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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
   FORM 10-K [X]
    
    ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 For the fiscal year ended September 30, 2004* Commission file number: 000-24923 CONEXANT SYSTEMS, INC. (Exact name of registrant as specified in its charter)
 Delaware
    
    25-1799439(State of incorporation)
    
    (I.R.S. Employer Identification No.)4000 MacArthur BoulevardNewport Beach, California
    
    92660-3095(Address of principal executive offices)
    
    (Zip code)
 Registrants telephone number, including area code: (949) 483-4600 Securities registered pursuant to Section 12(b) of the Act: NONE Securities registered pursuant toSection 12(g)of the Act: Common Stock, $0.01 Par
Value Per Share
(including associated Preferred Share Purchase Rights) Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [  ] Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of Registrants knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [  ] Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act).
Yes [X] No [  ] The aggregate market value of the Registrants voting stock held by
non-affiliates of the Registrant (based on the closing price as reported on the
Nasdaq National Market on April 2, 2004) was approximately $2.86 billion.
Shares of voting stock held by each officer and director and by each shareowner
affiliated with a director have been excluded from this calculation because
such persons may be deemed to be affiliates. This determination of officer or
affiliate status is not necessarily a conclusive determination for other
purposes. The number of outstanding shares of the Registrants Common Stock as
of November 26, 2004 was 469,544,176. Documents Incorporated by Reference Portions of the Registrants Proxy Statement for the 2005 Annual Meeting
of Shareowners to be held on February 23, 2005, are incorporated by reference
into Part III of this Form 10-K.    *
    
    For presentation purposes of this Form 10-K, references made to the
September 30, 2004 period relate to the actual fiscal year ended October
1, 2004.    1




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TABLE OF CONTENTS  PART IItem 1. BusinessItem 2. PropertiesItem 3. Legal ProceedingsItem 4. Submission of Matters to Vote of Security HoldersPART IIItem 5. Market for Registrants Common Equity, Related Stockholder Matters and Issuer Purchases of Equity SecuritiesItem 6. Selected Financial DataItem 7. Managements Discussion and Analysis of Financial Condition and Results of OperationsItem 7A. Quantitative and Qualitative Disclosures About Market RiskItem 8. Financial Statements and Supplementary DataCONSOLIDATED BALANCE SHEETSCONSOLIDATED STATEMENTS OF OPERATIONSCONSOLIDATED STATEMENTS OF CASH FLOWSCONSOLIDATED STATEMENTS OF SHAREHOLDERS EQUITY AND COMPREHENSIVE LOSSNOTES TO CONSOLIDATED FINANCIAL STATEMENTSItem 9. Changes in and Disagreements With Accountants on Accounting and Financial DisclosureItem 9A. Controls and ProceduresItem 9B. Other InformationPART IIIItem 10. Directors and Executive Officers of the RegistrantItem 11. Executive CompensationItem 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder MattersItem 13. Certain Relationships and Related TransactionsItem 14. Principal Accountant Fees and ServicesPART IVItem 15. Exhibits and Financial Statement SchedulesSIGNATURESEXHIBIT INDEXEXHIBIT 10.F-3EXHIBIT 10.J-2EXHIBIT 10.Q-1EXHIBIT 10.Q-2EXHIBIT 21EXHIBIT 23EXHIBIT 24EXHIBIT 31.1EXHIBIT 31.2EXHIBIT 32    Table of Contents  CAUTIONARY STATEMENT This Annual Report on Form 10-K 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 impact of excess channel inventory on our
near-term revenue expectations; the cyclical nature of the semiconductor
industry and the markets addressed by our products and our customers products;
demand for and market acceptance of new and existing products; successful
development of new products; the timing of new product introductions; the
availability of manufacturing capacity; pricing pressures and other competitive
factors; changes in product mix; product obsolescence; our ability to develop
and implement new technologies and to obtain protection of the related
intellectual property; the uncertainties of litigation; the risk that the
businesses of Conexant and GlobespanVirata will not be successfully integrated;
the successful implementation of our expense reduction and restructuring
initiatives, as well as other risks and uncertainties, including those set
forth herein and those detailed from time to time in our filings with the
Securities and Exchange Commission. These forward-looking statements are made
only as of the date hereof, and we undertake no obligation to update or revise
the forward-looking statements, whether as a result of new information, future
events or otherwise. 2




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PART I 
 Item 1. Business General Conexant Systems, Inc. (we, 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, we completed our merger with GlobespanVirata, Inc.
(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 acquiror. In
exchange for 100% of the outstanding shares of common stock of GlobespanVirata
(approximately 150.7 million shares), we 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
and warrants 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. On June 27, 2003, we completed the distribution to our shareholders of all
outstanding shares of our wholly owned subsidiary Mindspeed Technologies, Inc.
(Mindspeed), to which we contributed our Internet infrastructure business,
including the stock of certain subsidiaries, and certain other assets and
liabilities, including $100.0 million in cash (hereinafter, the Mindspeed
Spin). In the Mindspeed Spin, Conexant shareholders received one share of
Mindspeed common stock for every three Conexant shares held and the Conexant
shareholders continued to hold their Conexant shares. Mindspeed issued us
a warrant to purchase 30 million shares of Mindspeed common stock, representing
approximately 20 percent of Mindspeeds outstanding common stock on a fully
diluted basis. The warrant is exercisable until June 27, 2013 at an exercise
price of $3.408 per share. The fair value of the warrant is recorded as an
asset on our consolidated balance sheet. Additionally, we entered into a
senior secured revolving credit facility pursuant to which Mindspeed may borrow
up to $50.0 million, subject to certain restrictions, for working capital and
general corporate purposes. In December 2004, the Mindspeed credit facility
was terminated (see Note 18 of Notes to Consolidated Financial Statements). On June 25, 2002, we completed the distribution to our shareholders of
outstanding shares of our wholly owned subsidiary Washington Sub, Inc.
(Washington), to which we contributed our wireless communications business,
other than certain assets and liabilities which we retained. Immediately
thereafter, Washington merged with and into Alpha Industries, Inc. (Alpha),
with Alpha the surviving corporation. As a result of these transactions,
Conexant shareholders received 0.351 of a share of Alpha common stock for each
Conexant share held and the Conexant shareholders continued to hold their
Conexant shares. Upon completion of these events, Alpha and its subsidiaries
purchased our semiconductor assembly and test facility located in Mexicali,
Mexico and our package design team that supports the Mexicali facility
(together, the Mexicali Operations) for $150.0 million. Effective June 26,
2002, Alpha changed its name to Skyworks Solutions, Inc. (Skyworks). All these
transactions, on a combined basis, are hereinafter referred to as the Skyworks
Spin. In March 2002, we and The Carlyle Group formed a new specialty foundry company
named Jazz Semiconductor, Inc. (Jazz). We contributed our Newport Beach,

California wafer fabrication operations and related assets and 3




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liabilities and certain intellectual property to Jazz in exchange for $19.3
million in cash and a 45% equity interest in Jazz, having an estimated fair
value of $42.5 million. In fiscal 2003, another party made an additional
investment in Jazz thereby reducing our equity interest to 38%. Except where otherwise noted, the financial information contained herein
represents our continuing operations, excluding the discontinued wireless
communications business, Mexicali Operations and the Mindspeed business, and
including the results of operations of GlobespanVirata since February 28, 2004,
following the completion of our Merger. Our net revenues in fiscal 2004 and 2003 were $901.9 million and $600.0
million, respectively. We incurred net losses of $544.6 million in fiscal 2004
and $705.3 million in fiscal 2003. Income from continuing operations for fiscal
2003 was $23.6 million. The loss from discontinued operations in fiscal 2003
was $728.9 million. We recorded special charges of $32.8 million and $18.4
million in fiscal 2004 and 2003, respectively. Additionally, during fiscal
2004 we recorded in-process research and development expenses of $160.8 million
related to the Merger and a $255.7 million charge for the impairment of
deferred tax assets. Our Strategy Our strategy is to create a portfolio of technologies which, in various
combinations, can be integrated to create solutions for broadband digital home
products that improve consumer entertainment and productivity applications.
Improvements may take the form of convenience, portability, cost reductions,
size, power or space savings, ease of installation, versatility or enabling
functionality that would otherwise be economically impractical. Key elements
in our strategy include the following: Target High-Growth Communications Markets An important aspect of our strategy is to identify segments of the broadband
digital home marketplace offering the potential for high growth and to develop
semiconductor system solutions for applications in these markets. Focus on System Solutions We seek to capitalize on our design capabilities and communications systems
knowledge and experience by providing suppliers of personal communications and
media processing products with complete semiconductor system solutions. High
levels of integration enhance the benefits of our products by reducing
production costs through fewer external components, reduced power consumption,
reduced board space and improved system assembly yields. These semiconductor
system solutions provide our original equipment manufacturer (OEM) and original
design manufacturer (ODM) customers with hardware, software and, in many cases,
a complete reference design. Leverage Our Core Technology We deploy technology building blocks such as digital signal processors,
mixed-signal processing cores and software modules across multiple product
platforms. This technology reuse creates economies of scale in research and
development and facilitates a reduction in the time-to-market for key products.
As we extend our own core technology portfolio and, in parallel, seek
alliances to gain access to emerging intellectual property, we will seek to
maintain our agility and flexibility to meet changing market and technology
requirements. Build Upon Strategic Customer Relationships We believe a business partnership approach yields maximum value to the customer
through multilevel organizational engagement and product roadmap alignment.
Further, we believe that the strength of our relationships with leading
customers in each of our markets is a competitive advantage that enables us to
more effectively target our research and development investments. We have
demonstrated our success in building strategic customer 4




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relationships within our long-standing dial-up modem customer base. Our
relationships have helped to provide us with rapid feedback from our customers
during the design process and have increased the likelihood that our products
satisfy our customers cost and performance requirements. Operate as a Fabless Semiconductor Company We operate as a fabless semiconductor company and outsource all of our
manufacturing needs. This allows us to focus our resources on the design,
development and marketing of our products while minimizing operating
infrastructure and capital requirements. As a result, we maintain maximum
flexibility in operations so that we can more rapidly adapt to changes in our
customers needs and our target markets. We enter into strategic agreements
with third parties to gain access to wafer fabrication capacity, including
advanced process technologies, and assembly and test services we require. Our Business We design, develop and sell semiconductor system solutions for use in products
driving broadband digital home information and entertainment applications. Our
expertise in mixed-signal processing allows us to deliver semiconductor devices
and 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 wireline communications networks, including asynchronous digital
subscriber line (ADSL), cable and Ethernet, over wireless local area networks
and over direct broadcast satellite, terrestrial and fixed wireless systems.
Our universal 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 media processing solutions include a variety of broadcast audio
and video decoder and encoder devices that enable the capture, display,
storage, playback and transfer of audio and video in digital home and small
office environment products such as PCs, set-top boxes, gaming consoles,
personal video recorders and digital versatile disk (DVD) applications. We
operate in one reportable segment. The Merger significantly enhanced our product portfolios in digital subscriber
line (DSL) and wireless products. In the DSL area, we acquired both central
office (CO) and customer premises equipment (CPE) products as well as
communication and network processor products. In the wireless area, we
acquired the PRISM® family of chipsets with the longest history of wireless
local area networking development and deployment in the industry. Broadband/DSL Access Products Our broadband/DSL access product portfolio is comprised of semiconductor
solutions that connect personal communications access devices to broadband
networks. Our portfolio of ADSL and cable modem semiconductor system solutions
permits high speed transmission of data, voice, audio and video over existing
standard copper wire telephone lines and cable operators coaxial cable
facilities. The Companys DSL products include broadband system-level solutions
for modems, routers, residential gateways, and DSL access multiplexers (DSLAM).
Additionally, our portfolio includes networking processor semiconductor
solutions that enable the networking of several computing or communications
devices to share broadband access as well as media content. Our DSL product portfolio is comprised of a family of System-On-Chip integrated
circuits for use in home and business DSL products that incorporate a
combination of multiple system functions. We offer CO and CPE solutions.
Solutions can optionally include a DSL asymmetric or symmetric modem, an
application specific network processor, and Ethernet, Peripheral Component
Interconnect (PCI) or Universal Serial Bus (USB) data interface. Our DSL
product offerings include various combinations of digital signal processors,
network or communication processors, integrated software on silicon, and analog
front-end chips, line drivers and reference design guides to help our customers
deploy DSL modems, routers, residential gateways, and DSLAMs located in
telephone service providers central offices. 5




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We offer both asymmetric and symmetric DSL CPE chipsets used in the equipment
that resides in the end users home or office. Our Titanium USB and Titanium
PCI chipsets provide ADSL network access through a personal computer USB
connection and PCI interface, respectively. Our highly integrated ADSL CPE
modem provides a cost-effective and highly interoperable solution for our
customers around the world, many of whom were ODM customers who had benefited
from our high levels of service and support when they marketed dial-up modem
products in the past. ADSL network access with router and bridge capabilities
through Ethernet and/or wireless connections are provided by our Titanium Plus
ENet and Argon chipsets. The convergence of DSL and wireless silicon in the
home offers an opportunity for us to provide highly integrated solutions to our
customers. Our asymmetric DSL CPE products support Annex A, B and C standards
to meet all international DSL market needs. In June 2004, we introduced our highly integrated Viking II Plus Ethernet modem
ADSL chipset, which offers OEMs a complete full-rate, full bridging, and
routing performance two-chip solution for ADSL Ethernet CPE applications. This
cost effective solution is based on Conexants fully programmable multimode DSL
digital signal processor that supports all standard compliant versions of ADSL.
This family is firmware upgradeable to both the ADSL2 and ADSL2plus standards. Our Titanium ADSL chipsets provide cost-effective, high-speed local loop access
for Internet and other applications where downstream transmission rates to end
users are faster than upstream transmission rates from end users. This
asymmetric transmission is provided over one pair of copper telephone wires
with downstream data transmission rates of up to 26 Megabits per second (Mbps)
or higher. ADSL also allows the telephone line to be used simultaneously for
standard telephone voice service and data transmission. Titanium is a family of
multi-port chipsets, ranging from 4 to 24 ports per digital signal processor
chip and from 4 to 8 ports per analog front-end chip. Our ADSL chipsets are designed to meet the American National Standards
Institute (ANSI) standard specification T1.413, and International
Telecommunications Union (ITU) standard G.992.1 for 8 Mbps configuration (known
as G.dmt), including Annex A, B and C options to these standards. Our chipsets
also meet ITU standard G.992.2 (known as G.Lite), exceeding the standards 1.5
Mbps specification with speeds up to 4 Mbps. Additionally, our chipsets offer
enhanced data rates of up to 16 Mbps and faster, compliant with newer standards
that are being established. Our symmetric digital subscriber line (SDSL) chip sets, marketed as Orion,
provide cost-effective network access where downstream transmission rates to
end users are the same as upstream transmission rates from end users. Our SDSL
chipsets are available in different DSL configurations, including IDSL, HDSL,
HDSL2, HDSL4 and G.SHDSL. The most popular symmetric configuration is G.SHDSL,
which delivers symmetric data rates from 192 Kilobits per second (Kbps) to 2.3
Mbps over one standard copper wire pair and up to 4.6 Mbps over two copper wire
pairs at distances much greater than traditionally deployed SDSL solutions.
Additionally, the extended reach of G.SHDSL allows service providers to
increase their customer service area by 30%. Our Orion chipsets offer
multi-port density, ranging from 2 to 8 ports per chip. Our Titanium G24 solution supports both ADSL and G.SHDSL standards on a single
platform. The Titanium G24 convergence platform is a high-density solution
with 24 channels capable of supporting asymmetric data rates of 26 Mbps and
higher as well as symmetric rates of up to 4.6 Mbps on a single chip. Our DSL engineering support includes our advanced software-based development
tools which allow ODMs, service providers and telecom companies to analyze,
configure and troubleshoot their ADSL networks remotely, saving precious time
and expense. Our cable modem product portfolio includes our single-package cable modem
solution containing an embedded microprocessor-based media access controller
for North American Data Over Cable Service Interface Specification (DOCSIS),
European DOCSIS and digital video broadcasting (DVB) applications. Our cable
modem products are DOCSIS 1.0, DOCSIS 1.1, and DOCSIS 2.0 compliant. We also
offer a single-chip silicon-based digital tuner, which supports both DOCSIS and
DVB/Digital Audio Visual Council (DAVIC) standards for computer cable modems
and set-top boxes. This device seamlessly interfaces with our digital cable
transceiver solutions. Our cable modem technology is capable of delivering
data, video, telephone and Internet access over existing coaxial cable networks
at speeds up to 1,000 times faster than a standard voiceband analog modem. In
addition, our solution 6




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supports the PCI, USB and Ethernet interfaces for connection with a PC and our
customers have used this solution to successfully complete the rigorous North
American CableLabs and European tComLabs certifications. These certifications
give consumers and cable operators the assurance that systems comply with
DOCSIS specifications and will be interoperable among multiple cable modem
vendors. To support the distribution of broadband content throughout the digital home,
we offer home networking products that enable personal communications devices
to share data, voice, audio and video using existing telephone line, coaxial
cable, power line and wireless links. We have developed a portfolio of home
network processors which can be used at the core of a variety of devices, such
as residential gateways, that consumers may use to access the Internet and
share content using a wide range of existing and emerging connectivity
technologies to link a network of home PCs and peripheral devices. In addition
to connecting broadband services to networks inside the home, these processors
offer processing power sufficient to implement a full-featured Statefull Packet
Inspection (SPI)-based firewall. The importance of a secure firewall is greater
than ever with the increasing use of always on Internet access in both the
home and small office environments. The scalable system architecture of our
home network processor product portfolio has also enabled digital voice
terminals for voice-over-internet protocol applications, internet
protocol-media terminals for video distribution, wireless data networking and
other emerging connectivity applications. We offer three families of communications and network processor products:
Helium, Nitrogen and Columbia. Our Helium family of communications processors
is a range of programmable single chip devices that are used primarily in CPE
products to provide network communication functions and added value features
for the end user. These chips are highly integrated solutions that include
PCI, USB and Ethernet controllers as well as flexible expansion interfaces to
enable customers to add capabilities such as home wireless networking. The
Nitrogen family of communications products is optimized for IP/Ethernet
applications only and are targeted for use in residential gateway and home
networking products. We also offer a programmable network communications
processor, Columbia, which combines both hardware and software implementations
to yield high performance and flexible processing of communication protocols
used in DSL network access systems. This product performs Asynchronous
Transfer Mode (ATM) and Internet Protocol (IP) processing, traffic management
and aggregation of multiple symmetric or asymmetric DSL access line into a
single high-speed connection into the wide area network. We expect that this
product will be primarily used in DSLAMs and equipment designed for use in
digital loop carriers and multi-dwelling or business multi-tenant unit
applications. Our network communications processor also has applications in
voice gateway cards, multi-service wide area network switches and edge routers.
The products flexible hardware and software implementation will also permit
a seamless migration from todays predominantly ATM networks to tomorrows
converged IP networks. Our ISOSTM software works in combination with the Helium and Nitrogen chips to
manage data, routing, bridging, switching and protocol conversions needed to
encapsulate and route information packets. Additional features of these
products include system management, firewall security, embedded web server,
auto-configuration of DSL services and Universal Plug-and-Play (UPNP). We also
offer customers a full set of software development tools including compilers,
linkers and other special-purpose tools to enable the customer to design
additional applications. Universal and Voice Access Products Our universal and voice access products consist of Internet access solutions
including 56 Kbps dial-up modem chipsets utilizing the V.90 and V.92 standards.
We supply mixed-signal intensive, controllerless modem chipsets and software
modem solutions that take advantage of the increasing power of PC central
processors and use software to perform functions traditionally enabled by
semiconductor components. In addition, we have extended sales of our modem portfolio beyond PC-related
products to other end-user products and we offer embedded modem solutions for a
host of products including fax machines, MFPs, POS terminals, set-top boxes,
personal digital assistants (PDAs), and Internet appliances including
Internet-connected televisions, digital picture frames, gaming consoles and web
phones. 7




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Voice-over-Packet (VoP) solutions enable telecom carriers to move their voice
services away from traditional circuit-switched networks to packet-based
networks, thereby reducing operational costs and providing a lower cost
alternative to traditional telephone services. Our VoP products consist of
single and multiple voice channel coprocessors coupled with voice codec and
home network processor technology to provide complete and scaleable
ITU-standard application support for Voice-over-IP and Voice-over-DSL services.
Additionally, our software offers solutions for a wide variety of voice and
telephone applications. During fiscal 2004, Conexant introduced the industrys first dial-up modem chip
with support for Intels High Definition Audio (HD Audio) bus architecture
audio standard. This device was the first in a family of planned products that
will make use of the HD Audio bus (formerly known by the Intel code name
Azalia) to transmit data between an internal narrowband modem and notebook
and desktop computers. Wireless and Networking Components Products Our Wireless and Networking Components (Wireless) product offerings include
various combinations of radio frequency (RF) transceivers, analog base-band
integrated circuits and digital base-band and Medium or Media Access Controller
(MAC) chips and reference design guides. Many of our chipsets utilize common
circuit blocks that leverage our overall product development resources and
expedite our overall time to market. We offer a wide variety of Wireless
networking chipsets and reference designs that are enabling a new generation of
wireless connectivity in notebooks, PDAs, digital cameras, MP3 players and
other handheld networking appliances. Our Wireless products address the complimentary high-growth wireless networking
market by offering one of the industrys most complete lines of the Institute
of Electrical and Electronics Engineers (IEEE) 802.11 wireless products for all
worldwide applications and standards. All products also adhere to and are
certified by the Wi-Fi Alliance as well as other specialty certifications such
as Microsofts Windows Hardware Quality Labs (WHQL), Cisco Compatible
Extensions (CCX) and Wi-Fi Protected Access (WPA). With the longest history
of wireless development and deployment, Conexants PRISM® technology has been
widely utilized by industry-leading companies to enable wireless connectivity
in thousands of innovative wireless networking products since 1996. Our PRISM® family of chipsets while sharing a similar base architecture have
specialized forms to serve retail, embedded, low power-portable, and
enterprise-grade end products. Such systems provide cost effective, wireless
access to high data rate broadband communications networks including both
enterprise systems and home systems served by broadband service providers. We
have one of the most complete sets of products in the market that spans a wide
range of technologies and platforms including reference designs, software and
all integrated circuits (ICs) necessary for wireless data communications at
data rates up to the standard 54 Mbps across the 2.4 and 5 GHz bands. We
support the main IEEE 802.11 b, a, and g standards with full system solutions
as well as multiband and multimode solutions culminating in a full a/b/g
worldband radio solution thus covering every major standard in one compact
design. We have also developed physical layer (PHY) and analog front-end (AFE) products
to support networking in the home. We offer a highly integrated, single-chip
HomePlug semiconductor solution for Ethernet bridges, HomePlug wireless bridges
and routers, and a variety of embedded applications such as media adaptors for
PCs. HomePlug powerline technology uses the existing home electrical wiring to
network devices such as PCs, providing Internet access and home connectivity
through power outlets within the home. And because this solution was designed
using our building block software platform approach, our HomePlug device can
also be combined with Conexants home network processors, ADSL and cable modem
solutions to allow designers to seamlessly incorporate HomePlug technology into
a variety of multi-functional products. Broadband Media Processing Products Our broadband media processing product offerings include an extensive portfolio
of components and system level solutions enabling digital cable, satellite and
terrestrial set-top boxes as well as an extensive suite of components and
system level solutions for a wide range of major video applications ranging
from standard and high-definition video 8




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to interactive consumer entertainment services delivered through set-top boxes,
PCs, digital video recorders (DVRs) and game consoles. A typical set-top box is comprised of front-end components and back-end
components. Among the front-end components, tuners and demodulators are
designed to receive and prepare signals from a satellite, cable or terrestrial
network and back-channel modems are used to communicate with the service
provider. In the back-end, integrated Motion Picture Experts Group (MPEG)
decoders are designed to process the audio and video signals and to control the
set-top box application software while video encoders format the video signal
for display on an analog television. We built upon our customer relationships established through our leadership
front-end products to win our first back-end product opportunities in fiscal
2004. We introduced and began shipments of our new single-chip solution
incorporating demodulation, MPEG processing, audio and video outputs, graphic
processing, back-channel communications capability and a control processor.
Combined with one of our silicon tuner devices, this product offers a complete
cost-effective set-top box solution for satellite, cable and terrestrial
networks. In fiscal 2004 we introduced our fifth-generation highly-integrated satellite
set-top box silicon tuner and demodulator component products, offering our
customers a tightly integrated path for their next generation products. We
also introduced our new octal phase shift keying (8PSK) demodulator for
satellite networks which employ an 8PSK advanced modulation scheme. We also
began to ship our new high-performance low-cost silicon germanium (SiGe) tuner
in fiscal 2004. Our digital video encoder ICs provide a combination of features, video
performance and flexibility for todays set-top box, PC video, DVD and other
video systems. These video encoder ICs convert digital video stored on DVDs or
on other digital media, or digitally transmitted to a set-top box, into the
analog signals which drive both standard and high definition televisions. In
addition, our line of stand-alone video decoders and integrated PCI video
decoders combine worldwide video standard support, integration and software
support. Our analog video decoders are designed to convert analog signals
received by a set-top box, PC video system or other consumer electronic analog
video device into digital streams that can be displayed by a digital video
monitor or saved using a form of digital recording media. As a result of our acquisition of GlobespanViratas iCompression video
compression business in 2002, we have successfully deployed stand-alone MPEG
video encoders and decoders and have accelerated the pace of development of
other advanced MPEG video products on our roadmap. This strategic acquisition
enhanced our portfolio by adding MPEG-2 and advanced MPEG-4 digital media
compression technologies, which we believe are important to our long-term
product strategy in the PC and set-top box markets. We furthered our MPEG-4
technology investment with the acquisition of Belfast-based Amphion in June
2004. This infusion of engineering talent and IP is expected to significantly
speed the development of critical H.264 technology required for next-generation
High Definition Television (HDTV) set-top box solutions. Research and Development We have significant research, development, engineering and product design
capabilities. At September 30, 2004, we had approximately 1,650 employees
engaged in research and development activities at multiple design centers
worldwide. Our design centers provide design engineering and product
application support as well as after-sales customer service. The design centers
are strategically located around the world to be in close proximity to our OEM
customers and to take advantage of key technical and engineering talent. We incurred research and development expenses of $240.0 million, $159.4 million
and $156.4 million in fiscal 2004, 2003 and 2002, respectively. 9




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Manufacturing In 2002 we contributed our Newport Beach, California wafer fabrication
operations to Jazz, a joint venture in which we hold a minority ownership, and
we contributed our Newbury Park, California gallium arsenide wafer fabrication
facility to Washington as part of the Skyworks Spin. These transactions
completed our transition to a fully fabless business model. Under our fabless business model, we no longer operate wafer fabrication
facilities (known as foundries or fabs) and we use third parties for wafer
fabrication services. We use complementary metal-oxide semiconductor (CMOS)
process technology for the majority of our products. Jazz, Taiwan Semiconductor
Manufacturing Corporation (TSMC) and United Microelectronics Corporation (UMC)
are our principal suppliers of CMOS products. We also use bipolar and bipolar
CMOS (BiCMOS) process technology for certain mixed-signal devices. These
products are supplied primarily by Jazz and TSMC. To obtain external wafer manufacturing capacity, we entered into a five-year
supply arrangement with Jazz in March 2002 under which we purchase a portion of
our requirements for silicon wafers. During the first two years of our supply
arrangement with Jazz, our cost of wafers was an amount which approximated our
historical cost. Thereafter, the cost of wafers will be based on market prices.
Additionally, we are obligated to purchase (and Jazz is obligated to supply)
certain minimum annual volumes of wafers during the first three years of the
arrangement. In the event our actual wafer purchases are less than the required
minimum volumes, we will be required to make additional payments to Jazz. Our
expected minimum purchase obligation under the supply agreement with Jazz, net
of a portion of the wafer purchase obligations assumed by a third party, will
be approximately $14.0 million in fiscal 2005. Our arrangements with other
foundries generally do not provide us with any guaranteed levels of supply. As part of the Skyworks Spin, Skyworks purchased our Mexicali, Mexico assembly
and test facility. We use third parties, including Skyworks, for the assembly
and test of all of our products. We entered into a three-year supply agreement
with Skyworks in June 2002, under which Skyworks provides us semiconductor
assembly and test services at our former Mexicali, Mexico facility. Under this
supply agreement, we have a minimum purchase obligation of $10.9 million with
Skyworks in fiscal 2005. We currently anticipate meeting the annual minimum purchase obligations under
the supply agreements with both Jazz and Skyworks. Customers, Marketing and Sales We market and sell our semiconductor products and system solutions directly to
leading 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 resellers accounted for approximately 36% of our
fiscal 2004 net revenues. In fiscal 2004, no customer accounted for 10% or more
of our net revenues. Our top 20 customers accounted for approximately 59% of
our fiscal 2004 net revenues. Revenues derived from customers located in the Americas, the Asia-Pacific
region and Europe were 11%, 80% and 9%, respectively, of our net revenues in
fiscal 2004. 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. See Note 17 of
Notes to Consolidated Financial Statements. We have a worldwide sales and marketing organization comprised of approximately
450 employees as of September 30, 2004 in various domestic and international
locations. To complement our direct sales and customer support efforts, we
also sell our products through approximately 56 independent manufacturers
representatives, distributors and dealers. In addition, our design and
applications engineering staff is actively involved with customers during all
phases of design and production and provides customer support through our
worldwide sales offices, which are generally in close proximity to customers
facilities. 10




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Backlog Our sales are made primarily pursuant to standard purchase orders for delivery
of products, with such purchase orders officially acknowledged by us according
to our own terms and conditions. Because industry practice allows customers to
cancel orders with limited advance notice to us prior to shipment, we believe
that backlog as of any particular date may not be indicative of our future
revenue levels. 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 U.S. and international suppliers that are both larger and smaller
than us in terms of resources and market share. We anticipate that additional
competitors will enter our markets and expect intense price and product
competition to continue. We compete primarily with Agere Systems, Inc., Analog Devices, Inc., Atheros
Communications, Inc., Broadcom Corporation, Centillium Communications, Inc.,
Intel Corporation, LSI Logic Corporation, Marvell Technology Group Ltd.,
Motorola, Inc., Philips Electronics N.V., Silicon Laboratories, Inc.,
STMicroelectronics N.V. and Texas Instruments Incorporated. Intellectual Property and Proprietary Rights We own or license a number of United States and foreign patents and patent
applications related to our products, processes and technologies. We also
cross license portions of our intellectual property and are also cross-licensed
under a number of intellectual property portfolios in the industry that are
relevant to our technologies and products. We have filed and received federal
and international trademark registrations of our Conexant trademarks. In
addition, we have registered or applied to register a number of additional
trademarks applicable to our products. We believe that intellectual property,
including patents, patent applications, licenses and trademarks are of material
importance to our business. In addition to protecting our proprietary
technologies and processes, we constantly strive to strengthen and enhance our
intellectual property portfolio. We use the portfolio to seek licensing
opportunities, to negotiate cross-licenses with other intellectual property
portfolios, to gain access to intellectual property of others and to avoid,
defend against, or settle litigation. While in the aggregate our patents,
patent applications, licenses and trademarks are considered important to our
operations, they are not considered of such importance that the loss or
termination of any one of them would materially affect our business or
financial condition. Various claims of patent infringement have been made against us. We believe
that none of these claims will have a material adverse effect on our financial
position or results of operations. Environmental Regulation Federal, state and local requirements relating to the discharge of substances
into the environment, the disposal of hazardous wastes, and other activities
affecting the environment have had, and will continue to have, an impact on our
former manufacturing operations. To date, compliance with environmental
requirements and resolution of environmental claims have been accomplished
without material effect on our liquidity and capital resources, competitive
position or financial condition. See Certain Business Risks  We may be
liable for penalties under environmental laws, rules and regulations, which
could adversely impact our business. We believe that any expenditures necessary for the resolution of environmental
claims will not have a material adverse effect on our liquidity and capital
resources, competitive position or financial condition. We cannot assess the
possible effect of compliance with future requirements. Cyclicality; Seasonality; Possible Significant Downturns We operate in a highly cyclical industry. See Certain Business Risks  We
operate in the highly cyclical semiconductor industry, which is subject to
significant downturns. Sales of certain of our products are subject to seasonal fluctuation related to
the increase in sales of end-user 11




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products which include our products, such as PCs, set-top boxes, game consoles
and facsimile machines, generally associated with the holiday season in
December. Our sales of semiconductor products and system solutions used in
these products generally increase beginning in August and September and
continue at a higher level through the end of the calendar year. Due to the
excess channel inventory that resulted from lower than expected customer
demand, we did not experience this seasonal demand in fiscal 2004, or in the
first quarter of fiscal 2005. Employees As of September 30, 2004, we had approximately 2,400 employees. Approximately
1,790 of our employees are engineers. None of our employees are covered by
collective bargaining agreements. We believe our future success will depend in
large part upon our continued ability to attract, motivate, develop and retain
highly skilled and dedicated employees. 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. You should carefully consider and evaluate all of the information in this
Annual Report, including the risk factors listed below. 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 fiscal year 2004 were $901.9 million. Our net loss for
fiscal 2004 was $544.6 million. 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 12




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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 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. We experienced a substantial decline in our revenues from the March quarter of
2004 to the September quarter of 2004. If the Merger had been completed on
January 1, 2004, the net revenues for the combined companies for the full
quarter ended March 31, 2004 would have been $293.3 million, or $49.5 million
higher than the reported March quarter net revenues of $243.8 million. Our
actual revenues for the quarter ended September 30, 2004 were $213.1 million,
or a decrease of approximately 27% from the pro forma March quarter amount.
This revenue decline was predominately attributable to: lower than expected customer demand which
resulted in excess channel inventory build-up at our direct customers,
distributors and resellers; price erosion in the Wireless and
Broadband/DSL product lines; and market share loss in our Wireless
product line. We 13




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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. The use of net revenues for the combined companies as if the Merger had closed
at the beginning of the quarter ended March 31, 2004 is a non-GAAP financial
measure, which is used by management to provide useful information in
establishing a meaningful comparison of sequential revenue levels and which is
not necessarily reflected in the results of operations as presented on a GAAP
basis. It is not intended to be an alternative to GAAP measures. As a result of the sequential decline in net revenues and excess channel
inventory discussed above, our inventory balances and our accounts receivable
days sales outstanding have increased. An increase in these accounts in a
period of declining revenues increases the risk that these assets may require
further valuation allowances or impairment in the future. 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 September 30, 2004, we have
$711.8 million aggregate principal amount of convertible subordinated notes
outstanding which become due in several tranches beginning in May of 2006 and
ending in February of 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. 14




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We believe that the principal competitive factors for semiconductor suppliers
in our addressed markets are:  
    
    time-to-market;  
    
    product quality, reliability and performance;  
    
    level of integration;  
    
    price and total system cost;  
    
    compliance with industry standards;  
    
    design and engineering capabilities;  
    
    strategic relationships with customers;  
    
    customer support;  
    
    new product innovation; and  
    
    access to manufacturing capacity. We cannot assure you that we will be able to successfully address these
factors. Current and potential competitors also have established or may establish
financial or strategic relationships among themselves or with our existing or
potential customers, resellers or other third parties. These relationships may
affect customers purchasing decisions. Accordingly, it is possible that new
competitors or alliances could emerge and rapidly acquire significant market
share. We cannot assure you that we will be able to compete successfully
against current and potential competitors. 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 anticipate. Integrating acquired organizations and their products and services may be
expensive, time-consuming and a strain on our resources and our relationships
with employees and customers, and ultimately may not be successful. The merger of Conexant and GlobespanVirata involves the integration of two
companies that previously operated independently. The difficulties of
combining the operations of the companies include:  
    
    the challenge of effecting integration while carrying on an ongoing business;  
    
    the necessity of coordinating geographically separate organizations;  
    
    retaining and integrating personnel with diverse business backgrounds;  
    
    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 expect 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. 15




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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 September 30,
2004, we have $708.5 million of goodwill, of which $632.4 million was generated
in the Merger. As a result of the decline in the price of our common stock,
our market capitalization is below our book value at September 30, 2004. This
is an indicator that goodwill may be impaired. We performed an evaluation of
our goodwill at September 30, 2004 and determined that as of that date, no
impairment was required. However, if our market capitalization remains 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. 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; and  
    
    our ability to invest in significant amounts of research and development. 16




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We cannot assure you that we will have sufficient resources to make the
substantial investment in research and development in order to develop and
bring to market new and enhanced products. Furthermore, we are required to
continually evaluate expenditures for planned product development and to choose
among alternative technologies based on our expectations of future market
growth. We cannot assure you that we will be able to develop and introduce new
or enhanced products in a timely and cost-effective manner, that our products
will satisfy customer requirements or achieve market acceptance, or that we
will be able to anticipate new industry standards and technological changes. We
also cannot assure you that we will be able to respond successfully to new
product announcements and introductions by competitors. In addition, prices of established products may decline, sometimes
significantly and rapidly, over time. We believe that in order to remain
competitive we must continue to reduce the cost of producing and delivering
existing products at the same time that we develop and introduce new or
enhanced products. We cannot assure you that we will be able to continue to
reduce the cost of our products to remain competitive. If we are unable to
reduce manufacturing costs in response to declines in selling prices for our
products, it will lead to declines in gross margins for such products. We may not be able to keep abreast of the rapid technological changes in our
markets. The demand for our products can change quickly and in ways we may not
anticipate because our markets generally exhibit the following characteristics:  
    
    rapid technological developments;  
    
    rapid changes in customer requirements;  
    
    frequent new product introductions and enhancements;  
    
    short product life cycles with declining prices over the life cycle of the products; and  
    
    evolving industry standards. Our products could become obsolete sooner than anticipated because of a faster
than anticipated change in one or more of the technologies related to our
products or in market demand for products based on a particular technology,
particularly due to the introduction of new technology that represents a
substantial advance over current technology. Currently accepted industry
standards are also subject to change, which may contribute to the obsolescence
of our products. We may not be able to attract and retain qualified personnel necessary for the
design, development and sale of our products. Our success could be negatively
affected if key personnel leave. Our future success depends on our ability to attract, retain and motivate
qualified personnel, including executive officers and other key management and
technical personnel. As the source of our technological and product
innovations, our key technical personnel represent a significant asset. The
competition for such personnel can be intense in the semiconductor industry.
While we have entered into employment agreements with some of our key
personnel, we cannot assure you that we will be able to attract and retain
qualified management and other personnel necessary for the design, development
and sale of our products. We may have particular difficulty attracting and retaining key personnel during
periods of poor operating performance. The loss of the services of one or more
of our key personnel, including 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. 17




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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. 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 36% of our net
revenues for fiscal 2004. We routinely purchase inventory based on estimates
of end-market demand for our customers products, which is difficult to
predict. This difficulty may be compounded when we sell to OEMs indirectly
through distributors and other resellers or contract manufacturers, or both, as
our forecasts of demand are then based on estimates provided by multiple
parties. In addition, our customers may change their inventory practices on
short notice for any reason. The cancellation or deferral of product orders,
the return of previously sold products or overproduction due to the failure of
anticipated orders to materialize could result in our holding excess or
obsolete inventory, which could result in write-downs of inventory. We are dependent upon third parties for the manufacture, assembly and test of
our products. We are entirely dependent upon outside wafer fabrication facilities (known as
foundries). 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. 18




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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 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 fiscal 2004, approximately 91% 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; 19




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
    
    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
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. 20




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Despite these precautions, it may be possible for a third party to copy or
otherwise obtain and use our technology without authorization, develop similar
technology independently or design around our patents. If any of our patents
fails to protect our technology it would make it easier for our competitors to
offer similar products. In addition, effective patent, copyright, trademark and
trade secret protection may be unavailable or limited in certain countries. We may be liable for penalties under environmental laws, rules and regulations,
which could adversely impact our business. Conexants former manufacturing operations used a variety of chemicals and were
subject to a wide range of environmental protection regulations in the United
States and Mexico. We have been designated as a potentially responsible party
and are engaged in groundwater remediation at one Superfund site located at a
former silicon wafer manufacturing facility and steel fabrication plant in
Parker Ford, Pennsylvania formerly occupied by Conexant. In addition, we are
engaged in remediations of groundwater contamination at Conexants former
Newport Beach, California wafer fabrication facility. We currently estimate the
remaining costs for these remediations to be approximately $3.2 million and
have accrued for these costs as of September 30, 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 September 30,
2004, Conexant had approximately $1.6 billion of U.S.
federal income tax net operating loss (NOL) carryforwards that can be used to
offset taxable income in subsequent years. The NOL carryforwards 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 carryforwards if the
ownership of our common stock changes by more than 50 percentage points in
certain circumstances over a three-year testing period. Based on information
known to us, we have not undergone such a change of ownership and the merger of
Conexant and GlobespanVirata did not constitute a change of ownership, although
the shares of our common stock issued in the Merger will be taken into account
in any change of ownership computations. Direct or indirect transfers of our
common stock, when taken together with the shift in ownership resulting from
the Merger, could result in a change of ownership that would trigger the
section 382 limitation. If such an ownership change occurs, section 382 would
limit our use of NOL carryforwards in each subsequent taxable year to an amount
equal to a federal long-term tax-exempt rate published by the Internal Revenue
Service at the time of the ownership change, multiplied by our fair market
value at such time; any unused annual limitation amounts may also be carried
forward. The Merger resulted in a change of ownership of GlobespanVirata and
the future use of GlobespanViratas NOL carryforwards are subject to the
section 382 limitation (or further limitation in the case of NOL carryforwards
already subject to limitation as a result of previous transactions) based on
the fair market value of GlobespanVirata at the time of the Merger. Provisions in our organizational documents and rights agreement and Delaware
law may make it difficult for someone to acquire control of us. 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; 21




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
    
    the ability of our board of directors to issue shares of our
preferred stock in one or more series without further authorization
of our shareholders;  
    
    a prohibition on shareholder action by written consent;  
    
    a requirement that shareholders provide advance notice of any
shareholder nominations of directors or any proposal of new business
to be considered at any meeting of shareholders;  
    
    a requirement that a supermajority vote be obtained to remove
a director for cause or to amend or repeal certain provisions of our
restated certificate of incorporation or by-laws;  
    
    elimination of the right of shareholders to call a special meeting of shareholders; and  
    
    a fair price provision. Our rights agreement gives our shareholders certain rights that would
substantially increase the cost of acquiring us in a transaction not approved
by our board of directors. In addition to the rights agreement and the provisions in our restated
certificate of incorporation and by-laws, Section 203 of the Delaware General
Corporation Law generally provides that a corporation shall not engage in any
business combination with any interested shareholder during the three-year
period following the time that such shareholder becomes an interested
shareholder, unless a majority of the directors then in office approves either
the business combination or the transaction that results in the shareholder
becoming an interested shareholder or specified shareholder approval
requirements are met. 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. Executive Officers Our executive officers are: Name
    
    Age
    
    PositionDwight W. Decker
    
    
    54
    
    
    Chairman of the Board and Chief Executive OfficerF. Matthew Rhodes
    
    
    47
    
    
    PresidentLewis C. Brewster
    
    
    40
    
    
    Executive Vice President and Chief Operating OfficerJ. Scott Blouin
    
    
    54
    
    
    Senior Vice President and Chief Financial OfficerDennis E. OReilly
    
    
    60
    
    
    Senior Vice President, Chief Legal Officer and Secretary
 There are no family relationships among our directors or executive officers.
Set forth below are the name, office and position held with the Company and
principal occupations and employment during the past 5 years of each of our 22




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executive officers. Dwight W. Decker  Chairman of the Board and Chief Executive Officer since
November 2004; non-executive Chairman of the Board from February 2004 to
November 2004; and Chairman of the Board and Chief Executive Officer prior
thereto. Mr. Decker received a Ph.D. in applied mathematics from the
California Institute of Technology and a B.Sc. in mathematics and physics from
McGill University. F. Matthew Rhodes  President since June 2003; Senior Vice President and
President of our former Broadband Communications segment from May 2002 to June
2003; and Senior Vice President and General Manager, Personal Computing prior
thereto. Mr. Rhodes received an M.B.A. from the Anderson Graduate School of
Management of the University of California, Los Angeles, an M.S. in electrical
engineering from Lehigh University and a B.S. in physics from The Pennsylvania
State University. Lewis C. Brewster  Executive Vice President and Chief Operating Officer since
November 2004; Executive Vice President, Sales, Operations and Quality from
February 2004 to November 2004; Executive Vice President and Chief Operating
Officer from June 2003 to February 2004; and Senior Vice President, Worldwide
Sales prior thereto. Mr. Brewster received an M.B.A. from Stanford University
and a B.S. in electrical engineering and biomedical engineering from Duke
University. J. Scott Blouin  Senior Vice President and Chief Financial Officer since
August 2004; Senior Vice President and Chief Accounting Officer from February
2004 to August 2004; Senior Vice President and Chief Financial Officer from
June 2003 to February 2004; Senior Vice President, Chief Accounting Officer and
Controller from March 2002 to June 2003; Senior Vice President and Chief
Accounting Officer from January 2001 to March 2002; and Chief Financial Officer
of Burr-Brown Corporation (semiconductors) from February 1996 to August 2000.
Mr. Blouin received an M.B.A. from Wake Forest University and a B.S. in
administration from the University of New Hampshire at Durham. Dennis E. OReilly  Senior Vice President, Chief Legal Officer and Secretary
since February 2004; and Senior Vice President, General Counsel and Secretary
prior thereto. Mr. OReilly received a J.D. from Boston University School of
Law and a B.A. from the State University of New York at Binghamton. Available Information We maintain an Internet website at http://www.conexant.com. Our annual reports
on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and
amendments to such reports filed or furnished pursuant to Section 13(a) or
15(d) of the Securities Exchange Act of 1934, as amended, along with our annual
report to shareowners and other information related to our company, are
available free of charge on this site as soon as reasonably practicable after
we electronically file or furnish these reports with the Securities and
Exchange Commission. Our Internet website and the information contained
therein or connected thereto are not intended to be incorporated into this
Annual Report on Form 10-K. 
 Item 2. Properties Our headquarters in Newport Beach, California consists of approximately 90,000
square feet of owned and approximately 235,000 square feet of leased floor
space. An additional 363,000 square feet of owned floor space at our Newport
Beach facility is leased to Jazz, 3,000 square feet of owned floor space at our
Newport Beach facility is leased to Skyworks, and 190,000 square feet of leased
floor space is sub-leased to Mindspeed. We also have facilities in Red Bank,
New Jersey which consists of approximately 100,000 square feet of leased space,
Palm Bay, Florida which consists of approximately 52,000 square feet of leased
space, and in San Diego, California which consists of approximately 180,000
square feet of leased space. We also own a facility in Noida, India with
approximately 23,000 square feet of floor space. Activities at all above locations include administration, sales and marketing,
research and development (including design centers) and operations functions. 23




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##### Table of Contents



At September 30, 2004, we also operated in 18 domestic and 21 international
offices. These facilities had an aggregate of approximately 290,000 square feet
of leased floor space. As a result of our reorganization and various restructuring related activities,
at September 30, 2004 we have an additional 466,000 square feet of unused and
vacant leased space, approximately 58% of which is being sub-leased. We
believe our properties have been well maintained, are in sound operating
condition and contain all the equipment and facilities necessary to operate at
present levels. Our California facilities, including one of our design centers, are located
near major earthquake fault lines. We maintain no earthquake insurance with
respect to these facilities. Certain of our facilities are located in countries
that may experience civil unrest, including Israel. 
 Item 3. Legal Proceedings Texas Instruments, Inc.The Companys Conexant, Inc. (formerly
GlobespanVirata, 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 Defendants 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. The
Company is a counterclaim defendant. Agere Systems, Inc.On October 17, 2002, Agere Systems, Inc. (Agere) filed suit
against Intersil Corporation (Intersil) in the U.S. District Court for the
District of Delaware. Conexant, Inc. (formerly GlobespanVirata, Inc.) acquired
the WLAN Group of Intersil in August 2003. Agere alleged that Intersil
infringed certain of its U.S. patents. Intersil counterclaimed against Agere
for infringement of certain patents, some of which are now owned by the
Companys Conexant, Inc. subsidiary and licensed to Intersil for purposes of
the suit. The parties filed a stipulated order adding Conexant, Inc. as a
party to the suit. On July 22, 2003, Agere filed a separate suit against
Intersil in the U.S. District Court for the District of Delaware alleging that
Intersil infringed certain additional U.S. patents. Conexant, Inc. was also
added as a party to this action. On October 30, 2002, Intersil and certain of its affiliated companies filed a
suit against Agere in the U.S. District Court for the Eastern District of
Pennsylvania alleging that Agere misappropriated certain Media Access Control
Wireless Local Area Network technology. This action sought an injunction to
prevent Agere, either alone or in cooperation with others, from developing,
making, and/or selling products that use that technology. Agere made similar
counterclaims against Conexant, Inc. and its affiliated companies and Intersil
and its affiliated companies. As a result of the acquisition of Intersils
WLAN Products Group and its Choice-Intersil Microsystems, Inc. 24




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##### Table of Contents



subsidiary, which was a party to this suit and the only remaining plaintiff,
Conexant, Inc. (formerly GlobespanVirata, Inc.) became involved in this suit. On November 4, 2004, the Company reached a settlement with Agere with respect
to the three lawsuits described above. Under the settlement, all pending
litigation between the companies has been dismissed with prejudice. As part of
this overall settlement, the Company made a cash payment to Agere in the
amount of $8.0 million in November 2004. The two companies have also entered
into various license agreements covering the patents involved in the suits and
other semiconductor devices. IPO Litigation.In November 2001, Collegeware Asset Management, LP, on behalf
of itself and a putative class of persons who purchased Conexant, Inc.
(formerly GlobespanVirata, 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. Various other lawsuits, claims and proceedings have been or may be instituted
or asserted against us or our subsidiaries, including those pertaining to
product liability, intellectual property, environmental, safety and health, and
employment matters. The outcome of litigation cannot be predicted with certainty and some lawsuits,
claims or proceedings may be disposed of unfavorably to the Company. Many
intellectual property disputes have a risk of injunctive relief and there can
be no assurance that a license will be granted. Injunctive relief could have a
material adverse effect on the financial condition or results of operations of
the Company. Based on its evaluation of matters which are pending or asserted
and taking into account the Companys reserves for such matters, management
believes the disposition of such matters will not have a material adverse
effect on the financial condition or results of operations of the Company. 
 Item 4. Submission of Matters to Vote of Security Holders No matters were submitted to a vote of our shareholders during the quarter
ended September 30, 2004. 25




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##### Table of Contents



PART II 
 Item 5. Market for Registrants Common Equity, Related Stockholder Matters and
Issuer Purchases of Equity Securities Our common stock is traded on the Nasdaq National Market under the symbol
CNXT. The following table lists the high and low per share sale prices for
our common stock as reported by the Nasdaq National Market for the periods
indicated: High
    
    LowFiscal year ended September 30, 2004:First quarter
    
    $
    6.42
    
    
    $
    4.64Second quarter
    
    
    7.85
    
    
    
    5.16Third quarter
    
    
    6.70
    
    
    
    3.72Fourth quarter
    
    
    2.65
    
    
    
    1.37Fiscal year ended September 30, 2003:First quarter
    
    $
    2.35
    
    
    $
    0.53Second quarter
    
    
    2.09
    
    
    
    1.20Third quarter (1)
    
    
    4.75
    
    
    
    1.49Fourth quarter
    
    
    6.77
    
    
    
    4.02
  (1)
    
    Sales prices for our common stock beginning in the third quarter of
fiscal 2003 reflect the completion of the Mindspeed Spin on June 27,
2003. As a result of the Mindspeed Spin, Conexant shareholders received
one share of common stock of Mindspeed Technologies, Inc. for every
three Conexant shares held and the Conexant shareholders continued to
hold their Conexant shares. At November 26, 2004, there were approximately 44,200 holders of record of our
common stock. We have never paid cash dividends on our capital stock. We currently intend to
retain any earnings for use in our business, and do not anticipate paying cash
dividends in the foreseeable future. The following provides information about purchases by or on our behalf or any
affiliated purchaser of shares of our common stock during the quarter ended
September 30, 2004: Issuer Purchases of Equity Securities Total Number of
    
    Maximum Number (orShares Purchased as
    
    Approximate Dollar Value) ofTotal Number of
    
    
    
    
    
    Part of Publicly
    
    Shares that May Yet BeShares
    
    Average Price
    
    Announced Plans or
    
    Purchased Under the Plan orPeriod
    
    Purchased
    
    Paid per Share
    
    Programs
    
    Programs7/1/04  7/31/04
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    8/1/04  8/31/04
    
    
    533,649
    *
    
    $
    1.51
    
    
    
    
    
    
    
    9/1/04  9/30/04
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Total
    
    
    533,649
    
    
    $
    1.51
    
    
    
    
    
    
    
    
 * In August 2004, we reacquired 533,649 shares of our common stock held
by two of our former executive officers as part of the settlement of
certain promissory notes and accrued interest owed to us by these
executives. The average price paid per share represents the average
closing price of our common stock for a specified number of days prior to
the date these shares were reacquired. 26




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##### Table of Contents



Item 6. Selected Financial Data The following selected financial data for the five years ended September 30,
2004 was derived from the audited consolidated financial statements of Conexant
and its subsidiaries. In June 2002, Conexant completed the spin-off of its
wireless communications business and the sale of its Mexicali Operations, and
in June 2003, Conexant completed the spin-off of its Mindspeed Technologies
Internet infrastructure business. The selected financial data for all periods
have been restated to reflect these businesses as discontinued operations. In
February 2004, Conexant completed the merger with GlobespanVirata, Inc. The
results of GlobespanVirata, Inc. have been included in the consolidated results
since February 28, 2004. The selected financial data should be read in conjunction with Managements
Discussion and Analysis of Financial Condition and Results of Operations and
the consolidated financial statements and notes thereto appearing elsewhere in
this report. 2004
    
    2003
    
    2002
    
    2001
    
    2000(in thousands, except per share amounts)Net revenues
    
    $
    901,854
    
    
    $
    599,977
    
    
    $
    521,726
    
    
    $
    541,688
    
    
    $
    1,211,410Cost of goods sold
    
    
    523,129
    
    
    
    338,161
    
    
    
    317,921
    
    
    
    522,560
    
    
    
    692,551Gross margin
    
    
    378,725
    
    
    
    261,816
    
    
    
    203,805
    
    
    
    19,128
    
    
    
    518,859Operating expenses:Research and development
    
    
    239,971
    
    
    
    159,354
    
    
    
    156,350
    
    
    
    175,026
    
    
    
    186,618Selling, general and administrative
    
    
    125,474
    
    
    
    93,426
    
    
    
    95,750
    
    
    
    141,276
    
    
    
    154,992Amortization of intangible assets
    
    
    20,769
    
    
    
    3,437
    
    
    
    19,489
    
    
    
    19,814
    
    
    
    11,508In-process research and development (3)
    
    
    160,818
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Special charges (1)
    
    
    32,801
    
    
    
    18,379
    
    
    
    30,499
    
    
    
    369,258
    
    
    
    35,000Total operating expenses
    
    
    579,833
    
    
    
    274,596
    
    
    
    302,088
    
    
    
    705,374
    
    
    
    388,118Operating income (loss)
    
    
    (201,108
    )
    
    
    (12,780
    )
    
    
    (98,283
    )
    
    
    (686,246
    )
    
    
    130,741Debt conversion costs
    
    
    
    
    
    
    
    
    
    
    10,435
    
    
    
    42,584
    
    
    
    Gain on extinguishment of debt
    
    
    
    
    
    
    (42,021
    )
    
    
    
    
    
    
    (11,710
    )
    
    
    Other (income) expense, net (4)
    
    
    99,808
    
    
    
    5,808
    
    
    
    36,870
    
    
    
    (837
    )
    
    
    (4,896
    )Income (loss) before income taxes
    
    
    (300,916
    )
    
    
    23,433
    
    
    
    (145,588
    )
    
    
    (716,283
    )
    
    
    135,637Provision (benefit) for income taxes (3)
    
    
    243,733
    
    
    
    (129
    )
    
    
    (1,838
    )
    
    
    (55,373
    )
    
    
    35,985Income (loss) from continuing operations
    
    
    (544,649
    )
    
    
    23,562
    
    
    
    (143,750
    )
    
    
    (660,910
    )
    
    
    99,652Loss from discontinued operations (2)
    
    
    
    
    
    
    (728,877
    )
    
    
    (737,017
    )
    
    
    (784,424
    )
    
    
    (290,579
    )Net loss
    
    $
    (544,649
    )
    
    $
    (705,315
    )
    
    $
    (880,767
    )
    
    $
    (1,445,334
    )
    
    $
    (190,927
    )Income (loss) from continuing
operations per share :Basic
    
    $
    (1.40
    )
    
    $
    0.09
    
    
    $
    (0.56
    )
    
    $
    (2.70
    )
    
    $
    0.47Diluted
    
    
    (1.40
    )
    
    
    0.09
    
    
    
    (0.56
    )
    
    
    (2.70
    )
    
    
    0.47Balance Sheet DataWorking capital
    
    $
    434,802
    
    
    $
    233,017
    
    
    $
    443,948
    
    
    $
    444,974
    
    
    $
    1,319,638Total assets
    
    
    1,880,522
    
    
    
    931,707
    
    
    
    1,911,035
    
    
    
    2,815,480
    
    
    
    4,416,197Long-term obligations
    
    
    780,708
    
    
    
    643,260
    
    
    
    743,523
    
    
    
    761,927
    
    
    
    1,054,934Shareholders equity
    
    
    828,387
    
    
    
    166,766
    
    
    
    947,827
    
    
    
    1,773,176
    
    
    
    2,906,759
  (1)
    
    In fiscal 2004, 2003 and 2002, we recorded special charges of $32.8
million, $18.4 million and $30.5 million, respectively, principally
related to the impairment of certain assets and restructuring activities.
Also included in the $32.8 million of special charges for fiscal 2004 is
$3.0 million related to our litigation settlement with Agere Systems, Inc.
In fiscal 2001, we recorded special charges of $369.3 million,
principally related to the impairment of certain manufacturing assets and
restructuring activities. In fiscal 2000, we recorded special charges of
$35.0 million related to the settlement of certain litigation.  (2)
    
    Loss from discontinued operations (net of income taxes) for all periods
represents the operating results of our former wireless communications
business and our Mexicali Operations which we disposed of in June 2002 and
the Mindspeed Technologies Internet infrastructure business which we
disposed of in June 2003.  (3)
    
    In fiscal 2004, we recorded $160.8 million of in-process research and
development expenses related to the Merger and a $255.7 million charge for
the impairment of deferred tax assets. 27




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##### Table of Contents



(4)
    
    See Note 7 of Notes to Consolidated Financial Statements for components
of other (income) expense, net. 
 Item 7. Managements Discussion and Analysis of Financial Condition and Results
of Operations Except where otherwise noted, this discussion of our financial condition and
results of operations represents our continuing operations, excluding our
discontinued wireless communications business and Mexicali Operations which we
disposed of in June 2002, and our discontinued Mindspeed Technologies business
which we disposed of in June 2003, and including the GlobespanVirata, Inc.
business from February 28, 2004, following completion of our merger with
GlobespanVirata, Inc. (the Merger). Merger with GlobespanVirata On February 27, 2004, we completed the Merger with GlobespanVirata, Inc., or
GlobespanVirata, a provider of broadband communications solutions for consumer,
enterprise and service provider markets. In May 2004, GlobespanVirata was
renamed Conexant, Inc. See Note 2 of Notes to Consolidated Financial
Statements for further information. Overview of Current Performance Our net revenues for fiscal 2004 and 2003 were $901.9 million and $600.0
million, respectively. This represents an increase of $301.9 million or 50.3%.
However, our quarterly revenues have declined sequentially each quarter from
March 2004 (as if the Merger had been completed on January 1, 2004) to
September 2004, and we anticipate that revenue will continue to
erode for the quarter ending December 31, 2004. If the Merger had been completed on January 1, 2004, the net revenues for the
combined companies for the full quarter ended March 31, 2004 would have been
$293.3 million, or $49.5 million higher than the reported net revenues of
$243.8 million. Our actual net revenues for the quarter ended September 30,
2004 were $213.1 million, or a decrease of approximately 27% from the March
2004 quarter pro forma amount. This sequential decrease in net revenues was
predominately attributable to: lower than expected customer demand which
resulted in excess channel inventory build-up at our direct customers,
distributors and resellers; price erosion in the Wireless and Broadband/DSL
product lines; and market share loss in our Wireless product line. These
factors will continue to negatively impact our net revenues and gross margin
levels. Additionally, these conditions are expected to further impact
the valuation of our inventories. The use of net revenues for the combined companies as if the Merger had closed
at the beginning of the quarter ended March 31, 2004 is a non-GAAP financial
measure, which is used by management to provide useful information in
establishing a meaningful comparison of sequential revenue levels. It is not
intended to be an alternative to GAAP measures. At the time of the Merger, we announced certain workforce reductions 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 $15.0 million by
the end of the fourth fiscal quarter ending September 30, 2005. The primary
drivers of the expense reductions will be an increasing shift of production
development resources to lower-cost regions and continued Merger-related
selling, general and administrative expense consolidation. We estimate that
the charges associated with such actions, which will be recorded in fiscal
2005, will be in the range of $10.0 million to $15.0 million. See Notes 2, 15
and 18 of Notes to Consolidated Financial Statements for further information.
The cost savings of these actions has not yet been fully reflected in our
operating results for the periods discussed below. 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 may require further actions to reduce operating
expenses. We do not believe that the actions announced to date, or possible
future actions, have or will inhibit our ability to invest in appropriate
levels of research and development in growth areas and be competitive in the
marketplace. 28




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##### Table of Contents



Spin-off of Mindspeed Technologies Business On June 27, 2003, we completed the distribution to Conexant shareholders of all
outstanding shares of Mindspeed, our wholly owned subsidiary, to which we
contributed our Internet infrastructure business, including the stock of
certain subsidiaries, and certain other assets and liabilities, including
$100.0 million in cash. In the Mindspeed Spin, Conexant shareholders received
one share of Mindspeed common stock for every three Conexant shares held and
the Conexant shareholders continued to hold their Conexant shares. Mindspeed
issued us a warrant to purchase 30 million shares of Mindspeed common stock,
representing approximately 20 percent of Mindspeeds outstanding common stock
on a fully diluted basis. The warrant is exercisable until June 27, 2013 at an
exercise price of $3.408 per share. The fair value of the warrant is presented
as an asset on our consolidated balance sheet. Additionally, we entered into a
senior secured revolving credit facility pursuant to which Mindspeed may borrow
up to $50.0 million for working capital and general corporate purposes. On
December 8, 2004, the Mindspeed credit facility was terminated (see Notes 11
and 18 of Notes to Consolidated Financial Statements). Spin-off of Wireless Communications Business On June 25, 2002, we completed the distribution to Conexant shareholders of
outstanding shares of our wholly owned subsidiary Washington Sub, Inc.
(Washington), to which we contributed our wireless communications business,
other than certain assets and liabilities which we retained. Immediately
thereafter, Washington merged with and into Alpha Industries, Inc. (Alpha),
with Alpha the surviving corporation. As a result of these transactions,
Conexant shareholders received 0.351 of a share of Alpha common stock for each
Conexant share held and the Conexant shareholders continued to hold their
Conexant shares. Upon completion of the above transactions, Alpha and its subsidiaries purchased
our semiconductor assembly and test facility located in Mexicali, Mexico and
our package design team that supports the Mexicali facility. In connection with
the purchase, we, Alpha and certain subsidiaries of Alpha entered into a
financing agreement pursuant to which Alpha and a subsidiary of Alpha delivered
to us promissory notes for $150.0 million (the Term Notes) guaranteed by Alpha
and certain Alpha subsidiaries and secured by substantially all assets of Alpha
in payment of the purchase price for the Mexicali facility and the package
design team. The financing agreement also provided for a revolving credit
facility under which Alpha could borrow up to $100.0 million, less specified
reserves, for one year at the same interest rate and with the same security
applicable to the Term Notes. Alpha subsequently changed its name to Skyworks
Solutions, Inc. (Skyworks). All the above transactions associated with the
spin-off of our wireless communications business and the sale of our Mexicali
operations, are herein referred to as the Skyworks Spin. In November 2002, we entered into a refinancing agreement with Skyworks
pursuant to which Skyworks repaid $105.0 million of the principal amount and
all accrued interest owed to us under the Term Notes, and the remaining
principal balance of the Term Notes was exchanged for $45.0 million principal
amount of a new 15% convertible note with a maturity date of June 30, 2005.
Skyworks also paid us all amounts outstanding under the credit facility, the
credit facility was cancelled and we released all security interests in
Skyworks assets and properties. In May 2004, the convertible note was
converted into 5.7 million shares of common stock of Skyworks (see Note 6 of
Notes to Consolidated Financial Statements). Newport Foundry Joint Venture In March 2002, we and The Carlyle Group formed a new specialty foundry company
named Jazz Semiconductor, Inc. (Jazz). We contributed our Newport Beach,
California wafer fabrication operations and related assets and liabilities and
certain intellectual property to Jazz. We also issued to Jazz a warrant to
purchase 2.9 million shares of Conexant common stock (with a current exercise
price of $3.76 per share, subject to adjustment). In connection with this
transaction, we received $19.3 million in cash and a 45% equity interest in
Jazz, having an estimated fair value of $42.5 million. We recognized a $2.6
million gain on the transaction. In fiscal 2003, an unrelated party made an
additional investment in Jazz thereby reducing our equity interest to 38%. In
accordance with Staff Accounting Bulletin No. 51, we recognized a $0.3 million
gain upon this additional investment. Through September 30, 2004, 29




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Jazz has purchased approximately 0.5 million shares under the warrant. The
outstanding balance of approximately 2.3 million shares subject to the warrant
are currently purchasable and the warrant expires in January 2007. We purchase a portion of our requirements for silicon-based semiconductor
products from Jazz. In March 2002, we entered into a five-year supply
arrangement with Jazz under which it provides capacity to meet a portion of our
requirements for CMOS and specialty-process wafer fabrication services and we
agreed to purchase certain minimum annual volumes of wafers during the first
three years of the supply agreement. We expect our 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 $14.0 million in
fiscal 2005. Business Enterprise Segments We operate in one reportable operating segment, broadband communications.
Statement of Financial Accounting Standards No. 131 (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 September 30, 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;  
    
    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 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 the same 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 our product lines are as follows (in millions): 2004
    
    2003
    
    2002Broadband/DSL Access
Products
    
    $
    254.6
    
    
    $
    64.3
    
    
    $
    26.5Universal and Voice
Access Products
    
    
    323.1
    
    
    
    325.2
    
    
    
    256.6Wireless and Networking
Components Products and
other
    
    
    110.0
    
    
    
    45.0
    
    
    
    61.8Broadband Media
Processing
Products
    
    
    214.2
    
    
    
    165.5
    
    
    
    176.8$
    901.9
    
    
    $
    600.0
    
    
    $
    521.7
 The increase in net revenues from fiscal 2003 to fiscal 2004 for Broadband/DSL
Access and Wireless and Networking Components is predominantly related to the
Merger. 30




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##### Table of Contents



Results of Operations Net Revenues (in millions)
    
    2004
    
    Change
    
    2003
    
    Change
    
    2002Net revenues
    
    $
    901.9
    
    
    
    50
    %
    
    $
    600.0
    
    
    
    15
    %
    
    $
    521.7
 We recognize revenues from product sales upon shipment and transfer of title,
in accordance with the shipping terms specified in the arrangement with the
customer. 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 other customers 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. Our net revenues for fiscal 2004 increased 50% over fiscal 2003. The increase
is primarily associated with increased unit shipments of our DSL and Wireless
products associated with the Merger, and to a lesser extent the increase in
sales of satellite set-top box solutions, and convergence video products using
MPEG codec technology. Partially offsetting the increase in revenues from
increased unit shipments is the erosion of average selling prices beginning in
the fourth quarter of fiscal 2004 due to (i) unfavorable product mix as newer,
higher margin products experienced slower than expected growth in the latter
portion of fiscal 2004 and (ii) intense competition in certain of our product
lines. Our net revenues for fiscal 2003 increased 15% over fiscal 2002. The increase
primarily reflects higher demand for our ADSL customer premises modems,
increased revenue from set-top box designs comprised of a richer mix of our
back-end and complete system level content as well as substantially increased
sales volume from dial-up modems embedded in consumer products such as gaming
consoles. Our revenues also were higher as a result of incremental sales of
new stand-alone MPEG audio and video processing devices from our acquisition of
GlobespanViratas video compression business as well as soft modem revenues
from products acquired from PCTEL in the third quarter of fiscal 2003. In
total, these increased revenue levels more than offset the loss of revenues in
fiscal 2003 resulting from the divestiture of Pictos CMOS sensors and image
processing products in late fiscal 2002 and substantially lower video encoder
sales resulting from an industry-wide transition toward integrated encoding
functionality within more powerful video system graphics processors. Gross Margin (in millions)
    
    2004
    
    Change
    
    2003
    
    Change
    
    2002Gross margin
    
    $
    378.7
    
    
    
    45
    %
    
    $
    261.8
    
    
    
    28
    %
    
    $
    203.8Percent of net revenues
    
    
    42
    %
    
    
    
    
    
    
    44
    %
    
    
    
    
    
    
    39
    %
 Gross margin represents revenues less cost of goods sold. As a fabless
semiconductor company, we use third parties for wafer production, assembly and
test services. Our costs of goods sold consist predominately of purchased
finished wafers, assembly and test services, royalty and other intellectual
property costs, and labor and overhead associated with product procurement.
Prior to the divestiture of our manufacturing operations in March 2002, our
cost of goods sold consisted primarily of purchased materials, labor and
overhead (including depreciation) associated with product manufacturing and
procurement, and sustaining engineering expenses. Gross margin percentage decreased from 44% in 2003 to 42% in 2004. This
decrease resulted from the effects of revenues in fiscal 2003 for products that
we had written down to zero cost basis during fiscal 2001. Gross margin
percentage increased from 39% in 2002 to 44% in 2003. This increase resulted
from the elimination of the burden of our underutilized former manufacturing
operations (which we contributed to Jazz in the second quarter of fiscal 2002)
and the favorable impact of our cost reduction actions. Gross margin for 2003
also benefited from a slightly 31




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improved product mix and the redeployment of our product and test engineering
teams previously assigned to our former manufacturing operations and included
in cost of goods sold and now redeployed to product development efforts and
part of research and development costs. Our gross margin for fiscal 2003 and 2002 also benefited from the sale of
inventories with an original cost of $10.9 million and $45.6 million,
respectively, that we had written down to a zero cost basis during fiscal year
2001. These sales resulted from renewed demand for certain products that was
not anticipated at the time of the write-downs. The previously written-down
inventories were generally sold at prices which exceeded their original cost.
Had we not previously written down the cost basis of these goods, our cost of
goods sold would include the original cost of these items, and our gross margin
for 2003 would have been $250.9 million (42% of our net revenues) compared to
$158.2 million (30% of our net revenues) for fiscal 2002. 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 is lower than originally projected, additional inventory write-downs may
be required. 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. Under our supply arrangement with Jazz, we are obligated to purchase certain
minimum annual volumes of wafers during fiscal year 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 the annual minimum
purchase obligations under both of these agreements. Research and Development (in millions)
    
    2004
    
    Change
    
    2003
    
    Change
    
    2002Research and development
    
    $
    240.0
    
    
    
    51
    %
    
    $
    159.4
    
    
    
    2
    %
    
    $
    156.4Percent of net revenues
    
    
    27
    %
    
    
    
    
    
    
    27
    %
    
    
    
    
    
    
    30
    %
 Our research and development (R&D) expenses consist principally of direct
personnel costs to develop new communications and semiconductor products,
photomask and other costs for pre-production evaluation and testing of new
devices and design and test tool costs. Our R&D expenses also include the costs
for design automation and advanced package development, and non-cash stock
compensation charges related to the amortization of the unvested stock options
exchanged in the Merger. The $80.6 million increase in R&D expenses for fiscal 2004 compared to fiscal
2003 primarily reflects additional development costs associated with DSL and
Wireless products as a result of the Merger, an increase of $4.9 million in
stock compensation charges primarily as a result of the Merger, and to a much
lesser extent, increased R&D project costs associated with purchased R&D and
electronic design automation tools. As a result of cost reduction 32




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initiatives we have implemented in fiscal 2004 and in the first quarter of
fiscal 2005, we expect that R&D expenses will be lower in future periods. The increase in R&D expenses for fiscal 2003 compared to fiscal 2002 primarily
reflects the higher costs of acquired technology, the 2003 addition of product
and test engineering teams and the additional week of activity to accommodate
our 52/53 week fiscal year. These increases were partially offset by workforce
reductions in our 2002 and 2003 restructuring actions and the contribution of a
majority of our advanced process development efforts to Jazz in March 2002. Selling, General and Administrative (in millions)
    
    2004
    
    Change
    
    2003
    
    Change
    
    2002Selling, general and administrative
    
    $
    125.5
    
    
    
    34
    %
    
    $
    93.4
    
    
    
    (2
    )%
    
    $
    95.8Percent of net revenues
    
    
    14
    %
    
    
    
    
    
    
    16
    %
    
    
    
    
    
    
    18
    %
 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 the unvested stock options exchanged in the Merger. The $32.1 million increase in SG&A expense for fiscal 2004 as compared to
fiscal 2003 are attributable to additional SG&A costs as a result of the
Merger, an increase of $1.8 million in stock compensation charges as a result
of the Merger, and $4.5 million in additional bad debt reserves, partially
offset by ($1.3) million in stock compensation charges associated with an
employee bonus plan in prior years which had variable accounting. As a result
of cost reduction initiatives we have implemented in fiscal 2004 and in the
first quarter of fiscal 2005, we expect that SG&A expenses will be lower in
future periods. The decrease in SG&A expenses for fiscal 2003 compared to fiscal 2002 primarily
reflects lower headcount and personnel-related costs resulting from the expense
reduction and restructuring actions initiated during fiscal 2003 and 2002,
partially offset by the additional week of activity in fiscal 2003 to
accommodate our 52/53 week fiscal year. Amortization of Intangible Assets (in millions)
    
    2004
    
    Change
    
    2003
    
    Change
    
    2002Amortization of intangible assets
    
    $
    20.8
    
    
    nm
    
    $
    3.4
    
    
    nm
    
    $
    19.5
 nm = not meaningful Amortization expense of $20.8 million in fiscal 2004 increased by $17.4 million
over the $3.4 million recorded in fiscal 2003. This increase is attributable
to the significant intangible assets we acquired in the Merger. The lower amortization expenses in fiscal 2003, as compared to fiscal 2002,
primarily resulted from the adoption of SFAS 141 and SFAS 142 as of the
beginning of fiscal 2003. SFAS 141 requires that all business combinations be
accounted for using the purchase method and provides new criteria for recording
intangible assets separately from goodwill. SFAS 142 addresses financial
accounting and reporting for acquired goodwill and other intangible assets, and
requires that we no longer amortize goodwill into our results of operations.
Instead, goodwill must be tested at least annually for impairment and written
down when impaired. We expect that amortization of intangible assets will be
approximately $31.6 million for fiscal 2005. 33




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Special Charges Special charges consist of the following: (in millions)
    
    2004
    
    Change
    
    2003
    
    Change
    
    2002Asset impairments
    
    $
    5.4
    
    
    nm
    
    $
    9.6
    
    
    nm
    
    $
    13.5Restructuring charges
    
    
    9.3
    
    
    nm
    
    
    5.2
    
    
    nm
    
    
    16.1Integration costs
    
    
    7.3
    
    
    nm
    
    
    
    
    
    nm
    
    
    Separation costs
    
    
    
    
    
    nm
    
    
    
    
    
    nm
    
    
    0.9Other
    
    
    10.8
    
    
    nm
    
    
    3.6
    
    
    nm
    
    
    $
    32.8
    
    
    
    
    
    
    $
    18.4
    
    
    
    
    
    
    $
    30.5
 nm = not meaningful Asset Impairments For a discussion of our asset impairment charges, see Note 15 of Notes to
Consolidated Financial Statements. Restructuring Charges We implemented a number of cost reduction initiatives to improve our operating
cost structure. For a discussion of our cost reduction initiatives and activity
under our restructuring plans, including remaining liabilities at September 30,
2004, see Note 15 of Notes to Consolidated Financial Statements. Integration Costs In fiscal 2004, we incurred $7.3 million of costs related to the integration
efforts of the employees, customers, operations and other business aspects
related to the Merger. Separation Costs In fiscal 2002, we incurred separation costs of approximately $0.9 million in
connection with the divestiture of our Newport Beach wafer fabrication
operations and our digital imaging business. Other Special Charges Other special charges for fiscal 2004 consist of stock option modification
charges of $0.8 million, one-time executive bonuses which were contractually
committed in the closing of the Merger of $1.2 million, $3.0 million related
to the settlement of our litigation with Agere Systems, Inc., and $5.8 million
of other special charges. Other special charges for fiscal 2003 principally consist of a $2.7 million
loss on the sale of certain semiconductor test equipment. Debt Conversion Costs In fiscal 2002, we exchanged 2.2 million shares of our common stock for
approximately $28.0 million principal amount of our 4.25% Convertible
Subordinated Notes due 2006. In connection with this transaction, we recognized
debt conversion costs of $10.4 million for the fair value of the shares we
issued in excess of the number of shares issuable in a conversion of the notes
pursuant to their original terms. Gain on Extinguishment of Debt During fiscal 2003, we purchased $100.0 million principal amount of our 4%
Convertible Subordinated Notes due 2007 at prevailing market prices, resulting
in a net gain of $42.0 million. 34




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##### Table of Contents



Other Expense, Net (in millions)
    
    2004
    
    Change
    
    2003
    
    Change
    
    2002Other expense, net
    
    $
    99.8
    
    
    nm
    
    $
    5.8
    
    
    nm
    
    $
    36.9
 Other expense, net for fiscal 2004 was comprised of $30.7 million of interest
expense primarily from our convertible subordinated notes, a $13.4 million
write-down of certain non-marketable investments, a $6.3 million decrease in
the fair value of the conversion right under the Skyworks 15% convertible
senior subordinated note prior to its conversion into Skyworks common stock in
May 2004, a $92.7 million decrease in the fair value of the Mindspeed warrant,
offset by $7.7 million of investment and interest income on invested cash
balances, $14.4 million of income in our equity method investees, and $24.1
million of gains on sales of investments. Due to variations in the fair value
of the common stock underlying the Mindspeed warrant, we expect that other
(income) expense may fluctuate significantly in future periods until this
derivative instrument is liquidated. Other expense, net for fiscal 2003 was comprised of a $30.2 million increase in
the fair value of the Mindspeed warrant, a $9.4 million increase in the fair
value of the conversion right under the Skyworks 15% convertible senior
subordinated notes, $8.6 million of gains on sales of investments and $15.6
million of investment income and interest income on invested cash balances,
offset by $28.1 million of interest expense primarily from our convertible
subordinated notes, a $39.4 million write-down of certain non-marketable
investments, and $3.1 million of losses in our equity method investments. Other expense, net for fiscal 2002 was comprised of $31.1 million of interest
expense on our convertible subordinated notes, a $21.2 million write-down of
certain non-marketable investments and $2.7 million of losses in our equity
method investments, partially offset by $13.1 million of investment income and
interest income on invested cash balances. The carrying values of certain non-marketable investments were written down to
their estimated fair values (in most cases, zero). These investments consist of
equity interests in early stage technology companies which we had accounted for
under the cost method. We estimated 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 determined that the
decline in the fair value of these investments was other than temporary. Provision (Benefit) for Income Taxes In fiscal 2004, we recorded an income tax provision of $243.7 million. This
provision is comprised of an increase in the valuation allowance on deferred
tax assets of $255.7 million, a current provision of $2.0 million for foreign
taxes incurred by certain of our international subsidiaries, partially offset
by a $14.0 million credit related to a federal income tax refund received in
September 2004 related to the carryback of a portion of our fiscal year 2001
net operating loss. The loss was carried back under the five-year carryback
provision enacted in 2002 and income taxes paid while Conexant was a subsidiary
of Rockwell Automation, Inc. were recovered. In fiscal 2003, we recorded income tax benefits of $0.1 million. These
benefits relate to tax refunds received offset by foreign income taxes incurred
by certain of our international subsidiaries. As a result of our cumulative operating losses, we determined that it is more
likely than not that the additional income tax benefits (principally net
operating losses we can carry forward to future years) will not be realized.
Accordingly, we increased our valuation allowance by approximately $255.7
million during fiscal 2004 for the deferred tax assets which we do not expect
to realize through the reduction of future income tax payments. See Note 8 of
Notes to Consolidated Financial Statements for further information. 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. While we will continue to be subject to foreign income taxes and
federal alternative minimum tax, we expect those taxes will be insignificant. 35




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##### Table of Contents



Quarterly Results of Operations The following table presents our operating results for each of the eight fiscal
quarters in the period ended September 30, 2004. The information for each of
these quarters is derived from our unaudited interim financial statements which
have been prepared on the same basis as the audited consolidated financial
statements included in this report. In our opinion, all necessary adjustments,
which consist only of normal and recurring accruals as well as the special
charges, in-process research and development, debt conversion costs, the gain
on extinguishment of debt, and the deferred tax asset valuation allowance have
been included to fairly present our unaudited quarterly results. The quarterly
financial data for all periods have been restated to reflect the wireless
communications business and Mexicali Operations and the Mindspeed Technologies
business as discontinued operations. In February 2004, Conexant completed the
merger with GlobespanVirata, Inc. The results of GlobespanVirata, Inc. have
been included in the consolidated results since February 28, 2004. This data
should be read together with our consolidated financial statements and the
notes thereto included in this report. Three months endedDec. 31,
    
    Mar. 31,
    
    June 30,
    
    Sept. 30,
    
    Dec. 31,
    
    Mar. 31,
    
    June 30,
    
    Sept. 30,2002
    
    2003
    
    2003
    
    2003
    
    2003
    
    2004
    
    2004
    
    2004(in thousands, except per share amounts)Statement of Operations DataNet revenues
    
    $
    144,201
    
    
    $
    140,123
    
    
    $
    150,950
    
    
    $
    164,703
    
    
    $
    177,333
    
    
    $
    243,781
    
    
    $
    267,617
    
    
    $
    213,123Cost of goods sold
    
    
    81,462
    
    
    
    78,107
    
    
    
    86,000
    
    
    
    92,592
    
    
    
    98,196
    
    
    
    142,116
    
    
    
    155,136
    
    
    
    127,681Gross margin
    
    
    62,739
    
    
    
    62,016
    
    
    
    64,950
    
    
    
    72,111
    
    
    
    79,137
    
    
    
    101,665
    
    
    
    112,481
    
    
    
    85,442Research and development
    
    
    40,237
    
    
    
    38,741
    
    
    
    38,849
    
    
    
    41,527
    
    
    
    39,154
    
    
    
    53,734
    
    
    
    74,317
    
    
    
    72,766Selling, general and
administrative
    
    
    22,779
    
    
    
    23,777
    
    
    
    22,915
    
    
    
    23,955
    
    
    
    22,809
    
    
    
    30,602
    
    
    
    36,371
    
    
    
    35,692Amortization of intangible
assets
    
    
    799
    
    
    
    799
    
    
    
    925
    
    
    
    914
    
    
    
    955
    
    
    
    3,653
    
    
    
    7,956
    
    
    
    8,205In-process research and
development
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    160,818
    
    
    
    
    
    
    
    Special charges
    
    
    6,774
    
    
    
    285
    
    
    
    6,526
    
    
    
    4,794
    
    
    
    605
    
    
    
    5,514
    
    
    
    8,294
    
    
    
    18,388Total operating expenses
    
    
    70,589
    
    
    
    63,602
    
    
    
    69,215
    
    
    
    71,190
    
    
    
    63,523
    
    
    
    254,321
    
    
    
    126,938
    
    
    
    135,051Operating income (loss)
    
    
    (7,850
    )
    
    
    (1,586
    )
    
    
    (4,265
    )
    
    
    921
    
    
    
    15,614
    
    
    
    (152,656
    )
    
    
    (14,457
    )
    
    
    (49,609
    )Gain on debt extinguishment
    
    
    
    
    
    
    (34,645
    )
    
    
    (7,376
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Other (income) expense, net
    
    
    (3,403
    )
    
    
    44,732
    
    
    
    (544
    )
    
    
    (34,977
    )
    
    
    (25,281
    )
    
    
    (9,736
    )
    
    
    56,308
    
    
    
    78,517Income (loss) before income taxes
    
    
    (4,447
    )
    
    
    (11,673
    )
    
    
    3,655
    
    
    
    35,898
    
    
    
    40,895
    
    
    
    (142,920
    )
    
    
    (70,765
    )
    
    
    (128,126
    )Provision (benefit) for income
taxes
    
    
    316
    
    
    
    381
    
    
    
    488
    
    
    
    (1,314
    )
    
    
    248
    
    
    
    459
    
    
    
    661
    
    
    
    242,365Income (loss) from continuing
operations
    
    
    (4,763
    )
    
    
    (12,054
    )
    
    
    3,167
    
    
    
    37,212
    
    
    
    40,647
    
    
    
    (143,379
    )
    
    
    (71,426
    )
    
    
    (370,491
    )Loss from discontinued
operations, net of income tax
    
    
    (620,610
    )
    
    
    (55,970
    )
    
    
    (52,297
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Net income (loss)
    
    $
    (625,373
    )
    
    $
    (68,024
    )
    
    $
    (49,130
    )
    
    $
    37,212
    
    
    $
    40,647
    
    
    $
    (143,379
    )
    
    $
    (71,426
    )
    
    $
    (370,491
    )Income (loss) per share, basic:Continuing operations
    
    $
    (0.02
    )
    
    $
    (0.05
    )
    
    $
    0.01
    
    
    $
    0.14
    
    
    $
    0.15
    
    
    $
    (0.41
    )
    
    $
    (0.15
    )
    
    $
    (0.79
    )Discontinued operations
    
    
    (2.33
    )
    
    
    (0.21
    )
    
    
    (0.19
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Net income (loss)
    
    $
    (2.35
    )
    
    $
    (0.26
    )
    
    $
    (0.18
    )
    
    $
    0.14
    
    
    $
    0.15
    
    
    $
    (0.41
    )
    
    $
    (0.15
    )
    
    $
    (0.79
    )Income (loss) per share, diluted:Continuing operations
    
    $
    (0.02
    )
    
    $
    (0.05
    )
    
    $
    0.01
    
    
    $
    0.12
    
    
    $
    0.13
    
    
    $
    (0.41
    )
    
    $
    (0.15
    )
    
    $
    (0.79
    )Discontinued operations
    
    
    (2.33
    )
    
    
    (0.21
    )
    
    
    (0.19
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Net income (loss)
    
    $
    (2.35
    )
    
    $
    (0.26
    )
    
    $
    (0.18
    )
    
    $
    0.12
    
    
    $
    0.13
    
    
    $
    (0.41
    )
    
    $
    (0.15
    )
    
    $
    (0.79
    )Shares used in computing
diluted loss per share-basic
    
    
    265,714
    
    
    
    266,543
    
    
    
    268,489
    
    
    
    273,241
    
    
    
    277,190
    
    
    
    349,968
    
    
    
    463,804
    
    
    
    467,556Shares used in computing
diluted loss per share-diluted
    
    
    265,714
    
    
    
    266,543
    
    
    
    271,051
    
    
    
    303,488
    
    
    
    307,545
    
    
    
    349,968
    
    
    
    463,804
    
    
    
    467,556
 Throughout fiscal 2003 and 2004 we recorded special charges primarily related
to our restructuring initiatives. We also recorded special charges for asset
impairments and litigation settlements. 36




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##### Table of Contents



In the second quarter of fiscal 2004, we recorded a $160.8 million non-cash
charge related to in-process research and development (IPR&D) in the Merger,
and in the fourth quarter of 2004, we recorded a $255.7 million non-cash charge
for the impairment of our deferred tax assets. In the past, our quarterly operating results have fluctuated due to a number of
factors, many of which are outside our control. These include changes in the
overall demand for communications electronics equipment, changes in product
mix, the timing of new product introductions, the timing of receipt, reduction
or cancellation of significant orders by customers, and other factors that have
had a significant impact on our revenues and gross margins. In addition, the
level of utilization of former manufacturing facilities affected our gross
margins. Significant quarterly fluctuations in results of operations have also
caused significant fluctuations in our liquidity and working capital, including
our cash and cash equivalents, accounts receivable and payable and inventories. Liquidity and Capital Resources Cash used in operating activities was $31.0 million in fiscal 2004 compared to
$32.2 million in fiscal 2003. Fiscal 2004 operating cash flows reflect our
loss from continuing operations of $544.6 million, offset by non-cash charges
of $563.3 million and a net decrease in the cash components of working capital
of $49.7 million. Non-cash charges consist primarily of IPR&D of $160.8
million, depreciation and amortization of $36.9 million, stock compensation of
$9.6 million, a net decrease in the fair value of the Mindspeed warrant and the
Skyworks convertible notes of $99.0 million, a write down of non-marketable
investments of $13.4 million, a net decrease in deferred tax assets of $256.0
million, offset by gains on sales of investments of $24.1 million, and a net
increase in equity in earnings of equity method investees of $14.4 million.
The working capital primarily consists of a $17.8 million increase in accounts
receivable, a $73.5 million increase in inventories, offset by a $46.3 million
increase in accounts payable and accrued expenses. The $73.5 million increase in inventories is attributable to the sequential
decline in net revenues during fiscal 2004, and the $17.8 million increase in
accounts receivable is attributable to growth in our days sales outstanding as
a result of excess channel inventory levels at our direct customers,
distributors and resellers. Cash provided by investing activities of $67.0 million in fiscal 2004 includes
net cash and cash equivalents acquired in acquisitions of $24.8 million, net
proceeds from the sale of assets and investments of $57.2 million, and the net
sales of marketable securities of $39.7 million, partially offset by capital
expenditures of $17.6 million, payment of deferred purchase consideration of
$4.0 million, payment of acquisition costs of $30.2 million, and investments of
$3.0 million. Cash provided by investing activities of $183.7 million in
fiscal 2003 includes the net repayment of the Term Notes and the credit
facility by Skyworks in the amount of $135.0 million, proceeds from the sale of
assets of $18.2 million, net sales of marketable securities of $62.5 million,
partially offset by capital expenditures of $19.8 million and payments of $12.2
million for acquisitions and investments in early stage technology companies. Cash provided by financing activities of $26.9 million in fiscal 2004 consisted
of proceeds from the exercise of stock options and warrants of $24.6 million,
and $2.3 million in proceeds upon repayment of notes receivable from
shareholders. In fiscal 2003, cash used by financing activities of $34.1
million consisted of proceeds from the exercise of stock options of $22.3
million, offset by $56.4 million paid in connection with the repurchase of a
portion of our convertible subordinated notes. Cash used in the discontinued operations of Mindspeed in fiscal 2003 was $202.3
million, which includes the $100.0 million of cash contributed to Mindspeed
prior to the Mindspeed Spin. Cash used in discontinued operations in fiscal
2002 of $222.6 million represents the funding of the discontinued wireless
communications business, the Mexicali Operations and the Mindspeed Technologies
business. As of September 30, 2004, our principal sources of liquidity are our existing
cash reserves, marketable securities, the current portion of the Mindpseed
warrant and cash generated from product sales. Combined cash and cash
equivalents and short-term investments at September 30, 2004 totaled $302.1
million compared to $175.5 million at September 30, 2003. Our working capital
at September 30, 2004 was $434.8 million compared to $233.0 million at
September 30, 2003. In addition, at September 30, 2004, we held $137.6 million
in long-term marketable securities which we could liquidate to fund operations
and/or future acquisitions. 37




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##### Table of Contents



Total cash, cash equivalents and marketable securities are as follows: September 30,
    
    September 30,(in millions)
    
    2004
    
    2003Cash and cash equivalents
    
    $
    139.0
    
    
    $
    76.2Skyworks 15% convertible senior subordinated notes
    
    
    
    
    
    
    55.6Equity
securities- Skyworks Solutions, Inc. (6.2 million shares at September 30, 2004, 0.5 million
shares at September 30, 2003)
    
    
    61.8
    
    
    
    4.6Equity
securities- SiRF Technologies, Inc. (5.9 million shares at September 30, 2004)
    
    
    87.5
    
    
    
    Other short-term marketable securities (primarily
mutual funds, domestic government agency
securities and corporate debt securities)
    
    
    13.8
    
    
    
    39.1Long-term marketable securities (primarily
domestic government agency securities and
corporate debt securities)
    
    
    137.6
    
    
    
    $
    439.7
    
    
    $
    175.5
 The current portion of the Mindspeed warrant at September 30, 2004 is $3.6
million, and the long-term portion is $23.0 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. 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 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 subordinated convertible
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 September 30, 2004, we had $439.7 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. 38




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##### Table of Contents



Commitments The following summarizes our contractual obligations at September 30, 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
    
    
    150.5
    
    
    
    28.8
    
    
    
    38.3
    
    
    
    21.3
    
    
    
    62.1Assigned leases
    
    
    17.5
    
    
    
    7.7
    
    
    
    4.9
    
    
    
    
    
    
    
    4.9Contingent consideration on acquisitions
    
    
    4.0
    
    
    
    
    
    
    
    4.0
    
    
    
    
    
    
    
    Capital commitments
    
    
    5.4
    
    
    
    5.4
    
    
    
    
    
    
    
    
    
    
    
    Purchase commitments
    
    
    24.9
    
    
    
    24.9
    
    
    
    
    
    
    
    
    
    
    
    Assigned purchase commitments
    
    
    12.0
    
    
    
    12.0
    
    
    
    
    
    
    
    
    
    
    
    Employee commitments
    
    
    5.9
    
    
    
    5.9
    
    
    
    
    
    
    
    
    
    
    
    $
    932.0
    
    
    $
    84.7
    
    
    $
    759.0
    
    
    $
    21.3
    
    
    $
    67.0
 (1) Excludes interest. See Note 9 of Notes to Consolidated 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 we currently occupy under a lease agreement.
Our plan is to complete a sale-leaseback transaction with respect to these
facilities by early calendar 2005. At September 30, 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
$8.5 million. In November 2004, we announced a plan to reduce quarterly operating expenses by
approximately $15.0 million by the end of the fourth fiscal quarter ending
September 30, 2005. The primary drivers of the expense reductions will be an
increasing shift of production development resources to lower-cost regions and
continued merger-related SG&A consolidation. We estimate that the charges
associated with such actions, which will be recorded in fiscal 2005, will be in
the range of $10.0 million to $15.0 million. Off-Balance Sheet Arrangements Our off-balance sheet arrangements consist of conventional operating leases,
capital commitments, employee commitments, and purchase commitments as
described in Notes 10 and 11 of Notes to Consolidated 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 10 of Notes
to the Consolidated Financial Statements. We do not have any special purpose
entities or variable interest entities as of September 30, 2004. 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. 39




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##### Table of Contents



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
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. 40




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In the event that actual demand or product pricing is lower than originally
projected, additional inventory write-downs may be required. Allowance for doubtful accounts We maintain allowances for doubtful accounts for estimated losses resulting
from the inability of our customers to make required payments. 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. 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. 41




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Restructuring charges We recorded $9.3 million, $5.2 million, and $16.1 million of restructuring
charges in fiscal years 2004, 2003 and 2002, respectively. These charges
relate primarily to reductions in our workforce and related impact on the use
of facilities. The estimated charges contain estimates and assumptions made by
management about matters which are uncertain at the time, for example the
timing and amount of sublease income that will be achieved on vacated property
and the operating costs to be paid until lease termination. While we have used
our best estimates based on facts and circumstances available at the time,
different estimates reasonably could have been used in the relevant periods,
and the actual results may be different, and those differences could have a
material impact on the presentation of our financial condition or results of
operations. Our policies require us to review the estimates and assumptions
periodically and reflect the effects of those revisions in the period that they
are determined to be necessary. In addition, as a result of the 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 will be reviewed periodically and adjusted accordingly. Employee benefit plans We have long-term liabilities recorded for a retirement medical plan and a
pension plan. These obligations and the related effects on operations are
determined using actuarial valuations. There are critical assumptions used in
these valuation models such as the discount rate, expected return on assets,
compensation levels, turnover rates and mortality rates. The discount rate
used is representative of a high-quality fixed income investment. The other
assumptions do not tend to change materially over time. We evaluate all
assumptions annually and they are updated to reflect our experience. 
 Item 7A. 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. 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 September 30, 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 corporate bonds and government
agency securities) principally have remaining terms of 1 to 3 years. Such
securities are subject to interest rate risk.At September 30, 2004, a 10%
adverse change in interest rates would result in a $13.7 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 September
30, 2004, a 10% adverse change in equity prices would result in a $15.0 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 September 30, 2004, the carrying value of
these securities included net unrealized gains of $92.5 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 September 30, 2004, a 10%
decrease in the market price of Mindspeeds common stock would decrease the
fair value of this warrant by approximately $3.7 million. At September 30,
2004, the market price of Mindspeeds common stock was $2.06 per share. For
fiscal 2004, the market price of Mindspeeds common stock ranged from a low of
$1.95 per share to a high of $11.36 per share. 42




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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
September 30, 2004: (in millions)
    
    Carrying Value
    
    Fair ValueCash and cash equivalents
    
    $
    139.0
    
    
    $
    139.0Mutual funds
    
    
    10.7
    
    
    
    10.7Marketable debt securities
    
    
    34.7
    
    
    
    34.7Marketable government agency securities
    
    
    105.2
    
    
    
    105.2Marketable equity securities
    
    
    150.1
    
    
    
    150.1Mindspeed warrant
    
    
    26.6
    
    
    
    26.6Long-term debt
    
    
    711.8
    
    
    
    641.9
 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 September 30, 2004,
we held no foreign currency forward exchange contracts. Based on our overall
currency rate exposure at September 30, 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. 43




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Item 8. Financial Statements and Supplementary Data 
 CONEXANT SYSTEMS, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands, except per share amounts) September 30,2004
    
    2003ASSETSCurrent AssetsCash and cash equivalents
    
    $
    139,031
    
    
    $
    76,186Short-term investments
    
    
    163,040
    
    
    
    99,283Receivables, net of allowance of $5,974 (2004) and $1,547 (2003)
    
    
    185,037
    
    
    
    79,557Inventories
    
    
    194,754
    
    
    
    59,548Deferred income taxes
    
    
    
    
    
    
    13,600Mindspeed warrant-current portion
    
    
    3,599
    
    
    
    Other current assets
    
    
    20,768
    
    
    
    26,524Total current assets
    
    
    706,229
    
    
    
    354,698Property, plant and equipment, net
    
    
    55,741
    
    
    
    36,310Goodwill
    
    
    708,544
    
    
    
    56,865Intangible assets, net
    
    
    135,241
    
    
    
    12,506Deferred income taxes
    
    
    
    
    
    
    241,260Mindspeed warrant
    
    
    23,000
    
    
    
    119,230Marketable securities
    
    
    137,604
    
    
    
    Other assets
    
    
    114,163
    
    
    
    110,838Total assets
    
    $
    1,880,522
    
    
    $
    931,707LIABILITIES AND SHAREHOLDERS EQUITYCurrent LiabilitiesAccounts payable
    
    $
    141,533
    
    
    $
    55,909Accrued compensation and benefits
    
    
    40,423
    
    
    
    28,865Restructuring and reorganization liabilities
    
    
    22,427
    
    
    
    12,091Other current liabilities
    
    
    67,044
    
    
    
    24,816Total current liabilities
    
    
    271,427
    
    
    
    121,681Convertible subordinated notes
    
    
    711,825
    
    
    
    581,825Other liabilities
    
    
    68,883
    
    
    
    61,435Total liabilities
    
    
    1,052,135
    
    
    
    764,941Commitments and contingencies
    
    
    
    
    
    
    Shareholders EquityPreferred and junior preferred stock, no par value: 25,000 shares authorized;
no shares issued or outstanding
    
    
    
    
    
    
    Common stock, $0.01 par value: 1,000,000 authorized shares; 469,441 (2004)
and 276,134 (2003) shares issued and 468,257 (2004) and 276,134 (2003)
shares outstanding
    
    
    4,694
    
    
    
    2,761Treasury stock, 1,184 shares at cost
    
    
    (5,584
    )
    
    
    Additional paid-in capital
    
    
    4,648,325
    
    
    
    3,506,070Accumulated deficit
    
    
    (3,877,176
    )
    
    
    (3,332,527
    )Accumulated other comprehensive income (loss)
    
    
    82,551
    
    
    
    (9,496
    )Notes receivable from stock sales
    
    
    (576
    )
    
    
    Unearned compensation
    
    
    (23,847
    )
    
    
    (42
    )Total shareholders equity
    
    
    828,387
    
    
    
    166,766Total liabilities and shareholders equity
    
    $
    1,880,522
    
    
    $
    931,707
 See accompanying notes to consolidated financial statements. 44




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CONEXANT SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts) Years Ended September 30,2004
    
    2003
    
    2002Net revenues
    
    $
    901,854
    
    
    $
    599,977
    
    
    $
    521,726Cost of goods sold (including $812 in 2004 related to
restructuring actions in the Merger- Notes 2 and 7)
    
    
    523,129
    
    
    
    338,161
    
    
    
    317,921Gross margin
    
    
    378,725
    
    
    
    261,816
    
    
    
    203,805Operating expenses:Research and development (including non-cash stock
compensation of $5,364, $477 and $(595) in 2004,
2003 and 2002, respectively)
    
    
    239,971
    
    
    
    159,354
    
    
    
    156,350Selling, general and administrative (including
non-cash stock compensation of $1,773, $1,272 and
$(1,499) in 2004, 2003 and 2002, respectively)
    
    
    125,474
    
    
    
    93,426
    
    
    
    95,750Amortization of intangible assets
    
    
    20,769
    
    
    
    3,437
    
    
    
    19,489In-process research and development
    
    
    160,818
    
    
    
    
    
    
    
    Special charges
    
    
    32,801
    
    
    
    18,379
    
    
    
    30,499Total operating expenses
    
    
    579,833
    
    
    
    274,596
    
    
    
    302,088Operating loss
    
    
    (201,108
    )
    
    
    (12,780
    )
    
    
    (98,283
    )Debt conversion costs
    
    
    
    
    
    
    
    
    
    
    10,435Gain on extinguishment of debt
    
    
    
    
    
    
    (42,021
    )
    
    
    Other expense, net
    
    
    99,808
    
    
    
    5,808
    
    
    
    36,870Income (loss) before income taxes
    
    
    (300,916
    )
    
    
    23,433
    
    
    
    (145,588
    )Provision (benefit) for income taxes
    
    
    243,733
    
    
    
    (129
    )
    
    
    (1,838
    )Income (loss) from continuing operations
    
    
    (544,649
    )
    
    
    23,562
    
    
    
    (143,750
    )Loss from discontinued operations, net of income taxes
    
    
    
    
    
    
    (728,877
    )
    
    
    (737,017
    )Net loss
    
    $
    (544,649
    )
    
    $
    (705,315
    )
    
    $
    (880,767
    )Income (loss) per share, basic:Continuing operations
    
    $
    (1.40
    )
    
    $
    0.09
    
    
    $
    (0.56
    )Discontinued operations
    
    
    
    
    
    
    (2.72
    )
    
    
    (2.84
    )Net loss
    
    $
    (1.40
    )
    
    $
    (2.63
    )
    
    $
    (3.40
    )Income (loss) per share, diluted:Continuing operations
    
    $
    (1.40
    )
    
    $
    0.09
    
    
    $
    (0.56
    )Discontinued operations
    
    
    
    
    
    
    (2.65
    )
    
    
    (2.84
    )Net loss
    
    $
    (1.40
    )
    
    $
    (2.56
    )
    
    $
    (3.40
    )Number of shares used in per share computation-basic
    
    
    389,630
    
    
    
    268,586
    
    
    
    258,998Number of shares used in per share computation-diluted
    
    
    389,630
    
    
    
    275,230
    
    
    
    258,998
 See accompanying notes to consolidated financial statements. 45




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CONEXANT SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands) Years Ended September 30,2004
    
    2003
    
    2002Cash Flows From Operating ActivitiesIncome (loss) from continuing operations
    
    $
    (544,649
    )
    
    $
    23,562
    
    
    $
    (143,750
    )Adjustments required to reconcile income (loss) from continuing
operations to net cash used in operating activities, net of
effects of acquisition/dispositions of businesses:Depreciation
    
    
    16,151
    
    
    
    16,828
    
    
    
    29,144Amortization of intangible assets
    
    
    20,769
    
    
    
    3,437
    
    
    
    19,489In-process research and development
    
    
    160,818
    
    
    
    
    
    
    
    Asset impairments
    
    
    5,435
    
    
    
    10,281
    
    
    
    13,522Write-down of non-marketable investments
    
    
    13,423
    
    
    
    39,402
    
    
    
    21,207Provision for losses on accounts receivable
    
    
    4,475
    
    
    
    (3,958
    )
    
    
    (5,814

    )Inventory provisions
    
    
    11,586
    
    
    
    14,451
    
    
    
    14,364Deferred income taxes
    
    
    256,041
    
    
    
    682
    
    
    
    3,667Stock compensation, option modification charges and other
    
    
    9,616
    
    
    
    2,520
    
    
    
    9,196Debt conversion costs
    
    
    
    
    
    
    
    
    
    
    10,435Gain on extinguishment of debt
    
    
    
    
    
    
    (42,021
    )
    
    
    Decrease (increase) in fair value of derivative instruments
    
    
    98,955
    
    
    
    (39,632
    )
    
    
    Gain on sale of investments
    
    
    (24,071
    )
    
    
    (8,618
    )
    
    
    Other non-cash charges, net
    
    
    (9,868
    )
    
    
    6,103
    
    
    
    (1,632
    )Changes in assets and liabilities, net of acquisitions/dispositions:Receivables
    
    
    (17,782
    )
    
    
    (14,621
    )
    
    
    21,428Inventories
    
    
    (73,524
    )
    
    
    (21,910
    )
    
    
    2,800Accounts payable
    
    
    43,453
    
    
    
    (27,166
    )
    
    
    5,293Accrued expenses and other current liabilities
    
    
    2,878
    
    
    
    (10,810
    )
    
    
    13,589Other
    
    
    (4,719
    )
    
    
    19,313
    
    
    
    (24,532
    )Net cash used in operating activities
    
    
    (31,013
    )
    
    
    (32,157
    )
    
    
    (11,594
    )Cash Flows From Investing ActivitiesPurchase of marketable securities
    
    
    (74,586
    )
    
    
    (79,632
    )
    
    
    (334,461
    )Sale of marketable securities
    
    
    114,323
    
    
    
    142,143
    
    
    
    392,902Refundable deposit
    
    
    
    
    
    
    
    
    
    
    150,000Proceeds from sale of assets and investments
    
    
    57,236
    
    
    
    18,228
    
    
    
    72,927Capital expenditures
    
    
    (17,563
    )
    
    
    (19,844
    )
    
    
    (13,058
    )Advances to Skyworks
    
    
    
    
    
    
    (35,000
    )
    
    
    (30,000
    )Repayment of Term Notes and advances by Skyworks
    
    
    
    
    
    
    170,000
    
    
    
    Cash received (paid for) acquisitions, net
    
    
    24,752
    
    
    
    (7,714
    )
    
    
    (21,000
    )Payment of acquisition related costs
    
    

    (30,196
    )
    
    
    
    
    
    
    Payment of deferred purchase consideration
    
    
    (4,000
    )
    
    
    
    
    
    
    Investments in businesses
    
    
    (3,015
    )
    
    
    (4,500
    )
    
    
    (9,800
    )Net cash provided by investing activities
    
    
    66,951
    
    
    
    183,681

    
    
    
    207,510Cash Flows From Financing ActivitiesProceeds from exercise of stock options and warrants
    
    
    24,559
    
    
    
    22,293
    
    
    
    14,733Repayment of notes receivable from stock sales and other employee
notes
    
    
    2,348
    
    
    
    
    
    
    
    Repurchase of convertible subordinated notes
    
    
    
    
    
    
    (56,378
    )
    
    
    Net cash provided by (used in) financing activities
    
    
    26,907
    
    
    
    (34,085
    )
    
    
    14,733Net cash used in discontinued operations
    
    
    
    
    
    
    (202,341
    )
    
    
    (222,569
    )Net increase (decrease) in cash and cash equivalents
    
    
    62,845
    
    
    
    (84,902
    )
    
    
    (11,920
    )Cash and cash equivalents at beginning of year
    
    
    76,186
    
    
    
    161,088
    
    
    
    173,008Cash and cash equivalents at end of year
    
    $
    139,031
    
    
    $
    76,186
    
    
    $
    161,088
 See accompanying notes to consolidated financial statements. 46




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CONEXANT SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS EQUITY AND COMPREHENSIVE LOSS
(in thousands) Common Stock
    
    Additional
    
    

    
    
    
    AccumulatedOther
    
    NotesReceivable
    
    
    
    
    
    
    
    
    
    TotalOutstanding
    
    
    
    
    
    Paid-In
    
    Accumulated
    
    Comprehensive
    
    From
    
    Treasury
    
    Unearned
    
    ShareholdersShares
    
    Amount
    
    Capital
    
    Deficit
    
    Income (Loss)
    
    Stock Sales
    
    Stock
    
    Compensation
    
    EquityBalance at September 30, 2001
    
    
    253,859
    
    
    $
    253,900
    
    
    $
    3,113,205
    
    
    $
    (1,566,209
    )
    
    $
    (17,204
    )
    
    $
    
    
    
    $
    (1,807
    )
    
    $
    (8,709
    )
    
    $
    1,773,176Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (880,767
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (880,767
    )Currency translation adjustment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (4,195
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (4,195
    )Change in unrealized gains on investments
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,072
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,072
    )Minimum pension liability adjustment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (5,649
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (5,649
    )Unrealized loss on forward exchange contracts
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    43
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    43Comprehensive loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (891,640
    )Purchase acquisitions
    
    
    1,420
    
    
    
    1,420
    
    
    
    16,658
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    18,078Conversion of debt
    
    
    2,233
    
    
    
    2,233
    
    
    
    35,720
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    37,953Issuance of common stock and warrants
    
    
    7,939
    
    
    
    7,939
    
    
    
    52,303
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (459
    )
    
    
    59,783Tax benefits from stock plans
    
    
    
    
    
    
    
    
    
    
    1,175
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,175Cancellation of treasury stock
    
    
    
    
    
    
    (41
    )
    
    
    (1,766
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,807
    
    
    
    
    
    
    
    Compensation expense related to
employee stock plans
    
    
    225
    
    
    
    225
    
    
    
    1,749
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    7,609
    
    
    
    9,583Distribution of business (discontinued operations)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (60,431
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    150
    
    
    
    (60,281
    )Balance at September 30, 2002
    
    
    265,676
    
    
    
    265,676
    
    
    
    3,219,044
    
    
    
    (2,507,407
    )
    
    
    (28,077
    )
    
    
    
    
    
    
    
    
    
    
    (1,409
    )
    
    
    947,827Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (705,315
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (705,315
    )Currency translation adjustment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,211
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,211Change in unrealized gains on investments
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,388
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,388Minimum pension liability adjustment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (2,731
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (2,731
    )Comprehensive loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (704,447
    )Effect of change in par value
    
    
    
    
    
    
    (263,779
    )
    
    
    263,779
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Purchase acquisitions
    
    
    150
    
    
    
    2
    
    
    
    812
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    814Issuance of common stock
    
    
    10,308
    
    
    
    862
    
    
    
    21,971
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (154
    )
    
    
    22,679Tax benefits from stock plans
    
    
    
    
    
    
    
    
    
    
    464
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    464Compensation expense related to
employee stock plans
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,521
    
    
    
    1,521Distribution of business (discontinued operations)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (119,805
    )
    
    
    17,713
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (102,092
    )Balance at September 30, 2003
    
    
    276,134
    
    
    
    2,761
    
    
    
    3,506,070
    
    
    
    (3,332,527
    )
    
    
    (9,496
    )
    
    
    
    
    
    
    
    
    
    
    (42
    )
    
    
    166,766Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (544,649
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (544,649
    )Currency translation adjustment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (183
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (183
    )Change in unrealized gains on investments
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    90,551
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    90,551Minimum pension liability adjustment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,679
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,679Comprehensive loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (452,602
    )Purchase acquisitions
    
    
    180,553
    
    
    
    1,805
    
    
    
    1,108,138
    
    
    
    
    
    
    
    
    
    
    
    (2,469
    )
    
    
    (4,778
    )
    
    
    (30,948
    )
    
    
    1,071,748Issuance of common stock
    
    
    12,754
    
    
    
    128
    
    
    
    32,859
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    32,987Interest earned on notes receivable
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (39
    )
    
    
    
    
    
    
    
    
    
    
    (39
    )Settlement of notes receivable
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,932
    
    
    
    (806
    )
    
    
    
    
    
    
    1,126Tax benefits from stock plans
    
    
    
    
    
    
    
    
    
    
    462
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    462Stock option modifications
    
    
    
    
    
    
    
    
    
    
    796
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    796Compensation expense related to
employee stock plans
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    7,143
    
    
    
    7,143Balance at September 30, 2004
    
    
    469,441
    
    
    $
    4,694
    
    
    $
    4,648,325
    
    
    $
    (3,877,176
    )
    
    $
    82,551
    
    
    $
    (576
    )
    
    $
    (5,584
    )
    
    $
    (23,847
    )
    
    $
    828,387
 See accompanying notes to consolidated financial statements. 47




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##### Table of Contents



CONEXANT SYSTEMS,
INC. 
 NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS
 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 the merger with GlobespanVirata,
Inc. (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 acquiror. In
exchange for 100% of the outstanding shares of common stock of GlobespanVirata
(approximately 150.7 million shares), Conexant issued 1.198 shares of its
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. On June 27, 2003, the Company completed the distribution to its shareholders of
all outstanding shares of its wholly owned subsidiary Mindspeed Technologies,
Inc. (Mindspeed), to which Conexant contributed its Internet infrastructure
business, including the stock of certain subsidiaries, and certain other assets
and liabilities, including $100.0 million in cash (hereinafter, the Mindspeed
Spin). In the Mindspeed Spin, Conexant shareholders received one share of
Mindspeed common stock for every three Conexant shares held and the Conexant
shareholders continued to hold their Conexant shares. Mindspeed issued the
Company a warrant to purchase 30 million shares of Mindspeed common stock,
representing approximately 20 percent of Mindspeeds then outstanding common
stock on a fully diluted basis. The warrant is exercisable until June 27, 2013
at an exercise price of $3.408 per share. The fair value of the warrant is
recorded as an asset on the Companys consolidated balance sheet.
Additionally, the Company entered into a senior secured revolving credit
facility pursuant to which Mindspeed may borrow up to $50.0 million, subject to
certain restrictions, for working capital and general corporate purposes. In
December 2004, the Mindspeed credit facility was terminated. See Note 18. On June 25, 2002, the Company completed the distribution to its shareholders of
outstanding shares of its wholly owned subsidiary Washington Sub, Inc.
(Washington), to which the Company contributed its wireless communications
business, other than certain assets and liabilities which were retained.
Immediately thereafter, Washington merged with and into Alpha Industries, Inc.
(Alpha), with Alpha the surviving corporation. As a result of these
transactions, Conexant shareholders received 0.351 of a share of Alpha common
stock for each Conexant share held and the Conexant shareholders continued to
hold their Conexant shares. Upon completion of the these transactions, Alpha
and its subsidiaries purchased Conexants semiconductor assembly and test
facility located in Mexicali, Mexico and Conexants package design team that
supports the Mexicali facility (together, the Mexicali Operations) for $150.0
million. Effective June 26, 2002, Alpha changed its name to Skyworks Solutions,
Inc. (Skyworks). All these transactions, on a combined basis, are hereinafter
referred to as the Skyworks Spin. Basis of Presentation The consolidated financial statements, prepared in
accordance with accounting principles generally accepted in the United States
of America, include the accounts of the Company and each of its subsidiaries.
All intercompany accounts and transactions have been eliminated in
consolidation. 48




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##### Table of Contents



CONEXANT SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) Fiscal Year The Company maintains a fifty-two/fifty-three week fiscal year
ending on the Friday closest to September 30. Fiscal 2004 comprised 52 weeks
and ended on October 1, 2004. Fiscal year 2003 comprised 53 weeks and ended on
October 3. Fiscal year 2002 comprised 52 weeks and ended on September 27. For
convenience, the accompanying consolidated financial statements have been shown
as ending on the last day of the calendar month. Use of Estimates The preparation of financial statements in conformity with
generally accepted accounting principles accepted in the United States of
America requires management to make estimates and assumptions that affect the
amounts reported in the consolidated financial statements and accompanying
notes. Among the significant estimates affecting the financial statements are
those related to the allowance for doubtful accounts, inventories, long-lived
assets, valuation of derivative financial instruments and investments,
restructuring reserves, in-process research and development, valuation of and
estimated useful lives of identifiable intangible assets, long-term employee
benefit plans, income taxes and litigation. On an ongoing basis, management
reviews its estimates based upon currently available information. Actual
results could differ materially from those estimates. Revenue Recognition Revenues from product sales are recognized upon shipment
and transfer of title, in accordance with the shipping terms specified in the
arrangement with the customer. 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. Development revenue is recognized when services are
performed and was not significant for any of the periods presented. 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 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. 49




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##### Table of Contents



CONEXANT SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) Total cash, cash equivalents and marketable securities are as follows (in
thousands): September 30,
    
    September 30,2004
    
    2003Cash and cash equivalents
    
    $
    139,031
    
    
    $
    76,186Skyworks 15% convertible senior subordinated notes
    
    
    
    
    
    
    55,566Equity securities- Skyworks Solutions, Inc. (6.2
million shares at September 30, 2004, 0.5 million
shares at September 30, 2003)
    
    
    61,767
    
    
    
    4,576Equity securities- SiRF Technologies, Inc. (5.9
million shares at September 30, 2004)
    
    
    87,509
    
    
    
    Other short-term marketable securities (primarily
mutual funds, domestic government agency securities and corporate debt securities)
    
    
    13,764
    
    
    
    39,141Subtotal- short-term investments
    
    
    163,040
    
    
    
    99,283Long-term marketable securities (primarily
domestic government agency securities and corporate debt securities)
    
    
    137,604
    
    
    
    $
    439,675
    
    
    $
    175,469
 For all investment securities, unrealized losses that are other than temporary
are recognized in net income. The Company does not hold these securities for
speculative or trading purposes. Inventories Inventories are stated at the lower of cost or market. Cost is
computed using the average cost method on a currently adjusted standard basis
(which approximates actual cost); market is based upon estimated net realizable
value. The valuation of inventories at the lower of cost or market requires the
use of estimates as to the amounts of current inventories that will be sold.
These estimates are dependent on the Companys assessment of current and
expected orders from its customers, and orders generally are subject to
cancellation with limited advance notice prior to shipment. Property, Plant and Equipment Property, plant and equipment are stated at
cost. Depreciation is based on estimated useful lives (principally 10 to 27
years for buildings and improvements; 3 to 5 years for machinery and equipment;
and the shorter of the remaining terms of the leases or the estimated economic
useful lives of the improvements for land and leasehold improvements).
Significant renewals and betterments are capitalized and replaced units are
written off. Maintenance and repairs are charged to expense. Investments The Company accounts for non-marketable investments using the
equity method of accounting if the investment gives the Company the ability to
exercise significant influence, but not control, over an investee. Significant
influence generally exists if the Company has an ownership interest
representing between 20% and 50% of the voting stock of the investee. Under the
equity method of accounting, investments are stated at initial cost and are
adjusted for subsequent additional investments and the Companys proportionate
share of income or losses and distributions. The Company records its share of
the investees earnings or losses in other income (expense) in the consolidated
statement of operations. Additional investments by other parties in the
investee will result in a reduction in the Companys ownership interest, and
the resulting gain or loss will be recorded in other income (expense) in the
consolidated statement of operations. Where the Company is unable to exercise
significant influence over the investee, investments are accounted for under
the cost method. Under the cost method, investments are carried at cost and
adjusted only for other-than-temporary declines in fair value, distributions of
earnings or additional investments. See Note 7, Other Assets, for further
information on investments. 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. Estimates of undiscounted cash flows may differ from actual cash flows
due to, among other things, technological changes, economic conditions, changes
to the business model or changes in operating performance. If the sum of the
undiscounted cash flows (excluding interest) is less 50




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##### Table of Contents



CONEXANT SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) than the carrying value, an impairment loss will be recognized, measured as the
amount by which the carrying value exceeds the fair value of the asset. See
Note 15 for discussion of impairment charges for long-lived assets in fiscal
years 2004, 2003 and 2002. Goodwill is tested for impairment annually, or when a possible impairment is
indicated, using the fair value based test prescribed by SFAS 142. The
estimates and assumptions described above (along with other factors such as
discount rates) will affect the outcome of the impairment tests and the amounts
of any resulting impairment losses. The Company performed its annual
assessment of goodwill and determined that no impairment exists as of September
30, 2004. Foreign Currency Translation and Remeasurement The Companys foreign
operations are subject to exchange rate fluctuations and foreign currency
transaction costs. The functional currency of the Companys principal foreign
subsidiaries is the local currency. Assets and liabilities denominated in
foreign functional currencies are translated into U.S. dollars at the rates of
exchange in effect at the balance sheet dates and income and expense items are
translated at the average exchange rates prevailing during the period. The
resulting foreign currency translation adjustments are accumulated as a
component of other comprehensive income. For the remainder of the Companys
foreign subsidiaries, the functional currency is the U.S. dollar. Inventories,
property, plant and equipment, cost of goods sold, and depreciation for those
operations are remeasured from foreign currencies into U.S. dollars at
historical exchange rates; other accounts are translated at current exchange
rates. Gains and losses resulting from those remeasurements are included in
earnings. Gains and losses resulting from foreign currency transactions are
recognized currently in earnings. Derivative Financial Instruments Derivative financial instruments are
recognized as either assets or liabilities in the balance sheet and are
measured at fair value. The Companys derivative financial instruments
principally consist of foreign currency forward exchange contracts which the
Company uses to manage its exposure to foreign currency risks, the Mindspeed
warrant, and prior to its conversion to Skyworks common stock, the conversion
rights of the Skyworks convertible notes. The Companys objectives are to
reduce the volatility of earnings and cash flows associated with changes in
foreign currency exchange rates. The Company may use other derivatives from
time to time to manage its exposure to changes in interest rates, equity prices
or other risks. The Company does not enter into derivative financial
instruments for speculative or trading purposes. The Company designates certain forward contracts as hedges of forecasted
intercompany transactions. Unrealized gains and losses on these contracts are
recorded as a component of accumulated other comprehensive income. Other
forward contracts are designated as hedges of intercompany accounts of the
Companys foreign subsidiaries. Unrealized gains and losses on these forward
contracts are recorded currently through earnings and offset the corresponding
losses and gains on the assets and liabilities being hedged. At September 30,
2004, the Company had no foreign currency forward contracts outstanding. During
fiscal 2004, 2003 and 2002, there were no significant gains or losses
recognized in earnings for hedge ineffectiveness. Prior to its conversion to Skyworks common stock in May 2004, the Company
accounted for the right to convert the Skyworks 15% convertible senior
subordinated notes into shares of Skyworks common stock as an embedded
derivative instrument. Changes in the fair value of the Skyworks 15%
convertible senior subordinated notes resulting from changes in the value of
the conversion right were included in other (income) expense, net each period.
The Company also accounts for the Mindspeed warrant as a derivative instrument
(see Note 7), and changes in the fair value of the warrant are included in
other (income) expense, net each period. Earnings (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 convertible notes
are dilutive. In periods of a net loss position, basic and diluted weighted
average shares are the same. 51




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##### Table of Contents



CONEXANT SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) The following table sets forth the computation of the numerator and denominator
of basic and diluted earnings per share: 2004
    
    2003
    
    2002Numerator (dollars in thousands):Income (loss) from continuing
operations
    
    $
    (544,649
    )
    
    $
    23,562
    
    
    $
    (143,750
    )Loss from discontinued operations, net of income
taxes
    
    
    
    
    
    
    (728,877
    )
    
    
    (737,017
    )Net
loss
    
    $
    (544,649
    )
    
    $
    (705,315
    )
    
    $
    (880,767
    )Denominator (weighted-average number of shares in thousands):Weighted average shares outstanding-
basic
    
    
    389,630
    
    
    
    268,586
    
    
    
    258,998Stock options and warrants (under the treasury stock
method)
    
    
    
    
    
    
    6,644
    
    
    
    Weighted average shares outstanding -
diluted
    
    
    389,630
    
    
    
    275,230
    
    
    
    258,998
 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: (weighted-average number of shares, in thousands)
    
    2004
    
    2003
    
    2002Stock options and warrants (under the treasury stock method)
    
    
    18,255
    
    
    
    
    
    
    
    4,6164.25% Convertible Subordinated Notes due 2006
    
    
    7,364
    
    
    
    6,242
    
    
    
    7,3424% Convertible Subordinated Notes due 2007
    
    
    12,137
    
    
    
    11,178
    
    
    
    11,6075.25% Convertible Subordinated Notes due 2006
    
    
    3,482
    
    
    
    
    
    
    
    Restricted stock
    
    
    13
    
    
    
    
    
    
    
    230
 Stock-Based CompensationThe Company accounts for employee stock-based
compensation in accordance with the provisions of Accounting Principles Board
Opinion No. 25, Accounting for Stock Issued to Employees (APB 25) and
therefore no compensation expense has been recognized for fixed stock option
plans as options are granted at fair market value on the date of grant. The
Company also has an employee stock purchase plan for all eligible employees.
The Company has adopted the pro forma disclosure provisions of Statement of
Financial Accounting Standards (SFAS) No. 123, Accounting for Stock-Based
Compensation, as amended by SFAS No. 148, Accounting for Stock-Based
Compensation- Transition and Disclosure. Had stock-based compensation been determined based on the fair value at the
grant date for awards consistent with the provisions of SFAS 123, the Companys
pro forma loss from continuing operations and pro forma loss from continuing
operations per share would have been the amounts indicated below (in thousands,
except per share amounts): 2004
    
    2003
    
    2002Income (loss) from continuing
operations, as
reported
    
    $
    (544,649
    )
    
    $
    23,562
    
    
    $
    (143,750
    )Add: expense determined under fair value
accounting included in loss from
continuing operations, as
reported
    
    
    7,137
    
    
    
    1,749
    
    
    
    (2,094
    )Deduct: total expense determined under
fair value accounting for all
awards
    
    
    (57,397
    )
    
    
    (60,105
    )
    
    
    (104,899
    )Pro forma loss from continuing operations
    
    $
    (594,909
    )
    
    $
    (34,794
    )
    
    $
    (250,743
    )Income (loss) from continuing operations
per share- basic, as reported
    
    $
    (1.40
    )
    
    $
    0.09
    
    
    $
    (0.56
    )Pro forma loss from continuing
operations per share- basic
    
    $
    (1.53
    )
    
    $
    (0.13
    )
    
    $
    (0.97
    )Income (loss) from continuing operations
per share-diluted, as reported
    
    $
    (1.40
    )
    
    $
    0.09
    
    
    $
    (0.56
    )Pro forma loss from continuing
operations per share- diluted
    
    $
    (1.53
    )
    
    $
    (0.13
    )
    
    $
    (0.97
    )
 52




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CONEXANT SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) For purposes of pro forma disclosures under SFAS 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
weighted-average assumptions: 2004
    
    2003
    
    2002Risk-free interest rate
    
    
    3.3
    %
    
    
    3.2
    %
    
    
    2.9
    %Expected volatility
    
    
    97
    %
    
    
    97
    %
    
    
    100
    %Dividend yield
    
    
    
    
    
    
    
    
    
    
    Expected life (years)
    
    
    4.1
    
    
    
    4.5
    
    
    
    4.5Weighted-average fair value
of options granted
    
    $
    4.91
    
    
    $
    2.27
    
    
    $
    8.65
 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. Income Taxes The provision (benefit) for income taxes is determined in
accordance with SFAS No. 109, Accounting for Income Taxes. Deferred tax
assets and liabilities are determined based on the temporary differences
between the financial reporting and tax bases of assets and liabilities,
applying enacted statutory tax rates in effect for the year in which the
differences are expected to reverse. A valuation allowance is recorded when it
is more likely than not that some or all of the deferred tax assets will not be
realized. ConcentrationsFinancial instruments that potentially subject the Company to
concentration of credit risk consist principally of cash and cash equivalents,
investments, and trade accounts receivable. The Company invests its cash
balances through high-credit quality financial institutions. The Company places
its investments in investment-grade debt securities and limits its exposure to
any one issuer. The Companys trade accounts receivable primarily are derived
from sales to manufacturers of communications products, consumer products and
personal computers. Management believes that credit risks on trade accounts
receivable are moderated by the diversity of its products, end customers and
geographic sales areas. The Company performs ongoing credit evaluations of its
customers financial condition and requires collateral, such as letters of
credit and bank guarantees, whenever deemed necessary. At September 30, 2004, no customer accounted for more than 10% of the Companys
accounts receivable; at September 30, 2003, four customers accounted for 15%,
14%, 13% and 11% of the Companys accounts receivable. In fiscal 2004, no
customer accounted for 10% or more of net revenues. In fiscal 2003 and 2002,
one customer (a distributor) accounted for 11% and 12%, respectively of net
revenues and no other customer accounted for 10% or more of net revenues. Supplemental Cash Flow Information Interest paid was $26.9 million, $25.9
million and $28.6 million during fiscal 2004, 2003 and 2002, respectively. Net
income taxes paid(refunds received) were $(14.9) million, $2.5 million and
$(9.1) million during fiscal 2004, 2003 and 2002, respectively. Non-cash activities: The Company satisfied $7.5 million, $2.1 million and
$31.2 million of liabilities from employee payroll deductions by issuing shares
of its common stock in connection with its Employee Stock Purchase Plan (see
Note 13) and its Retirement Savings Plan (see Note 14), in fiscal years 2004,
2003 and 2002, respectively. See Note 2 for a discussion of common stock,
common stock options, net assets acquired, and other items in the Companys
acquisitions. 53




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CONEXANT SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) Comprehensive Income (Loss) Other comprehensive income (loss) includes
foreign currency translation adjustments, unrealized holding gains on
available-for-sale marketable securities, unrealized gains (losses) on forward
exchange contracts, and minimum pension liability adjustments. The components
of accumulated other comprehensive loss at fiscal year-ends are as follows (in
thousands): 2004
    
    2003Foreign currency translation adjustments
    
    $
    (3,206
    )
    
    $
    (3,023
    )Unrealized gains on available-for-sale securities
    
    
    92,458
    
    
    
    1,907Minimum pension liability adjustments
    
    
    (6,701
    )
    
    
    (8,380
    )Accumulated other comprehensive income (loss)
    
    $
    82,551
    
    
    $
    (9,496
    )
 Business Enterprise Segments The Company operates in one reportable operating
segment, broadband communications. 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 the Company had four
operating segments at September 30, 2004, under the aggregation criteria set
forth in SFAS No. 131, the Company only operates 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 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;  
    
    the type or class of customer for their products and services; and  
    
    the methods used to distribute their products or provide their services. The Company meets each of the aggregation criteria for the following reasons:  
    
    the sale of products is the only material source of revenue for each of its four operating segments;  
    
    the products sold by each of its operating segments use the same standard manufacturing process;  
    
    the products marketed by each of its operating segments are sold to similar customers; and  
    
    all of its products are sold through an internal sales force and common distributors. Because the Company met each of the criteria set forth above and each of its
operating segments has similar economic characteristics, the Company aggregates
its results of operations in one reportable operating segment. Change in Accounting Principle The Company adopted SFAS No. 141, Business
Combinations for acquisitions initiated after June 30, 2001 and SFAS No. 142,
Goodwill and Other Intangible Assets as of the beginning of fiscal 2003. SFAS
141 requires that all business combinations initiated after June 30, 2001 be
accounted for using the purchase method and provides new criteria for recording
intangible assets separately from goodwill. Upon adoption, the existing
goodwill and intangible assets were evaluated against the new criteria, which
resulted in certain intangible assets with a carrying value of $0.4 million
being subsumed into goodwill. SFAS 142 addresses financial accounting and
reporting for acquired goodwill and other intangible assets and requires that
goodwill and intangible assets that have indefinite useful lives no longer be
amortized into results of operations, but instead be tested at least annually
for impairment and written down when impaired. Upon adoption of SFAS 142, the
Company ceased amortizing goodwill against its results of operations. During the second quarter of fiscal 2003, the Company completed the transition
impairment test of its goodwill (as of the beginning of fiscal 2003) required
by SFAS 142. The Company determined that it has a single reporting unit (as
defined in SFAS 142). For purposes of the impairment test, the fair value of
the reporting unit was determined considering both an income approach and a
market approach. Management determined that the recorded value of its 54




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CONEXANT SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) goodwill at the transition date was not impaired. See Note 3 for the
transitional impairment charge recorded by Mindspeed and included in the
Companys loss from discontinued operations of Mindpseed in fiscal 2003. The following table shows the Companys annual net loss and net loss per share,
adjusted for the effect of the adoption of the non-amortization provisions of
SFAS 142 (in thousands, except per share amounts): 2003
    
    2002Net loss, as reported
    
    $
    (705,315
    )
    
    $
    (880,767
    )Amortization of goodwill
    
    
    
    
    
    
    277,388Amortization of assembled workforce previously
classified as an intangible asset
    
    
    
    
    
    
    1,899Adjusted net loss
    
    $
    (705,315
    )
    
    $
    (601,480
    )Loss per share, basic:Net loss, as reported
    
    $
    (2.63
    )
    
    $
    (3.40
    )Adjusted net loss
    
    
    (2.63
    )
    
    
    (2.32
    )Loss per share, diluted:Net loss, as reported
    
    $
    (2.56
    )
    
    $
    (3.40
    )Adjusted net loss
    
    
    (2.56
    )
    
    
    (2.32
    )
 Reclassifications Certain prior year amounts have been reclassified to
conform to the current year presentation. 2. Acquisitions 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 acquiror. 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 and warrants 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 55




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CONEXANT SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) average remaining vesting period of approximately 2.6 years. A total of $7.1
million of this unearned compensation was recognized as an expense in the year
ended September 30, 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, the Company recorded restructuring and asset impairment
charges related to Conexants operations of $14.6 million during the year ended
September 30, 2004. These charges are included in Special Charges and Cost of
Goods Sold in the accompanying consolidated statement of operations.
Additionally, the Company initially recognized $14.8 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.
Subsequent to the Merger, but prior to September 30, 2004, these liabilities
were reduced by $3.3 million against the purchase price allocation (goodwill)
for certain facilities related decisions and revised estimates of severance and
relocation costs. 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. Finalization and execution of the
Reorganization Plan is not yet complete and further actions may be taken such
as additional or different facilities impairments, workforce reductions or
relocations and/or product related decisions with respect to duplicate
technology licenses, duplicate maintenance contracts, production masks and
inventory of goods for which there will no longer be an active market for the
combined company. The Reorganization Plan and its related actions are expected
to be completed by the end of calendar 2004, and when taken, charges and/or
reductions will be recorded as an adjustment to goodwill. Any actions relating
to the acquiring corporation will be charged against operations. See Note 15
for a further description of the Companys reorganization and restructuring
plans. In the Merger, the Company acquired a $4.8 million 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 September 30, 2004, upon further review of the information, the
Company increased the reserve for these income tax contingencies against the
purchase price allocation (goodwill) by an additional $3.4 million. As these
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 March 2005 quarter) as defined by SFAS No. 141. If the
contingencies are not settled by the March 2005 quarter, any changes after that
date, whether favorable or unfavorable, will be recorded to operations. 56




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CONEXANT SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) The following sets forth the Companys estimates of the fair values of the
assets acquired and liabilities assumed in the Merger as of February 27, 2004,
as revised for matters discussed above (in thousands). The amounts below may
change further as the Reorganization Plan is completed and the pre-acquisition
tax contingencies are resolved. 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
    
    
    632,403Accounts payable
    
    
    (41,580
    )Accrued expenses
    
    
    (78,048
    )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 $16.6 million for the year
ended September 30, 2004. The amount recorded as goodwill of $632.4 million is
not deductible for tax purposes. The amount allocated to IPR&D of $160.8 million was expensed upon completion of
the Merger (as a charge not deductible for tax purposes) as it was determined
that the underlying products had not reached technological feasibility, had no
alternative uses and successful development was uncertain. The Company
identified and valued two IPR&D projects relating to the development of DSL and
wireless LAN products. The DSL project represented 70% of the total IPR&D
acquired. Both projects were approximately 87% complete at the date of the
merger. The estimated costs to complete for the DSL and wireless LAN projects
were approximately $14.1 million and $6.2 million, respectively. These projects
will be completed in fiscal 2005. The fair values assigned to these projects
were based on the income approach and used projected cash flows which were
discounted at a rate of 19%. The discount rate was derived from a
weighted-average cost of capital analysis, adjusted upwards to reflect
additional risks inherent in the development process, including the probability
of achieving technological success and market acceptance. Each of the IPR&D
projects was analyzed considering technological innovations, the existence and 57




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CONEXANT SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) 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 that amounts are representative of
fair values. Through September 30, 2004, actual results do not materially
differ from the estimates used in the valuations of IPR&D or developed
technologies. The treasury stock of $9.2 million represented 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 acquisition
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 each period presented and includes amortization of identifiable intangibles
and unearned compensation from that date. Year ended September 30,2004
    
    2003Net revenues
    
    $
    1,088,630
    
    
    $
    892,954Net loss
    
    
    (568,542
    )
    
    
    (795,949
    )Net loss per common share  basic and diluted
    
    
    (1.23
    )
    
    
    (1.77
    )
 The pro forma results are based on various assumptions and are not necessarily
indicative of what would have occurred had the merger closed on October 1, 2003
and 2002, respectively. 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
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 or 2003. 58




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CONEXANT SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) During fiscal 2003 and 2002, the Company completed the following acquisitions
that were accounted for using the purchase method of accounting. Fiscal 2003 In May 2003, the Company acquired the soft modem business of PCTEL, Inc.
(PCTEL), a provider of Internet access products and wireless mobility software.
Consideration for the acquisition consisted of cash of $6.8 million, and a
commitment to pay additional cash totaling $4.0 million in November and
December 2003. The Company also agreed to purchase copies of PCTELs
proprietary software for a total of $1.0 million, payable in quarterly
installments through June 30, 2004. In addition, the Company and PCTEL
entered into a cross-license agreement whereby the Company contributed to PCTEL
certain patents and patent applications and, in exchange, the Company received
a non-exclusive, worldwide license to incorporate certain PCTEL technology into
its products. The Company will pay royalties to PCTEL of up to $8.0 million
over a four-year period on the sale of certain licensed products, with a
maximum of $0.5 million per quarter, through June 30, 2007. The amounts
payable to PCTEL, at their present values, have been included in other current
or long-term liabilities in the accompanying consolidated balance sheet. The tangible assets of the acquired business totaled $2.5 million. Assumed
liabilities totaled $0.5 million. Identifiable intangible assets, principally
consisting of developed technology and customer-related intangibles, total $3.6
million and are being amortized over estimated lives of five years. The
residual amount of $6.2 million is classified as goodwill and is deductible for
income tax purposes. The results of operations of the acquired business are included in the
consolidated financial statements from the date of acquisition. The pro forma
effect of this acquisition was not material to the Companys results of
operations in fiscal 2003 or 2002. Fiscal 2002 In June 2002, the Company acquired the video compression business of
iCompression, Inc. (iCompression), a wholly owned subsidiary of
GlobespanVirata, Inc. Consideration for the acquisition consisted of 1.25
million shares of the Companys common stock and promissory notes for $21.0
million, of which 150,000 shares of common stock and a promissory note for $1.8
million were held in a one-year escrow for the settlement of any contingent
indemnity claims. The Company paid the amounts owed under the promissory notes
in July 2002. The escrow settled in June 2003 and all funds were released to
iCompression. Under the asset purchase agreement, the Company guaranteed the value of the
shares issued to iCompression for a defined period through September 2003
(subject to certain conditions and elections). In the event that the common
stock delivered to iCompression (including the shares of Skyworks common stock
received in respect thereof) did not maintain a market value per share equal to
or greater than $12.00 for at least seven consecutive trading days during the
guaranty period, Conexant would be required to make an additional cash payment
to iCompression for the difference between $12.00 and the market value per
share of such shares as of specified dates. Consequently, the Company valued
the shares delivered to iCompression at the guaranteed value of $12.00 per
share. In September 2003, the Company paid $0.7 million cash to iCompression in
full settlement of this guaranty. The payment was recorded as a reduction of
shareholders equity in accordance with SFAS No. 141. The tangible assets of the acquired video compression business totaled $0.3
million, net of liabilities of $1.6 million. The results of operations of the
video compression business are included in the consolidated financial
statements from the date of acquisition. The pro forma effect of this
acquisition was not material to the Companys results of operations in fiscal
2002. Consideration for the acquisitions in fiscal 2004, 2003 and 2002 consisted of
cash, shares of the Companys common stock or a combination of cash and stock
and the fair value of outstanding stock options of the acquired companies
converted into options to purchase shares of the Companys common stock. The
value of the common stock issued was based on market prices at the time of
announcement of the acquisition. 59




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CONEXANT SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) The value of the consideration for each acquisition was allocated among the
assets and liabilities acquired, including identified intangible assets, based
upon estimated fair values. The excess of the value of the consideration over
the net assets acquired is allocated to goodwill. Identified intangible assets, principally consisting of developed technology,
are being amortized over estimated lives of two to seven years (principally
five years). 3. Discontinued Operations Mindspeed Technologies On June 27, 2003, Conexant completed the distribution to Conexant shareholders
of all outstanding shares of Mindspeed Technologies, Inc. (Mindspeed), a
wholly owned subsidiary of Conexant to which Conexant contributed its Internet
infrastructure business, including the stock of certain subsidiaries, and
certain other assets and liabilities, including $100.0 million in cash
(hereinafter, the Mindspeed Spin). In the Mindspeed Spin, Conexant
shareholders received one share of Mindspeed common stock for every three
Conexant shares held and the Conexant shareholders continued to hold their
Conexant shares. Mindspeed issued to Conexant a warrant to purchase 30 million
shares of Mindspeed common stock, representing approximately 20 percent of
Mindspeeds outstanding common stock on a fully diluted basis. The warrant is
exercisable until June 27, 2013 at an exercise price of $3.408 per share (the
fair market value on the date of grant of the warrant). The warrant was
initially assigned a fair value of $89.0 million (recorded as a return of
capital to Conexant) using the Black-Scholes option pricing model (assuming
volatility of 90%, a risk-free interest rate of 3.5%, and no dividend yield),
and is presented as an asset on the consolidated balance sheet. The carrying
value of the net assets which the Company contributed to Mindspeed in June 2003
was $193.4 million. Additionally, Conexant entered into a senior secured
revolving credit facility pursuant to which Mindspeed may borrow up to $50.0
million for working capital and general corporate purposes. In December 2004,
the Mindspeed credit facility was terminated (see Notes 11 and 18). Wireless Communications and Mexicali Operations On June 25, 2002, Conexant completed the distribution to Conexant shareholders
of outstanding shares of Washington Sub, Inc. (Washington), a wholly owned
subsidiary of Conexant to which Conexant contributed its wireless
communications business, other than certain assets and liabilities which
Conexant retained. Immediately thereafter, Washington merged with and into
Alpha Industries, Inc. (Alpha), with Alpha the surviving corporation.
Together, these transactions are hereinafter referred to as the Skyworks Spin.
As a result of the Skyworks Spin, Conexant shareholders received 0.351 of a
share of Alpha common stock for each Conexant share held and the Conexant
shareholders continued to hold their Conexant shares. Effective June 26, 2002,
Alpha changed its name to Skyworks Solutions, Inc. (Skyworks). In connection with the Skyworks Spin, Alpha and its subsidiaries purchased
Conexants semiconductor assembly and test facility located in Mexicali, Mexico
including Conexants package design team that supports the Mexicali facility
(together, the Mexicali Operations) for $150.0 million. In connection with the
purchase, Conexant, Alpha and certain subsidiaries of Alpha entered into a
financing agreement pursuant to which Alpha and a subsidiary of Alpha delivered
to Conexant promissory notes for $150.0 million (the Term Notes) guaranteed by
Alpha and certain Alpha subsidiaries and secured by substantially all assets of
Alpha in payment of the purchase price for the Mexicali Operations. The
financing agreement also provided for a revolving credit facility under which
Alpha could borrow up to $100.0 million, less specified reserves, for one year
at the same interest rate and with the same security applicable to the Term
Notes. As of September 30, 2002, borrowings of $30.0 million were outstanding
under the credit facility. In November 2002, the Company restructured the financing agreements with
Skyworks. Skyworks repaid $105.0 million of the principal amount and all
accrued interest owed to the Company under the Term Notes and the remaining
principal amount of the Term Notes was exchanged for $45.0 million principal
amount of the Skyworks 15% convertible senior subordinated notes with a
maturity date of June 30, 2005. Skyworks also repaid all amounts 60




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CONEXANT SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) outstanding under the credit facility, the credit facility was cancelled and
the Company released all security interests in Skyworks assets and properties.
In May 2004, the senior subordinated notes were converted into 5.7 million
shares of Skyworks common stock (see Note 6). The Skyworks Spin was completed pursuant to the Contribution and Distribution
Agreement and the Agreement and Plan of Reorganization entered into as of
December 16, 2001 (the measurement date for financial accounting purposes), as
amended. The carrying value of the net assets which the Company contributed to
Washington (including the Mexicali Operations) in June 2002 was $210.4 million. The accompanying consolidated financial statements have been restated to
reflect the wireless communications business and Mexicali Operations, and the
Mindspeed Technologies business, which were completed in fiscal 2002 and fiscal
2003, respectively, as discontinued operations. For financial accounting
purposes, the sale of the Mexicali Operations by Conexant to Skyworks was
treated as if Conexant had contributed the Mexicali Operations to Washington as
part of the Skyworks Spin, and the $150.0 million purchase price was treated as
a return of capital to Conexant. The operating results of the discontinued wireless communications business,
Mexicali Operations and the discontinued Mindspeed Technologies business,
including the separation costs paid by the Company, included in the
accompanying consolidated statements of operations were as follows (in
thousands): 2003
    
    2002Net revenues
    
    $
    58,719
    
    
    $
    352,967Loss before income taxes
    
    $
    (155,231
    )
    
    $
    (733,169
    )Provision for income taxes
    
    
    462
    
    
    
    3,848Cumulative effect of change in accounting for goodwill
    
    
    (573,184
    )
    
    
    Loss from discontinued operations
    
    $
    (728,877
    )
    
    $
    (737,017
    )
 2003
    
    2002Loss from discontinued operations:Wireless communications business and Mexicali Operations
    
    $
    
    
    
    $
    (68,431
    )Mindspeed Technologies business
    
    
    (728,877
    )
    
    
    (668,586
    )Loss from discontinued operations
    
    $
    (728,877
    )
    
    $
    (737,017
    )
 4. Sales of Assets Fiscal 2004 In fiscal 2004, the Company sold a portion of its common stock ownership in
SiRF Technology Holdings, Inc. (SiRF) after SiRFs initial public offering in
April 2004. The Company sold approximately 2.5 million shares in SiRF for net
proceeds of $28.2 million, which resulted in a gain of $26.5 million. The
Company continues to hold approximately 5.9 million shares of common stock of
SiRF as a short-term investment which is included in marketable securities (see
Note 5). In fiscal 2004, the Company sold several of its cost basis investments in early
stage technology companies for cash of $5.9 million, with an additional $1.0
million to be held in escrow for a period of eighteen to twenty four months for
potential buyer indemnity claims. A total loss of $3.0 million was recognized
on these sales. In addition, the Company sold a building for net cash proceeds
totaling $22.8 million. A loss of $3.2 million was recognized on the sale. Fiscal 2003 In fiscal 2003, the Company sold certain manufacturing assets to Jazz for $1.0
million payable over four quarters. A $4.8 million impairment loss was
recognized on these assets. In fiscal 2003, the Company sold two of its cost basis investments in early
stage technology companies for cash of $15.0 million, with an additional $2.1
million to be held in escrow for a period of twelve to eighteen months for 61




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CONEXANT SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) potential buyer indemnity claims. A total gain of $8.6 million was recognized
on these sales. In addition, the Company accrued $2.0 million for
non-cancelable commitments related to one of these transactions for losses to
complete the production of certain inventory items and the rendering of future
services. Fiscal 2002 In March 2002, the Company and The Carlyle Group formed a new specialty foundry
company named Jazz Semiconductor, Inc. (Jazz). In the transaction, Conexant
contributed its Newport Beach, California wafer fabrication operations and
certain intellectual property to Jazz and the Company received $19.3 million in
cash and a 45% equity interest in Jazz, having an estimated fair value of $42.5
million. In addition to contributing its Newport Beach wafer fabrication
operations (with a carrying value of approximately $43.2 million) and certain
related assets and liabilities (with carrying values of $7.4 million and $7.8
million, respectively), the Company also issued to Jazz a warrant to purchase
2.9 million shares of Conexant common stock at a price of $13.05 per share (the
fair market value on the date of grant of the warrant) exercisable through
January 2005. The warrant had a fair value of $14.2 million, determined by
management using the Black-Scholes option pricing model (assuming volatility of
68.5%, a risk-free interest rate of 4.1%, and no dividend yield) and discounted
20% for the lack of marketability. At September 30, 2004, the exercise price of
the warrant is $3.76 per share, and is subject to adjustment for certain
events. Through September 30, 2004, Jazz has purchased 0.6 million shares
under the warrant. The 2.3 million shares remaining subject to the warrant are
purchasable until January 2005. In November 2004, the Company extended the
expiration date of the warrant until January 2007. See Note 18. This transaction resulted in a $2.6 million gain, which represented the
difference between the Companys carrying value and the fair value of the net
assets deemed to have been sold by the Company to Jazz. The Company accounts
for its investment in Jazz under the equity method of accounting. In fiscal
2003, an unrelated party made an additional investment in Jazz thereby reducing
the Companys equity interest in Jazz to 38%. In accordance with Staff
Accounting Bulletin (SAB) No. 51, a gain of $0.3 million was recognized upon
this additional investment. In fiscal 2004, an unrelated party repaid a $30.0
million note issued in connection with a previous equity investment in Jazz.
Also in accordance with SAB No. 51, the Company recognized an $11.4 million
gain upon the payment of this note. In July 2002, the Company completed the planned divestiture of its digital
imaging business and merged the business with Zing Network, Inc. to create a
new privately held company named Pictos Technologies, Inc. (Pictos). The
Company contributed assets to Pictos in exchange for shares of Pictos stock.
The Company subsequently sold its investment in Pictos to an unrelated party. During fiscal 2002, the Company sold four buildings for net proceeds of $46.8
million. A $2.4 million gain arising from the sale of one building was
recognized upon completion of the transaction. The Company will continue to
occupy the remaining three buildings under 15-year leases. Consequently, gains
of $19.6 million arising from the sale of the leased-back buildings have been
deferred and will be recognized ratably over the term of the leases. 5. Marketable Securities Marketable securities include asset-backed securities, mutual funds, corporate
bonds, government securities and marketable equity securities. All of the
Companys marketable securities are classified as available for sale and are
recorded at fair value, based upon quoted market prices. As of September 30,
2004, net unrealized gains of $92.5 million on these securities are included in
accumulated other comprehensive income. 62




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CONEXANT SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) Marketable securities consist of the following: Gross
    
    GrossUnrealized
    
    UnrealizedAmortized
    
    Holding
    
    Holding
    
    FairShort-term investments (in thousands):
    
    Cost
    
    Gains
    
    Losses
    
    ValueSeptember 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
    )
    
    $
    163,040September 30, 2003:Skyworks 15% convertible senior subordinated notes
    
    $
    46,542
    
    
    $
    9,024
    
    
    $
    
    
    
    $
    55,566Domestic government agency securities
    
    
    14,640
    
    
    
    25
    
    
    
    (18
    )
    
    
    14,647Foreign government securities
    
    
    2,044
    
    
    
    15
    
    
    
    
    
    
    
    2,059Corporate debt securities
    
    
    21,625
    
    
    
    74
    
    
    
    (59
    )
    
    
    21,640Equity securities
    
    
    2,320
    
    
    
    3,051
    
    
    
    
    
    
    
    5,371$
    87,171
    
    
    $
    12,189
    
    
    $
    (77
    )
    
    $
    99,283
 The Company accounted for the Skyworks 15% convertible senior subordinated
notes as available-for-sale securities carried at their fair value. Unrealized
gains or losses resulting from changes in the fair value of the underlying debt
were included in other comprehensive income. The right to convert the Skyworks
15% convertible senior subordinated notes into shares of Skyworks common stock
was, for financial accounting purposes, an embedded derivative instrument.
Changes in the fair value of the Skyworks 15% convertible senior subordinated
notes resulting from changes in the value of the conversion right were included
in other (income) expense, net each period. In May 2004, the Company converted
the notes into 5.7 million shares of Skyworks common stock at the conversion
price of $7.87 per share (see Note 6). The mutual fund holdings at September 30, 2004 invest in adjustable rate
mortgages and government agency securities. Gross
    
    GrossUnrealized
    
    UnrealizedAmortized
    
    Holding
    
    Holding
    
    FairLong-term investments (in thousands):
    
    Cost
    
    Gains
    
    Losses
    
    ValueSeptember 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. The amortized cost and estimated fair value of debt securities at September 30,
2004, by contractual maturity, are shown below (in thousands). Expected
maturities will differ from contractual maturities because the issuers of the
securities may have the right to prepay obligations without prepayment
penalties. Amortized
    
    FairCost
    
    ValueDue in 1 year or less
    
    $
    110,245
    
    
    $
    109,441Due in 1  2 years
    
    
    22,324
    
    
    
    22,174Due in 2  5 years
    
    
    17,586
    
    
    
    17,477Due after 5 years
    
    
    1,508
    
    
    
    1,495$
    151,663
    
    
    $
    150,587
 6. Skyworks Notes As of September 30, 2002, the Company held notes receivable from Skyworks with
an aggregate principal amount of $180.0 million, including promissory notes for
$150.0 million guaranteed by Skyworks and certain Skyworks subsidiaries and
secured by substantially all of the assets of Skyworks (the Term Notes) and
$30.0 million outstanding under the $100.0 million credit facility which the
Company had made available to Skyworks. In 63




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CONEXANT SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) November 2002, the Company restructured the financing agreements with Skyworks.
Skyworks repaid $105.0 million of the principal amount and all accrued interest
owed to the Company under the Term Notes and the remaining principal amount of
the Term Notes was exchanged for $45.0 million principal amount of the Skyworks
15% convertible senior subordinated notes with a maturity date of June 30,
2005. Skyworks also repaid all amounts outstanding under the 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. 7. Supplemental Financial Statement Data Inventories Inventories at fiscal year-ends consist of the following (in thousands): 2004
    
    2003Work-in-process
    
    $
    99,226
    
    
    $
    42,662Finished goods
    
    
    95,528
    
    
    
    16,886$
    194,754
    
    
    $
    59,548
 At September 30, 2004 and 2003, inventories are net of $23.3 million and $25.2
million, respectively, of allowances for excess and obsolete inventories. In the second fiscal quarter of 2004, as a result of strategic decisions made
at the time of the Merger, the Company wrote down $0.8 million of on-hand
inventory products which will no longer be actively marketed or sold. This
amount was charged to cost of goods sold. The Company assesses the recoverability of inventories through an ongoing
review of inventory levels in relation to sales backlog and forecasts, product
marketing plans and product life cycles. When the inventory on hand exceeds the
foreseeable demand, the value of inventory that at the time of the review is
not expected to be sold is written down. The amount of the write-down is the
excess of historical cost over estimated realizable value (generally zero).
Once established, these write-downs are considered permanent adjustments to the
cost basis of the excess inventory. The assessment of the recoverability of inventories, and the amounts of any
write-downs, is based on currently available information and assumptions about
future demand (generally over nine to twelve months) and market conditions.
Demand for the Companys 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. The Company may retain and make available for sale some or all of the
inventories which have been written down. In the event that actual demand is
higher than originally projected, the Company may be able to sell a portion of
these inventories in the future. The Company generally scraps inventories which
have been written down and are identified as obsolete. 64




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CONEXANT SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) Property, Plant and Equipment Property, plant and equipment at fiscal year-ends consist of the following (in
thousands): 2004
    
    2003Land
    
    $
    1,960
    
    
    $
    1,663Land and leasehold improvements
    
    
    17,678
    
    
    
    10,477Buildings
    
    
    35,133
    
    
    
    34,799Machinery and equipment
    
    
    152,617
    
    
    
    121,162Construction in progress
    
    
    178
    
    
    
    3,330207,566
    
    
    
    171,431Accumulated depreciation and amortization
    
    
    (151,825
    )
    
    
    (135,121
    )$
    55,741
    
    
    $
    36,310
 Other Assets Other assets at fiscal year-ends consist of the following (in thousands): 2004
    
    2003Investments
    
    $
    69,555
    
    
    $
    80,353Other
    
    
    44,608
    
    
    
    30,485$
    114,163
    
    
    $
    110,838
 Investments consist of non-marketable equity interests in early stage
technology companies and the Companys investment in Jazz. Goodwill During fiscal 2004, goodwill was adjusted as follows (in thousands): Goodwill, September 30, 2003
    
    $
    56,865Acquisitions, net of adjustments
    
    
    651,679Goodwill, September 30, 2004
    
    $
    708,544
 Intangible Assets Intangible assets at fiscal year-ends consist of the following (in thousands): 2004
    
    2003Gross
    
    Accumulated
    
    
    
    
    
    Gross
    
    AccumulatedAsset
    
    Amortization
    
    Net
    
    Asset
    
    Amortization
    
    NetDeveloped technology
    
    $
    145,946
    
    
    $
    (25,359
    )
    
    $
    120,587
    
    
    $
    15,904
    
    
    $
    (7,456
    )
    
    $
    8,448Customer base
    
    
    2,050
    
    
    
    (847
    )
    
    
    1,203
    
    
    
    2,050
    
    
    
    (358
    )
    
    
    1,692Other intangible assets
    
    
    20,908
    
    
    
    (7,457
    )
    
    
    13,451
    
    
    
    7,443
    
    
    
    (5,077
    )
    
    
    2,366$
    168,904
    
    
    $
    (33,663
    )
    
    $
    135,241
    
    
    $
    25,397
    
    
    $
    (12,891
    )
    
    $
    12,506
 Intangible assets are amortized over a weighted-average period of approximately
five years. Annual amortization expense is expected to be as follows (in
thousands): 2005
    
    2006
    
    2007
    
    2008
    
    2009Amortization expense
    
    $
    31,645
    
    
    $
    29,901
    
    
    $
    29,169
    
    
    $
    28,714
    
    
    $
    13,210
 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 September 30, 2004, the aggregate fair value
of the Mindspeed warrant was $26.6 million. The current portion of $3.6
million was determined using current pricing data, and the remaining portion
was determined using a Black-Scholes model with terms for portions of the 65




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CONEXANT SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) warrant varying from 1 to 5 years to coincide with the Companys intent and
ability to liquidate the warrant in installments, 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. Other Current Liabilities Included in other current liabilities at September 30, 2004 and 2003 are $5.8
million and $9.2 million, respectively, of royalty and technology license
liabilities. Other Expense, Net Other expense, net consists of the following (in thousands): 2004
    
    2003
    
    2002Investment and interest income
    
    $
    (7,742
    )
    
    $
    (15,622
    )
    
    $
    (13,116
    )Interest expense
    
    
    30,708
    
    
    
    28,120
    
    
    
    31,069Change in the fair value of the
conversion right under the Skyworks 15%
convertible senior subordinated notes
    
    
    6,292
    
    
    
    (9,402
    )
    
    
    Change in the fair value of the
Mindspeed warrant
    
    
    92,663
    
    
    
    (30,230
    )
    
    
    Gain on sale of investments
    
    
    (24,071
    )
    
    
    (8,618
    )
    
    
    Equity in (earnings) losses of equity
method investees
    
    
    (14,422
    )
    
    
    3,119
    
    
    
    3,864Write-down of non-marketable investments
    
    
    13,423
    
    
    
    39,402
    
    
    
    21,207Other
    
    
    2,957
    
    
    
    (961
    )
    
    
    (6,154
    )$
    99,808
    
    
    $
    5,808
    
    
    $
    36,870
 In fiscal 2004, an unrelated party repaid a $30.0 million note issued in
connection with a previous equity investment in an entity in which the Company
owns a 38% interest. In accordance with Staff Accounting Bulletin No. 51, the
Company recognized an $11.4 million gain upon the payment of this note, which
is included in equity in earnings of equity method investees. In fiscal 2004, SiRF Technology Holdings, Inc. (SiRF) completed its initial
public offering of shares of its common stock at a public offering price of
$12.00 per share. The Company sold approximately 2.5 million shares in the
SiRF offering for net proceeds of $28.2 million and recorded a related gain of
$26.5 million, which is included in gains on sales of investments above. In fiscal 2004, the Company sold a building for net cash proceeds of $22.8
million. A loss of $3.2 million was recognized on the sale. In fiscal 2003, the Company sold two of its investments in early stage
technology companies for cash of $15.0 million, with an additional $2.1 million
to be held in escrow for a period of up to eighteen months for potential buyer
indemnity claims. A gain of $8.6 million was recognized on these sales. During fiscal 2004, 2003 and 2002, the Company recorded charges of $13.4
million, $39.4 million and $21.2 million, respectively, to write down the
carrying values of certain non-marketable investments to their estimated fair
values (in most cases, zero). The investments consisted of equity interests in
early stage technology companies which the Company had accounted for under the
cost method. Management estimated the fair value of these investments based
upon available financial and other information, including then-current and
projected business prospects for the subject companies, and determined that the
decline in the fair value of these investments was other than temporary. 66




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CONEXANT SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) 8. Income Taxes The components of the provision (benefit) for income taxes on continuing
operations are as follows (in thousands): 2004
    
    2003
    
    2002Current:United States
    
    $
    (12,890
    )
    
    $
    (668
    )
    
    $
    (2,767
    )Foreign
    
    
    1,565
    
    
    
    457
    
    
    
    673State and local
    
    
    198
    
    
    
    (134
    )
    
    
    409Total current.
    
    
    (11,127
    )
    
    
    (345
    )
    
    
    (1,685
    )Deferred:United States
    
    
    254,286
    
    
    
    
    
    
    
    Foreign
    
    
    574
    
    
    
    216
    
    
    
    (153
    )State and local
    
    
    
    
    
    
    
    
    
    
    Total deferred
    
    
    254,860
    
    
    
    216
    
    
    
    (153
    )$
    243,733
    
    
    $
    (129
    )
    
    $
    (1,838
    )
 The total provision (benefit) for income taxes is recorded as follows (in
thousands): 2004
    
    2003
    
    2002Continuing operations
    
    $
    243,733
    
    
    $
    (129
    )

    
    $
    (1,838
    )Discontinued operations
    
    
    
    
    
    
    462
    
    
    
    3,848$
    243,733
    
    
    $
    333
    
    
    $
    2,010
 Deferred income tax assets and liabilities at fiscal year-ends consist of the
tax effects of temporary differences related to the following (in thousands): 2004
    
    2003Deferred tax assets:Inventories
    
    $
    28,757
    
    
    $
    17,002Property, plant and equipment
    
    
    28,979
    
    
    
    33,602Investments
    
    
    64,781
    
    
    
    64,781Deferred revenue
    
    
    7,150
    
    
    
    7,059Accrued compensation and benefits
    
    
    8,018
    
    
    
    6,747Product returns and allowances
    
    
    20,033
    
    
    
    13,219Retirement benefits and deferred compensation
    
    
    2,196
    
    
    
    16,621Intangible assets
    
    
    167,402
    
    
    
    10,234Capitalized research and development
    
    
    117,635
    
    
    
    65,060Net operating losses
    
    
    566,148
    
    
    
    364,866Research and development and investment
credits
    
    
    138,376
    
    
    
    120,748Other, net
    
    
    35,847
    
    
    
    9,107Valuation allowance
    
    
    (1,123,077
    )
    
    
    (413,049
    )Total deferred tax assets
    
    
    62,245
    
    
    
    315,997Deferred tax liabilities:Unrealized gains on investments
    
    
    
    
    
    
    (17,088
    )Deferred state taxes
    
    
    (62,245
    )
    
    
    (44,049
    )Total deferred tax liabilities
    
    
    (62,245
    )
    
    
    (61,137
    )Net deferred tax assets
    
    $
    
    
    
    $
    254,860
 In assessing the realizability of deferred tax assets, SFAS No. 109 establishes
a more likely than not standard. If it is determined that it is more likely
than not that deferred tax assets will not be realized, a valuation allowance
must be established against the deferred tax assets. The ultimate realization
of the assets is dependent on the generation of future taxable income during
the periods in which the associated temporary differences become deductible.
Management considers the scheduled reversal of deferred tax liabilities,
projected future taxable income and tax planning strategies when making this
assessment. SFAS No. 109 further states that forming a conclusion that a valuation
allowance is not required is difficult when there is negative evidence such as
cumulative losses in recent years. As a result of the Companys recent
cumulative losses, the Company concluded that a full valuation allowance was
required as of September 30, 2004. 67




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CONEXANT SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) The valuation allowance as of September 30, 2004 and 2003 was $1.1 billion and
$413.0 million, respectively. The net change in the valuation allowance for
fiscal 2004 was $710.0 million, which includes $386.0 million of net deferred
tax assets acquired in the Merger and $9.5 million related to stock option
exercises. To the extent the Company recognizes a future benefit from net
deferred tax assets acquired in the Merger, the benefit will be recorded to
goodwill. To the extent the Company obtains a tax benefit for the net
operating losses attributable to the stock option exercises, such amounts will
be recorded to shareholders equity. As of September 30, 2004, the Company has U.S. Federal net operating loss
carryforwards of approximately $1.6 billion which expire at various dates
through 2023 and aggregate state net operating loss carryforwards of
approximately $446.0 million which expire at various dates through 2014. The
Company also has U.S. Federal and state income tax credit carryforwards of
approximately $66.8 million and $71.6 million, respectively. The U.S. Federal
credits expire at various dates through 2023. The state credit carryforwards
include California Manufacturers Investment Credits of approximately $24.2
million which expire at various dates through 2010, while the remaining state
credits have no expiration date. Approximately $19.2 million of additional
California Manufacturers Investment Credit carryforward was generated while
the Company was part of Rockwell. Under the terms of the tax allocation
agreement with Rockwell, Conexant must pay Rockwell the benefits from such
portion of the credit carryforwards if they are realized. Tax benefits from the exercise of stock options (including payments received
from former affiliated companies, primarily Rockwell and Boeing, under tax
allocation agreements) totaling $0.5 million, $0.4 million and $1.2 million for
fiscal 2004, 2003 and 2002, respectively, were credited directly to
shareholders equity. A reconciliation of income taxes computed at the U.S. Federal statutory income
tax rate to the provision (benefit) for income taxes on continuing operations
follows (in thousands): 2004
    
    2003
    
    2002U.S. Federal statutory tax at 35%
    
    $
    (105,321
    )
    
    $
    8,202
    
    
    $
    (50,956
    )State taxes, net of federal effect
    
    
    (8,567
    )
    
    
    (3,444
    )
    
    
    (8,110
    )Foreign income taxes in excess of U.S
    
    
    (3,874
    )
    
    
    (822
    )
    
    
    5,831Research and development credits
    
    
    (9,682
    )
    
    
    (7,876
    )
    
    
    (9,453
    )Nondeductible amortization of intangible assets
    
    
    
    
    
    
    
    
    
    
    3,038In-process research and development
    
    
    56,286
    
    
    
    
    
    
    
    Valuation allowance
    
    
    314,569
    
    
    
    3,569
    
    
    
    53,902Other
    
    
    322
    
    
    
    242
    
    
    
    3,910Provision (benefit) for income taxes
    
    $
    243,733
    
    
    $
    (129
    )
    
    $
    (1,838
    )
 Income (loss) before income taxes from continuing operations consists of the
following components (in thousands): 2004
    
    2003
    
    2002United States
    
    $
    (318,097
    )
    
    $
    19,160
    
    
    $
    (130,416
    )Foreign
    
    
    17,181
    
    
    
    4,273
    
    
    
    (15,172
    )$
    (300,916
    )
    
    $
    23,433
    
    
    $
    (145,588
    )
 Certain of the Companys foreign income tax returns for the years 2001 through
2002 are currently under examination. Management believes that adequate
provision for income taxes has been made for all years, and the results of the
examinations will not have a material impact on the Companys financial
position, cash flows or results of operations. No provision has been made for U.S. Federal, state or additional foreign income
taxes which would be due upon the actual or deemed distribution of
approximately $38.0 million and $34.0 million of undistributed earnings of
foreign subsidiaries as of September 30, 2004 and 2003, respectively, which
have been or are intended to be permanently reinvested. 68




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CONEXANT SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) 9. Long-Term Debt The Company and its consolidated subsidiaries have three issues of convertible
subordinated notes, including the 5.25% Convertible Subordinated Notes which
were acquired in the Merger. At September 30, 2004, the components of
convertible subordinated notes are as follows (in thousands): 4.0% Convertible Subordinated Notes due February 2007 with a
conversion price of $42.43
    
    $
    515,0004.25% Convertible Subordinated Notes due May 2006 with a
conversion price of $9.08
    
    
    66,8255.25% Convertible Subordinated Notes due May 2006 with a
conversion price of $22.26
    
    
    130,000Total convertible subordinated notes
    
    $
    711,825
 In February 2004 in connection with the Merger, the Company assumed $130.0
million principal of 5.25% Convertible Subordinated Notes, which are unsecured
obligations of Conexant, Inc., are contractually subordinated in right of
payment to all senior indebtedness of Conexant, Inc., and mature on May 15,
2006. The holders may convert the notes into shares of Conexant common stock
at any time prior to maturity at a conversion price of $22.262 per share,
subject to adjustment. On and after May 20, 2004, Conexant, Inc. at its option
may redeem the notes at any time, in whole or in part, at the redemption price
shown in the notes, plus accrued interest, if any. In February 2000, the Company issued $650.0 million principal amount of its 4%
Convertible Subordinated Notes due February 2007 for net proceeds (after costs
of issuance) of approximately $631.0 million. The notes are general unsecured
obligations of the Company. Interest on the notes is payable in arrears
semiannually on each February 1 and August 1. The notes are convertible, at
the option of the holder, at any time prior to redemption or maturity into
shares of the Companys common stock at a current conversion price of $42.432
per share, subject to adjustment for certain events. The notes may be redeemed
at the Companys option at a declining premium to par. During fiscal 2001 and
2003, the Company purchased $35.0 million and $100.0 million, respectively,
principal amount of its 4% Convertible Subordinated Notes at prevailing market
prices, resulting in net gains of $11.7 million, and $42.0 million,
respectively. In May 1999, the Company issued $350.0 million principal amount of its 4.25%
Convertible Subordinated Notes due May 2006 for net proceeds (after costs of
issuance) of approximately $339.6 million. The notes are general unsecured
obligations of the Company. Interest on the notes is payable in arrears
semiannually on each May 1 and November 1. The notes are convertible, at the
option of the holder, at any time prior to redemption or maturity into shares
of the Companys common stock at a current conversion price of $9.075 per
share, subject to adjustment for certain events. The notes may be redeemed at
the Companys option at a declining premium to par. During fiscal 2001,
approximately $255.2 million principal amount of the Companys 4.25%
Convertible Subordinated Notes was converted into approximately 11.0 million
shares of common stock at a cost to the Company of $42.6 million. During fiscal
2002, the Company exchanged 2.2 million shares of its common stock for
approximately $28.0 million principal amount of its 4.25% Convertible
Subordinated Notes. In connection with the exchanges in fiscal 2002, the
Company recognized debt conversion costs of $10.4 million for the fair value of
the shares issued in excess of the number of shares issuable in a conversion of
the notes pursuant to their original terms. At September 30, 2004, the fair value of the convertible subordinated notes
(based on quoted market prices) was approximately $641.9 million compared to
their carrying value of $711.8 million. 10. Commitments 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 $21.3 million, $16.8 million and $13.0 million during
fiscal 2004, 2003 and 2002, respectively. 69




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CONEXANT SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) At September 30, 2004, future minimum lease payments under operating leases,
excluding any sublease income, were as follows (in thousands): Fiscal Year2005
    
    $
    28,8272006
    
    
    21,4452007
    
    
    16,7952008
    
    
    12,1142009
    
    
    9,172Thereafter
    
    
    62,097Total future minimum lease payments
    
    $
    150,450
 At September 30, 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 $8.5 million. The summary of future minimum lease payments includes an aggregate of $49.4
million of lease obligations that principally expire through fiscal 2021, which
have been accrued for in connection with the Companys restructuring actions
(see Note 15) 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. During the first two years of the supply
arrangement with Jazz, the Companys cost of wafers was an amount which
approximated its historical cost. Thereafter, the cost of wafers is based on
market prices. Additionally, the Company is obligated to purchase certain
minimum annual volumes of wafers during the first three years of the
arrangement. In the event the Companys actual wafer purchases are less than
the required minimum volumes, it will be required to make additional payments
to Jazz. The Companys expected minimum purchase obligations under the supply
agreement with Jazz, net of a portion of the wafer purchase obligations assumed
by a third party, will be approximately $14.0 million in fiscal 2005. The
Company is contingently liable for the approximate $12.0 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 during fiscal 2005 in the amount of $10.9 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 annual minimum purchase
obligations under the supply agreements with Jazz and Skyworks. At September 30, 2004, the Company is contingently liable for approximately
$17.5 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 $5.4 million as of September 30,
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 early calendar
2005. The Company has made commitments to certain employees in the amount of $5.9
million as of September 30, 2004. Such amounts will be earned and paid over
the next twelve months. In November 2004, the Company announced further restructuring actions. See
Note 18. 70




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CONEXANT SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) 11. Mindspeed Credit Facility In connection with the Mindspeed Spin, the Company entered into a senior
secured revolving credit facility pursuant to which Mindspeed may borrow up to
$50.0 million for working capital and general corporate purposes. Mindspeed
may borrow under the credit facility only to restore its cash balance to $25.0
million. Borrowings accrue interest at 10% per annum, payable at maturity, and
are collateralized by substantially all assets of Mindspeed. The credit
facility expires on June 29, 2007. As of September 30, 2004, no amounts were
outstanding under the credit facility. In connection with the credit facility, Mindspeed issued to the Company
warrants to purchase up to approximately 8.3 million shares of Mindspeed common
stock. The number of shares that may be acquired under the warrants will
depend on the level of borrowings under the credit facility, increasing pro
rata as the principal balance of Mindspeeds borrowings increases. The
warrants will be exercisable for a period of ten years after the Mindspeed Spin
at a price per share equal to the fair market value of a share of Mindspeed
common stock at the time of issuance of the warrants or at the time of the
borrowing that entitles the Company to acquire shares thereunder, whichever is
lower. In December 2004, the Mindspeed credit facility was terminated. See Note 18. 12. Contingencies Certain claims have been asserted against the Company, including claims
alleging the use of the intellectual property rights of others in certain of
the Companys products. The resolution of these matters may entail the
negotiation of a license agreement, a settlement, or the resolution of such
claims through arbitration or litigation. Texas Instruments, Inc.The Companys Conexant, Inc. (formerly
GlobespanVirata, 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. The
Company is a counterclaim defendant. Agere Systems, Inc.On October 17, 2002, Agere Systems, Inc. (Agere) filed suit
against Intersil Corporation (Intersil) in the U.S. District Court for the
District of Delaware. Conexant, Inc. (formerly GlobespanVirata, Inc.) acquired
the WLAN Group of Intersil in August 2003. Agere alleges that Intersil
infringes certain of its U.S. patents. Intersil has counterclaimed against
Agere for infringement of certain patents, some of which are now owned by the
Companys Conexant, Inc. subsidiary and licensed to Intersil for purposes of
the suit. The parties 71




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CONEXANT SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) have filed a stipulated order adding Conexant, Inc. as a party to the suit.
On July 22, 2003, Agere filed a separate suit against Intersil in the U.S.
District Court for the District of Delaware alleging that Intersil infringes
certain additional U.S. patents. Conexant, Inc. has also been added as a party
to this action. Conexant, Inc. believes it has the benefit of an indemnity
and/or warranty from Intersil which the Company believes limits Conexant,
Inc.s liability for monetary damages related to these suits, but the
possibility exists that the court could issue an injunction against future
sales of affected wireless products. It is unclear whether Intersil contests
its obligation to indemnify Conexant, Inc. However, the Company believes that
any challenge to Intersils obligation to indemnify Conexant, Inc. is without
merit. On October 30, 2002, Intersil and certain of its affiliated companies filed a
suit against Agere in the U.S. District Court for the Eastern District of
Pennsylvania alleging that Agere misappropriated certain Media Access Control
Wireless Local Area Network technology. This action seeks an injunction to
prevent Agere, either alone or in cooperation with others, from developing,
making, and/or selling products that use that technology. Agere has made
similar counterclaims against Conexant, Inc. and its affiliated companies and
Intersil and its affiliated companies. As a result of the acquisition of
Intersils WLAN Products Group and its Choice-Intersil Microsystems, Inc.
subsidiary, which is a party to this suit and the only remaining plaintiff,
Conexant, Inc. (formerly GlobespanVirata, Inc.) has become involved in this
suit. Conexant, Inc. believes it has the benefit of an indemnity and/or
warranty from Intersil which the Company believes limits Conexant, Inc.s
liability for monetary damages, but the possibility exists that the court could
issue an injunction against future sales of affected wireless products. It is
unclear whether Intersil contests its obligation to indemnify Conexant, Inc.
However, the Company believes that any challenge to Intersils obligation to
indemnify Conexant, Inc. is without merit. The Company settled these litigation matters with Agere in November 2004. See
Note 18. 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. The outcome of litigation cannot be predicted with certainty and some lawsuits,
claims or proceedings may be disposed of unfavorably to the Company. Many
intellectual property disputes have a risk of injunctive relief and there can
be no assurance that a license will be granted. Injunctive relief could have a
material adverse effect on the financial condition or results of operations of
the Company. Based on its evaluation of matters which are pending or asserted
and taking into account the Companys reserves for such matters, management
believes the disposition of such matters will not have a material adverse
effect on the financial condition or results of operations of the Company. 72




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CONEXANT SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) Conexant 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 $3.2
million and has accrued for these costs as of September 30, 2004. The Company has made guarantees and indemnities, under which it may be required
to make payments to a guaranteed or indemnified party, in relation to certain
transactions. In connection with the Companys spin-off from Rockwell, the
Company assumed responsibility for all contingent liabilities and then-current
and future litigation (including environmental and intellectual property
proceedings) against Rockwell or its subsidiaries in respect of the operations
of the semiconductor systems business of Rockwell. In connection with the
Companys contribution of certain of its manufacturing operations to Jazz, the
Company agreed to indemnify Jazz for certain environmental matters and other
customary divestiture-related matters. In connection with the sales of its
products, the Company provides intellectual property indemnities to its
customers. In connection with certain facility leases, the Company has
indemnified its lessors for certain claims arising from the facility or the
lease. The Company indemnifies its directors and officers to the maximum extent
permitted under the laws of the State of Delaware. The duration of the
guarantees and indemnities varies, and in many cases is indefinite. The
guarantees and indemnities to customers in connection with product sales
generally are subject to limits based upon the amount of the related product
sales. The majority of other guarantees and indemnities do not provide for any
limitation of the maximum potential future payments the Company could be
obligated to make. The Company has not recorded any liability for these
guarantees and indemnities in the accompanying consolidated balance sheets.
Product warranty costs are not significant. 13. Stock Plans The Companys authorized capital consists of 1,000,000,000 shares of common
stock, par value $0.01 per share, and 25,000,000 shares of preferred stock,
without par value, of which 1,500,000 shares are designated as Series A junior
participating preferred stock (the Junior Preferred Stock). The Company has a preferred share purchase rights plan to protect shareholders
rights in the event of a proposed takeover of the Company. A preferred share
purchase right (a Right) is attached to each share of common stock pursuant to
which the holder may, in certain takeover-related circumstances, become
entitled to purchase from the Company 1/200th of a share of Junior Preferred
Stock at a price of $300, subject to adjustment. Also, in certain
takeover-related circumstances, each Right (other than those held by an
acquiring person) will generally be exercisable for shares of the Companys
common stock or stock of the acquiring person having a market value of twice
the exercise price. In certain events, each Right may be exchanged by the
Company for one share of common stock or 1/200th of a share of Junior Preferred
Stock. The Rights expire on December 31, 2008, unless earlier exchanged or
redeemed at a redemption price of $0.01 per Right, subject to adjustment. Stock Options The Company has stock option plans and long-term incentive plans under which
employees and directors may be granted options to purchase shares of the
Companys common stock. As of September 30, 2004, approximately 36.0 million
shares are available for grant under the stock option and long-term incentive
plans. Stock options are generally granted with exercise prices at not less
than the fair market value at grant date, generally vest over four years and
expire eight or ten years after the grant date. The Company has also assumed
stock option plans in connection with the Merger. In September 2001, 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 $25.00 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. Approximately 73




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CONEXANT SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) 27.5 million options, with a weighted-average exercise price of $50.89 per
share, were tendered by employees and on October 2, 2001 those options were
accepted and cancelled by the Company. The Company undertook to grant new stock
options to the affected employees, on a one-for-one basis, at least six months
and one day after the acceptance of the old options for exchange and
cancellation. In April 2002, the Company granted new options to purchase an
aggregate of 26.7 million shares of its common stock at an exercise price of
$11.71 per share (based upon the closing market price of the Companys common
stock on the grant date), with vesting and other provisions substantially the
same as the old options. In connection with the Skyworks Spin in June 2002, each option holder, other
than holders of options granted to employees of the former Mindspeed
Technologies segment on March 30, 2001 and options held by persons in certain
foreign locations (Mindspeed March 30 options), received an option to purchase
an equal number of shares of Washington common stock. The exercise prices of
the outstanding Conexant options and the Washington options were adjusted so
that the aggregate intrinsic value of the options was equal to the intrinsic
value of the Conexant option immediately prior to the Skyworks Spin and the
ratio of the exercise price per share to the market value per share of each
option was the same immediately before and after the Skyworks Spin. Each
outstanding Washington option was converted into an option to purchase Skyworks
common stock based upon the exchange ratio in the Skyworks Spin. Mindspeed
March 30 options remained exercisable only for shares of Conexant common stock,
with appropriate adjustment to the number of shares and exercise prices thereof
such that the aggregate intrinsic value of the options was equal to the
intrinsic value of the options immediately prior to the Skyworks Spin and the
ratio of the exercise price per share to the market value per share of each
option was the same immediately before and after the Skyworks Spin. In connection with the Mindspeed Spin in June 2003, holders of options to
purchase Conexant common stock received options to purchase shares of Mindspeed
common stock. The number and exercise prices of the outstanding Conexant
options and the new Mindspeed options were adjusted so that the aggregate
intrinsic value of the options was equal to the intrinsic value of the Conexant
options immediately prior to the Mindspeed Spin. In connection with the Merger in February 2004, the Company issued 43.6 million
options to purchase Conexant common stock in exchange for the stock options
former GlobespanVirata employees held to purchase GlobespanVirata common stock
(see Note 2 of Notes to Consolidated Financial Statements). A summary of stock option activity follows (shares in thousands): 2004
    
    2003
    
    2002Weighted-
    
    
    
    
    
    Weighted-
    
    
    
    
    
    Weighted-Average
    
    
    
    
    
    Average
    
    
    
    
    
    AverageNumber of
    
    Exercise
    
    Number of
    
    Exercise
    
    Number of
    
    ExerciseShares
    
    Price
    
    Shares
    
    Price
    
    Shares
    
    PriceOutstanding at beginning of year
    
    
    81,089
    
    
    $
    3.02
    
    
    
    88,805
    
    
    $
    3.90
    
    
    
    80,029
    
    
    $
    25.36Granted
    
    
    19,984
    
    
    
    7.16
    
    
    
    16,529
    
    
    
    3.13
    
    
    
    31,762
    
    
    
    11.16Adjustments for the Skyworks Spin
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    17,029
    
    
    
    3.23Adjustments for the Mindspeed Spin
    
    
    
    
    
    
    
    
    
    
    (1,451
    )
    
    
    
    
    
    
    
    
    
    
    Assumed/exchanged in the Merger
    
    
    43,602
    
    
    
    3.45
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Exercised
    
    
    (8,015
    )
    
    
    2.73
    
    
    
    (8,320
    )
    
    
    2.85
    
    
    
    (2,775
    )
    
    
    5.15Cancelled
    
    
    (9,540
    )
    
    
    9.74
    
    
    
    (14,474
    )
    
    
    4.78
    
    
    
    (37,240
    )
    
    
    41.33Outstanding at end of year
    
    
    127,120
    
    
    
    4.78
    
    
    
    81,089
    
    
    
    3.02
    
    
    
    88,805
    
    
    
    3.90Exercisable at end of year
    
    
    83,024
    
    
    
    4.57
    
    
    
    52,109
    
    
    
    3.13
    
    
    
    50,683
    
    
    
    3.75
 74




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CONEXANT SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) The following table summarizes stock options outstanding at September 30, 2004
(shares in thousands): Outstanding
    
    ExercisableAverage
    
    Weighted-
    
    
    
    
    
    Weighted-Remaining
    
    Average
    
    
    
    
    
    AverageRange of
    
    Number
    
    Contractual
    
    Exercise
    
    Number
    
    ExerciseExercise Prices
    
    of Shares
    
    Life (Years)
    
    Price
    
    of Shares
    
    Price$ 0.20 - 2.62
    
    
    
    18,858
    
    
    
    4.58
    
    
    $
    1.69
    
    
    
    9,762
    
    
    $
    1.842.63
    
    
    
    18,215
    
    
    
    3.98
    
    
    
    2.63
    
    
    
    18,199
    
    
    
    2.632.64  3.44
    
    
    
    21,167
    
    
    
    4.43
    
    
    
    2.83
    
    
    
    15,251
    
    
    
    2.823.45
    
    
    
    16,636
    
    
    
    4.93
    
    
    
    3.45
    
    
    
    16,340
    
    
    
    3.453.46 5.21
    
    
    
    7,042
    
    
    
    6.68
    
    
    
    3.96
    
    
    
    3,454
    
    
    
    3.905.22
    
    
    
    4,045
    
    
    
    6.43
    
    
    
    5.22
    
    
    
    1,051
    
    
    
    5.225.23 - 7.35
    
    
    
    8,003
    
    
    
    4.11
    
    
    
    6.20
    
    
    
    5,163
    
    
    
    6.297.42
    
    
    
    18,614
    
    
    
    7.41
    
    
    
    7.42
    
    
    
    1,040
    
    
    
    7.427.45  10.34
    
    
    
    2,508
    
    
    
    4.42
    
    
    
    8.05
    
    
    
    2,309
    
    
    
    8.0310.35
    
    
    
    6,078
    
    
    
    6.92
    
    
    
    10.35
    
    
    
    4,585
    
    
    
    10.3510.36  96.93
    
    
    
    5,954
    
    
    
    4.37
    
    
    
    15.14
    
    
    
    5,870
    
    
    
    15.190.20  96.93
    
    
    
    127,120
    
    
    
    5.30
    
    
    
    4.78
    
    
    
    83,024
    
    
    
    4.57
 At September 30, 2004, of the 127.1 million stock options outstanding,
approximately 91.9 million were held by current employees and directors of the
Company, and approximately 35.2 million were held by employees of Rockwell, a
former Rockwell business, or a former business of the Company (i.e. Mindspeed,
Skyworks, etc.) who remain employed by one of these businesses. In November 2004, the Company modified certain outstanding stock options and
initiated a common stock option exchange program. See Note 18. Restricted Stock The Companys long-term incentive plans also provide for awards of restricted
shares of common stock and other stock-based incentive awards to officers and
other employees and certain non-employees of the Company. Restricted stock
awards are subject to forfeiture if employment terminates during the prescribed
retention period (generally within two years of the date of award) or, in
certain cases, if prescribed performance criteria are not met. During fiscal
2003 and 2002, the Company issued approximately 22,000 and 37,000 restricted
shares of common stock at weighted-average fair values per share of $2.06 and
$9.14, respectively. No shares of restricted stock were granted in fiscal
2004. The fair value of restricted stock awards is charged to expense over
the vesting period. In fiscal 2003 and 2002, the Company recorded compensation
expense of $0.7 million and $2.8 million, respectively, for the value of
restricted stock awards. Directors Stock Plan The Company has a Directors Stock Plan which provides for each non-employee
director to receive specified levels of stock option grants upon election to
the Board of Directors and periodically thereafter. Under the Directors Stock
Plan, each non-employee director may elect to receive all or a portion of the
cash retainer to which the director is entitled through the issuance of common
stock. During fiscal 2004, 2003 and 2002, the Company issued approximately
21,000, 60,000 and 29,000 shares, respectively, of common stock and
approximately 380,000, 460,000, and 80,000 stock options, respectively, under
the Director Stock Plan. As of September 30, 2004, an aggregate of
approximately 113,000 shares of the Companys common stock are available for
grant under the Directors Stock Plan. 75




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CONEXANT SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) Employee Stock Purchase Plan The Company has an employee stock purchase plan (ESPP) which allows eligible
employees to purchase shares of the Companys common stock at six-month
intervals during an offering period at 85% of the lower of the fair market
value on the first day of the offering period or on the purchase date. The
Company has reserved 42.1 million shares for delivery under the ESPP. Under
the ESPP, employees may authorize the Company to withhold up to 15% of their
compensation for each pay period to purchase shares under the plan, subject to
certain limitations, and employees are limited to the purchase of 2,000 shares
per offering period. Offering periods generally commence on the first trading
day of February and August of each year and are generally 24 months in
duration, but may be terminated earlier under certain circumstances. During
fiscal 2004, 2003 and 2002, the Company issued 4.0 million, 1.7 million and 3.4
million shares of common stock under the ESPP at weighted-average prices per
share of $1.88, $1.19 and $5.07, respectively. The weighted average per share
fair values of the employees purchase rights granted in fiscal 2004, 2003 and
2002 were $0.74, $1.12 and $1.80 using the Black-Scholes model. Other than an
expected life of six months, assumptions used are consistent with those used
for the Companys stock options plans (see Note 1). At September 30, 2004, an
aggregate of 30.2 million shares of the Companys common stock are available
for future purchases under the ESPP. Performance Plan Shares In fiscal 2002, the Company reserved 4.0 million shares of common stock for
issuance under various employee performance plans. During fiscal 2004, 2003
and 2002, the Company issued 256,987, 75,674 and 225,143 shares of common stock
at weighted-average per share prices of $6.31, $1.25 and $5.73, respectively,
under employee performance plans. At September 30, 2004, approximately 3.4
million shares of the Companys common stock are available for future grant.
Awards granted under the performance plans are subject to variable accounting. 14. Employee Benefit Plans Retirement Savings Plans The Company sponsors 401(k) retirement savings plans that allow eligible U.S.
employees to contribute a portion of their compensation, on a pre-tax or
after-tax basis, subject to annual limits. The Company may match employee
contributions in whole or part up to specified levels, and the Company may make
an additional discretionary contribution at fiscal year-end, based on the
Companys performance. Prior to June 4, 2004, all Company contributions to the
retirement savings plans were invested in shares of the Companys common stock
and were vested immediately. Since June 4, 2004, Company contributions are made
in cash, and are allocated based on the employees current investment
elections. Participants may choose to purchase shares of Company common stock
as one of their investment options in the plan. During fiscal 2002, the
Company issued 1.7 million shares of common stock under the retirement savings
plan at a weighted-average price per share of $8.07. No new shares were issued
in fiscal 2004 or 2003. Expense under the retirement savings plans was $4.8
million, $3.7 million and $5.5 million for fiscal 2004, 2003 and 2002,
respectively. Retirement Medical Plan The Company has a retirement medical plan which covers certain of its employees
and provides for medical payments to eligible employees and dependents upon
retirement. At the time of the spin-off from Rockwell, the Company ceased
offering retirement medical coverage to active salaried employees. Effective
January 1, 2003, the Company elected to wind-down this plan and it will be
phased out after December 31, 2007. Retirement medical expense, consisting
principally of interest accrued on the accumulated retirement medical
obligation and the effects of the wind-down of the plan beginning in fiscal
2003, was approximately $(3.2) million, $(1.5) million and $1.9 million in
fiscal 2004, 2003 and 2002, respectively. 76




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CONEXANT SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) The changes in the retirement medical obligation for the fiscal years ending
September 30 are as follows (in millions): 2004
    
    2003Change in benefit obligation:Benefit obligation at beginning of year
    
    $
    3.8
    
    
    $
    20.7Service cost
    
    
    
    
    
    
    Interest cost
    
    
    0.1
    
    
    
    0.8Plan participants contributions
    
    
    1.0
    
    
    
    0.7Effect of wind-down
    
    
    
    
    
    
    (22.6
    )Actuarial (gain) loss
    
    
    (0.3
    )
    
    
    6.9Benefits paid
    
    
    (2.7
    )
    
    
    (2.7
    )Benefit obligation at end of year
    
    
    1.9
    
    
    
    3.8Change in plan assets:Fair value of plan assets at beginning of year
    
    
    
    
    
    
    Actual return on plan assets
    
    
    
    
    
    
    Employer contribution
    
    
    1.6
    
    
    
    2.0Plan participants contributions
    
    
    1.1
    
    
    
    0.7Benefits paid
    
    
    (2.7
    )
    
    
    (2.7
    )Fair value of plan assets at end of year
    
    
    
    
    
    
    Funded status
    
    
    (1.9
    )
    
    
    (3.8
    )Unrecognized net actuarial loss
    
    
    6.7
    
    
    
    9.0Unrecognized prior service cost
    
    
    (18.5
    )
    
    
    (23.8
    )Accrued benefit cost
    
    $
    (13.7
    )
    
    $
    (18.6
    )
 The accrued benefit obligation is based on discount rates of 3.0% (2004) and
3.25% (2003), with the change attributable to the wind-down of the plan.
Increasing the health care cost trend rate by 1% would not increase the
accumulated retirement medical obligation at September 30, 2004 and would not
increase retirement medical expense due to the wind-down of the plan. Pension Plans In connection with a restructuring plan initiated in September 1998, the
Company offered a voluntary early retirement program (VERP) to certain salaried
employees. Pension benefits under the VERP are paid from a newly established
pension plan (the VERP Plan) of Conexant. Benefits payable under the VERP Plan
are equal to the excess of the total early retirement pension benefit over the
vested benefit obligation retained by Rockwell under a pension plan sponsored
by Rockwell prior to the Distribution. The Company also has certain pension
plans covering its non-U.S. employees and retirees. Prior to the formation of
Jazz in March 2002, the Company also had a pension plan covering certain hourly
employees, principally in its manufacturing operations, which was assumed by
Jazz. Net pension expense was approximately $1.2 million, $1.1 million and $1.2
million for fiscal 2004, 2003 and 2002, respectively. As of September 30, 2004
and 2003, the aggregate projected benefit obligation included in the
consolidated balance sheet was approximately $7.0 million and $11.7 million,
respectively. The pension obligations are based on a discount rate of 6.25%
(2004) and 6.0% (2003). The accrued pension liability at September 30, 2004
includes $6.7 million of additional minimum liability, not yet recognized in
net pension expense, which has been charged against accumulated other
comprehensive loss. 15. Special Charges Special charges consist of the following (in thousands): 2004
    
    2003
    
    2002Asset impairments
    
    $
    5,435
    
    
    $
    9,575
    
    
    $
    13,523Restructuring charges
    
    
    9,264
    
    
    
    5,215
    
    
    
    16,098Integration charges
    
    
    7,310
    
    
    
    
    
    
    
    Separation costs
    
    
    
    
    
    
    
    
    
    
    878Other
    
    
    10,792
    
    
    
    3,589
    
    
    
    $
    32,801
    
    
    $
    18,379
    
    
    $
    30,499
 77




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CONEXANT SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) Asset Impairments 2004 Impairments-During fiscal 2004, the Company recorded impairment charges
of $5.4 million, related to various Conexant operating assets which were
determined to be redundant and no longer required as a result of the Merger and
other subsequent actions. These assets have been abandoned. 2003 Impairments- During fiscal 2003, the Company recorded impairment charges
of $4.8 million, related to leasehold improvements associated with properties
no longer occupied by the Company and other assets that management determined
to abandon or scrap. In fiscal 2003, the Company sold certain manufacturing assets to Jazz
Semiconductor for $1.0 million. A $4.8 million impairment loss on these assets
held for sale was recognized in the quarter ended June 30, 2003. 2002 Impairments- In the first half of fiscal 2002, the Company recorded an
impairment charge of $13.0 million to write down the carrying value
(approximately $22.0 million) of the goodwill related to its digital imaging
business. The impairment charge resulted from the Companys exit of its digital
imaging business. Management evaluated the recoverability of the digital
imaging business assets to determine if their value was impaired. The amount of
the impairment charge was determined by comparing the assets estimated fair
values, less costs to sell, to their carrying values. The estimated fair values
were determined by management based upon all available information on the
proceeds expected to result from the disposition of the assets. Management
believes the assumptions used in estimating the fair values were reasonable and
the estimated fair values approximated the amounts that would be realized upon
the ultimate disposition of the related assets. The write-down established a
new cost basis for the impaired assets. The Company completed the planned
divestiture of its digital imaging business in July 2002. 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 statements of operations. The costs and expenses that relate 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). 2004 Restructuring Actions The Company has 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 November 2004, the Company announced
further plans to reduce its operating expense level by the end of the fourth
fiscal quarter of 2005 (see Note 18). 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 portion 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. 78




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CONEXANT SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) 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 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 September 30, 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
    
    
    $
    10,141
 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
employees will be leaving the Company through the December 2004 quarter.
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 recorded $5.1 million based on the estimates of the cost
of severance benefits for the affected employees and will charge an additional
$2.5 million to restructuring expense in future periods 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 September 30, 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
    
    
    $
    6,294
 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. 79




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##### Table of Contents



CONEXANT SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) Activity and liability balances related to the 2003 Corporate Restructuring
Plan through September 30, 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
    
    
    $
    1,995
 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 Skyworks Spin. In connection with the fiscal 2002
corporate and manufacturing restructuring actions, the Company terminated
approximately 120 employees and recorded charges aggregating $2.4 million based
upon estimates of the cost of severance benefits for the affected employees.
The Company completed these actions in fiscal 2002. In addition, the Company
recorded restructuring charges of $12.5 million for costs associated with the
consolidation of certain facilities and commitments under license obligations
that management determined would not be used in the future. As part of the 2002 Corporate and Manufacturing Restructuring Plan, during the
first quarter of fiscal 2003, the Company initiated a further workforce
reduction affecting 58 employees and recorded additional charges of $1.9
million based upon estimates of the cost of severance benefits for the affected
employees. During the third quarter of fiscal 2003, the Company revised its
estimate of liabilities for severance benefits and facility costs due to
unfavorable sublease experience to date, and charged an additional $1.5 million
to restructuring. 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 September 30, 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
    
    
    $
    3,997
 Through September 30, 2004, the Company has paid an aggregate of $36.5 million
in connection with all of its restructuring plans and has a remaining accrued
restructuring balance of $22.4 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. 80




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CONEXANT SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) Separation Costs In fiscal 2002, the Company incurred separation costs of approximately $0.9
million in connection with the divestiture of its Newport Beach wafer
fabrication operations and its digital imaging business. Integration Costs In fiscal 2004, the Company incurred $7.3 million of costs related to the
integration efforts of the employees, customers, operations and other business
aspects related to the Merger. Other Special Charges Other special charges for fiscal 2004 principally consist of stock option
modification charges of $0.8 million, approximately $1.2 million of one-time
executive bonuses which were contractually committed in the closing of the
Merger, $3.0 million related to a litigation settlement, and $5.8 million in
other special charges. Other special charges for fiscal 2003 principally consist of a $2.7 million
loss on the sale of certain semiconductor test equipment. 16. Related Party Transaction In connection with the Merger, the Company assumed loans originally made in
1999 by former GlobespanVirata, Inc. to certain executives of the Company.
Upon maturation of these loans, the full principal and interest amounts owed,
aggregating approximately $3.5 million, were settled with the Company receiving
$2.1 million in cash, taking back 0.5 million shares of common stock valued at
$0.8 million, and canceling $0.6 million of other liabilities owing to those
executives. 17. Segment Information Net revenues by geographic area are presented based upon the country of
destination. No other foreign country represented 10% or more of net revenues
for any of the fiscal years presented. Net revenues by geographic area were as
follows (in thousands): 2004
    
    2003
    
    2002United States
    
    $
    82,508
    
    
    $
    57,652
    
    
    $
    59,324Other Americas
    
    
    18,756
    
    
    
    11,086
    
    
    
    23,633Total Americas
    
    
    101,264
    
    
    
    68,738
    
    
    
    82,957Taiwan
    
    
    140,257
    
    
    
    88,369
    
    
    
    125,151China
    
    
    327,267
    
    
    
    211,642
    
    
    
    133,801Other Asia-Pacific
    
    
    200,674
    
    
    
    96,101
    
    
    
    81,094Total Asia-Pacific
    
    
    668,198
    
    
    
    396,112
    
    
    
    340,046Japan
    
    
    53,495
    
    
    
    84,943
    
    
    
    41,735Europe, Middle East and Africa
    
    
    78,897
    
    
    
    50,184
    
    
    
    56,988$
    901,854
    
    
    $
    599,977
    
    
    $
    521,726
 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 fiscal 2004, no customer accounted for 10% or more of net
revenues, for fiscal 2003, one customer (a foreign distributor) accounted for
11% of net revenues, and for fiscal 2002, one customer (a foreign distributor)
accounted for 12% of net revenues. No other customer accounted for 10% or more
of the Companys net revenues for fiscal 2003 or 2002. 81




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CONEXANT SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) Net revenues by product lines are as follows (in thousands): 2004
    
    2003
    
    2002Broadband/DSL
Access
Products
    
    $
    254,581
    
    
    $
    64,310
    
    
    $
    26,496Universal and Voice
Access Products
    
    
    323,073
    
    
    
    325,220
    
    
    
    256,655Wireless and
Networking
Components Products
and
Other
    
    
    110,014
    
    
    
    44,954
    
    
    
    61,828Broadband Media
Processing
Products
    
    
    214,186
    
    
    
    165,493
    
    
    
    176,747$
    901,854
    
    
    $
    599,977
    
    
    $
    521,726
 Long-lived assets consist of property, plant and equipment, goodwill,
intangible assets, the Mindspeed warrant and other assets. Long-lived assets by
geographic area at fiscal year ends were as follows (in thousands): 2004
    
    2003United States
    
    $
    1,152,444
    
    
    $
    323,918Europe, Middle East and Africa
    
    
    17,640
    
    
    
    10,222Other
    
    
    4,209
    
    
    
    1,609$
    1,174,293
    
    
    $
    335,749
 18. Subsequent Events On November 4, 2004, the Company settled its litigation matters with Agere (see
Note 12). Under the settlement, the Company made a cash payment to Agere in
the amount of $8.0 million in November 2004. The Company and Agere have agreed
to dismiss all claims with prejudice against each other as described in Note
12, and have also entered into various license agreements covering the patents
involved in the suits and other semiconductor devices. The Company had
previously reserved $5.0 million for this litigation matter. The unreserved
portion of this settlement of $3.0 million has been recorded as a special
charge in the accompanying consolidated statement of operations for the year
ended September 30, 2004. On November 5, 2004, the Companys Board of Directors approved a modification
of the outstanding warrant to purchase approximately 2.3 million shares of
Companys common stock held by Jazz (see Note 4). The expiration date has been
extended by two years, to January 2007. Additionally, outstanding options to
purchase approximately 1.6 million shares of the Companys common stock held by
current employees of Jazz were modified to extend the expiration date by two
years, to December 31, 2006. The non-cash stock compensation charges
associated with these two modifications will be recorded in fiscal 2005. On November 9, 2004, the Companys Board of Directors appointed Dwight W.
Decker as chief executive officer in addition to his existing role of Chairman
of the Board, replacing Armando Geday, who resigned from his position of chief
executive officer for personal reasons. On November 12, 2004, Mr. Geday also
resigned as a director of the Company. On November 9, 2004, the Company also announced a restructuring plan to reduce
operating expenses by increasing the shift of production development resources
to lower-cost regions and continued Merger-related sales, general and
administrative expense consolidation. Charges associated with the
restructuring plan will be recorded during fiscal 2005. 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 can 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
are also required to exchange all options granted within six months of the
exchange offer. The offering period expires December 13, 2004, unless extended.
Under the terms of the offer, exchanged stock options will be cancelled, and
new options will be granted at an exercise price equal to the closing market
price of the Companys common stock at a date that is at least six months and
one day after the acceptance of the old options. 82




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CONEXANT SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) On December 3, 2004, the Company purchased all the outstanding capital stock of
Paxonet Communications, Inc., a privately held company headquartered in
Fremont, California, with an engineering workforce primarily based in India.
The purchase price was approximately $15.0 million in cash. On December 2, 2004 the Company and Mindspeed amended the Mindspeed credit
facility as described in Note 11. On December 8, 2004, Mindspeed completed a
$46.0 million convertible senior note offering, thereby terminating the credit
facility in accordance with the amended credit facility agreement. 83




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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To The Board of Directors and Shareholders of Conexant
Systems, Inc.: We have audited the accompanying consolidated balance sheets of Conexant
Systems, Inc. and subsidiaries (the Company) as of September 30, 2004 and
2003, and the related consolidated statements of operations, cash flows, and
shareholders equity and comprehensive loss for each of the three years in the
period ended September 30, 2004. Our audits also included the financial
statement schedule listed at Item 15(a)(2). These financial statements and the
financial statement schedule are the responsibility of the Companys
management. Our responsibility is to express an opinion on these financial
statements and the financial statement schedule based on our audits. We conducted our audits in accordance with standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we
plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of the Company and its
subsidiaries at September 30, 2004 and 2003, and the results of their
operations and their cash flows for each of the three years in the period ended
September 30, 2004, in conformity with accounting principles generally accepted
in the United States of America. Also, in our opinion, the related financial
statement schedule, when considered in relation to the basic consolidated
financial statements taken as a whole, presents fairly, in all material
respects, the information set forth therein. As discussed in Note 1 to the consolidated financial statements, the Company
changed its method of accounting for goodwill and intangible assets during the
year ended September 30, 2003 as a result of adopting Statement of Financial
Accounting Standards No. 142, Goodwill and Intangible Assets. As discussed in Note 3 to the consolidated financial statements, on June 27,
2003, the Company completed the spin-off of its Mindspeed Technologies
business. The consolidated financial statements referred to above have been
restated to report the Mindspeed Technologies business as a discontinued
operation for all periods presented. /s/ DELOITTE & TOUCHE LLP Costa Mesa, California
November 2, 2004, except for Note 18, as to which the     date
is December 8, 2004 84




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Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure Not applicable. 
 Item 9A. 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. The Company
is evaluating measures to remedy the deficiencies and will implement actions to
enhance the Companys internal controls. Except as described above, there were no changes in the Companys internal
control over financial reporting during the fiscal quarter ended September 30,
2004 that have materially affected, or are reasonably likely to materially
affect, the Companys internal control over financial reporting. 
 Item 9B. Other Information Not applicable. 
 PART III Certain information required by Part III is omitted from this Annual Report in
that the Registrant will file its definitive Proxy Statement for the Annual
Meeting of Shareowners to be held on February 23, 2005 pursuant to Regulation
14A of the Securities Exchange Act of 1934 (the Proxy Statement) not later than
120 days after the end of the fiscal year covered by this Annual Report, and
certain information included in the Proxy Statement is incorporated herein by
reference. 
 Item 10. Directors and Executive Officers of the Registrant  (a)
    
    Executive Officers  See Executive Officers in Part I, Item 1 hereof.(b)
    
    Directors  The information required by this Item is incorporated herein
by reference to the section entitled Election of Directors in the Proxy
Statement.(c)
    
    Audit Committee Financial Expert  The board of directors has determined
that D. Scott Mercer, Chairman of the Audit Committee, is an audit
committee financial expert and independent as defined under applicable
SEC and Nasdaq rules. The boards affirmative determination was based,
among other things, upon his extensive 85




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##### Table of Contents



experience as chief financial officer of Western Digital Corporation and,
prior to that, as Vice President, Finance, European Operations of Dell Inc.(d)
    
    The Company has adopted its Standards of Business Conduct, a code of
ethics that applies to all employees, including its executive officers. A
copy of the Standards of Business Conduct is posted on the Companys
Internet site at http://www.conexant.com. In the event that the Company
makes any amendment to, or grants any waivers of, a provision of the
Standards of Business Conduct that applies to the principal executive
officer, principal financial officer, or principal accounting officer that
requires disclosure under applicable SEC rules, the Company intends to
disclose such amendment or waiver and the reasons therefor on its Internet
site. 
 Item 11. Executive Compensation The information required by this Item is incorporated herein by reference to
the sections entitled Executive Compensation and Directors Compensation in
the Proxy Statement. 
 Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters The information required by this Item is incorporated herein by reference to
the sections entitled Security Ownership of Certain Beneficial Owners and
Management and Equity Compensation Plan Information in the Proxy Statement. 
 Item 13. Certain Relationships and Related Transactions The information required by this Item is incorporated herein by reference to
the section entitled Certain Relationships and Related Transactions in the
Proxy Statement. 
 Item 14. Principal Accountant Fees and Services The information required by this Item is incorporated herein by reference to
the section entitled Principal Accountant Fees and Services in the Proxy
Statement. 
 PART IV 
 Item 15. Exhibits and Financial Statement Schedules (a)(1) Financial Statements The following consolidated financial statements of the Company for the fiscal
year ended September 30, 2004 are included herewith: Consolidated Balance Sheets, Consolidated Statements of Operations,
Consolidated Statements of Cash Flows, Consolidated Statements of Shareholders
Equity and Comprehensive Loss, Notes to Consolidated Financial Statements, and
Report of Deloitte & Touche LLP, Independent Registered Public Accounting Firm (2) Supplemental Schedules Schedule II - Valuation and Qualifying Accounts 86




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All other schedules have been omitted since the required information is not
present in amounts sufficient to require submission of the schedule, or because
the required information is included in the consolidated financial statements
or notes thereto. (3) Exhibits Exhibits
    
    Description3-a-1
    
    
    Amended and Restated Certificate of Incorporation of the Company,
as amended, filed as Exhibit 3.a.1 to the Companys Quarterly
Report on Form 10-Q for the quarter ended March 31, 2004, is
incorporated herein by reference.3-a-2
    
    
    Amended By-Laws of the Company, filed as Exhibit 3.b.1 to the
Companys Quarterly Report on Form 10-Q for the quarter ended
March 31, 2004, is incorporated herein by reference.4-a-1
    
    
    Rights Agreement, dated as of November 30, 1998, by and between
the Company and Mellon Investor Services (formerly ChaseMellon
Shareholder Services, L.L.C.), as rights agent, filed as Exhibit
4.4 to the Companys Registration Statement on Form S-8
(Registration No. 333-68755), is incorporated herein by
reference.4-a-2
    
    
    First Amendment to Rights Agreement, dated as of December 9,
1999, filed as Exhibit 4.1 to the Companys Quarterly Report on
Form 10-Q for the quarter ended December 31, 1999, is
incorporated herein by reference.4-b-1
    
    
    Indenture, dated as of May 1, 1999, between the Company and Bank
One Trust Company, National Association, as successor to The
First National Bank of Chicago, as trustee, including the form of
the Companys 41⁄4% Convertible Subordinated Notes Due May 1,
2006 attached as Exhibit A thereto, filed as Exhibit 4.1 to the
Companys Registration Statement on Form S-3 (Registration No.
333-82399), is incorporated herein by reference.4-b-2
    
    
    Indenture, dated as of February 1, 2000, between the Company and
Bank One Trust Company, National Association, as trustee,
including the form of the Companys 4% Convertible Subordinated
Notes Due February 1, 2007 attached as Exhibit A thereto, filed
as Exhibit 4.04 to the Companys Registration Statement on Form
S-4 (Registration No. 333-96033), is incorporated herein by
reference.4-b-3
    
    
    Indenture, dated as of May 11, 2001, between GlobespanVirata,
Inc. (now named Conexant, Inc.) and The Bank of New York
(successor to United States Trust Company of New York), as
Trustee, including the form of 5.25% Convertible Subordinated
Note due 2006 of GlobespanVirata, Inc. attached as Exhibit A
thereto, filed as Exhibit 4.1 to GlobespanVirata, Inc.s Current
Report on Form 8-K dated May 15, 2001 (File No. 000-26401), is
incorporated herein by reference.4-b-4
    
    
    First Supplemental Indenture, dated as of February 27, 2004,
between GlobespanVirata, Inc. (now named Conexant, Inc.) and The
Bank of New York (successor to United States Trust Company of New
York), as Trustee, filed as Exhibit 4.2 to the Companys
Quarterly Report on Form 10-Q for the quarter ended March 31,
2004, is incorporated herein by reference.*10-a-1
    
    
    Conexant Systems, Inc. 1998 Stock Option Plan, filed as Exhibit
10.6 to the Companys Registration Statement on Form 10 (File No.
000-24923), is incorporated herein by reference.*10-a-2
    
    
    Copy of resolution of the Board of Directors of the Company,
adopted March 1, 1999, amending the Companys 1998 Stock Option
Plan, filed as Exhibit 10-b-2 to the Companys Annual Report on
Form 10-K for the year ended September 30, 1999, is incorporated
herein by reference.*10-a-3
    
    
    Forms of Stock Option Agreements under Rockwells 1988 Long-Term
Incentives Plan for options granted after November 1, 1993 and
prior to December 1, 1994, filed as Exhibit 10-d-6 to Rockwells
Annual Report on Form 10-K for the year ended September 30, 1993
(File No. 1-1035), are incorporated herein by reference.*10-a-4
    
    
    Forms of Stock Option Agreements under Rockwells 1988 Long-Term
Incentives Plan for options granted after December 1, 1994, filed
as Exhibit 10-d-7 to Rockwells Annual Report on
 87




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##### Table of Contents



Exhibits
    
    DescriptionForm 10-K for
the year ended September 30, 1994 (File No. 1-1035), are
incorporated herein by reference.*10-a-5
    
    
    Forms of Stock Option Agreements under Rockwells 1995 Long-Term
Incentives Plan for options granted prior to December 3, 1997,
filed as Exhibit 10-e-2 to Rockwells Annual Report on Form 10-K
for the year ended September 30, 1994 (File No. 1-1035), are
incorporated herein by reference.*10-a-6
    
    
    Forms of Stock Option Agreements under Rockwells 1995 Long-Term
Incentives Plan for options granted between December 3, 1997 and
August 31, 1998, filed as Exhibit 10-b-3 to Rockwells Annual
Report on Form 10-K for the year ended September 30, 1998 (File
No. 1-12383), are incorporated herein by reference.*10-a-7
    
    
    Form of Stock Option Agreement under Rockwells 1995 Long-Term
Incentives Plan for options granted on April 23, 1998, filed as
Exhibit 10-b-4 to Rockwells Annual Report on Form 10-K for the
year ended September 30, 1998 (File No. 1-12383), is incorporated
herein by reference.*10-a-8
    
    
    Form of Stock Option Agreement under Rockwells 1995 Long-Term

Incentives Plan for options granted on August 31, 1998, filed as
Exhibit 10-b-5 to Rockwells Annual Report on Form 10-K for the
year ended September 30, 1998 (File No. 1-12383), is incorporated
herein by reference.*10-a-9
    
    
    Form of Stock Option Agreement under Rockwells Directors Stock
Plan, filed as Exhibit 10-d to Rockwells Quarterly Report on
Form 10-Q for the quarter ended March 31, 1996 (File No. 1-1035),
is incorporated herein by reference.*10-a-10
    
    
    Copy of resolution of the Board of Directors of Rockwell, adopted
November 6, 1996, adjusting outstanding awards under Rockwells
(i) 1988 Long-Term Incentives Plan, (ii) 1995 Long-Term
Incentives Plan and (iii) Directors Stock Plan, filed as Exhibit
4-g-2 to Rockwells Registration Statement on Form S-8
(Registration No. 333-17055), is incorporated herein by
reference.*10-a-11
    
    
    Copy of resolution of the Board of Directors of Rockwell, adopted
September 3, 1997, adjusting outstanding awards under Rockwells
(i) 1988 Long-Term Incentives Plan, (ii) 1995 Long-Term
Incentives Plan and (iii) Directors Stock Plan, filed as Exhibit
10-e-3 to Rockwells Annual Report on Form 10-K for the year
ended September 30, 1997 (File No. 1-12383), is incorporated
herein by reference.*10-a-12
    
    
    Copy of resolution of the Board of Directors of Rockwell, adopted
December 2, 1998, assigning to the Company outstanding options to
purchase shares of Company Common Stock, filed as Exhibit 4.f.4
to the Companys Registration Statement on Form S-3 (Registration
No. 333-70085), is incorporated herein by reference.*10-a-13
    
    
    Copy of resolution of the Board of Directors of the Company,
adopted November 30, 1998, assuming outstanding options to
purchase shares of Company Common Stock, filed as Exhibit 4.f.5
to the Companys Registration Statement on Form S-3 (Registration
No. 333-70085), is incorporated herein by reference.*10-b-1
    
    
    Conexant Systems, Inc. 1999 Long-Term Incentives Plan, as
amended, filed as Exhibit 4.7 to the Companys Registration
Statement on Form S-8 (Registration No. 333-37918), is
incorporated herein by reference.*10-b-2
    
    
    Copy of resolution of the Board of Directors of the Company,
adopted April 20, 1999, amending the Companys 1999 Long-Term
Incentives Plan, filed as Exhibit 10-c-2 to the Companys Annual
Report on Form 10-K for the year ended September 30, 1999, is
incorporated herein by reference.*10-b-3
    
    
    Form of Stock Option Agreement under the Companys 1999 Long-Term
Incentives Plan, filed as Exhibit 10.1 to the Companys Quarterly
Report on Form 10-Q for the quarter ended March 31, 1999, is
incorporated herein by reference.*10-b-4
    
    
    Form of Restricted Stock Agreement (Performance Vesting) under
the Companys 1999 Long-Term Incentives Plan, filed as Exhibit
10.2 to the Companys Quarterly Report on Form 10-Q for the
quarter ended March 31, 1999, is incorporated herein by
reference.
 88




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##### Table of Contents



Exhibits
    
    Description*10-b-5
    
    
    Form of Restricted Stock Agreement (Time Vesting) under the
Companys 1999 Long-Term Incentives Plan, filed as Exhibit 10.3
to the Companys Quarterly Report on Form 10-Q for the quarter
ended March 31, 1999, is incorporated herein by reference.*10-b-6
    
    
    Memorandum of Adjustments to Outstanding Options Under the
Conexant Stock Plans approved and adopted by the Board of
Directors of the Company on May 9, 2002, as amended June 13,

2002, in connection with the Skyworks Spin, filed as Exhibit
10-b-9 to the Companys Annual Report on Form 10-K for the year
ended September 30, 2002, is incorporated herein by reference.*10-b-7
    
    
    Memorandum of Proposed Amendments to the Conexant Systems, Inc.
Stock Option Plans adopted by the Board of Directors of the
Company on June 13, 2002 in connection with the Skyworks Spin,
filed as Exhibit 10-b-10 to the Companys Annual Report on Form
10-K for the year ended September 30, 2002, is incorporated
herein by reference.*10-b-8
    
    
    Memorandum of Adjustments to Outstanding Options Under the
Conexant Stock Plans approved and adopted by the Board of
Directors of the Company on June 5, 2003 in connection with the
Mindspeed Spin, filed as Exhibit 10-b-11 to the Companys Annual
Report on Form 10-K for the year ended September 30, 2003, is
incorporated herein by reference.*10-b-9
    
    
    Memorandum of Proposed Amendments to the Conexant Systems, Inc.
Stock Option Plans adopted by the Board of Directors of the
Company on June 5, 2003 in connection with the Mindspeed Spin,
filed as Exhibit 10-b-12 to the Companys Annual Report on Form
10-K for the year ended September 30, 2003, is incorporated
herein by reference.*10-c-1
    
    
    Conexant Systems, Inc. Retirement Savings Plan, as amended, filed
as Exhibit 4.5 to the Companys Registration Statement on Form
S-8 (Registration No. 333-73142), is incorporated herein by
reference.*10-d-1
    
    
    Copy of resolutions of the Board of Directors of the Company,
adopted August 13, 1999 amending, among other things, the
Companys 1999 Long-Term Incentives Plan, filed as Exhibit 10-e-1
to the Companys Annual Report on Form 10-K for the year ended
September 30, 1999, is incorporated herein by reference.*10-e-1
    
    
    Conexant Systems, Inc. Directors Stock Plan, as amended, filed as
Exhibit 4.5 to the Companys Registration Statement on Form S-8
(Registration No. 333-113395), is incorporated herein by
reference.*10-f-1
    
    
    Conexant Systems, Inc. 2000 Non-Qualified Stock Plan, as amended,
filed as Exhibit (D) (2) to the Companys Amendment No. 2 to
Schedule TO dated December 1, 2004, is incorporated herein by
reference.*10-f-2
    
    
    Resolutions adopted by the Board of Directors of the Company on
February 25, 2004 with respect to the use of shares available
under certain GlobespanVirata, Inc. stock plans for future grants
under the Conexant Systems, Inc. 2000 Non-Qualified Stock Plan,
filed as Exhibit 4.5.2 to the Companys Registration Statement on
Form S-8 (Registration No. 333-113595), is incorporated herein by
reference.*10-f-3
    
    
    Form of Stock Option Agreement under the Conexant Systems, Inc.
2000 Non-Qualified Stock Plan, as amended.*10-g-1
    
    
    Conexant Systems, Inc. GlobespanVirata, Inc. 1999 Equity
Incentive Plan, as amended, filed as Exhibit 4.5.1 to the
Companys Registration Statement on Form S-8 (Registration No.
333-113399), is incorporated herein by reference.*10-h-1
    
    
    Conexant Systems, Inc. GlobespanVirata, Inc. 1999 Supplemental
Stock Option Plan, as amended, filed as Exhibit 4.5.2 to the
Companys Registration Statement on Form S-8 (Registration No.
333-113399), is incorporated herein by reference.*10-i-1
    
    
    Conexant Systems, Inc. Amended and Restated GlobespanVirata, Inc.
1999 Stock Incentive Plan, as amended, filed as Exhibit 4.5.3 to
the Companys Registration Statement on Form S-8 (Registration
No. 333-113399), is incorporated herein by reference.*10-j-1
    
    
    Conexant Systems, Inc. 2004 New-Hire Equity Incentive Plan, filed
as Exhibit 99.1 to the Companys Registration Statement on Form
S-8 (Registration No. 333-115983), is incorporated
 89




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##### Table of Contents



Exhibits
    
    Descriptionherein by reference.*10-j-2
    
    
    Form of Stock Option Agreement under the Conexant Systems, Inc.
2004 New-Hire Equity Incentive Plan.*10-k-1
    
    
    Employment Agreement dated December 15, 1998 filed as Exhibit
10.5 to the Companys Quarterly Report on Form 10-Q for the
quarter ended December 31, 1998, is incorporated herein by
reference.*10-k-2
    
    
    Schedule identifying agreements substantially identical to the
Employment Agreement constituting Exhibit 10-k-1 hereto entered
into by the Company with L.C. Brewster, D.E. OReilly and F.M.
Rhodes, filed as Exhibit 10-f-2 to the Companys Annual Report on
Form 10-K for the year ended September 30, 2003, is incorporated
herein by reference.*10-k-3
    
    
    Employment Agreement dated December 15, 1998 between the Company
and D.W. Decker, filed as Exhibit 10.7 to the Companys Quarterly
Report on Form 10-Q for the quarter ended December 31, 1998, is
incorporated herein by reference.*10-k-4
    
    
    Agreement dated March 28, 2003 between the Company and B.S. Iyer,
filed as Exhibit 10.1 to the Companys Quarterly Report on Form
10-Q for the quarter ended March 31, 2003, is incorporated herein
by reference.***10-k-5
    
    
    Employment Agreement dated as of December 18, 2002 by and between
the Company and J.S. Blouin, filed as Exhibit 10-f-5 to the
Companys Annual Report on Form 10-K for the year ended September
30, 2003, is incorporated herein by reference.*10-k-6
    
    
    General Agreement dated as of September 30, 2003 by and between
the Company and D.E. OReilly, filed as Exhibit 10-f-6 to the
Companys Annual Report on Form 10-K for the year ended September
30, 2003, is incorporated herein by reference.*10-k-7
    
    
    Employment Agreement between the Company and D.W. Decker dated as
of January 15, 2004, filed as Exhibit 10.a to the Companys
Registration Statement on Form S-4 (Registration No. 333-111179),
is incorporated herein by reference.*10-k-8
    
    
    Employment Agreement between the Company and A. Geday dated as of
January 15, 2004, filed as Exhibit 10.b to the Companys
Registration Statement on Form S-4 (Registration No. 333-111179),
is incorporated herein by reference.*10-k-9
    
    
    Employment Agreement between the Company and F.M. Rhodes dated as
of January 15, 2004, filed as Exhibit 10.c to the Companys
Registration Statement on Form S-4 (Registration No. 333-111179),
is incorporated herein by reference.*10-k-10
    
    
    Employment Agreement between the Company and D.E. OReilly dated
as of January 15, 2004, filed as Exhibit 10.e to the Companys
Registration Statement on Form S-4 (Registration No. 333-111179),
is incorporated herein by reference.*10-k-11
    
    
    Employment Agreement between the Company and C.M. Powell dated as
of January 15, 2004, filed as Exhibit 10.f to the Companys
Registration Statement on Form S-4 (Registration No. 333-111179),
is incorporated herein by reference.*10-k-12
    
    
    Amendment dated as of February 27, 2004 to Employment Agreement
between the Company and J.S. Blouin, filed as Exhibit 10.1 to the
Companys Quarterly Report on Form 10-Q for the quarter ended
March 31, 2004, is incorporated herein by reference.*10-k-13
    
    
    Employment Agreement between the Company and L.C. Brewster dated
as of February 27, 2004, filed as Exhibit 10.2 to the Companys
Quarterly Report on Form 10-Q for the quarter ended March 31,
2004, is incorporated herein by reference.*10-k-14
    
    
    Amendment dated November 12, 2004 between the Company and F.M.
Rhodes to Employment Agreement dated as of January 15, 2004
between the Company and F.M. Rhodes, filed as Exhibit 10 to the
Companys Current Report on Form 8-K dated November 15, 2004, is
incorporated herein by reference.10-l-1
    
    
    Distribution Agreement dated as of December 31, 1998 by and
between the Company and Rockwell International Corporation, filed
as Exhibit 2.1 to the Companys Current Report on Form 8-K dated
January 12, 1999, is incorporated herein by reference.10-m-1
    
    
    Contribution and Distribution Agreement dated as of December 16,
2001, as amended as of June
 90




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##### Table of Contents



Exhibits
    
    Description25, 2002, by and between the Company
and Washington (excluding schedules) filed as Exhibit 2.2 to the
Companys Current Report on Form 8-K dated July 1, 2002, is
incorporated herein by reference.10-m-2
    
    
    Employee Matters Agreement dated as of June 25, 2002 by and among
the Company, Washington and Alpha (excluding schedules) filed as
Exhibit 2.3 to the Companys Current Report on Form 8-K dated
July 1, 2002, is incorporated herein by reference.10-m-3
    
    
    Tax Allocation Agreement dated as of June 25, 2002 by and among
the Company, Washington and Alpha (excluding schedules) filed as
Exhibit 2.4 to the Companys Current Report on Form 8-K dated
July 1, 2002, is incorporated herein by reference.10-n-1
    
    
    Distribution Agreement dated as of June 25, 2003, by and between
the Company and Mindspeed Technologies, Inc. (excluding
schedules) filed as Exhibit 2.1 to the Companys Current Report
on Form 8-K dated July 1, 2003, is incorporated herein by
reference.10-n-2
    
    
    Employee Matters Agreement dated as of June 27, 2003 by and
between the Company and Mindspeed (excluding schedules) filed as
Exhibit 2.2 to the Companys Current Report on Form 8-K dated
July 1, 2003, is incorporated herein by reference.10-n-3
    
    
    Tax Allocation Agreement dated as of June 27, 2003 by and between
the Company and Mindspeed (excluding schedules) filed as Exhibit
2.3 to the Companys Current Report on Form 8-K dated July 1,
2003, is incorporated herein by reference.10-n-4
    
    
    Credit Agreement dated as of June 27, 2003 by and among
Mindspeed, the subsidiaries of Mindspeed from time to time
parties thereto and the Company, filed as Exhibit 2.5 to the
Companys Current Report on Form 8-K dated July 1, 2003, is
incorporated herein by reference.10-o-1
    
    
    Capacity & Reservation Deposit Agreement dated as of March 20,
2000 by and between the Company and UMC Group (USA), filed as
Exhibit 10-k-1 to the Companys Annual Report on Form 10-K for
the year ended September 30, 2002, is incorporated herein by
reference. **10-o-2
    
    
    Amendment No. 1 to Capacity & Reservation Deposit Agreement dated
as of March 24, 2000 between the Company and UMC Group (USA),
filed as Exhibit 10-k-2 to the Companys Annual Report on Form
10-K for the year ended September 30, 2002, is incorporated
herein by reference.10-o-3
    
    
    Amendment No. 2 to Capacity & Reservation Deposit Agreement dated
as of August 1, 2000 between the Company and UMC Group (USA),
filed as Exhibit 10-k-3 to the Companys Annual Report on Form
10-K for the year ended September 30, 2002, is incorporated
herein by reference. **10-o-4
    
    
    Amendment No. 3 to Capacity & Reservation Deposit Agreement dated
as of May 17, 2001 between the Company and UMC Group (USA), filed
as Exhibit 10-k-4 to the Companys Annual Report on Form 10-K for
the year ended September 30, 2002, is incorporated herein by
reference. **10-o-5
    
    
    Amendment No. 4 to Capacity & Reservation Deposit Agreement dated
as of August 24, 2001 between the Company and UMC Group (USA),
filed as Exhibit 10-k-5 to the Companys Annual Report on Form
10-K for the year ended September 30, 2002, is incorporated
herein by reference. **10-o-6
    
    
    Foundry Agreement dated as of July 27, 2000 by and between the
Company and UMC Group (USA), filed as Exhibit 10-k-6 to the
Companys Annual Report on Form 10-K for the year ended September
30, 2002, is incorporated herein by reference. **10-p-1
    
    
    Wafer Supply and Services Agreement dated as of March 30, 2002 by
and between Specialtysemi, Inc. (now named Jazz Semiconductor,
Inc.) and the Company, filed as Exhibit 10.1 to the Companys
Quarterly Report on Form 10-Q for the quarter ended March 31,
2002, is incorporated herein by reference. ***10-q-1
    
    
    Form of Indemnity Agreement between the Company and the directors
and certain executives of the Company.
 91




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##### Table of Contents



Exhibits
    
    Description*10-q-2
    
    
    Schedule identifying agreements substantially identical to the
Form of Indemnity Agreement constituting Exhibit 10-q-1 hereto
entered into by the Company and the directors and certain
executives of the Company.21
    
    
    List of Subsidiaries of the Company.23
    
    
    Consent of Independent Registered Public Accounting Firm24
    
    
    Power of Attorney authorizing certain persons to sign this Annual
Report on Form 10-K on behalf of certain directors and officers
of the Company.31.1
    
    
    Certification of Chief Executive Officer of Periodic Report
Pursuant to Rule 13a-15(e) or Rule 15d-15(e).31.2
    
    
    Certification of Chief Financial Officer of Periodic Report
Pursuant to Rule 13a-15(e) or Rule 15d-15(e).32
    
    
    Certification by Chief Executive Officer and Chief Financial
Officer of Periodic Report Pursuant to 18 U.S.C. Section 1350.
   *
    
    Management contract or compensatory plan or arrangement.**
    
    Certain confidential portions of this Exhibit have been omitted pursuant
to a request for confidential treatment. Omitted portions have been filed
separately with the Securities and Exchange Commission. (b) Exhibits See subsection (a) (3) above. (c) Financial Statement Schedules See subsections (a) (1) and (2) above. 92




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SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, as amended, the Registrant has duly caused this Report to be
signed on its behalf by the undersigned, thereunto duly authorized, in the City
of Newport Beach, State of California, on this 8th day of December, 2004. CONEXANT SYSTEMS, INC.By:
    /s/ Dwight W. DeckerDwight W. DeckerChairman of the Board and Chief Executive Officer 93




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##### Table of Contents



Pursuant to the requirements of the Securities Exchange Act of 1934, as
amended, this report has been signed on the 8th day of December, 2004 by the
following persons on behalf of the Registrant and in the capacities indicated: Signature
    
    Title/s/ Dwight W. Decker
Dwight W. Decker
    
    Chairman of the Board and Chief Executive Officer
(Principal Executive Officer)J. Scott Blouin*
J.Scott Blouin
    
    Senior Vice President
and Chief Financial Officer
(Principal Financial and Accounting Officer)Donald R. Beall*
Donald R. Beall
    
    DirectorSteven J. Bilodeau*
Steven J. Bilodeau
    
    DirectorRalph J. Cicerone*
Ralph J. Cicerone
    
    DirectorDipanjan Deb*
Dipanjan Deb
    
    DirectorF. Craig Farrill*
F. Craig Farrill
    
    DirectorBalakrishnan S. Iyer*
Balakrishnan S. Iyer
    
    DirectorJohn W. Marren*
John W. Marren
    
    DirectorD. Scott Mercer*
D. Scott Mercer
    
    DirectorJerre L. Stead*
Jerre L. Stead
    
    DirectorGiuseppe P. Zocco*
Giuseppe P. Zocco
    
    Director
 *By:
    /s/
Dennis E. OReillyDennis E. OReilly, Attorney-in-Fact**  **
    
    By authority of the power of attorney filed as Exhibit 24 hereto 94




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##### Table of Contents



SCHEDULE II VALUATION AND QUALIFYING ACCOUNTS (In thousands)
 AdditionsBalance at
    
    Charged to
    
    
    
    
    
    Balance atBeginning
    
    Costs and
    
    Deductions
    
    End ofDescription
    
    of Year
    
    Expenses
    
    (1)
    
    YearYear ended September 30, 2004:Allowance for doubtful accounts
    
    $
    1,547
    
    
    $
    4,475
    
    
    $
    (48
    )
    
    $
    5,974Reserve for sales returns
and allowances
    
    
    1,891
    
    
    
    14,504
    
    
    
    (6,921
    )
    
    
    9,474Allowance for excess and
obsolete inventories
    
    
    25,177
    
    
    
    11,586
    
    
    
    (13,445
    )
    
    
    23,318Year ended September 30, 2003:Allowance for doubtful accounts
    
    $
    6,508
    
    
    $
    (3,958
    )(2)
    
    $
    (1,003
    )
    
    $
    1,547Reserve for sales returns
and allowances
    
    
    2,660
    
    
    
    3,636
    
    
    
    (4,405
    )
    
    
    1,891Allowance for excess and
obsolete inventories
    
    
    23,401
    
    
    
    14,451
    
    
    
    (12,675
    )
    
    
    25,177Year ended September 30, 2002:Allowance for doubtful accounts
    
    $
    10,970
    
    
    $
    (5,814
    )(2)
    
    $
    1,352
    
    
    $
    6,508Reserve for sales returns
and allowances
    
    
    2,521
    
    
    
    10,373
    
    
    
    (10,234
    )
    
    
    2,660Allowance for excess and
obsolete inventories
    
    
    21,326
    
    
    
    14,364
    
    
    
    (12,289
    )
    
    
    23,401
   (1) Deductions in the allowance for doubtful accounts reflect amounts written
off. In fiscal 2002, amounts represent recoveries of accounts receivable
previously valued at zero associated with a discontinued business. (2) Additions charged to costs and expenses in the allowance for doubtful
accounts reflect a credit balance recorded in each of fiscal 2003 and fiscal
2002 resulting from reductions in the allowance account associated with overall
collections experience more favorable than previously estimated. 95




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EXHIBIT INDEX Exhibits
    
    Description10-f-3
    
    
    Form of Stock Option Agreement under the Conexant Systems, Inc.
2000 Non-Qualified Stock Plan, as amended.10-j-2
    
    
    Form of Stock Option Agreement under the Conexant Systems, Inc.
2004 New-Hire Equity Incentive Plan.*10-q-1
    
    
    Form of Indemnity Agreement between the Company and the directors
and certain executives of the Company.*10-q-2
    
    
    Schedule identifying agreements substantially identical to the
Form of Indemnity Agreement constituting Exhibit 10-q-1 hereto
entered into by the Company and the directors and certain
executives of the Company.21
    
    
    List of Subsidiaries of the Company.23
    
    
    Consent of Independent Registered Public Accounting Firm24
    
    
    Power of Attorney authorizing certain persons to sign this Annual
Report on Form 10-K on behalf of certain directors and officers
of the Company.31.1
    
    
    Certification of Chief Executive Officer of Periodic Report
Pursuant to Rule 13a-15(e) or Rule 15d-15(e).31.2
    
    
    Certification of Chief Financial Officer of Periodic Report
Pursuant to Rule 13a-15(e) or Rule 15d-15(e).32
    
    
    Certification by Chief Executive Officer and Chief Financial
Officer of Periodic Report Pursuant to 18 U.S.C. Section 1350.
   *
    Management contract or compensatory plan or arrangement. 96