CONEXANT SYSTEMS INC – 10-K – Management’s Discussion and Analysis of Financial Condition and Results of Operations

 You should read the following discussion and analysis in conjunction with our Consolidated Financial Statements and related Notes thereto included in Part II, Item 8 of this Annual Report and the Risk Factors included in Part I, Item 1A of this Annual Report, as well as other cautionary statements and risks described elsewhere in this Annual Report.  

Overview

  We design, develop and sell semiconductor system solutions, comprised of semiconductor devices, software and reference designs, for imaging, audio, embedded-modem, and video applications. These solutions include a comprehensive portfolio of imaging solutions for multifunction printers (MFPs), fax platforms, and interactive display frame market segments. Our audio solutions include high-definition (HD) audio integrated circuits, HD audio codecs, and speakers-on-a-chip solutions for personal computers, PC peripheral sound systems, audio subsystems, speakers, notebook docking stations, voice-over-IP speakerphones, USB headsets supporting Microsoft Office Communicator and Skype, and audio-enabled surveillance applications. We also offer a full suite of embedded-modem solutions for set-top boxes, point-of-sale systems, home automation and security systems, and desktop and notebook PCs. Additional products include decoders and media bridges for video surveillance, security and monitoring applications, and system solutions for analog video-based multimedia applications.  Fiscal Year  Our fiscal year is the 52- or 53-week period ending on the Friday closest to September 30 each year. In a 52-week year, each fiscal quarter consists of 13 weeks. The additional week in a 53-week year is added to the fourth quarter, making such quarter consist of 14 weeks. References made to our fiscal year ended September 30, 2011, or fiscal 2011, refer to the combined results of the Predecessor for the period from October 2, 2010 through April 19, 2011, and the Successor for the period from April 20, 2011 through September 30, 2011. References made to our fiscal year ended October 1, 2010, or fiscal 2010, refer to the results of the Predecessor for the period from October 3, 2009 through October 1, 2010. References made to our fiscal year ended October 2, 2009, or fiscal 2009, refer to the results of the Predecessor for the period from October 4, 2008 through October 2, 2009. Fiscal years 2011, 2010 and 2009 were each fiscal years that consisted of 52-weeks.  

Merger with Conexant Holdings, Inc.

  On April 19, 2011, Conexant, completed the Merger with Merger Sub, and Conexant Holdings, pursuant to the Merger Agreement, dated as of February 20, 2011. In connection with the Merger, shares of our common stock ceased to be traded on the NASDAQ Stock Market after the close of market on April 19, 2011.  The aggregate consideration for all equity securities including cancelled and converted stock options and restricted stock units ("RSUs") of the Company was $203.8 million. An additional $0.1 million of consideration was paid to satisfy an existing bank line of credit outstanding on the Merger date. The Merger was funded with the proceeds of equity contributions from Golden Gate Capital and affiliated entities in the amount of $203.9 million.  

Termination of Merger Agreement with Standard Microsystems Corporation

  On February 23, 2011, we terminated our previously announced Agreement and Plan of Merger, dated January 9, 2011 (the "SMSC Agreement"), with Standard Microsystems Corporation, a Delaware corporation ("SMSC"), and Comet Acquisition Corp., a Delaware corporation and wholly owned subsidiary of SMSC. Pursuant to the terms of the SMSC Agreement, we paid a termination fee of $7.7 million to SMSC.  Sale of Real Property  On December 22, 2010, we sold certain real property adjacent to our Newport Beach, California headquarters to Uptown Newport L.P. for $23.5 million, which consisted of $21.5 million in cash and a limited partnership interest in the property, which we have valued at $0.4 million. The property primarily consists of approximately 25 acres of land, and included two leased buildings, improvements and site development costs. The net book value of the property sold was as follows (in thousands):                                                           Predecessor                Land                                   $       1,662                Land and leasehold improvements, net             356                Buildings, net                                 5,610                Machinery and equipment, net                     262                Site development costs                         7,583                                                        $      15,473                                             27 

--------------------------------------------------------------------------------

  Table of Contents  Discontinued Operations  Broadband Access Business  In August 2009, we completed the sale of our Broadband Access ("BBA") business to Ikanos Communications, Inc. ("Ikanos"). The results of the BBA business have been reported as discontinued operations in the consolidated statements of operations for all periods presented.  

Business Enterprise Segments

  We operate in one reportable segment, the semiconductor system solutions market. Based on the accounting guidance in accordance with Segment Reporting, public business enterprises must report information about operating segments in their annual consolidated financial statements. We have one operating segment, comprised of one reporting unit, which was identified based upon the availability of discrete financial information and the chief operating decision makers' regular review of the financial information for this operating segment. Geographic segment reporting information is included in Note 17 to consolidated financial statements in this report.  

Critical Accounting Policies

  We have prepared our discussion of the results of operations for fiscal 2011 by adding the statements of operations and cash flows for the Successor twenty-three weeks ended September 30, 2011 and Predecessor twenty-eight weeks ended April 19, 2011. Although this combined presentation does not comply with United States generally accepted accounting principles ("GAAP"), we believe that it provides a meaningful method of comparison. The combined operating results have not been prepared on a pro forma basis under applicable regulations and may not reflect the actual results we would have achieved absent the Transactions and may not be predictive of future results of operations.  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 the consolidated financial statements are those related to fair-value measurements applied to tangible and intangible assets acquired and liabilities assumed in connection with the Merger, revenue recognition, allowance for doubtful accounts, reserves related to inventories and sales returns, long-lived assets (including goodwill and intangible assets), deferred income taxes, valuation of warrants, our 7.5% investment in Uptown Newport L.P, stock-based compensation, environmental remediation reserve, restructuring charges, and other loss 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 our estimates and assumptions 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.  

Revenue recognition

  We recognize revenue when (i) persuasive evidence of an arrangement exists, (ii) delivery has occurred, (iii) the sales price and terms are fixed and determinable, and (iv) the collection of the receivable is reasonably assured. These terms are typically met upon shipment of product to the customer. The majority of our distributors have limited stock rotation rights, which allow them to rotate up to 10% of product in their inventory two times per year. We recognize revenue to these distributors upon shipment of product to the distributor, as the stock rotation rights are limited and we believe that we have the ability to reasonably estimate and establish allowances for expected product returns in accordance with accounting guidance for revenue recognition when right of return exists. We also have established allowances for price adjustments, rebates and warranty returns. The estimate of future returns and credits is based on historical sales returns, analysis of credit memo data, and other factors known at the time of revenue recognition. The Company monitors product returns and potential price adjustments on an ongoing basis.  We accrue 100% of potential rebates at the time of sale and do not apply a breakage factor. We reverse the accrual for unclaimed rebate amounts as specific rebate programs contractually end and when we believe unclaimed rebates are no longer subject to payment and will not be paid. Development revenue is recognized when services are performed and was not significant for any periods presented.                                           28 

--------------------------------------------------------------------------------

Table of Contents

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. At September 30, 2011 and October 1, 2010, our allowances for doubtful accounts were within management's expectations.  

Derivatives

  We account for derivatives in accordance with guidance on derivatives and hedging. As of September 30, 2011, derivatives consisted of our warrant to purchase 6.1 million shares of Mindspeed common stock. The fair value of this warrant is determined using a standard Black-Scholes-Merton valuation model with assumptions consistent with current market conditions and our intent to liquidate the warrant over a specified time period. The Black-Scholes-Merton valuation 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. There were no changes to the underlying valuation model during the current fiscal year. Changes in the value of the warrant are recorded in income or loss in the period in which they occur.  

Inventories

  We assess the recoverability of our inventories at least quarterly through a review of inventory levels in relation to foreseeable demand, generally over 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. Demand for our products may fluctuate significantly over time, and actual demand and market conditions may be more or less favorable than those projected by management. In the event that actual demand or product pricing is lower than originally projected, additional inventory write-downs may be required. Further, on a quarterly basis, we assess the net realizable value of our inventories. When the estimated average selling price of our inventory, net of selling expenses, falls below our inventory cost, we adjust our inventory to the current estimated market value. 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.  

Impairment of goodwill, intangible and long assets

Goodwill

  Goodwill is not amortized. Instead, goodwill is tested for impairment on an annual basis and between annual tests whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. Goodwill is tested at the reporting unit level, which is defined as an operating segment or one level below the operating segment. Goodwill is tested annually during the fourth fiscal quarter and, if necessary, whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. Goodwill impairment testing is a two-step process. The first step of the goodwill impairment test, used to identify potential impairment, compares the fair value of a reporting unit with its carrying amount, including goodwill. In our annual test in the fourth quarter of fiscal 2011, we assessed the fair value of our reporting unit for purposes of goodwill impairment testing using a weighted average of fair values calculated using the income approach, which uses valuation techniques to convert future cash flows to a single discounted present value amount and the market approach which uses prices and other relevant information generated by market transactions involving identical or comparable assets or liabilities, including a business. The resulting fair value of the reporting unit is then compared to the carrying amounts of the net assets of the reporting unit, including goodwill. As we have only one reporting unit, the carrying amount of the reporting unit equals our net book value.  If the carrying amount of a reporting unit exceeds its fair value, the second step of the goodwill impairment test must be performed to measure the amount of impairment loss, if any. The second step of the goodwill impairment test, used to measure the amount of impairment loss, compares the implied fair value of reporting unit goodwill with the carrying amount of that goodwill. If the carrying amount of reporting unit goodwill exceeds the implied fair value of that goodwill, an impairment loss must be recognized in an amount equal to that excess. Goodwill impairment testing requires significant judgment and management estimates, including, but not limited to, the determination of (i) the number of reporting units, (ii) the goodwill and other assets and liabilities to be allocated to the reporting units and (iii) the fair values of the reporting units. The estimates and assumptions described above, along with other factors such as discount rates, will significantly affect the outcome of the impairment tests and the amounts of any resulting impairment losses.                                           29

--------------------------------------------------------------------------------

Table of Contents

  Based on the result of the first step of the goodwill impairment test, we determined that the fair value of our business was less than its carrying value as of September 30, 2011. As a result, we performed the second step of the goodwill impairment test. Based on the result of the second step test we determined that the implied fair value of goodwill was greater than the carrying amount of goodwill as of September 30, 2011 therefore no impairment of goodwill was required as of September 30, 2011. Because of the significance of our remaining goodwill and intangible asset balances, any future impairment of these assets could have a material adverse effect on our financial condition and results of operations, although, as a charge, it would have no effect on our cash flow. Significant impairments may also impact shareholders' equity.  

Intangible and long-lived assets

  An intangible and long-lived asset that is subject to amortization is reviewed for impairment in accordance with the guidance for impairment or disposal of long-lived assets. If indicators of impairment are present, then a recoverability test is performed based on an estimate of undiscounted cash flows expected to result from the use of the intangible and long-lived asset compared to its carrying value. 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 our business model or changes in operating performance. If the sum of the undiscounted cash flows (excluding interest) is less 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 intangible or long-lived asset. Fair value is determined using available market data, comparable asset quotes and/or discounted cash flow models. Our significant intangible and long-lived assets include fixed assets and intangible assets for customer relationships and patents.  During the fourth quarter of fiscal 2011, we determined that indicators of impairment existed based on our operating results for the fiscal year ended September 30, 2011 and decreases in sales forecasts for future periods. As a result of these indicators of impairment we compared the sum of the undiscounted cash flows related to customer relationship and patent intangible assets to their carrying values as of September 30, 2011. The sum of undiscounted cash flows related to the customer relationships intangible asset was less than its carrying value, therefore we recorded an impairment charge of $19.1 million representing the difference between its fair value and its carrying value as of September 30, 2011. The sum of undiscounted cash flows related to the patents intangible asset was greater than its carrying value as of September 30, 2011 therefore no impairment charge was recorded on the patents intangible asset as of September 30, 2011.  An intangible asset that is not subject to amortization is tested for impairment annually, or more frequently if events or changes in circumstances indicate that the asset might be impaired. The impairment test consists of a comparison of the fair value of an intangible asset to its carrying amount. Fair value is determined using available market data, comparable asset quotes and/or discounted cash flow models. Our indefinite-lived intangible assets consist of in-process research and development ("IPR&D") and trade name and trademarks.  During the fourth quarter of fiscal 2011, we determined that indicators of impairment existed based on our operating results for the fiscal year ended September 30, 2011 and decreases in sales forecasts for future periods. As a result of these indicators of impairment, we tested our indefinite-lived intangible assets for impairment by comparing the fair value of the indefinite-lived intangible assets to their carrying amounts. The fair value of the IPR&D intangible asset, based on a discounted cash flow model using our revised sales forecast for each project which continued to be classified as IPR&D as of September 30, 2011, was less than the carrying amount of the IPR&D intangible asset as of September 30, 2011 resulting in an impairment charge of $15.1 million. In addition, one IPR&D project was completed and a product based on the project began shipping as of September 30, 2011. As a result, the fair value of the project, based on the discounted cash flow from the product shipments was transferred to amortizable intangible assets as of September 30, 2011. The fair value for this project was calculated to be $0.9 million, which was less than the historical carrying value of the project in IPR&D of $4.1 million as of the Merger date resulting in an impairment charge of $3.2 million. Amortization expense on the project in the successor period from April 20, 2011 through September 30, 2011 was $0.1 million. The fair value of the trade name and trademarks intangible asset, based on a discounted cash flow model using our revised sales forecast was less than the carrying amount of trade name and trademarks resulting in an impairment charge of $3.6 million.  

Income Taxes

  We utilize the liability method of accounting for income taxes. Under the liability method, deferred taxes are determined based on the temporary differences between the financial statement and tax basis of assets and liabilities using tax rates expected to be in effect during the years in which the basis differences reverse. A valuation allowance is recorded when it is more likely than not that some of the deferred tax assets will not be realized.  In assessing the need for a valuation allowance, we consider all positive and negative evidence, including scheduled reversals of deferred tax liabilities, projected future taxable income, tax planning strategies, and recent financial performance. 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 our cumulative losses in the U.S. and the full utilization of our loss carryback opportunities, management has concluded that a full valuation allowance against our net deferred tax assets is appropriate in such jurisdictions. In certain other foreign jurisdictions where we do not have cumulative losses, a valuation allowance is                                           30

--------------------------------------------------------------------------------

Table of Contents

  recorded to reduce the net deferred tax assets to the amount management believes is more likely than not to be realized. In the future, if we realize a deferred tax asset that currently carries a valuation allowance, a reduction to income tax expense may be recorded in the period of such realization.  We recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position in accordance with the accounting guidance for uncertainty in income taxes. The tax benefits recognized in the financial statements from such a position are measured based on the largest benefit that has a greater than 50% likelihood of being realized upon ultimate settlement. We recognize interest and penalties related to these unrecognized tax benefits in the income tax provision.  The accounting guidance also provides for de-recognition of income tax assets and liabilities, classification of current and deferred income tax assets and liabilities, accounting for interest and penalties associated with tax positions, and income tax disclosures.  As a multinational corporation, we are subject to taxation in many jurisdictions, and the calculation of our tax liabilities involves dealing with uncertainties in the application of complex tax laws and regulations in various taxing jurisdictions. If, based on new facts that arise in a period, management ultimately determines that the payment of these liabilities will be unnecessary, the liability will be reversed and we will recognize a tax benefit during the period in which it is determined the liability no longer applies. Conversely, we may record additional tax charges in a period in which it is determined that a recorded tax liability is less than the ultimate assessment is expected to be.  The application of tax laws and regulations is subject to legal and factual interpretation, judgment and uncertainty. Tax laws and regulations themselves are subject to change as a result of changes in fiscal policy, changes in legislation, the evolution of regulations and court rulings. Therefore, the actual liability for federal, state or foreign taxes may be materially different from management's estimates, which could result in the need to record additional tax liabilities or potentially reverse previously recorded tax liabilities.  

Valuation of equity securities

  We have a portfolio of investments in non-marketable equity securities. We review equity securities periodically for other-than-temporary impairments, which requires significant judgment. In determining whether a decline in value is other-than-temporary, we evaluate, among other factors, (i) the duration and extent to which the fair value has been less than cost, (ii) the financial condition and near-term prospects of the issuer and (iii) our intent and ability to retain the investment for a period of time sufficient to allow for any anticipated recovery in fair value. These reviews may include assessments of each investee's financial condition, its 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. We have experienced substantial impairments in the value of our equity securities over the past few years. Future adverse changes in market conditions or poor operating results of underlying investments could result in our inability to recover the carrying amounts of our investments, which could require additional impairment charges to write-down the carrying amounts of such investments.  

Stock-based compensation

  We recognize the fair-value of stock-based compensation awards at the date of grant using the Black-Scholes-Merton option pricing model. In addition, forfeitures are estimated when recognizing compensation expense and the estimate of forfeitures will be adjusted over the requisite service period to the extent that actual forfeitures differ, or are expected to differ, from such estimates. Changes in estimated forfeitures will be recognized through a cumulative catch-up adjustment in the period of change and will also impact the amount of compensation expense to be recognized in future periods.  The Black-Scholes-Merton model requires certain assumptions to determine an option fair value, including expected stock price volatility, risk-free interest rate, and expected life of the option. The expected stock price volatility rates are based on the historical volatility of our common stock. The risk free interest rates are based on the U.S. Treasury yield curve in effect at the time of grant for periods corresponding with the expected life of the option or award. The average expected life represents the weighted average period of time that options or awards granted are expected to be outstanding, as calculated using the simplified method. We measure service-based awards at the stock price on the grant date.  Restructuring charges  Restructuring activities and related charges have related 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 that are uncertain at the time that the assumptions are made (for example, the timing and amount of sublease income that will be achieved on vacated property and the operating costs to be paid until lease termination, and the discount rates used in                                           31 

--------------------------------------------------------------------------------

Table of Contents

  determining the present value (fair value) of remaining minimum lease payments on vacated properties). While we have used our best estimates based on facts and circumstances available at the time, different estimates reasonably could have been used in the relevant periods, the actual results may be different, and those differences could have a material impact on the presentation of our financial position or results of operations. Our policies require us to review the estimates and assumptions periodically and to reflect the effects of any revisions in the period in which they are determined to be necessary. Such amounts also contain estimates and assumptions made by management, and are reviewed periodically and adjusted accordingly.  

Results of Operations

Net Revenues

  Net revenues consist of product sales, which we generally recognize upon shipment, less an estimate for returns and allowances. We sell our products to distributors, contract manufacturers (ODMs) and end-customers (OEMs), whose products include our products. End customers may purchase directly from us or from distributors or contract manufacturers.  Our net revenues decreased 31% to $166.0 million in the Successor period in fiscal 2011 and the Predecessor period in fiscal 2011 from $240.7 million in the Predecessor fiscal year ended October 1, 2010. This decrease was primarily driven by a 23% decrease in unit volume shipments due to lower demand across all product lines and a 12% decrease in average selling prices (ASPs) in audio, video, imaging and modem product lines due to competitive pressures.  Our net revenues increased 15% to $240.7 million in the Predecessor fiscal year ended October 1, 2010 from $208.4 million in the Predecessor fiscal year ended October 2, 2009. This increase was primarily driven by a 14% increase in unit volume shipments and a 1% increase in ASPs. The volume increase between the Predecessor fiscal year ended October 1, 2010 and the Predecessor fiscal year ended October 2, 2009 was driven by the shipment growth of our imaging, audio, and video solutions, partially offset by declines in our analog modems, specifically our computer modems and modems for digital television platforms in Japan. The increase in ASPs was attributable to a change in product mix, partially offset by pricing erosion in our audio and video businesses.  We were fortunate that the tsunami event which impacted Japan in March, 2011 and the flood event that impacted Thailand in November, 2011 did not have a material impact on our business. Our primary sources of supply were not materially affected by these catastrophic events and, in situations where other suppliers to our customers were affected, our manufacturing suppliers activated their qualified second source raw material suppliers and moved quickly to qualify new sources of supply as well. While we experienced some minor changes in requested delivery dates because of these events they were not material to our annual results for the Successor or Predecessor periods in fiscal 2011.  

Gross Margin

  Gross margin represents net revenue less cost of goods sold. As a fabless semiconductor company, we use third parties for wafer production and assembly and test services. Our cost of goods sold consists predominantly of purchased finished wafers, assembly and test services, royalties, labor and overhead associated with product procurement and non-cash stock-based compensation charges for procurement personnel.  Our gross margin percentage for the Successor period in fiscal 2011 and the Predecessor period in fiscal 2011 was 41% compared with 61% for the Predecessor fiscal year ended October 1, 2010. The decrease in gross margin percentage is primarily attributable to the $23.1 million sell-off and $1.7 million reserve of fair value applied to inventory as part of the purchase price allocated in connection with the Merger. Excluding the inventory purchase price fair value reserve, our gross margin percentage for the Successor period in fiscal 2011 and the Predecessor period in fiscal 2011 was 56%. The 5% decrease in gross margin percentage compared to the Predecessor fiscal year ended October 1, 2010 was due to price erosion, reserves for excess and obsolete inventory and product mix.  Our gross margin percentage for the Predecessor fiscal year ended October 1, 2010 was 61% compared with 58% for the Predecessor fiscal year ended October 2, 2009. The increase in gross margin percentage is attributable to lower product manufacturing costs and a favorable revenue product mix.  

Research and Development

  Our research and development (R&D) expenses consist principally of direct personnel costs to develop new semiconductor solutions, allocated indirect costs of the R&D function, photo mask and other costs for pre-production evaluation and testing of new devices, and design and test tool costs. Our R&D expenses also include the costs for design automation advanced package development and non-cash stock-based compensation charges for R&D personnel.  

R&D expense increased $1.0 million, or 2%, in the Successor period in fiscal 2011 and the Predecessor period in fiscal 2011 compared to the Predecessor fiscal year ended October 1, 2010. The increase is due primarily to higher employee headcount and salary expense and higher allocated facility costs, offset by lower stock-based compensation and project expenses.

                                       32

--------------------------------------------------------------------------------

Table of Contents

  R&D expense increased $4.4 million, or 9%, in the Predecessor fiscal year ended October 1, 2010 compared to the Predecessor fiscal year ended October 2, 2009. The increase is due to higher compensation expenses from higher incentive programs and higher photo mask expenses.  

Selling, General and Administrative

  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, customer service, sales, marketing, field application engineering, allocated indirect costs of the SG&A function, and non-cash stock-based compensation charges for SG&A personnel.  SG&A expense decreased $8.7 million, or 18%, in the Successor period in fiscal 2011 and the Predecessor period in fiscal 2011 compared to the Predecessor fiscal year ended October 1, 2010. The decrease is primarily due to a 29% decrease in headcount primarily in the successor period, and lower incentive accruals and professional fees, offset by an increase in legal expenses and allocated facility costs.  SG&A expense decreased $14.5 million, or 23%, in the Predecessor fiscal year ended October 1, 2010 compared to the Predecessor fiscal year ended October 2, 2009. The decrease is primarily due to the 22% decline in SG&A headcount from the Predecessor fiscal year ended October 2, 2009 to the Predecessor fiscal year ended October 1, 2010, resulting from restructuring activities and cost-cutting measures.  

Amortization of Intangible Assets

  Intangible assets subject to amortization of $57.5 million were recorded in connection with the Merger. As a result, amortization expense increased to $9.8 million in the Successor period in fiscal 2011 and the Predecessor period in fiscal 2011, compared to $1.2 million in the Predecessor fiscal year ended October 1, 2010. An impairment charge of $19.1 million was recorded on customer relationships as of September 30, 2011. The remaining balance of intangible assets subject to amortization of $30.1 million is being amortized over a weighted-average remaining period of approximately 6.6 years.  Amortization expense decreased $1.8 million, or 58%, in the Predecessor fiscal year ended October 1, 2010 compared to the Predecessor fiscal year ended October 2, 2009. The decrease in amortization expense is primarily attributable to intangible assets that became fully amortized in the Predecessor fiscal year ended October 2, 2009.  

Gain on Sale of Intellectual Property

  In the Predecessor period in fiscal 2011, we sold certain internally developed Conexant RF Patents and MPEG Patents to Skyworks and terminated our exclusive rights in Skyworks RF Patents obtained pursuant to an agreement we entered into with Skyworks in 2003, in exchange for non-exclusive licenses to each of the Conexant RF Patents, MPEG Patents and Skyworks RF Patents and $1.25 million in cash. We received $0.6 million of the sale price in November 2010 and the remainder in March 2011. The entire $1.25 million was recognized as gain as the patents had no book value.  In the Predecessor fiscal year ended October 2, 2009, we sold a portfolio of patents including patents related to our wireless networking technology to a third party for cash of $14.5 million, net of costs, and recognized a gain of $12.9 million on the transaction. In accordance with the terms of the agreement with the third party, we retain a cross-license to this portfolio of patents.  

Asset Impairments

  During the Successor period in fiscal 2011, we recorded intangible asset impairment charges of $41.0 million, consisting primarily of a $19.1 million impairment of customer relationships, $3.6 million impairment of trade name and trademarks, and an $18.3 million impairment of capitalized IPR&D costs.  During the Predecessor fiscal year ended October 2, 2009, we recorded impairment charges of $10.8 million, consisting primarily of an $8.3 million impairment of a patent license with Freescale Semiconductor, Inc., land and fixed asset impairments of $1.4 million, electronic design automation ("EDA") tool impairments of $0.8 million, intangible asset impairments of $0.3 million. Asset impairments recorded in continuing operations were $5.7 million, and asset impairments related to the BMP and BBA business units were $5.1 million and were recorded in discontinued operations.                                           33

--------------------------------------------------------------------------------

   Table of Contents  Special Charges                                          Successor                                                Predecessor                                   Period from April               Period from                                   20, 2011 through              October 2, 2010             Fiscal Year Ended             Fiscal Year Ended                                     September 30,              through April 19,               October 1,                    October 2,                                         2011                         2011                         2010                          2009 Severance charges                $             9,621          $             2,873          $               342           $                - Merger transaction charges                                           68                       16,860                           -                             - Environmental remediation charges                                        1,483                          145                           -                             - Lease impairment charges                       2,279                           87                          188                            - Restructuring charges                          1,786                          925                         (282 )                      15,116 Settlements                                       -                            -                           589                         3,475 Other special charges                             -                            -                            -                            392                                   $            15,237          $            20,890          $               837           $            18,983    For the Successor period in fiscal 2011, special charges consisted primarily of $9.6 million of severance charges resulting from reduction in headcount after the Merger, $2.3 million of lease impairment charges resulting from under-utilized space after the Merger under which we have continuing lease obligations, $1.8 million for restructuring charges resulting primarily from changes in projected sub-lease income on restructured leases and $1.5 million additional accrual for environmental remediation charges. For the Predecessor period in fiscal 2011, special charges consisted primarily of $16.9 million for transaction charges, including payment of a $7.7 million fee for termination of the SMSC Agreement and $9.2 million of financial advisory, legal and other fees related to the terminated merger with SMSC and the Merger, $2.9 million for severance benefits associated with reductions in headcount primarily in the first quarter of fiscal 2011, and $0.9 million of restructuring charges from accretion of lease liability related to restructured facilities.  Special charges for the Predecessor fiscal year ended October 1, 2010 consisted primarily of an estimated settlement amount for unasserted insurance claims, lease charge and a one-time severance benefit associated with certain reductions in headcount, and restructuring credits due to an increase of subtenant income.  Special charges for the Predecessor fiscal year ended October 2, 2009 consisted primarily of restructuring charges due to reduction of subtenant income from restructured office space and $3.5 million for a settlement of our class action lawsuit related to our 401(k) plan.  

Interest Expense

  Interest expense decreased $10.8 million to $19.2 million in the Successor period in fiscal 2011 and the Predecessor period in fiscal 2011 from $30.1 million in the Predecessor fiscal year ended October 1, 2010. The decrease is primarily attributable to the extinguishment of debt in the Predecessor fiscal year ended October 1, 2010 and resulting reduction in interest and debt discount expense, and $2.0 million amortization of $20.1 million debt premium on the Company's 11.25% senior secured notes recorded at the Merger date. Interest expense in the Predecessor fiscal year ended October 1, 2010 includes debt discount amortization of $8.0 million.  Interest expense decreased $4.6 million, or 13%, during the Predecessor fiscal year ended October 1, 2010 compared to the Predecessor fiscal year ended October 2, 2009. The decrease is primarily attributable to lower debt balances due to the extinguishment of $238.8 million of our 4.00% convertible subordinated notes, partially offset by a higher interest rate charged on our 11.25% senior secured notes. Interest expense in the Predecessor fiscal year ended October 1, 2010 and the Predecessor fiscal year ended October 2, 2009 also includes debt discount amortization of $7.8 million and $14.0 million, respectively.                                           34 

--------------------------------------------------------------------------------

   Table of Contents  Other Expense (Income), Net                                        Successor                                               Predecessor                                   April 20, 2011               Period from                                      through                 October 2, 2010             Fiscal Year Ended            Fiscal Year Ended                                   September 30,             through April 19,               October 1,                   October 2,                                        2011                       2011                         2010                         2009 Investment and interest income                           $           (101 )        $              (159 )        $              (265 )        $            (1,747 ) Gain on sale of investments                                    (5 )                     (1,393 )                    (16,054 )                     (1,856 ) Loss on extinguishment of debt                                           -                            -                        18,583                           - Decrease (increase) in the fair value of derivative instruments                                 9,509                        9,469                      (15,632 )                     (4,508 ) Impairment of equity securities                                     -                            -                            -                         2,770 Loss on termination of interest rate swap                             -                            -                            -                         1,087 Other                                         (10 )                        506                          913                         (771 )  Other expense (income), net                              $          9,393          $             8,423          $           (12,455 )        $            (5,025 )    Other expense, net of $17.8 million during the Successor period in fiscal 2011 and the Predecessor period in fiscal 2011 consisted primarily of a $19.0 million decrease in the value of the Mindspeed warrant partially offset by a $1.4 million gain on sale of equity investments. Of the $1.4 million gain on sale of equity investments, we have received proceeds in the amount of $0.8 million. The difference between the gain and proceeds has been recorded as a receivable.  Other income of $12.5 million, net, during the Predecessor fiscal year ended October 1, 2010 primarily consisted of a $16.1 million gain on sale of equity investments and a $15.6 million increase in the fair value of our warrant to purchase 6.1 million shares of Mindspeed common stock, partially offset by a loss of $18.6 million on extinguishment of debt, which consisted of $13.4 million of unamortized debt discount, $1.8 million premium over par paid upon extinguishment and $3.4 million of transaction costs.  Other income, net for the Predecessor fiscal year ended October 2, 2009 was primarily comprised of a $4.5 million increase in the fair value of our warrant to purchase 6.1 million shares of Mindspeed common stock, $1.9 million in gains on sales of equity securities, $1.7 million of investment and interest income on invested cash balances, offset by $2.8 million of impairments on equity securities and a $1.1 million realized loss on the termination of interest rate swaps.  Provision for Income Taxes  We recorded a tax benefit of $2.6 million for the Successor period in fiscal 2011, primarily due to the reduction of our deferred tax liability due to the impairment of our indefinite life intangible assets. We recorded a tax provision of $0.4 million for the Predecessor period in fiscal 2011, primarily reflecting income taxes imposed on our foreign subsidiaries. All of our U.S. federal income taxes and the majority of our state income taxes are offset by fully reserved deferred tax assets.  The acquisition of our common stock in connection with the Merger triggered an ownership change under Section 382. Section 382 imposes an annual limitation (based upon the value at the time of the ownership change, as determined under Section 382 of the Internal Revenue Code) on the amount of taxable income that can be offset with net operating loss ("NOL") carryovers that existed at time of the acquisition. Section 383 will also limit our ability to use R&D tax credit carryovers. In addition, as the tax basis of our assets exceeded the fair market value of our assets at the time of the ownership change, Section 382 will also limit our ability to use amortization of capitalized R&D and goodwill to offset taxable income for the first five years following an ownership change. Any unused annual limitation may be carried over to later years until the applicable expiration date for the respective NOLs. Similar limitations have been implemented by states and certain foreign jurisdictions. We are in the process of finalizing the impact of Section 382 on the Company's deferred tax items and, we have preliminarily assessed the impact of Section 382 on our fully reserved deferred tax assets. The change of ownership has significantly limited our ability to utilize our federal and state deferred tax assets and impaired the carrying value of the deferred tax assets and changed the amount of our unrecognized tax benefits. As the federal and state deferred tax assets are fully reserved, this impairment has not had an impact on our current year financial position or results of operations. However, the limitation on the use of our NOLs, credits and amortization which resulted from the ownership changes could adversely impact our future operating results and financial condition. As a result of the Section 382 limitation, as of September 30, 2011, the Company has U.S. federal and California net realizeable net operating loss carryforwards of approximately $272 million and $553 million, respectively.  In addition, we can within nine and a half months of the Merger elect under Section 338 of the Internal Revenue Code to treat the Merger as if it were an asset purchase for federal income tax purposes. If we make a Section 338 election, generally our tax basis of our assets will equal the fair market value at the time of the Merger, the intangible assets would be deductible over 15 years under IRC Section 197 and the net operating losses, federal credits and remaining deferred taxes would be eliminated. Our financial position and results of operations and cash flows could materially change if we make a Section 338 election.  In the Predecessor fiscal years ended October 1, 2010 and 2009, we recorded income tax provisions of $0.6 million and $0.9 million, respectively, primarily reflecting income taxes imposed on our foreign subsidiaries. All of our U.S. federal income taxes and the majority of our state income taxes are offset by fully reserved deferred tax assets. The Company has                                           35

--------------------------------------------------------------------------------

Table of Contents

  significant federal and state net operating losses and other deferred tax assets that the Company expects will eliminate its federal and the majority of its state taxes payable for the foreseeable future. When the Company believes that the future realization of its deferred tax assets is more likely than not, the Company will release some or all of its valuation allowance. If and when this occurs, the release of the valuation allowance will result in a deferred income tax benefit.  

Income (Loss) on Equity Method Investments

  Income (loss) on equity method investments includes our share of the earnings or losses of the investments that are recorded under the equity method of accounting, as well as the gains and losses recognized on the sale of our equity method investments.  Income on equity method investments for the Successor period in fiscal 2011 and the Predecessor period in fiscal 2011 was $1.9 million. Loss on equity method investments for the Predecessor fiscal years ended October 1, 2010 and 2009 was $0.1 million and $2.8 million, respectively.  

Loss from Discontinued Operations, net of tax

  Loss from discontinued operations, net of tax, consists of the operating results of our discontinued BMP and BBA businesses. For the Successor period in fiscal 2011 and Predecessor period in fiscal 2011 and the Predecessor fiscal years 2010 and 2009, BMP and BBA operations consisted of the following:                                            Successor                                                Predecessor                                     Period from April               Period from                                     20, 2011 through              October 2, 2010             Fiscal Year Ended            Fiscal Year Ended                                       September 30,              through April 19,               October 1,                   October 2,                                           2011                         2011                         2010                         2009 Net revenues                       $                -           $                -           $             1,428          $           116,590 Cost of goods sold                                  -                            -                            54                       59,680  Gross margin                                        -                            -                         1,374                       56,910 Operating expenses: Research and development                            -                            -                            45                       40,085 Selling, general and administrative                                      -                           (64 )                        108                        4,863 Amortization of intangible assets                                              -                            -                            -                         4,430 Asset impairments                                   -                            -                            -                         5,164 Special charges                                  2,268                          820                        2,157                       14,518  Total operating expenses                         2,268                          756                        2,310                       69,060  Operating loss                                  (2,268 )                       (756 )                       (936 )                    (12,150 ) Interest expense                                    -                            -                            -                         2,741 Other expense (income), net                         -                           (45 )                        988                        1,132  Loss from continuing operations before income taxes                                           (2,268 )                       (711 )                     (1,924 )                    (16,023 ) Provision for income taxes                          -                          (250 )                         81                        1,498  Loss from discontinued operations, net of tax             $            (2,268 )        $              (461 )        $            (2,005 )        $           (17,521 )   

Liquidity and Capital Resources

  Our principal sources of liquidity are our cash and cash equivalents, sales of non-core assets, borrowings and operating cash flow. In addition, we have generated additional liquidity in the past through the sale of equity and debt securities.  Our cash and cash equivalents decreased $16.4 million in the Successor period in fiscal 2011 and the Predecessor period in fiscal 2011. The decrease was primarily due to cash used in operating activities of $46.7 million, including $16.9 million related to the Merger and terminated merger transactions and $11.1 million for severance payments, acquisition of Predecessor of $203.9 million, the redemption of our remaining $11.2 million of outstanding 4.00% convertible subordinated notes due 2026, purchases of property, plant and equipment of $1.6 million, and employee tax paid by us in lieu of issuing restricted stock units of $0.7 million offset by the equity contributions of $203.9 million, sale of real property for net proceeds of $21.1 million, proceeds from the maturity of marketable securities of $20.0 million, proceeds from the sale of intellectual property of $1.3 million, proceeds from sale of equity investments of $0.8 million and release of restricted cash of $0.5 million.                                           36

--------------------------------------------------------------------------------

Table of Contents

  Our cash and cash equivalents decreased $70.9 million between October 2, 2009 and October 1, 2010. The decrease was primarily due to the repurchase of our long-term and short-term debt, partially offset by common stock offerings and issuance of our 11.25% senior secured notes due 2015, restricted cash released upon repayment of our short-term debt and escrow, partially offset by the net purchase of marketable securities and cash generated by operations.  

Cash flows are as follows (in thousands):

                                         Successor                                              Predecessor                                   Period from April              Period from                                   20, 2011 through            October 2,  2010            Fiscal Year Ended           Fiscal Year Ended                                     September 30,             through April 19,              October 1,                  October 2,                                         2011                        2011                        2010                        2009 Net cash (used in) provided by operating activities          $           (15,478 )       $           (31,237 )       $             4,478         $             8,476 Net cash (used in) provided by investing activities                     (204,682 )                    42,994                      11,451                      85,404 Net cash provided by (used in) financing activities                     197,422                      (5,429 )                   (86,848 )                   (74,378 )  Net (decrease) increase in cash and cash equivalents        $           (22,738 )       $             6,328         $           (70,919 )       $            19,502    Operating Activities  Cash used in operating activities was $46.7 million for the Successor period in fiscal 2011 and the Predecessor period in fiscal 2011 compared to $4.5 million provided by operating activities for the Predecessor fiscal year ended October 1, 2010. Cash used in operating activities for the Successor period in fiscal 2011 and the Predecessor period in fiscal 2011 was primarily driven by a net loss of $149.4 million, offset by $95.2 million of net non-cash operating expenses and a $7.5 million increase from changes in working capital.  Cash provided by operating activities was $4.5 million for the Predecessor fiscal year ended October 1, 2010 compared to $8.5 million for the Predecessor fiscal year ended October 2, 2009. Cash provided by operating activities for the Predecessor fiscal year ended October 1, 2010 was primarily driven by $20.2 million in net income, net non-cash operating expenses of $6.2 million, partially offset by net cash used by changes in operating assets and liabilities of $22.0 million.  Investing Activities  Cash used in investing activities was $161.7 million for the Successor period in fiscal 2011 and the Predecessor period in fiscal 2011 compared to cash provided by investing activities of $11.5 million for the Predecessor fiscal year ended October 1, 2010. Cash used in investing activities for the Successor period in fiscal 2011 and the Predecessor period in fiscal 2011 was primarily driven by the acquisition of the Predecessor for $203.9 million and capital expenditures of $1.6 million offset by proceeds from the sale of real property of $21.1 million, proceeds from the maturity of marketable securities of $20.0 million, proceeds from the sale of intellectual property of $1.2 million, proceeds from the sale of equity investments of $0.8 million and release of restricted cash of $0.5 million.  Cash provided by investing activities was $11.5 million for the Predecessor fiscal year ended October 1, 2010 compared to $85.4 million for the Predecessor fiscal year ended October 2, 2009. Cash provided by investing activities for the Predecessor fiscal year ended October 1, 2010 was primarily due to the release of restricted cash of $9.3 million, of which $8.5 million is associated with repayment of short-term debt, and $6.8 million associated with divestiture contingency from the sale of our BBA business, partially offset by our net purchase of marketable securities of $3.4 million and capital expenditures of $2.0 million.  Financing Activities  Cash provided by financing activities was $192.0 million for the Successor period in fiscal 2011 and the Predecessor period in fiscal 2011 compared to $86.8 million used in financing activities for the Predecessor fiscal year ended October 1, 2010. Cash provided by financing activities for the Successor period in fiscal 2011 and the Predecessor period in fiscal 2011 was primarily driven by the equity contributions of $203.9 million, offset by the redemption of our remaining $11.2 million of outstanding 4.00% convertible subordinated notes due 2026 and employee tax paid by us in lieu of issuing restricted stock units of $0.7 million.  Cash used in financing activities was $86.8 million</money> for the Predecessor fiscal year ended October 1, 2010 compared to $74.4 million for the Predecessor fiscal year ended October 2, 2009. Cash used in financing activities for the Predecessor fiscal year ended October 1, 2010, was primarily due to the extinguishment of our remaining floating rate senior secured notes due November 2010 for $62.0 million, extinguishment of our 4.00% convertible subordinated notes due March 2026 for $226.7 million and repayment of $29.1 million of our short-term debt, partially offset by the common stock offering and issuance of our 11.25% senior secured notes due 2015, net of expenses, of $62.5 million and $168.4 million, respectively and issuance of common stock under employee stock plans for $0.1 million.                                           37 

--------------------------------------------------------------------------------

Table of Contents

Recent Financing Transactions

On April 19, 2011, the Predecessor was acquired for $203.9 million, funded with the proceeds of equity financings from Golden Gate Capital and affiliated entities.

On March 1, 2011, we redeemed the remaining $11.2 million of 4.00% convertible subordinated notes due 2026.

  On December 22, 2010, we sold certain real property adjacent to our Newport Beach, California headquarters to Uptown Newport L.P. for $23.5 million, which consisted of $21.5 million in cash and a limited partnership interest in the property, which we have valued at $0.4 million.  

Effective on the date of the Merger, our credit facility with a bank was terminated. No amounts were due under the facility at the termination date.

  We believe that our existing sources of liquidity, together with cash expected to be generated from operations, will be sufficient to fund our operations, research and development, anticipated capital expenditures and working capital for at least the next twelve months.  

Contractual Obligations and Commitments

  Contractual obligations at September 30, 2011 were as follows (in thousands):                                                                     Payments Due by Fiscal Year                                    Total         2012         2013         2014         2015         2016        Thereafter Long-term debt                   $ 175,000     $     -      $     -      $     -      $ 175,000     $    -      $         - Interest on debt                    68,908       19,688       19,688       19,688         9,844          -                - Operating leases                    67,495       13,717       13,799       12,702        10,118       7,963            9,196 Other purchase commitments           9,735        8,237        1,498           -             -           -                -                                   $ 321,138     $ 41,642     $ 34,985     $ 32,390     $ 194,962     $ 7,963     $      9,196    At September 30, 2011, we had many sublease arrangements on operating leases for terms ranging from near term to approximately six years. Aggregate scheduled sublease income based on current terms is approximately $18.3 million and is not reflected in the table above.  

Other purchase commitments include our commitments to foundries for wafer production, contractual obligations to acquire engineering design tools and other contractual payments.

  In addition to the amounts shown in the table above, as of September 30, 2011, we have $10.0 million of unrecognized tax benefits, which includes $1.7 million for potential interest related to these unrecognized tax benefits. We are uncertain as to if or when such amounts may be settled.  

Off-Balance Sheet Arrangements

  We have made guarantees and indemnities, under which we may be required to make payments to a guaranteed or indemnified party, in relation to certain transactions. In connection with our spin-off from Rockwell International Corporation ("Rockwell"), we 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 our contribution of certain of our manufacturing operations to Jazz Semiconductor, Inc. (now "TowerJazz"), we agreed to indemnify TowerJazz for certain environmental matters and other customary divestiture-related matters. In connection with our sale of the BMP business to NXP, we agreed to indemnify NXP for certain claims related to the transaction. In connection with our sale of the BBA business to Ikanos, we agreed to indemnify Ikanos for certain claims related to the transaction. In connection with the sales of our products, we provide intellectual property indemnities to our customers. In connection with certain facility leases, we have indemnified our lessors for certain claims arising from the facility or the lease. We indemnify our directors and officers to the maximum extent permitted under the laws of the State of Delaware.                                           38

--------------------------------------------------------------------------------

Table of Contents

  The durations of our guarantees and indemnities vary, and in many cases are 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 we could be obligated to make. We have not recorded any liability for these guarantees and indemnities in our consolidated balance sheets. Product warranty costs are not significant. We have other outstanding letters of credit collateralized by restricted cash aggregating $5.1 million to secure various long-term operating leases and our self-insured worker's compensation plan. The restricted cash associated with these letters of credit is classified as other long-term assets on the consolidated balance sheets.  

Special Purpose Entities

  We have one special purpose entity, Conexant CF, which is not permitted, nor may its assets be used, to guarantee or satisfy any of our obligations or those of our subsidiaries. Effective on the date of the Merger, the credit facility between Conexant CF and a bank was terminated. No amounts were due under the facility at the termination date.  

Recently Issued Accounting Pronouncements

  In June 2011, the Financial Accounting Standards Board, ("FASB"), issued guidance regarding the presentation of comprehensive income. The new standard requires the presentation of comprehensive income, the components of net income and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. The new standard also requires presentation of adjustments for items that are reclassified from other comprehensive income to net income in the statement where the components of net income and the components of other comprehensive income are presented. The updated guidance is effective on a retrospective basis for financial statements issued for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2011. The adoption of this guidance will not have a material impact on our financial statements.  In May 2011, the FASB issued additional guidance on fair value measurements that clarifies the application of existing guidance and disclosure requirements, changes certain fair value measurement principles and requires additional disclosures about fair value measurements. The updated guidance is effective on a prospective basis for financial statements issued for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2011. The adoption of this guidance will not have a material impact on our financial statements.  In September 2011 the FASB issued new accounting guidance intended to simplify goodwill impairment testing. Entities will be allowed to perform a qualitative assessment on goodwill impairment to determine whether a quantitative assessment is necessary. This guidance is effective for goodwill impairment tests performed in interim and annual periods for fiscal years beginning after December 15, 2011. Early adoption is permitted. The adoption of this guidance will not have a material impact on our financial statements.