit facility is available
through June 29, 2007 and as of March 31, 2004, no amounts were outstanding. We believe that our existing sources of liquidity will be sufficient to fund
our operations, research and development efforts, anticipated capital
expenditures, remaining accrued restructuring and reorganization liabilities
balance of $23.4 million, and other capital requirements, including our
commitment under the credit facility with Mindspeed, for at least the next
twelve months. We will need to continue a focused program of capital
expenditures to meet our research and development and corporate requirements.
We may also consider acquisition opportunities to extend our technology
portfolio and design expertise and to expand our product offerings. In order to
fund capital expenditures, increase our working capital or complete any
acquisitions, we may seek to obtain additional debt financing or issue
additional shares of our common stock. However, we cannot assure you that such
financing will be available to us on favorable terms, or at all. The following summarizes our contractual obligations at March 31, 2004: Payments due by periodLess than 1
    
    
    
    
    
    
    
    
    
    More than 5(in millions)

    
    Total
    
    Year
    
    1-3 years
    
    3-5 years
    
    yearsConvertible subordinated notes
    
    $
    711.8
    
    
    $
    
    
    
    $
    711.8
    
    
    $
    
    
    
    $
    Operating leases
    
    
    144.0
    
    
    
    24.4
    
    
    
    37.7
    
    
    
    24.0
    
    
    
    57.9Assigned leases
    
    
    31.3
    
    
    
    1.1
    
    
    
    22.2
    
    
    
    2.7
    
    
    
    5.3Capital commitments
    
    
    8.0
    
    
    
    8.0
    
    
    
    
    
    
    
    
    
    
    
    Purchase commitments
    
    
    48.8
    
    
    
    45.2
    
    
    
    3.6
    
    
    
    
    
    
    
    $
    943.9
    
    
    $
    78.7
    
    
    $
    775.3
    
    
    $
    26.7
    
    
    $
    63.2
 29




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##### Table of Contents



Off-Balance Sheet Arrangements Our off-balance arrangements consist of conventional operating leases, the
Mindspeed senior secured revolving credit facility, capital commitments and
purchase commitments as described in Notes 5 and 10 of Notes to Consolidated
Condensed Financial Statements. We also have contingent liabilities for other
items assigned to Mindspeed and Skyworks at the time of their separation from
Conexant. See Note 5 of Notes to Consolidated Condensed Financial Statements.
We do not have any special purpose entities or variable interest entities as of
March 31, 2004. Recent Accounting Standards See Note 1 of Notes to Consolidated Condensed Financial Statements. Critical Accounting Policies The preparation of financial statements in accordance with accounting
principles generally accepted in the United States requires us to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Among the significant estimates affecting our
consolidated financial statements are those relating to allowances for doubtful
accounts, inventories, long-lived assets, in-process research and development
(IPR&D), the valuation of and estimated lives of identifiable intangible
assets, income taxes, valuation of derivative instruments, restructuring costs,
long-term employee benefit plans and other contingencies. We regularly evaluate
our estimates and assumptions based upon historical experience and various
other factors that we believe to be reasonable under the circumstances, the
results of which form the basis for making judgments about the carrying values
of assets and liabilities that are not readily apparent from other sources. To
the extent actual results differ from those estimates, our future results of
operations may be affected. Business combinations We account for acquired businesses using the purchase method of accounting
which requires that the assets and liabilities assumed be recorded at the date
of acquisition at their respective fair values. Because of the expertise
required to value intangible assets and IPR&D, we typically engage a third
party valuation firm to assist management in determining those values.
Valuation of intangible assets and IPR&D entails significant estimates and
assumptions including, but not limited to: determining the timing and expected
costs to complete projects, estimating future cash flows from product sales,
and developing appropriate discount rates and probability rates by project. We
believe that the fair values assigned to the assets acquired and liabilities
assumed are based on reasonable assumptions. To the extent actual results
differ form those estimates, our future results of operations may be affected.
Additionally, estimates for the purchase price allocation may change as
subsequent information becomes available. Impairment of long-lived assets Long-lived assets, including fixed assets and intangible assets (other than
goodwill), are continually monitored and are reviewed for impairment whenever
events or changes in circumstances indicate that the carrying amount of any
such asset may not be recoverable. The determination of recoverability is based
on an estimate of undiscounted cash flows expected to result from the use of an
asset and its eventual disposition. The estimate of cash flows is based upon,
among other things, certain assumptions about expected future operating
performance, growth rates and other factors. Our estimates of undiscounted cash
flows may differ from actual cash flows due to, among other things,
technological changes, economic conditions, changes to our business model or
changes in our operating performance. If the sum of the undiscounted cash flows
(excluding interest) is less than the carrying value, we recognize an
impairment loss, measured as the amount by which the carrying value exceeds the
fair value of the asset. We determine fair value by using available market
data, comparable asset quotes and/or discounted cash flow models. 30




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Goodwill is tested for impairment annually, or when a possible impairment is
indicated, using the fair value based test prescribed by SFAS No. 142. The
estimates and assumptions described above (along with other factors such as
discount rates) will affect the outcome of our impairment tests and the amounts
of any resulting impairment losses. Deferred income taxes We evaluate the realizability of our deferred tax assets and assess the need
for a valuation allowance quarterly. We record a valuation allowance to reduce
our deferred tax assets to the net amount that is more likely than not to be
realized. Our assessment of the need for a valuation allowance is based upon
our expectations of future taxable income and the ongoing prudent and feasible
tax planning strategies available to us. In the event that we determine that we
will not be able to realize all or part of our deferred tax assets in the
future, an adjustment to the deferred tax assets would be charged against
income in the period such determination is made. Likewise, in the event we were
to determine that we will be able to realize our deferred tax assets in the
future in excess of the net recorded amount, an adjustment to the deferred tax
assets would increase income in the period such determination is made. Inventories We write down our inventory for estimated obsolescence or unmarketable
inventory in an amount equal to the difference between the cost of inventory
and the estimated market value based upon assumptions about future demand and
market conditions. If actual market conditions are less favorable than our
estimates, additional inventory write-downs may be required. Allowance for doubtful accounts We maintain allowances for doubtful accounts for estimated losses resulting
from the inability of our customers to make required payments. If the financial
condition of our customers were to deteriorate, our actual losses may exceed
our estimates, and additional allowances would be required. Non-Marketable Equity Securities We have a portfolio of strategic investments in non-marketable equity
securities. Our ability to recover our investments in private, non-marketable
equity securities and to earn a return on these investments is primarily
dependent on how successfully these companies are able to execute to their
business plans and how well their products are accepted, as well as their
ability to obtain venture capital funding to continue operations and to grow.
We review all of our investments periodically for impairment and an impairment
analysis of non-marketable equity securities requires significant judgment.
This analysis includes assessment of each investees financial condition, the
business outlook for its products and technology, its projected results and
cash flows, the likelihood of obtaining subsequent rounds of financing and the
impact of any relevant contractual equity preferences held by us or by others.
Equity prices, including non-marketable equity securities, have declined
significantly over the past two years and we have experienced substantial
impairments in the value of non-marketable equity securities investments we
hold. Future adverse changes in market conditions or poor operating results of
underlying investments could result in an inability to recover the carrying
value of our investments that may not be reflected in their current carrying
values, which could require additional impairment charges to write down the
carrying values of such investments. Revenue Recognition Revenue from product sales is recognized upon shipment to the customer, when
the risk of loss has been transferred to the customer, price and terms are
fixed, no significant vendor obligation exists and collection of the resulting
receivable is reasonably assured. Our revenue recognition policy is
significant because our revenue is a key component of our operations and the
timing of revenue recognition determines the timing of certain expenses, such
as sales commissions. In addition, we record reductions to revenue for
estimated product returns, and allowances such as competitive pricing programs
and rebates. We follow very specific and detailed guidelines in measuring
revenue. Revenue results are difficult to predict, and any shortfall in
revenues could cause our operating results to vary significantly from period to
period. Valuation of Derivative Instruments We have two primary types of derivatives our warrant to purchase shares of
common stock of Mindspeed and the conversion right of the Skyworks 15%
convertible senior subordinated notes. We determine the fair value of the
conversion right of the Skyworks notes using the actual trading price of the
underlying shares of Skyworks common 31




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stock. We determine the fair value of the current portion of the Mindspeed
warrant using current pricing data. The fair value of the long-term portion of
the Mindspeed warrant is determined using a standard Black-Scholes pricing
model with assumptions consistent with current market conditions and our
current intent to liquidate the warrant over a specified time period. The
Black-Scholes pricing model requires the input of highly subjective assumptions
including expected stock price volatility. Changes in these assumptions could
cause the fair value of the Mindspeed warrant to vary significantly from period
to period. Restructuring Charges We recorded $5.2 million, $16.1 million and $16.9 million of restructuring
charges in fiscal years 2003, 2002 and 2001, respectively. These charges
relate primarily to reductions in our workforce and related impact on the use
of facilities. The estimated charges contain estimates and assumptions made by
management about matters which are uncertain at the time, for example the
timing and amount of sublease income that will be achieved on vacated property
and the operating costs to be paid until lease termination. While we have used
our best estimates based on facts and circumstances available at the time,
different estimates reasonably could have been used in the relevant periods,
and the actual results may be different, and those differences could have a
material impact on the presentation of our financial condition or results of
operations. Our policies require us to review the estimates and assumptions
periodically and reflect the effects of those revisions in the period that they
are determined to be necessary. In addition, as a result of the
GlobespanVirata merger in February 2004, we acquired $14.8 million of
additional restructuring liabilities which were recorded through the purchase
price allocation. Such amounts also contain estimates and assumptions made by
management, and will be reviewed periodically, and adjusted accordingly. Employee Benefit Plans We have long-term liabilities recorded for a retirement medical plan and a
pension plan. These obligations and the related effects on operations are
determined using actuarial valuations. There are critical assumptions used in
these valuation models such as the discount rate, expected return on assets,
compensation levels, turnover rates and mortality rates. The discount rate
used is representative of a high-quality fixed income investment. The other
assumptions do not tend to change materially over time. We evaluate all
assumptions annually and they are updated to reflect our experience. 32




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Certain Business Risks Our business, financial condition and operating results can be impacted by a
number of factors, any one of which could cause our actual results to vary
materially from recent results or from our anticipated future results. Any of
these risks could materially and adversely affect our business, financial
condition and results of operations, which in turn could materially and
adversely affect the price of our common stock or other securities. Unless the context otherwise indicates, as used in this section, the terms
Conexant and GlobespanVirata refer to the separate businesses of Conexant
Systems, Inc. and GlobespanVirata, Inc., respectively, as they were conducted
for periods prior to the completion of the merger of Conexant and
GlobespanVirata on February 27, 2004. References to we, us, our, the
combined company and other similar terms refer to the combined Conexant and
GlobespanVirata business from and after the completion of the merger. References in this section to Conexants fiscal year refer to the fiscal year
ending on the Friday nearest September 30 of each year and references to
GlobespanViratas fiscal year refer to the fiscal year ending December 31 of
each year. Each of Conexant and GlobespanVirata has recently incurred substantial losses. Conexants net revenues in fiscal 2003 were $600.0 million compared to $521.7
million in fiscal 2002 and $541.7 million in fiscal 2001. Although Conexant had
income from continuing operations of $23.6 million in fiscal 2003, it incurred
losses from continuing operations of $143.8 million in fiscal 2002 and $660.9
million in fiscal 2001. Including discontinued operations, Conexant incurred
net losses of $705.3 million in fiscal 2003, $880.8 million in fiscal 2002, and
$1.4 billion in fiscal 2001. GlobespanViratas net revenues for fiscal 2003
were $379.1 million compared to $228.9 million in fiscal 2002 and $264.9
million in fiscal 2001. GlobespanVirata also had losses from continuing
operations of $49.6 million in fiscal 2003, $636.9 million in fiscal 2002 and
$372.0 million in fiscal 2001. Including discontinued operations,
GlobespanVirata incurred net losses of $59.3 million in fiscal 2003, $655.0
million in fiscal 2002, and $377.5 million in fiscal 2001. We operate in the highly cyclical semiconductor industry, which is subject to
significant downturns. The semiconductor industry is highly cyclical and is characterized by constant
and rapid technological change, rapid product obsolescence and price erosion,
evolving technical standards, short product life cycles and wide fluctuations
in product supply and demand. From time to time these and other factors,
together with changes in general economic conditions, cause significant upturns
and downturns in the industry, and in our business in particular. Periods of
industry downturns have been characterized by diminished product demand,
production overcapacity, high inventory levels and accelerated erosion of
average selling prices. These factors have caused substantial fluctuations in
the revenues and results of operations of Conexant and GlobespanVirata.
Conexant and GlobespanVirata experienced these cyclical fluctuations in their
businesses in the past and we may experience cyclical fluctuations in the
future. Demand for our products in each of the communications electronics end-markets
which we address is subject to a unique set of factors, and a downturn in
demand affecting one market may be more pronounced, or last longer, than a
downturn affecting another of our markets. We are subject to intense competition. The communications semiconductor industry in general and the markets in which
we compete in particular are intensely competitive. We compete worldwide with a
number of United States and international semiconductor providers that are both
larger and smaller than us in terms of resources and market share. We currently
face significant competition in our markets and expect that intense price and
product competition will continue. This competition has resulted and is
expected to continue to result in declining average selling prices for our
products. We also anticipate that additional competitors will enter our markets
as a result of expected growth opportunities in communications electronics, the
trend toward global expansion by foreign and domestic competitors,
technological and public policy changes and relatively low barriers to entry in
certain markets of the industry. Moreover, as with many companies in the
semiconductor industry, customers for certain of our products offer other
products that 33




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compete with similar products offered by us. Many of our competitors have
certain advantages over us, such as significantly greater sales and marketing,
manufacturing, distribution, technical and other resources. We believe that the principal competitive factors for semiconductor suppliers in our addressed markets are:  
    
    time-to-market;  
    
    product quality, reliability and performance;  
    
    level of integration;  
    
    price and total system cost;  
    
    compliance with industry standards;  
    
    design and engineering capabilities;  
    
    strategic relationships with customers;  
    
    customer support;  
    
    new product innovation; and  
    
    access to manufacturing capacity. We cannot assure you that we will be able to successfully address these
factors. Current and potential competitors also have established or may establish
financial or strategic relationships among themselves or with our existing or
potential customers, resellers or other third parties. These relationships may
affect customers purchasing decisions. Accordingly, it is possible that new
competitors or alliances could emerge and rapidly acquire significant market
share. We cannot assure you that we will be able to compete successfully
against current and potential competitors. Our success depends on our ability to timely develop competitive new products
and reduce costs. Our operating results will depend largely on our ability to continue to
introduce new and enhanced semiconductor products on a timely basis. Successful
product development and introduction depends on numerous factors, including,
among others:  
    
    our ability to anticipate customer and market requirements and
changes in technology and industry standards;  
    
    our ability to accurately define new products;  
    
    our ability to timely complete development of new products and
bring our products to market on a timely basis;  
    
    our ability to differentiate our products from offerings of our competitors; and  
    
    overall market acceptance of our products. We cannot assure you that we will have sufficient resources to make the
substantial investment in research and development in order to develop and
bring to market new and enhanced products. Furthermore, we are required to
continually evaluate expenditures for planned product development and to choose
among alternative technologies based on our expectations of future market
growth. We cannot assure you that we will be able to develop and introduce new
or enhanced products in a timely and cost-effective manner, that our products
will satisfy customer requirements or achieve market acceptance, or that we
will be able to anticipate new industry standards and technological changes. We
also cannot assure you that we will be able to respond successfully to new
product announcements and introductions by competitors. In addition, prices of established products may decline, sometimes
significantly and rapidly, over time. We believe that in order to remain
competitive we must continue to reduce the cost of producing and delivering
existing products at the same time that we develop and introduce new or
enhanced products. We cannot assure you that we will be able to continue to
reduce the cost of our products to remain competitive. If we are unable to
reduce manufacturing costs in response to declines in selling prices for our
products, it will lead to declines in gross margins for such products. 34




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We may not be able to keep abreast of the rapid technological changes in our
markets. The demand for our products can change quickly and in ways we may not
anticipate because our markets generally exhibit the following characteristics:  
    
    rapid technological developments;  
    
    rapid changes in customer requirements;  
    
    frequent new product introductions and enhancements;  
    
    short product life cycles with declining prices over the life cycle of the products; and  
    
    evolving industry standards. Our products could become obsolete sooner than anticipated because of a faster
than anticipated change in one or more of the technologies related to our
products or in market demand for products based on a particular technology,
particularly due to the introduction of new technology that represents a
substantial advance over current technology. Currently accepted industry
standards are also subject to change, which may contribute to the obsolescence
of our products. We may not be able to attract and retain qualified personnel necessary for the
design, development and sale of our products. Our success could be negatively
affected if key personnel leave. Our future success depends on our ability to attract, retain and motivate
qualified personnel, including executive officers and other key management and
technical personnel. As the source of our technological and product
innovations, our key technical personnel represent a significant asset. The
competition for such personnel can be intense in the semiconductor industry.
While we have entered into employment agreements with some of our key
personnel, we cannot assure you that we will be able to attract and retain
qualified management and other personnel necessary for the design, development
and sale of our products. We may have particular difficulty attracting and retaining key personnel during
periods of poor operating performance. The loss of the services of one or more
of our key personnel, including Armando Geday, our Chief Executive Officer, F.
Matthew Rhodes, our President, or certain key design and technical personnel,
or our inability to attract, retain and motivate qualified personnel could have
a material adverse effect on our ability to operate our business. If OEMs of communications electronics products do not design our products into
their equipment, we will be unable to sell those products. Moreover, a design
win from a customer does not guarantee future sales to that customer. Our products are not sold directly to the end-user but are components of other
products. As a result, we rely on OEMs of communications electronics products
to select our products from among alternative offerings to be designed into
their equipment. We may be unable to achieve these design wins. Without
design wins from OEMs, we would be unable to sell our products. Once an OEM
designs another suppliers semiconductors into one of its product platforms, it
will be more difficult for us to achieve future design wins with that OEMs
product platform because changing suppliers involves significant cost, time,
effort and risk. Achieving a design win with a customer does not ensure that we
will receive significant revenues from that customer and we may be unable to
convert design wins into actual sales. Even after a design win, the customer is
not obligated to purchase our products and can choose at any time to stop using
our products if, for example, it or its own products are not commercially
successful. Because of the lengthy sales cycles of many of our products, we may incur
significant expenses before we generate any revenues related to those products. Our customers may need six months or longer to test and evaluate our products
and an additional six months or more to begin volume production of equipment
that incorporates our products. The lengthy period of time required also
increases the possibility that a customer may decide to cancel or change
product plans, which could reduce or eliminate sales to that customer. As a
result of this lengthy sales cycle, we may incur significant research and
development, and selling, general and administrative expenses before we
generate the related revenues for these products, and we may never generate the
anticipated revenues if our customer cancels or changes its product plans. 35




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Uncertainties involving the ordering and shipment of our products could
adversely affect our business. Our sales are typically made pursuant to individual purchase orders and we
generally do not have long-term supply arrangements with our customers.
Generally, our customers may cancel orders until 30 days prior to shipment. In
addition, we sell a portion of our products through distributors and other resellers, some of whom
have a right to return unsold products to us. Sales to distributors
and other resellers accounted
for approximately 40% of Conexants net revenues for fiscal 2003, whereas
GlobespanViratas sales were primarily to OEM customers. We routinely purchase
inventory based on estimates of end-market demand for our customers products,
which is difficult to predict. This difficulty may be compounded when we sell
to OEMs indirectly through distributors and other resellers or contract manufacturers, or both, as
our forecasts of demand are then based on estimates provided by multiple
parties. In addition, our customers may change their inventory practices on
short notice for any reason. The cancellation or deferral of product orders,
the return of previously sold products or overproduction due to the failure of
anticipated orders to materialize could result in our holding excess or
obsolete inventory, which could result in write-downs of inventory. We are dependent upon third parties for the manufacture, assembly and test of
our products. We are entirely dependent upon outside wafer fabrication facilities (known as
foundries), including Jazz Semiconductor, Inc., in which we hold a minority
interest. Under our fabless business model, our long-term revenue growth is
dependent on our ability to obtain sufficient external manufacturing capacity,
including wafer production capacity. If the semiconductor industry experiences
a shortage of wafer fabrication capacity in the future, we may experience
delays in shipments or increased manufacturing costs.
There are significant risks associated with our reliance on third-party
foundries, including:  
    
    the lack of assured wafer supply, potential wafer shortages and higher wafer prices;  
    
    limited control over delivery schedules, manufacturing yields, production costs and product quality; and  
    
    the unavailability of, or delays in obtaining, access to key process technologies. Although we have a long-term supply arrangement with Jazz to obtain external
wafer manufacturing capacity, the foundries we use may allocate their limited
capacity to fulfill the production requirements of other customers that are
larger and better financed than we. If we choose to use a new foundry, it
typically takes several months to redesign our products for the process
technology and intellectual property cores of the new foundry and to complete
the qualification process before we can begin shipping products from the new
foundry. We are also dependent upon third parties, including Skyworks Solutions, Inc.,
for the assembly and test of our products. Our reliance on others to assemble
and test our products subjects us to many of the same risks as are described
above with respect to our reliance on outside wafer fabrication facilities. Wafer fabrication processes are subject to obsolescence, and foundries may
discontinue a wafer fabrication process used for certain of our products. In
such event, we generally offer our customers a last time buy program to
satisfy their anticipated requirements for our products. The unanticipated
discontinuation of wafer fabrication processes on which we rely may adversely
affect our revenues and our customer relationships. The foundries and other suppliers on whom we rely may experience financial
difficulties or suffer disruptions in their operations due to causes beyond our
control, including labor strikes, work stoppages, electrical power outages,
fire, earthquake, flooding or other natural disasters. Certain of our
suppliers manufacturing facilities are located near major earthquake fault
lines in California, Mexico and the Asia-Pacific region. In the event of a
disruption of the operations of one or more of our suppliers, we may not have a
second manufacturing source immediately available. Such an event could cause
significant delays in shipments until we could shift the products from an
affected facility or supplier to another facility or supplier. The
manufacturing processes we rely on are specialized and are available from a
limited number of suppliers. Alternate sources of manufacturing capacity,
particularly wafer production capacity, may not be available to us on a timely
basis. Even if alternate wafer production capacity is available, we may not be
able to obtain it on favorable terms, or at all. Difficulties or delays in
securing an adequate supply of our products on favorable terms, or at all,
could impair our ability to meet our customers requirements and have a
material adverse effect on our operating results. 36




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In addition, the highly complex and technologically demanding nature of
semiconductor manufacturing has caused foundries to experience from time to
time lower than anticipated manufacturing yields, particularly in connection
with the introduction of new products and the installation and start-up of new
process technologies. Lower than anticipated manufacturing yields may affect
our ability to fulfill our customers demands for our products on a timely
basis. Moreover, lower than anticipated manufacturing yields may adversely
affect our cost of goods sold and our results of operations. Our success depends, in part, on our ability to effect suitable investments,
alliances and acquisitions. Although we invest significant resources in research and development
activities, the complexity and rapidity of technological changes make it
impractical for us to pursue development of all technological solutions on our
own. On an ongoing basis, we review investment, alliance and acquisition
prospects that would complement our existing product offerings, augment our
market coverage or enhance our technological capabilities. However, we cannot
assure you that we will be able to identify and consummate suitable investment,
alliance or acquisition transactions in the future. Moreover, if we consummate such transactions, they could result in:  
    
    issuances of equity securities dilutive to our existing shareholders;  
    
    large initial one-time write-offs of in-process research and development;  
    
    the incurrence of substantial debt and assumption of unknown liabilities;  
    
    the potential loss of key employees from the acquired company;  
    
    amortization expenses related to intangible assets; and  
    
    the diversion of managements attention from other business concerns. Additionally, in periods subsequent to an acquisition, we must evaluate
goodwill and acquisition-related intangible assets for impairment. When such
assets are found to be impaired, they will be written down to estimated fair
value, with a charge against earnings. We may have difficultly integrating businesses we acquire. In particular, we
may be unable to integrate successfully the operations of Conexant and
GlobespanVirata and realize the full cost savings we anticipate. Integrating acquired organizations and their products and services may be
expensive, time-consuming and a strain on our resources and our relationships
with employees and customers, and ultimately may not be successful. The merger of Conexant and GlobespanVirata involves the integration of two
companies that previously operated independently. The difficulties of
combining the operations of the companies include:  
    
    the challenge of effecting integration while carrying on an ongoing business;  
    
    the necessity of coordinating geographically separate organizations;  
    
    retaining and integrating personnel with diverse business backgrounds;  
    
    retaining existing customers and strategic partners of each company; and  
    
    implementing and maintaining consistent standards, controls,
procedures, policies and information systems. The process of integrating operations could cause an interruption of, or loss
of momentum in, the activities of one or more of our businesses and the loss of
key personnel. The diversion of managements attention and any delays or
difficulties encountered in connection with the merger and the integration of
the two operations could have an adverse effect on our business, results of
operations or financial condition. We cannot assure you that the economies of
scale and operating efficiencies that we expect to result from the merger will
be realized within the time periods contemplated or at all. We face a risk that capital needed for our business will not be available when
we need it. We believe that our existing sources of liquidity together with cash expected
to be generated from product sales will be sufficient to fund our operations,
research and development, anticipated capital expenditures, working capital and 37




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other financing requirements for at least the next twelve months. However, we
cannot assure you that this will be the case and we may need to obtain
alternate sources of financing in the future. We cannot assure you that we will
have access to additional sources of capital on favorable terms or at all. In addition, any strategic investments and acquisitions that we may make to
help us grow our business may require additional capital resources. We cannot
assure you that the capital required to fund these investments and acquisitions
will be available in the future. We are subject to the risks of doing business internationally. Approximately 90% of Conexants net revenues for fiscal 2003 and approximately
92% of GlobespanViratas net revenues for fiscal 2003 were from customers
located outside the United States, primarily in the Asia-Pacific region and
Europe. In addition, we have design centers and suppliers located outside the
United States, including the Skyworks assembly and test facility in Mexico and
assembly and test service providers and foundries located in the Asia-Pacific
region. Our international sales and operations are subject to a number of risks
inherent in selling and operating abroad. These include, but are not limited
to, risks regarding:  
    
    currency exchange rate fluctuations;  
    
    local economic and political conditions;  
    
    disruptions of capital and trading markets;  
    
    restrictive governmental actions, such as restrictions on the
transfer or repatriation of funds and trade protection measures,
including export duties and quotas and customs duties and tariffs;  
    
    changes in legal or regulatory requirements;  
    
    difficulty in obtaining distribution and support;  
    
    the laws and policies of the United States and other countries
affecting trade, foreign investment and loans, and import or export
licensing requirements;  
    
    tax laws; and  
    
    limitations on our ability under local laws to protect our intellectual property. Because most of our international sales, other than sales to Japan (which are
denominated principally in Japanese yen), are currently denominated in U.S.
dollars, our products could become less competitive in international markets if
the value of the U.S. dollar increases relative to foreign currencies. We
cannot assure you that the factors described above will not have a material
adverse effect on our ability to increase or maintain our foreign sales. From time to time, we may enter into foreign currency forward exchange
contracts to minimize risk of loss from currency exchange rate fluctuations for
foreign currency commitments entered into in the ordinary course of business.
We have not entered into foreign currency forward exchange contracts for other
purposes. Our financial condition and results of operations could be affected
(adversely or favorably) by currency fluctuations. Our operating results may be negatively affected by substantial quarterly and
annual fluctuations and market downturns. The revenues, earnings and other operating results of Conexant and
GlobespanVirata fluctuated in the past and our revenues, earnings and other
operating results may fluctuate in the future. These fluctuations are due to a
number of factors, many of which are beyond our control. These factors include,
among others:  
    
    changes in end-user demand for the products manufactured and sold by our customers;  
    
    the timing of receipt, reduction or cancellation of significant orders by customers;  
    
    seasonal customer demand;  
    
    the gain or loss of significant customers;  
    
    market acceptance of our products and our customers products;  
    
    our ability to develop, introduce and market new products and technologies on a timely basis;  
    
    the timing and extent of product development costs;  
    
    new product and technology introductions by competitors;  
    
    changes in the mix of products we develop and sell; 38




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
    
    fluctuations in manufacturing yields;  
    
    availability and cost of products from our suppliers;  
    
    intellectual property disputes; and  
    
    the effects of competitive pricing pressures, including decreases
in average selling prices of our products. The foregoing factors are difficult to forecast, and these as well as other
factors could materially adversely affect our quarterly or annual operating
results. If our operating results fail to meet the expectations of analysts or
investors, it could materially and adversely affect the price of our common
stock and other securities. The value of our common stock may be adversely affected by market volatility. The trading price of our common stock fluctuates significantly and may be
influenced by many factors, including:  
    
    our operating and financial performance and prospects;  
    
    the depth and liquidity of the market for our common stock;  
    
    investor perception of us and the industry and markets in which we operate;  
    
    our inclusion in, or removal from, any equity market indices;  
    
    the level of research coverage of our common stock;  
    
    changes in earnings estimates or buy/sell recommendations by analysts; and  
    
    general financial, domestic, international, economic and other market conditions. In addition, public stock markets have experienced, and are currently
experiencing, extreme price and trading volume volatility, particularly in the
technology sectors of the market. This volatility has significantly affected
the market prices of securities of many technology companies for reasons
frequently unrelated to or disproportionately impacted by the operating
performance of these companies. These broad market fluctuations may adversely
affect the market price of our common stock. We may be subject to claims of infringement of third-party intellectual
property rights or demands that we license third-party technology, which could
result in significant expense and loss of our ability to use, make, sell,
export or import our products or one or more components comprising our
products. The semiconductor industry is characterized by vigorous protection and pursuit
of intellectual property rights. From time to time, third parties have asserted
and may in the future assert patent, copyright, trademark and other
intellectual property rights to technologies that are important to our business
and have demanded and may in the future demand that we license their patents
and technology. Any litigation to determine the validity of claims that our
products infringe or may infringe these rights, including claims arising
through our contractual indemnification of our customers, regardless of their
merit or resolution, could be costly and divert the efforts and attention of
our management and technical personnel. We cannot assure you that we would
prevail in litigation given the complex technical issues and inherent
uncertainties in intellectual property litigation. If litigation results in an
adverse ruling we could be required to:  
    
    pay substantial damages;  
    
    cease the manufacture, use or sale of infringing products;  
    
    discontinue the use of infringing technology;  
    
    expend significant resources to develop non-infringing technology; or  
    
    license technology from the third party claiming infringement,
which license may not be available on commercially reasonable terms, or
at all. If we are not successful in protecting our intellectual property rights, it may
harm our ability to compete. We rely primarily on patent, copyright, trademark and trade secret laws, as
well as nondisclosure and confidentiality agreements and other methods, to
protect our proprietary technologies and processes. At times we incorporate the
intellectual property of our customers into our designs, and we have
obligations with respect to the non-use and non-disclosure of their
intellectual property. In the past, Conexant and GlobespanVirata engaged in
litigation to enforce their intellectual property rights, to protect their
trade secrets or to determine the validity and scope of proprietary 39




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rights of others, including their customers. We may engage in future litigation
on similar grounds, which may require us to expend significant resources and to
divert the efforts and attention of our management from our business
operations. We cannot assure you that:  
    
    the steps we take to prevent misappropriation or infringement of
our intellectual property or the intellectual property of our customers
will be successful;  
    
    any existing or future patents will not be challenged, invalidated or circumvented; or  
    
    any of the measures described above would provide meaningful protection. Despite these precautions, it may be possible for a third party to copy or
otherwise obtain and use our technology without authorization, develop similar
technology independently or design around our patents. If any of our patents
fails to protect our technology it would make it easier for our competitors to
offer similar products. In addition, effective patent, copyright, trademark and
trade secret protection may be unavailable or limited in certain countries. We may be liable for penalties under environmental laws, rules and regulations,
which could adversely impact our business. Conexants former manufacturing operations used a variety of chemicals and were
subject to a wide range of environmental protection regulations in the United
States and Mexico. In connection with Conexants spin-off from Rockwell
International Corporation (now Rockwell Automation, Inc.) in December 1998,
Conexant assumed all liabilities in respect of environmental matters related to
the former operations of its business. We have been designated as a potentially
responsible party and are engaged in groundwater remediation at one Superfund
site located at a former silicon wafer manufacturing facility and steel
fabrication plant in Parker Ford, Pennsylvania formerly occupied by Conexant.
In addition, we are engaged in remediations of groundwater contamination at
Conexants former Newport Beach, California wafer fabrication facility. We
currently estimate the remaining costs for these remediations to be
approximately $3.3 million and have accrued for these costs as of September 30,
2003. In the United States, environmental regulations often require parties to fund
remedial action regardless of fault. Consequently, it is often difficult to
estimate the future impact of environmental matters, including potential
liabilities. While Conexant and GlobespanVirata have not experienced any
material adverse effects on their operations as a result of such regulations,
we cannot assure you that the costs that might be required to complete remedial
actions, if any, will not have a material adverse effect on our business,
financial condition and results of operations. We may be limited in the future in the amount of NOLs that we can use to offset
taxable income. As of September 30, 2003, Conexant had approximately $1 billion of U.S. federal
income tax net operating loss, or NOL, carryforwards that can be used to offset
taxable income in subsequent years. The NOL carryforwards are scheduled to
expire at various dates through 2024. Section 382 of the Internal Revenue Code
could limit the future use of some or all of the NOL carryforwards if the
ownership of our common stock changes by more than 50 percentage points in
certain circumstances over a three-year testing period. Based on information
known to us, we have not undergone such a change of ownership and the merger of
Conexant and GlobespanVirata did not constitute a change of ownership, although
the shares of our common stock issued in the merger will be taken into account
in any change of ownership computations. Direct or indirect transfers of our
common stock, when taken together with the shift in ownership resulting from
the merger, could result in a change of ownership that would trigger the
section 382 limitation. If such an ownership change occurs, section 382 would
limit our use of NOL carryforwards in each subsequent taxable year to an amount
equal to a federal long-term tax-exempt rate published by the Internal Revenue
Service at the time of the ownership change, multiplied by our fair market
value at such time; any unused annual limitation amounts may also be carried
forward. The merger resulted in a change of ownership of GlobespanVirata and
the future use of GlobespanViratas NOL carryforwards are subject to the
section 382 limitation (or further limitation in the case of NOL carryforwards
already subject to limitation as a result of previous transactions) based on
the fair market value of GlobespanVirata at the time of the merger. Provisions in our organizational documents and rights agreement and Delaware
law may make it difficult for someone to acquire control of us. 40




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We have established certain anti-takeover measures that may affect our common
stock and convertible notes. Our restated certificate of incorporation, our
by-laws, our rights agreement with Mellon Investor Services LLC, as rights
agent, dated as of November 30, 1998, as amended, and the Delaware General
Corporation Law contain several provisions that would make more difficult an
acquisition of control of us in a transaction not approved by our board of
directors. Our restated certificate of incorporation and by-laws include
provisions such as:  
    
    the division of our board of directors into three classes to be
elected on a staggered basis, one class each year;  
    
    the ability of our board of directors to issue shares of our
preferred stock in one or more series without further authorization of
our shareholders;  
    
    a prohibition on shareholder action by written consent;  
    
    a requirement that shareholders provide advance notice of any
shareholder nominations of directors or any proposal of new business to
be considered at any meeting of shareholders;  
    
    a requirement that a supermajority vote be obtained to remove a
director for cause or to amend or repeal certain provisions of our
restated certificate of incorporation or by-laws;  
    
    elimination of the right of shareholders to call a special meeting of shareholders; and  
    
    a fair price provision. Our rights agreement gives our shareholders certain rights that would
substantially increase the cost of acquiring us in a transaction not approved
by our board of directors. In addition to the rights agreement and the provisions in our restated
certificate of incorporation and by-laws, Section 203 of the Delaware General
Corporation Law generally provides that a corporation shall not engage in any
business combination with any interested shareholder during the three-year
period following the time that such shareholder becomes an interested
shareholder, unless a majority of the directors then in office approves either
the business combination or the transaction that results in the shareholder
becoming an interested shareholder or specified shareholder approval
requirements are met. 41




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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Our financial instruments include cash and cash equivalents, marketable debt
securities, the Skyworks 15% convertible senior subordinated notes, the
Mindspeed warrant, equity securities and our long-term debt. Our main
investment objectives are the preservation of investment capital and the
maximization of after-tax returns on our investment portfolio. Consequently, we
invest with only high-credit-quality issuers and we limit the amount of our
credit exposure to any one issuer. Our cash and cash equivalents, and short-term marketable securities are not
subject to significant interest rate risk due to the short maturities of these
instruments. As of March 31, 2004, the carrying value of our cash and cash
equivalents and short-term marketable securities approximates fair value. Our
long-term marketable securities (consisting of commercial paper, corporate
bonds and government securities) principally have remaining terms of 1 to 3
years. Such securities are subject to interest rate risk.At March 31, 2004, a
10% adverse change in interest rates would result in a $19.2 million decrease
in the value of our long-term marketable securities. Marketable equity
securities are subject to equity price risk. As of March 31, 2004, a 10%
adverse change in equity prices would result in a $0.6 million decrease in the
value of our marketable equity securities. We hold Skyworks 15% convertible senior subordinated notes having an aggregate
principal amount of $45.0 million. The conversion right is considered an
embedded derivative for financial accounting purposes and the value of the
Skyworks 15% convertible senior subordinated notes is subject to significant
risk related to changes in the market price of Skyworks common stock. As of
March 31, 2004, a 10% decrease in the market price of Skyworks common stock
would decrease the fair value of the Skyworks 15% convertible senior
subordinated notes by approximately $6.8 million. The Skyworks 15% convertible
senior subordinated notes are also subject to interest rate risk. At March 31,
2004, the market price of Skyworks common stock was $11.89 per share. For the
quarter ended March 31, 2004, the market price of Skyworks common stock ranged
from a low of $9.18 per share to a high of $12.35 per share. We received a
notice dated April 22, 2004 from Skyworks advising that Skyworks would redeem
in full on May 12, 2004 the 15% convertible senior subordinated notes held by
us. We exercised our right to convert all of the notes into 5,717,916 shares of Skyworks
common stock prior to the scheduled redemption date at a conversion price of
$7.87 per share. We received the 15% convertible senior subordinated notes from Skyworks in
exchange for the remaining $45.0 million principal amount of the Term Notes
(originally delivered to us by Skyworks in payment of the purchase price for
our Mexicali assembly and test facility). We do not purchase derivative
financial instruments for speculative or investment purposes. We hold a warrant to purchase 30 million shares of common stock of Mindspeed.
For financial accounting purposes, this is a derivative instrument and the fair
value of the warrant is subject to significant risk related to changes in the
market price of Mindspeeds common stock. As of March 31, 2004, a 10% decrease
in the market price of Mindspeeds common stock would decrease the fair value
of this warrant by approximately $19.5 million. At March 31, 2004, the market
price of Mindspeeds common stock was $6.82 per share. For the quarter ended
March 31, 2004, the market price of Mindspeeds common stock ranged from a low
of $5.85 per share to a high of $11.28 per share We classify all of our marketable debt and equity securities as
available-for-sale securities. As of March 31, 2004, the carrying value of
these securities included net unrealized gain of $3.8 million. Our long-term debt consists of convertible subordinated notes with interest at
fixed rates. Consequently, we do not have significant cash flow exposure on our
long-term debt. However, the fair value of our convertible subordinated notes
is subject to significant fluctuation due to their convertibility into shares
of our common stock. 42




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The following table shows the fair values of our financial instruments as of
March 31, 2004: (in millions)

    
    Carrying Value
    
    Fair ValueCash and cash equivalents
    
    $
    134.8
    
    
    $
    134.8Marketable debt securities
    
    
    29.7
    
    
    
    29.7Marketable government securities
    
    
    164.1
    
    
    
    164.1Skyworks 15% convertible senior subordinated notes
    
    
    67.9
    
    
    
    67.9Marketable equity securities
    
    
    6.3
    
    
    
    6.3Mindspeed warrant
    
    
    141.8
    
    
    
    141.8Long-term debt
    
    
    711.8
    
    
    
    710.3
 We transact business in various foreign currencies, and we have established a
foreign currency hedging program utilizing foreign currency forward exchange
contracts to hedge certain foreign currency transaction exposures. Under this
program, we seek to offset foreign currency transaction gains and losses with
gains and losses on the forward contracts, so as to mitigate our overall risk
of foreign transaction gains and losses. We do not enter into forward contracts
for speculative or trading purposes. At March 31, 2004, we held no foreign
currency forward exchange contracts. Based on our overall currency rate
exposure at March 31, 2004, a 10 percent change in the currency rates would not
have a material effect on our consolidated financial position, results of
operations or cash flows. 
 ITEM 4. CONTROLS AND PROCEDURES An evaluation as of the end of the period covered by this report was carried
out under the supervision and with the participation of the Companys
management, including the Companys Chief Executive Officer and its Senior Vice
President and Chief Financial Officer, of the effectiveness of the design and
operation of the Companys disclosure controls and procedures, which are
defined under Securities and Exchange Commission rules as controls and other
procedures of a company that are designed to ensure that information required
to be disclosed by a company in the reports that it files under the Exchange
Act is recorded, processed, summarized and reported within required time
periods. Based upon that evaluation, the Companys Chief Executive Officer and
its Senior Vice President and Chief Financial Officer concluded that the
Companys disclosure controls and procedures were effective. There were no changes in the Companys internal control over financial
reporting during the quarter ended March 31, 2004 that have materially
affected, or are reasonably likely to materially effect, the Companys internal
control over financial reporting. 43




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PART II. OTHER INFORMATION 
 ITEM 2. CHANGES IN SECURITIES, USE OF PROCEEDS AND ISSUER PURCHASES OF EQUITY
SECURITIES (a) On March 2, 2004 following completion of the GlobespanVirata merger, the
Companys Restated Certificate of Incorporation was amended to increase the
number of shares of the Companys preferred stock designated as Series A Junior
Participating Preferred Stock for issuance in connection with the exercise of
the Companys preferred share purchase rights from 1,500,000 to 5,000,000. No
shares of Series A Junior Participating Preferred Stock are issued or
outstanding. (b) The following provides information about purchases by or on behalf of the
Company or any affiliated purchaser of shares of Conexant common stock during
the quarter ended March 31, 2004: Issuer Purchases of Equity Securities Maximum Number (orTotal Number of
    
    Approximate DollarShares Purchased
    
    Value) of Shares thatTotal Number
    
    Average
    
    as Part of Publicly
    
    May Yet Be Purchasedof Shares
    
    Price Paid
    
    Announced Plans
    
    Under the Plan orPeriod
    
    Purchased
    
    per Share
    
    or Programs
    
    Programs1/1/04  1/31/04
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2/1/04  2/29/04
    
    
    1,250,000
    *
    
    $
    7.35
    
    
    
    
    
    
    
    3/1/04  3/31/04
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Total
    
    
    1,250,000
    
    
    $
    7.35
    
    
    
    
    
    
    
    
  *
    
    In connection with the GlobespanVirata merger on February 27, 2004, the
Company indirectly reacquired 1,250,000 shares of Conexant common stock
held by iCompression, Inc., a subsidiary of GlobespanVirata. The merger
was accounted for under the purchase method of accounting with the Company
as the acquiring company for accounting purposes. The fair value of the
1,250,000 shares was estimated to be approximately $9,188,000, or an
average of $7.35 per share. These shares were originally acquired by
iCompression from the Company in June 2002 in connection with the
Companys purchase of iCompressions video compression business. 
 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS The Companys annual meeting of shareholders was held on February 25, 2004 in
Costa Mesa, California. At the meeting, the following matters were voted on by
the Companys shareholders and approved by the following votes: Number of SharesVoted For
    
    WithheldElection of directors:Donald R. Beall
    
    
    221,338,099
    
    
    
    24,999,382Balakrishnan S. Iyer
    
    
    232,923,486
    
    
    
    13,413,995Jerre L. Stead
    
    
    233,145,354
    
    
    
    13,192,127
 44




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Number of SharesVoted
    
    
    
    
    
    BrokerVoted For
    
    Against
    
    Abstentions
    
    Non-VotesProposal to approve the issuance of
shares of the Companys common stock in
the merger with GlobespanVirata.
    
    
    147,328,176
    
    
    
    3,487,296
    
    
    
    1,117,275
    
    
    
    94,404,734Proposal to approve amendments to the
Companys Directors Stock Plan
    
    
    104,678,236
    
    
    
    44,499,677
    
    
    
    2,754,834
    
    
    
    94,404,734Proposal to approve the assumption and
adoption of GlobespanVirata, Inc.s
1999 Equity Incentive Plan, 1999
Supplemental Stock Option and Amended
and Restated 1999 Stock Incentive Plan
    
    
    108,681,934
    
    
    
    40,394,778
    
    
    
    2,856,035
    
    
    
    94,404,734Proposal to ratify appointment of
Deloitte & Touche LLP as the Companys
independent auditors
    
    
    242,627,508
    
    
    
    2,133,504
    
    
    
    1,576,468
    
    
    
    N/A
 
 ITEM 5. OTHER INFORMATION In addition to the directors elected at the 2004 annual meeting of
shareholders, the Companys Board of Directors also includes the following
directors whose terms of office continue after the annual meeting: Ralph J.
Cicerone, Dwight W. Decker, F. Craig Farrill and D. Scott Mercer. On February
27, 2004, the following directors were appointed to fill vacancies created by
the expansion of the Board of Directors to 12 members in connection with the
completion of the GlobespanVirata merger: Armando Geday, Steven J. Bilodeau,
Dipanjan Deb, John W. Marren and Giuseppe P. Zocco. 45




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ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits: 3.a.1
    
    Amended and Restated Certificate of Incorporation of the Company, as amended.3.a.2
    
    Certificate of Increase in the Number of Authorized Shares of Series A
Junior Participating Preferred Stock of the Company.3.b.1
    
    Amended By-Laws of the Company.3.b.2
    
    Resolutions adopted by the Board of Directors of the Company on May 7, 2004
amending the Amended By-Laws of the Company.4.1
    
    Indenture, dated as of May 11, 2001, between GlobespanVirata and The Bank of
New York (successor to United States Trust Company of New York), as Trustee,
including the form of 5-1/4% Convertible Subordinated Note due 2006 of
GlobespanVirata attached as Exhibit A thereto, filed as Exhibit 4.1 to
GlobespanViratas Current Report on Form 8-K dated May 15, 2001 (File No.
000-26401), is incorporated herein by reference.4.2
    
    First Supplemental Indenture, dated as of February 27, 2004, between
GlobespanVirata and The Bank of New York (successor to United States Trust
Company of New York), as Trustee.10.1
    
    Amendment to Employment Agreement between the Company and J. Scott Blouin10.2
    
    Employment Agreement between the Company and Lewis C. Brewster10.3
    
    Employment Agreement between the Company and Dwight W. Decker, filed as
Exhibit 10.a to the Companys Registration Statement on Form S-4
(Registration No. 333-111179), is incorporated herein by reference.10.4
    
    Employment Agreement between the Company and Armando Geday, filed as Exhibit
10.b to the Companys Registration Statement on Form S-4 (Registration No.
333-111179), is incorporated herein by reference.10.5
    
    Employment Agreement between the Company and F. Matthew Rhodes, filed as
Exhibit 10.c to the Companys Registration Statement on Form S-4
(Registration No. 333-111179), is incorporated herein by reference.10.6
    
    Employment Agreement between the Company and Robert McMullan, filed as
Exhibit 10.d to the Companys Registration Statement on Form S-4
(Registration No. 333-111179), is incorporated herein by reference.10.7
    
    Employment Agreement between the Company and Dennis E. OReilly, filed as
Exhibit 10.e to the Companys Registration Statement on Form S-4
(Registration No. 333-111179), is incorporated herein by reference.10.8
    
    Employment Agreement between the Company and C. Michael Powell, filed as
Exhibit 10.f to the Companys Registration Statement on Form S-4
(Registration No. 333-111179), is incorporated herein by reference.31.1
    
    Certification of the Chief Executive Officer of Periodic Report Pursuant to
Rule 13a -15(e) or 15d-15(e).31.2
    
    Certification of the Chief Financial Officer of Periodic Report Pursuant to
Rule 13a -15(e) or 15d-15(e).
 46




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32
    
    Certification by Chief Executive Officer and Chief Financial Officer of
Periodic Report Pursuant to 18 U.S.C. Section 1350.
 (b) Reports on Form 8-K Current Report on Form 8-K dated January 28, 2004, furnishing the Companys
press release dated January 28, 2004, announcing its financial results for the
first quarter ended December 31, 2003. (Item 12) Current Report on Form 8-K dated March 12, 2004, reporting the completion of
the merger with GlobespanVirata, Inc. (Items 2 and 7) Current Report on Form 8-K dated April 26, 2004, furnishing the Companys press
release dated April 26, 2004, announcing its financial results for the second
quarter ended March 31, 2004. (Item 12) 47




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SIGNATURE Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized. CONEXANT SYSTEMS, INC.
(Registrant)Date: May 17, 2004
    By
    /s/ Robert McMullanRobert McMullanSenior Vice President and
Chief Financial Officer
(principal financial officer) 48




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EXHIBIT INDEX 3.a.1
    
    Amended and Restated Certificate of Incorporation of the Company, as amended.3.a.2
    
    Certificate of Increase in the Number of Authorized Shares of Series A
Junior Participating Preferred Stock of the Company.3.b.1
    
    Amended By-Laws of the Company.3.b.2
    
    Resolutions adopted by the Board of Directors of the Company on May 7, 2004
amending the Amended By-Laws of the Company.4.2
    
    First Supplemental Indenture, dated as of February 27, 2004, between
GlobespanVirata and The Bank of New York (successor to United States Trust
Company of New York), as Trustee.10.1
    
    Amendment to Employment Agreement between the Company and J. Scott Blouin.10.2
    
    Employment Agreement between the Company and Lewis C. Brewster.31.1
    
    Certification of the Chief Executive Officer of Periodic Report Pursuant to
Rule 13a 15(e) or 15d-15(e).31.2
    
    Certification of the Chief Financial Officer of Periodic Report Pursuant to
Rule 13a 15(e) or 15d-15(e).32
    
    Certification by Chief Executive Officer and Chief Financial Officer of
Periodic Report Pursuant to 18 U.S.C. Section 1350.
 49