SIGMATEL INC - 10-K Annual Report

Indicate by check mark whether 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) had 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 the 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. x

Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). Yes x No ¨

The aggregate market value of the voting and non-voting common equity held by non-affiliates computed by reference to the price at which the common equity was last sold as of the last business day of the registrant’s most recently completed second fiscal quarter (June 30, 2004) was $773,239,203 (assuming, for this purpose, that only directors and officers are deemed affiliates).

The number of shares outstanding of the Registrant’s Common Stock, $0.0001 par value, was 35,225,746 as of January 20, 2005.

Portions of the Proxy Statement for the registrant’s 2005 Annual Meeting of Stockholders are incorporated by reference into Part II and Part III of this Form 10-K.

Index to Financial Statements

Except for the historical financial information contained herein, the matters discussed in this report on Form 10-K (as well as documents incorporated herein by reference) may be considered 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. Such forward-looking statements are based upon current expectations that involve risks and uncertainties and include declarations regarding the intent, belief or current expectations of us and our management and may be signified by the words “believes”, “anticipates”, “plans”, “expects”, “intends” and similar expressions. Our actual results and the timing of certain events may differ significantly from the results discussed in the forward-looking statements. Factors that might cause such a discrepancy include, but are not limited to, those discussed in “Business and Factors Affecting Our Future Operating Results” and elsewhere in this report. All forward-looking statements in this document are based on information available to us as of the date hereof, and we assume no obligation to update any such forward-looking statements, whether as a result of new information, future events, or otherwise. All discussion in this report should be read in conjunction with our financial statements and the accompanying notes contained in this report. Unless expressly stated of the context otherwise requires, the terms “we”, “our”, “us” and “SigmaTel” refer to SigmaTel, Inc.

We are a fabless semiconductor company that designs, develops, and markets proprietary, analog-intensive, mixed-signal integrated circuits, or ICs, for a variety of products in the consumer electronics and computing markets, including portable compressed audio players, such as MP3 players, notebook and desktop PCs, consumer audio, including DVD players, digital televisions, and set-top boxes, and Universal Serial Bus, or USB, infrared devices. We provide our customers complete, system-level solutions that include highly-integrated ICs, customizable firmware and software, software development tools, reference designs, and applications support. Our focus on providing system-level solutions enables our customers to rapidly introduce and offer electronic products that are small, light-weight, power-efficient, reliable, and cost-effective.

According to market research firm iSuppli Corporation, the worldwide Analog IC market was $50.8 billion in 2003 and will climb to $91.5 billion by 2008. The source of this statistic is the iSuppli report: “Rising ASPs in 2004: The Resurgence of Standard Linear ICS—Analog and Interface—H1 2004.” Analog ICs monitor and manipulate real world signals such as sound, light, pressure, motion, temperature, and electrical current, and are used in a wide variety of electronic products such as PCs, cellular handsets, DVD players, automotive electronics, and medical imaging equipment. Digital ICs perform arithmetic functions on data represented by a series of ones and zeroes, provide critical processing power, and have enabled many of the computing and communication advances of recent years. As digital systems proliferate, there is a growing need for analog functionality to enable these digital systems to interface with the real world.

Several powerful trends are driving demand for analog-intensive, mixed-signal ICs in electronic devices:

Index to Financial Statements

Integrating analog and digital components on a single, mixed-signal IC can enable manufacturers to make portable electronic devices that are small, light-weight, power-efficient, reliable and cost-effective. However, creating mixed-signal ICs is complex. Significant experience is required to effectively partition an IC between analog and digital functions to achieve optimal performance and cost. Moreover, combining high-speed digital circuits and sensitive analog circuits onto a single, mixed-signal IC can create electromagnetic interference, or noise, which reduces IC performance. Finally, in contrast to digital circuit design, there are very few automated electronic design tools to effectively assist in the development and reuse of analog portions of mixed signal ICs. Instead, analog circuits usually are designed and integrated with digital circuits through a difficult and time-consuming manual process. Years of experience are required to effectively design mixed-signal ICs, and engineers with these skills are in short supply.

Many analog IC companies offer broad product lines of general-purpose building block components. These analog components usually must be combined with other ICs, resulting in larger and heavier products that consume more power, require larger and more complex printed circuit boards, are more expensive, and can be less reliable than systems on a chip, or SoCs, that are optimized for specific product applications. Many analog IC companies also do not have the software and firmware design capabilities or system-level expertise required to provide integrated system-level solutions to electronics manufacturers.

Manufacturers of electronic products are under increasing pressure to bring their products to market rapidly, at lower cost and with differentiated features. In response to these pressures, manufacturers have reduced their

Index to Financial Statements

own research and development efforts and are increasingly turning to third-party, mixed-signal IC companies that are capable of providing higher levels of integration, greater functionality in a smaller size with lower power consumption, at a reduced total bill of materials cost. They are also seeking to work with mixed-signal IC companies with system-level expertise that are capable of supplying them with complete hardware and software solutions to enable them to quickly introduce customized products to meet rapidly changing consumer preferences.

We are a provider of analog-intensive, mixed-signal ICs for a variety of products, including portable MP3 players, notebook and desktop PCs, DVD players, digital TVs, and set-top boxes. We offer a complete, system-level solution including highly-integrated ICs, customizable firmware and software, software development tools, reference designs, and applications support.

Our analog-intensive, mixed-signal ICs provide our customers with the following benefits:

Mixed-Signal Integration Reduces Size and Cost. We are able to integrate into a single IC many of the components of an entire electronic system or sub-system. For example, in our portable audio SoCs, we incorporate standard digital components such as a processor and memory, certain peripheral connections such as a USB interface, as well as proprietary analog components such as analog-to-digital and digital-to-analog converters, a DC-to-DC converter for dynamic power management, and audio signal amplifiers. Our integration of such a large number of analog and digital components on the same IC eliminates significant design challenges that would otherwise be faced by our customers, enabling them to reduce their overall bill of materials cost and to produce smaller, lighter, more reliable and more power-efficient portable products. For example, A-MAX Technology and Creative Technology have used our portable audio SoC to produce audio-enabled flash storage drive products which are approximately the size of a package of chewing gum.

Power Management Expertise Enables Extended Battery Life. Our ICs enhance the battery life of our customers’ portable devices. We integrate proprietary DC-DC conversion technology to optimize voltage levels to run different functional areas of our ICs at the minimum power necessary. We also use proprietary design techniques to reduce power consumption, such as the partition or division of our ICs into multiple clock domains to enable us to shut off functional areas of our ICs when not in use. Further, we use highly-optimized software and firmware to reduce the amount of processing power and memory required for a given function, further reducing power consumption. For example, some of our customers have found that their portable compressed audio players that use our ICs provide up to 50 hours of battery life on a AA battery. Instead of extending battery life, many of our customers use smaller batteries, thus enabling them to significantly reduce the overall size and weight of their devices.

Complete, System-Level Solution Accelerates Customer Time to Market. We enable our customers to shorten their time to market and reduce their execution risk by offering complete system-level solutions. As a result, our customers can avoid the need to negotiate with and purchase multiple analog and digital ICs from separate vendors and engineer larger, more complex printed circuit boards, or PCBs, required to accommodate multiple ICs. Less complex PCBs also enable our customers to reduce the time required to set up their manufacturing lines and to reduce overall assembly time, further shortening the time to market for their products. Finally, our customers are not required to engage in the time-consuming process of writing their own firmware or software. Instead, we provide our customers with customizable firmware and software and design tools, through a software development kit, to allow them to rapidly add features to differentiate their products.

Hardware and Software Design for Enhanced End User Experience. We enable our customers to offer products with superior audio quality and advanced features. Our circuit design expertise has enabled us to design highly-integrated products with low noise levels, and thus high audio quality. Our audio codecs facilitate the connection of computers and consumer audio equipment by incorporating consumer, audio-centric interfaces. In addition, the software provided with our ICs allows an end user to enjoy many advanced features such as 3D

Index to Financial Statements

audio or sound spatialization, surround sound, and software equalization. In addition, our audio codecs’ Universal Jacks^{^™} feature is designed to simplify the use of microphones and speakers, reducing technical support requirements. Our hardware and firmware architecture, combined with our software development kit also enables our customers to customize their products with features such as menu structure and options, configuration of buttons, and other aspects of the user interface.

Our objective is to be a leading supplier of highly-integrated, analog-intensive, mixed-signal ICs for the portable device, personal computing and consumer electronic markets. To achieve this goal, we are pursuing the following strategies:

Target Multiple High-Growth Portable Electronic Device Markets. By leveraging our proprietary design methodologies and extensive experience, we intend to introduce new analog-intensive, mixed-signal ICs that are small and power-efficient. We have applied our capabilities successfully to expand into the portable compressed audio player and USB peripherals markets. We are currently the leading supplier of portable audio SoCs for use in flash memory-based compressed audio players. We believe our integration expertise and proprietary power management technology will enable us to efficiently develop new products for existing and emerging portable device market opportunities, such as industrial and medical devices.

Focus on Industry-Leading Customers. Many of our customers are industry leaders in their respective markets. We are focused on developing close relationships with industry leaders to facilitate rapid adoption of our products, drive higher sales volumes, and gain greater insight into market trends to help us more efficiently develop new products. For a given customer, we seek to expand our product opportunities both within an existing application as well as within new application segments served by these customers. For example, we have been able to leverage sales of our audio codecs for notebook PC customers into sales of audio codecs for desktop PCs sold by these same customers. In addition, our goal is to build strong, collaborative relationships with leading ODMs to help ensure the adoption of our products in their next generation products.

Reuse Core Technologies to Create New Products. We have designed many of the proprietary circuits contained in our mixed-signal ICs to be reusable. By redeploying these reusable circuits, we intend to develop new ICs for use in existing or emerging applications to minimize the risk of and accelerate new product development. Our reuse of proven circuit blocks not only accelerates our internal circuit design process, but also reduces the manufacturing risks associated with the development of new products, allowing us to realize higher product performance, reliability, and manufacturing yields.

Continue to Invest in Technology Development to Extend Market Leadership Position. We believe we have established a reputation as a technology leader in the design and development of analog-intensive, mixed-signal ICs. We intend to extend our technology leadership by leveraging our talent pool of engineers and investing significant resources in recruiting and developing additional expertise in analog-intensive, mixed-signal IC design. As of December 31, 2004, we held 42 U.S. patents. We are actively expanding our intellectual property position by aggressively investing in research and development and pursuing additional patent applications. In addition, we are actively pursuing patent infringement litigation, which could include International Trade Commission proceedings, against third parties that we believe infringe our patents.

Capitalize on Highly-Focused Business Model. We are a fabless semiconductor company, utilizing third parties to manufacture, assemble and test our products. This approach reduces our capital and operating requirements and enables us to focus on product development. We use standard digital CMOS technology in mature process geometries to reduce our costs and time to market. We rely primarily on a worldwide network of distributors to sell our products, supplemented with direct sales efforts to a limited number of customers. We believe this approach to sales reduces our selling and marketing expenses while enabling us to rapidly grow our business.

Index to Financial Statements

We currently design, develop and market proprietary, analog-intensive, mixed-signal ICs for portable compressed audio players, notebook and desktop PCs, consumer audio equipment, and infrared peripherals.

Advances in file compression technology and growth in broadband usage have made it increasingly convenient to store and transfer digital audio files. The most common standard today, MP3, typically provides a greater than ten-to-one file size reduction for digital audio content. Other standards, such as Windows Media Audio, or WMA, and mp3PRO offer even greater compression capabilities. In recent years, a number of companies have introduced products that play compressed digital audio files. These products require ICs to decode the compressed files into audible sound.

Our portable audio SoCs are highly-integrated, battery-optimized ICs designed to decode compressed audio files, such as MP3 files. We offer a broad range of portable audio SoCs at various price points and with a variety of features. For example, some of our more advanced portable audio SoCs incorporate USB2.0 Hi-Speed capability, a next generation USB standard that allows for faster data transfer rates than USB1.1. In addition, several of our portable audio SoCs feature support for miniature hard disk drives, or HDDs, enabling recording onto high-capacity media.

Index to Financial Statements

Notebook and desktop PCs continue to become increasingly media oriented as consumers use their PCs to play compressed audio files, CDs, advanced video games and DVDs. Microsoft’s Media Center initiative continues to push the PC into living room entertainment center which requires higher levels of audio fidelity. Intel’s Digital Home and Digital Office initiatives are creating new opportunities for increased audio capabilities. Today’s PC applications require high performance audio codecs with varying capabilities offered at various price points. The notebook PC segment and various smaller form factor desktop PCs require small form factors and low power consumption.

We offer a family of notebook and desktop PC audio codecs that provide playback and record functions with high audio fidelity. Until 2004, our PC audio codecs have been built in accordance with an Intel sponsored specification called “Audio Codec, 1997,” or AC 97. We worked with Intel to develop Intel’s High Definition Audio (HD Audio) specification which was released in 2003 to enable increased audio performance in the PC and in PC-like systems.

In 2004, we introduced our first products which were developed in accordance with the HD Audio specification. Building on our mixed signal expertise, we developed a second generation of HD Audio codecs that are targeted at providing high fidelity audio to notebook and desktop PCs. Our new 2-channel HD-Audio codec sets a new performance standard for notebook PCs. Our new 8-channel HD Audio codecs are specifically targeted to provide theater quality 7.1 audio to entertainment and mainstream PCs. These new codecs provide true 24-bit audio capabilities with SNR (Signal-to-Noise Ratio) performance that is similar to consumer electronics products. The continued convergence of PC and consumer audio equipment has led to increasing demand for our audio codecs within consumer electronic devices such as digital TVs and set-top boxes. To address this trend, we incorporate interfaces such as Inter-IC Sound, or I²S, Sony/Philips digital interface, or S/PDIF, and ADAT within our products to facilitate connectivity.

In conjunction with our PC audio codecs, we also provide advanced software solutions for traditional stereo and multi-channel PC audio. Our complete solution eliminates the need for add-in sound cards when integrating our codec solutions directly on the desktop motherboard and into notebook PCs, providing speed, performance, power saving efficiencies and lower overall system cost. Our SigmaTel Kernel Processing Interface (SKPI) enables advanced professional grade software plug-ins from SigmaTel and third parties to further enhance the performance of the audio subsystem.

The following table summarizes our family of notebook and desktop PC audio codecs:

Index to Financial Statements

Consumer audio devices typically require superior audio quality, more audio channels, and greater power output than PCs. However, consumer devices, such as digital TVs and personal video recorders, are increasingly incorporating PC components such as hard disk drives and microprocessors. As a result, the same AC97 and HD Audio codec technology currently employed in nearly all PCs is increasingly being used in non-PC consumer products.

Our consumer audio codecs typically provide surround sound playback capability at very high audio performance levels. We believe our AC97 and HD Audio codecs, which employ the consumer audio-centric I²S interfaces and S/PDIF interfaces, are well positioned to take advantage of the emerging convergence of PC and consumer audio equipment.

USB is a common peripheral connection featured on PCs. USB enables high data transfer rates and is replacing prior technologies such as serial and parallel ports. Data is typically transferred from a PC’s USB connection by means of a physical cable, or through more advanced technologies such as infrared transmission, to peripheral devices such as cell phones and personal digital assistants. Our products address wireless infrared communications.

IrDA is a standard defined by the Infrared Data Association consortium to specify the point-to-point wireless transfer of data via infrared radiation. Because only two devices are allowed to communicate at a time, the security risks associated with IrDA are greatly minimized. The primary devices that incorporate IrDA are notebook and desktop PCs, PDAs, computer printers, cell phones, digital cameras and medical devices. Due to the portable nature of many of these applications, IrDA components must be small, lightweight and consume little power.

Our initial product in the USB peripherals market was a USB/IrDA bridge controller IC implementing the USB 1.1 interface standard to enable high-speed (up to 4 megabits per second) wireless infrared data communications through a standard desktop or notebook PC USB port to infrared enabled mobile devices. Our USB-to-Infrared bridge device is commonly used in external peripheral devices, typically called infrared dongles, to enable standard desktop PCs and notebook PCs which do not include an integrated infrared transceiver to communicate with other infrared equipped products. Infrared dongles may be configured as a small

Index to Financial Statements

plastic case with an integrated infrared window and a typical USB connector or cable. If the USB connector is integrated directly into the plastics and the cable is eliminated, the unit is typically called an Infrared stick.

During the first quarter of 2004, we introduced our second USB Infrared bridge controller IC, the STIR4210, implementing the higher speed USB 2.0 Hi-Speed interface. The STIR4210 enables Serial Infrared (SIR), Medium Infrared (MIR) and Fast Infrared (FIR) IrDA communications up to 4 megabits per second. In the third quarter of 2004, we introduced the STIR4220 USB Infrared bridge controller that is the world’s first Very Fast Infrared (VFIR) controller providing IrDA communications up to 16 million bits per second. VFIR enables the wireless transfer of a 3 megabyte digital music file or high resolution photo in approximately 2 seconds.

The following table sets forth our revenues for each product class which accounted for greater than 15% of our revenues during any of the last three years (Audio Codecs include both notebook and desktop PC audio codecs and consumer audio codecs):

Our marketing and sales strategy is to achieve design wins with technology leaders and emerging participants in the portable compressed audio player, personal computer, consumer audio equipment, and USB peripherals markets. We principally rely on distributors to market our products. Our direct and indirect customers include both OEMs and ODMs.

Many of the leading OEMs in our markets use ODMs to manufacture their products. Accordingly, a significant portion of our revenues are based on sales to ODMs by our distributors. Three of the largest ODMs that purchase our products are Tai Guen Enterprise, A-MAX Technology, and Creative Technology. These ODMs not only manufacture portable compressed audio players and notebook or desktop PCs for Legend Computer, Dell, Gateway, and others, but they also manufacture their own branded products.

During the twelve months ended December 31, 2004, each of the following customers purchased more than $2 million of our products directly from us or through our distributors:

We have sold products to more than 300 direct and indirect customers during the last twelve months. During the year ended December 31, 2004, GMI, a distributor, Holystone, also a distributor, and Creative Technology, an affiliate, contributed 27.3%, 17.0% and 14.1% of our revenues, respectively. During the year ended December 31, 2003, revenues from Holystone, Creative Technology and GMI contributed 31.9%, 14.3% and 10.6% of our revenues, respectively. During the year ended December 31, 2002, Holystone and Creative Technology contributed 35.0% and 21.2% of our revenues, respectively.

We utilize independent sales representatives and distributors with locations throughout the world. These “SigmaTel Qualified Distributors” have been selected based on their understanding of the mixed-signal IC

Index to Financial Statements

marketplace and are measured on their ability to provide effective field sales support for our products. To supplement these sales representatives and distributors, we maintain direct sales offices in Texas, California and Hong Kong to call on certain key customers. We also utilize application engineers to provide technical support and assistance to existing and potential customers in designing, testing and qualifying systems that incorporate our products. Information about our revenues and long-lived assets in different geographic regions of the world is provided in Note 17 to the financial statements.

Our marketing group focuses on our product strategy, product development road maps, new product introduction process, demand assessment and competitive analysis. The group works closely with our sales and research and development groups to align our product development road map to meet key channel technology requirements from a strategic perspective. The group also ensures that product development activities, product launches, channel marketing program activities, and ongoing demand and supply planning occur in a well-managed, timely basis in coordination with our development, operations, and sales groups, as well as our ODMs, OEMs and distributors.

Our sales are made primarily pursuant to standard purchase orders. Because industry practice allows customers to reschedule or cancel orders on relatively short notice, we believe that backlog is not a good indicator of our future sales.

We engage in substantial research and development to develop new products to support our growth. We employ product designers who have expertise in system architecture, mixed-signal design, customizable firmware and software, and software development tools. As of December 31, 2004, we had 160 full-time employees engaged in research and development. Our research and development expense was $32.3 million, $17.9 million, and $11.9 million for the years ended December 31, 2004, 2003 and 2002, respectively. All development is carried out using ISO9001:2000-certified design processes, and our design tools are frequently enhanced to improve design, fabrication, and verification of our products.

We have several key technological core competencies and have assembled a development team with extensive mixed-signal design expertise to capitalize on these competencies. Where cost-effective, we purchase designed and verified function blocks, such as a DSP core and USB controller, from third-party vendors.

We combine high performance analog functionality on the same chip with digital functionality. One attribute of digital circuits is high-speed switching between logic states which generates transients known as electromagnetic interference or electrical noise. There are significant design and development challenges involved in mixing noisy digital circuits with noise-sensitive high performance analog circuits on the same IC. Our designers are skilled at solving these problems to achieve high-fidelity audio performance on a mixed-signal SoC.

Our engineers possess a high degree of systems-level knowledge of both the customer’s OEM system functionality and the advantages and limits to the analog and digital signal processing that may be performed on the SoC. Optimizing the partitioning of system functionality between analog and digital signal processing, whether through hardware, firmware or software, is key to minimizing die size while maintaining functional flexibility via programmability.

We design all of our ICs to be manufactured using industry standard digital CMOS technologies. While it is significantly more difficult to design high performance analog in digital CMOS processes, as opposed to processes especially adapted to analog, there are multiple advantages to this approach, including reduced cost, reduced manufacturing risk, and greater worldwide foundry capacity.

Index to Financial Statements

We design and develop our products and electronically transfer our proprietary designs to third-party foundries to process silicon wafers and produce the ICs. The wafers are then shipped from foundries to our subcontractors, where they are assembled into finished ICs and electronically tested before delivery to our customers. We believe that our outsourced manufacturing model significantly reduces our capital requirements and allows us to focus our resources on the design, development and marketing of our ICs. In addition, we benefit from our suppliers’ manufacturing expertise, and from the flexibility to select those vendors that we believe offer the best capability and value.

Our principal foundries are Taiwan Semiconductor Manufacturing Company in Taiwan and Chartered Semiconductor Manufacturing in Singapore. We also use Hyundai Electronics Industries in South Korea for certain products. These foundries currently fabricate our devices using mature and stable CMOS process technology with feature sizes of 0.18-micron and higher. We regularly evaluate the benefits and feasibility, on a product by product basis, of migrating to smaller process geometries to reduce cost and improve performance.

Following wafer processing, our wafers are shipped to our subcontractors where they are singulated into die, assembled into finished IC packages, and electrically tested. Our products are designed to use low cost, industry standard packages and be tested with widely available automatic test equipment. We develop and control all product test programs used by our subcontractors. These test programs are developed based on product specifications, thereby maintaining our ownership for the functional and parametric performance of our devices. We currently rely on ASAT Holdings in Hong Kong and China, United Test and Assembly Center in Singapore, Advanced Semiconductor Engineering in Taiwan, and Signetics in South Korea to assemble and test our products.

We have designed and implemented a quality management system that provides the framework for continual improvement of products, processes and customer service. We apply well-established design rules and practices for CMOS devices through standard design, layout and test processes. We also rely on in-depth simulation studies, testing and practical application testing to validate and verify our products. We emphasize a strong supplier quality management practice in which our manufacturing suppliers are pre-qualified by our operations and quality teams. Suppliers are required to have a quality management system, certified to ISO9000 standard and an environmental management system certified to ISO14000 standard. To ensure consistent product quality, reliability and yield, we closely monitor the production cycle by reviewing electrical, parametric and manufacturing process data from each wafer foundry and assembly subcontractor.

The markets for our ICs are intensely competitive. We believe that the principal bases of competition in our industry are:

We believe that we compete favorably with respect to each of these factors. However, some of our larger competitors have greater financial resources, a greater ability to influence industry standards, and much more

Index to Financial Statements

extensive patent portfolios than we do. We anticipate that the market for our products will be subject to rapid technological change. As we enter new markets and pursue additional applications for our products, we expect to face competition from a larger number of competitors. We face significant competition in each of our product lines. Within the portable compressed audio player market, we primarily compete with Actions Semiconductor, Philips Semiconductor, PortalPlayer, Samsung, Telechips and Texas Instruments. In the audio codec market, we compete primarily with AKM, Analog Devices, C-Media, Cirrus Logic, and Realtek. Within the USB peripherals market, we compete primarily with MosChip Semiconductor and Prolific Technology, and with other multi-chip solutions. We expect to face competition in the future from our current competitors, other manufacturers and designers of semiconductors, and innovative start-up semiconductor design companies. Certain of our customers have developed products or technologies internally which are competitive with our products. Other customers could develop internal solutions or enter into strategic relationships with or acquire existing mixed-signal IC providers. Any of these actions could replace their need for our products.

Our success and future growth will depend on our ability to protect our intellectual property. We rely primarily on patent, copyright, trademark and trade secret laws, contractual provisions, and licenses to protect our intellectual property. We also attempt to protect our trade secrets and other proprietary information through agreements with our customers, suppliers, employees and consultants, and through other security measures.

As of December 31, 2004, we held 42 issued U.S. patents. Our patents and patent applications cover features employed in each of our existing product families. Our patents have expiration dates ranging from 2015 to 2023. We continue to actively pursue the filing of additional patent applications.

We claim copyright protection for the proprietary documentation used in our products and for the firmware and software components of our products. We have registered 16 U.S. copyrights, covering certain of our firmware and software applications. We have also registered the “SigmaTel” name and logo as trademarks in the U.S.

While our patents and other intellectual property rights are important, we believe that our technical expertise and ability to introduce new products in a timely manner will also be important factors in maintaining our competitive position.

We intend to protect our rights vigorously, but there can be no assurance that our efforts will be successful. Thus, despite our precautions, a third party may copy or otherwise obtain and use our products, services or technology without authorization, develop similar technology independently or design around our patents. In addition, effective copyright, trademark and trade secret protection may be unavailable or limited in certain foreign countries. Moreover, we often incorporate the intellectual property of third parties into our designs, and we have certain obligations with respect to the non-use and non-disclosure of such intellectual property. There can be no assurance that the steps we have taken to prevent misappropriation or infringement of our intellectual property or third parties will be successful.

As of December 31, 2004, we employed 238 full-time people, including 160 in research and development, 21 in operations, 26 in sales and marketing, and 31 in administration. We have never had a work stoppage and none of our employees is represented by a labor organization. We consider our employee relations to be good.

Our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those filed or furnished pursuant to Sections 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, are available free of charge. These may be obtained from our website at www.sigmatel.com, as soon as reasonably practicable after we electronically file such material with, or furnish it to, the Securities and Exchange Commission, or at the SEC website at www.sec.gov.

Index to Financial Statements

Our business is inherently risky. You should carefully consider the risks described below and all of the other information contained in this annual report on Form 10-K and other filings with the Securities and Exchange Commission in evaluating our business. The risks and uncertainties described below are not the only risks and uncertainties we face. Additional risks and uncertainties not presently known to us or that we currently deem immaterial may also impair our business operations.

Our limited history of sales of our key products makes it difficult to evaluate our prospects.

Most of our key products have only been sold in significant quantities for a short time. For example, our STMP 3410 portable audio SoC was introduced in the fourth quarter of 2001 but did not begin shipping in significant quantities until the second quarter of 2002, and production volumes of our STMP 35XX family of portable audio SoC products began shipping in the fourth quarter of 2003. Sales of both the STMP 3410 and the STMP 35XX family of products are highly dependent upon continued acceptance of portable MP3 music players by consumers. Since we cannot accurately monitor sell-through of our ultimate end customers’ MP3 players which contain our portable audio SoCs, it is possible that some of these products may not be selling through. As a result, our customers could experience inventory growth that could cause them to purchase fewer products from us or seek to return products to us in the future. There can be no assurance that our customers have not or will not place orders in excess of their requirements in response to actual or perceived shortages in the supply of our ICs. In such event, it will be more difficult for us to forecast our future revenues and budget our operating expenses, and our operating results would be adversely affected to the extent such excess orders are cancelled or rescheduled. We have limited historical financial data from which to predict our future sales and operating results for our portable audio SoCs and other key products that we have recently introduced. Our limited operating experience with these products, combined with the rapidly evolving nature of the markets in which we sell our products, and other factors which are beyond our control, limit our ability to accurately forecast quarterly or annual sales. Because most of our expenses are fixed in the short term or incurred in advance of anticipated sales, we may not be able to decrease our expenses in a timely manner to offset any shortfall in sales. We are currently expanding our staffing and increasing our expenditures to support future growth. If our growth does not materialize, our operating results would be adversely impacted.

Due primarily to increased sales of our portable audio SoCs, we have experienced significant revenue growth and have gained significant market share in a relatively short period of time. Specifically, our annual revenues increased from $30.9 million in 2002 to $100.2 million in 2003 and to $194.8 million in 2004. However, we do not expect similar revenue growth or market share gains in future periods. Accordingly, you should not rely on the results of any prior quarterly or annual periods as an indication of our future operating performance.

We have incurred losses in prior periods and may incur losses in the future.

Although we had net income of $52.6 million and $10.0 million for the years ended December 31, 2004 and 2003, respectively, we incurred a net loss of approximately $8.3 million for the year ended December 31, 2002, and we may incur losses in the future. We expect our operating expenses to increase as we pursue our strategic objectives. Our results of operations for the year ended December 31, 2004 include non-cash charges of $2.2 million related to stock based compensation. We will continue to incur stock-based compensation in the future as a result of past option grants. Our ability to maintain profitability depends on the rate of growth of our target markets, the continued market acceptance of our customers’ products, the competitive position of our products, and our ability to develop new products. Even though we have achieved profitability, we may not be able to sustain or increase profitability on a quarterly or an annual basis.

Index to Financial Statements

We depend on a few key customers for a substantial majority of our sales and the loss of, or a significant reduction in orders from, any of them would likely significantly reduce our revenues.

For the years ended December 31, 2004, 2003 and 2002, sales to our top five customers accounted for approximately 72.3%, 71.9% and 75.7%, respectively, of our revenues. Our operating results in the foreseeable future will likely continue to depend on sales to a relatively small number of customers, as well as the ability of these customers to sell products that use our ICs. Our revenues would likely decline if one or more of these customers were to significantly reduce, delay or cancel their orders for any reason. In addition, any difficulty in collecting outstanding amounts due from our customers, particularly customers who place large orders, would harm our financial performance. Because our sales are made by means of standard purchase orders rather than long term contracts, we cannot assure you that our customers will continue to purchase our products at current levels, or at all.

We rely primarily on a small number of distributors to market and distribute our products, and if we fail to maintain or expand these sales channels, our revenues would likely decline.

Sales to a small number of distributors generate a significant amount of our revenues. Our sales through distributors accounted for 73.9%, 70.3% and 65.5% of our revenues for the years ended December 31, 2004, 2003, and 2002, respectively. Our sales to GMI and Holystone, two large distributors, accounted for 44.4%, 42.5% and 39.4% of our revenues in the years ended December 31, 2004, 2003 and 2002, respectively. If GMI, Holystone or our other distributors were to materially reduce their purchases from us, our business, financial condition and results of operations would suffer.

Our business will depend on our ability to maintain and expand our relationships with distributors, develop additional channels for the distribution and sale of our products and effectively manage these relationships. Our distributors decide whether to include our products among those that they sell and may carry and sell product lines that are competitive with ours. Because our distributors are not required to make a specified minimum level of purchases from us, we cannot be sure that they will prioritize selling our products. As we continue to expand our indirect sales capabilities, we will need to manage the potential conflicts that may arise within our indirect sales force. We also rely on our distributors to accurately and timely report to us their sales of our products and to provide certain engineering support services to customers. Our inability to obtain accurate and timely reports and to successfully manage these relationships would adversely affect our business and financial results.

Our business is highly dependent on the consumer electronics market, which is characterized by short product life cycles, fluctuations in demand and seasonality, and subject to risks related to product transitions and supply of other components.

We derive a substantial portion of our revenues from a limited number of products that are used in consumer electronic devices. The consumer electronics market is characterized by intense competition, rapidly evolving technology, and ever-changing consumer preferences. These factors result in the frequent introduction of new products, short product life cycles and significant price competition. The dynamic nature of this market limits our, as well as our customers’, ability to accurately forecast quarterly and annual sales. If we, or our customers, are unable to manage product transitions, our business and results of operations could be negatively affected. For example, if our customers transition from one type of flash memory to another type and our product is not compatible with the new type of flash memory, sales of our ICs would be adversely affected if we were unable to update our product in a timely manner. In addition, we are subject to the risk of supply problems with other components of the end products of our customers. For example, if our customers could not obtain sufficient supplies of flash memory or hard disk drives, key components in many portable compressed audio players, the sales of our products that are also included in such devices would be adversely affected. Furthermore, continuing technological advancement in consumer electronic devices, which is a significant driver of customer demand, is largely beyond our control.

The expansion of the consumer electronics market in general, and the demand for MP3 products in particular, may be adversely impacted by the enforcement of limits on file sharing and downloadable music. The

Index to Financial Statements

major record labels have complained about consumers downloading music off of the Internet without paying any fees or royalties to the owners of that music. In particular, the Recording Industry Association of America, a recording industry trade group, has sued numerous individuals who illegally distribute copyrighted songs over the Internet. If the record labels, other music producers, or other parties are successful in limiting the ability of consumers to obtain free music on the Internet, the demand for consumer electronic devices such as MP3 players that use our ICs may decline. Any decline in consumer spending, whether relating to general economic conditions, future terrorist attacks or disease outbreaks, such as Severe Acute Respiratory Syndrome, or SARS, could also limit the expansion of the consumer electronics market, thus adversely affecting our business.

Because many of our ICs are designed for use in consumer electronic products, such as portable compressed audio players, PCs, and DVD players, we expect our business to be subject to seasonality, with increased revenue in the third and fourth quarters of each year, when customers place orders to meet year-end holiday demand, and lower revenue in the first and second quarters of each year. However, our recent rapid growth in revenues makes it difficult for us to assess the impact of seasonal factors on our business. In particular, strong sales of our portable audio SoCs resulted in increased revenues during the first quarter of 2003 compared to the fourth quarter of 2002, offsetting seasonal demand factors. If we or our customers are unable to ramp up production of new or existing products to meet any increases in demand due to seasonality or other factors, our revenues from such products would be adversely affected.

China and South Korea, where we have significant sales, are currently experiencing a slowing in economic growth, which may reduce our expected revenues while the slowing continues.

A significant portion of our sales to manufacturers of compressed digital audio players occur in China and South Korea, two countries that are currently experiencing a slowdown in economic growth. During the year ended December 31, 2004, 40% of our sales occurred in China and 6% of our sales occurred in South Korea. While we cannot precisely determine the percentage of worldwide end user purchases of compressed digital audio players that occur in China and South Korea, some of our customers have indicated that the growth in their sales to end customers in China and South Korea will be slower than originally anticipated due to the overall slowdown in economic growth in those countries. Thus, our ability to increase revenues and grow our profits in the short term could be negatively impacted as a result of the current slowdown in economic growth in China and South Korea.

Because of the lengthy sales cycles for our products and the fixed nature of a significant portion of our expenses, we may incur substantial expenses before we earn associated revenues and may not ultimately achieve our forecasted sales for our products.

Our sales cycles can take up to 12 months to complete and volume production of products that use our ICs can take an additional 3 to 6 months to be achieved, if at all. Sales cycles for our products are lengthy for a number of reasons:

As a result of our lengthy sales cycles, we may incur substantial expenses before we earn associated revenues because a significant portion of our operating expenses is relatively fixed and based on expected

Index to Financial Statements

revenues. The lengthy sales cycles of our products make forecasting the volume and timing of orders difficult. In addition, the delays inherent in lengthy sales cycles raise additional risks that customers may cancel or change their orders. Our sales are made by purchase orders. Because industry practice allows customers to reschedule or cancel orders on relatively short notice, backlog is not always a good indicator of our future sales. If customer cancellations or product changes occur, this could result in the loss of anticipated sales without allowing us sufficient time to reduce our inventory and operating expenses.

We derive a substantial portion of our revenues from our portable audio SoCs, the selling prices of our products tend to decline over time, and if we are unable to develop successful new products in a timely manner, our operating results and competitive position could be harmed.

Our recent revenue growth has been primarily from sales of our portable audio SoCs, which account for 89% of our revenues in the year ended December 31, 2004. Our future success depends on our ability to develop successful new products in a timely and cost-effective manner. We are required to continually evaluate expenditures for planned product developments and choose among alternatives based upon our expectations of future market trends. We cannot assure you that we will be able to develop and introduce new or enhanced products in a timely and cost-effective manner or that our products will generate significant revenues. The development of our ICs is highly complex, and successful product development and market acceptance of our products depend on a number of factors, including:

As is typical in the semiconductor industry, the selling price of a product tends to decline significantly over the life of the product. If we are unable to offset any reductions in the selling prices of our products by introducing new products at higher prices or by reducing our costs, our revenues, gross margins and operating results would be adversely affected.

We rely on third-party contractors to manufacture, assemble and test our products and our failure to successfully manage our relationships with these contractors could damage our relationships with our customers, decrease our sales, and limit our growth.

We rely on third-party contractors to manufacture, assemble, and test our ICs. We currently do not have long-term supply contracts with any of our third-party vendors. None of our third-party vendors are obligated to perform services or supply products to us for any specific period, or in any specific quantities, except as may be provided in a particular purchase order. There are significant risks associated with our reliance on these third-party contractors, including:

Index to Financial Statements

Because future foundry capacity may be limited and because we do not have long-term agreements with our foundries, we may not be able to secure adequate manufacturing capacity to satisfy the demand for our products.

Our products are designed to be foundry-portable. In general, each of our products is primarily manufactured at a single foundry. We provide these foundries with monthly rolling forecasts of our production requirements; however, the ability of each foundry to provide wafers to us is limited by the foundry’s available capacity. Moreover, the price of our wafers will fluctuate based on changes in available industry capacity. We do not have long term supply contracts with any of our foundries. Therefore, our foundry suppliers could choose to prioritize capacity for other customers, particularly larger customers, reduce or eliminate deliveries to us on short notice or increase the prices they charge us. Accordingly, we cannot be certain that our foundries will allocate sufficient capacity to satisfy our requirements. If we are not able to obtain foundry capacity as required, our relationships with our existing customers would be harmed and our sales would likely decline.

If our foundries do not achieve satisfactory yields or quality, our sales could decrease, and our relationships with our customers and our reputation may be harmed.

Minor deviations in the IC manufacturing process can cause substantial decreases in yields, and in some cases, cause production to be suspended. For example, a design error by one of our third-party foundries during 2001 caused very low yields for several months, which negatively impacted our business. Our foundries are responsible for yield losses due to their errors, but these yield losses could cause us to delay shipments to our customers. Our parts are qualified with our foundries, at which time a minimum acceptable yield is established. If actual yield is below the minimum, the foundry incurs the cost of the wafers. If actual yield is above the minimum, we incur the cost of the wafers. The manufacturing yields for our new products tend to be lower initially and increase as we achieve full production. Our product pricing is based on the assumption that an increase in manufacturing yields will continue, even with the increasing complexity of our ICs. Shorter product life cycles require us to develop new products faster and to manufacture these products for shorter periods of time. In many cases, these shorter manufacturing periods will not reach the longer, high volume manufacturing periods conducive to higher manufacturing yields and declining costs. As a result, if our foundries fail to deliver fabricated silicon wafers of satisfactory quality in the volume and at the price required, we will be unable to meet our customers’ demand for our products or to sell those products at an acceptable profit margin, which would adversely affect our sales and margins and damage our customer relationships.

We often build our products based on forecasts provided by customers before receiving purchase orders for the products and may therefore incur product shortages or excess product inventory.

In order to ensure availability of our products for some of our largest customers, we begin the manufacturing of our products in advance of receiving purchase orders based on forecasts provided by these customers and our distributors. These forecasts, however, do not represent binding purchase commitments and we do not recognize sales for these products until they are shipped to the customer. As a result, we incur inventory and manufacturing costs in advance of anticipated sales. Because demand for our products may not materialize, manufacturing based on forecasts subjects us to increased risks of high inventory carrying costs and

Index to Financial Statements

increased obsolescence and may increase our operating costs. These inventory risks are exacerbated when our customers purchase indirectly through contract manufacturers because this causes us to have less visibility regarding the accumulated levels of inventory for such customers. A resulting write-off of unusable or excess inventories would adversely affect our operating results.

Our third-party foundries, other subcontractors and many of our customers and end customers are located in the Pacific Rim, an area subject to significant earthquake risk and adverse consequences related to the outbreak of SARS and other public health concerns.

All of the principal foundries that manufacture our products and all of the principal subcontractors that assemble, package, and test our products are located in either South Korea, Singapore, Hong Kong, or Taiwan. Many of our customers are also located in these areas. The risk of an earthquake in these Pacific Rim locations is significant. The occurrence of an earthquake or other natural disaster near these foundries or subcontractors could result in damage, power outages and other disruptions that impair their production and assembly capacity. Any disruption resulting from such events could cause significant delays in the production or shipment of our products until we are able to shift our manufacturing, assembling, packaging or production testing from the affected contractor to another third-party vendor. While we have some foundry capacity in the United States, we may not be able to increase our foundry capacity in the United States, or obtain other alternate foundry capacity on favorable terms, if at all. The 2003 outbreak of SARS curtailed travel to and from certain countries (primarily in the Asia-Pacific region) and limited travel and shopping within those countries and any future outbreaks of SARS or other public health concerns could have similar consequences. In addition, outbreaks of disease or other disasters could limit consumer demand for our ICs or the products that use our ICs.

Our recent expansion has placed a significant strain on our management, personnel, systems and resources, and the continued success of our business depends on our ability to successfully manage any future expansion.

Our business has expanded rapidly, and we expect that further expansion will be required to address the potential growth in our customer base. This expansion has placed, and any future expansion will continue to place, a significant strain on our management, personnel, systems and resources. If we are unable to manage our growth effectively, we may not be able to take advantage of market opportunities, develop new products, enhance our technological capabilities, satisfy customer requirements, execute on our business plan or respond to competitive pressures. To successfully manage our growth, we believe we must effectively:

We may experience significant period-to-period quarterly and annual fluctuations in our revenues and operating results, which may result in volatility in our stock price.

We have in the past and may in the future experience significant period-to-period fluctuations in our revenues and operating results due to a number of factors, including:

Index to Financial Statements

Any variations in our quarter-to-quarter performance may cause our stock price to fluctuate. It is likely that in some future period our operating results will be below the expectations of public market analysts or investors. If this occurs, our stock price may drop, perhaps significantly.

The semiconductor industry is highly cyclical. The industry has experienced significant downturns, often in connection with, or in anticipation of, maturing product cycles (of both semiconductor companies’ and their customers’ products) and declines in general economic conditions. These downturns have been characterized by production overcapacity, high inventory levels and accelerated erosion of average selling prices. Any future downturns could significantly harm our sales or reduce our profitability for a prolonged period of time. From time to time, the semiconductor industry also has experienced periods of increased demand and production capacity constraints. We may experience substantial changes in future operating results due to general semiconductor industry conditions, general economic conditions and other factors.

Because the markets in which we compete are highly competitive and many of our competitors have greater resources than us, we cannot be certain that our products will compete favorably in the marketplace.

We face competition from a relatively large number of competitors in each of our targeted markets. In the PC and consumer audio markets, we compete primarily with AKM, Analog Devices, C-Media, Cirrus Logic, and Realtek. In the portable compressed audio market, our principal competitors include Actions Semiconductor, Philips Semiconductor, PortalPlayer, Samsung, Telechips and Texas Instruments. Within the USB peripherals market, we compete primarily with MosChip Semiconductor and Prolific Technology, and other companies providing various multi-chip solutions. We expect to face increased competition in the future from our current and emerging competitors. In addition, some of our customers have developed and other customers could develop their own internal ICs that could replace their need for our products or otherwise reduce demand for our products.

The consumer electronics market, which is a principal end market for our ICs, has historically been subject to intense price competition. In many cases, low cost, high volume producers have entered markets and driven down profit margins. If a low cost, high volume producer should develop products that are competitive with our products, our sales and profit margins would suffer.

Many of our current and potential competitors have longer operating histories, greater name recognition, access to larger customer bases and significantly greater financial, sales and marketing, manufacturing,

Index to Financial Statements

distribution, technical and other resources than us. As a result, they may be able to respond more quickly to changing customer demands or to devote greater resources to the development, promotion and sales of their products than we can. Our current and potential competitors may develop and introduce new products that will be priced lower, provide superior performance or achieve greater market acceptance than our products. In addition, in the event of a manufacturing capacity shortage, these competitors may be able to obtain capacity when we are unable to do so. Furthermore, our current or potential competitors have established or may establish, financial and strategic relationships among themselves or with existing or potential customers or other third parties to increase the ability of their products to address the needs of our prospective customers. Accordingly, it is possible that new competitors or alliances among competitors could emerge and rapidly acquire significant market share, which would harm our business.

We depend on our key personnel to manage our business effectively, and if we are unable to retain our current personnel and hire additional personnel, our ability to develop and successfully market our products could be harmed.

We rely heavily on the services of our key employees, including Ronald Edgerton, our Chief Executive Officer. In addition, our analog designers and other key technical personnel represent a significant asset and serve as the source of our technological and product innovations. We believe our future success will depend upon our ability to retain these key employees and our ability to attract and retain other skilled managerial, engineering and sales and marketing personnel. Any of our current employees may terminate their employment with us at any time. The competition for such personnel is intense in our industry. We may not be successful in attracting and retaining sufficient numbers of technical personnel to support our anticipated growth. The loss of any of our key employees or our inability to attract or retain qualified personnel, including engineers, could delay the development and introduction of, and negatively impact our ability to sell, our products.

Our products are complex and may require modifications to resolve undetected errors or failures in our hardware and software, which could lead to an increase in our costs, a loss of customers or a delay in market acceptance of our products.

Our ICs are complex and may contain undetected hardware and software errors or failures when first introduced or as new versions are released. These errors could cause us to incur significant re-engineering costs, divert the attention of our engineering personnel from product development efforts and cause significant customer relations and business reputation problems. If we deliver products with errors, defects or bugs, our credibility and the market acceptance and sales of our products could be harmed. Defects could also lead to liability for defective products as a result of lawsuits against us or against our customers. We have agreed to indemnify our customers in some circumstances against liability from defects in our products. A successful product liability claim could require us to make significant damage payments.

We have substantial international activities, which expose us to additional business risks including increased logistical complexity and political instability.

We recently established an international subsidiary and opened an office in Hong Kong to increase our international activities in Asia. The percentage of our revenues from customers located outside of the U.S. were 99.9%, 99.4% and 98.3% for the years ended December 31, 2004, 2003 and 2002, respectively. We plan to expand our international sales activities, but may not be able to maintain or increase international market demand for our products. Our international sales and operations are subject to a number of risks, including:

Index to Financial Statements

To date, all of our sales to international customers and purchases of components from international suppliers have been denominated in U.S. dollars. As a result, an increase in the value of the U.S. dollar relative to foreign currencies could make our products more expensive for our international customers, thus potentially leading to a reduction in sales and profitability. Furthermore, many of our competitors are foreign companies that could benefit from such a currency fluctuation making it more difficult for us to compete with those companies.

We may be unable to effectively protect our intellectual property, which would negatively affect our ability to compete.

We believe that the protection of our intellectual property rights will continue to be important to the success of our business. We rely on a combination of patent, copyright, trademark and trade secret laws and restrictions on disclosure to protect our intellectual property rights. We also enter into confidentiality or license agreements with our employees, consultants and business partners, and control access to and distribution of our documentation and other proprietary information. Despite these efforts, unauthorized parties may attempt to copy or otherwise obtain and use our proprietary technology. Monitoring unauthorized use of our technology is difficult, and we cannot be certain that the steps we have taken will prevent unauthorized use of our technology, particularly in foreign countries where the laws may not protect our proprietary rights as fully as do the laws of the U.S. Many U.S. companies have encountered substantial infringement problems in foreign countries, including countries in which we sell products. We do not currently hold any non-U.S. patents. We cannot be certain that patents will be issued as a result of our pending applications nor can we be certain that any issued patents would protect or benefit us or give us adequate protection from competing products. For example, issued patents may be circumvented or challenged and declared invalid or unenforceable. We also cannot be certain that others will not develop our unpatented proprietary technology or effective competing technologies on their own.

Significant litigation over intellectual property in our industry may cause us to become involved in costly and lengthy litigation, which could subject us to liability, require us to stop selling our products or force us to redesign our products.

In recent years, there has been significant litigation in the U.S. involving patents and other intellectual property rights in the semiconductor industry. In the past, we have found it necessary to engage in litigation to enforce and defend our intellectual property rights, to protect our trade secrets or to determine the validity and scope of proprietary rights of others. For example, in 2000 we settled a patent infringement and trade secret claim filed by Cirrus Logic related to our audio codec products. Most recently, we filed a lawsuit against Actions Semiconductor seeking to halt its infringement of our intellectual property rights. We believe future litigation involving intellectual property could occur.

From time to time, we receive letters from various industry participants alleging infringement of patents or trade secrets. We typically respond when appropriate and as advised by legal counsel. Any lawsuits resulting from such allegations could subject us to significant liability for damages and invalidate our proprietary rights. These lawsuits, regardless of their success, would likely be time-consuming and expensive to resolve and would divert management time and attention. Any potential intellectual property litigation also could force us to do one or more of the following:

Index to Financial Statements

Our intellectual property indemnification practices may adversely impact our business.

We have historically indemnified our customers for certain costs and damages of patent infringement in circumstances where our product is the factor creating the customer’s infringement exposure. This practice may subject us to significant indemnification claims by our customers. In some instances, our products are designed for use in devices manufactured by our customers that comply with international standards, such as the MP3 standard. These international standards are often covered by patent rights held by third parties, which may include our competitors. The combined costs of identifying and obtaining licenses from all holders of patent rights essential to such international standards could be high and could reduce our profitability or increase our losses. The cost of not obtaining such licenses could also be high if a holder of such patent rights brings a claim for patent infringement. We are aware that certain of our customers have received a notice from a third party seeking to grant a royalty bearing patent license to those customers and claiming that those customers’ manufacture and sale of products capable of decoding MP3 files violates patents which the third party has the right to enforce. We have not received any such notice, and we are not aware of any claimed violations on our part. In the contracts under which we distribute MP3 decoding products, we generally have not agreed to indemnify our customers with respect to patent claims related to MP3 decoding technology. However, we cannot assure you that claims for indemnification will not be made or that if made, such claims would not have a material adverse effect on our business, operating results or financial condition.

Any acquisition activity could disrupt our ongoing business and may present risks not contemplated at the time of the transaction.

We may acquire companies that have products, services, personnel and technologies that complement our strategic direction and product roadmap. These acquisitions may involve significant risks and uncertainties, including difficulties in incorporating the acquired companies’ operations and technologies; distraction of management’s attention away from normal business operations; insufficient revenue generation to offset liabilities assumed and expenses associated with acquisition; and unidentified issues not discovered in our due diligence process, including product quality issues and legal contingencies. Acquisitions are inherently risky, and no assurance can be given that any acquisitions will be successful and will not materially adversely affect business, operating results or financial condition. Should we issue our common stock or other equity related purchase rights as consideration in an acquisition, current stockholders’ percentage ownership and earnings per share may become diluted.

The industry standards supported by our products are continually evolving, and our success depends on our ability to adapt our products to meet these changing industry standards.

Our ability to compete in the future will depend on our ability to ensure that our products are compliant with evolving industry standards, such as the introduction of new compression algorithms for compressed audio players. The emergence of new industry standards could render our products incompatible with products developed by other suppliers. As a result, we could be required to invest significant time and effort and to incur significant expense to redesign our products to ensure compliance with relevant standards. If our products are not in compliance with prevailing industry standards for a significant period of time, we could miss opportunities to achieve crucial design wins. We may not be successful in developing or using new technologies or in developing new products or product enhancements that achieve market acceptance and such efforts may require substantial time and expenses.

If securities or industry analysts do not continue to publish research or reports about our business, our stock price and trading volume could decline.

The trading market for our common stock will depend on the research and reports that industry or securities analysts publish about us or our business. We do not have any control over these analysts. If one or more of the analysts who cover us downgrade our stock, our stock price would likely decline. If one or more of these analysts cease coverage of our company or fail to regularly publish reports on us, we could lose visibility in the financial markets, which in turn could cause our stock price or trading volume to decline.

Index to Financial Statements

Our products may be found to be defective, product liability claims may be asserted against us and we may not have sufficient liability insurance.

One or more of our products may be found to be defective after shipment, requiring a product replacement, recall or a software solution, that would cure the defect but impede performance of the product. We may also be subject to product returns which could impose substantial costs and harm our business. In addition, product liability claims may be asserted with respect to our technology or products. Our products are typically sold at prices that are significantly lower than the cost of the end-products into which they are incorporated. A defect or failure in our product could give rise to failures in our customer’s end-product, so we may face claims for damages that are disproportionately higher than the revenues and profits we receive from the products involved, especially if our customer seeks to recover for damage claims made against it by its own customers. While we maintain insurance, there can be no assurance that we have obtained a sufficient amount of insurance coverage, that asserted claims will be within the scope of coverage of the insurance, or that we will have sufficient resources to satisfy any asserted claims.

Changes to financial accounting standards may affect our results of operations and cause us to change our business practices.

We prepare our financial statements to conform with generally accepted accounting principles, or GAAP, in the United States. These accounting principles are subject to interpretation by the American Institute of Certified Public Accountants, the Securities and Exchange Commission and various bodies formed to interpret and create appropriate accounting policies. A change in those policies can have a significant effect on our reported results and may affect our reporting of transactions completed before a change is announced. Changes to those rules or the questioning of current practices may adversely affect our reported financial results or the way we conduct our business. For example, under the recently issued Financial Accounting Standard Board Statement No. 123R, we will be required to apply certain expense recognition provisions beginning July 1, 2005 to share-based payments to employees using the fair value method. This new accounting policy and any other changes in accounting policies in the future may result in significant accounting charges.

As a public company, we incur significant legal, accounting and other expenses that we did not incur as a private company. In addition, the Sarbanes-Oxley Act of 2002, as well as new rules subsequently implemented by the Securities and Exchange Commission and new listing requirements subsequently adopted by Nasdaq in response to Sarbanes-Oxley, have required changes in corporate governance practices of public companies. These new rules, regulations, and listing requirements have increased our legal and financial compliance costs, and made some activities more time consuming and costly. For example, as a result of becoming a public company, we have added additional independent directors, created several board committees, adopted additional internal controls and disclosure controls and procedures, retained a transfer agent and a financial printer, adopted an insider trading policy, and have all of the internal and external costs of preparing and distributing periodic public reports in compliance with our obligations under the securities laws. These new rules and regulations have made it more difficult and more expensive for us to obtain director and officer liability insurance. These new rules and regulations could also make it more difficult for us to attract and retain qualified members of our board of directors, particularly to serve on our audit committee, and qualified executive officers.

The emergence of alternative models for downloading digital music content may impact our business in ways we cannot anticipate.

Currently, most purchased music content is available through a pay-per-download model in which consumers purchase and own the song file which they can download and play on their personal media player. Microsoft is in the process of launching digital rights management software which is expected to provide personal media players access to music content on a subscription basis in which consumers can pay a subscription fee to rent, rather than own, the song file. The technology seeks to add a security feature to

Index to Financial Statements

Microsoft’s digital rights management technology to allow a personal media player to determine when a specific file has expired. If this technology is successful and our customers are unable to integrate with such technology, it could compete with existing pay-per-download music services. We cannot predict the impact on our business should this or other similar technology or other content distribution models become widely adopted. In addition, to the extent other providers of digital content or providers of platforms or components for personal media players take market share away from our customers’ products and services, our business and results of operations could be materially harmed.

Our main executive, administrative and technical offices currently occupy approximately 74,000 square feet in Austin, Texas, under a lease agreement that requires us to lease an additional approximately 22,000 to 26,000 square feet by the fourth quarter of 2005, which lease expires in December of 2011 with one five year renewal option. We have subleased approximately 25,000 square feet of office space in Austin, Texas, which we do not currently utilize, to an unrelated third party through February of 2007, which is the term of the underlying lease. We have also subleased approximately 23,000 square feet of our former principal executive office space in Austin, Texas, which we do not currently utilize, to an unrelated third party through September of 2006, which is the term of the underlying lease. We also lease approximately 23,000 additional square feet of our former principal executive office space under a lease that expires in September of 2006 and approximately 9,500 additional square feet in another facility under a sublease that expires in September of 2007, both of which spaces we do not currently occupy, and we are actively seeking to sublease these to third parties.

We believe that our facilities are adequate for our current needs and that suitable additional or substitute space will be available as needed to accommodate foreseeable expansion of our operations.

Many participants in the semiconductor industry have a significant number of patents and have frequently demonstrated a willingness to commence litigation based on allegations of patent and other intellectual property infringement. From time to time, we have received, and expect to continue to receive, notices of claims of infringement, misappropriation or misuse of other parties’ proprietary rights. Some of these claims have led to litigation. We cannot assure you that we will prevail in these actions, or that other actions alleging infringement by us of third-party patents, misappropriation or misuse by us of third-party trade secrets, or invalidity of our patents will not be asserted or prosecuted against us, or that any assertions of infringement, misappropriation or misuse or prosecutions seeking to establish the invalidity of our patents will not materially and adversely affect our business, financial condition and results of operations. As of December 31, 2004, we were party to the following legal proceeding:

On January 4, 2005, we filed a lawsuit against Actions Semiconductor Company, Ltd., based in Zhuhai, Guangdong, China (“Actions Semiconductor”), in the United States District Court for the Western District of Texas, Austin Division. We assert that certain Actions Semiconductor ICs that are incorporated as components in MP3 players being shipped into the United States infringe multiple SigmaTel patents related to our portable audio SoCs. We are seeking damages and requesting a permanent injunction prohibiting Actions Semiconductor from designing, manufacturing or selling the infringing MP3 integrated circuits in the United States. We are also requesting a permanent injunction prohibiting further shipment of products into the United States that use Actions Semiconductor integrated circuits.

Index to Financial Statements

Item 5. Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

Our common stock has been quoted on the Nasdaq National Market under the symbol “SGTL” since September 19, 2003. Prior to this time, there was no public market for our common stock. The following table sets forth, for the periods indicated, the high and low sale prices per share for our common stock as reported on the Nasdaq National Market. As of January 20, 2005, there were 68 holders of record of our common stock.

We have never declared or paid any cash dividends on our capital stock, and we currently do not intend to pay cash dividends on our common stock. We currently expect to retain any future earnings to fund the operation and expansion of our business. Any future determination to pay cash dividends on our common stock will be at the discretion of our board of directors and will be dependent upon our financial condition, operating results, capital requirements and other factors that our board deems relevant.

The Securities and Exchange Commission declared the Company’s first registration statement, which the Company filed on Form S-1 (Registration No. 333-106796) under the Securities Act of 1933 in connection with the initial public offering of its common stock, effective on September 18, 2003. Under this registration statement, the Company registered 11,500,000 shares of its common stock, including 1,500,000 shares subject to the underwriters’ over-allotment option (which option was exercised in full), with an aggregate public offering price of $172.5 million. The Company registered 7,383,917 of these shares on its behalf and 4,116,083 of these shares on behalf of certain selling stockholders of the Company.

The underwriting syndicate was managed by Merrill Lynch & Co., JPMorgan, CIBC World Markets and Needham & Company, Inc.

The offering commenced, and was completed on September 19, 2003, at a price to the public of $15.00 per share. The underwriters exercised the over-allotment option effective as of September 22, 2003, and the offering terminated as of that date with the sale of all securities registered.

The sale of shares of common stock by the Company, including the sale of 383,917 shares pursuant to the exercise of the over-allotment option by the underwriters, resulted in aggregate gross proceeds of approximately $110.8 million, approximately $7.8 million of which the Company applied to underwriting discounts and commissions and approximately $1.6 million of which the Company applied to related costs. As a result, the Company received approximately $101.4 million of the offering proceeds.

Index to Financial Statements

The information under the caption “Equity Compensation Plan Information” appearing in the Proxy Statement is incorporated herein by reference.

The selected balance sheet data as of December 31, 2004 and 2003 and the selected statements of operations data for the years ended December 31, 2004, 2003 and 2002 have been derived from audited financial statements included in this Form 10-K. The selected balance sheet data as of December 31, 2002, 2001 and 2000 and the selected statements of operations data for the years ended December 31, 2001 and 2000 have been derived from audited financial statements not included in this Form 10-K. You should read this selected financial data in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our financial statements and the notes to those statements included in this Form 10-K.

Index to Financial Statements

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion should be read in conjunction with the consolidated financial statements and related notes which appear elsewhere in this report on Form 10-K. This discussion contains forward-looking statements that involve risks and uncertainties. Please see the “Cautionary Statement” above. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of various factors, including those discussed below and elsewhere in this report on Form 10-K, particularly under the heading “Factors Affecting Our Future Operating Results.”

We are a fabless semiconductor company that designs, develops, and markets proprietary, analog-intensive, mixed-signal ICs. We were founded in 1993 with an initial focus on providing semiconductor design services on a contract basis. We began to develop our first IC product, an AC97 audio codec for PC sound cards, in 1995 and began shipping this product in 1997. From 1997 to 2000, our annual revenues grew rapidly from $1.2 million to $47.4 million. During that time, we began to develop an asymmetric digital subscriber line, or ADSL, SoC and a portable audio SoC. Neither of these products generated revenues, which led to significant operating losses in 2000 and 2001. During 2000 and 2001, the PC audio market transitioned from sound cards to host audio solutions, which are integrated on desktop PC motherboards and in notebook PCs. As sound cards began to lose market share, we experienced a significant loss in market share and a revenue decline from 2000 to 2001.

In early 2001, we hired our current Chief Executive Officer, Ronald Edgerton, and established a new management team. This new management team stopped development of our ADSL SoC, reduced headcount, and redirected our development efforts towards host audio codecs and portable audio SoCs. Due primarily to increased sales of our portable audio SoCs, our revenues increased from $30.9 million for the year ended December 31, 2002 to $100.2 million for the year ended December 31, 2003 and $194.8 million for the year ended December 31, 2004, and our operating results improved from an operating loss of $5.6 million for the year ended December 31, 2002 to operating income of $11.3 million for the year ended December 31, 2003 and $53.1 million for the year ended December 31, 2004.

We currently offer products that serve four markets: portable compressed audio players, notebook and desktop PC audio, consumer audio, and USB peripherals. We made our first commercial shipments of PC audio codecs during 1997. We made our first commercial shipments of USB peripheral ICs in 2000, primarily targeting USB-to-Infrared wireless connectivity applications. We made our first commercial shipments of portable audio SoCs in 2001. The primary market for these products is the portable compressed audio player market. During 2001, we also began to sell our audio codecs into the consumer electronics market for products such as DVD players and set top boxes.

As a fabless semiconductor company, our business model is less capital intensive because we rely on third parties to manufacture, assemble, and test our ICs. We principally rely on distributors to market our products. Our sales through distributors result in lower gross margins, but also lower selling expenses than are associated

Index to Financial Statements

with direct sales to end customers. A few customers account for a substantial portion of our sales. The following table sets forth our customers that represented 10% or more of our revenues for the periods indicated:

The percentage of our revenues from customers located outside the U.S. was 99.9%, 99.4% and 98.3% for the years ended December 31, 2004, 2003 and 2002, respectively. Most of the products that use our ICs are manufactured outside of the U.S. As a result, we believe that a substantial majority of our revenues will continue to come from customers located outside of the U.S. All of our revenues to date have been denominated in U.S. dollars.

The percentages of our revenues by country are set forth in the following table:

Our sales cycles can take up to 12 months to complete and volume production of products that use our ICs can take an additional 3 to 6 months to be achieved, if at all. The lengthy sales cycles of our products make forecasting the volume and timing of orders difficult. In addition, the delays inherent in lengthy sales cycles increase the risk that customers may seek to cancel or modify their orders. Our sales are made by purchase orders. Because industry practice allows customers to reschedule or cancel orders on relatively short notice, backlog is not a good indicator of our future sales. Cancellations of customer orders or changes in product specifications could result in the loss of anticipated sales without allowing us sufficient time to reduce our inventory and operating expenses.

Because many of our ICs are designed for use in consumer electronic products, such as portable compressed audio players, PCs, and DVD players, we expect our business to be subject to seasonality, with increased revenues in the third and fourth quarters of each year, when customers place orders to meet year-end holiday demand, and lower revenues in the first and second quarters of each year. However, our recent rapid revenue growth makes it difficult for us to assess the impact of seasonal factors on our business. In particular, strong sales of our portable audio SoCs resulted in increased revenues during the first quarter of 2003 compared to the fourth quarter of 2002, offsetting seasonal demand factors.

Index to Financial Statements

the Delaware subsidiary conducted no operations and had no assets or liabilities other than $1,000 of cash contributed to it by the Texas corporation. SigmaTel Hong Kong Ltd. was established and incorporated in Hong Kong in July 2004 and became a wholly owned subsidiary of SigmaTel, Inc. in August of 2004, for the purpose of providing engineering support to our customers in Asia for their product development activities.

Revenues. Revenues consist primarily of sales of our ICs, net of sales discounts or incentives. We recognize revenues on direct sales at the time of shipment to our customers, or later if dictated by shipping terms. We defer revenues on sales through distributors with rights of return and price protection until products are resold by such distributors to their customers.

Cost of Goods Sold. Cost of goods sold consists primarily of the costs of purchasing silicon wafers, and also includes costs associated with assembly, test and shipping of our ICs, costs of personnel and equipment associated with manufacturing support and quality assurance, and occupancy costs. Because we do not have long-term, fixed-price supply contracts, our wafer costs are subject to the cyclical demand for semiconductors.

Research and Development. Research and development expense consists primarily of employee, contractor, and related costs, expenses for development testing, evaluation, masking revisions, occupancy costs, and depreciation on research and development equipment. All research and development costs are expensed as incurred. We plan to continue to invest a significant amount in research and development activities to develop new products. We expect research and development expenses to increase in future periods in absolute dollars to support the pursuit of new product development opportunities.

Selling, General and Administrative. Selling, general and administrative expense consists primarily of employee, contractor, and related costs, occupancy costs, sales commissions to independent sales representatives, professional services, and promotional and marketing expenses. We expect selling expenses will fluctuate with changes in revenues, and we expect that general and administrative expenses will increase in future periods to support our future operations as well as the additional costs of operating as a publicly traded company.

Amortization of Deferred Stock-Based Compensation. In connection with grants of stock options and the issuance of warrants as a private company in 2000, 2001, 2002 and 2003, we recorded an aggregate of $7.5 million in deferred stock-based compensation. These options and warrants are considered compensatory because the fair value of our stock determined for financial reporting purposes was greater than the fair value determined by our board of directors on the date of grant or issuance. As of December 31, 2004, we had an aggregate of $1.3 million of deferred stock-based compensation remaining to be amortized. We are amortizing deferred stock-based compensation over the vesting period of the related options and warrants, which is generally four or five years. This deferred stock-based compensation balance will be amortized as follows: $0.9 million during 2005 and $0.4 million during 2006.

Provision for Income Taxes. We accrue federal and state income taxes at the applicable statutory rates adjusted for certain items including non-deductible expenses, research and development tax credits, interest income from tax advantaged investments, as well as changes in our deferred tax asset valuation allowance. In the third quarter of 2004, we released $8.4 million of our deferred tax asset valuation allowance due to management’s belief that it is more likely than not that we will realize our remaining net deferred tax asset. We expect our future effective tax rate to more closely approximate the statutory rate due to the release of the majority of the deferred tax valuation allowance.

Index to Financial Statements

The following table sets forth our statements of operations as a percentage of revenues for the periods indicated:

Comparison of Year Ended December 31, 2004 to Year Ended December 31, 2003

Revenues. Revenues for the year ended December 31, 2004 were $194.8 million compared to $100.2 million for the year ended December 31, 2003, an increase of 94.4%. This increase was due to an increase in revenues from our portable audio SoCs, offset by a decrease in revenues from our audio codecs and USB peripheral ICs. The increase in revenues from our portable audio SoCs was due to the growth of the emerging portable compressed audio player market and our favorable competitive position within that market. Revenues from our portable audio SoCs were 89.3% of total revenues for the year ended December 31, 2004. Our favorable competitive position in this market is primarily due to our integration of analog and digital components onto a single IC, and the resulting small form factor, low power consumption, and overall low system cost to our customers. The decrease in revenues from audio codecs was due to decreased sales to sound card manufacturers. The decrease in revenues from USB peripheral ICs was primarily due to competitive pricing pressures.

Revenues from GMI, our largest distributor located in Hong Kong, increased by $42.7 million to 27.3% of total revenues during the year ended December 31, 2004 from 10.6% of total revenues during the year ended December 31, 2003 due to stronger demand for our portable audio SoCs in China, including Hong Kong. Revenue from Holystone, a distributor located in Taiwan, increased by $1.2 million, but decreased to 17.0% of total revenues during the year ended December 31, 2004 from 31.9% during the year ended December 31, 2003 due to stronger demand for our portable audio SoCs in geographic regions such as China and South Korea. Sales to Creative Technology, an affiliate, increased by $13.2 million but decreased to 14.1% of total revenues during the year ended December 31, 2004 from 14.3% during the year ended December 31, 2003 due to sales growth at other customers and a reduction in sales of their sound cards, which include our audio codecs, partially offset by increased sales of our portable audio SoCs which are a component of their portable compressed audio players. Creative Technology purchases our standard products at prices and on terms similar to other customers who buy similar products and volumes.

Index to Financial Statements

Gross Profit. Gross profit as a percentage of revenues, or gross margin, was 54.2% for the year ended December 31, 2004 compared with 47.6% for the year ended December 31, 2003. The increase in gross margin was primarily due to a favorable product mix and a reduction in manufacturing costs, which included both lower wafer costs and lower test costs. The favorable product mix resulted from increased revenues from our portable audio SoCs as a percentage of total revenues, as the gross margin from these products is generally higher than from our audio codecs. Included in cost of goods sold for the year ended December 31, 2003 was $0.3 million of depreciation related to the abandonment of certain testing equipment. We expect our gross margins for the first quarter of 2005 to be consistent with those achieved during the fourth quarter of 2004. However, increased competition could adversely impact our pricing, particularly in the portable compressed audio player market, which could adversely impact our gross margins longer term.

Research and Development. Research and development expenses increased to $32.3 million, or 16.6% of revenues, for the year ended December 31, 2004 from $17.9 million, or 17.8% of revenues, for the year ended December 31, 2003. This dollar increase of 80.5% was primarily due to increases in our engineering headcount, including independent contractors, as well as increases in the costs of design tools. Such increases were primarily to support hardware and software development on our latest portable audio SoCs, the STMP 36XX family of products, and our new High Definition Audio 92XX family of products. This increased research and development spending has resulted in substantial completion of the design of these products and the creation of several patentable inventions, enabling us to file additional U.S. patent applications covering inventions made during the STMP 36XX and 92XX design process. We expect that research and development expenses will increase in absolute dollars in future periods as we continue to increase our staffing and associated costs to pursue additional new product development opportunities, but such expenses will fluctuate as a percentage of revenue due to changes in sales volume.

Selling, General and Administrative. Selling, general and administrative expenses increased to $18.1 million, or 9.3% of revenues, for the year ended December 31, 2004 from $10.2 million, or 10.2% of revenues, for the year ended December 31, 2003. This dollar increase of 77.7% was due to increases in sales, marketing, and administrative personnel, as well as increases in commissions paid to independent sales representatives due to our revenue growth. Included in selling, general and administrative expenses for the year ended December 31, 2004 was $2.0 million related to the abandonment of a lease of office space. In December 2004, we abandoned the lease in order to move our Austin, TX operations to a larger office space at a lower cost per square foot that would accommodate our rapidly growing staff of engineers as well as support staff. The total amount incurred in connection with the lease abandonment charge was approximately $2.0 million, which was expensed in 2004 and is reflected in selling, general and administrative expense. We expect to pay $1.2 million in 2005 and $0.8 million in 2006 from general corporate funds related to this charge. We do not expect any future charges related to this abandonment. Included in selling, general and administrative expenses for the year ended December 31, 2003 was $0.4 million of accelerated amortization related to the abandonment of accounting software. We expect selling, general and administrative expenses will increase in absolute dollars in future periods as we continue to increase our staffing and associated costs, but such expenses will fluctuate as a percentage of revenues due to changes in sales volumes.

Amortization of Deferred Stock-Based Compensation. We record deferred stock-based compensation for the difference between the exercise price of option grants and the fair value of our common stock at the time of such grants which resulted in amortization expense of $2.2 million and $3.9 million for the years ended December 31, 2004, and 2003, respectively. Amounts recorded during the year ended December 31, 2003 include $0.9 million of amortization expense related to the vesting of an option that occurred as a result of our initial public offering.

Litigation Settlements. In September 1999, a suit was filed against us by Crystal Semiconductor, Inc. and Cirrus Logic, Inc. (the parent company of Crystal) alleging that certain of our products infringed on two of Crystal’s patents. We settled the suit in November 2000. As part of the settlement, we issued shares of common stock to Cirrus valued at $3.0 million at the date of issuance, which was recorded as a litigation settlement expense. We also agreed to a perpetual contingent guarantee which provided that these shares would have a value

Index to Financial Statements

of at least $10.5 million at the time of an initial public offering. Upon the closing of our initial public offering in 2003, we recorded an expense of and paid Cirrus $4.5 million in satisfaction of the contingent guarantee.

Interest Expense. Interest expense decreased to $23,000 for the year ended December 31, 2004 from $1.3 million for the year ended December 31, 2003. This was due to a decrease in non-cash interest charges related to warrants issued to investors for their guarantee of certain of our indebtedness from April 2001 through April 2003, as well as, decreased interest expense on lower levels of debt outstanding during the 2004 period. During the first quarter of 2003, we raised $8.1 million from sales of our preferred stock and used the proceeds to pay down our debt. During the third quarter of 2003, we successfully completed an initial public offering of approximately 7.4 million shares of our common stock, which resulted in net proceeds to us of approximately $101.4 million. A portion of the proceeds was used to pay off all of our existing long-term debt.

Interest Income. Interest income increased to $1.7 million for the year ended December 31, 2004 from $0.3 million for the year ended December 31, 2003. This was due to increased income earned on our cash balances and investments in short-term marketable securities since the completion of our initial public offering in September 2003.

Income Tax Expense. Income tax expense increased to $2.3 million for the year ended December 31, 2004 from $0.3 million for the year ended December 31, 2003. This was primarily due to increased income before income taxes, as well as an increase in our effective tax rate to 4.1% for the year ended December 31, 2004 from 3.2% in the year ended December 31, 2003. The increase in the effective rate was primarily due to management’s decision to no longer place a full valuation allowance against the net deferred tax asset, based on the determination that it is more likely than not that we will realize the remaining net deferred tax asset. Our income tax expense for the year ended December 31, 2004 includes the benefit of a $14.7 million reduction in our deferred tax asset valuation allowance, $6.3 million of which represented the utilization of deferred tax assets not previously recognized, and $8.4 million of which was released by management at September 30, 2004.

Comparison of Year Ended December 31, 2003 to Year Ended December 31, 2002

Revenues. Revenues for the year ended December 31, 2003 were $100.2 million compared to $30.9 million for the year ended December 31, 2002, an increase of 224.3%. This increase was due to an increase in revenues from all of our product lines—portable audio SoCs, audio codecs and USB peripheral ICs. The increase in revenues from our portable audio SoCs was due to the growth of the emerging portable compressed audio player market and our favorable competitive position within that market. Revenues from our portable audio SoCs were 75.9% of total revenues for the year ended December 31, 2003. Our favorable competitive position in this market is primarily due to our integration of analog and digital components onto a single IC, and the resulting small form factor, low power consumption, and overall low cost to our customers. The increase in revenues from audio codecs was due to increased sales to PC manufacturers and their ODMs partially offset by decreased sales to sound card manufacturers.

Revenues from Holystone, our largest distributor located in Taiwan, increased by $21.1 million, but decreased to 31.9% of total revenues during the year ended December 31, 2003 from 35.0% during the year ended December 31, 2002 due to stronger demand for our portable audio SoCs in geographic regions such as China and South Korea. Sales to Creative Technology, an affiliate, decreased to 14.3% of total revenues during the year ended December 31, 2003 from 21.2% during the year ended December 31, 2002 due to a reduction in sales of their sound cards, which include our audio codecs, partially offset by increased sales of our portable audio SoCs which are a component of their portable compressed audio players. Creative Technology purchases our standard products at prices and on terms similar to other customers who buy similar products and volumes.

Gross Profit. Gross profit as a percentage of revenues, or gross margin, was 47.6% for the year ended December 31, 2003 compared with 36.5% for the year ended December 31, 2002. The increase in gross margin was primarily due to a favorable product mix and a reduction in manufacturing costs, which included both lower

Index to Financial Statements

wafer costs and lower test costs. The favorable product mix resulted from increased revenues from our portable audio SoCs and USB peripheral ICs, as a percentage of total revenues, as the gross margin from these products is generally higher than from our audio codecs. Included in cost of goods sold for the year ended December 31, 2003 was $0.3 million of depreciation related to the abandonment of certain testing equipment. We expect our gross margins for the first quarter of 2004 to be consistent with those achieved during the fourth quarter of 2003. However, increased competition could adversely impact our pricing, particularly in the portable compressed audio player market, which could adversely impact our gross margins.

Research and Development. Research and development expenses increased to $17.9 million, or 17.8% of revenues, for the year ended December 31, 2003 from $11.9 million, or 38.6% of revenues, for the year ended December 31, 2002. This dollar increase of 49.8% was primarily due to increases in our engineering headcount, including independent contractors, as well as increases in the costs of design tools. Such increases were primarily to support hardware and software development on our STMP 35XX family of portable audio SoCs and our STBD 2010 USB peripheral IC. This increased research and development spending has resulted in substantial completion of the design of these products and the creation of several patentable inventions, enabling us to file additional U.S. patent applications covering inventions made during the STMP 35XX and STBD 2010 design processes. We expect that research and development expenses will increase in absolute dollars in future periods as we continue to increase our staffing and associated costs to pursue additional new product development opportunities, but such expenses will fluctuate as a percentage of revenue due to changes in sales volume.

Selling, General and Administrative. Selling, general and administrative expenses increased to $10.2 million, or 10.2% of revenues, for the year ended December 31, 2003 from $5.0 million, or 16.1% of revenues, for the year ended December 31, 2002. This dollar increase of 105.0% was due to increases in sales, marketing, and administrative personnel, as well as increases in commissions paid to independent sales representatives due to our revenue growth. Included in selling, general and administrative expenses for the year ended December 31, 2003 was $0.4 million of accelerated amortization related to the abandonment of accounting software. We expect selling, general and administrative expenses will increase in absolute dollars in future periods as we continue to increase our staffing and associated costs, but such expenses will fluctuate as a percentage of revenues due to changes in sales volumes.

Amortization of Deferred Stock-Based Compensation. We record deferred stock-based compensation for the difference between the exercise price of option grants and the fair value of our common stock at the time of such grants which resulted in amortization expense of $3.9 million and $29,000 for the years ended December 31, 2003, and 2002, respectively. Amounts recorded during the year ended December 31, 2003 include $0.9 million of amortization expense related to the vesting of an option that occurred as a result of our initial public offering.

Interest Expense. Interest expense decreased to $1.3 million for year ended December 31, 2003 from $2.7 million for the year ended December 31, 2002. This was due to a decrease in non-cash interest charges related to warrants issued to investors for their guarantee of certain of our indebtedness from April 2001 through April 2003, as well as, decreased interest expense on lower levels of debt outstanding during the 2003 period. During the first quarter of 2003, we raised $8.1 million from sales of our preferred stock and used the proceeds to pay down our debt. During the third quarter of 2003, we successfully completed an initial public offering of approximately 7.4 million shares of our common stock, which resulted in net proceeds to us of approximately $101.4 million. A portion of the proceeds was used to pay off all of our existing long-term debt.

Index to Financial Statements

Interest Income. Interest income increased to $0.3 million for the year ended December 31, 2003 from $42,000 for the year ended December 31, 2002. This was due to increased income earned on our cash balances and investments in short-term marketable securities since the completion of our initial public offering in September 2003.

As of December 31, 2004, we had $141.7 million in cash, cash equivalents and short-term investments. On September 19, 2003, we completed an initial public offering of approximately 7.4 million shares of our common stock resulting in net proceeds to us of approximately $101.4 million. On February 18, 2004, we completed a follow-on public offering of 250,000 shares of our common stock resulting in net proceeds to us of approximately $5.3 million.

Net cash provided by operating activities was $52.6 million and $12.3 million for the years ended December 31, 2004 and 2003, respectively, while our operating activities used cash in the amount of $4.2 million during the year ended December 31, 2002. The improvement in our operating cash flows is the result of increased revenue and net income. Our inventories, net of allowances, increased $9.5 million, $4.2 million and $1.6 million during the years ended December 31, 2004, 2003 and 2002, respectively. Our finished goods inventory increased $3.4 million, $3.2 million and $1.7 million during the years ended December 31, 2004, 2003 and 2002, respectively, to enable us to meet increased customer demand for our products. Our reserve for slow-moving and obsolete inventory as a percentage of total inventory was 10.1% and 12.5% as of December 31, 2004 and 2003, respectively. We monitor and analyze our inventory for obsolescence and adjust this reserve accordingly. Our accounts receivable, net of allowances, increased $18.2 million and $11.1 million during the years ended December 31, 2004 and 2003, respectively. These changes are due to increases in revenues and the timing of customer payments. Our accounts payable increased $13.0 million and $4.5 million during the years ended Decembers 31, 2004 and 2003, respectively. These changes are primarily due to increases in inventories and operating expenses, as well as the timing of payments to suppliers. Our deferred revenue increased $3.5 million and $3.2 million during the years ended December 31, 2004 and 2003, respectively, due to increases in our products held at distributors to enable them to meet increased customer demand for our products.

Our investing activities used cash of $76.9 million, $52.9 million and $1.5 million during the years ended December 31, 2004, 2003 and 2002, respectively. Investing activities primarily represented purchases of capital equipment, investments in short-term marketable securities, proceeds from sales of testing equipment, and proceeds from maturities of restricted investments related to deposits for real estate leases.

Capital expenditures were $11.5 million, $3.6 million and $1.7 million during the years ended December 31, 2004, 2003 and 2002, respectively. These expenditures were for the purchase of design software and engineering tools and other computer equipment and software. We purchased certain intellectual property from a third party during the third quarter of 2003 that resulted in cash expenditures of $0.8 million in the fourth quarter of 2003 and $3.8 million during the year ended December 31, 2004. Research and development resources are required to develop and expand our core technologies and proprietary product offerings. Our research and development expenses were $32.3 million, $17.9 million and $11.9 million during the years ended December 31, 2004, 2003 and 2002, respectively. These expenditures resulted in the enhancement of our product offerings, technological know how and inventions that have yielded several U.S. patents and pending U.S. patents. We expect to continue to incur significant research and development expenses and will fund these expenses with operating cash flow and existing cash balances.

Our financing activities used cash of $10.3 million during the year ended December 31, 2004, while our financing activities provided $99.5 million and $2.3 million during the years ended December 31, 2003 and 2002, respectively. Financing activities primarily represented repurchases of common stock outstanding, proceeds from the issuance of common stock and convertible preferred stock, proceeds from long-term debt, and proceeds and repayments under our revolving line of credit during the year ended December 31, 2002. During the first quarter of 2003, we received proceeds of $8.1 million from the issuance of convertible preferred stock. A

Index to Financial Statements

substantial portion of these proceeds was used to pay down and refinance our bank credit facility. On September 18, 2003, we completed our initial public offering and received $101.4 million of net offering proceeds. We used a portion of the net proceeds to repay outstanding term debt of $4.2 million and pay a litigation settlement obligation totaling $4.5 million. The remaining net proceeds in addition to our existing cash balances were invested in short-term, investment grade, interest bearing instruments, pending their use to fund working capital and capital expenditures as required. On February 18, 2004, we completed a follow-on equity offering and received $5.3 million of net offering proceeds. We also received $3.8 million in proceeds from the exercise of employee stock options and $1.6 million from the purchase of stock under our Employee Stock Purchase Plan during the year ended December 31, 2004. These proceeds were invested in short-term, investment grade, interest bearing instruments, pending their use to fund working capital and capital expenditures as required. During year ended December 31, 2004, we used $21.0 million to repurchase and retire 1,381,991 shares of common stock under a plan of open market purchases approved by our Board of Directors in July of 2004.

The fair value of our investments in marketable securities at December 31, 2004 was $114.5 million. Investments with maturities beyond one year may be classified as short-term based on their highly liquid nature and because such marketable securities represent the investment of cash that is available for current operations. Our investment policy is to manage our investment portfolio to preserve principal and liquidity while maximizing the return on the investment portfolio through the full investment of available funds. We diversify the marketable securities portfolio by investing in multiple types of investment-grade securities. Our investment portfolio is primarily invested in short-term securities with at least an investment grade rating to minimize interest rate and credit risk as well as to provide for an immediate source of funds. Although changes in interest rates may affect the fair value of the investment portfolio and cause unrealized gains or losses, such gains or losses would not be realized unless the investments are sold.

The following table describes our commitments to settle contractual obligations in cash as of December 31, 2004:

We believe our existing cash balances and short-term investments, together with cash expected to be generated from operating activities, will be sufficient to meet our anticipated cash needs for at least the next 12 months. Our future capital requirements will depend on many factors, including our level of revenues, the timing and extent of spending to support product development efforts, the expansion of sales and marketing activities, the timing of introductions of new products, the costs to ensure access to adequate manufacturing capacity, and the continuing market acceptance of our products. We could be required, or could elect, to seek additional funding through public or private equity or debt financing and additional funds may not be available on terms acceptable to us or at all.

Our discussion and analysis of our financial condition and results of operations are based upon our financial statements, which have been prepared in accordance with accounting principles generally accepted in the U.S.

Index to Financial Statements

The preparation of these financial statements requires us to make estimates and judgments that affect the reported amount of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, we evaluate our estimates, including those related to uncollectible accounts receivable, inventories, investments, intangible assets, income taxes, financing operations, warranty obligations and contingencies and litigation. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making the judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Because this can vary in each situation, actual results may differ from the estimates under different assumptions and conditions.

We believe the following critical accounting policies affect our more significant judgments used in the preparation of our financial statements.

Revenue Recognition. We recognize revenues in accordance with Securities and Exchange Commission Staff Accounting Bulletin No. 101, Revenue Recognition in Financial Statements, as amended by SAB 101A and 101B (“SAB 101”) and SAB 104, Revenue Recognition. SAB 101 requires that four basic criteria must be met before revenue can be recognized: (1) persuasive evidence of an arrangement exists; (2) delivery has occurred or services have been rendered; (3) the fee is fixed and determinable; and (4) collectibility is reasonably assured. Determination of criteria (3) and (4) are based on management’s judgment regarding the fixed nature of the fee charged for products delivered and the collectibility of those fees. Should changes in conditions cause management to determine these criteria are not met for certain future transactions, revenues recognized for any reporting period could be adversely impacted.

Revenues from product sales to customers other than distributors are recognized upon shipment and reserves are provided for estimated allowances. We defer recognition of revenues on sales to distributors with rights of return and price protection until our product has been sold by the distributor to their customers.

Short-term Investments. Short-term investments consist of corporate, state and municipal securities with readily determinable fair market values and original maturities in excess of three months. Investments with maturities beyond one year may be classified as short-term based on their highly liquid nature and because such marketable securities represent the investment of cash that is available for current operations. Our investments are classified as “available-for-sale” and accordingly are reported at fair value, with unrealized gains and losses, if material, reported as a component of stockholder’s equity. Unrealized losses are charged against income when a decline in the fair market value of an individual security is determined to be other than temporary. Realized gains and losses on investments are included in interest income.

Inventory Valuation. We value our inventory at the lower of the actual costs of our inventory or its current estimated market value. We record inventory provisions for estimated obsolescence or unmarketable inventories based upon assumptions about future demand and market conditions. If actual market conditions are less favorable than those projected by management, additional inventory provisions may be required.

Accounting for Stock-Based Compensation. Our stock-based employee compensation plans are described more fully in Note 10 to the financial statements. We account for these plans under the recognition and measurement principles of Accounting Principles Board (“APB”) Opinion No. 25, Accounting for Stock issued to Employees, and related interpretations. We amortize stock-based compensation over the vesting periods of the related options, which are generally either four or five years, in accordance with FASB Interpretation No. 28, Accounting for Stock Appreciation Rights and Other Variable Stock Option or Award Plans, an interpretation of APB Opinions No. 15 and 25.

We have recorded deferred stock-based compensation representing the difference between the deemed fair value of our common stock for accounting purposes and the option exercise price. We determined the deemed fair value of our common stock based upon several factors, including trends in the broad market for technology

Index to Financial Statements

stocks and the expected valuation we would obtain in an initial public offering. Had different assumptions or criteria been used to determine the deemed fair value of our common stock, materially different amounts of stock-based compensation could have been reported.

Pro forma information regarding net income (loss) attributable to common stockholders and net income (loss) per share attributable to common stockholders is required in order to show our net income (loss) as if we had accounted for employee stock options under the fair value method of Statement of Financial Accounting Standards (“SFAS”) No. 123, Accounting for Stock-Based Compensation, as amended by SFAS No. 148, Accounting for Stock-Based Compensation, Transition and Disclosure. This information is contained in Note 2 to our financial statements. The fair value of options and shares issued pursuant to our option plan at the grant date were estimated using the Black-Scholes option-pricing model.

Impairment of Long-lived Assets. We evaluate long-lived assets held and used by us for impairment whenever events or changes in circumstances indicate that their net book value may not be recoverable. When such factors and circumstances exist, we compare the projected undiscounted future cash flows associated with the related asset or group of assets over their estimated useful lives against their respective carrying amounts. Impairment, if any, is based on the excess of the carrying amount over the fair value, based on market value when available, or discounted expected cash flows, of those assets and is recorded in the period in which the determination is made.

Accounting for Income Taxes. We account for income taxes under SFAS No. 109, Accounting for Income Taxes. Under this method, we determine deferred tax assets and liabilities based upon the difference between the financial and tax bases of assets and liabilities using enacted tax rates in effect for the year in which we expect the differences will affect taxable income. Valuation allowances are established when necessary to reduce deferred tax assets to the amounts expected to be realized.

Because tax laws and financial accounting standards differ in their recognition and measurement of assets, liabilities, equity, revenue, expenses, gains and losses, differences arise between the amount of taxable income and pretax financial income for a year and between the tax bases of assets or liabilities and their reported amounts in the financial statements. Where it is assumed that the reported amounts will be recovered and settled, and that a difference between the tax basis of an asset or liability and its reported amount in the balance sheet will result in a taxable or deductible amount in some future year, a deferred tax asset or liability is established. We assess the likelihood that our deferred tax assets will be recovered from future taxable income and feasible tax planning strategies, and to the extent we believe it is not likely, we establish a valuation allowance.

As of December 31, 2003, we had recorded a full valuation allowance of $16.0 million against our deferred tax assets due to uncertainties related to our ability to utilize net operating loss and research and development credit carryforwards prior to their expiration. At September 30, 2004, we released $8.4 million of the valuation allowance due to our increased profitability and our expectations of future taxable income. In addition, the valuation allowance was reduced by $6.3 million to reflect utilization of deferred tax assets that had not been previously recognized. Certain of our carryforwards are subject to limits that may result in the expiration of the carryforwards prior to their utilization. Therefore we have maintained a valuation allowance of $1.3 million at December 31, 2004.

In January 2003, the Financial Accounting Standards Board (“FASB”) issued FASB Interpretation No. 46 (“FIN 46”), Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51, which addresses consolidation by business enterprises of variable interest entities (“VIEs”) either: (1) that do not have sufficient equity investment at risk to permit the entity to finance its activities without additional subordinated financial support, or (2) in which the equity investors lack an essential characteristic of a controlling financial interest. In December 2003, the FASB completed deliberations of proposed modifications to FIN 46 (Revised Interpretations) resulting in multiple effective dates based on the nature as well as the creation date of the VIE.

Index to Financial Statements

VIEs created after January 31, 2003, but prior to January 1, 2004, may be accounted for either based on the original interpretation or the Revised Interpretations. However, the Revised Interpretations must be applied no later than the first quarter of fiscal year 2004. VIEs created after January 1, 2004 must be accounted for under the Revised Interpretations. The adoption of this standard did not have a material impact on our financial position, results of operations or cash flows.

In April 2004, the EITF released Issue No. 03-06, Participating Securities and the Two Class Method under SFAS No. 128, Earnings per Share, which addressed a number of questions regarding the computation of earnings per share by companies that have issued securities other than common stock that contractually entitle the holder to participate in dividends and earnings of the company when, and if, it declares dividends on its common stock. It requires that undistributed earnings for the period be allocated to a participating security based on the contractual participation rights of the security to share in those earnings as if all the earnings for the period had been distributed in calculating earnings per share. EITF Issue No. 03-06 is effective for fiscal periods beginning after March 15, 2004. It requires that prior period earnings per share amounts be restated to ensure comparability year over year. The adoption of EITF Issue No. 03-06 did not have a material impact on our financial position, results of operations or cash flows.

In November 2004, the FASB issued SFAS 151, Inventory Costs, an amendment of ARB No. 43, Chapter 4. The standard requires that abnormal amounts of idle capacity and spoilage costs should be excluded from the cost of inventory and expensed when incurred. The provision is effective for fiscal periods beginning after June 15, 2005. We do not expect the adoption of this standard to have a material effect on our financial position, results of operations or cash flows.

In December 2004, the FASB issued SFAS 153, Exchanges of Nonmonetary Assets, an amendment of APB No. 29, Accounting for Nonmonetary Transactions. SFAS 153 requires exchanges of productive assets to be accounted for at fair value, rather than at carryover basis, unless (1) neither the asset received nor the asset surrendered has a fair value that is determinable within reasonable limits or (2) the transactions lack commercial substance. SFAS 153 is effective for nonmonetary asset exchanges occurring in fiscal periods beginning after June 15, 2005. We do not expect the adoption of this standard to have a material effect on our financial position, results of operations or cash flows.

In December 2004, the FASB released its final revised standard, SFAS No. 123R, Share-Based Payment. SFAS 123R requires that a public entity measure the cost of equity based service awards based on the grant-date fair value of the award. That cost will be recognized over the period during which an employee is required to provide service in exchange for the award or the vesting period. No compensation cost is recognized for equity instruments for which employees do not render the requisite service. A public entity will initially measure the cost of liability based service awards based on its current fair value; the fair value of that award will be remeasured subsequently at each reporting date through the settlement date. Changes in fair value during the requisite service period will be recognized as compensation cost over that period. Adoption of SFAS 123R is required for fiscal periods beginning after June 15, 2005. We are evaluating SFAS 123R and believe it may have a material effect on our financial position, results of operations or cash flows.

Interest Rate Risk The primary objective of our investment activities is to preserve principal while maximizing the income without significantly increasing risk. Some of the securities in which we invest may be subject to market risk. This means that a change in prevailing interest rates may cause the principal amount of the investment to fluctuate. To minimize this risk in the future, we intend to maintain our portfolio of cash equivalents and short-term investments in a variety of securities, including commercial paper, money market funds, government and non-government debt securities and certificates of deposit. The risk associated with fluctuating interest rates is limited to our investment portfolio and we do not believe that a 10% change in interest rates would have a significant impact on our interest income. As of December 31, 2004, all of our investments were in money market accounts or investment grade securities.

Index to Financial Statements

The consolidated financial statements required by this item are included in Part IV, Item 15 of this Form 10-K and are presented beginning on page F-1.

The following tables set forth our unaudited quarterly consolidated statements of operations for each of the eight quarters ended December 31, 2004, as well as such data expressed as a percentage of our revenues for the quarters presented. We have prepared the unaudited information on the same basis as our audited consolidated financial statements. This table includes all adjustments, consisting only of normal recurring adjustments, that we consider necessary for a fair presentation of our financial position and operating results for the quarters presented. Operating results for any quarter are not necessarily indicative of results for any future periods.

Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

Index to Financial Statements

We have performed an evaluation under the supervision and with the participation of our management, including our Chief Executive Officer (CEO) and Chief Financial Officer (CFO), of the effectiveness of our disclosure controls and procedures, as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934 (the Exchange Act). Based on that evaluation, our management, including our CEO and CFO, concluded that our disclosure controls and procedures were effective as of December 31, 2004 to ensure that information required to be disclosed by us in the reports filed or submitted by us under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. As a result of this evaluation, there were no significant changes in our internal control over financial reporting during the three months ended December 31, 2004 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Our management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rule 13a-15(f) under the Exchange Act. We have performed an evaluation under the supervision and with the participation of our management, including our CEO and CFO, of the effectiveness of our internal control over financial reporting. Our management used the framework in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations (COSO) to perform this evaluation. Based on that evaluation, our management, including our CEO and CFO, concluded that our internal control over financial reporting was effective as of December 31, 2004.

Our management’s assessment of the effectiveness of our internal control over financial reporting as of December 31, 2004 has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their report, a copy of which is included in this Annual Report on Form 10-K.

Certain information required by Part III is omitted from this report because we intend to file a definitive Proxy Statement pursuant to Regulation 14A (the “Proxy Statement”) no later than 120 days after the end of the fiscal year covered by this report, and certain information to be included therein is incorporated herein by reference.

The information required by this Item is incorporated by reference to the Proxy Statement under the sections captioned “Proposal 1- Election of Directors,” “Executive Compensation” and “Compliance with Section 16(a) of the Securities Exchange Act of 1934.”

The information under the caption “Executive Compensation” appearing in the Proxy Statement is incorporated herein by reference.

Index to Financial Statements

The information under the captions “Ownership of Securities” and “Equity Compensation Plan Information” appearing in the Proxy Statement is incorporated herein by reference.

The information under the captions “Certain Transactions” appearing in the Proxy Statement is incorporated herein by reference.

The information related to audit fees and services appearing in the Proxy Statement is incorporated herein by reference.

The exhibits listed on the accompanying index to exhibits in Item 15(b) below are filed as part of, or hereby incorporated by reference into, this Form 10-K.

Index to Financial Statements

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, in Austin, Texas, on February 7, 2005.


SIGMATEL, INC.

By:		/s/ RONALD P. EDGERTON
		Ronald P. Edgerton President and Chief Executive Officer

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated:

Index to Financial Statements

We have completed an integrated audit of SigmaTel, Inc.’s 2004 consolidated financial statements and of its internal control over financial reporting as of December 31, 2004 and audits of its 2003 and 2002 consolidated financial statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Our opinions, based on our audits, are presented below.

In our opinion, the consolidated financial statements listed in the index appearing under Item 15(a)(1) present fairly, in all material respects, the financial position of SigmaTel, Inc. and its subsidiaries at December 31, 2004 and 2003, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2004 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule listed in the index appearing under Item 15(a)(2) presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. These financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits. We conducted our audits of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit of financial statements includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

Also, in our opinion, management’s assessment, included in Management’s Report on Internal Control Over Financial Reporting appearing under Item 9A, that the Company maintained effective internal control over financial reporting as of December 31, 2004 based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), is fairly stated, in all material respects, based on those criteria. Furthermore, in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2004, based on criteria established in Internal Control - Integrated Framework issued by the COSO. The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express opinions on management’s assessment and on the effectiveness of the Company’s internal control over financial reporting based on our audit. We conducted our audit of internal control over financial reporting in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. An audit of internal control over financial reporting includes obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we consider necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinions.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting

Index to Financial Statements

includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

Index to Financial Statements

The accompanying notes are an integral part of these consolidated financial statements.

Index to Financial Statements

The accompanying notes are an integral part of these consolidated financial statements.

Index to Financial Statements

The accompanying notes are an integral part of these consolidated financial statements.

Index to Financial Statements

The accompanying notes are an integral part of these consolidated financial statements.

Index to Financial Statements

SigmaTel, Inc. (the “Company” or “SigmaTel”) was incorporated on December 28, 1993 and is a fabless designer of analog-intensive mixed-signal integrated circuits headquartered in Austin, Texas. SigmaTel Hong Kong, Ltd. was established and incorporated in Hong Kong in July 2004 and became a wholly owned subsidiary of SigmaTel, Inc. in August of 2004, for the purpose of providing engineering support to customers in Asia for their product development activities. The accompanying consolidated financial statements include the accounts of both SigmaTel, Inc. and SigmaTel Hong Kong Ltd., and all material intercompany accounts and transactions have been eliminated in consolidation.

On September 11, 2003, the Company completed a one-for-three reverse stock split of the Company’s outstanding common stock. All share and per share amounts have been retroactively restated in the accompanying consolidated financial statements and notes for all periods presented to reflect the reverse stock split.

SigmaTel, Inc. was incorporated in Texas in 1993 and changed its state of incorporation to Delaware in August 2003 by merging into a wholly owned subsidiary. As a result of the merger, that subsidiary succeeded to all rights and obligations of the Texas corporation, and the Texas corporation ceased to exist. Prior to the merger, the Delaware subsidiary conducted no operations and had no assets or liabilities other than $1,000 of cash contributed to it by the Texas corporation. As a result of the reincorporation, the Company is authorized to issue 170,000,000 shares of $0.0001 par value Common Stock and 30,000,000 shares of $0.01 par value Preferred Stock. The Board of Directors has the authority to issue the undesignated Preferred Stock in one or more series and to fix the rights, preferences, privileges and restrictions thereof. The par value of the Preferred Stock and shares of Common Stock and Preferred Stock authorized in the balance sheets at December 31, 2003 and in the statements of stockholders’ equity (deficit) for the two years ended December 31, 2003 and 2002 have been retroactively adjusted to reflect the reincorporation.

On September 18, 2003, the Securities and Exchange Commission declared effective the Company’s first registration statement, which the Company filed on Form S-1 (Registration No. 333-106796) under the Securities Act of 1933 in connection with the initial public offering of its common stock. Under this registration statement, the Company registered 11,500,000 shares of its common stock, including 1,500,000 shares subject to the underwriters’ overallotment option (which was exercised in full), with a public offering price of $15.00 per share and aggregate proceeds of approximately $172,500,000. The Company registered 7,383,917 of these shares on its behalf and 4,116,083 shares on behalf of certain stockholders of the Company. The underwriting syndicate was managed by Merrill Lynch & Co., JPMorgan, CIBC World Markets and Needham & Company, Inc. This offering terminated after the sale of all of the shares of the Company’s common stock that it registered under its registration statement on Form S-1. The sale of shares of common stock by the Company, including the sale of 383,917 shares pursuant to the exercise of the over-allotment option by the underwriters, resulted in aggregate gross proceeds of approximately $110.8 million, approximately $7.8 million of which the Company applied to underwriting discounts and commissions and approximately $1.6 million of which the Company applied to related costs. As a result, the Company received approximately $101.4 million of the offering proceeds. The sale of shares of common stock by the selling stockholders resulted in aggregate gross proceeds of $61.7 million, $4.3 million of which the selling stockholders applied to underwriting discounts and commissions. As a result, the selling stockholders received $57.4 million of the offering proceeds. Upon completion of the initial public offering, 22,022,367 outstanding shares of the Company’s redeemable convertible preferred stock were converted into 19,177,818 shares of common stock.

On February 18, 2004, the Securities and Exchange Commission declared effective the Company’s registration statement, which the Company filed on Form S-1 under the Securities Act of 1933 in connection with a follow-on offering of its common stock. Under this registration statement, the Company registered 9,830,422 shares of its common stock, including 1,282,229 shares subject to the underwriters’ overallotment option (of

Index to Financial Statements

which 212,229 shares were exercised), with a public offering price of $25.01 per share. The Company registered 250,000 of these shares on its behalf and 9,580,422 on behalf of certain stockholders of the Company. The Company received $5.3 million in proceeds after deducting the underwriters fees and transaction costs.

In July of 2004, the Company’s Board of Directors authorized a share repurchase plan for up to $30 million of common stock. Under this plan, the Company used $21.0 million of cash during July and August of 2004 to purchase 1,381,991 shares of common stock. All shares purchased during the year ended December 31, 2004 were retired during the period.

The consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America.

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates.

The fair values of the Company’s cash and cash equivalents, accounts receivable, accounts payable and accrued expenses approximate carrying values due to their short maturities.

The Company’s operating results are significantly dependent on its ability to market and develop products. The inability of the Company to successfully develop and market its products as a result of competition or other factors would have a material adverse affect on the Company’s business, financial condition and results of operations. The majority of the Company’s products are currently manufactured by three companies in Asia. The Company does not have long-term agreements with any of these suppliers. A manufacturing disruption experienced by one or more of these manufacturing entities would impact the production of the Company’s products for a substantial period of time which could have a material adverse effect on its business, financial condition and results of operations. The Company’s customers are mainly in Asia, the United States of America and Europe.

Index to Financial Statements

Financial instruments that potentially subject the Company to significant concentrations of credit risk consist primarily of cash, cash equivalents, short-term investments and accounts receivable. The Company places its cash, cash equivalents and short-term investments primarily in multiple types of investment-grade securities. The Company performs ongoing credit evaluations of its customers’ financial condition and has a foreign trade insurance policy for significant international customers to minimize credit risk. The Company maintains an allowance for doubtful accounts receivable to cover the uninsured portion of trade receivables and estimated losses resulting from uncollectible accounts. The Company will write off a receivable account once the account is deemed uncollectible. Accounts receivable write-offs to date have been minimal. As of December 31, 2004 and 2003, the Company had an allowance for doubtful accounts of $0.5 million and $0.4 million, respectively.

The Company considers all highly liquid investments with original maturities of three months or less to be cash equivalents. The Company is exposed to credit risk in the event of default by the financial institutions and issuers of the investments. The Company maintains cash and cash equivalent balances in highly rated financial institutions and has not experienced any material losses relating to any cash or cash equivalents.

Short-term investments consist of corporate, state and municipal securities with readily determinable fair market values and original maturities in excess of three months. Investments with maturities beyond one year may be classified as short-term based on their highly liquid nature and because such marketable securities represent the investment of cash that is available for current operations. The Company’s investments are classified as “available-for-sale” and accordingly are reported at fair value, with unrealized gains and losses, if material, reported as a component of stockholder’s equity. Unrealized losses are charged against income when a decline in the fair market value of an individual security is determined to be other than temporary. Realized gains and losses on investments are included in interest income.

Inventories are stated at the lower of cost (approximate costs are determined on a first-in, first-out basis) or market. Provisions are made to reduce excess or obsolete inventories to their estimated net realizable values.

Property and equipment is stated at cost and depreciated using the straight-line method over the estimated useful lives of the assets. Amortization of assets under capital leases is included in depreciation and is computed using the straight-line method over the shorter of the estimated useful lives of the assets or the lease term.

Purchased software is capitalized and stated at cost and depreciated using the straight-line method over the estimated useful life of the software.

Upon disposal of assets, related accumulated depreciation is removed from the accounts and the related gain or loss is included in operations. Repairs and maintenance costs are expensed as incurred.

The Company evaluates long-lived assets held and used by the Company for impairment whenever events or changes in circumstances indicate that their net book value may not be recoverable. When such factors and

Index to Financial Statements

circumstances exist, the Company compares the projected undiscounted future cash flows associated with the related asset or group of assets over their estimated useful lives against their respective carrying amounts. Impairment, if any, is based on the excess of the carrying amount over the fair value, based on market value when available, or discounted expected cash flows, of those assets and is recorded in the period in which the determination is made.

Intangible assets consist of licenses to use intellectual property in manufacturing and patents. Intangible assets are recorded at cost and amortized over the shorter of the contractual life or the estimated useful life, which is generally between five to seven years.

The Company has repurchased shares of its common stock which have been held as treasury stock. The Company accounts for treasury stock under the cost method. Upon the retirement of treasury stock shares, the par value and any related additional paid-in capital are removed from the accounts.

The Company accounts for income taxes under the provisions of Statement of Financial Accounting Standards (“SFAS”) No. 109, Accounting for Income Taxes. Under this method, deferred tax assets and liabilities are determined based on the difference between the financial statement and tax bases of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to affect taxable income. Valuation allowances are established when necessary to reduce deferred tax assets to the amounts expected to be realized.

Revenues from product sales are recognized upon shipment, or later if required by shipping terms, provided title is transferred, prices are fixed, and collection is deemed probable. Revenues primarily consist of product sales to distributors. Revenues and related costs of goods sold on sales to distributors with rights of return and price protection on products unsold are deferred and subsequently recognized upon sell-through to their end customer.

The Company may provide replacements for products which its customers purchased and which have been authorized for return. Warranty returns have been infrequent, and relate to defective or off-specification parts. The Company records an allowance for sales returns, based on evaluations of returns experience and revenues, to provide for the anticipated costs associated with product returns. To date, the Company has not experienced significant costs associated with warranty returns.

The Company is primarily self-insured for employee health benefits. The Company records its self-insurance liability based on claims filed and an estimate of claims incurred but not yet reported. If more claims are made than were estimated or if the costs of actual claims increases beyond what was anticipated, reserves recorded may not be sufficient and additional accruals may be required in future periods.

Index to Financial Statements

Costs of shipping and handling for delivery of the Company’s products that are reimbursed by its customers are recorded as revenue in the statement of operations. Shipping and handling costs are charged to cost of goods sold as incurred.

Employee stock awards under the Company’s compensation plans are accounted for in accordance with Accounting Principles Board (“APB”) Opinion No. 25, Accounting for Stock Issued to Employees, Financial Accounting Standards Board Interpretation No. 44, Emerging Issues Task Force (“EITF”) Issue No. 00-23, and related interpretations. The Company accounts for equity awards issued to non-employees in accordance with the provisions of SFAS No. 123, Accounting for Stock-Based Compensation, and EITF Issue No. 96-18, Accounting for Equity Instruments that are Issued to other than Employees for Acquiring, or in Conjunction with Selling Goods or Services and related interpretations. The following table illustrates the effect on net income (loss) as if the Company had applied the fair value recognition provisions of SFAS No. 123 to stock-based employee compensation (in thousands, except share data):

Costs for research and development of the Company’s products are expensed as incurred.

Advertising costs are expensed as incurred and are included in selling, general and administrative expense. Total advertising and promotional expenses were approximately $0.1 million, $0.2 million and $0.3 million for the years ended December 31, 2004, 2003 and 2002, respectively.

Comprehensive income includes all changes in stockholders’ equity (deficit) during a period from non-owner sources. For the years ended December 31, 2004, 2003 and 2002, there were no differences between the Company’s net income (loss) and its comprehensive income (loss).

Index to Financial Statements

Basic net income (loss) attributable to common stockholders per share is computed by dividing net income (loss) attributable to common stockholders by the weighted-average number of shares of common stock outstanding for the period. Diluted net income (loss) attributable to common stockholders per share is computed giving effect to all potential dilutive common stock, including options, warrants, common stock subject to repurchase and redeemable convertible preferred stock.

A reconciliation of the numerator and denominator used in the calculation of basic and diluted net income (loss) attributable to common stockholders per share follows (in thousands, except share data):

The following outstanding options, common stock subject to repurchase, redeemable convertible preferred stock and warrants were excluded from the computation of diluted net income (loss) per share as they had an antidilutive effect:

Included in the calculation of net income (loss) attributable to common stockholders are deemed dividends of zero, $8.8 million and $0.3 million for the years ended December 31, 2004, 2003 and 2002, respectively, related to the issuance of the Company’s Series F, H and J Preferred Stock.

Index to Financial Statements

In January 2003, the Financial Accounting Standards Board (“FASB”) issued FASB Interpretation No. 46 (“FIN 46”), Consolidation of Variable Interest Entities, an interpretation of ARB NO. 51, which addresses consolidation by business enterprises of variable interest entities (“VIEs”) either: (1) that do not have sufficient equity investment at risk to permit the entity to finance its activities without additional subordinated financial support, or (2) in which the equity investors lack an essential characteristic of a controlling financial interest. In December 2003, the FASB completed deliberations of proposed modifications to FIN 46 (Revised Interpretations) resulting in multiple effective dates based on the nature as well as the creation date of the VIE. VIEs created after January 31, 2003, but prior to January 1, 2004, may be accounted for either based on the original interpretation or the Revised Interpretations. However, the Revised Interpretations must be applied no later than the first quarter of fiscal year 2004. VIEs created after January 1, 2004 must be accounted for under the Revised Interpretations. The adoption of these deferred provisions in the first quarter of fiscal year 2004 had no material impact on the Company’s financial statements.

In April 2004, the EITF released Issue No. 03-06, Participating Securities and the Two Class Method under SFAS No. 128, Earnings per Share, which addressed a number of questions regarding the computation of earnings per share by companies that have issued securities other than common stock that contractually entitle the holder to participate in dividends and earnings of the company when, and if, it declares dividends on its common stock. It requires that undistributed earnings for the period be allocated to a participating security based on the contractual participation rights of the security to share in those earnings as if all the earnings for the period had been distributed in calculating earnings per share. EITF Issue No. 03-06 is effective for fiscal periods beginning after March 15, 2004. It requires that prior period earnings per share amounts be restated to ensure comparability year over year. The adoption of EITF Issue No. 03-06 did not have an impact on the Company’s financial position, results of operations or cash flows.

In November 2004, the FASB issued SFAS 151, Inventory Costs, an amendment of ARB No. 43, Chapter 4. The standard requires that abnormal amounts of idle capacity and spoilage costs should be excluded from the cost of inventory and expensed when incurred. The provision is effective for fiscal periods beginning after June 15, 2005. The Company does not expect the adoption of this standard to have a material effect on its financial position, results of operations or cash flows.

In December 2004, the FASB issued SFAS 153, Exchanges of Nonmonetary Assets, an amendment of APB No. 29, Accounting for Nonmonetary Transactions. SFAS 153 requires exchanges of productive assets to be accounted for at fair value, rather than at carryover basis, unless (1) neither the asset received nor the asset surrendered has a fair value that is determinable within reasonable limits or (2) the transactions lack commercial substance. SFAS 153 is effective for nonmonetary asset exchanges occurring in fiscal periods beginning after June 15, 2005. The Company does not expect the adoption of this standard to have a material effect on its financial position, results of operations or cash flows.

In December 2004, the FASB released its final revised standard, SFAS No. 123R, Share-Based Payment. SFAS 123R requires that a public entity measure the cost of equity based service awards based on the grant-date fair value of the award. That cost will be recognized over the period during which an employee is required to provide service in exchange for the award or the vesting period. No compensation cost is recognized for equity instruments for which employees do not render the requisite service. A public entity will initially measure the cost of liability based service awards based on its current fair value; the fair value of that award will be remeasured subsequently at each reporting date through the settlement date. Changes in fair value during the requisite service period will be recognized as compensation cost over that period. Adoption of SFAS 123R is required for fiscal periods beginning after June 15, 2005. The Company is evaluating SFAS 123R and believes it may have a material effect on the Company’s financial position, results of operations or cash flows.

Index to Financial Statements

Short-term investments at December 31, 2004 and 2003, consisting of corporate, state and municipal securities, were acquired at an aggregate cost of $114.8 million and $49.4 million, respectively. The fair value of these instruments are based on market interest rates and other market information available to management as of each balance sheet date presented and was not materially different than the aggregate cost.

Management classifies investments in marketable securities at the time of purchase and reevaluates such classification at each balance sheet date. Securities classified as available-for-sale are stated at cost, which is not materially different than market value. $11.9 million of total liquid investments mature within three months, $18.2 million mature beyond three months but within one year, $2.5 million mature beyond one year and within five years and $92.3 million mature beyond five years, but have interest reset maturities of less than thirty days.

At December 31, 2004 and 2003, the Company’s reserve for slow-moving and obsolete inventory was approximately $2.2 million and $1.4 million, respectively.

Index to Financial Statements

At December 31, 2004 and 2003, property, equipment and software under capital leases consist of equipment and furniture and fixtures of approximately $0.2 million and $0.3 million, respectively. Accumulated amortization for equipment and furniture and fixtures under capital leases totaled approximately $0.2 million and $0.1 million as of December 31, 2004 and 2003, respectively.

Depreciation expense for the years ended December 31, 2004, 2003 and 2002 was approximately $3.8 million, $3.1 million and $2.6 million, respectively.

Intangible assets subject to amortization expense relate to licenses to use intellectual property in manufacturing and patents. The Company purchased certain intellectual property from third parties during the year ended December 31, 2004. Intangible assets consist of the following (in thousands):

Intangible asset amortization expense for the year ended December 31, 2004 was $1.0 million. Estimated aggregate intangible asset amortization expense is estimated to be $1.1 million for each of the years ended December 31, 2005, 2006 and 2007, $0.9 million for the year ending December 31, 2008 and $0.1 million for the year ending December 31, 2009. The weighted average amortization period for intangible assets is five years.

On March 2, 1998, the Company issued a $1.0 million convertible note (the “Note”), bearing interest at a rate of 8% per annum payable on demand after March 31, 2001. In connection with the Note, the Company issued a warrant to purchase up to 223,000 shares of Series B Preferred Stock at an exercise price of $2.25 per share. The fair value of the warrant amounted to approximately $0.2 million resulting in a discount to the Note. The Note and warrant were cancelled in April 2001 in connection with the issuance of new convertible subordinated promissory notes.

Index to Financial Statements

On April 10, 2001, the Company sold to current shareholders convertible subordinated promissory notes (the “Convertible Notes”) in the aggregate principal amount of $6.4 million. The Convertible Notes were issued in exchange for $5.0 million in cash and the cancellation of the Note. The balance of the Note at the cancellation date was $1.3 million. The Convertible Notes bore simple interest at the rate of 10% per annum, were to mature on April 10, 2006 and were convertible, at the option of the holder, into shares of the Company’s Series I Preferred Stock at the conversion rate of $2.57 per share. Upon closing of the Company’s initial public offering in September 2003, the principal amount of the convertible notes of $6.4 million was converted into 1,022,102 shares of common stock with $1.6 million of accrued interest paid using proceeds from the Company’s initial public offering.

In connection with the Credit Agreement amendment on March 4, 2003, the Company entered into a three-year $5.0 million term loan with the bank. The note was payable in monthly installments and bore a fixed annual interest rate of 6%. The note balance was paid off in its entirety during September 2003 with proceeds from the Company’s initial public offering.

In May of 2000, the Company entered into a one-year credit agreement (the “Credit Agreement”) with a bank that allowed for a revolving line of credit with borrowings of up to $6.5 million. In March of 2003, the Credit Agreement was amended to (i) increase the maximum borrowing amount under the revolving line of credit to $8.0 million, modify certain financial covenants, extend the maturity date to March 1, 2005 and lower the interest rate from 175 basis points above the Bank’s Prime Rate to 100 basis points above the Bank’s Prime Rate. In April of 2004, the Company terminated this revolving line of credit agreement.

Upon the closing of the Company’s initial public offering in September 2003, all outstanding shares of the Company’s redeemable convertible preferred stock converted into an aggregate of 19,177,818 shares of common stock.

Following is a summary of convertible Preferred Stock that was designated by the Company (in thousands, except share data):

The carrying value of the Preferred Stock represents the proceeds from the sale of the stock net of issuance costs of approximately $1.7 million. Issuance costs were accreted from the date of issuance and recorded as deemed dividends. In conjunction with the Company’s initial public offering and conversion of all outstanding preferred stock, all remaining issuance costs were accreted.

Index to Financial Statements

In February 2003, the Company issued 7,157,584 shares of Series J Preferred Stock to existing investors at $1.14 per share resulting in total proceeds to the Company of approximately $8.2 million. In connection with the issuance of the Series J Preferred Stock, the Company recognized a deemed dividend of $8.1 million, representing the difference between the conversion price of the Series J Preferred Stock and the deemed fair value of the Company’s common stock at issuance.

In February 2003, the Company amended its articles of incorporation to eliminate its Series B Preferred Stock.

The Series A, C, E, F, G, H, I and J Preferred Stock had the following characteristics:

The holders of the Preferred Stock were entitled to vote, together with the holders of common stock, on all matters submitted to stockholders for a vote. Each preferred stockholder was entitled to the number of votes equal to the number of shares of common stock into which each share of preferred stock was convertible at the time of such vote. Holders of the various series of Preferred Stock also had the right to vote as a class on various matters specified in the Company’s articles of incorporation.

The holders of Preferred Stock were entitled to receive, when and as declared by the board of directors and out of funds legally available, non-cumulative dividends at a rate per share based upon a percent of the issue price as declared by the board of directors. As of December 31, 2003, no dividends have been declared or paid.

In the event of any liquidation, dissolution or winding up of the affairs of the Company, the holders of the then outstanding Series A, C, E, F, G, H, I and J Preferred Stock were entitled to receive for each share an amount equal to the sum of $1.47, $3.28, $1.818, $1.818, $1.1025, $4.75, $7.71 and $1.72 per share of Series A, C, E, F, G, H, I and J Preferred Stock, respectively, plus all declared but unpaid dividends, payable in preference and priority to any payments made to the holders of the then outstanding common stock.

Each share of Preferred Stock, at the option of the holder, was convertible into a number of fully paid shares of common stock as determined by dividing the respective Preferred Stock issue price by the conversion price in effect at the time of conversion. The conversion price of Series A, C, E, F, G, H, I and J Preferred Stock was $1.1025, $1.9136, $2.0463, $2.0463, $1.5127, $6.2439, $6.2439 and $1.3732 respectively, and was subject to adjustment in accordance with antidilution provisions contained in the Company’s articles of incorporation.

At any time after August 6, 2004 (in the case of Series F Preferred Stock), August 15, 2005 (in the case of Series H Preferred Stock), April 19, 2006 (in the case of Series I Preferred Stock) and February 21, 2008 (in the case of Series J Preferred Stock), the Company would have been required to redeem all of the outstanding shares of Series F, H, I, or J, as applicable, upon the written request of the holders of a majority of the Series F Preferred Stock or two thirds of the shares of Series H, I and J Preferred Stock. The redemption price would have been the greater of (i) the issuance price of $1.818 per share for Series F Preferred Stock, $4.75 per share for Series H

Index to Financial Statements

Preferred Stock, $2.57 per share for Series I Preferred Stock and $1.1444 per share for Series J Preferred Stock, plus any declared and unpaid dividends thereon or (ii), the fair market value per share as determined by the board of directors.

Upon the closing of the Company’s initial public offering in September 2003, all outstanding preferred stock warrants converted to common stock warrants. In March 2004, the Company issued 19,900 shares in a cashless exercise of warrants issued in 2001 and 2002 to a bank in connection with modifications to a revolving line of credit. In December of 2004, the Company issued 457,485 shares in a cashless exercise of warrants issued in 2002 to an unaffiliated customer in connection with an exclusive supply agreement. There were no warrants outstanding as of December 31, 2004.

As of December 31, 2004, the Company had authorized 2,349,148 shares of common stock for issuance under the Company’s 1995 Stock Option/Stock Issuance Plan (the “1995 Plan”). Under the 1995 Plan, incentive stock options may be granted to employees and non-statutory stock options may be granted to non-employees, directors or consultants at prices not lower than 100% of the fair market value of the Company’s common stock at the date of grant as determined by the board of directors. Any 10% shareholder must be granted options to purchase the Company’s common stock at an exercise price no lower than 110% of the fair market value of the Company’s common stock at the date of grant as determined by the board of directors. Generally, options vest either (i) at the rate of 20% per year over five years, or (ii) over a four year period (25% at end of the first year from date of grant, and 1/36 of remaining shares per month over next 36 months) and are exercisable for a period of ten years from the date of grant.

In February 2003, the Board of Directors approved an increase of 1,641,667 shares available for issuance under the 1995 Plan.

In connection with the resignation of a member of the Board of Directors in June 2003, the Company accelerated the vesting of an option to purchase approximately 16,000 shares of common stock and recorded a charge of $0.1 million.

Effective upon completion of the Company’s initial public offering, no more options may be issued under the 1995 Plan.

In July 2003, the Company approved the 2003 Equity Incentive Plan (the “2003 Plan”) that became effective upon completion of the initial public offering. The 2003 Plan provides for the grant of incentive stock options and nonqualified stock options, stock awards and stock purchase rights for the purchase of up to 6,866,747 shares of the Company’s common stock by officers, employees, consultants and directors of the Company. However, this share reserve shall be reduced by the exercise of stock options outstanding under the Company’s 1995 Stock Option/Stock Issuance Plan. As of December 31, 2004, options to purchase 2,349,148 shares of the Company’s common stock were outstanding under the 1995 plan. The compensation committee of the Board of Directors is responsible for administration of the 2003 Plan. The compensation committee determines the term of each option, the option exercise price, the number of shares for which each option is granted and the rate at which each option is exercisable. Incentive stock options may be granted to any officer or employee at an exercise price per share of not less than the fair value per common share on the date of the grant (not less than 110% of fair value in the case of holders of more than 10% of the Company’s voting stock) and with a term not to exceed ten years from the date of the grant (five years for incentive stock options granted to

Index to Financial Statements

holders of more than 10% of the Company’s voting stock). Generally, options vest either (i) at the rate of 20% per year over five years, or (ii) over a four year period (25% at end of the first year from date of grant, and 1/36 of remaining shares per month over next 36 months) and are exercisable for a period of ten years from the date of grant. Nonqualified stock options may be granted to any officer, employee, consultant or director at an exercise price per share of not less than the market value per share.

The Company recorded $7.5 million of deferred stock-based compensation during the year ended December 31, 2003, related to the issuance of stock options below fair value at the date of grant. Such amount is included as a reduction of stockholders’ deficit and is being amortized over the vesting period of each award in accordance with FASB Interpretation No. 28, Accounting for Stock Appreciation Rights and Other Variable Stock Option or Award Plans, an interpretation of APB Opinions No. 15 and 25. The Company recorded $2.2 million of related stock-based compensation for the year ended December 31, 2004.

As of December 31, 2004, the Company had promissory notes from non-officer employees totaling $7,000 relating to the exercise of stock options by those employees. These promissory notes were issued during the year ended December 31, 2000 with an interest rate between 6.45% and 6.60% and maturity dates between March 2005 and July 2005. Interest is accrued monthly, and principal and interest are payable bi-weekly through payroll deduction.

Index to Financial Statements

The weighted average fair value of common stock options granted during the years ended December 31, 2004, 2003 and 2002 was $13.16, $4.16 and $1.65, respectively.

The following table summarizes information with respect to common stock options outstanding at December 31, 2004:

The fair value of common stock options granted in 2004, 2003 and 2002 is estimated on the date of grant using the Black-Scholes option pricing model with the following weighted-average assumptions:

In March 2001, the Company executed an employment agreement with a key executive whereby it granted this executive an option, exercisable over ten years, to purchase up to 518,807 shares of Series I Preferred Stock at an exercise price of $2.57 per share. One half of these option shares vest immediately. The remaining option shares vested upon the closing of a firm commitment underwritten public offering resulting in a $0.9 million expense. Due to the automatic conversion of all of the Company’s then outstanding preferred stock into common stock in conjunction with its initial public offering, the option is exercisable for 213,541 shares of common stock at an exercise price of $6.24 per share and has a remaining life of 6.25 years.

Index to Financial Statements

A reconciliation of the amount of the income tax provision (benefit) that results from applying the statutory Federal income tax rates to pretax income (loss) and the reported amount of income tax provision is as follows (in thousands):

The significant components of the provision for income taxes for the years ended December 31, 2004, 2003 and 2002 are as follows (in thousands):

The significant components of the net deferred tax assets are as follows (in thousands):

Index to Financial Statements

The table below summarizes changes in the deferred tax asset valuation allowance (in thousands):

At December 31, 2004, the Company had federal net operating loss carryforwards of approximately $6.6 million, with expiration dates ranging from 2018 to 2023, federal research and development credit carryforwards of approximately $2.2 million with expiration dates ranging from 2011 to 2024, state research and development credit carryforwards of approximately $0.9 million with expiration dates ranging from 2020 to 2024, and federal alternative minimum tax credits of approximately $0.9 million with no expiration.

Under the provisions of the Internal Revenue Code, certain substantial changes in the Company’s ownership may result in a limitation on the amount of net operating loss and credit carryforwards which can be used in future years. As of December 31, 2004, the Company has approximately $2.1 million of net operating loss and $0.1 million of research and development credit carryforwards with limitations on the amount that can be recognized in any annual period. This limit may result in the expiration of the carryforwards prior to their utilization.

The valuation allowance for the deferred tax asset was reduced by approximately $14.7 million during 2004. This was due to the utilization during the current year of $6.3 million of deferred tax assets not previously recognized and to the release at September 30, 2004 of $8.4 million of the allowance based on management’s belief that it is more likely than not that the Company will generate sufficient future taxable income to realize the remaining net deferred tax asset. The Company has maintained a valuation allowance of approximately $1.3 million at December 31, 2004 related to the uncertainty of the utilization of certain loss and credit carryforwards prior to their expiration. There can be no assurance that the Company will meet its expectations of future taxable income. As a result, the amount of the deferred tax assets considered realizable could be reduced if estimates of future taxable income are reduced. Such an occurrence could materially adversely affect the Company’s results of operations and financial condition.

During 2004 and 2003, the Company recognized certain tax benefits related to stock option plans in the amount of $9.9 million and $0, respectively. These benefits were recorded as a reduction of income taxes payable and an increase in additional paid-in capital.

The determination of the provision for income taxes requires the Company to take positions on certain issues where there is uncertainty in the application of the tax law. The provision for income taxes includes amounts intended to satisfy unfavorable adjustments by the Internal Revenue Service and other tax authorities in an examination of the Company’s income tax returns. The ultimate resolution of these uncertainties may result in an assessment that is materially different from the current estimate of the liability and, if favorable, may result in income tax benefits being recognized in a future period.

The Company leases its office space and certain office equipment under noncancelable operating leases. Certain of these leases provide for periodic payments that increase over the life of the lease. The aggregate of the minimum periodic payments is expensed on a straight-line basis over the term of the related lease without consideration of renewal option periods. The lease agreements contain provisions that require the Company to

Index to Financial Statements

pay for normal operating expenses including repairs and maintenance, property taxes, and insurance. Total rent expense under these operating leases was approximately $4.3 million, $2.1 million and $2.2 million for the years ended December 31, 2004, 2003 and 2002, respectively. During the years ended December 31, 2004, 2003 and 2002, the Company earned $0.7 million, $0.8 and $0.7 million in rental income from office space subleased to third parties.

Future minimum lease payments under capital leases and noncancelable operating leases at December 31, 2004 are as follows (in thousands):

In connection with a technology license agreement with Metanoia Technologies, Inc. (“Metanoia”) (Note 16), the Company has indemnified Metanoia with respect to the infringement of third party proprietary rights. The indemnification is limited to $2.5 million. No claims or assertions have been made against the Company in connection with this indemnification.

In the normal course of its business, the Company enters into contracts that contain a variety of representations and warranties and which provide general indemnifications. The Company’s exposure under these arrangements is unknown as this would involve future claims that might be made against the Company that have not yet occurred. However based on experience, the Company expects the risk of any loss to be remote.

In December 2004, the Company abandoned a lease of office space in order to move its Austin, TX operations to a larger location that would accommodate the Company’s rapidly growing staff of engineers as well as support staff. The total amount incurred in connection with the lease abandonment charge was approximately $2.0 million which was expensed entirely in 2004 and is reflected in the selling, general and administrative operating expense in the consolidated statement of operations. The liability is allocated between a short-term liability of approximately $1.2 million and a long-term liability of approximately $0.8 million. The Company does not expect any future charges related to this abandonment.

In September 1999, a suit was filed against the Company by Crystal Semiconductor, Inc. (“Crystal”) and Cirrus Logic, Inc. (“Cirrus”) (the parent company of Crystal) alleging that certain of the Company’s products

Index to Financial Statements

infringed on two of Crystal’s patents. The Company settled the suit in November 2000. As part of the settlement, the Company issued shares of common stock to Cirrus valued at $3.0 million at the date of issuance, which was recorded as a litigation settlement expense. The Company also agreed to a perpetual contingent guarantee which provided that these shares would have a value of at least $10.5 million at the time of an initial public offering. Upon the closing of its initial public offering, the Company recorded an expense of and paid Cirrus $4.5 million in satisfaction of the contingent guarantee. In addition, Cirrus was to receive a warrant, exercisable for 60 days after the effective date of the initial public offering, to purchase shares of the Company’s common stock. In August 2003, this warrant was cancelled.

Revenues from a significant stockholder were approximately $27.5 million, $14.4 million and $6.7 million for the years ended December 31, 2004, 2003 and 2002, respectively.

Accounts receivable from sales to an affiliated customer were approximately $7.0 million and $5.6 million as of December 31, 2004 and 2003, respectively.

For the years ended December 31, 2004, 2003 and 2002, respectively, the Company paid approximately $0.2 million, $0.7 million and $4,000, respectively, for legal services to a law firm affiliated with a stockholder of the Company.

At December 31, 2004 and 2003, the Company had approximately $7,000 and $0.1 million, respectively, in receivables from employees to finance their purchases of restricted common stock (Note 10).

For the years ended December 31, 2004 and 2003, respectively, the Company paid approximately $10,000 and zero to a independent member of the Board of Directors for sales organization consulting services performed.

The Company has a defined contribution plan (the “401(k) Plan”) which is qualified under Section 401(k) of the Internal Revenue Code. Eligible employees may make voluntary contributions to the 401(k) Plan, not to exceed the statutory amount, and the Company may make matching contributions. The Company made no contributions to the 401(k) Plan for the years ended December 31, 2004, 2003 and 2002.

In July 2003, the Company approved an Employee Stock Purchase Plan (ESPP) that became effective upon completion of the initial public offering. Employees who own less than 5% of the Company, work more than 20 hours a week and are generally employed for greater than 5 months per year are eligible and may designate up to 15% of their compensation for the purchase of common stock semi-annually at the lower of 85% of the fair market value of the stock at the beginning or end of the six-month payment period, through accumulation of payroll deductions. Common stock reserved under the ESPP is 841,111 shares at December 31, 2004. The weighted average fair value of the employees purchase rights, as shown below, was estimated for the purpose of calculating pro forma net income (loss) attributable to common stockholders (Note 2) using the Black-Scholes model with the following assumptions:

Index to Financial Statements

Weighted average, grant date fair value of purchase rights granted under the Employee Stock Purchase Plan for the purpose of calculating pro forma net income (loss) attributable to common stockholders (Note 2) are as follows:

In October 2001, the Company entered into an asset purchase and license agreement with Metanoia, a company started by a former officer and then-current common stockholder of SigmaTel. The agreement requires the Company to exclusively license DSL technology developed and owned by the Company to Metanoia. The total consideration payable to the Company included (i) approximately 1,400,000 shares of Metanoia’s preferred stock; (ii) $207,000 payable in cash; and (iii) a note receivable of $1,000,000 bearing interest at 8% per annum payable on April 24, 2002. The Company accounts for its investment in Metanoia preferred stock using the cost method. Given the limited capitalization and operations of Metanoia at the time of this transaction, no value was assigned to the non-cash consideration received. In March 2002, prior to the maturity of the note, Metanoia exercised its option to extend the maturity date of the note to January 24, 2003 (the “New Maturity Date”). In December 2002, prior to the New Maturity Date, the Company entered into an agreement with Metanoia to extend the maturity of the note to January 24, 2005 and to remove certain licensing restrictions for the use of the technology. In consideration for the amendment, Metanoia issued a new note in the amount of $500,000 to the Company bearing interest at 8% per annum and maturing on January 24, 2004. Metanoia is in the process of raising capital for its business operations. The Company has received little cash consideration from the Metanoia transactions. As of December 31, 2004, the Company had not recognized a gain on the non-cash consideration received as Metanoia had not generated operating cash flows and there is no active trading market for Metanoia securities.

Index to Financial Statements

The Company operated in a single segment, and the Company’s chief operating decision makers use measurements aggregated at the entity-wide level to manage the business.

The following table summarizes the percentages of revenues by geographic region:

The table below summarizes the percentage of long-lived assets by geographic region:

The following table sets forth the Company’s revenues for each product class which accounted for greater than 15% of its revenues during any of the last three years (Audio Codecs include both notebook and desktop PC audio codecs and consumer audio codecs):


		Page No.
PART I:

Item 1.	Business and Factors Affecting Our Future Operating Results	3

Item 2.	Properties	25

Item 3.	Legal Proceedings	25

Item 4.	Submission of Matters to a Vote of Security Holders	25

PART II:

Item 5.	Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities	26

Item 6.	Selected Financial Data	27

Item 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	28

Item 7A.	Quantitative and Qualitative Disclosures about Market Risk	39

Item 8.	Financial Statements and Supplementary Data	40

Item 9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure	40

Item 9A.	Controls and Procedures	41

Item 9B.	Other Information	41

PART III:

Item 10.	Directors and Executive Officers of the Registrant	41

Item 11.	Executive Compensation	41

Item 12.	Security Ownership of Certain Beneficial Owners and Management	42

Item 13.	Certain Relationships and Related Transactions	42

Item 14.	Principal Accountant Fees and Services	42

PART IV:

Item 15.	Exhibits and Financial Statement Schedule	42

Signatures		44


	Year Ended December 31,
	2004		2003		2002
Portable Audio SoCs	89.3	%	75.9	%	51.8	%
Audio Codecs	8.5		19.6		44.9


A-MAX Technology	Foxda	MSI
ASUS	IDT	Philips
ATLM	JingWah	Quanta
AVC	IMT	Thomson
Compal	Lanview	Samsung
Cowon	Lite-on	Tai Guen Enterprise
Creative Technology	Meizu	Truly


	Common Stock Price
	High		Low
Fiscal Year 2003
Third Quarter (From September 19, 2003)	$	22.15	$	17.50
Fourth Quarter	$	30.92	$	20.01
Fiscal Year 2004
First Quarter	$	32.34	$	17.79
Second Quarter	$	29.20	$	21.54
Third Quarter	$	28.80	$	13.79
Fourth Quarter	$	37.34	$	21.93


	Year Ended December 31,
	2004		2003			2002			2001			2000
	(in thousands, except share data)
Statements of Operations Data:
Revenues, net	$	194,805	$	100,225		$	30,917		$	24,380		$	47,430
Gross profit		105,618		47,734			11,287			692			8,401
Research and development		32,253		17,867			11,927			13,678			15,201
Selling, general and administrative		18,098		10,184			4,969			6,572			13,788
Amortization of deferred stock-based compensation		2,162		3,907			29			95			189
Litigation settlements		—		4,500			—			(3,000	)		3,000
Total operating expenses		52,513		36,458			16,936			17,335			31,345
Operating income (loss)		53,105		11,276			(5,649	)		(16,643	)		(22,944	)
Net income (loss)		52,556		9,989			(8,279	)		(18,377	)		(22,709	)
Deemed dividends on preferred stock		—		(8,768	)		(316	)		(316	)		(312	)
Net income (loss) attributable to common stockholders		52,556		1,221			(8,595	)		(18,693	)		(23,021	)
Basic net income (loss) attributable to common stockholders per share	$	1.52	$	0.09		$	(1.47	)	$	(3.34	)	$	(5.21	)
Diluted net income (loss) attributable to common stockholders per share	$	1.39	$	0.04		$	(1.47	)	$	(3.34	)	$	(5.21	)
Weighted-average number of shares used in basic net income (loss) attributable to common stockholders per share calculations		34,668,904		13,449,687			5,836,026			5,597,511			4,414,522
Weighted-average number of shares used in diluted net income (loss) attributable to common stockholders per share calculations		37,871,618		31,086,166			5,836,026			5,597,511			4,414,522


	December 31,
	2004		2003		2002			2001			2000
	(in thousands)
Balance Sheet Data:
Cash and cash equivalents	$	27,246	$	61,841	$	2,859		$	6,308		$	2,975
Short-term investments		114,451		49,420		—			—			—
Total assets		219,915		146,877		18,529			20,459			35,422
Long-term debt		7		63		7,437			11,602			204
Redeemable convertible preferred stock		—		—		40,761			40,445			40,133
Total stockholders’ equity (deficit)		180,916		126,108		(44,985	)		(37,565	)		(21,852	)


	Amount of Commitment Maturing by Year
	Total		Less than 1 year		1-3 years		3-5 years		More than 5 years
Operating leases	$	20,320	$	4,439	$	6,817	$	4,492	$	4,572
Capital leases		70		63		7		—		—
Long-term liabilities (excluding amounts related to operating leases presented above)		60		—		60		—		—
Purchase obligations (primarily inventory)		53,164		51,148		1,906		110		—

Total commitments	$	73,614	$	55,650	$	8,790	$	4,602	$	4,572


	Three Months Ended
	December 31, 2004			September 30, 2004			June 30, 2004			March 31, 2004			December 31, 2003			September 30, 2003			June 30, 2003			March 31, 2003
	(in thousands, except share data)
Statements of Operations Data:
Revenues, net	$	78,585		$	48,112		$	36,608		$	31,500		$	34,971		$	32,706		$	19,672		$	12,876
Gross profit		42,993			26,079			19,830			16,716			17,676			15,718			8,802			5,538
Research and development		10,397			8,603			7,170			6,083			5,377			4,674			4,154			3,662
Selling, general and administrative		7,632			3,964			3,603			2,899			3,213			2,716			2,717			1,538
Amortization of deferred stock-based compensation		341			424			402			995			919			1,860			889			239
Litigation settlements		—			—			—			—			—			4,500			—			—
Total operating expenses		18,370			12,991			11,175			9,977			9,509			13,750			7,760			5,439
Operating income		24,623			13,088			8,655			6,739			8,167			1,968			1,042			99
Net income (loss)		19,486			17,318			8,821			6,931			8,157			1,682			765			(615	)
Net income (loss) attributable to common stockholders		19,486			17,318			8,821			6,931			8,157			1,169			686			(8,791	)
Basic net income (loss) attributable to common stockholders per share	$	0.56		$	0.50		$	0.25		$	0.20		$	0.24		$	0.15		$	0.12		$	(1.50	)
Diluted net income (loss) attributable to common stockholders per share	$	0.52		$	0.46		$	0.23		$	0.18		$	0.21		$	0.04		$	0.03		$	(1.50	)
Basic weighted-average number of shares used in per share calculations		34,500,533			34,537,784			35,146,977			34,486,515			34,109,901			7,733,292			5,853,738			5,845,938
Diluted weighted-average number of shares used in per share calculations		37,485,379			37,381,964			38,767,712			38,446,198			38,289,376			29,536,606			30,142,756			5,845,938
As a Percentage of Revenues:
Revenues, net		100.0	%		100.0	%		100.0	%		100.0	%		100.0	%		100.0	%		100.0	%		100.0	%
Gross profit		54.7			54.2			54.2			53.1			50.5			48.1			44.7			43.0
Research and development		13.2			17.9			19.6			19.3			15.4			14.3			21.1			28.4
Selling, general and administrative		9.7			8.2			9.8			9.2			9.2			8.3			13.8			11.9
Amortization of deferred stock-based compensation		0.4			0.9			1.1			3.2			2.6			5.7			—			—
Litigation settlements		—			—			—			—			—			13.8			—			—
Total operating expenses		23.4			27.0			30.5			31.7			27.2			42.0			39.4			42.2
Operating income		31.3			27.2			23.6			21.4			23.4			6.0			5.3			0.8
Net income (loss)		24.8			36.0			24.1			22.0			23.3			5.1			3.9			(4.8	)
Net income (loss) attributable to common stockholders		24.8			36.0			24.1			22.0			23.3			3.6			3.5			(68.3	)


		Page
Report of Independent Registered Public Accounting Firm		F-2
Consolidated Balance Sheets		F-4
Consolidated Statements of Operations		F-5
Consolidated Statements of Changes in Stockholders’ Equity (Deficit)		F-6
Consolidated Statements of Cash Flows		F-7
Notes to Consolidated Financial Statements		F-8


Exhibit Number
3.1	(1)	Second Restated Certificate of Incorporation of SigmaTel, Inc.

3.2	(2)	Amended and Restated Bylaws of SigmaTel, Inc.

4.1	(2)	Specimen certificate for shares of common stock

10.1	(2)	SigmaTel 1995 Stock Option/Stock Issuance Plan, as amended to date

10.2	(2)	SigmaTel 2003 Equity Incentive Plan

10.3	(2)	SigmaTel Employee Stock Purchase Plan

10.4	(2)	Second Amended and Restated Investors’ Rights Agreement dated August 15, 2000, by and among SigmaTel and certain holders of preferred stock or common stock

10.5	(2)	First Amendment to Second Amended and Restated Investors’ Rights Agreement dated November 17, 2000, by and between SigmaTel and Cirrus Logic, Inc.

10.6	(2)	Second Amendment to Second Amended and Restated Investors’ Rights Agreement dated July 1, 2003, by and between SigmaTel and certain holders of preferred or common stock.

10.7	(2)	Lease Agreement effective August 6, 1999, by and between SigmaTel and Desta Two Partnership Ltd.

10.8	(2)	Amendment No. 1 to Lease Agreement, effective January 1, 2000, by and between SigmaTel and Desta Two Partnership Ltd.


Exhibit Number

10.9	(2)	Sublease dated July 16 2001, by and between SigmaTel and Texas Networking, Inc.

10.10	(2)	Office Building Lease Agreement dated June 12, 2000, by and between SigmaTel and BC Plaza II/III Ltd.

10.11	(2)	Amended and Restated Loan and Security Agreement dated March 4, 2003, by and between SigmaTel and Silicon Valley Bank

10.12	(2)	Executive Employment Agreement dated as of March 26, 2001 by and between Ronald Edgerton and SigmaTel

10.13	(3)	Form of Indemnification Agreement for directors and officers

10.14	(4)	Executive Employment Agreement dated as of May 20, 2003 by and between Ross Goolsby and SigmaTel

10.15	(5)	Lease Agreement dated July 29, 2004, by and between SigmaTel, Inc. and Prentiss Properties Acquisition Partners, L.P.

10.16	(6)	Independent Contracting Agreement between SigmaTel, Inc. and Robert Derby, effective October 19, 2004

10.17	(7)	Incentive Bonus Plan for certain full-time senior employees of SigmaTel

21.1		List of SigmaTel’s subsidiaries

23.1		Consent of PricewaterhouseCoopers LLP, Independent Registered Public Accounting Firm

31.01		Certification of Chief Executive Officer pursuant to Securities Exchange Act Rules 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

31.02		Certification of Chief Financial Officer pursuant to Securities Exchange Act Rules 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

32.01	*	Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.


NAME	TITLE	DATE

/s/ RONALD P. EDGERTON Ronald P. Edgerton	President and Chief Executive Officer (principal executive officer)	February 7, 2005

/s/ ROSS A. GOOLSBY Ross A. Goolsby	Vice President of Finance, Chief Financial Officer and Secretary (principal financial and accounting officer)	February 7, 2005

/s/ ALEXANDER M. DAVERN Alexander M. Davern	Director	February 7, 2005

/s/ JOHN A. HIME John A. Hime	Director	February 7, 2005

/s/ KENNETH P. LAWLER Kenneth P. Lawler	Director	February 7, 2005

/s/ ROBERT T. DERBY Robert T. Derby	Director	February 7, 2005

/s/ WILLIAM P. OSBORNE William P. Osborne	Director	February 7, 2005


	Common Stock				Additional Paid-In Capital			Notes Receivable from Stockholders			Deferred Stock-Based Compensation			Treasury Stock			Accumulated Surplus (Deficit)			Total Stockholders’ Equity (Deficit)
	Shares		Amount		Additional Paid-In Capital			Notes Receivable from Stockholders			Deferred Stock-Based Compensation			Treasury Stock			Accumulated Surplus (Deficit)			Total Stockholders’ Equity (Deficit)
Balance, December 31, 2001	6,597,898		$	1	$	10,237		$	(278	)	$	(108	)	$	(2,609	)	$	(44,808	)	$	(37,565	)
Issuance of common stock upon exercise of options	7,419			—		13			—			—			—			—			13
Repurchase of 1,433 shares of common stock	—			—		—			—			—			(1	)		—			(1	)
Deferred stock-based compensation	—			—		(29	)		—			29			—			—			—
Amortization of deferred stock-based compensation	—			—		—			—			29			—			—			29
Warrants issued to a customer	—			—		973			—			—			—			—			973
Issuance of common stock for software licenses	33,333			—		100			—			—			—			—			100
Warrants issued in connection with financing	—			—		72			—			—			—			—			72
Retirement of treasury stock	(648,022	)		—		(1,869	)		—			—			1,869			—			—
Interest on amounts receivable from stockholder	—			—		—			(15	)		—			—			—			(15	)
Payment of amounts receivable from stockholder	—			—		—			4			—			—			—			4
Deemed dividends on redeemable convertible preferred stock	—			—		(316	)		—			—			—			—			(316	)
Net loss	—			—		—			—			—			—			(8,279	)		(8,279	)

Balance, December 31, 2002	5,990,628			1		9,181			(289	)		(50	)		(741	)		(53,087	)		(44,985	)
Issuance of common stock upon initial public offering, net of issuance costs of $1,664	7,383,917			—		101,361			—			—			—			—			101,361
Issuance of common stock upon exercise of options	227,257			—		307			—			—			—			—			307
Conversion of redeemable convertible preferred stock to common stock	19,177,818			2		49,526			—			—			—			—			49,528
Conversion of convertible notes payable to common stock	1,022,102			—		6,382			—			—			—			—			6,382
Issuance of common stock upon net exercise of warrants	471,906			—		—			—			—			—			—			—
Payment of amounts receivable from stockholder	—			—		—			181			—			—			—			181
Interest on amounts receivable from stockholder	—			—		—			(11	)		—			—			—			(11	)
Repurchase and cancellation of 2,667 shares of common stock	(2,667	)		—		(4	)		4			—			—			—			—
Deferred stock-based compensation	—			—		7,665			—			(7,535	)		—			—			130
Amortization of deferred stock-based compensation	—			—		—			—			3,907			—			—			3,907
Deemed dividends on redeemable convertible preferred stock	—			—		(681	)		—			—			—			—			(681	)
Net income	—			—		—			—			—			—			9,989			9,989

Balance, December 31, 2003	34,270,961			3		173,737			(115	)		(3,678	)		(741	)		(43,098	)		126,108
Issuance of common stock upon exercise of options	1,476,996			1		3,807			—			—			—			—			3,808
Issuance of common stock upon follow-on equity offering, net of issuance costs of $699	250,000			—		5,271			—			—			—			—			5,271
Issuance of common stock upon offering from Employee Stock Purchase Plan	111,391			—		1,623			—			—			—			—			1,623
Issuance of common stock upon net exercise of warrants	477,385			—		—			—			—			—			—			—
Repurchase and cancellation of 1,381,991 shares of common stock	(1,381,991	)		—		(21,021	)		—			—			—			—			(21,021	)
Payment of amounts receivable from stockholder	—			—		—			109			—			—			—			109
Interest on amounts receivable from stockholder	—			—		—			(1	)		—			—			—			(1	)
Tax benefit related to exercise of employee stock options	—			—		9,860			—			—			—			—			9,860
Deferred stock-based compensation	—			—		203			—			238			—			—			441
Amortization of deferred stock-based compensation	—			—		—			—			2,162			—			—			2,162
Net income	—			—		—			—			—			—			52,556			52,556

Balance, December 31, 2004	35,204,742		$	4	$	173,480		$	(7	)	$	(1,278	)	$	(741	)	$	9,458		$	180,916


	Customers That Accounted For Greater Than 10% of Accounts Receivable, net				Customers That Accounted For Greater Than 10% of Revenues, net
	December 31,				Year Ended December 31,
	2004		2003		2004		2003		2002
Customer A (an affiliate)	20	%	34	%	14	%	14	%	21	%
Customer B	21	%	17	%	17	%	32	%	35	%
Customer C	10	%	—		—		—		—
Customer D	21	%	14	%	27	%	11	%	—
Customer E	—		14	%	—		—		—


	Estimated Useful Lives in Years	December 31,
	Estimated Useful Lives in Years	2004			2003
Computers and equipment	2-5	$	9,241		$	4,801
Furniture and fixtures	5		3,437			1,646
Purchased software	3		6,797			5,905

			19,475			12,352
Less—accumulated depreciation and amortization			(12,359	)		(8,560	)

		$	7,116		$	3,792


Series	Date Designated	Number of Shares Authorized	Shares Issued and Outstanding	Total Proceeds		Carrying Amount at December 31,				Liquidation Value at December 31, 2002
						Carrying Amount at December 31,
						2003		2002
Series A	July 1997	1,170,601	1,170,601	$	1,721	$	—	$	1,695	$	1,721
Series C	August 1998	304,878	304,878		1,000		—		984		1,000
Series E	January 1999	661,730	661,730		1,203		—		1,203		1,203
Series F	August 1999	8,303,631	6,919,692		12,580		—		12,065		12,580
Series G	September 1999	755,250	755,250		833		—		833		833
Series H	August 2000	5,052,632	5,052,632		24,000		—		23,981		24,000
Series I	April 2001	5,012,576	—		—		—		—		—
Series J	February 2003	7,157,584	7,157,584		8,191		—		—		—
Undesignated		1,581,118	—		—		—		—		—

		30,000,000	22,022,367	$	49,528	$	—	$	40,761	$	41,337


	Options Outstanding
	Available for Grant		Shares		Exercise Price		Weighted average exercise price
Outstanding—December 31, 2001	441,514		1,617,008		$	0.12–12.00	$	3.54
Options authorized	648,022		—			—		—
Options granted	(522,200	)	522,200			3.00		3.00
Options exercised	—		(7,419	)		1.50–3.00		1.65
Options forfeited	50,414		(50,414	)		1.50–9.00		4.92

Outstanding—December 31, 2002	617,750		2,081,375		$	0.12–12.00	$	3.36
Options authorized	4,388,009		—			—		—
Options granted	(2,255,773	)	2,255,773			0.75–29.93		3.57
Options exercised	—		(227,257	)		0.75–7.50		1.85
Options forfeited	58,543		(58,543	)		0.75–23.26		4.11

Outstanding—December 31, 2003	2,808,529		4,051,348		$	0.12–29.93	$	3.55
Options authorized	—		—			—		—
Options granted	(1,416,305	)	1,416,305			14.55–36.00		23.22
Options exercised	—		(1,476,996	)		0.11–12.00		2.58
Options forfeited	107,262		(107,262	)		0.75–36.00		6.58

Outstanding—December 31, 2004	1,499,486		3,883,395		$	0.75–$36.00	$	11.01


Common Stock Options Granted with Exercise Price	Weighted Average Exercise Price						Weighted Average Grant Date Fair Values
Common Stock Options Granted with Exercise Price	Year Ended December 31,						Year Ended December 31,
	2004		2003		2002		2004		2003		2002
Equal to common stock value at date of grant	$	23.22	$	24.33	$	3.00	$	13.16	$	14.16	$	1.65
Less than common stock value at date of grant		—		1.94		—		—		3.48		—
Greater than common stock value at date of grant		—		—		—		—		—		—


	Options outstanding				Options exercisable
Range of exercise price	Number outstanding	Weighted- average remaining contractual life (years)	Weighted- average exercise price		Number exercisable	Weighted- average exercise price
$0.75–$2.40	952,097	8.1	$	0.78	835,435	$	0.78
3.00– 5.25	1,057,424	6.9		3.15	1,057,424		3.15
6.75– 7.50	216,803	8.0		6.91	216,803		6.91
9.00–20.24	768,200	9.0		18.07	122,824		9.56
20.27–27.96	693,936	9.3		24.67	37,362		26.17
28.94–36.00	194,935	9.9		31.82	1,438		29.93

	3,883,395	8.2	$	11.01	2,271,286	$	3.38


	Balance at Beginning of Period			Additions			Deductions		Balance at End of Period
Year ended December 31, 2002	$	(16,425	)	$	(3,301	)	$	—	$	(19,726	)

Year ended December 31, 2003	$	(19,726	)	$	—		$	3,755	$	(15,971	)

Year ended December 31, 2004	$	(15,971	)	$	—		$	14,701	$	(1,270	)


Year ending December 31,	Operating leases			Capital leases
2005	$	4,439		$	63
2006		4,223			7
2007		2,594			—
2008		2,286			—
2009		2,206			—
Future		4,572			—

		20,320			70
Less: sublease rental income		(1,730	)

Operating lease obligation net of sublease	$	18,590

Less: portion representing interest					(6	)

Capital lease obligation					64
Less: current portion					(57	)

Capital lease obligation, net of current portion				$	7


	Balance at Beginning of Period			Additions			Deductions		Balance at End of Period
Allowance for sales returns:
Year ended December 31, 2002	$	(50	)	$	—		$	—	$	(50	)

Year ended December 31, 2003		(50	)		(50	)		—		(100	)

Year ended December 31, 2004		(100	)		(159	)		109		(150	)

Reserve for excess and obsolete inventory:
Year ended December 31, 2002		(617	)		(151	)		463		(305	)

Year ended December 31, 2003		(305	)		(1,529	)		419		(1,415	)

Year ended December 31, 2004		(1,415	)		(2,238	)		1,470		(2,183	)

Allowance for doubtful accounts:
Year ended December 31, 2002		—			—			—		—

Year ended December 31, 2003		—			(400	)		—		(400	)

Year ended December 31, 2004	$	(400	)	$	(118	)	$	12	$	(506	)