UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
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.
| Delaware | 25-1799439 | |
| (State of incorporation) | (I.R.S. Employer Identification No.) | |
| 4000 MacArthur Boulevard | ||
| Newport 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 to Section 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. |
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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.
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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
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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
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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.
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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
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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.
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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
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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.
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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.
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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
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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
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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
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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.
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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.
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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. |
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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.
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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. |
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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; |
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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. |
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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 l