##### Table of Contents



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
 
 FORM 10-Q þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
 For the quarterly period ended December 31, 2004 OR o
    
    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.)
 4000 MacArthur Boulevard
Newport Beach, California 92660-3095
(Address of principal executive offices) (Zip code) (949) 483-4600
(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 þ No o Indicate by check mark whether the registrant is an accelerated filer (as defined by Rule 12b-2 of
the Exchange Act).
Yes þ No o Number of shares of registrants common stock outstanding as of January 28, 2005 was 469,728,299.    1




---



##### Table of Contents



CAUTIONARY STATEMENT This Quarterly Report on Form 10-Q 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 substantial losses the company has incurred recently; the cyclical nature of the
semiconductor industry and the markets addressed by the companys and its customers products;
demand for and market acceptance of new and existing products; successful development of new
products; the timing of new product introductions and product quality; the companys ability to
anticipate trends and develop products for which there will be market demand; the availability of
manufacturing capacity; pricing pressures and other competitive factors; changes in product mix;
product obsolescence; the ability to develop and implement new technologies and to obtain
protection of the related intellectual property; the uncertainties of litigation and the demands it
may place on the time and attention of company management; and the risk that the businesses of
Conexant and GlobespanVirata have not yet been completely and may 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




---



##### Table of Contents



CONEXANT SYSTEMS, INC. INDEX PAGEPART I. FINANCIAL INFORMATIONItem 1.
    
    Financial Statements (unaudited):Consolidated Condensed Balance Sheets  December 31, 2004 and September 30, 2004
    
    
    4Consolidated Condensed Statements of Operations  Three Months Ended December
31, 2004 and 2003
    
    
    5Consolidated Condensed Statements of Cash Flows  Three Months Ended December
31, 2004 and 2003
    
    
    6Notes to Consolidated Condensed Financial Statements
    
    
    7Item 2.
    
    Managements Discussion and Analysis of Financial Condition and Results of
Operations
    
    
    26Item 3.
    
    Quantitative and Qualitative Disclosures About Market Risk
    
    
    47Item 4.
    
    Controls and Procedures
    
    
    48PART II. OTHER INFORMATIONItem 1.
    
    Legal Proceedings
    
    
    49Item 6.
    
    Exhibits
    
    
    49Signature
    
    
    50EXHIBIT 31.1EXHIBIT 31.2EXHIBIT 32EXHIBIT 99
 3




---



##### Table of Contents



PART I. FINANCIAL INFORMATION 
 ITEM 1. FINANCIAL STATEMENTS CONEXANT SYSTEMS, INC. 
 Consolidated Condensed Balance Sheets
 (unaudited, in thousands, except per share amounts)
 December 31,
    
    
    September 30,2004
    
    
    2004ASSETSCurrent assets:Cash and cash equivalents
    
    $
    132,326
    
    
    $
    139,031Short-term investments
    
    
    135,597
    
    
    
    163,040Receivables, net of allowance of $5,478 and $5,974 at
December 31, 2004 and September 30, 2004, respectively
    
    
    92,864
    
    
    
    185,037Inventories
    
    
    136,438
    
    
    
    194,754Mindspeed warrant-current portion
    
    
    5,634
    
    
    
    3,599Other current assets
    
    
    17,521
    
    
    
    20,768Total current assets
    
    
    520,380
    
    
    
    706,229Property, plant and equipment, net
    
    
    53,266
    
    
    
    55,741Goodwill
    
    
    714,852
    
    
    
    708,544Intangible assets, net
    
    
    128,947
    
    
    
    135,241Mindspeed warrant
    
    
    35,737
    
    
    
    23,000Marketable securities
    
    
    123,266
    
    
    
    137,604Other assets
    
    
    112,936
    
    
    
    114,163Total assets
    
    $
    1,689,384
    
    
    $
    1,880,522LIABILITIES AND SHAREHOLDERS EQUITYCurrent liabilities:Accounts payable
    
    $
    89,171
    
    
    $
    141,533Accrued compensation and benefits
    
    
    44,511
    
    
    
    40,423Restructuring and reorganization liabilities
    
    
    28,205
    
    
    
    22,427Other current liabilities
    
    
    51,502
    
    
    
    67,044Total current liabilities
    
    
    213,389
    
    
    
    271,427Convertible subordinated notes
    
    
    711,825
    
    
    
    711,825Other liabilities
    
    
    64,741
    
    
    
    68,883Total liabilities
    
    
    989,955
    
    
    
    1,052,135Commitments and contingencies
    
    
    
    
    
    
    Shareholders equity:Preferred and junior preferred stock
    
    
    
    
    
    
    Common stock, $0.01 par value: 1,000,000 shares
authorized; 469,722 and 469,441 shares issued, and
468,538 shares and 468,257 shares outstanding at
December 31, 2004 and September 30, 2004,
respectively
    
    
    4,697
    
    
    
    4,694Treasury stock: 1,184 shares at cost
    
    
    (5,584
    )
    
    
    (5,584
    )Additional paid-in capital
    
    
    4,651,343
    
    
    
    4,648,325Accumulated deficit
    
    
    (3,997,894
    )
    
    
    (3,877,176
    )Accumulated other comprehensive income
    
    
    68,802
    
    
    
    82,551Notes receivable from stock sales
    
    
    (386
    )
    
    
    (576
    )Unearned compensation
    
    
    (21,549
    )
    
    
    (23,847
    )Total shareholders equity
    
    
    699,429
    
    
    
    828,387Total liabilities and shareholders equity
    
    $
    1,689,384
    
    
    $
    1,880,522
 See accompanying notes to consolidated condensed financial statements. 4




---



##### Table of Contents



CONEXANT SYSTEMS, INC. 
 Consolidated Condensed Statements of Operations
 (unaudited, in thousands, except per share amounts)
 Three months endedDecember 31,2004
    
    
    2003Net revenues
    
    $
    140,621
    
    
    $
    177,333Cost of goods sold
    
    
    133,465
    
    
    
    98,196Gross margin
    
    
    7,156
    
    
    
    79,137Operating expenses:Research and development (including
non-cash stock compensation of $2,245
and $23 for the three months ended
December 31, 2004 and 2003,
respectively)
    
    
    72,541
    
    
    
    39,154Selling, general and administrative
(including non-cash stock compensation
of $744 and $0 for the three months
ended December 31, 2004 and 2003,
respectively)
    
    
    30,006
    
    
    
    22,809Amortization of intangible assets
    
    
    8,293
    
    
    
    955Special charges
    
    
    19,257
    
    
    
    605Total operating expenses
    
    
    130,097
    
    
    
    63,523Operating income (loss)
    
    
    (122,941
    )
    
    
    15,614Other (income) expense, net
    
    
    (2,755
    )
    
    
    (25,281
    )Income (loss) before income taxes
    
    
    (120,186
    )
    
    
    40,895Provision for income taxes
    
    
    532
    
    
    
    248Net income (loss)
    
    $
    (120,718
    )
    
    $
    40,647Net income (loss) per share  basic
    
    $
    (0.26
    )
    
    $
    0.15Net income (loss) per share  diluted
    
    $
    (0.26
    )
    
    $
    0.13Number of shares used in per share
computation-basic
    
    
    468,369
    
    
    
    277,190Number of shares used in per share
computation-diluted
    
    
    468,369
    
    
    
    307,545
 See accompanying notes to consolidated condensed financial statements. 5




---



##### Table of Contents



CONEXANT SYSTEMS, INC. 
 Consolidated Condensed Statements of Cash Flows
 (unaudited, in thousands)
 Three
months ended December 31,2004
    
    
    2003Cash flows from operating activities:Net income (loss)
    
    $
    (120,718
    )
    
    $
    40,647Adjustments to reconcile net income (loss) to net cash provided by
(used in) operating activities, net of effects of acquisition:Depreciation
    
    
    4,838
    
    
    
    3,155Amortization of intangible assets
    
    
    8,293
    
    
    
    955Reduction of provision for bad debt
    
    
    (500
    )
    
    
    Inventory provisions
    
    
    45,001
    
    
    
    1,644Increase in fair value of Skyworks note and Mindspeed warrant
    
    
    (14,773
    )
    
    
    (19,719
    )Equity in losses (earnings) of equity method investees
    
    
    3,089
    
    
    
    (10,165
    )Stock compensation, option modification charges and other
    
    
    2,989
    
    
    
    Other non-cash items, net
    
    
    (95
    )
    
    
    504Changes in assets and liabilities:Receivables
    
    
    92,824
    
    
    
    (6,057
    )Inventories
    
    
    13,427
    
    
    
    (1,075
    )Accounts payable
    
    
    (53,016
    )
    
    
    12,074Agere patent litigation settlement
    
    
    (8,000
    )
    
    
    Special charges, net of $10.6 million and $2.3 million
of payments, respectively
    
    
    8,632
    
    
    
    (1,672
    )Accrued expenses and other current liabilities
    
    
    (1,291
    )
    
    
    5,270Other
    
    
    3,250
    
    
    
    (2,976
    )Net cash provided by (used in) operating activities
    
    
    (16,050
    )
    
    
    22,585Cash flows from investing activities:Cash paid for acquisition, net of cash acquired
    
    
    (14,501
    )
    
    
    Purchases of marketable securities
    
    
    (7,080
    )
    
    
    (12,580
    )Sales of marketable securities
    
    
    34,170
    
    
    
    8,266Capital expenditures
    
    
    (2,082
    )
    
    
    (4,857
    )Deferred merger costs
    
    
    
    
    
    
    (1,432
    )Payment of deferred purchase consideration
    
    
    
    
    
    
    (4,000
    )Investments in businesses
    
    
    (1,755
    )
    
    
    (471
    )Net cash provided by (used in) investing activities
    
    
    8,752
    
    
    
    (15,074
    )Cash flows from financing activities:Proceeds from exercise of stock options
    
    
    397
    
    
    
    6,065Repayment of notes receivable from stock sales
    
    
    196
    
    
    
    Net cash provided by financing activities
    
    
    593
    
    
    
    6,065Net increase (decrease) in cash and cash equivalents
    
    
    (6,705
    )
    
    
    13,576Cash and cash equivalents at beginning of period
    
    
    139,031
    
    
    
    76,186Cash and cash equivalents at end of period
    
    $
    132,326
    
    
    $
    89,762
 See accompanying notes to consolidated condensed financial statements. 6




---



##### Table of Contents



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 reportable segment. On February 27, 2004, the Company completed its merger with GlobespanVirata, Inc. (GlobespanVirata)
with GlobespanVirata becoming a wholly-owned subsidiary of the Company. See Note 2 for further
information. Interim Reporting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
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, 2004. Fiscal PeriodsFor presentation purposes, references made to the periods ended December 31, 2003
and 2004, relate to the actual fiscal 2004 first quarter ended January 2, 2004 and the actual first
fiscal quarter of 2005 ended December 31, 2004. Supplemental Cash Flow Information Cash paid for interest was $4.8 million and $1.4 million for
the three months ended December 31, 2004 and 2003, respectively. Cash paid for income taxes for the
three months ended December 31, 2004 and 2003 was $0.3 million and $0.6 million, respectively. Revenue Recognition The Company recognizes 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. The Company sells a portion of its products to electronic component distributors under
agreements allowing for a right to return unsold products. The
Company defers the recognition of revenue on
all sales to these distributors until the products are sold by the distributors to a third party.
The Company records 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. Conexant has more than 20 distributor customers for whom revenue is recognized upon its shipment of
product to them, as the contractual terms provide for no rights of return. During the first fiscal
quarter of 2005, the Company made a business decision to assist primarily three distribution
customers to more rapidly sell their inventory by accepting net product returns of $13.3 million
and making price adjustments of $7.9 million on certain of their products in inventory. As a
result of implementing these returns and adjustments, which are a
departure from the contractual
terms with these customers, the Company has decided that it is appropriate to defer the recognition
of revenue on sales to these three distributors until the purchased products are sold by the
distributors to a third party. Income (Loss) Per Share Basic income (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 convertible subordinated notes for the period of time such
notes were outstanding, if such stock options and 7




---



##### Table of Contents



CONEXANT SYSTEMS, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(unaudited) convertible notes are dilutive. In periods of a net loss position, basic and diluted weighted
average shares are the same. The following table sets forth the computation of the numerator and denominator of basic and
diluted earnings per share: Three months endedDecember 31,2004
    
    
    2003Numerator (dollars in thousands):Net income (loss)- basic
    
    $
    (120,718
    )
    
    $
    40,647Effect of assumed conversion of 4.25% Convertible
Subordinated Notes due 2006
    
    
    
    
    
    
    439Net income (loss)- diluted
    
    $
    (120,718
    )
    
    $
    41,086Denominator (weighted-average number of shares in thousands):Weighted average shares outstanding- basic
    
    
    468,369
    
    
    
    277,190Stock options and warrants (under the treasury stock
method)
    
    
    
    
    
    
    22,973Restricted stock
    
    
    
    
    
    
    18Assumed conversion of 4.25% Convertible Subordinated Notes
due 2006
    
    
    
    
    
    
    7,364Weighted average shares outstanding - diluted
    
    
    468,369
    
    
    
    307,545
 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 endedDecember 31,(weighted-average number of shares, in thousands)
    
    2004
    
    
    2003Stock options and warrants (under the treasury stock method)
    
    
    1,921
    
    
    
    4.25% Convertible Subordinated Notes due 2006
    
    
    7,364
    
    
    
    5.25% Convertible Subordinated Notes due 2006
    
    
    5,840
    
    
    
    4.00% Convertible Subordinated Notes due 2007
    
    
    12,137
    
    
    
    12,137Restricted stock
    
    
    6
    
    
    
    
 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. 8




---



##### Table of Contents



CONEXANT SYSTEMS, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(unaudited) 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 net income (loss) and pro
forma net income (loss) per share would have been the amounts indicated below (in thousands, except
per share amounts): Three months endedDecember 31,2004
    
    
    2003Net income (loss), as reported
    
    $
    (120,718
    )
    
    $
    40,647Add: expense determined under fair
value accounting included in net
income (loss), as reported
    
    
    2,989
    
    
    
    23Deduct: total expense determined
under fair value accounting for all
awards
    
    
    (18,566
    )
    
    
    (13,130
    )Pro forma net income (loss)
    
    $
    (136,295
    )
    
    $
    27,540Net income (loss) per share  basic,
as reported
    
    $
    (0.26
    )
    
    $
    0.15Pro forma net income (loss) per
share  basic
    
    $
    (0.29
    )
    
    $
    0.10Net income (loss) per share 
diluted, as reported
    
    $
    (0.26
    )
    
    $
    0.13Pro forma net income (loss) per
share  diluted
    
    $
    (0.29
    )
    
    $
    0.10
 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 endedDecember 31,2004
    
    
    2003Risk-free interest rate
    
    
    3.6
    %
    
    
    3.3
    %Expected volatility
    
    
    97
    %
    
    
    97
    %Dividend yield
    
    
    
    
    
    
    Expected life (years)
    
    
    4.5
    
    
    
    4.5Weighted-average fair value
of options granted
    
    $
    1.58
    
    
    $
    4.23
 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. The Company accounts for non-employee stock-based compensation in accordance with the terms of SFAS
No. 123 (See Note 7 - Other). Recent Accounting PronouncementsIn December 2004, the Financial Accounting Standards Board
issued SFAS No. 123 (R), Share-Based Payment. This pronouncement amends SFAS No. 123, and
supersedes APB Opinion No. 25. SFAS No. 123 (R) requires that public companies account for awards
of equity instruments issued to employees under the fair value method of accounting and recognize
such amounts in the statement of operations. This statement is effective beginning with the
Companys fiscal 2005 fourth quarter beginning July 2, 2005. The Company expects the impact of
this new pronouncement to be significant to its results of operations. Cash, Cash Equivalents and Investments  marketable securitiesThe Company considers all highly
liquid investments with insignificant interest rate risk and original maturities of three months or
less from the date of purchase to be cash equivalents. The carrying amounts of cash and cash
equivalents approximate their fair values. Short-term marketable securities consist of mutual
funds, debt securities with original maturity dates between ninety days and one year, and equity
securities. Long-term marketable securities consist of debt securities with original 9




---



##### Table of Contents



CONEXANT SYSTEMS, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(unaudited) 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 (loss).
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. Equity securities included in short-term marketable securities represent the Companys common stock
holdings in publicly traded companies and are classified as short-term based on the Companys
ability and intent to liquidate the securities as necessary to meet liquidity requirements. The
reported fair value of these equity securities is based on the quoted market prices of the
securities at each reporting date. Based on the overall state of the stock market, the
availability of buyers for the shares when the Company wants to sell, and other restrictions, at
any point in time the amounts ultimately realized upon liquidation of these securities may be
significantly different than the carrying value. Total cash, cash equivalents and marketable securities at December 31, 2004 and at September 30,
2004 are as follows (in thousands): December 31,
    
    
    September 30,2004
    
    
    2004Cash and cash equivalents
    
    $
    132,326
    
    
    $
    139,031Equity securities- Skyworks Solutions, Inc. (6.2
million shares at December 31, 2004 and September 30,
2004)
    
    
    58,305
    
    
    
    61,767Equity securities- SiRF Technologies, Inc. (5.9
million shares at December 31, 2004 and September 30,
2004)
    
    
    74,705
    
    
    
    87,509Other short-term marketable securities (primarily
mutual funds, domestic government agency securities
and corporate debt securities)
    
    
    2,587
    
    
    
    13,764Subtotal- short-term investments
    
    
    135,597
    
    
    
    163,040Long-term marketable securities (primarily domestic
government agency securities and corporate debt
securities)
    
    
    123,266
    
    
    
    137,604Total cash, cash equivalents and marketable securities
    
    $
    391,189
    
    
    $
    439,675
 For all investment securities, unrealized losses that are other than temporary are recognized
in net income (loss). The Company does not hold these securities for speculative or trading
purposes. 2. Acquisitions Acquisition of Paxonet Communications, Inc. On December 3, 2004, the Company acquired all of the outstanding capital stock of Paxonet
Communications, Inc. (Paxonet), a privately held company headquartered in Fremont, California, with
an engineering workforce primarily based in India. The consideration for this purchase was $14.8 million in cash. Net tangible assets acquired were
$0.4 million. Approximately $0.7 million of the purchase price was allocated to unearned
compensation representing the intrinsic value of unvested stock options exchanged in the
transaction and the remainder to identifiable intangible assets and goodwill. The unearned
compensation will be amortized to expense over the four year remaining vesting period of the stock
options. The identifiable intangible assets of $2.0 million are being amortized on a straight-line
basis over five years. The amount recorded as goodwill of $11.7 million is not deductible for tax
purposes. The purchase price allocation is preliminary and is subject to change pending
finalization of a third party valuation report of acquired identifiable intangible assets. The pro forma effect of this acquisition was not material to the Companys results of operations
for fiscal 2005 or 2004. 10




---



##### Table of Contents



CONEXANT SYSTEMS, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(unaudited) 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. For accounting purposes, the transaction was
accounted for under the purchase method of accounting with the Company as the acquirer. 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 (or approximately 180.6 million shares of Conexant common
stock) 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 (or approximately 43.6 million options to purchase shares of Conexant common
stock). In May 2004, the GlobespanVirata, Inc. subsidiary was renamed Conexant, Inc., and
hereinafter will be referred to as Conexant, Inc., and the overall business combination is
hereinafter referred to as the Merger. 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
    
    
    12,900Total purchase consideration
    
    $
    1,121,253
 The fair value of Conexant common stock and stock options issued of $1.1 billion has been
allocated to common 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 acquired 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 $3.0 million of this unearned compensation was recognized as
an expense in the three months ended December 31, 2004. In connection with the Merger, the Company began to formulate a reorganization and restructuring
plan (the Reorganization Plan). As a result of the Reorganization Plan, through September 30, 2004,
the Company recognized an aggregate of $11.5 million as liabilities assumed in the purchase
business combination related to restructuring liabilities for estimated costs related to Conexant,
Inc. facilities consolidation and the related impact on Conexant, Inc. outstanding real estate
leases and Conexant, Inc. involuntary employee terminations and relocations. 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. The Reorganization Plan was complete as of December 31, 2004 and no
adjustments were made to goodwill for these actions during the first fiscal quarter of 2005. In the Merger, the Company acquired a reserve for income tax contingencies for foreign income tax
matters which arose due to items recorded in the income tax returns of the former GlobespanVirata
subsidiaries. As of September 30, 2004, this reserve balance was $8.2 million. In the quarter
ended December 31, 2004, a portion of this income tax contingency was settled with the taxing
authorities, and as a result, the amount of the liability in excess of the settlement amount of
$5.4 million was reduced with a corresponding reduction to goodwill. As the remaining
pre-acquisition contingencies continue to evolve and settle with the taxing authorities, the
Company will record such changes, favorable or unfavorable, against the purchase price allocation
(goodwill) through the expiration of the allocation period (the end of the fiscal 2005 second
quarter) as defined by SFAS No. 141. If the contingencies are not settled by the end of the fiscal
2005 second quarter, any changes after that date, whether favorable or unfavorable, will be
recorded to operations. 11




---



##### Table of Contents



CONEXANT SYSTEMS, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(unaudited) The following sets forth the Companys estimates of the fair values of the assets acquired and
liabilities assumed in the Merger (in thousands). The amounts below may change further through the
end of the allocation period. Cash and cash equivalents
    
    $
    42,515Short-term and long-term investments
    
    
    153,099Accounts receivable
    
    
    91,259Inventories
    
    
    73,281Prepaids and other current assets
    
    
    4,236Property and equipment
    
    
    46,883Other long-term assets
    
    
    20,600Identifiable intangible assets
    
    
    137,931In-process research and development
    
    
    160,818Goodwill
    
    
    626,981Accounts payable
    
    
    (41,580
    )Accrued expenses
    
    
    (72,626
    )Accrued restructuring and reorganization liabilities
    
    
    (11,465
    )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
    
    $
    1,121,253
 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 digital subscriber line (DSL) and
wireless local area network (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 $6.9 million for the
three months ended December 31, 2004. The Company does not believe that any indicator of permanent
impairment exists with respect to the identifiable intangible assets. The Company continues to
evaluate the indicators of impairment and if such indicators are determined to exist, the Company
will formally evaluate the recoverability of these assets. The amount recorded as goodwill of
$627.0 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 networking 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 networking projects were
approximately $14.1 million and $6.2 million, respectively. These projects are planned to 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- 12




---



##### Table of Contents



CONEXANT SYSTEMS, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(unaudited) 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 these amounts are representative of fair values. Actual results do not differ
materially from the estimates used in the valuation of IPR&D. 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 the former GlobespanVirata, which were
effectively repurchased at the Merger closing date of February 27, 2004. The Merger was accounted for as a purchase and the operating results of the former GlobespanVirata
have 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 the period presented and includes amortization of identifiable intangibles and
unearned compensation from that date. Three monthsended Dec. 31,2003Net revenues
    
    $
    314,581Net income
    
    $
    38,633Net income per common share  basic
    
    $
    0.08Net income per common share  diluted
    
    $
    0.08
 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. Acquisition of Amphion Semiconductor On June 29, 2004, the Company purchased all the outstanding capital stock of Amphion Semiconductor
Limited (Amphion), a company located in Belfast, Northern Ireland specializing in developing video
compression technology. The Company completed this strategic acquisition as a complement to
existing products. The consideration for this purchase was $20.0 million in cash, 600,000 shares
of common stock (valued at $6.0 million) and $0.4 million in transaction costs. Net tangible
assets acquired were $2.4 million. The excess of the purchase price over the net tangible assets
was assigned to developed technology of $4.2 million and $19.4 million to goodwill. The developed
technology will be amortized on a straight-line basis over five years. The amount recorded as
goodwill of $19.4 million is not deductible for tax purposes. Under the stock purchase agreement, the Company guaranteed the value of the shares issued to the
former Amphion shareholders for a defined period through June 29, 2006 (subject to certain
conditions and elections). The guaranty is subject to adjustment for any stock split, stock
dividend, recapitalization, merger or similar transaction. In the event that the market price of
the Conexant common stock does not equal or exceed $10.00 for at least five consecutive trading
days during this period, Conexant would be required to make an additional payment (in cash or
additional shares of common stock at Conexants option) to former Amphion shareholders for the
difference between the $10.00 and the market price per share of such shares as of specified dates.
Consequently, the Company has valued the shares delivered to the former Amphion shareholders at the
guaranteed value of $10.00 per share, or a total of $6.0 million. To the extent the Company is
required to make an additional payment under the guaranty, the payment will not increase the total
purchase price. The terms of this acquisition include provisions under which the former shareholders of Amphion
could receive additional consideration of up to $4.0 million during the twelve to eighteen months
following the acquisition if 13




---



##### Table of Contents



CONEXANT SYSTEMS, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(unaudited) certain technology milestones are achieved. This contingent consideration has not been included in
the purchase price allocation and if earned, such amounts will be capitalized as an addition to
goodwill. The pro forma effect of this acquisition was not material to the Companys results of operations
for fiscal 2004. 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: Short-term investments (in thousands): Gross
    
    
    GrossUnrealized
    
    
    UnrealizedAmortized
    
    
    Holding
    
    
    Holding
    
    
    FairCost
    
    
    Gains
    
    
    Losses
    
    
    ValueDecember 31, 2004:Corporate debt securities
    
    $
    1,405
    
    
    $
    
    
    
    $
    (2
    )
    
    $
    1,403Equity securities
    
    
    56,524
    
    
    
    77,670
    
    
    
    
    
    
    
    134,194$
    57,929
    
    
    $
    77,670
    
    
    $
    (2
    )
    
    $
    135,597September 30, 2004:Mutual funds
    
    $
    10,837
    
    
    $
    
    
    
    $
    (125
    )
    
    $
    10,712Corporate debt securities
    
    
    2,274
    
    
    
    
    
    
    
    (3
    )
    
    
    2,271Equity securities
    
    
    56,524
    
    
    
    93,533
    
    
    
    
    
    
    
    150,057$
    69,635
    
    
    $
    93,533
    
    
    $
    (128
    )
    
    $
    163,040
 The mutual fund holdings at September 30, 2004 were invested in adjustable rate mortgages and
government agency securities. Long-term investments (in thousands): Gross
    
    
    GrossUnrealized
    
    
    UnrealizedAmortized
    
    
    Holding
    
    
    Holding
    
    
    FairCost
    
    
    Gains
    
    
    Losses
    
    
    ValueDecember 31, 2004:Domestic government agency securities
    
    $
    88,738
    
    
    $
    
    
    
    $
    (434
    )
    
    $
    88,304Corporate debt securities
    
    
    35,202
    
    
    
    3
    
    
    
    (243
    )
    
    
    34,962$
    123,940
    
    
    $
    3
    
    
    $
    (677
    )
    
    $
    123,266September 30, 2004:Domestic government agency securities
    
    $
    105,956
    
    
    $
    
    
    
    $
    (800
    )
    
    $
    105,156Corporate debt securities
    
    
    32,595
    
    
    
    
    
    
    
    (147
    )
    
    
    32,448$
    138,551
    
    
    $
    
    
    
    $
    (947
    )
    
    $
    137,604
 The Companys long-term marketable securities principally have original contractual maturities
from one to three years. Inventories
Inventories consist of the following (in thousands): December 31,
    
    
    September 30,2004
    
    
    2004Work-in-process
    
    $
    70,785
    
    
    $
    99,226Finished goods
    
    
    65,653
    
    
    
    95,528$
    136,438
    
    
    $
    194,754
 At December 31, 2004 and September 30, 2004, inventories are net of $49.5 million and $23.3
million, respectively, of allowances for excess and obsolete inventories. In addition, at December
31, 2004, inventories are net of $18.8 million in lower of cost or market reserves. In the quarter ended December 31, 2004, in response to lower market prices and reduced end-customer
demand for Broadband Access and Wireless Networking products, the Company recorded $26.2 million in
excess and obsolete charges and $18.8 million of charges to reduce certain Wireless Networking
inventory to its estimated lower of cost or market value. 14




---



##### Table of Contents



CONEXANT SYSTEMS, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(unaudited) Goodwill
During the first quarter of fiscal 2005, goodwill was adjusted as follows (in thousands): Goodwill, September 30, 2004
    
    $
    708,544Acquisition of Paxonet
    
    
    11,731Adjustments to prior purchase price allocation (1)
    
    
    (5,423
    )Goodwill, December 31, 2004
    
    $
    714,852
 (1) In the Merger, the Company acquired a reserve for income tax contingencies for
foreign income tax matters which arose due to items recorded in the income tax returns of the
former GlobespanVirata subsidiaries. In the quarter ended December 31, 2004, a portion of this
income tax contingency was settled with the taxing authorities, and as a result, the amount of the
liability in excess of the settlement amount of $5.4 million was reduced with a corresponding
reduction to goodwill.


Intangible Assets
Intangible assets consist of the following (in thousands):

December 31, 2004
    
    
    September 30, 2004Gross
    
    
    Accumulated
    
    
    
    
    
    
    Gross
    
    
    AccumulatedAsset
    
    
    Amortization
    
    
    Net
    
    
    Asset
    
    
    Amortization
    
    
    NetDeveloped technology
    
    $
    145,946
    
    
    $
    (32,659
    )
    
    $
    113,287
    
    
    $
    145,946
    
    
    $
    (25,359
    )
    
    $
    120,587Customer base
    
    
    4,050
    
    
    
    (1,052
    )
    
    
    2,998
    
    
    
    2,050
    
    
    
    (847
    )
    
    
    1,203Other intangible assets
    
    
    20,908
    
    
    
    (8,246
    )
    
    
    12,662
    
    
    
    20,908
    
    
    
    (7,457
    )
    
    
    13,451$
    170,904
    
    
    $
    (41,957
    )
    
    $
    128,947
    
    
    $
    168,904
    
    
    $
    (33,663
    )
    
    $
    135,241


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 of2005
    
    
    2006
    
    
    2007
    
    
    2008
    
    
    2009
    
    
    ThereafterAmortization expense
    
    $
    23,651
    
    
    $
    30,301
    
    
    $
    29,569
    
    
    $
    29,114
    
    
    $
    13,611
    
    
    $
    2,701


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 December 31,
2004, the aggregate fair value of the Mindspeed warrant included on the accompanying consolidated
condensed balance sheet was $41.4 million. The current portion of $5.6 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.

The valuation of this derivative instrument is subjective, and option valuation models require the
input of highly subjective assumptions, including the expected stock price volatility. Changes in
these assumptions can materially affect the fair value estimate. The Company could, at any point
in time, ultimately realize amounts significantly different than the carrying value.

15



---



##### Table of Contents



CONEXANT SYSTEMS, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(unaudited) Convertible Subordinated Notes
At December 31, 2004, the components of convertible subordinated notes are as follows (in
thousands): 4.00% 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
 Other (Income) Expense, Net
Other (income) expense, net consists of the following (in thousands): Three months endedDecember 31,2004
    
    
    2003Investment and interest income
    
    $
    (551
    )
    
    $
    (2,497
    )Decrease in fair value of the conversion right under
the Skyworks 15% convertible senior subordinated
notes
    
    
    
    
    
    
    4,911Increase in fair value of the Mindspeed warrant
    
    
    (14,773
    )
    
    
    (24,630
    )Interest expense
    
    
    8,431
    
    
    
    6,689Equity in (earnings) losses of equity method investees
    
    
    3,089
    
    
    
    (10,165
    )Other
    
    
    1,049
    
    
    
    411Other (income) expense, net
    
    $
    (2,755
    )
    
    $
    (25,281
    )
 During the three months ended December 31, 2003, an unrelated party repaid a $30.0 million
note issued in connection with a previous equity investment in Jazz Semiconductor, Inc., 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. At the same time,
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. The Company received a notice dated April 22, 2004 from Skyworks advising that on May 12, 2004,
Skyworks would redeem in full the 15% convertible senior subordinated notes held by the Company.
The Company exercised its right to convert all of the notes into shares of Skyworks common stock
prior to the scheduled redemption date at the conversion price of $7.87 per share. On May 10,
2004, the Company received 5.7 million shares of Skyworks common stock in full satisfaction of the
notes. 5. Commitments and Contingencies Legal Matters 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 16




---



##### Table of Contents



CONEXANT SYSTEMS, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(unaudited) license agreement, a settlement, or the adjudication of such claims through arbitration or
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, results of
operations, or cash flows of the Company. IPO Litigation.In November 2001, Collegeware Asset Management, LP, on behalf of itself and a
putative class of persons who purchased Conexant, Inc. 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 Conexant, Inc.s initial
and secondary public offerings as well as certain Conexant, Inc. officers and directors. The
complaint alleges that the defendants violated federal securities laws by issuing and selling
Conexant, Inc.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 Conexant, Inc.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 Conexant, Inc. 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. Texas Instruments, Inc.The Companys Conexant, Inc. 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, Conexant, Inc. 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 Conexant, Inc. products.
Conexant, Inc. 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
Conexant, Inc. and (iv) an injunction prohibiting the Defendants from pursuing patent litigation
against Conexant, Inc. and its customers. On August 11, 2003 and September 9, 2003, the Defendants
answered the complaint, denied Conexant, Inc.s claims and filed counterclaims alleging that
Conexant, Inc. has infringed certain of their ADSL patents. In addition to other relief, the
Defendants are seeking to collect damages for alleged past infringement and to enjoin Conexant,
Inc. from continuing to use the Defendants ADSL patents. Although the Company believes that
Conexant, Inc. has strong arguments in favor of its position in this dispute, it can give no
assurance that Conexant, Inc. will prevail on any of these grounds in litigation. If any such
litigation is adversely resolved, Conexant, Inc. could be held responsible for the payment of
damages and/or future royalties and/or have the sale of certain of Conexant, Inc. products stopped
by an injunction, any of which could have a material adverse effect on the Companys business,
financial condition and results of operations. 17




---



##### Table of Contents



CONEXANT SYSTEMS, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(unaudited) Class Action Suits.In December 2004 and January 2005, the Company and certain current and former
officers were named as defendants in several complaints filed on behalf of all persons who
purchased Company common stock during a specified class period in the U.S. District Court of New
Jersey and the U.S. District Court for the Central District of California, alleging that the
defendants violated the Securities Exchange Act of 1934 (the Exchange Act) by allegedly
disseminating materially false and misleading statements and/or concealing material adverse facts.
The defendants believe these charges are without merit and intend to vigorously defend the
litigation. Shareholder Derivative Suits.In January 2005, the Company and certain current and former directors
and officers were named as defendants in purported shareholder derivative actions in California
State Court for the County of Orange, alleging that the defendants breached their fiduciary duties,
abused control, mismanaged the company, wasted corporate assets and unjustly enriched themselves.
The defendants believe these charges are without merit and intend to vigorously defend the
litigation. Agere Systems, Inc. On November 4, 2004, the Company reached a settlement with Agere Systems Inc.
(Agere), which among other things, dismissed with prejudice all litigation matters between the two
companies. The settlement agreement also provided for the dismissal with prejudice of all claims
brought by and against Intersil. Conexant, Inc. (formerly GlobespanVirata, Inc.) acquired the WLAN
Group of Intersil in August 2003. As part of this overall litigation settlement, the Company made
a cash payment, which was accrued in fiscal 2004, to Agere in the amount of $8.0 million in
November 2004 and the two companies entered into various license agreements covering the patents
involved in the suits and other semiconductor devices. Other 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 $3.0 million and has accrued for these costs as of
December 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 $5.7 million and $4.4 million for the three months ended December 31, 2004
and 2003, respectively. At December 31, 2004, future minimum lease payments under operating leases, excluding any sublease
income, were as follows (in thousands): Fiscal Year2005 remaining 9 months
    
    $
    21,6202006
    
    
    21,4452007
    
    
    16,7952008
    
    
    12,1142009
    
    
    9,172Thereafter
    
    
    62,097Total future minimum lease payments
    
    $
    143,243
 At December 31, 2004, the Company has many sublease arrangements on operating leases for terms
ranging from near term to approximately 6 years. Aggregate scheduled sublease income based on
current terms is approximately $7.5 million. The summary of future minimum lease payments includes an aggregate gross amount of $44.7 million of
lease obligations that principally expire through fiscal 2021, which have been accrued for in
connection with the 18




---



##### Table of Contents



CONEXANT SYSTEMS, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(unaudited) Companys reorganization and restructuring actions (see Note 7) and previous actions taken by
GlobespanVirata prior to the Merger. The Company purchases a portion of its requirements for silicon-based semiconductor products from
Jazz Semiconductor, Inc. (Jazz). 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 supply agreement with Jazz, net of a
portion of the wafer purchase obligations assumed by a third party, will be approximately $7.0
million for the remainder of fiscal year 2005. The Company is contingently liable for the
approximate $6.0 million in the minimum purchase obligations assumed by that third party. Additionally, the Company entered into a 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 2005 in the amount of $7.2 million. 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 minimum purchase obligations under the supply
agreements with Jazz and Skyworks. At December 31, 2004, the Company is contingently liable for approximately $14.6 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 $4.4 million as of December 31, 2004. The Company has exercised its purchase option for approximately $60.0 million to purchase two
buildings in Newport Beach, California which are currently occupied under a lease agreement. The
Companys plan is to complete a sale-leaseback transaction with respect to these facilities in the
quarter ending March 31, 2005. The Company has made commitments to certain employees in the amount of $4.6 million as of December
31, 2004. Such amounts will be earned and paid over the next twelve months. 6. Comprehensive Income (Loss) Comprehensive income (loss) is as follows (in thousands): Three months endedDecember 31,2004
    
    
    2003Net income (loss)
    
    $
    (120,718
    )
    
    $
    40,647Other comprehensive income (loss):Foreign currency translation adjustments
    
    
    1,628
    
    
    
    458Change in unrealized gains on available-for-sale securities
    
    
    (15,464
    )
    
    
    (451
    )Minimum pension liability adjustments
    
    
    87
    
    
    
    86Effect of income taxes
    
    
    
    
    
    
    172Other comprehensive income (loss)
    
    
    (13,749
    )
    
    
    265Comprehensive income (loss)
    
    $
    (134,467
    )
    
    $
    40,912
 19




---



##### Table of Contents



CONEXANT SYSTEMS, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(unaudited) The components of accumulated other comprehensive income are as follows (in thousands): December 31,
    
    
    September 30,2004
    
    
    2004Foreign currency translation adjustments
    
    $
    (1,578
    )
    
    $
    (3,206
    )Unrealized gains on available-for-sale securities
    
    
    76,994
    
    
    
    92,458Minimum pension liability adjustments
    
    
    (6,614
    )
    
    
    (6,701
    )Accumulated other comprehensive income
    
    $
    68,802
    
    
    $
    82,551
 7. Special Charges Special charges consist of the following (in thousands): Three months endedDecember 31,2004
    
    
    2003Asset impairments
    
    $
    455
    
    
    $
    153Restructuring charges
    
    
    11,971
    
    
    
    448Integration charges
    
    
    3,525
    
    
    
    Other
    
    
    3,306
    
    
    
    4$
    19,257
    
    
    $
    605
 Asset Impairments During the first fiscal quarter of 2005, the Company recorded asset impairment charges of $0.5
million related to various operating assets which were determined to be redundant and no longer
required as a result of restructuring activities. These assets have been abandoned. Restructuring Charges The Company has implemented a number of cost reduction initiatives since late fiscal 2001 to
improve its operating cost structure. The cost reduction initiatives included workforce reductions,
and the closure or consolidation of certain facilities, among other actions. The costs and expenses
associated with the restructuring activities, except for the liabilities associated with the 2004
Reorganization Plan that related to the employees and facilities of Conexant, Inc., are included in
special charges in the accompanying consolidated condensed statements of operations. The costs and
expenses resulting from the 2004 Reorganization Plan which related to the employees and facilities
of Conexant, Inc. have been recorded as acquired liabilities in the Merger and included as part of
the purchase price allocation in accordance with EITF 95-3 and SFAS No. 141 (see Note 2).
Subsequent actions that impacted the employees and facilities of Conexant, Inc. have been included
in special charges on the Companys statements of operations. 2005 Restructuring Action In November 2004, the Company announced additional plans to reduce its
operating expense level by the end of the fourth fiscal quarter of 2005. The components of this
plan are a shift of product development resources to lower-cost regions and cost savings from
continued Merger-related sales, general and administrative consolidation. During the first fiscal
quarter of 2005, the Company completed numerous senior management changes and notified an
additional 13 employees in selling, general and administrative areas of their involuntary
termination. The Company recorded total charges of $6.1 million based on the estimates of the cost
of severance benefits for the affected employees and will charge an additional $0.5 million to
restructuring expense in the next two fiscal quarters as certain severance benefits are earned.
Additionally, the Company recorded restructuring charges of $4.0 million relating to the
consolidation of certain facilities under non-cancelable leases which were vacated. The facility
charges were determined in accordance with the provisions of SFAS No. 146, Accounting for Costs
Associated with Exit or Disposal Activities. As a result, the Company recorded the present value
of the future lease obligations, in excess of the expected future sublease income, using a discount
rate of approximately 8.0%, and will accrete the approximate $2.2 million into expense over the
remaining life of the leases. The accrual for facility charges includes a $1.0 million non-cash
reclassification of a portion of the deferred 20




---



##### Table of Contents



CONEXANT SYSTEMS, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(unaudited) gain on the previous sale of the facility, which has now been partially vacated. Subsequent to
December 31, 2004, the Company launched an additional set of headcount reduction actions. Activity and liability balances recorded as part of the 2005 Restructuring Action through December
31, 2004 were as follows (in thousands): Workforce
    
    
    Facilityreductions
    
    
    and other
    
    
    TotalCharged to costs and expenses
    
    $
    6,073
    
    
    $
    4,006
    
    
    $
    10,079Non-cash items
    
    
    (22
    )
    
    
    979
    
    
    
    957Cash payments
    
    
    (3,333
    )
    
    
    
    
    
    
    (3,333
    )Restructuring balance, December 31, 2004
    
    $
    2,718
    
    
    $
    4,985
    
    
    $
    7,703
 2004 Restructuring Actions The Company approved several restructuring plans during fiscal
2004. In connection with the Merger, the Company began to formulate a plan which included
workforce reductions and facility consolidation actions. This plan was communicated at the time of
the Merger and has been completed (the 2004 Merger Related Restructuring and Reorganization Plans).
During the fourth fiscal quarter of 2004, the Company announced additional workforce reduction and
facility consolidation actions in response to lower than anticipated revenue levels. In connection with the Merger, the Company began to formulate the 2004 Merger Related
Reorganization Plan which consisted primarily of workforce reductions to eliminate redundant
positions and consolidation of worldwide facilities. The portions of the plan that pertained to
Conexant, Inc. employees and facilities were recorded as acquired liabilities in the Merger and
included as part of the purchase price allocation, in accordance with EITF No. 95-3 and SFAS No.
141. This plan consisted of an involuntary workforce reduction which affected approximately 35
employees of Conexant, Inc. These employees were located in the United States in sales and
administrative functions. The charge associated with these workforce reductions of approximately
$1.3 million was based upon estimates of the severance and fringe benefits for the affected
employees, in addition to relocation benefits for others. The facility consolidation plan resulted
in an initial charge of $13.5 million and included assumptions regarding sublease rates and time
periods and other costs to prepare and sublease the applicable spaces. Additionally, at the date
of the Merger, there had been a decline in the real estate market in certain geographic regions in
which Conexant, Inc. had leased facilities. A portion of the facilities related charges represent
adjustments to the fair market value rates of those leases. These non-cancelable lease commitments
range from near term to 17 years in length. The Company reduced the original facility
consolidation charge by approximately $3.6 million and increased the workforce related charge by
approximately $0.2 million as a result of finalizing the 2004 Merger Related Reorganization Plan
and recorded these changes as adjustments to the purchase price allocation (goodwill). Activity and liability balances recorded as part of the 2004 Merger Related Reorganization Plan
pertaining to Conexant, Inc. employees and facilities through December 31, 2004 were as follows (in
thousands): Workforce
    
    
    Facilityreductions
    
    
    and other
    
    
    TotalRecorded in purchase price allocation
    
    $
    1,300
    
    
    $
    13,509
    
    
    $
    14,809Adjusted to purchase price allocation
    
    
    210
    
    
    
    (3,554
    )
    
    
    (3,344
    )Cash payments
    
    
    (536
    )
    
    
    (788
    )
    
    
    (1,324
    )Restructuring balance, September 30, 2004
    
    
    974
    
    
    
    9,167
    
    
    
    10,141Cash payments
    
    
    (277
    )
    
    
    (273
    )
    
    
    (550
    )Restructuring balance, December 31, 2004
    
    $
    697
    
    
    $
    8,894
    
    
    $
    9,591
 The portion of the 2004 restructuring actions pertaining to Conexant Systems, Inc. employees
and facilities was recorded to special charges during fiscal 2004 (the 2004 Merger Related
Restructuring Plan). Approximately 90 employees in the sales and administrative and information
technology areas were involuntarily terminated, resulting in charges of $1.9 million, which was
based upon estimates of severance benefits for the affected employees. These 21




---



##### Table of Contents



CONEXANT SYSTEMS, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(unaudited) employees left the Company through December 2004. Additionally, the Company recorded restructuring
charges of $1.9 million relating to the consolidation of certain facilities under non-cancelable
leases which were vacated. During the fourth fiscal quarter of 2004, the Company announced additional workforce reduction
actions in response to lower than anticipated revenue levels. The Company has recorded a total of
$9.0 million based on the estimates of the cost of severance benefits for the affected employees
and will charge an additional $0.8 million to restructuring expense in the next two fiscal quarters
as certain severance benefits are earned. The Company notified approximately 230 employees of
their involuntary termination, including approximately 180 domestic and 50 international employees.
These employees will be leaving the Company through June 2005. The workforce reductions affected
employees in all areas of the business. Activity and liability balances recorded as part of the 2004 Merger Related Restructuring Plan
pertaining to Conexant Systems, Inc. employees and facilities and the additional fourth fiscal
quarter of 2004 restructuring action through December 31, 2004 were as follows (in thousands): Workforce
    
    
    Facilityreductions
    
    
    and other
    
    
    TotalCharged to costs and expenses
    
    $
    7,066
    
    
    $
    1,877
    
    
    $
    8,943Cash payments
    
    
    (2,368
    )
    
    
    (281
    )
    
    
    (2,649
    )Restructuring balance, September 30, 2004
    
    
    4,698
    
    
    
    1,596
    
    
    
    6,294Charged to costs and expenses
    
    
    1,892
    
    
    
    
    
    
    
    1,892Cash payments
    
    
    (2,034
    )
    
    
    (197
    )
    
    
    (2,231
    )Restructuring balance, December 31, 2004
    
    $
    4,556
    
    
    $
    1,399
    
    
    $
    5,955
 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 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. Activity and liability balances related to the 2003 Corporate Restructuring Plan through December
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
    
    
    
    448Expense reversal
    
    
    (81
    )
    
    
    
    
    
    
    (81
    )Cash payments
    
    
    (1,086
    )
    
    
    (933
    )
    
    
    (2,019
    )Restructuring balance, September 30, 2004
    
    
    
    
    
    
    1,995
    
    
    
    1,995Cash payments
    
    
    
    
    
    
    (38
    )
    
    
    (38
    )Restructuring balance, December 31, 2004
    
    $
    
    
    
    $
    1,957
    
    
    $
    1,957
 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 and merger of
the Companys wireless communications business with Alpha Industries, Inc. to form Skyworks. 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 22




---



##### Table of Contents



CONEXANT SYSTEMS, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(unaudited) 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. 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. Activity and liability balances related to the 2002 Corporate and Manufacturing Restructuring Plan
through December 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
    
    
    
    8,444Expense reversal
    
    
    (46
    )
    
    
    
    
    
    
    (46
    )Cash payments
    
    
    (452
    )
    
    
    (3,949
    )
    
    
    (4,401
    )Restructuring balance, September 30,
2004
    
    
    
    
    
    
    3,997
    
    
    
    3,997Cash payments
    
    
    
    
    
    
    (998
    )
    
    
    (998
    )Restructuring balance, December 31, 2004
    
    $
    
    
    
    $
    2,999
    
    
    $
    2,999
 Through December 31, 2004, the Company has paid an aggregate of $43.6 million in connection
with all of its restructuring plans and has a remaining accrued restructuring balance of $28.2
million. The Company expects to pay the amounts accrued for the workforce reductions through fiscal
2005 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 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 During the three months ended December 31, 2004, the Company incurred $3.5 million of costs related
to the integration efforts of the employees, customers, operations and other business aspects
related to the Merger. Other Other special charges in the first fiscal quarter of 2005 principally consist of $2.3 million of
stock option and warrant modification charges and $1.0 million of other special charges. 8. Segment Information SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information, establishes
standards for the way that public business enterprises report information about operating segments
in annual consolidated financial statements. Although we had four operating segments at December
31, 2004, under the aggregation criteria set forth in SFAS No. 131, we only operate in one
reportable operating segment, broadband communications. Under SFAS No. 131, two or more operating segments may be aggregated into a single operating
segment for financial reporting purposes if aggregation is consistent with the objective and basic
principles of SFAS No. 131, if the segments have similar economic characteristics, and if the
segments are similar in each of the following areas:  
    the nature of products and services;  
    the nature of the production processes; 23




---



##### Table of Contents



CONEXANT SYSTEMS, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(unaudited)  
    the type or class of customer for their products and services; and  
    the methods used to distribute their products or provide their services. We meet each of the aggregation criteria for the following reasons:  
    the sale of semiconductor products is the only material source of revenue for each of our four
operating segments;  
    the products sold by each of our operating segments use a similar standard manufacturing process;  
    the products marketed by each of our operating segments are sold to similar customers; and  
    all of our products are sold through our internal sales force and common distributors. Because we meet each of the criteria set forth above and each of our operating segments has similar
economic characteristics, we aggregate our results of operations in one reportable operating
segment. Net revenues by geographic area, based upon country of destination, are as follows (in thousands): Three months endedDecember 31,2004
    
    
    2003Americas
    
    $
    18,439
    
    
    $
    22,401Asia-Pacific
    
    
    105,472
    
    
    
    140,362Europe, Middle East and Africa
    
    
    16,710
    
    
    
    14,570$
    140,621
    
    
    $
    177,333
 The Company believes a 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 months ended December 31, 2004, no
customer accounted for 10% of net revenues. For the three months ended December 31, 2003, one
customer (a foreign reseller) accounted for 14% of net revenues. No other customer accounted for
10% or more of the Companys net revenues for the three months ended December 31, 2003. 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 International Corporation (now named Rockwell Automation, Inc.),
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., 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 certain 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. 24




---



##### Table of Contents



CONEXANT SYSTEMS, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(unaudited) 10. Mindspeed Credit Facility In connection with the spin-off of our Mindspeed Technologies business in June 2003, the Company
entered into a senior secured revolving credit facility pursuant to which Mindspeed could have
borrowed up to $50.0 million for working capital and general corporate purposes. On December 2,
2004, the Company and Mindspeed amended the credit facility. On December 8, 2004 Mindspeed
completed a $46.0 million convertible subordinated note offering, thereby terminating the credit
facility in accordance with the amended agreement. 11. Stock Option Exchange Program On November 12, 2004, the Company commenced an offer to its employees to voluntarily exchange
certain outstanding stock options. Under the terms of the offer, employees holding stock options
having an exercise price equal to or greater than $5.00 per share could exchange their options for
new options to purchase an equal number of shares of the Companys common stock (subject to
adjustment in certain circumstances). Employees accepting the exchange offer were also required
to exchange all options granted within six months of the exchange offer, regardless of the exercise
price. The offering period expired on December 13, 2004 and approximately 32.7 million common stock
options, with a weighted-average exercise price of $8.00 per share, were tendered to the Company,
accepted and cancelled. The Company will grant new options to the affected employees, on a
one-for-one basis, at a date that is at least six months and one day after the acceptance of the
old options for exchange and cancellation. The exercise price of the new options will be equal to
the closing market price of Company common stock on such date. If the cancelled options were
granted on or before December 31, 2002 or the eligible employee is a senior executive of the
Company, the new options will vest in three equal installments on the first, second and third
anniversaries of the grant date; otherwise the new options will vest 50% on the first anniversary
of the grant date and 25% on each of the second and third anniversaries of the grant date.   25




---



##### Table of Contents



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, 2004. Except where otherwise noted, this discussion of our financial condition and results of operations
represents our current operations, which include the GlobespanVirata, Inc. business from February
28, 2004 following the completion of our merger with GlobespanVirata, Inc. (the Merger). 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 (LAN) 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 DSL
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 chipsets 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
reportable 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 26% of net revenues
in the first fiscal quarter of 2005. No customer accounted for 10% of our net revenues in the first
fiscal quarter of 2005. Our top 20 customers accounted for approximately 74% of net revenues for
the first fiscal quarter of 2005. Revenues derived from customers located in the Asia-Pacific
region, the Americas, and Europe were 75%, 13%, and 12%, respectively, of our net revenues for the
first fiscal quarter of 2005. We believe a 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. Overview of Current Performance Our net revenues for the first fiscal quarter of 2005 and 2004 were $140.6 million and $177.3
million, respectively. This represents a decrease of $36.7 million or 20.7%. Our net revenues for
the first fiscal quarter of 2004 do not include the results of the GlobespanVirata business. The
decline in net revenues from the first fiscal quarter of 2004 is due to lower revenues in our
Universal and Voice Access and Broadband Media Processing businesses caused by reduced demand and
lower average selling prices, offset by additional revenues from our Wireless Networking business
as a result of products acquired in the Merger. Pro forma net revenue (including the results of the GlobespanVirata business from October 1, 2003)
for the first fiscal quarter of 2004 was $314.6 million. Compared to pro forma first fiscal
quarter of 2004 net revenues, our first fiscal quarter of 2005 net revenues declined $173.9 million
or 55.3%. Compared to our net revenues for the fourth 26




---



##### Table of Contents



fiscal quarter of 2004, our first fiscal quarter of 2005 net revenues declined $72.5 million or
34.0% from $213.1 million. The use of net revenues for the combined companies as if the Merger had closed at the beginning of
the quarter ended December 31, 2003 is a non-GAAP financial measure, which is used by management to
provide useful information in establishing a meaningful comparison of revenue levels. It is not
intended to be an alternative to GAAP measures. During fiscal 2004, we experienced lower than expected end customer demand which resulted in excess
channel inventory build up at our direct customers, distributors and resellers, price erosion in
the Wireless Networking and Broadband Access businesses and market share loss in our Wireless
Networking business. During the quarter ended December 31, 2004, we reduced channel inventory at
our distributors by approximately $40.0 million and we believe that there was an approximate $10.0
million reduction of channel inventory at our direct customers (See Results of Operations  Net
Revenues). The reduction in demand, average selling price erosion and channel inventory reduction resulted in
the net revenue decline from the quarter ended December 31, 2003 to the quarter ended December 31,
2004. The sequential decline in net revenues from the quarter ended September 30, 2004 to the
quarter ended December 31, 2004 is primarily attributable to the reduction in channel inventories
as mentioned above and lower net revenues in the Broadband Access business. The reduced demand outlook for fiscal year 2005 and the further decline of average selling prices
in Wireless Networking products resulted in first quarter internal and channel inventory charges
aggregating $52.9 million. These charges include $26.2 million for excess and obsolete inventory
primarily related to Broadband Access and Wireless Networking products, $18.8 million of lower of
cost or market write-downs for Wireless Networking inventory and $7.9 million of pricing
adjustments to inventories in the channel (See Results of Operations- Net Revenues). Since the completion of the Merger, we have announced several workforce reduction and facilities
consolidation actions in order to achieve operational efficiencies. In the fourth quarter of fiscal
2004, we announced additional workforce reductions to implement further Merger synergies and to
align our operating expenses to lower revenue forecasts. Certain of these actions have been
completed, and others are in the process of being completed. In November 2004, we announced a plan
to reduce quarterly operating expenses by an additional $15.0 million. The primary drivers of the
expense reductions are expected to be an increasing shift of product development resources to
lower-cost regions and cost savings from continued Merger-related selling, general and
administrative consolidation. In December 2004, we completed the acquisition of Paxonet
Communications, a semiconductor product development company with an experienced and lower-cost
engineering team based in India. In January 2005, we launched an additional set of headcount
reduction actions that will bring us closer to our operating expense objectives. See Notes 2 and 7
of Notes to Consolidated Condensed Financial Statements for further information. The cost savings
of these actions are expected to be fully reflected in the quarter ending December 31, 2005. We
continuously evaluate our business in light of current market and competitive conditions to ensure
that our operating expenses are in line with our expected revenue forecasts. As a result, future
periods will require further actions to reduce operating expenses. We do not believe that these
actions have or will inhibit our ability to invest in appropriate levels of research and
development. 27




---



##### Table of Contents



Results of Operations Net Revenues Three months ended
    
    
    Change from
    
    
    Change fromDec. 31,
    
    
    Sept. 30,
    
    
    Dec. 31,
    
    
    Sept. 2004
    
    
    Dec. 2003(in millions)
    
    2004
    
    
    2004
    
    
    2003
    
    
    Quarter
    
    
    QuarterNet revenues
    
    $
    140.6
    
    
    $
    213.1
    
    
    $
    177.3
    
    
    
    (34
    )%
    
    
    (21
    )%
 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. We have more than 20 distributor customers for whom revenue is recognized upon our shipment of
product to them, as our contractual terms provide for no rights of return. During the first fiscal
quarter of 2005, we made a business decision to assist primarily three distribution customers to
more rapidly sell their inventory by accepting net product returns of $13.3 million and making
price adjustments of $7.9 million on certain of their products in inventory. As a result of
implementing these returns and adjustments, which are a departure from our contractual terms with
these customers, we have decided that it is appropriate to defer the recognition of revenue on
sales to these distributors until the purchased products are sold by the distributors to a third
party. We do not believe that this method of revenue recognition, for these three customers, will
have a material impact on our net revenues in future quarters. See Overview of Current Performance above for a discussion of net revenues. Gross Margin Three months ended
    
    
    Change from
    
    
    Change fromDec. 31,
    
    
    Sept. 30,
    
    
    Dec. 31
    
    
    Sept. 2004
    
    
    Dec. 2003(in millions)
    
    2004
    
    
    2004
    
    
    2003
    
    
    Quarter
    
    
    QuarterGross margin
    
    $
    7.2
    
    
    $
    85.4
    
    
    $
    79.1
    
    
    
    (92
    )%
    
    
    (91
    )%Percent of net revenues
    
    
    5
    %
    
    
    40
    %
    
    
    45
    %
 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 first fiscal quarter of 2005 was 5% compared with the similar period of
fiscal 2004 gross margin of 45% and the immediately preceding quarter of 40%. The gross margin
percentage decrease from the first fiscal quarter of 2004 is attributable to the effects of the
$52.9 million of internal and channel inventory charges recorded in the first fiscal quarter of
2005, of which $45.0 million was recorded against cost of goods sold and $7.9 million against net
revenues, and lower average selling prices on many of our products. Excluding the above mentioned
charges of $52.9 million in the first fiscal quarter of 2005, our gross margin would have remained
at 40%, consistent with the fourth fiscal quarter of 2004. We assess the recoverability of our inventories at least quarterly through a review of inventory
levels in relation to foreseeable demand, generally over nine to twelve months. Foreseeable demand
is based upon all available information, including sales backlog and forecasts, product marketing
plans and product life cycle information. When the inventory on hand exceeds the foreseeable
demand, we write down the value of those inventories which, 28




---



##### Table of Contents



at the time of our review, we expect to be unable to sell. The amount of the inventory write-down
is the excess of historical cost over estimated realizable value. Once established, these
write-downs are considered permanent adjustments to the cost basis of the excess inventory. 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 write-downs may be required. Similarly, in
the event that actual demand exceeds original projections, gross margins may be favorably impacted
in future periods. During the quarter ended December 31, 2004, we recorded $26.2 million in
inventory charges for excess and obsolete inventory. 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. Further, on a quarterly basis, we assess the net realizable value of our inventories. When the
estimated average selling price, plus costs to sell our inventory falls below our inventory cost,
we adjust our inventory to its current estimated market value. During the quarter ended December
31, 2004, we recorded $18.8 million in inventory charges to adjust certain Wireless Networking
products to their estimated market value. Increases or decreases to this inventory reserve may be
required based upon actual average selling prices and changes to our current estimates. These
reserve adjustments may impact our gross margin percentage in future periods. Under our supply arrangement with Jazz Semiconductor, Inc. (Jazz), we are obligated to purchase
certain minimum annual volumes of wafers through March 2005. Additionally, under a supply agreement
with Skyworks, we are obligated to purchase certain minimum amounts of assembly and test services
during fiscal year 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 supply agreements with Jazz and Skyworks. Research and Development Three months ended
    
    
    Change from
    
    
    Change fromDec. 31,
    
    
    Sept. 30,
    
    
    Dec. 31,
    
    
    Sept. 2004
    
    
    Dec. 2003(in millions)
    
    2004
    
    
    2004
    
    
    2003
    
    
    Quarter
    
    
    QuarterResearch and development
    
    $
    72.5
    
    
    $
    72.8
    
    
    $
    39.2
    
    
    nm
    
    
    85
    %Percent of net revenues
    
    
    52
    %
    
    
    34
    %
    
    
    22
    %
 nm = not meaningful


Our research and development (R&D) expenses consist principally of direct personnel costs to
develop new communications and semiconductor products, photo mask 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, and
non-cash stock compensation charges related to the amortization of unvested stock options exchanged
in the Merger.

The $33.3 million increase in R&D expenses for the first quarter of fiscal 2005 compared to the
similar period of fiscal 2004 primarily reflects additional development costs associated with DSL
and Wireless Networking products as a result of the Merger, an increase of $2.2 million in stock
compensation charges as a result of the Merger, and to a much lesser extent, increased R&D project
costs associated with increases in labor, purchased R&D and electronic design automation tools. As
a result of cost reduction initiatives, we expect that R&D expenses will be lower in future
periods.

29



---



##### Table of Contents



Selling, General and Administrative Three months ended
    
    
    Change from
    
    
    Change fromDec. 31,
    
    
    Sept. 30,
    
    
    Dec. 31,
    
    
    Sept. 2004
    
    
    Dec. 2003(in millions)
    
    2004
    
    
    2004
    
    
    2003
    
    
    Quarter
    
    
    QuarterSelling, general and administrative
    
    $
    30.0
    
    
    $
    35.7
    
    
    $
    22.8
    
    
    
    (16
    )%
    
    
    32
    %Percent of net revenues
    
    
    21
    %
    
    
    17
    %
    
    
    13
    %
 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, and non-cash stock compensation charges related to the amortization of unvested stock
options exchanged in the Merger. The $7.2 million increase in SG&A expense for the three months ended December 31, 2004 compared to
the same period of fiscal 2004 is attributable to additional SG&A costs as a result of the Merger
and a $0.7 million increase in stock compensation charges as a result of the Merger. When compared to the immediately preceding quarter, SG&A expense decreased $5.7 million to $30.0
million from $35.7 million. This decrease is primarily a result of accounts receivable bad debt
charges taken in the fourth fiscal quarter of 2004 and to a lesser extent the impact of our cost
reduction initiatives. As a result of cost reduction initiatives, we expect that SG&A expenses
will be lower in future periods. Amortization of Intangible Assets Three months ended December 31,(in millions)
    
    2004
    
    
    Change
    
    
    2003Amortization of intangible assets
    
    $
    8.3
    
    
    nm
    
    $
    1.0Percent of net revenues
    
    
    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 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 months ended December 31, 2004 compared to the
three months ended December 31, 2003 is primarily attributable to the significant intangible assets
we acquired in the Merger. See Note 2 of Notes to Consolidated Condensed Financial Statements for
further information. We expect that amortization of intangible assets will be approximately $23.7
million for the remainder of fiscal 2005. Special Charges Special charges consist of the following: Three months ended December 31,(in millions)
    
    2004
    
    
    Change
    
    
    2003Restructuring charges
    
    $
    12.0
    
    
    nm
    
    $
    0.4Asset impairment charges
    
    
    0.5
    
    
    nm
    
    
    0.2Integration charges
    
    
    3.5
    
    
    nm
    
    
    Other
    
    
    3.3
    
    
    nm
    
    
    $
    19.3
    
    
    
    
    
    
    $
    0.6
 nm= not meaningful 30




---



##### Table of Contents



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 December 31,(in millions)
    
    2004
    
    
    Change
    
    
    2003Other (income) expense, net
    
    $
    (2.8
    )
    
    nm
    
    $
    (25.3
    )Percent of net revenues
    
    nm
    
    

    
    
    
    
    nm
 nm= not meaningful Other (income) expense, net for the first fiscal quarter of 2005 was comprised of a $14.8
million increase in the fair value of the Mindspeed warrant, $0.6 million of investment and
interest income on invested cash balances, offset by $8.4 million of interest expense primarily
from our convertible subordinated notes, $3.1 million of loss in our equity method investments and
foreign exchange transaction losses. Due to variations in the fair value of the common stock
underlying the Mindspeed warrant, we expect that other (income) expense, net may fluctuate
significantly in future periods until this derivative instrument is liquidated. Other (income) expense, net for the first quarter of fiscal 2004 was comprised of a $24.6 million
increase in the fair value of the Mindspeed warrant, $10.2 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) and $2.5 million of
investment and interest income on invested cash balances, offset by $6.7 million of interest
expense on our convertible subordinated notes and a $4.9 million decrease in the fair value of the
conversion right under the Skyworks 15% convertible senior subordinated notes. The $11.4 million
gain in our investment in Jazz is the result of our ownership in Jazz decreasing from 45% to
approximately 38% when the additional favorable investment was realized. As a result of the acquisition of $130.0 million of the 5.25% convertible subordinated notes in the
Merger, interest expense in the three months ended December 31, 2004 was higher than in the three
months ended December 31, 2003. 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 for which
we had accounted 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 $0.5 million and $0.2 million for the three months ended December
31, 2004 and 2003, respectively, primarily reflecting taxes imposed on our foreign subsidiaries.
No federal income tax expense was recorded for the first fiscal quarter of 2005 due to our net loss
in the quarter and no federal income tax was recorded in the first fiscal quarter of 2004 as the
net income for that period was offset by net operating loss carryovers that have a full valuation
allowance recorded against them. Except to the extent of the federal alternative minimum tax, we
expect this will continue for the foreseeable future. We do not expect to recognize any income tax
benefits relating to future operating losses until we believe that such tax benefits are more
likely than not to be realized. As of December 31, 2004, Conexant had $1.1 billion of fully reserved deferred tax assets which are
available to offset future tax obligations subject to limitations imposed by section 382 of the
Internal Revenue Code. 31




---



##### Table of Contents



Liquidity and Capital Resources Our cash and cash equivalents decreased by $6.7 million during the first fiscal quarter of 2005.
Cash used by operating activities was $16.1 million for the first fiscal quarter of 2005, compared
to cash provided by operating activities of $22.6 million for the comparable period in fiscal 2004.
Operating cash flows for the first fiscal quarter of 2005 were approximately $4.0 million,
excluding an $8.0 million payment to Agere for the settlement of patent litigation, and $12.0
million of payments related to special charges and other items. The $4.0 million was primarily a
result of approximately $55.2 million of favorable changes in accounts receivable, inventories,
accounts payable, accrued expenses and other current liabilities and other during the first fiscal
quarter of 2005. Cash provided by investing activities of $8.8 million for the first fiscal quarter of 2005 includes
net sales of marketable securities of $27.1 million, partially offset by net cash paid for an
acquisition of $14.5 million, capital expenditures of $2.1 million, and investments of $1.8
million. Cash used in investing activities of $15.1 million in the first three months of fiscal
2004 principally consisted of $4.3 million of net purchases of marketable securities, capital
expenditures of $4.9 million, payment of deferred purchase consideration of $4.0 million, and
deferred merger costs of $1.4 million. Cash provided by financing activities of $0.6 million for the first fiscal quarter of 2005
consisted of $0.4 million in proceeds from the exercise of stock options and $0.2 million from
repayment of an employee loan. The $6.1 million in cash provided by financing activities for the
comparable period of fiscal 2004 consisted of proceeds from the exercise of stock options. As of December 31, 2004, our principal sources of liquidity are our existing cash reserves and
marketable securities, the current portion of the Mindspeed warrant, our investments in third
parties, such as Jazz, and cash generated from product sales. Our working capital at December 31,
2004 was $307.0 million compared to $434.8 million at September 30, 2004. In addition, at December
31, 2004, we held $123.3 million in long-term marketable securities which we could liquidate to
fund operations and/or future acquisitions. Total cash, cash equivalents and marketable securities are as follows: December 31,
    
    
    September 30,(in millions)
    
    2004
    
    
    2004Cash and cash equivalents
    
    $
    132.3
    
    
    $
    139.0Other short-term marketable securities (primarily
mutual funds, domestic government agencies and
corporate debt securities)
    
    
    2.6
    
    
    
    13.8Long-term marketable securities (primarily domestic
government agencies and corporate debt securities)
    
    
    123.3
    
    
    
    137.6Subtotal
    
    
    258.2
    
    
    
    290.4Equity securities- Skyworks Solutions, Inc. (6.2
million shares at December 31, 2004 and September 30,
2004)
    
    
    58.3
    
    
    
    61.8Equity securities- SiRF Technologies, Inc. (5.9
million shares at December 31, 2004 and September 30,
2004)
    
    
    74.7
    
    
    
    87.5Subtotal Skyworks and SiRF
    
    
    133.0
    
    
    
    149.3Total cash, cash equivalents and marketable securities
    
    $
    391.2
    
    
    $
    439.7
 The current portion of the Mindspeed warrant at December 31, 2004 is $5.6 million, and the
long-term portion is $35.7 million. The valuation of this derivative instrument is subjective, and
at any point in time could ultimately result in the realization of amounts significantly different
than the carrying value. Further, there is no assurance that the equity markets would allow for
the Company to liquidate a substantial portion of these warrants within a short time period without
significantly impacting the market value. We believe that our existing sources of liquidity will
be sufficient to fund our operations, research and development efforts, anticipated capital
expenditures, and other liabilities and commitments, and other capital requirements, 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 32




---



##### Table of Contents



common stock. However, we cannot assure you that such financing will be available to us on
favorable terms, or at all. We have $711.8 million aggregate principal amount of convertible subordinated notes outstanding of
which approximately $200.0 million become due in fiscal 2006 and the remainder becomes due in
fiscal 2007. The conversion prices of the notes are currently in excess of the market value of our
common stock. As of December 31, 2004, we had $391.2 million of cash and investments. If we are
unable to generate sufficient cash flows from our operations or realize additional value from our
investments and other assets, we may have to seek additional sources of financing. 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 December 31, 2004: Payments due by periodLess than 1
    
    
    
    
    
    
    
    
    
    
    More than 5(in millions)
    
    Total
    
    
    Year
    
    
    1-3 years
    
    
    3-5 years
    
    
    yearsConvertible subordinated notes (1)
    
    $
    711.8
    
    
    $
    
    
    
    $
    711.8
    
    
    $
    
    
    
    $
    Operating leases
    
    
    143.2
    
    
    
    27.0
    
    
    
    35.9
    
    
    
    20.5
    
    
    
    59.8Assigned leases
    
    
    14.6
    
    
    
    5.3
    
    
    
    4.5
    
    
    
    
    
    
    
    4.8Contingent consideration on acquisitions
    
    
    4.0
    
    
    
    
    
    
    
    4.0
    
    
    
    
    
    
    
    Capital commitments
    
    
    4.4
    
    
    
    4.4
    
    
    
    
    
    
    
    
    
    
    
    Purchase commitments
    
    
    14.2
    
    
    
    14.2
    
    
    
    
    
    
    
    
    
    
    
    Assigned purchase commitments
    
    
    6.0
    
    
    
    6.0
    
    
    
    
    
    
    
    
    
    
    
    Employee commitments
    
    
    4.6
    
    
    
    4.6
    
    
    
    
    
    
    
    
    
    
    
    $
    902.8
    
    
    $
    61.5
    
    
    $
    756.2
    
    
    $
    20.5
    
    
    $
    64.6
   (1)
    
    Excludes interest. See Note 3 of Notes to Consolidated Condensed Financial Statements
for interest terms. In addition to the contractual obligations listed above, we have exercised our purchase option for
approximately $60.0 million to purchase two buildings in Newport Beach, California which are
currently occupied under a lease agreement. Pursuant to the terms of the currently proposed
sale-leaseback transaction with respect to these facilities, which is expected to be executed in
the quarter ending March 31, 2005, the proceeds from the sale-leaseback transaction will
substantially exceed the purchase price of $60.0 million. At December 31, 2004, the Company has many sublease arrangements on operating leases for terms
ranging from near term to approximately 6 years. Aggregate scheduled sublease income based on
current terms is approximately $7.5 million. Off-Balance Sheet Arrangements Our off-balance arrangements consist of conventional operating leases, capital commitments,
employee commitments, and purchase commitments as described in Note 5 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 December 31, 2004. In connection with the Mindspeed Spin, we entered into a senior secured revolving credit facility
pursuant to which Mindspeed could have borrowed up to $50.0 million for working capital and general
corporate purposes. On December 2, 2004, we and Mindspeed amended the credit facility. On
December 8, 2004 Mindspeed completed a $46.0 million convertible subordinated note offering,
thereby terminating the credit facility in accordance with the amended agreement. 33




---



##### Table of Contents



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), 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 from those estimates, our
future results of operations may be affected by incurring charges to our statements of operations.
Additionally, estimates for purchase price allocations 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. 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 history of operating results, 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 34




---



##### Table of Contents



determination is made. To the extent that we realize a benefit from reducing the valuation
allowance on acquired deferred tax assets, the benefit will be credited to goodwill. Inventories We assess the recoverability of our inventories at least quarterly through a review of inventory
levels in relation to foreseeable demand, generally over nine to twelve months. Foreseeable demand
is based upon all available information, including sales backlog and forecasts, product marketing
plans and product life cycle information. When the inventory on hand exceeds the foreseeable
demand, we write down the value of those inventories which, at the time of our review, we expect to
be unable to sell. The amount of the inventory write-down is the excess of historical cost over
estimated realizable value. Once established, these write-downs are considered permanent
adjustments to the cost basis of the excess inventory. 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 or product pricing is lower than
originally projected, additional inventory write-downs may be required. Further, on a quarterly
basis, we assess the net realizable value of our inventories. When the estimated average selling
price, plus costs to sell our inventory falls below our inventory cost, we adjust our inventory to
its current estimated market value. Allowance for doubtful accounts We maintain allowances for doubtful accounts for estimated losses resulting from the inability of
our customers to make required payments. We use a specific identification method for some items,
and a percentage of aged receivables for others. The percentages are determined based on our past
experience. 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. Overall business valuations have declined significantly over
the past two years, and as a result 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. Revenue recognition is
deferred in all instances where the earnings process is incomplete. Certain product sales are made
to electronic component distributors under agreements allowing for a right to return unsold
products. Recognition of revenue on all sales to these distributors is deferred until the products
are sold by the distributors to a third party. A reserve for sales returns and allowances for other
customers is recorded based on historical experience or specific identification of an event
necessitating a reserve. 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. Revenue results are difficult to predict, and any shortfall
in revenues could cause our operating results to vary significantly from period to period. Conexant has more than 20 distributor customers for whom revenue is recognized upon its shipment of
product to them, as the contractual terms provide for no rights of return. During the first fiscal
quarter of 2005, the Company made a business decision to assist primarily three distribution
customers to more rapidly sell their inventory by 35




---



##### Table of Contents



accepting net product returns of $13.3 million and making price adjustments of $7.9 million on
certain of their products in inventory. As a result of implementing these returns and adjustments,
which are a departure from our contractual terms with these
customers, we have decided
that it is appropriate to defer the recognition of revenue on sales to these three distributors
until the purchased products are sold by the distributors to a third party. Valuation of derivative instruments We had 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.
Until its conversion to common stock in May 2004, we determined the fair value of the conversion
right of the Skyworks notes using the actual trading price of the underlying shares of Skyworks
common 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, or in the underlying valuation
model, could cause the fair value of the Mindspeed warrant to vary significantly from period to
period. Restructuring charges We recorded $12.0 million of restructuring charges in the quarter ended December 31, 2004. These
charges relate 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, and the discount
rates used in determining the present value (fair value) of remaining minimum lease payments on
vacated properties. 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 any revisions in the
period that they are determined to be necessary. In addition, as a result of the Merger in
February 2004, we acquired $11.5 million (as adjusted) of additional restructuring liabilities
which were recorded through the purchase price allocation. Such amounts also contain estimates and
assumptions made by management, and are 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. Stock-based compensation We account 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. We also have an employee stock purchase
plan for all eligible employees. We have 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. In December 2004, the Financial Accounting Standards Board issued SFAS No. 123
(R), Share-Based Payment. This pronouncement amends SFAS No. 123 and supersedes APB Opinion No.
25. SFAS No 123 (R) requires that public companies account for awards of equity instruments issued
to employees under the fair value method of accounting and recognize such amounts in the statement
of operations. This statement is effective beginning with our fourth fiscal 2005
quarter beginning July 2, 2005. We expect the impact of this new pronouncement to be significant
to our results of operations. 36




---



##### Table of Contents



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, GlobespanVirata and the combined company has recently incurred substantial losses
and we anticipate additional future losses. Our net revenues for the first quarter of fiscal 2005 and for fiscal 2004 were $140.6 million and
$901.9 million, respectively. Our net loss for the first quarter of fiscal 2005 and for fiscal
2004 was $120.7 million and $544.6 million, respectively. Conexants net revenues in fiscal 2003 were $600.0 million compared to $521.7 million in fiscal
2002. 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. Including
discontinued operations, Conexant incurred net losses of $705.3 million in fiscal 2003, and $880.8
million in fiscal 2002. GlobespanViratas net revenues for fiscal 2003 were $379.1 million
compared to $228.9 million in fiscal 2002. GlobespanVirata also had losses from continuing
operations of $49.6 million in fiscal 2003 and $636.9 million in fiscal 2002. Including
discontinued operations, GlobespanVirata incurred net losses of $59.3 million in fiscal 2003 and
$655.0 million in fiscal 2002. We have implemented a number of expense reduction and restructuring initiatives since late fiscal
2001 to improve our operating cost structure. The cost reduction initiatives included workforce
reductions, the closure or consolidation of certain facilities and an increasing shift of product
development resources to lower-cost regions, among other actions. However, these expense reduction
initiatives alone will not return us to profitability. We expect that excess levels of channel
inventory at our direct customers, distributors and resellers, reduced end-customer demand, changes
in our revenue mix and other factors will continue to adversely affect our operating results in the
near term. In order to return to profitability, we must achieve substantial revenue growth and
currently we continue to face an environment of uncertain demand in many of the markets our
products address. We cannot assure you as to whether or when we will return to profitability or
whether we will be able to sustain such profitability, if achieved. 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 our revenues and results of operations and those of Conexant and
GlobespanVirata. Conexant and 37




---



##### Table of Contents



GlobespanVirata experienced these cyclical fluctuations in their businesses in the past and we have
experienced, and may in the future experience, cyclical fluctuations. 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. 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;  
    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. Our net revenues for the first fiscal quarter of 2005 and 2004 were $140.6 million and $177.3
million, respectively. This represents a decrease of $36.7 million or 20.7%. Our net revenues for
the first fiscal quarter ended December 31, 2003 do not include the results of the GlobespanVirata
business. Our pro forma net revenue (as if the Merger had been completed on October 1, 2003) for
the first fiscal quarter ended December 31, 2003 was $314.6 million. Compared to pro forma net
revenues for the first fiscal quarter of 2004, our first fiscal quarter of 2005 net revenues
declined $173.9 million or 55.3%. Compared to our net revenues for the fourth fiscal quarter of
2004, our first fiscal quarter of 2005 revenues have declined $72.5 million or 34.0% from $213.1
million. The use of net revenues for the combined companies as if the Merger had closed at the beginning of
the quarter ended December 31, 2003 is a non-GAAP financial measure, which is used by management to
provide useful information in establishing a meaningful comparison of revenue levels. It is not
intended to be an alternative to GAAP measures. During fiscal 2004, we experienced lower than expected customer demand, price erosion in the
Wireless Networking and Broadband Access businesses and market share loss in our Wireless
Networking business. During the December quarter of 2004, we reduced channel inventory at our
distributors by approximately $40.0 million and we believe that there was an additional $10.0
million of channel inventory reduction at our direct customers. The reduction in demand, average
selling price erosion in the Wireless Networking product line, and channel inventory reduction led
to the year over year net revenue decline. The sequential decline in revenue is primarily
attributable to the reduction in channel inventory and to lower net
revenues in the Broadband Access
business. We cannot assure you whether or when these factors will improve and our business, financial
condition and results of operations may continue to be adversely impacted by these factors. 38




---



##### Table of Contents



We face a risk that capital needed for our business and to repay our convertible notes 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 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. At December 31, 2004, we have $711.8 million
aggregate principal amount of convertible subordinated notes outstanding which become due in
several tranches beginning in May 2006 and ending in February 2007. The conversion prices of the
notes are currently in excess of the market value of our common stock. If we are unable to
generate sufficient cash flows from our operations or realize additional value from our investments
and other assets, we may be unable to meet our debt obligations as they become due. We cannot
assure you that we will have access to additional sources of capital, or be able to refinance our
debt, on favorable terms or at all. In periods of a depressed stock price, raising capital through
the equity markets would have a greater effect on shareholder dilution. We hold as marketable securities available for sale a significant amount of equity securities in
publicly traded companies. For most of our equity security holdings, there are risks associated
with the overall state of the stock market, having available buyers for the shares we sell, and
ultimately being able to liquidate the securities at a favorable price. We cannot assure you that
the carrying value of these assets will ultimately be realized. In addition, any strategic investments and acquisitions that we may desire to 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 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 in 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 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 39




---



##### Table of Contents



rapidly acquire significant market share. We cannot assure you that we will be able to compete
successfully against current and potential competitors. We may have difficulty 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 anticipated. 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;  
    the challenge of realizing expected operating efficiencies of combining two companies;  
    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 product lines 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 expected to result from the merger will be realized within the time periods
contemplated or at all. 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, at least on an annual basis, 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. At December 31, 2004, we have $714.9 million of goodwill, of which $627.0 million was
generated in the Merger. Our market capitalization was above our book value at December 31, 2004,
but our market capitalization was below our book value at September 30, 2004. When market
capitalization is below book value, it is an indicator that goodwill may be impaired. We performed
an evaluation of our goodwill at December 31, 2004 and determined that as of that date, no
impairment was required. However, if our market capitalization drops below our book value for a
prolonged period of time, we may be required to write down the value of our goodwill by taking a
non-cash charge against earnings. 40




---



##### Table of Contents



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. 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;  
    overall market acceptance of our products;  
    our ability to invest in significant amounts of research and development; and  
    our ability to transition product development efforts between and among sites as we complete our restructuring actions. 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 successful and as a result gross margins
may decline in future periods. 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: 41




---



##### Table of Contents




    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 management, technical and other 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
Dwight W. Decker, our Chairman of the Board and 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. 42




---



##### Table of Contents



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 26% and 36% of our net revenues for the first
quarter of fiscal 2005 and for fiscal 2004, respectively. 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. For example, the reduced demand outlook for fiscal year 2005 and the
further decline of average selling prices for Wireless Networking products resulted in first
quarter fiscal 2005 inventory charges and revenue adjustments aggregating $52.9 million. Inventory
charges include $26.2 million for excess and obsolete inventory primarily related to broadband
access and wireless networking products and $18.8 million of lower of cost or market write-downs
for Wireless Networking inventory. Revenue adjustments of $7.9 million were made to certain
channel inventories at certain of our customers. 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). Under our
fabless business model, our 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 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 us. 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 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
herein 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 43




---



##### Table of Contents



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. In addition, the highly complex and technologically demanding nature of semiconductor manufacturing
has caused foundries from time to time to experience 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. We are subject to the risks of doing business internationally. For the first quarter of fiscal 2005 and for fiscal 2004, approximately 90% and 91%, respectively,
of our net revenues were from customers located outside of the United States, primarily in the
Asia-Pacific region and Europe. 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 an assembly and test
provider 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 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. 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 44




---



##### Table of Contents



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 have engaged in litigation to enforce their intellectual
property rights, to protect their trade secrets or to determine the validity and scope of
proprietary 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. Uncertainties involving litigation could adversely affect our business. We and certain of our current and former officers and directors have been sued in several purported
securities class action lawsuits, which we expect will ultimately be consolidated into a single
action. We and certain of our directors and officers have also been sued in a purported
shareholder derivative action. Although we believe that these lawsuits are without merit, an
adverse determination could have an impact on the price of our stock. Moreover, regardless of the
ultimate result, the lawsuits may divert managements attention and resources from other matters,
which could also adversely affect our business and results of operations. 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. 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 45




---



##### Table of Contents



Beach, California wafer fabrication facility. We currently estimate the remaining costs for these
remediations to be approximately $3.0 million and have accrued for these costs as of December 31,
2004. 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 we have not experienced any material
adverse effects on our 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 net operating losses that we can use to offset
taxable income. As of December 31, 2004, Conexant had approximately $1.6 billion of U.S. federal income tax net
operating loss (NOL) carry forwards that can be used to offset taxable income in subsequent years.
The NOL carry forwards are scheduled to expire at various dates through 2023. Section 382 of the
Internal Revenue Code could limit the future use of some or all of the NOL carry forwards 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 carry forwards 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 carry forwards are subject to the
section 382 limitation (or further limitation in the case of NOL carry forwards 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. 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 46




---



##### Table of Contents



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. Our internal control over financial reporting may not be considered effective, which could result
in a loss of investor confidence in our financial reports and in turn have an adverse effect on our
stock price. Pursuant to Section 404 of the Sarbanes-Oxley Act of 2002, beginning with our Annual Report on Form
10-K for the fiscal year ending September 30, 2005, we will be required to furnish a report by our
management on our internal control over financial reporting. Such report will contain, among other
matters, an assessment of the effectiveness of our internal control over financial reporting as of
the end of our fiscal year, including a statement as to whether or not our internal control over
financial reporting is effective. This assessment must include disclosure of any material
weaknesses in our internal control over financial reporting identified by management. The report
will also contain a statement that our independent registered public accounting firm has issued an
attestation report on managements assessment of internal controls. We are currently performing the system and process documentation needed to comply with Section 404
and the new standard issued by the Public Company Accounting Oversight Board. This process is
both costly and challenging. During this process, if our management identifies one or more
material weaknesses in our internal control over financial reporting, we will be unable to assert
that such internal control is effective. If we are unable to assert that our internal control is
effective as of September 30, 2005 (or if our independent registered public accounting firm is
unable to attest that our managements report is fairly stated or they are unable to express an
opinion on our managements evaluation or on the effectiveness of our internal controls), investors
could lose confidence in the accuracy and completeness of our financial reports, which in turn
could have an adverse effect on our stock price. 
 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Our financial instruments include cash and cash equivalents, marketable debt securities, 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. See also Part I, Item 7A, Quantitative and Qualitative
Disclosures About Market Risk in the Companys Annual Report on Form 10-K for the year ended
September 30, 2004. 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 December 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 December 31, 2004, a 10% adverse change in interest rates would
result in a $12.3 million decrease in the value of our long-term marketable securities. Marketable equity securities are subject to equity price risk. For most of our equity security
holdings, there are risks associated with the overall state of the stock market, having available
buyers for shares we sell, and ultimately being able to liquidate the securities at a favorable
price. As of December 31, 2004, a 10% adverse change in equity prices would result in a $13.4
million decrease in the value of our marketable equity securities. We classify all of our marketable debt and equity securities as available-for-sale securities. As
of December 31, 2004, the carrying value of these securities included net unrealized gain of $77.0
million. 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
December 31, 2004, a 10% decrease in the market price of Mindspeeds common stock would decrease
the fair value of this warrant by approximately $5.7 million. At December 31, 2004, the market
price of Mindspeeds common stock was $2.78 per share. For the 47




---



##### Table of Contents



quarter ended December 31, 2004, the market price of Mindspeeds common stock ranged from a low of
$1.81 per share to a high of $2.98 per share. 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. The following table shows the fair values of our financial instruments as of December 31, 2004: (in millions)
    
    Carrying Value
    
    
    Fair ValueCash and cash equivalents
    
    $
    132.3
    
    
    $
    132.3Marketable debt securities
    
    
    36.4
    
    
    
    36.4Marketable government agency securities
    
    
    88.3
    
    
    
    88.3Marketable equity securities
    
    
    134.2
    
    
    
    134.2Mindspeed warrant
    
    
    41.4
    
    
    
    41.4Long-term debt
    
    
    711.8
    
    
    
    660.0
 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, from time to time, we 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 December 31, 2004, we held no foreign currency forward exchange
contracts. Based on our overall currency rate exposure at December 31, 2004, a 10% 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
Chairman and 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 Chairman and Chief
Executive Officer and its Senior Vice President and Chief Financial Officer concluded that the
Companys disclosure controls and procedures were effective. In connection with the audit of the Companys consolidated financial statements for the fiscal year
ended September 30, 2004, certain deficiencies in the Companys internal control over financial
reporting were identified, including with respect to the reconciliation of certain accounts payable
accounts. These deficiencies arose in connection with the transfer of responsibility for certain
accounting functions from Conexants Newport Beach, California offices to the Companys Red Bank,
New Jersey offices as part of the post-merger integration process following the merger of Conexant
and GlobespanVirata in February 2004. The Company and its independent auditors did not consider
these deficiencies to be a material weakness under applicable auditing standards and they had no
material effect on the Companys financial statements. In the quarter ended December 31, 2004, the
Company implemented actions to remedy the deficiencies and enhance the Companys internal controls.
These actions are expected to be complete in the quarter ending March 31, 2005. Except as described above, there were no changes in the Companys internal control over financial
reporting during the quarter ended December 31, 2004 that have materially affected, or are
reasonably likely to materially affect, the Companys internal control over financial reporting. 48




---



##### Table of Contents



PART II. OTHER INFORMATION 
 ITEM 1. LEGAL PROCEEDINGS Class Action Suits.In December 2004 and January 2005, the Company and certain current and former
officers were named as defendants in several complaints filed on behalf of all persons who
purchased Company common stock during a specified class period in the U.S. District Court of New
Jersey and the U.S. District Court for the Central District of California, alleging that the
defendants violated the Securities Exchange Act of 1934 (the Exchange Act) by allegedly
disseminating materially false and misleading statements and/or concealing material adverse facts.
The defendants believe these charges are without merit and intend to vigorously defend the
litigation. Shareholder Derivative Suits.In January 2005, the Company and certain current and former directors
and officers were named as defendants in purported shareholder derivative actions in California
State Court for the County of Orange, alleging that the defendants breached their fiduciary duties,
abused control, mismanaged the company, wasted corporate assets and unjustly enriched themselves.
The defendants believe these charges are without merit and intend to vigorously defend the
litigation. Agere Systems, Inc. On November 4, 2004, the Company reached a settlement with Agere Systems Inc.
(Agere), which among other things, dismissed with prejudice all litigation matters between the two
companies. The settlement agreement also provided for the dismissal with prejudice of all claims
brought by and against Intersil. Conexant, Inc. (formerly GlobespanVirata, Inc.) acquired the WLAN
Group of Intersil in August 2003. As part of this overall litigation settlement, the Company made
a cash payment to Agere in the amount of $8.0 million in November 2004 and the two companies
entered into various license agreements covering the patents involved in the suits and other
semiconductor devices. 
 ITEM 6. EXHIBITS Exhibits: 10.1
    
    Amendment dated November 12, 2004 between the Company and F. Matthew Rhodes to Employment Agreement
dated as of January 15, 2004 between the Company and Mr. Rhodes filed as Exhibit 10 to the Companys
Current Report on Form 8-K dated November 9, 2004 (File No. 000-24923), is incorporated herein by
reference.10.2
    
    Retention and Separation Agreement by and between the Company and C. Michael Powell filed as Exhibit
10.1 to the Companys Current Report on Form 8-K dated December 13, 2004 (File No. 000-24923), is
incorporated herein by reference.10.3
    
    Separation Agreement by and between the Company and Armando Geday filed as Exhibit 10.1 to the
Companys Current Report on Form 8-K dated December 16, 2004 (File No. 000-24923), 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).32
    
    Certification by Chief Executive Officer and Chief Financial Officer of Periodic Report Pursuant to 18
U.S.C. Section 1350.99
    
    Summary of Non-Employee Director Compensation and Benefits
 49




---



##### Table of Contents



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: February 8, 2005
    
    By
    
    /s/ J. Scott BlouinJ. Scott Blouin
Senior Vice President and
Chief Financial Officer
(principal financial officer)
 50




---



##### Table of Contents



EXHIBIT INDEX 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 1350.99
    
    Summary of Non-Employee Director Compensation and Benefits
 51