##### Table of Contents



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
   FORM 10-Q   (Mark One) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 For the Quarterly Period Ended October 3, 2004 OR [  ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 For the transition period from _______ to ________ Commission File Number: 0-11674   LSI LOGIC CORPORATION (Exact name of registrant as specified in its charter)
 Delaware
    
    94-2712976(State of Incorporation)
    
    (I.R.S. Employer Identification Number)
 1621 Barber Lane
Milpitas, California 95035
(Address of principal executive offices)
(Zip code) (408) 433-8000
(Registrants telephone number, including area code)   Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. YES [X]                      NO [  ] Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act) YES [X] NO [  ] As of November 5, 2004, there were 384,930,760 shares of the registrants
Common Stock, $.01 par value, outstanding.




---



LSI LOGIC CORPORATION
Form 10-Q
For the Quarter Ended September 30, 2004
INDEX  
 PageNo.PART I. FINANCIAL INFORMATIONItem 1 Financial StatementsConsolidated Balance Sheets  September 30, 2004 (unaudited) and December 31, 2003
    
    
    3Consolidated Statements of Operations  Three and Nine Months Ended September 30, 2004 and 2003 (unaudited)
    
    
    4Consolidated Statements of Cash Flows  Nine Months Ended September 30, 2004 and 2003 (unaudited)
    
    
    5Notes to Unaudited Consolidated Financial Statements
    
    
    6Item 2 Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    19Item 3 Quantitative and Qualitative Disclosures About Market Risk
    
    
    35Item 4 Controls and Procedures
    
    
    36PART II. OTHER INFORMATIONItem 1 Legal Proceedings
    
    
    36Item 2 Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    36Item 6 Exhibits
    
    
    37Signatures
    
    
    38Index to Exhibits
    
    
    39EXHIBIT 2.1EXHIBIT 2.2EXHIBIT 2.3EXHIBIT 2.4EXHIBIT 10.1EXHIBIT 10.2EXHIBIT 10.3EXHIBIT 10.4EXHIBIT 10.5EXHIBIT 10.6EXHIBIT 10.7EXHIBIT 31.1EXHIBIT 31.2EXHIBIT 32.1EXHIBIT 32.2
  2




---



##### Table of Contents



PART I  FINANCIAL INFORMATION 
 Item 1. Financial Statements LSI LOGIC CORPORATION 
 CONSOLIDATED BALANCE SHEETS (UNAUDITED)
 September 30,
    
    December 31,2004
    
    2003(In thousands, exceptper-share amounts)AssetsCash and cash equivalents
    
    $
    202,627
    
    
    $
    269,682Short-term investments
    
    
    606,217
    
    
    
    544,007Accounts receivable, less allowances of $5,494 and $7,415
    
    
    264,832
    
    
    
    231,184Inventories
    
    
    244,272
    
    
    
    198,517Deferred tax assets
    
    
    8,089
    
    
    
    8,116Prepaid expenses and other current assets
    
    
    127,240
    
    
    
    138,531Total current assets
    
    
    1,453,277
    
    
    
    1,390,037Property and equipment, net
    
    
    237,189
    
    
    
    481,489Intangibles, net
    
    
    131,324
    
    
    
    161,236Goodwill
    
    
    973,060
    
    
    
    968,483Deferred tax assets
    
    
    7,273
    
    
    
    7,484Non-current assets and deposits
    
    
    260,907
    
    
    
    318,176Investment in equity securities
    
    
    16,847
    
    
    
    35,455Other assets
    
    
    77,806
    
    
    
    85,541Total assets
    
    $
    3,157,683
    
    
    $
    3,447,901Liabilities and Stockholders EquityAccounts payable
    
    $
    131,689
    
    
    $
    102,632Accrued salaries, wages and benefits
    
    
    76,805
    
    
    
    75,968Other accrued liabilities
    
    
    181,175
    
    
    
    153,857Income taxes payable
    
    
    67,670
    
    
    
    58,417Current portion of long-term obligations
    
    
    270
    
    
    
    377Total current liabilities
    
    
    457,609
    
    
    
    391,251Long-term debt and capital lease obligations
    
    
    784,225
    
    
    
    865,606Other non-current liabilities
    
    
    131,986
    
    
    
    141,096Total long-term obligations and other liabilities
    
    
    916,211
    
    
    
    1,006,702Commitments and contingencies (Notes 14 and 15)Minority interest in subsidiary
    
    
    274
    
    
    
    7,498Stockholders equity:Preferred shares; $.01 par value; 2,000 shares authorized, none outstanding
    
    
    
    
    
    
    Common stock; $.01 par value; 1,300,000 shares authorized; 384,929 and
381,491 shares outstanding
    
    
    3,849
    
    
    
    3,815Additional paid-in capital
    
    
    2,959,708
    
    
    
    2,950,051Deferred stock compensation
    
    
    (10,961
    )
    
    
    (24,839
    )Accumulated deficit
    
    
    (1,186,895
    )
    
    
    (920,790
    )Accumulated other comprehensive income
    
    
    17,888
    
    
    
    34,213Total stockholders equity
    
    
    1,783,589
    
    
    
    2,042,450Total liabilities and stockholders equity
    
    $
    3,157,683
    
    
    $
    3,447,901
 The accompanying notes are an integral part of these Consolidated Financial Statements. 3




---



##### Table of Contents



LSI LOGIC CORPORATION 
 CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
 Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,2004
    
    2003
    
    2004
    
    2003(In thousands, except per share amounts)Revenues
    
    $
    380,217
    
    
    $
    450,227
    
    
    $
    1,280,471
    
    
    $
    1,230,225Cost of revenues
    
    
    228,418
    
    
    
    265,243
    
    
    
    718,424
    
    
    
    751,780Gross profit
    
    
    151,799
    
    
    
    184,984
    
    
    
    562,047
    
    
    
    478,445Research and development
    
    
    108,134
    
    
    
    103,803
    
    
    
    327,173
    
    
    
    330,256Selling, general and administrative
    
    
    63,460
    
    
    
    57,715
    
    
    
    188,375
    
    
    
    172,214Restructuring of operations and other items, net
    
    
    228,624
    
    
    
    24,516
    
    
    
    231,055
    
    
    
    184,709Amortization of non-cash deferred stock compensation (*)
    
    
    2,593
    
    
    
    3,398
    
    
    
    6,422
    
    
    
    22,825Amortization of intangibles
    
    
    19,212
    
    
    
    19,200
    
    
    
    56,884
    
    
    
    58,592Loss from operations
    
    
    (270,224
    )
    
    
    (23,648
    )
    
    
    (247,862
    )
    
    
    (290,151
    )Interest expense
    
    
    (5,999
    )
    
    
    (6,971
    )
    
    
    (17,978
    )
    
    
    (23,116
    )Interest income and other, net
    
    
    (209
    )
    
    
    4,967
    
    
    
    17,735
    
    
    
    15,106Loss before income taxes
    
    
    (276,432
    )
    
    
    (25,652
    )
    
    
    (248,105
    )
    
    
    (298,161
    )Provision for income taxes
    
    
    6,000
    
    
    
    6,000
    
    
    
    18,000
    
    
    
    18,000Net loss
    
    $
    (282,432
    )
    
    $
    (31,652
    )
    
    $
    (266,105
    )
    
    $
    (316,161
    )Net loss per share:Basic
    
    $
    (0.73
    )
    
    $
    (0.08
    )
    
    $
    (0.69
    )
    
    $
    (0.84
    )Dilutive
    
    $
    (0.73
    )
    
    $
    (0.08
    )
    
    $
    (0.69
    )
    
    $
    (0.84
    )Shares used in computing per share amounts:Basic
    
    
    384,876
    
    
    
    378,749
    
    
    
    383,355
    
    
    
    376,931Dilutive
    
    
    384,876
    
    
    
    378,749
    
    
    
    383,355
    
    
    
    376,931(*)
    Amortization of non-cash deferred stock compensation, if not shown
separately, would have been included in cost of revenues, research and
development and selling, general and administrative expenses as shown
below:Three months ended
    
    Nine months endedSeptember 30,
    
    September 30,2004
    
    2003
    
    2004
    
    2003(In thousands)Cost of revenues
    
    $
    52
    
    
    $
    122
    
    
    $
    148
    
    
    $
    392Research and development
    
    
    2,085
    
    
    
    2,469
    
    
    
    4,796
    
    
    
    18,010Selling, general and administrative
    
    
    456
    
    
    
    807
    
    
    
    1,478
    
    
    
    4,423Total
    
    $
    2,593
    
    
    $
    3,398
    
    
    $
    6,422
    
    
    $
    22,825
 The accompanying notes are an integral part of these Consolidated Financial Statements. 4




---



##### Table of Contents



LSI LOGIC CORPORATION 
 CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
 Nine Months EndedSeptember 30,2004
    
    2003(In thousands)Operating activities:Net loss
    
    $
    (266,105
    )
    
    $
    (316,161
    )Adjustments:Depreciation and amortization
    
    
    136,407
    
    
    
    208,615Amortization of non-cash deferred stock compensation
    
    
    6,422
    
    
    
    22,825Non-cash restructuring and other items
    
    
    214,058
    
    
    
    145,828(Gain) on sale of equity securities, net of loss on write down
    
    
    (2,113
    )
    
    
    9,043(Gain)/loss on repurchase of Convertible Subordinated Notes
    
    
    (1,767
    )
    
    
    3,191Gain on sale of property and equipment
    
    
    (5,881
    )
    
    
    (2,150
    )Changes in deferred tax assets and liabilities
    
    
    238
    
    
    
    (94
    )Changes in assets and liabilities, net of assets acquired and liabilities
assumed in business combinations:Accounts receivable
    
    
    (32,855
    )
    
    
    (14,773
    )Inventories
    
    
    (46,032
    )
    
    
    (7,050
    )Prepaid expenses and other assets
    
    
    (2,068
    )
    
    
    63,149Accounts payable
    
    
    29,908
    
    
    
    (1,338
    )Accrued and other liabilities
    
    
    34,343
    
    
    
    27,319Net cash provided by operating activities
    
    
    64,555
    
    
    
    138,404Investing activities:Purchase of debt securities available-for-sale
    
    
    (641,435
    )
    
    
    (1,995,322
    )Maturities and sales of debt securities available-for-sale
    
    
    568,178
    
    
    
    1,890,065Purchases of equity securities
    
    
    (2,250
    )
    
    
    Proceeds from sales of equity securities
    
    
    10,518
    
    
    
    Purchases of property and equipment
    
    
    (41,794
    )
    
    
    (48,775
    )Proceeds from sale of property and equipment
    
    
    8,597
    
    
    
    13,677Proceeds from the sale-lease back of equipment
    
    
    
    
    
    
    160,000Deposit received toward the sale of the Japan manufacturing facility
    
    
    
    
    
    
    4,869Increase in non-current assets and deposits
    
    
    (313,013
    )
    
    
    (390,135
    )Decrease in non-current assets and deposits
    
    
    369,464
    
    
    
    256,606Acquisition of companies, net of cash acquired
    
    
    (32,025
    )
    
    
    Net cash used in investing activities
    
    
    (73,760
    )
    
    
    (109,015
    )Financing activities:Repurchase of Convertible Subordinated Notes
    
    
    (68,117
    )
    
    
    (461,983
    )Proceeds from borrowings
    
    
    
    
    
    
    350,000Cash paid for call spread options
    
    
    
    
    
    
    (28,000
    )Debt issuance costs
    
    
    
    
    
    
    (10,936
    )Repayment of debt obligations
    
    
    (297
    )
    
    
    (264
    )Purchase of minority interest in subsidiary
    
    
    (7,978
    )
    
    
    Issuance of common stock
    
    
    17,864
    
    
    
    17,763Net cash used in financing activities
    
    
    (58,528
    )
    
    
    (133,420
    )Effect of exchange rate changes on cash and cash equivalents
    
    
    678
    
    
    
    4,937Decrease in cash and cash equivalents
    
    
    (67,055
    )
    
    
    (99,094
    )Cash and cash equivalents at beginning of period
    
    
    269,682
    
    
    
    448,847Cash and cash equivalents at end of period
    
    $
    202,627
    
    
    $
    349,753
 The accompanying notes are an integral part of these Consolidated Financial Statements. 5




---



##### Table of Contents



LSI LOGIC CORPORATION 
 NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
 NOTE 1  BASIS OF PRESENTATION In the opinion of LSI Logic Corporation (the Company or LSI), the
accompanying unaudited consolidated financial statements contain all
adjustments (consisting only of normal recurring adjustments and restructuring
and other items, net as discussed in Note 5 to the Unaudited Consolidated
Financial Statements, hereafter referred to as the Notes), necessary to
present fairly the financial information included herein. While the Company
believes that the disclosures are adequate to make the information not
misleading, it is suggested that these financial statements be read in
conjunction with the audited consolidated financial statements and accompanying
notes included in the Companys Annual Report on Form 10-K for the year ended
December 31, 2003. For financial reporting purposes, the Company reports on a 13 or 14-week
quarter with a year ending December 31. The current quarter ended October 3,
2004. For presentation purposes, the consolidated financial statements refer
to the calendar quarters for convenience. The results of operations for the
quarter ended October 3, 2004, are not necessarily indicative of the results to
be expected for the full year. The nine months ended October 3, 2004 consisted
of approximately 40 weeks, while the nine months ended September 28, 2003
consisted of approximately 39 weeks. The third quarter of 2004 and 2003 both
consisted of 13 weeks. 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 contingent assets and liabilities
at the date of the consolidated financial statements and the reported amounts
of revenues and expenses during the reporting periods. Actual results could
differ significantly from these estimates. Recent Accounting Pronouncements In
October 2004, the Emerging Issues Task Force (EITF) issued EITF Issue No.
04-08, Accounting Issues Related to Certain Features of Contingently
Convertible Debt and the Effect on Diluted Earnings Per Share. This issue
addresses when contingently convertible instruments should be included in
diluted earnings per share computations. The pronouncement will be
effective for reporting periods ending after December 15, 2004. The adoption of this standard is not expected to have an impact on the
Companys computation of diluted earnings per share. In
October 2004, the EITF issued EITF Issue No. 04-10, Applying
Paragraph 19 of Statement of Financial Accounting Standards
(SFAS) No. 131 in Determining Whether to Aggregate Operating Segments
that do not meet the Quantitative Thresholds. SFAS No. 131, Disclosures About Segments of an Enterprise and
Related Information, requires
that a public business enterprise report financial and descriptive information
about its reportable operating segments. This issue addresses how to
aggregate operating segments that do not meet the quantitative thresholds in
SFAS No. 131. The pronouncement is effective for fiscal years ending
after October 13, 2004. The adoption of this standard did not have an impact to the
existing reportable operating segments of the Company. In July 2004, the Emerging Issues Task Force (EITF) issued EITF Issue
No. 02-14, Whether an Investor Should Apply the Equity Method of Accounting to
Investments Other Than Common Stock. This issue addresses the determination
of whether an investment is in-substance common stock and when to perform that
evaluation, but does not address the determination of whether an investor has
the ability to exercise significant influence over the operating and financial
policies of the investee. The pronouncement is effective for fiscal periods
beginning after September 15, 2004. For existing investments, the investor
should make an initial determination as to whether the investment is
in-substance common stock based on the circumstances existing as of the date of
first application of this issue. The Company does not believe that the
adoption of this standard will have a material impact on its consolidated
balance sheet or statement of operations. In March 2004, the EITF issued EITF Issue No. 03-06, Participating
Securities and the Two-class Method Under SFAS No. 128, Earnings Per
Share. EITF Issue No. 03-06 addresses a number of questions regarding the
computation of earnings per share (EPS) 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. The issue also provides further guidance in
applying the two-class method of calculating EPS. It clarifies what constitutes
a participating security and how to apply the two-class method of computing EPS
once it is determined that a security is participating, including how to
allocate undistributed earnings to such a security. This pronouncement is
effective for fiscal periods beginning after March 31, 2004. The adoption of
this standard did not have an impact on the Companys computation of EPS. In March 2004, the EITF reached a consensus on Issue No. 03-01, The
Meaning of Other-Than-Temporary Impairment and Its Application to Certain
Investments. EITF No. 03-01 provides guidance on recording
other-than-temporary impairments of cost method investments and requires
additional disclosures for those investments. In September 2003, a FASB Staff
Position was issued that delays the recognition and measurement guidance in
EITF No. 03-01 until the final issuance of Financial Accounting
Standards Board (FASB) Staff Position Issue 03-01a.
The adoption of the recognition and measurement provisions is not expected to
have a material impact on the Companys consolidated balance sheet or statement
of operations. The disclosure requirements are effective for fiscal years
ending after June 15, 2004, and are required only for annual periods. In December 2003, the FASB
released a revision to FASB Interpretation No. 46 (FIN 46), Consolidation of
Variable Interest Entities, an Interpretation of ARB No. 51. FIN 46 requires
certain variable interest entities to be consolidated by the primary
beneficiary of the entity if the equity investors in the entity do not have the
characteristics of a 6




---



##### Table of Contents



controlling financial interest or do not have sufficient equity at risk for the
entity to finance its activities without additional subordinated financial
support from other parties. A public entity shall apply the provisions of the
FIN 46 revision no later than the end of the first reporting period that ends
after March 15, 2004. However, a public entity shall apply FIN 46 to entities
considered to be special-purpose entities no later than as of the end of the
first reporting period that ends after December 15, 2003. The adoption of this
standard did not have a material impact on the consolidated balance sheet or
statement of operations. NOTE 2  SEPARATION OF LSI LOGIC STORAGE SYSTEMS, INC. On July 29, 2004, LSI announced jointly with Engenio (Engenio or
Storage Systems segment) the postponement of the initial public offering of
its common stock due to market conditions. During the nine months ended
September 30, 2004, the Company recorded $3.5 million in fees related to the
initial public offering as selling, general and administrative (SG&A)
expenses in the statement of operations. The fees include professional
services that were directly and solely related to the initial public offering
of Engenio common stock. The separation of Engenio from the Company, including the transfer of
related assets, liabilities and intellectual property rights, was substantially
completed in December 2003. At that time, the Company and Engenio entered into
a Master Separation Agreement, General Assignment and Assumption Agreement,
Intellectual Property Agreement, Employee Matters Agreement and an
Indemnification and Insurance Matters Agreement, as more fully described in the
Companys Annual Report on Form 10-K. In March 2004, the Company and Engenio
entered into the following additional agreements that further specify the terms
of the separation. Tax Sharing Agreement.The Tax Sharing Agreement sets forth the principal
arrangements between the Company and Engenio regarding the filing of tax
returns, the payment of taxes and the conduct of tax audits or disputes. The
Tax Sharing Agreement provides that Engenios stand-alone tax liability equals
its taxable income multiplied by the highest corporate tax rate in effect for
the year, modified by taking into account its losses and loss carryovers from
prior years and, to the extent actually used, its credits. Engenio is
obligated to pay the Company the amount of its stand-alone tax liability to the
extent Engenio is included in any consolidated, combined or unitary tax return
with the Company. Under the Tax Sharing Agreement, the Company is required to prepare and
file all consolidated, combined or unitary tax returns of the Company and
Engenio through the date that Engenio ceases to be a member of the Companys
consolidated or combined group, including the final consolidated federal income
tax return. The Company has the right to review and consent to the federal and
state income tax returns filed for the first tax year after Engenio ceases to
be a member of the Companys consolidated group, which may not be withheld
unreasonably. In addition, the Company has sole and complete authority to
control and resolve all tax audits and other disputes relating to any
consolidated, combined or unitary returns filed by the Company. However, the
Company may not enter into any dispute settlement that would materially
increase Engenios liability under the Tax Sharing Agreement without Engenios
consent, which cannot be withheld unreasonably. Transition Services Agreement.The Transition Services Agreement governs
the provisions by the Company to Engenio of services such as finance,
accounting and treasury, human resources, sales support, legal matters and
information technology. Real Estate Matters Agreement.The Real Estate Matters Agreement
describes the manner in which the Company will transfer to or share with
Engenio various properties leased and owned by the Company. The agreement
provides that all reasonable costs required to effect the transfers, including
landlord consent fees and landlord attorneys fees, will be paid by the
Company. Investor Rights Agreement.The Investor Rights Agreement provides for
specified registration and other rights relating to the Companys ownership of
Engenios shares of Class B common stock. NOTE 3  BUSINESS COMBINATIONS Acquisition of Accerant Inc.On May 11, 2004, the Company acquired
Accerant Inc. (Accerant). The acquisition is anticipated to expand consumer
product offerings within the Semiconductor segment. The acquisition was
accounted for as a purchase of a business. 7




---



##### Table of Contents



The Company paid approximately $14.1 million in cash for the acquisition.
The Company will also issue approximately 234,000 restricted common shares to
certain Accerant employees hired as part of the transaction. Resulting
deferred stock compensation will be amortized over a vesting period of two
years using the straight-line method. The total purchase price was allocated to
the estimated fair value of net assets acquired based on management estimates
as follows: (In thousands)Fair value of tangible net assets acquired
    
    $
    31Current technology
    
    
    5,700Non-compete agreements
    
    
    400Goodwill
    
    
    7,972Total purchase price excluding deferred stock compensation
    
    
    14,103Deferred stock compensation
    
    
    1,765Total purchase price
    
    $
    15,868
 The Company may also pay additional cash of up to $4.0 million if certain
revenue targets are achieved over a period ending December 31, 2005. Such
contingent consideration will represent additional purchase price and be
included in goodwill when and if such targets are met. Useful life of intangible assets.The amounts allocated to current
technology and non-compete agreements are being amortized over their estimated
useful lives of 5 and 2 years, respectively using the straight-line method. Acquisition of Velio Communications.On April 2, 2004, the Company
acquired Velio Communications, Inc. (Velio). The acquisition is
anticipated to expand product offerings for high-speed interconnect and switch
fabric application specific standard products (ASSPs) in the global
communications market within the Semiconductor segment. The acquisition was
accounted for as a purchase of a business. The Company paid approximately $19.8 million in cash for the acquisition.
The Company will also issue approximately 100,000 restricted common shares to
certain Velio employees hired as part of the transaction. Resulting deferred
stock compensation will be amortized over a vesting period of two years using
the straight-line method. The total purchase price was allocated to the
estimated fair value of net assets acquired based on management estimates as
follows: (In thousands)Fair value of tangible net assets acquired
    
    $
    1,529Current technology
    
    
    8,788Customer base
    
    
    8,788Non-compete agreements
    
    
    450Existing purchase orders
    
    
    200Total purchase price excluding deferred stock compensation
    
    
    19,755Deferred stock compensation
    
    
    1,000Total purchase price
    
    $
    20,755
 Useful life of intangible assets.The amounts allocated to current
technology, customer base, non-compete agreements and existing purchase orders
are being amortized over their estimated useful lives of 9 months to 5.5 years
using the straight-line method. Pro forma statements of earnings information have not been presented
because the effect of these acquisitions was not material either individually
or on an aggregate basis. NOTE 4  STOCK-BASED COMPENSATION The following table provides pro forma disclosures as if the Company had
recorded compensation costs based on the estimated grant date fair value, as
defined by the Statement of Financial Accounting Standards (SFAS) No. 123,
for awards granted under its stock option and stock purchase plans. The
estimated weighted-average grant date fair value, as defined by SFAS No. 123,
was calculated using the Black-Scholes model. The Black-Scholes model was
developed to estimate the fair value of freely tradable, fully 8




---



##### Table of Contents



transferable options without vesting restrictions, which significantly differ
from the Companys stock option awards. These models also require highly
subjective assumptions, including future stock price volatility and expected
time until exercise, which greatly affect the calculated grant date fair value. Three months ended
    
    Nine months endedSeptember 30,
    
    September 30,2004
    
    2003
    
    2004
    
    2003(In thousands, except per share amounts)Net loss, as reported
    
    $
    (282,432
    )
    
    $
    (31,652
    )
    
    $
    (266,105
    )
    
    $
    (316,161
    )Add: Amortization of
non-cash deferred stock
compensation expense
determined under the
intrinsic value method
as reported in net
loss, net of related
tax effects *
    
    
    749
    
    
    
    1,476
    
    
    
    2,771
    
    
    
    7,605Deduct: Total
stock-based employee
compensation expense
determined under fair
value method for all
awards, net of related
tax effects
    
    
    (27,038
    )
    
    
    (47,959
    )
    
    
    (97,635
    )
    
    
    (156,149
    )Pro forma net loss **
    
    $
    (308,721
    )
    
    $
    (78,135
    )
    
    $
    (360,969
    )
    
    $
    (464,705
    )Net loss per share:Basic -as reported
    
    $
    (0.73
    )
    
    $
    (0.08
    )
    
    $
    (0.69
    )
    
    $
    (0.84
    )Basic -pro forma
    
    $
    (0.80
    )
    
    $
    (0.21
    )
    
    $
    (0.94
    )
    
    $
    (1.23
    )Diluted -as reported
    
    $
    (0.73
    )
    
    $
    (0.08
    )
    
    $
    (0.69
    )
    
    $
    (0.84
    )Diluted -pro forma
    
    $
    (0.80
    )
    
    $
    (0.21
    )
    
    $
    (0.94
    )
    
    $
    (1.23
    )
 * This amount excludes amortization of non-cash deferred stock compensation on
restricted stock awards. ** The amounts for the three and nine months ended September 30, 2003 have been
adjusted to reflect higher calculated fair values for the Employee Stock
Purchase Plan, which resulted in a 3% and 2% increase in the pro forma net loss
in the three months and nine months ended September 30, 2003, respectively. NOTE 5  RESTRUCTURING AND OTHER ITEMS The Company recorded charges of $229 million and $231 million in
restructuring of operations and other items for the three and nine months ended
September 30, 2004, respectively, primarily in the Semiconductor segment. The
Company recorded a charge of $25 million and $185 million in restructuring of
operations and other items for the three and nine months ended September 30,
2003, respectively. For a complete discussion of the 2003 restructuring
actions, please refer to the Companys Annual Report on Form 10-K for fiscal
year 2003. Restructuring and impairment of long-lived assets: First quarter of 2004: The Company recorded a gain of $3.3 million on the sale of fixed assets
that had previously been held for sale and an expense of $1.1 million for the
abandonment of fixed assets that had previously been held for sale. In
addition, an expense of $1.1 million was recorded for the write-down of fixed
assets due to impairment. An expense of $0.3 million was recorded to reflect the change in time
value of accruals for facility lease termination costs, net of adjustments for
changes in sublease assumptions for certain previously accrued facility lease
termination costs. An expense of $0.2 million was recorded primarily for
severance and termination benefits for four employees involved in research and
development. Second quarter of 2004: The Company recorded a gain of $1.0 million on the sale of fixed assets
that had previously been held for sale and an expense of $4.0 million primarily
for the write-down of the Colorado Springs fabrication facility to reflect a
decline in fair market value and to write down certain spare parts for fixed
assets. 9




---



##### Table of Contents



An expense of $0.4 million was recorded to reflect the change in time
value of accruals for facility lease termination costs, net of adjustments for
changes in sublease assumptions for certain previously accrued facility lease
termination costs. Previously accrued contract termination fees of $0.4
million were reversed as the result of more favorable than expected
negotiations to terminate those contracts. Third quarter of 2004: As a result of the decline in revenues in the semiconductor industry and a
corresponding decline in the Companys outlook as of the latter part of the
third quarter of 2004, the Company initiated a comprehensive restructuring
program, which included asset impairments, a global reduction in workforce and
the consolidation of certain facilities as described further below. The Company concluded in accordance with SFAS No. 144, Accounting for the
Impairment or Disposal of Long-Lived Assets, that the Gresham manufacturing
facility assets were impaired. Accordingly, an asset write-down of $205.5
million was recorded in the semiconductor segment during the third quarter of
2004 and the Company estimates an additional write-down of approximately $177
million will be recorded in the fourth quarter of 2004. The fair value of
impaired equipment and facilities were estimated by management. The charge in
the fourth quarter will reflect the impairment of the equipment that will be
purchased in connection with the termination of the operating leases as
described in Note 14. The impairment charges will be non-cash charges. The
fourth quarter cash flows will reflect the buyout of the leases, net of the
return of the cash collateral associated with the leases for a net
outflow of $21 million. The Company announced workforce reductions for approximately 558 positions
worldwide across all job functions and recorded a charge of $14.6 million in
the Semiconductor segment for severance and termination benefits. The Company recorded a gain of $1.9 million on the sale of fixed assets
that had previously been held for sale and an expense of $3.4 million for the
write-down of the Colorado Springs fabrication facility to reflect a decline in
fair market value, the impairment of certain acquired intangible assets in the
Semiconductor segment and the write-down of leasehold improvements related to
the facility operating leases discussed below. In the third quarter of 2004, the Company consolidated additional
non-manufacturing facilities and recorded $6.1 million for costs associated
with exiting certain operating leases for real estate as the facilities ceased
being used. An expense of $0.4 million was recorded to reflect the change in
time value of prior accruals for facility lease termination costs. In
addition, an expense of $1.8 million was recorded for changes in sublease
assumptions for certain previously accrued facility lease termination costs. Assets held for sale of $24 million and $30 million were included as a
component of prepaid expenses and other current assets as of September 30, 2004
and December 31, 2003, respectively. Assets classified as held for sale are
not depreciated. The fair values of impaired equipment and facilities were
estimated by management. Given that current market conditions for the sale of
older fabrication facilities and related equipment may fluctuate, there can be
no assurance that the Company will realize the current net carrying value of
the assets held for sale. The Company reassesses the realizability of the
carrying value of these assets at the end of each quarter until the assets are
sold or otherwise disposed of and additional adjustments may be necessary. The following table sets forth the Companys restructuring reserves as of
September 30, 2004, which are included in other accrued liabilities on the
balance sheet: Restructur
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    RestructurBalance at
    
    ing
    
    Utilized
    
    Restructuring
    
    Release of
    
    Utilized
    
    ing
    
    Utilized
    
    Balance atDecember 31,
    
    Expense
    
    during Q1
    
    Expense
    
    reserves
    
    during Q2
    
    Expense
    
    during Q3
    
    September 30,2003
    
    Q1 2004
    
    2004
    
    Q2 2004
    
    Q2 2004
    
    2004
    
    Q3 2004
    
    2004
    
    2004(In thousands)Write-down of
excess assets (a)
    
    $
    2,661
    
    
    $
    (1,118
    )
    
    $
    718
    
    
    $
    3,203
    
    
    $
    (160
    )
    
    $
    (3,414
    )
    
    $
    207,035
    
    
    $
    (207,324
    )
    
    $
    1,601Lease terminations
and maintenance
contracts (b)
    
    
    21,021
    
    
    
    252
    
    
    
    (1,886
    )
    
    
    379
    
    
    
    (375
    )
    
    
    (2,312
    )
    
    
    8,336
    
    
    
    (2,214
    )
    
    
    23,201Facility closure
and other exit
costs (c)
    
    
    2,136
    
    
    
    64
    
    
    
    (782
    )
    
    
    
    
    
    
    
    
    
    
    (369
    )
    
    
    
    
    
    
    (234
    )
    
    
    815Payments to
employees for
severance (d)
    
    
    874
    
    
    
    204
    
    
    
    (767
    )
    
    
    
    
    
    
    (18
    )
    
    
    (227
    )
    
    
    14,573
    
    
    
    (838
    )
    
    
    13,801Total
    
    $
    26,692
    
    
    $
    (598
    )
    
    $
    (2,717
    )
    
    $
    3,582
    
    
    $
    (553
    )
    
    $
    (6,322
    )
    
    $
    229,944
    
    
    $
    (210,610
    )
    
    $
    39,418
 10




---



##### Table of Contents



(a)
    
    The amounts utilized in 2004 reflect $215.4 million of non-cash
write-downs of long-lived assets in the U.S. due to impairment and $0.8
million in cash payments to decommission and sell assets, offset by a $6.2
million realized gain on the sale of fixed assets previously held for
sale. The write-downs of long-lived assets were accounted for as a
reduction of the assets and did not result in a liability. The $1.6
million balance as of September 30, 2004, relates to machinery and
equipment decommissioning costs in the U.S. and estimates of selling costs
for assets held for sale and is expected to be utilized during the first
half of 2005.(b)
    
    Amounts utilized represent cash payments. The balance remaining for
primarily real estate lease terminations and maintenance contracts will be
paid during the remaining terms of these contracts, which extend through
2011.(c)
    
    Amounts utilized represent cash payments. The balance remaining for
facility closure and other exit costs will be paid during the first half
of 2005.(d)
    
    Amounts utilized represent cash severance payments to 68 employees during
the nine months ended September 30, 2004. The balance remaining for
severance is expected to be paid by the end of 2005.Other Items During the second quarter of 2004, the Company reclassified a parcel of
land in Colorado with a book value of $1.4 million from a long-term asset to a
current asset held for sale. The land is part of total assets in the
Semiconductor segment. The Company expects to sell the property within the
next 12 months for an amount not less than book value. During the third quarter of 2004, the Company reclassified a parcel of
land in Japan with a book value of $1.4 million from a long-term asset to a
current asset held for sale. The land is part of the total assets in the
Semiconductor segment. The Company expects to sell the property within the
next 12 months for an amount not less than book value. During the third quarter of 2004, the Company entered into two new lease
agreements for wafer fabrication equipment (see Note 14). The equipment was
previously on lease immediately prior to the closing of the new lease
agreements. The Company had capitalized and was amortizing fees related to the
previous lease agreements. Upon entering into the new lease agreements, $2.5
million in remaining unamortized fees for the previous leases were recorded as
an expense in the statement of operations. During the third quarter of 2004, the Company discontinued hedge
accounting treatment on the interest rate swap related to the equipment
operating leases that were refinanced and recorded the $3.8 million balance in
accumulated comprehensive income as a gain in the statement of operations (see
Notes 7 and 14). NOTE 6 INVESTMENTS September 30,
    
    December 31,2004
    
    2003(In thousands)Available-for-sale debt securitiesAsset and mortgage-backed securities
    
    $
    300,187
    
    
    $
    345,625U.S. government and agency securities
    
    
    235,843
    
    
    
    104,173Corporate and municipal debt securities
    
    
    70,187
    
    
    
    90,730Auction rate preferred stock
    
    
    
    
    
    
    3,150Foreign debt securities
    
    
    
    
    
    
    329Total short-term investments
    
    $
    606,217
    
    
    $
    544,007Long-term investment in equity securities
    
    $
    16,847
    
    
    $
    35,455
 An
unrealized loss on available-for-sale securities of $0.9 million, net
of the related tax effect of $0.5 million, and an unrealized gain of $8
million, net of the related tax effect of $4 million, was included in
accumulated other comprehensive income as of September 30, 2004 and December
31, 2003, respectively. Net realized gains on sales of available-for-sale debt
securities were $0.5 million and $1.1 million for the three and nine months
ended September 30, 2004, respectively. Net realized gains on sales of 11




---



##### Table of Contents



available-for-sale debt securities were $0.1 million and $9 million for
the three and nine months ended September 30, 2003, respectively. The Company realized pre-tax gains of $8 million related to the following
for the nine months ended September 30, 2004:  
    
    A $5 million pre-tax gain related to the sales of certain marketable
available-for-sale equity securities in the second quarter of 2004; and
    
    A $3 million pre-tax gain associated with marketable available-for-sale
equity securities of a certain technology company that was acquired by
another technology company in the first quarter of 2004. The following table includes the details of pre-tax losses related to
investments in equity securities that the Company has recorded during the nine
months ended September 30, 2004 and 2003. Management believed that the
declines in value were other than temporary. Non-marketable
    
    Marketable equityequity investments
    
    investments(in millions)Pre-tax loss:Three months ended September 30, 2004
    
    $
    1.9
    
    
    $
    4.1Nine months ended September 30, 2004
    
    
    3.1
    
    
    
    4.1Pre-tax loss:Three months ended September 30, 2003
    
    $
    0.5
    
    
    $
    Nine months ended September 30, 2003
    
    
    7.8
    
    
    
    2.7Total carrying value of impaired investments as of
September 30, 2004
    
    $
    5.0
    
    
    $
    2.0
 NOTE 7  DERIVATIVE FINANCIAL INSTRUMENTS Foreign currency risk The Company enters into forward contracts that are designated as foreign
currency cash-flow hedges of forecasted payments in Euros. Changes in the fair
value of the forward contracts due to changes in time value are excluded from
the assessment of effectiveness and are recognized in interest income and
other, net. As of September 30, 2004 and December 31, 2003, the Company held
forward contracts designated as foreign currency cash flow hedges of forecasted
Euro payment transactions that were set to expire over three-month and
twelve-month periods, respectively. For the three and nine months ended
September 30, 2004 and 2003, the change in time value of these forward
contracts was not significant. As of September 30, 2004, unrealized losses
included in accumulated other comprehensive income, which will be recorded in
the income statement over the next three months, were not significant. There
were no unrealized gains or losses included in accumulated other comprehensive
income as of December 31, 2003. The expense for the three and nine months ended
September 30, 2004 and the benefit for three and nine months ended September
30, 2003 recorded in the income statement was not significant. The Company did
not record any gains or losses due to hedge ineffectiveness for the three and
nine months ended September 30, 2004 and 2003. Forward exchange contracts and options are also used to hedge certain
foreign currency-denominated assets or liabilities. These derivatives do not
qualify for SFAS No. 133 hedge accounting treatment. Accordingly, changes in
the fair value of these hedges are recorded immediately in earnings to offset
the changes in fair value of the assets or liabilities being hedged. The
related gains and losses included in interest income and other, net were not
significant. Interest rate risk With the objective of protecting cash flows and earnings of the Company
from the impact of fluctuations in interest rates, while minimizing the cost of
capital, the Company may enter into or terminate interest rate swaps, such as
the below mentioned transactions. 12




---



##### Table of Contents



In the second quarter of 2003, the Company entered into an interest rate
swap transaction to effectively convert the LIBOR-based floating rate interest
payments on the equipment operating leases discussed in Note 14, with an
initial notional amount of $395 million, to a fixed interest rate (the Lease
Swap). The Lease Swap qualified to be accounted for as a cash flow hedge of
the forecasted interest payments attributable to the benchmark interest rate on
the equipment operating leases through September 2006. In August 2004, the
Company entered into two new equipment operating leases for the wafer
fabrication equipment that was previously on the above-mentioned leases. As a
result of entering into the new leases, the hedged forecasted interest payments
are no longer probable to occur. Hedge accounting treatment was discontinued
prospectively and the balance in accumulated other comprehensive income was
immediately recorded as a gain of $3.8 million in restructuring and other items
in the statement of operations. In September 2004, the Company terminated the
Lease Swap. As of September 30, 2004, $12 million was recorded in other
current assets for the amount to be received from the termination and the
collateral that will be returned to the Company. NOTE 8  BALANCE SHEET DETAIL September 30,
    
    December 31,2004
    
    2003(In thousands)Cash and cash equivalents:Cash in financial institutions
    
    $
    38,070
    
    
    $
    108,989Cash equivalents
    
    
    164,557
    
    
    
    160,693$
    202,627
    
    
    $
    269,682Inventories:Raw materials
    
    $
    21,495
    
    
    $
    15,352Work-in-process
    
    
    145,056
    
    
    
    116,340Finished goods
    
    
    77,721
    
    
    
    66,825$
    244,272
    
    
    $
    198,517Intangible assets, net of accumulated amortization:Semiconductor segment
    
    $
    116,450
    
    
    $
    137,230Storage Systems segment
    
    
    14,874
    
    
    
    24,006$
    131,324
    
    
    $
    161,236
 The changes in the carrying amount of goodwill for the nine months ended
September 30, 2004 are as follows (in thousands): Semiconductor
    
    Storage Systemssegment
    
    segment
    
    TotalBalance as of January 1, 2004
    
    $
    887,992
    
    
    $
    80,491
    
    
    $
    968,483Goodwill acquired during the year
    
    
    8,045
    
    
    
    
    
    
    
    8,045Adjustment to goodwill acquired in a
prior year for the resolution of
a pre-acquisition income tax
contingency
    
    
    (4,463
    )
    
    
    
    
    
    
    (4,463
    )Adjustment to goodwill acquired in
prior periods
    
    
    
    
    
    
    142
    
    
    
    142Purchase of minority interest
    
    
    853
    
    
    
    
    
    
    
    853Balance as of September 30, 2004
    
    $
    892,427
    
    
    $
    80,633
    
    
    $
    973,060
 The Company monitors the recoverability of goodwill recorded in connection
with acquisitions annually, or sooner if events or changes in circumstances
indicate that the carrying amount may not be recoverable. An impairment, if
any, would be determined in accordance with SFAS No. 142, which uses a fair
value model for determining the carrying value of goodwill. As a result of the
decline in revenues in the semiconductor industry and the corresponding decline
in the Companys outlook as of the latter part of the third quarter of 2004 and
the conclusion that the Gresham manufacturing facility was impaired (see Note
5), the Company reviewed goodwill by reporting unit for impairment as of
September 30, 2004. The Companys reporting units are Semiconductor and
Storage 13




---



##### Table of Contents



Systems or Engenio. The impairment testing is a two-step process. The first
step requires comparing the fair value of each reporting unit to its net book
value. The Company uses management estimates of future cash flows to perform
the first step of the goodwill impairment test. These estimates include
assumptions about future conditions such as future revenues, gross margins and
operating expenses. Two methodologies were used to obtain the fair value for
each reporting unit as of September 30, 2004: Discounted Cash Flow and Market
Multiple. The Company concluded that goodwill was not impaired under the first
step as of September 30, 2004. The second step is only performed if impairment
exists, as it involves measuring the actual impairment to goodwill. NOTE 9  DEBT Interest
    
    Conversion
    
    September 30,
    
    December 31,Maturity
    
    Rate *
    
    Price
    
    2004
    
    2003(In thousands)2003 Convertible Subordinated Notes
    
    
    2010
    
    
    
    4
    %
    
    $
    13.4200
    
    
    $
    350,000
    
    
    $
    350,0002001 Convertible Subordinated Notes
    
    
    2006
    
    
    
    4
    %
    
    $
    26.3390
    
    
    
    421,500
    
    
    
    490,000Deferred gain on terminated swaps
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    12,725
    
    
    
    25,416Capital lease obligations
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    270
    
    
    
    567784,495
    
    
    
    865,983Current portion of long-term debt
and capital lease obligations
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (270
    )
    
    
    (377
    )Long-term debt and capital lease obligations
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    784,225
    
    
    $
    865,606
 * The interest rate on a portion of the Convertible Subordinated Notes
(Convertible Notes) was converted to floating rates through interest rate
swaps. Interest rate swaps with a notional amount of $740 million were
terminated in the second quarter of 2003. The weighted average interest rate
on the Convertible Subordinated Notes, after adjusting for the impact of the
interest rate swaps, for the three months ended September 30, 2004 and 2003,
was 4.00% and 4.02%, respectively, and 4.00% and 3.03% for the nine months
ended September 30, 2004 and 2003, respectively. During the three months ended September 30, 2004, the Company repurchased
approximately $69 million of the 2001 Convertible Subordinated Notes (the 2001
Convertible Notes). A net pre-tax gain of approximately $2 million was
recognized, in interest income and other, net, on the repurchases of the 2001
Convertible Notes. The pre-tax gain is net of the write-off of debt issuance
costs and a portion of the deferred gain on the related terminated interest
rate swap. NOTE 10  COMMON STOCK Stock purchase plans.In May 2004, the stockholders approved an increase
in the number of shares of common stock reserved for issuance under the
Companys Employee Stock Purchase Plan by 10 million shares. As of September
30, 2004, there were approximately 19 million shares of common stock reserved
for issuance under the Employee Stock Purchase Plan. 14




---



##### Table of Contents



NOTE 11  RECONCILIATION OF BASIC AND DILUTED LOSS PER SHARE A reconciliation of the numerators and denominators of the basic and
diluted loss per share computations are as follows: Three Months Ended September 30,2004
    
    2003Per-
    
    
    
    
    
    
    
    
    
    Per-Share
    
    
    
    
    
    
    
    
    
    ShareLoss*
    
    Shares+
    
    Amount
    
    Loss*
    
    Shares+
    
    Amount(In thousands except per share amounts)Basic EPS:Net loss available to common stockholders
    
    $
    (282,432
    )
    
    
    384,876
    
    
    $
    (0.73
    )
    
    $
    (31,652
    )
    
    
    378,749
    
    
    $
    (0.08
    )Effect of dilutive securities:
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Diluted EPS:Net loss available to common stockholders
    
    $
    (282,432
    )
    
    
    384,876
    
    
    $
    (0.73
    )
    
    $
    (31,652
    )
    
    
    378,749
    
    
    $
    (0.08
    )
 Nine Months Ended September 30,2004
    
    2003Per-
    
    
    
    
    
    
    
    
    
    
    
    
    
    Per-Share
    
    
    
    
    
    
    
    
    
    
    
    
    
    ShareLoss*
    
    Shares+
    
    Amount
    
    Loss*
    
    
    
    
    
    Shares+
    
    Amount(In thousands except per share amounts)Basic EPS:Net loss available to common stockholders
    
    $
    (266,105
    )
    
    
    383,355
    
    
    $
    (0.69
    )
    
    $
    (316,161
    )
    
    
    
    
    
    
    376,931
    
    
    $
    (0.84
    )Effect of dilutive securities:
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Diluted EPS:Net loss available to common stockholders
    
    $
    (266,105
    )
    
    
    383,355
    
    
    $
    (0.69
    )
    
    $
    (316,161
    )
    
    
    
    
    
    
    376,931
    
    
    $
    (0.84
    )
 * Numerator + Denominator Options to purchase 70,078,980 shares and 68,664,265 shares were
outstanding at September 30, 2004 and 2003, respectively, and were excluded
from the computation of diluted shares because of their antidilutive effect on
loss per share for the three and nine months then ended. The exercise price of
these options ranged from $0.06 to $72.25 at September 30, 2004 and 2003. For the three months and nine months ended September 30, 2004, weighted
average potentially dilutive common shares of 43,413,634 and 44,266,694,
respectively, associated with the 2003 and 2001 Convertible Notes were excluded
from the calculation of diluted shares because of their antidilutive effect on
net loss per share. For the three and nine months ended September 30, 2003
weighted average potentially dilutive common shares of 57,882,950 and
52,527,478, respectively, associated with the 2003, 2001, 2000 and 1999
Convertible Notes were excluded from the calculation of diluted shares because
of their antidilutive effect on loss per share. NOTE 12  COMPREHENSIVE LOSS Comprehensive loss is defined as a change in equity of a company during a
period from transactions and other events and circumstances, excluding
transactions resulting from investments by owners and distributions to owners.
Comprehensive loss, net of taxes for the current reporting period and
comparable period in the prior year is as follows: Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,2004
    
    2003
    
    2004
    
    2003(In thousands)Net loss
    
    $
    (282,432
    )
    
    $
    (31,652
    )
    
    $
    (266,105
    )
    
    $
    (316,161
    )Change in unrealized gain/loss on derivative
instruments designated as and qualifying as
cash-flow hedges
    
    
    (3,473
    )
    
    
    1,059
    
    
    
    (2,003
    )
    
    
    1,523Change in unrealized gain on available for sale
securities
    
    
    2,687
    
    
    
    2,735
    
    
    
    (8,725
    )
    
    
    4,446Change in foreign currency translation adjustments
    
    
    (1,109
    )
    
    
    10,643
    
    
    
    (5,597
    )
    
    
    19,057Comprehensive loss
    
    $
    (284,327
    )
    
    $
    (17,215
    )
    
    $
    (282,430
    )
    
    $
    (291,135
    )
 15




---



##### Table of Contents



NOTE 13  SEGMENT REPORTING The Company operates in two reportable segments: the Semiconductor segment
and the Storage Systems segment. The Storage Systems segment may also be
referred to as Engenio. In the Semiconductor segment, the Company uses advanced
process technology and comprehensive design methodologies to design, develop,
manufacture and market highly complex integrated circuits. These
system-on-a-chip solutions include application specific integrated circuits,
commonly referred to as ASICs, RapidChip® Platform ASICs and application
specific standard products in silicon, or ASSPs. Semiconductor segment product
offerings also include RAID host bus adapters and related products and
services. In the Storage Systems segment, the Company provides modular,
high-performance, disk storage systems and sub-assemblies to server and storage
original equipment manufacturers. Products of the Storage Systems segment are
sold as complete storage systems or sub-assemblies configured from modular
components, including storage controller modules, disk drive enclosure modules
and related management software. The following is a summary of operations by segment for the three and nine
months ended September 30, 2004 and 2003: Three months ended
    
    Nine months endedSeptember 30,
    
    September 30,2004
    
    2003
    
    2004
    
    2003(In thousands)Revenues:Semiconductor
    
    $
    283,542
    
    
    $
    346,447
    
    
    $
    956,066
    
    
    $
    925,661Storage Systems
    
    
    96,675
    
    
    
    103,780
    
    
    
    324,405
    
    
    
    304,564Total
    
    $
    380,217
    
    
    $
    450,227
    
    
    $
    1,280,471
    
    
    $
    1,230,225(Loss)/ income from operations:Semiconductor
    
    $
    (265,102
    )
    
    $
    (33,835
    )
    
    $
    (259,936
    )
    
    $
    (302,261
    )Storage Systems
    
    
    (5,122
    )
    
    
    10,187
    
    
    
    12,074
    
    
    
    12,110Total
    
    $
    (270,224
    )
    
    $
    (23,648
    )
    
    $
    (247,862
    )
    
    $
    (290,151
    )
 Intersegment revenues for the periods presented above were not
significant. For the three and nine months ended September 30, 2004,
restructuring of operations and other items, net of $229 million and $231
million, respectively, were primarily included in the Semiconductor segment.
For the three months ended September 30, 2003, charges of $25 million for
restructuring of operations and other items, net primarily impacted the
Semiconductor segment. For the nine months ended September 30, 2003,
restructuring of operations and other items, net of $170 million and $15
million were included in the Semiconductor segment and the Storage Systems
segment, respectively. Significant Customers.The following table summarizes the number of our
significant customers, each of whom accounted for 10% or more of our revenues,
along with the percentage of revenues they individually represent on a
consolidated basis and by segment: Three months ended September 30,
    
    Nine months ended September 30,2004
    
    2003
    
    2004
    
    2003Semiconductor segment:Number of significant customers
    
    
    2
    
    
    
    1
    
    
    
    
    
    
    
    1Percentage of segment revenues
    
    
    12%, 11
    %
    
    
    27
    %
    
    
    
    
    
    
    18
    %Storage Systems segment:Number of significant customers
    
    
    3
    
    
    
    3
    
    
    
    3
    
    
    
    3Percentage of segment revenues
    
    
    54%, 15%, 12
    %
    
    
    58%, 12%, 11
    %
    
    
    53%, 14%, 11
    %
    
    
    50%, 14%, 12
    %Consolidated:Number of significant customers
    
    
    1
    
    
    
    2
    
    
    
    1
    
    
    
    2Percentage of consolidated revenues
    
    
    15
    %
    
    
    21%, 15
    %
    
    
    15
    %
    
    
    14%, 14
    %
 16




---



##### Table of Contents



The following is a summary of total assets by segment as of September 30,
2004 and December 31, 2003: September 30,
    
    December 31,2004
    
    2003(In thousands)Total assets:Semiconductor
    
    $
    2,821,671
    
    
    $
    3,115,610Storage Systems
    
    
    336,012
    
    
    
    332,291Total
    
    $
    3,157,683
    
    
    $
    3,447,901
 Revenues from domestic operations were $194 million, representing 51% of
consolidated revenues for the third quarter of 2004 compared to $209 million,
representing 46% of consolidated revenues for the same period of 2003. Revenues from domestic operations were $682 million, representing 53% of
consolidated revenues, for the first nine months of 2004 compared to $633
million, representing 51% of consolidated revenues, for the same period of
2003. NOTE 14 COMMITMENTS AND CONTINGENCIES On March 28, 2003, the Company entered into two lease and security
agreements, each with Bank of America, National Association (BANA), acting as
the Lessor, and Wells Fargo Bank Northwest, as the Agent, for a total of $395
million for certain wafer fabrication equipment (the Equipment). The leases
qualify for operating lease accounting treatment. Each lease has a term of 3.5
years with no option for renewal. The Company may, at the end of the lease
term, return or purchase, at a pre-determined amount, all of the Equipment.
The first lease was for $235 million and was for equipment that was previously
on lease immediately prior to closing this transaction. In October 2003, BANA,
with the Companys approval, assigned its rights as Lessor on the first lease
to Bank of the West. The second lease was for $160 million and was for
Equipment that was sold to BANA and then immediately leased back in a
transaction commonly referred to as a sale-leaseback. The Equipment sold had a
book value of approximately $103 million. These two leases were terminated on
August 6, 2004. On August 6, 2004, the Company entered into two lease and security
agreements, each with Wells Fargo Bank Northwest, acting as the Agent. One
lease for $134 million is with Bank of the West acting as the Lessor, and the
second lease for $201 million is with BTM Capital Corporation acting as the
Lessor. As of September 30, 2004, the amount under both leases was fully
drawn. The leases are for wafer fabrication equipment (the Equipment) that
was previously on the above-mentioned lease immediately prior to closing this
transaction. The new leases qualify for operating lease accounting treatment.
Each lease has a term of 3 years. The Company may, at the end of the lease
term, return or purchase, at a pre-determined amount, all of the Equipment.
The Company has $311 million in cash that is posted as collateral for the
leases as of September 30, 2004. The lessor has access to the Companys cash
collateral only in the event of a default. Of this cash collateral, $50
million, representing the amount of cash collateral to be released in the next
12 months, is reflected in other current assets and the remaining cash
collateral of $261 million is recorded in other non-current assets. The Company
is required to maintain unrestricted cash and short-term investments reserves
in an amount no less than the higher of a) the sum of $100 million plus the
principal amount of the Companys 2001 Convertible Subordinated Notes due in
2006 or b) $350 million. The Company was in compliance with this requirement
as of September 30, 2004. The $56 million gain on the sale of the Equipment on
the former lease will be deferred until the end of the new lease term and has
been recorded as a non-current liability as of September 30, 2004. No officer
or employee of the Company has any financial interest in these leasing
arrangements. The Company guarantees residual values related to the leased equipment.
As of September 30, 2004, the Companys maximum potential exposure to residual
value guarantees was approximately $141 million. The Company concluded that
exposure related to residual value guarantees existed in connection with the
conclusion that the Gresham manufacturing facility was impaired as discussed in
Note 5. The fair value of the guarantee of the residual value of the equipment
was determined using management estimates and was recorded as a non-current
asset and liability each in the amount of $6 million as of September 30, 2004. 17




---



##### Table of Contents



On October 27, 2004, the Company notified the required parties of its
intention to exercise its early buyout right to purchase all of the Equipment
under the two lease and security agreements discussed above, dated August 6,
2004. The date on which the purchase is to occur under each lease is November
29, 2004. The early termination or buyout amount is a total of $332 million
for both leases. Termination fees under the lease agreements are not
considered to be material. The Company expects to record an impairment charge
of approximately $177 million in the fourth quarter of 2004 in connection with
the termination of the operating leases. The impairment charges will be
non-cash charges. The fourth quarter cash flows will reflect the buyout of
both leases, net of the return of collateral associated with the leases for a
net outflow of $21 million. The Company leases the majority of its facilities under non-cancelable
operating leases, which expire through 2014. The facility lease agreements
typically provide for base rental rates that are increased at various times
during the terms of the lease and for renewal options at the fair market rental
value. During the nine months ended September 30, 2004, the Company
renegotiated the existing lease agreements for six buildings located in
California and established one new lease in California and one new lease in
India. The future minimum payments for these new and renegotiated building
leases will be $1 million, $5 million, $6 million, $6 million, $6 million and
$24 million for the years ending December 31, 2004, 2005, 2006, 2007, 2008 and
thereafter, respectively. The Company is a party to a variety of agreements pursuant to which it may
be obligated to indemnify the other party with respect to certain matters.
Typically, these obligations arise in connection with contracts and license
agreements or the sale of assets, under which the Company customarily agrees to
hold the other party harmless against losses arising from a breach of
warranties, representations and covenants related to such matters as title to
assets sold, validity of certain intellectual property rights, non-infringement
of third-party rights, and certain income tax related matters. In each of
these circumstances, payment by the Company is typically subject to the other
party making a claim to and cooperating with the Company pursuant to the
procedures specified in the particular contract. This usually allows the
Company to challenge the other partys claims or, in case of breach of
intellectual property representations or covenants, to control the defense or
settlement of any third-party claims brought against the other party. Further,
the Companys obligations under these agreements may be limited in terms of
activity (typically to replace or correct the products or terminate agreement
with a refund to the other party), duration and/or amounts. In some instances,
the Company may have recourse against third parties and/or insurance covering
certain payments made by the Company. NOTE 15  LEGAL MATTERS In February 1999, a lawsuit alleging patent infringement was filed in the
United States District Court for the District of Arizona by the Lemelson
Medical, Education & Research Foundation, Limited Partnership (Lemelson)
against 88 electronics industry companies, including us. The case number is
CIV990377PHXRGS. The patents involved in this lawsuit are alleged to relate to
semiconductor manufacturing and computer imaging, including the use of bar
coding for automatic identification of articles. The plaintiff has sought a
judgment of infringement, an injunction, treble damages, attorneys fees and
further relief as the court may provide. In September 1999, the Company filed
an answer denying infringement and raising affirmative defenses. In addition,
the Company asserted a counterclaim for declaratory judgment of
non-infringement, invalidity and unenforceability of Lemelsons patents. As of
September 30, 2004, a claim construction hearing has been set to be held in
November 2004, but no trial date has been set. While the Company cannot make
any assurance regarding the eventual resolution of this matter, the Company
does not believe it will have a material adverse effect on the consolidated
results of operations or financial condition. On May 4, 2001, Ning Frank Hui caused a lawsuit to be filed against
C-Cube Microsystems Inc. in the Superior Court of California for the County of
Santa Clara. Hui caused the lawsuit to be filed on his behalf and on behalf of
all others similarly situated, approximately 600 employees of C-Cube
Microsystems who were employed by C-Cube Microsystems in May 2000 at the time
of the acquisition of certain C-Cube Microsystems assets by Harmonic, Inc.
Subsequent to the filing of the lawsuit, the Superior Court granted Huis
motion for class certification. In the Complaint, Hui alleges that C-Cube
Microsystems management improperly reduced the conversion factor for unvested
employee stock options when such options were converted at the time of the
Harmonic transaction. The Company denies these allegations. While the Company
cannot make any assurance regarding the eventual resolution of this matter, the
Company does not believe it will have a material adverse effect on the
consolidated results of operations or financial condition. The Company is a party to other litigation matters and claims that are
normal in the course of its operations, and while the results of such
litigation and claims cannot be predicted with certainty, the Company believes
that the final outcome of such matters is not expected to have a material
adverse effect on the Companys consolidated results of operations and
financial condition. 18




---



##### Table of Contents



NOTE 16  SUBSEQUENT EVENTS See Note 14 of the Notes for a discussion on the termination of the
operating leases for Gresham manufacturing equipment on October 27, 2004. 
 Item 2. Managements Discussion and Analysis of Financial Condition and Results
of Operations This Form 10-Q contains forward-looking statements. In many cases you can
identify forward-looking statements by terminology such as may, will,
should, expect, plan, anticipate, believe, estimate, predict,
potential, intend or continue, or the negative of such terms and other
comparable terminology. In addition,
forward-looking statements in this document include, but are not limited to,
the following: projected revenues in the fourth quarter of 2004, projections
of gross profit margins in the fourth quarter of 2004, projected savings as a result of restructuring actions and projected capital expenditures in
2004. We assume no obligation to update any such forward-looking statements, and
these statements involve risks and uncertainties that could cause actual
results to differ materially from those in the forward-looking statements. For
a summary of such risks and uncertainties, please see the paragraphs located at
the end of this Item 2 entitled Factors that May Affect Future Operating
Results and please also see the risk factors located in the Form 10-K for our
fiscal year ended December 31, 2003. OVERVIEW Revenues for the three months ended September 30, 2004 were $380 million
representing a 16% decrease compared to the same period of 2003 and a 15%
decrease from the three months ended June 30, 2004. The decline in revenues
reflects customer end-demand reassessments and the ongoing semiconductor
industry-wide effort to decrease excess supply chain inventory. As a result of
the decline in revenues in the semiconductor industry and a corresponding
decline in our outlook as of the latter part of the third quarter of
2004, we initiated a comprehensive restructuring program, which included a
reduction in global workforce, asset impairment charges that were mainly for
the impairment of our Gresham manufacturing facility and the consolidation of
certain non-manufacturing facilities. See Note 5 of the Notes for a more
complete description of the actions and related charges. Cash, cash equivalents and short-term investments were $809 million as of
September 30, 2004. We generated positive operating cash flows for the tenth
consecutive quarter. We repurchased approximately $69 million in principal of
the 2001 Convertible Notes during the quarter, recognizing a slight gain. See
Note 9 of the Notes. Customer interest in our RapidChip Platform ASIC accelerated in the third
quarter of 2004 with a corresponding increase in our design-win rate. This
heightened level of sales activity is expected to continue into the fourth
quarter of 2004. We expect revenues to be in the $360 million to $390 million range in the
fourth quarter of 2004. Separation of our Storage Systems business.On July 29, 2004, we announced
jointly with Engenio Information Technologies, Inc. (Engenio or Storage
Systems segment) the postponement of the initial public offering of its common
stock due to market conditions. Significant acquisitions.We are continually exploring strategic
acquisitions that build upon our existing library of intellectual property,
human capital and engineering talent, and increase our leadership position in
the markets in which we operate. We acquired Velio Communications, Inc.
(Velio) during the first quarter of 2004 and Accerant Inc. (Accerant)
during the second quarter of 2004. Both were accounted for as purchases of
businesses and, accordingly, the estimated fair value of assets acquired and
liabilities assumed and the results of operations were included in our
Consolidated Financial Statements as of the effective date of the acquisitions.
The transactions are summarized in the table below. There were no significant
differences between our accounting policies and those of the companies
acquired. (See Note 3 of the Notes.) 19




---



##### Table of Contents



Fair Value ofEntity Name;
    
    
    
    
    
    
    
    
    
    
    
    
    
    Tangible NetSegment Included in;
    
    
    
    
    
    Total
    
    
    
    
    
    Assets/
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    DeferredDescription of Acquired
    
    
    
    
    
    Purchase
    

    Type of
    
    (Liabilities)
    
    
    
    
    Amortizable
    
    
    
    
    
    StockBusiness
    
    Acquisition Date
    
    Price
    
    Consideration
    
    Acquired
    
    Goodwill
    
    Intangible Assets
    
    
    IPR&D
    

    Compensation(in millions)Accerant Inc.;
Semiconductor segment;
    
    
    
    
    
    
    
    
    
    $14.1 cash; and 0.2Consumer product
    
    
    
    
    
    
    
    
    
    million restrictedapplications
    
    May 11, 2004
    
    $
    15.9
    
    
    common shares
    
    
    
    
    
    
    
    
    
    $
    8.0
    
    
    $
    6.1
    
    
    
    
    
    
    
    $
    1.8Velio Communications, Inc;
Semiconductor segment;
High-speed interconnect
    
    
    
    
    
    
    
    
    
    $19.8 cash; andand switch fabric
    
    
    
    
    
    
    
    
    
    0.1 millionapplication specific
    
    
    
    
    
    
    
    
    
    restricted commonstandard products
    
    April 2, 2004
    
    $
    20.8
    
    
    shares
    
    
    
    $
    1.5
    
    
    
    
    
    
    
    
    $
    18.3
    
    
    
    
    
    
    
    $
    1.0
 Where more than one significant factor contributed to changes in results
from year to year, we have quantified such factors throughout the Managements
Discussion & Analysis, where practicable. RESULTS OF OPERATIONS Revenues: Three months ended
    
    Nine months endedSept. 30, 2004
    
    June 30, 2004
    
    Sept. 30, 2003
    
    Sept. 30, 2004
    
    Sept. 30, 2003(in millions)Semiconductor segment
    
    $
    283.5
    
    
    $
    335.6
    
    
    $
    346.4
    
    
    $
    956.1
    
    
    $
    925.6Storage Systems segment
    
    
    96.7
    
    
    
    112.3
    
    
    
    103.8
    
    
    
    324.4
    
    
    
    304.6Consolidated
    
    $
    380.2
    
    
    $
    447.9
    
    
    $
    450.2
    
    
    $
    1,280.5
    
    
    $
    1,230.2
 There were no significant intersegment revenues during the periods presented. Third quarter of 2004 compared to the second quarter of 2004 Total consolidated revenues for the third quarter of 2004 decreased $67.7
million or 15% from the second quarter of 2004. Revenues for the Semiconductor segment decreased $52.1 million or 16% in
the third quarter of 2004 as compared to the second quarter of 2004. The
decrease in the Semiconductor segment was primarily attributable to a decrease
in demand for semiconductors used in storage and communication product
applications. The decline in semiconductors used in storage product
applications is mainly due to the continued softening demand in the SAN adapter
and server markets. The decline in semiconductors used in communication
product applications is due primarily to lower demand for office automation
products. These decreases were partially offset by a seasonal increase in
demand for semiconductors used in consumer product applications, in particular
the video game products. Revenues for the Storage Systems segment decreased $15.6 million or 14%
from the second quarter of 2004. The majority of this decline related to lower
demand for products sold to IBM. Revenues from IBM decreased $9.3 million for
the three months ended September 30, 2004 as compared to the three months ended
June 30, 2004. As a percentage of total Storage Systems segment revenues,
revenues from IBM represented 54% in the third quarter of 2004 and 55% in the
second quarter of 2004. Three and nine months ended September 30, 2004 compared to the same period
of 2003 Total consolidated revenues for the third quarter of 2004 decreased $70.0
million or 16% as compared to the third quarter of 2003. For the nine months
ended September 30, 2004, revenues increased $50.3 million or 4% as compared to
the same period of 2003. 20




---



##### Table of Contents



Revenues for the Semiconductor segment decreased $62.9 million or 18% for
the third quarter of 2004 and increased $30.5 million or 3% for the nine months
ended September 30, 2004 as compared to the same periods of the previous year.
The decrease in revenues in the Semiconductor segment in the third quarter of
2004, as compared to the same period of 2003, is attributable to a decrease in
demand for semiconductors used in consumer product applications, specifically
videogame platforms, communication and storage product applications. For the
nine months ended September 30, 2004 compared to the same period of the
previous year, the increase in revenues for the Semiconductor segment was
primarily due to an increase in demand for semiconductors used in storage and
communication product applications. In addition, the demand for semiconductors
used in consumer product applications, such as DVD recordable increased,
partially offset by a decrease in demand for semiconductors used in consumer
products applications, such as video game platforms. Revenues for the Storage Systems segment decreased $7.1 million or 7% for
the third quarter of 2004 and increased $19.8 million or 7% for the nine months
ended September 30, 2004 as compared to the same periods of 2003. The decrease
in revenues in the Storage Systems segment for the third quarter of 2004 as
compared to the same period of 2003 is primarily due to a decrease in demand
for products sold to IBM, offset in part by increased revenues for products
sold to StorageTek. The increase in revenues for the Storage Systems segment
for the nine months ended September 30, 2004 compared to the same period of
2003, is primarily due to an increase in demand from IBM, StorageTek and SGI
for new controller products that were introduced in late April 2003 and
increased demand for our other controller and disk enclosure related products.
        . Significant Customers.The following table summarizes the number of our
significant customers, each of whom accounted for 10% or more of our revenues,
along with the percentage of revenues they individually represent on a
consolidated basis and by segment (See Note 13 of the Notes): Three months ended September 30,
    
    Nine months ended September 30,2004
    
    2003
    
    2004
    
    2003Semiconductor segment:Number of significant customers
    
    
    2
    
    
    
    1
    
    
    
    
    
    
    
    1Percentage of segment revenues
    
    
    12%, 11
    %
    
    
    27
    %
    
    
    
    
    
    
    18
    %,Storage Systems segment:Number of significant customers
    
    
    3
    
    
    
    3
    
    
    
    3
    
    
    
    3Percentage of segment revenues
    
    
    54%, 15%, 12
    %
    
    
    58%, 12%, 11
    %
    
    
    53%, 14%, 11
    %
    
    
    50%, 14%, 12
    %Consolidated:Number of significant customers
    
    
    1
    
    
    
    2
    
    
    
    1
    
    
    
    2Percentage of consolidated
revenues
    
    
    15
    %
    
    
    21%, 15
    %
    
    
    15
    %
    
    
    14%, 14
    %
 Revenues by geography.The following table summarizes our revenues by
geography: Three months ended
    
    Nine months endedSept. 30, 2004
    
    June 30, 2004
    
    Sept. 30, 2003
    
    Sept. 30, 2004
    
    Sept. 30, 2003(In millions)Revenues:North America
    
    $
    194.1
    
    
    $
    243.3
    
    
    $
    209.3
    
    
    $
    682.2
    
    
    $
    633.0Asia, including Japan
    
    
    156.7
    
    
    
    164.9
    
    
    
    207.6
    
    
    
    486.2
    
    
    
    487.1Europe
    
    
    29.4
    
    
    
    39.7
    
    
    
    33.3
    
    
    
    112.1
    
    
    
    110.1Total
    
    $
    380.2
    
    
    $
    447.9
    
    
    $
    450.2
    
    
    $
    1,280.5
    
    
    $
    1,230.2
 Third quarter of 2004 compared to the second quarter of 2004 In the third quarter of 2004, revenues decreased in North America, Asia,
including Japan and Europe, as compared to the second quarter of 2004. The
decrease in North America is primarily attributable to a decline in demand for
semiconductors used in storage product applications, such as disk drive
solutions and modular storage products associated with Engenio. The decrease
in revenues for 21




---



##### Table of Contents



Asia, including Japan is primarily due to the decline in demand for
communication product applications, such as office automation products. The
decrease in revenues for Europe represents decreased demand across all
semiconductor product applications. Three and nine months ended September 30, 2004 compared to the same
periods of 2003 Revenues in North America and Asia, including Japan and Europe decreased
in the third quarter of 2004 as compared to the third quarter of 2003. The
decrease in North America is mainly due to the decrease in demand for
semiconductors used in storage product applications, such as disk drive
solutions and modular storage products associated with Engenio. The decrease
in revenues for Asia, including Japan is primarily due to decreased demand for
semiconductors used in consumer product applications, such as video game
platforms, offset in part by an increase in demand for semiconductors used in
consumer product applications, such as DVD-recordable. The decrease in
revenues for Europe represents decreased demand across all semiconductor
product applications. During the nine months ended September 30, 2004, revenues increased in
North America and Europe, and declined slightly in Asia, including Japan, as
compared to the same period in 2003. The increase in demand in North America
and Europe was for semiconductors used in storage component and communication
product applications, such as routers and switches and modular storage products
associated with Engenio, partially offset by a decrease in demand for
semiconductors used in consumer product applications, such as DVD-recordable.
The decrease in revenues in Asia, including Japan was mainly due to a decline
in demand for semiconductors used in certain consumer product applications,
such as video game platforms and communication product applications, such as
office automation products. This decrease was offset by an increase in demand
for semiconductors used in storage component applications, such as Ultra 320
SCSI, and certain consumer product applications, such as DVD-recordable. Operating costs and expenses.Key elements of the consolidated statements of
operations for the respective segments are as follows: Gross profit margin: Three months ended
    
    Nine months endedSept. 30, 2004
    
    June 30, 2004
    
    Sept. 30, 2003
    
    Sept. 30, 2004
    
    Sept. 30, 2003(In millions)Semiconductor segment
    
    $
    119.8
    
    
    $
    166.5
    
    
    $
    144.1
    
    
    $
    442.5
    
    
    $
    362.8Percentage of revenues
    
    
    42
    %
    
    
    50
    %
    
    
    42
    %
    
    
    46
    %
    
    
    39
    %Storage Systems segment
    
    $
    32.0
    
    
    $
    42.3
    
    
    $
    40.9
    
    
    $
    119.5
    
    
    $
    115.6Percentage of revenues
    
    
    33
    %
    
    
    38
    %
    
    
    39
    %
    
    
    37
    %
    
    
    38
    %Consolidated
    
    $
    151.8
    
    
    $
    208.8
    
    
    $
    185.0
    
    
    $
    562.0
    
    
    $
    478.4Percentage of revenues
    
    
    40
    %
    
    
    47
    %
    
    
    41
    %
    
    
    44
    %
    
    
    39
    %
 Third quarter of 2004 compared to the second quarter of 2004 The consolidated gross profit margin as a percentage of revenues decreased
to 40% in the third quarter of 2004 from 47% in the second quarter of 2004. The gross profit margin as a percentage of revenues for the Semiconductor
segment decreased to 42% in the third quarter of 2004 from 50% in the second
quarter of 2004. The decrease in gross profit margin for the Semiconductor
segment was primarily attributable to the following factors:  Higher inventory charges for non-marketable inventories in the third
quarter of 2004 as compared to the second quarter of 2004; and  An unfavorable shift in product mix to selling products with
relatively lower margins. The gross profit margin as a percentage of revenues for the Storage
Systems segment decreased to 33% for the third quarter of 2004 from 38% for the
second quarter of 2004. The decrease is mainly a result of an unfavorable
change in the mix of products sold 22




---



##### Table of Contents



and lower utilization of manufacturing facilities due to lower revenues in the
third quarter of 2004 as compared to the second quarter of 2004. We expect our consolidated gross profit margin to be in the range of 41%
to 43% in the fourth quarter of 2004. Three and nine months ended September 30, 2004 compared to the same
periods of 2003 The consolidated gross profit margin as a percentage of revenues decreased
to 40% for the third quarter of 2004 from 41% for the same period of 2003. The
consolidated gross profit margin as a percentage of revenues increased to 44%
for the nine months ended September 30, 2004 as compared to 39% for the same
period of 2003. The gross profit margin as a percentage of revenues for the Semiconductor
segment remained unchanged at 42% in the third quarters of 2004 and 2003. The
gross profit margin as a percentage of revenues for the Semiconductor segment
increased to 46% for the nine months ended September 30, 2004 as compared to
39% in the same period of 2003. The improvement in gross profit margin for the
Semiconductor segment was primarily attributable to the following factors:  
    
    Higher revenues and a favorable shift in product mix to products with
higher margins for the nine months ended September 30, 2004 as compared
to the same period of 2003;
    
    Lower manufacturing variances for the Gresham manufacturing facility
associated with yield improvements, improved operating efficiencies and
better factory utilization; and
    
    A reduction in cost of revenues as a result of the sale of our Japan
manufacturing facility in the fourth quarter of 2003. Sales of previously reserved inventory for the nine months ended September
30, 2004 compared to the same period of 2003 was not significant. The gross profit margin as a percentage of revenues for the Storage
Systems segment decreased to 33% in the third quarter of 2004 as compared with
39% for the third quarter of 2003. The gross profit margin as a percentage of
revenues for the Storage Systems segment decreased to 37% for the nine months
ended September 30, 2004 as compared to 38% in the same period of 2003. The
decrease in gross profit margin as a percentage of Storage Systems segment
revenues is primarily a result of an unfavorable shift in mix of products sold. Factors that may affect gross profit margins We have wafer-manufacturing operations in Gresham, Oregon. We also acquire
wafers from foundries in other locations. Utilizing a diversity of
manufacturing locations allows us to better manage potential disruption in the
manufacturing process due to economic and geographic risks associated with each
location. Our operating environment, combined with the resources required to operate
in the Semiconductor and Storage Systems industries, requires that we manage a
variety of factors which could have a significant impact on our gross margin in
future periods. These factors include, among other things:  
    
    Competitive pricing pressures;
    
    Product mix;
    
    Factory capacity and utilization;
    
    Manufacturing yields;
    
    Availability of certain raw materials;
    
    Terms negotiated with third-party subcontractors; and
    
    Foreign currency fluctuations. 23




---



##### Table of Contents



Research and development: Three months ended
    
    Nine months endedSept. 30, 2004
    
    June 30, 2004
    
    Sept. 30, 2003
    
    Sept. 30, 2004
    
    Sept. 30, 2003(in millions)Semiconductor segment
    
    $
    93.3
    
    
    $
    96.1
    
    
    $
    91.7
    
    
    $
    284.2
    
    
    $
    297.3Percentage of revenues
    
    
    33
    %
    
    
    29
    %
    
    
    26
    %
    
    
    30
    %
    
    
    32
    %Storage Systems segment
    
    $
    14.8
    
    
    $
    14.0
    
    
    $
    12.1
    
    
    $
    43.0
    
    
    $
    33.0Percentage of revenues
    
    
    15
    %
    
    
    12
    %
    
    
    12
    %
    
    
    13
    %
    
    
    11
    %Consolidated
    
    $
    108.1
    
    
    $
    110.1
    
    
    $
    103.8
    
    
    $
    327.2
    
    
    $
    330.3Percentage of revenues
    
    
    28
    %
    
    
    25
    %
    
    
    23
    %
    
    
    26
    %
    
    
    27
    %
 Third quarter of 2004 compared to the second quarter of 2004 Research and development (R&D) expenses decreased $2.0 million or 2% in
the third quarter of 2004 as compared to the second quarter of 2004 on a
consolidated basis. R&D expenses in the Semiconductor segment decreased $2.8 million or 3% in
the third quarter of 2004 as compared to the second quarter of 2004. The
decrease in R&D expenses for the Semiconductor segment is primarily related to
lower manufacturing spending on test chips. R&D expenses for the Semiconductor
segment increased to 33% of revenues in the third quarter of 2004 from 29% in
the second quarter of 2004. We continued the build-out of the RapidChip platform infrastructure in the
third quarter of 2004. Products utilizing RapidChip technology combine the
high-density, high-performance and proven intellectual property benefits of
cell-based ASICs with the advantages of lower development costs and faster time
to market. We expect products utilizing RapidChip technology to have
performance comparable to cell-based ASICs at a cost significantly lower than
Field Programmable Gate Arrays (FPGAs). Markets for our RapidChip platform
ASIC solutions will include communications, storage, consumer, industrial and
others. Our customer base for RapidChip technology encompasses a range from
small start-up companies to major system OEMs throughout all of our geographic
markets. We shipped our first RapidChip platform products in the fourth quarter
of 2003. Design wins and product shipments for RapidChip platform products
continued to increase in the third quarter of 2004. R&D expenses in the Storage Systems segment increased $0.8 million or 6%
in the third quarter of 2004 as compared to the second quarter of 2004
primarily due to higher expenses for materials and outside service providers
related to development programs. R&D expenses for the Storage Systems
segment increased to 15% of revenues in the third quarter of 2004 from 12% in
the second quarter of 2004. Three and nine months ended September 30, 2004 compared to the same period
of 2003 R&D expenses, on a consolidated basis, increased $4.3 million or 4% during
the third quarter of 2004 as compared to the same period of 2003. R&D expenses
for the nine months ended September 30, 2004 decreased by $3.1 million or 1% as
compared to the same period of the prior year on a consolidated basis. R&D expenses for the Semiconductor segment increased $1.6 million or 2% in
the third quarter of 2004 and decreased $13.1 million or 4% for the nine months
ended September 30, 2004 as compared to the same periods of 2003. The increase
in the third quarter of 2004 as compared to the same period of 2003 is due
primarily to R&D expenses associated with acquisitions made in the first half
of 2004 (see Note 3 of the Notes). The decrease in R&D expenses for the
Semiconductor segment for the nine months ended September 30, 2004 as compared
to the same period of the prior year is primarily a result of benefits from the
cost-cutting measures implemented as part of the restructuring actions in 2003
(see Note 5 of the Notes). 24




---



##### Table of Contents



R&D expenses as a percentage of revenues for the Semiconductor segment
increased to 33% in the third quarter of 2004 compared to 26% in the same
quarter of 2003. R&D expenses as a percentage of revenues for the
Semiconductor segment decreased to 30% in the nine months ended September 30,
2004 as compared to 32% in the same period of 2003. R&D expenses for the Storage Systems segment increased by $2.7 million or
22% in the third quarter of 2003 and $10.0 million or 30% in the nine months
ended September 30, 2004 as compared to the same periods of 2003. This is
primarily a result of increased compensation costs due to higher headcount,
higher expenses for outside service providers related to development programs
and higher depreciation expense related to new assets purchased for product
development. R&D expenses as a percentage of revenues for the Storage Systems segment
increased to 15% in the third quarter of 2004 from 12% in the same quarter of
2003. R&D expenses as a percentage of revenues for the Storage Systems segment
increased to 13% in the nine months ended September 30, 2004 as compared to 11%
in the same period of 2003. Selling, general and administrative: Three months ended
    
    Nine months endedSept. 30, 2004
    
    June 30, 2004
    
    Sept. 30, 2003
    
    Sept. 30, 2004
    
    Sept. 30, 2003(In millions)Semiconductor segment
    
    $
    44.0
    
    
    $
    45.2
    
    
    $
    42.2
    
    
    $
    133.1
    
    
    $
    126.0Percentage of revenue
    
    
    16
    %
    
    
    13
    %
    
    
    12
    %
    
    
    14
    %
    
    
    14
    %Storage Systems segment
    
    $
    19.4
    
    
    $
    18.6
    
    
    $
    15.5
    
    
    $
    55.3
    
    
    $
    46.2Percentage of revenue
    
    
    20
    %
    
    
    17
    %
    
    
    15
    %
    
    
    17
    %
    
    
    15
    %Consolidated
    
    $
    63.4
    
    
    $
    63.8
    
    
    $
    57.7
    
    
    $
    188.4
    
    
    $
    172.2Percentage of revenue
    
    
    17
    %
    
    
    14
    %
    
    
    13
    %
    
    
    15
    %
    
    
    14
    %
 Third
quarter of 2004 compared to the second quarter of 2004 Selling, general and administrative (SG&A) expenses remained flat in the
third quarter of 2004 as compared to the second quarter of 2004 on a
consolidated basis. As a percentage of revenues, consolidated SG&A expenses
increased to 17% in the third quarter of 2004 from 14% in the second quarter of
2004. SG&A expenses for the Semiconductor segment decreased $1.2 million or 3%
in the third quarter of 2004 as compared to the second quarter of 2004. This
decrease is mainly due to lower spending for professional services, such as
legal services. For the Semiconductor segment, SG&A expenses, as a percentage
of revenues, increased to 16% in the third quarter of 2004 from 13% in the
second quarter of 2004. SG&A expenses for the Storage Systems segment increased $0.8 million or 4%
in the third quarter of 2004 as compared to the second quarter of 2004. The
increase is primarily due to $1.5 million of expenses associated with the
proposed initial public offering and the separation from us, which includes
fees for professional services that were directly and solely related to the
initial public offering; lower reimbursements of selling expenses related to
the master distributor agreement with StorageTek due to the timing of billings
and the underlying level of revenues; partially offset by lower commissions and
compensation-related costs as a result of lower revenues from the second
quarter to the third quarter of 2004. On July 29, 2004, we announced jointly
with Engenio the postponement of the initial public offering of its common
stock due to market conditions. For the Storage Systems segment, SG&A expenses, as a percentage of
revenues increased to 20% in the third quarter of 2004 as compared with 17% in
the second quarter of 2004. Three and nine months ended September 30, 2004 compared to the same period
of 2003 Consolidated SG&A expenses increased $5.7 million or 10% during the third
quarter of 2003 and increased $16.2 million or 9% during the nine months ended
September 30, 2004 as compared to the same periods of 2003. As a percentage of
revenues, SG&A expenses increased to 17% in the third quarter of 2004 as
compared with 13% in the third quarter of 2003. As a percentage of revenues,
SG&A expenses increased to 15% in the nine months ended September 30, 2004 as
compared with 14% for the same period in 2003. 25




---



##### Table of Contents



SG&A expenses for the Semiconductor segment increased $1.8 million or 4%
for the third quarter of 2004 and $7.1 million or 6% for the nine months ended
September 30, 2004, as compared to the same periods of 2003. The increase for
the Semiconductor segment in the third quarter of 2004 as compared to the same
period in 2003 is primarily attributable to higher compensation-related costs,
higher selling expenses including bad debt expenses and one-time distributor
commissions. The increase for the Semiconductor segment in the nine months
ended September 30, 2004 as compared to the same period of 2003 is primarily
due to higher compensation-related costs, higher spending on professional
services including legal services, higher selling expenses including bad debt
expenses and one-time distributor commissions. SG&A expenses as a percentage of revenues for the Semiconductor segment
increased to 16% in the third quarter of 2004 as compared with the 12% in the
same quarter of 2003. SG&A expenses as a percentage of revenues for the
Semiconductor segment remained unchanged at 14% in the nine months ended
September 30, 2004 as compared to the same period of 2003. SG&A expenses for the Storage Systems segment increased by $3.9 million or
25% in the third quarter of 2004 and by $9.1 million or 20% in the nine months
ended September 30, 2004 as compared to the same periods of 2003. During the
three and nine months ended September 30, 2004 we recorded $2.5 million and
$3.5 million, respectively, in expenses associated with the proposed initial
public offering and the separation from us, which includes fees for
professional services that were directly and solely related to the initial
public offering. On July 29, 2004, we announced jointly with Engenio the
postponement of the initial public offering of its common stock due to market
conditions. Compensation-related costs also increased during both the three
and nine months ended September 30, 2004 as a result of employees hired for
customer training and customer engineering positions, as well as administrative
employees hired in anticipation of the initial public offering of Engenios
common stock. During the nine months ended September 30, 2004, these increases
were offset in part by higher reimbursements of selling expenses related to the
master distributor agreement with StorageTek due to the timing of billings and
the underlying level of revenues. SG&A expenses as a percentage of revenues for the Storage Systems segment
increased to 20% in the third quarter of 2004 from 15% in the same quarter of
2003. SG&A expenses as a percentage of revenues for the Storage Systems
segment increased to 17% in the nine months ended September 30, 2004 as
compared to 15% in the same period of 2003. Restructuring of operations and other items:We recorded charges of
$228.6 million and $231.1 million in restructuring of operations and other
items for the three and nine months ended September 30, 2004, respectively,
which was primarily associated with the Semiconductor segment. We recorded a
charge of $24.5 million and $184.7 million in restructuring of operations and
other items for the three and nine months ended September 30, 2003,
respectively. For a complete discussion of the 2003 restructuring actions,
please refer to our Annual Report on Form 10-K for fiscal year 2003. Restructuring and impairment of long-lived assets: First quarter of 2004: We recorded a gain of $3.3 million on the sale of fixed assets that had
previously been held for sale and an expense of $1.1 million for the
abandonment of fixed assets that had previously been held for sale. In
addition, an expense of $1.1 million was recorded for the write-down of fixed
assets due to impairment. An expense of $0.3 million was recorded to reflect the change in time
value of accruals for facility lease termination costs, net of adjustments for
changes in sublease assumptions for certain previously accrued facility lease
termination costs. An expense of $0.2 million was recorded primarily for
severance and termination benefits for four employees involved in research and
development. Second quarter of 2004: We recorded a gain of $1.0 million on the sale of fixed assets that had
previously been held for sale and an expense of $4.0 million primarily for the
write-down of the Colorado Springs fabrication facility to reflect a decline in
fair market value and to write down certain spare parts for fixed assets. An expense of $0.4 million was recorded to reflect the change in time
value of accruals for facility lease termination costs, net of adjustments for
changes in sublease assumptions for certain previously accrued facility lease
termination costs. Previously accrued contract termination fees of $0.4
million were reversed as the result of favorable negotiations to terminate
those contracts. 26




---



##### Table of Contents



Third quarter of 2004: As a result of the decline in revenues in the semiconductor industry and a
corresponding decline in our outlook as of the latter part of the third quarter
of 2004, we initiated a comprehensive restructuring program, which included a
reduction in workforce, asset impairment charges and the consolidation of
certain facilities as discussed further below. We concluded in accordance with SFAS No. 144 Accounting for the
Impairment or Disposal of Long-Lived Assets, that the Gresham manufacturing
facility assets were impaired. Accordingly, an asset write down of $205.5
million was recorded in the semiconductor segment during the third quarter of
2004 and we estimate an additional write down of approximately $177 million
will be recorded in the fourth quarter of 2004. The fair value of impaired
equipment and facilities were estimated by management. The charge in the fourth
quarter will reflect the impairment of the equipment that will be purchased in
connection with the termination of the operating leases as described in Note 14
of the Notes. The impairment charges will be non-cash charges. The fourth
quarter cash flows will reflect the buyout of the leases, net of the return of
the cash collateral associated with the leases for a net outflow of
$21 million. We announced workforce reductions of approximately 558 positions worldwide
across all job functions and recorded a charge of $14.6 million in the
Semiconductor segment for severance and termination benefits. We recorded a gain of $1.9 million on the sale of fixed assets that had
previously been held for sale and an expense of $3.4 million for the write-down
of the Colorado Springs fabrication facility to reflect a decline in fair
market value, the impairment of certain acquired intangible assets in the
Semiconductor segment and the write down of leasehold improvements related to
the facility operating leases discussed below. In the third quarter of 2004, we consolidated additional non-manufacturing
facilities and recorded $6.1 million for costs associated with exiting certain
operating leases for real estate as the facilities ceased being used. An
expense of $0.4 million was recorded to reflect the change in time value of
accruals for facility lease termination costs. In addition, an expense of $1.8
million was recorded for changes in sublease assumptions for certain previously
accrued facility lease termination costs. Assets held for sale of $24 million and $30 million were included as a
component of prepaid expenses and other current assets as of September 30, 2004
and December 31, 2003, respectively. Assets classified as held for sale are
not depreciated. The fair values of impaired equipment and facilities were
estimated by management. Given that current market conditions for the sale of
older fabrication facilities and related equipment may fluctuate, there can be
no assurance that we will realize the current net carrying value of the assets
held for sale. We reassess the realizability of the carrying value of these
assets at the end of each quarter until the assets are sold or otherwise
disposed of and additional adjustments may be necessary. The following table sets forth our restructuring reserves as of September
30, 2004, which are included in other accrued liabilities on the balance sheet: Restruc
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    RestructurBalance at
    
    turing
    

    Utilized

    
    Restructuring
    
    Utilized
    
    Release of
    
    ing
    
    
    
    Balance atDecember 31,
    
    Expense
    
    during Q1
    
    Expense
    
    during Q2
    
    reserves
    
    Expense
    
    Utilized
    
    September 30,2003
    
    Q1 2004
    
    2004
    
    Q2 2004
    
    2004
    
    Q2 2004
    
    Q3 2004
    
    during Q3 2004
    
    2004(In thousands)Write-down of
excess assets (a)
    
    $
    2,661
    
    
    $
    (1,118
    )
    
    $
    718
    
    
    $
    3,203
    
    
    $
    (160
    )
    
    $
    (3,414
    )
    
    $
    207,035
    
    
    $
    (207,324
    )
    
    $
    1,601Lease terminations
and maintenance
contracts (b)
    
    
    21,021
    
    
    
    252
    
    
    
    (1,886
    )
    
    
    379
    
    
    
    (375
    )
    
    
    (2,312
    )
    
    
    8,336
    
    
    
    (2,214
    )
    
    
    23,201Facility closure
and other exit
costs (c)
    
    
    2,136
    
    
    
    64
    
    
    
    (782
    )
    
    
    
    
    
    
    
    
    
    
    (369
    )
    
    
    
    
    
    
    (234
    )
    
    
    815Payments to
employees for
severance (d)
    
    
    874
    
    
    
    204
    
    
    
    (767
    )
    
    
    
    
    
    
    (18
    )
    
    
    (227
    )
    
    
    14,573
    
    
    
    (838
    )
    
    
    13,801Total
    
    $
    26,692
    
    
    $
    (598
    )
    
    $
    (2,717
    )
    
    $
    3,582
    
    
    $
    (553
    )
    
    $
    (6,322
    )
    
    $
    229,944
    
    
    $
    (210,610
    )
    
    $
    39,418
  (a)
    
    The amounts utilized in 2004 reflect $215.4 million of non-cash
write-downs of long-lived assets in the U.S. due to impairment and $0.8
million in cash payments to decommission and sell assets, offset by a $6.2
million realized gain on the sale of fixed assets previously held for
sale. The write-downs of long-lived assets were accounted for as a
reduction of the assets and did not result in a liability. The $1.6
million balance as of September 30, 2004, relates to machinery and
equipment decommissioning costs in the U.S. and estimates of selling costs
for assets held for sale and is expected to be utilized during the first
half of 2005. 27




---



##### Table of Contents



(b)
    
    Amounts utilized represent cash payments. The balance remaining for
primarily real estate lease terminations and maintenance contracts will be
paid during the remaining terms of these contracts, which extend through
2011.(c)
    
    Amounts utilized represent cash payments. The balance remaining for
facility closure and other exit costs will be paid during the first half
of 2005.(d)
    
    Amounts utilized represent cash severance payments to 68 employees during
the nine months ended September 30, 2004. The balance remaining for
severance is expected to be paid by the end of 2005. We expect to realize savings of approximately $100 million as a result of
these restructuring actions. Other Items During the second quarter of 2004, we reclassified a parcel of land in
Colorado with a book value of $1.4 million from a long-term asset to a current
asset held for sale. The land is part of total assets in the Semiconductor
segment. We expect to sell the property within the next 12 months for an
amount not less than book value. During the third quarter of 2004, we reclassified a parcel of land in
Japan with a book value of $1.4 million from a long-term asset to a current
asset held for sale. The land is part of the total assets in the Semiconductor
segment. We expect to sell the property within the next 12 months for an
amount not less than book value. During the third quarter of 2004, we entered into two new lease agreements
for wafer fabrication equipment (see Note 14 of the Notes). The equipment was
previously on lease immediately prior to the closing of the new lease
agreements. We had capitalized and were amortizing fees related to the
previous lease agreements. Upon entering into the new lease agreements, $2.5
million in remaining unamortized fees for the previous leases were recorded as
an expense in the statement of operations. During the third quarter of 2004, we discontinued hedge accounting
treatment on the interest rate swap related to the equipment operating lease
that were refinanced and recorded the $3.8 million balance in accumulated
comprehensive income as a gain in the statement of operations (see Note 7 and
14 of the Notes). Amortization of non-cash deferred stock compensation:Amortization of
non-cash deferred stock compensation was $2.6 million for the three months
ended September 30, 2004, $2.0 million for the three months ended June 30,
2004, $3.4 million for the three months ended September 30, 2003. For the nine
months ended September 30, 2004 and 2003, the amortization of non-cash deferred
stock compensation was $6.4 million and $22.8 million, respectively. The
acquisitions for which deferred stock compensation and related amortization
were recorded consisted primarily of the Accerant transaction in the second
quarter of 2004 and the Velio transaction in the first quarter of 2004 (see
Note 3 of the Notes); an acquisition in the fourth quarter of 2002; the
acquisition of C-Cube, and the RAID business from AMI in 2001; and the
acquisition of DataPath in 2000. We also recorded non-cash deferred stock
compensation for restricted common shares issued to our employees, Engenio
employees and the non-employee directors of Engenio during the nine months
ended September 30, 2004. We amortize deferred stock compensation ratably over
the related vesting periods. Deferred stock compensation is adjusted to
reflect the forfeitures prior to vesting. Amortization of intangibles:Amortization of intangible assets was $19.2
million for the third quarter of 2004 as compared to $19.4 million for the
second quarter of 2004. Amortization of intangible assets for the third quarter of 2004 remained
flat as compared to the same period in 2003. For the nine months ended
September 30, 2004 and 2003, amortization of intangible assets was $56.9
million and $58.6 million, respectively. The decrease is attributable to the
write-down in the first quarter of 2003 of $15.1 million of intangible assets
in the Semiconductor segment and $9.0 million of intangible assets in the
Storage Systems segment. In the third quarter of 2003, we wrote-down an
additional $21.0 million of intangible assets originally acquired in connection
with the acquisition of C-Cube, which was added to our Semiconductor segment in
the second quarter of 2001. The charges were recorded in restructuring and
other items, net in 2003. These decreases were offset in part by amortization
of intangible assets acquired in the first and second quarters of 2004. As of
September 30, 2004, we had approximately $131.3 million of intangible assets,
net of accumulated amortization, which will continue to amortize. We monitor the recoverability of goodwill recorded in connection with
acquisitions annually, or sooner if events or changes in circumstances indicate
that the carrying amount may not be recoverable. Impairment, if any, would be
determined in accordance with 28




---



##### Table of Contents



SFAS No. 142, which uses a fair value model for determining the carrying value
of goodwill. As a result of the decline in revenues in the semiconductor
industry and the corresponding decline in our outlook as of the latter part of
the third quarter of 2004 and the conclusion that the Gresham manufacturing
facility was impaired (see Note 5 of the Notes), we reviewed goodwill by
reporting unit for impairment as of September 30, 2004. Our reporting units
are Semiconductor and Storage Systems or Engenio. The impairment testing is a
two-step process. The first step requires comparing the fair value of each
reporting unit to its net book value. We use management estimates of future
cash flows to perform the first step of the goodwill impairment test. These
estimates include assumptions about future conditions such as future revenues,
gross margins and operating expenses. Two methodologies were used to obtain the
fair value for each reporting unit as of September 30, 2004: Discounted Cash
Flow and Market Multiple. We concluded that goodwill was not impaired under
the first step as of September 30, 2004. The second step is only performed if
impairment exists, as it involves measuring the actual impairment to goodwill. Interest expense:Interest expense decreased to $6.0 million in the third
quarter of 2004 from $6.1 million in the second quarter of 2004. Interest
expense decreased by $1.0 million during the three months ended September 30,
2004 from $7.0 million during the same period of 2003. Interest expense
decreased $5.1 million to $18.0 million for the nine months ended September 30,
2004 from $23.1 million in the same period of 2003. The decrease is due to the
repurchase/redemption of approximately $710.0 million of Convertible Notes
during 2003, $68.5 million in the third quarter of 2004 and changes in the
benefit received from the interest rate swaps before/after termination (see
Note 9 of the Notes), offset by the issuance of $350.0 million of Convertible
Notes during the second quarter of 2003. Interest income and other, net:Interest income and other, net, was an
expense of $0.2 million for the third quarter of 2004 as compared to income of
$8.8 million for the second quarter of 2004. Interest income increased to $4.6
million in the third quarter of 2004 from $3.5 million in the second quarter of
2004. The increase in interest income is mainly due to higher realized gains
on our short-term investments. Other expense, net of $4.8 million in the third
quarter of 2004 included a net pre-tax gain of $1.8 million on repurchase of
2001 Convertible Notes (see Note 9 of the Notes), a pre-tax loss of $6.0
million for the impairment of certain marketable and non-marketable
available-for-sale equity securities determined by management to be other than
temporary (see Note 6 of the Notes) and other miscellaneous items. Other income, net of $5.3 million in the
second quarter of 2004 included a pre-tax gain of $5.1 million on sales of
certain marketable available-for-sale equity securities and other miscellaneous items. In the third quarter of 2003, interest income and other, net, was $5.0
million. Interest income was $5.2 million in the third quarter of 2003. The
decrease in interest income for the third quarter of 2004 as compared to the
third quarter of 2003 is mainly due to lower realized gains on the sale of
short-term investments and lower returns. Other expense, net of $0.2 million
in the third quarter of 2003 included a net pre-tax loss of $1 million on the
redemption of $172 million in principal of our 1999 Convertible Notes, offset
in part by net gains on foreign exchange and the sale of miscellaneous assets. Interest income and other, net increased to $17.7 million in the nine
months ended September 30, 2004 from $15.1 million in the same period of 2003.
Interest income decreased by $11.1 million to $13.6 million in the nine months
ended September 30, 2004 from $24.7 million in the same period of 2003. The
decrease in interest income is mainly due to lower realized gains on the sale
of short-term investments and lower returns during the nine months ended
September 30, 2004. Other income, net of $4.1 million in the nine months ended
September 30, 2004 included a pre-tax gain of $3.0 million associated with our
investment in marketable available-for-sale equity securities of a certain
technology company that was acquired by another publicly traded technology
company during the first quarter of 2004, a pre-tax gain of $5.1 million on
sales of certain marketable available-for-sale equity securities in the second
quarter of 2004, pre-tax gain of $1.8 million on repurchase of 2001 Convertible
Notes (see Note 9 of the Notes), a pre-tax loss of $6.0 million on impairment
of certain marketable and non-marketable available-for-sale equity securities (See Note 6 of the
Notes) and other miscellaneous items. Other expense, net of $9.6 million in the
nine months ended September 30, 2003 included $9.1 million in charges for
write-downs of investments in equity securities due to impairment considered to
be other than temporary, a net loss on the redemption/repurchase of Convertible
Notes of $3.2 million, and currency option premium expenses, offset in part by
net foreign exchange gains, gains on sale of miscellaneous assets, and other
expenses that were individually insignificant. Provision for income taxes:We recorded an income tax expense of $6.0
million for the three months ended September 30, 2004 and 2003, and $18.0
million for the nine months ended September 30, 2004 and 2003. The expense
relates to foreign income taxes. Excluding certain foreign jurisdictions, the
future benefit of temporary differences, including operating losses, is not
being recognized. 29




---



##### Table of Contents



FINANCIAL CONDITION, CAPITAL RESOURCES AND LIQUIDITY Cash, cash equivalents and short-term investments decreased to $808.8
million at September 30, 2004, from $813.7 million at December 31, 2003. As
described below, the decrease is mainly due to net cash inflows from operating
activities and net cash outflows from investing and financing activities. Working capital.Working capital decreased by $3.1 million to $995.7
million at September 30, 2004, from $998.8 million at December 31, 2003.
Working capital for the nine months ended September 30, 2004 was impacted by
the following activities:  
    
    Accounts payable increased by $29.1 million to $131.7 million at
September 30, 2004 from $102.6 million at December 31, 2003, primarily
due to the timing of invoice receipt and payments;
    
    Other accrued liabilities increased by $27.3 million to $181.2
million as of September 30, 2004 from $153.9 million as of December 31,
2003. The primary reasons for the increase are:  -
    
    Our restructuring reserves increased by $14.4 million
during the nine months ended September 30, 2004 primarily as a
result of the restructuring actions taken in the third quarter, net
of utilization during the nine-month period (see Note 5 of the
Notes).-
    
    Accrued interest payable increased due to the timing of
interest payments on our Convertible Subordinated Notes.-
    
    In addition, there was an increase in accrued rent payments
for the equipment operating leases that resulted from the timing of
payments subsequent to entering into the new leases during the
third quarter of 2004 (see Note 14 of the Notes).  
    
    Prepaid expenses and other current assets decreased by $11.3 million
primarily due to:  -
    
    A $7.5 million decrease in the current portion of the
collateral balance on the equipment operating leases (see Note 14
of the Notes);-
    
    The receipt of a $6.6 million income tax refund in the
first quarter of 2004;-
    
    A $5.5 million decrease in assets held for sale due to
sales and retirements, net of additions (see Note 5 of the Notes);
and-
    
    Normal amortization of software maintenance contracts.-
    
    These decreases were offset by a $12.3 million increase in
an other receivable due to the termination of the interest rate
swap on the equipment operating leases (see Note 7 of the Notes).  
    
    Income taxes payable increased by $9.3 million primarily due to the
timing of income tax payments made and the income tax provision recorded
in the first nine months of 2004; and
    
    Cash, cash equivalents and short-term investments decreased by $4.9
million to $808.8 million at September 30, 2004, as compared to $813.7
million at December 31, 2003. The decrease in working capital was offset, in part, by the following:  
    
    Accounts receivable increased by $33.6 million to $264.8 million at
September 30, 2004 from $231.2 million at December 31, 2003. The
increase is mainly attributable to slower collections in the third
quarter of 2004 as compared to the fourth quarter of 2003 and higher
billings in the last month of the third quarter of 2004 as compared to
the last month of the fourth quarter of 2003; and
    
    Inventories increased by $45.8 million to $244.3 million as of
September 30, 2004 from $198.5 million as of December 31, 2003. This is
mainly due to lower than expected revenues in the later part of the
third quarter of 2004 as well as the purchase of raw materials and the
manufacture of inventory to support expected future sales. Cash and cash equivalents generated from operating activities.During the
nine months ended September 30, 2004, we generated $64.6 million of net cash
and cash equivalents from operating activities compared to $138.4 million
generated in the same period of 2003. Cash and cash equivalents generated by
operating activities for the nine months ended September 30, 2004 were the
result of the following: 30




---



##### Table of Contents




    
    Income (before depreciation and amortization, non-cash restructuring
and other items, amortization of non-cash deferred stock compensation,
gains on sale and exchange of equity securities, loss on write-down of
equity securities, gain on repurchase of Convertible Subordinated Notes,
and gain on the sale of property and equipment), offset by a net
decrease in assets and liabilities, net of assets acquired and
liabilities assumed in business combinations. The non-cash items and
other non-operating adjustments are quantified in our Consolidated
Statements of Cash Flows included in this Current Report on Form 10-Q;
and
    
    Changes in working capital components from December 31, 2003 to
September 30, 2004 as discussed above. Cash and cash equivalents used in investing activities.Cash and cash
equivalents used in investing activities were $73.8 million for the nine months
ended September 30, 2004, compared to $109.0 million in the same period in
2003. The primary investing activities during the nine months ended September
30, 2004 were as follows:  
    
    Purchases of debt and equity securities available for sale, net of sales and maturities;
    
    Purchases of property and equipment;
    
    Proceeds from the sale of property and equipment;
    
    Acquisition of companies, net of cash acquired (see Note 3 of the Notes); and
    
    A reduction in non-current assets and deposits during the nine months
ended September 30, 2004, primarily as a result of a decrease in
collateral during the third quarter as a result of entering into the new
equipment operating leases, the refund of collateral from the former
equipment operating leases during the first six months of 2004 (see Note
14 of the Notes) and the termination of a letter of credit arrangement
during the first quarter of 2004. We believe that maintaining technological leadership in the highly
competitive worldwide semiconductor manufacturing industry requires access to
advanced manufacturing capacity. Our focus is on establishing strategic
supplier alliances with foundry semiconductor manufacturers, which enables us
to supplement internal manufacturing capability with additional external
manufacturing capacity, and reduces our capital spending requirements. We
expect capital expenditures to be approximately $80 million in 2004. Cash and cash equivalents used in financing activities. Cash and cash
equivalents used in financing activities during the nine months ended September
30, 2004 were $58.5 million as compared to $133.4 million in the same period in
2003. The primary financing activities during the nine months ended September
30, 2004 were as follows:  
    
    The repurchase of a portion of the Convertible Subordinated Notes due in 2006;
    
    Additional purchase of minority interests in our Japanese subsidiary;
    
    The issuance of common stock under our employee stock option and purchase plans; and
    
    The repayment of debt obligations. We may seek additional equity or debt financing from time to time. We
believe that our existing liquid resources and funds generated from operations,
combined with funds from such financing and our ability to borrow funds, will
be adequate to meet our operating and capital requirements and obligations for
the foreseeable future. However, we cannot be certain that additional financing
will be available on favorable terms. Moreover, any future equity or
convertible debt financing will decrease the percentage of equity ownership of
existing stockholders and may result in dilution, depending on the price at
which the equity is sold or the debt is converted. On July 29, 2004, we announced jointly with Engenio the postponement of
the initial public offering of its common stock due to market conditions. 31




---



##### Table of Contents



Contractual Obligations The following table summarizes our contractual obligations at September
30, 2004, and the effect these obligations are expected to have on our
liquidity and cash flow in future periods. Payments due by periodContractual Obligations
    
    Less than 1 year
    
    1  3 years
    
    4  5 years
    
    After 5 years
    
    Total(in millions)Convertible Subordinated
Notes
    
    $
    
    
    
    $
    421.5
    
    
    $
    
    
    
    $
    350.0
    
    
    $
    771.5Operating lease obligations
    
    
    84.1
    
    
    
    79.2
    
    
    
    38.9
    
    
    
    38.6
    
    
    
    240.8Capital lease obligations
    
    
    0.3
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    0.3Purchase commitment
    
    
    273.1
    
    
    
    2.7
    
    
    
    
    
    
    
    
    
    
    
    275.8Total
    
    $
    357.5
    
    
    $
    503.4
    
    
    $
    38.9
    
    
    $
    388.6
    
    
    $
    1,288.4
 Convertible Subordinated Notes As of September 30, 2004, we have $422 million of Convertible Subordinated
Notes due in October 2006 (2001 Convertible Notes) and $350 million of
Convertible Subordinated Notes due in May 2010 (2003 Convertible Notes). All
of the Convertible Notes are subordinated to all existing and future senior
debt and are convertible at the holders option, at any time prior to the
maturity date of the Convertible Notes, into shares of our common stock. The
2001 and 2003 Convertible Notes have conversion prices of approximately $26.34
per share and $13.42 per share, respectively. The 2001 Convertible Notes are
redeemable at our option, in whole or in part, on at least 30 days notice at
any time on or after the call date, which is two years before the due date. We
cannot elect to redeem the 2003 Convertible Notes prior to maturity. Each
holder of the 2001 and 2003 Convertible Notes has the right to cause us to
repurchase all of such holders convertible notes at 100% of their principal
amount plus accrued interest upon the occurrence of any fundamental change to
us, which includes a transaction or event such as an exchange offer,
liquidation, tender offer, consolidation, merger or combination. Interest is
payable semiannually. Fluctuations in our stock price impact the prices of our outstanding
convertible securities and the likelihood of the convertible securities being
converted into cash or equity. If we are required to redeem any of the
Convertible Notes for cash, it may affect our liquidity position. However, in
the event they do not convert to equity, we believe that our current cash
position and expected future operating cash flows will be adequate to meet
these obligations as they mature. From time to time, we may buy back
Convertible Notes. Operating Lease Obligations On August 6, 2004, we entered into two lease and security agreements, each
with Wells Fargo Bank Northwest, acting as the Agent. One lease for $134
million is with Bank of the West acting as the Lessor, and the second lease for
$201 million is with BTM Capital Corporation acting as the Lessor. The leases
are for wafer fabrication equipment (the Equipment) that was previously on
lease immediately prior to closing this transaction. See Note 14 of the Notes
for a discussion of these former leases entered into on March 28, 2003. The
new leases qualify for operating lease accounting treatment. Each lease has a
term of 3 years. We may, at the end of the lease term, return or purchase, at
a pre-determined amount, all of the Equipment. We have $311 million in cash
that is posted as collateral for the leases as of September 30, 2004. We are
required to maintain unrestricted cash and short-term investments reserves in
an amount no less than the higher of a) the sum of $100 million plus the
principal amount of our 2001 Convertible Subordinated Notes due in 2006 or b)
$350 million. We were in compliance with this requirement as of September 30,
2004. We guarantee residual values related to the leased equipment. As of
September 30, 2004, our maximum potential exposure to residual value guarantees
was approximately $141 million. We concluded that exposure related to residual
value guarantees existed in connection with the conclusion that the Gresham
manufacturing facility was impaired as discussed in Note 5 of the
Notes. The fair value of
the guarantee of the residual value of the equipment was determined using
management estimates and was recorded as a non-current asset and liability each
in the amount of $6 million as of September 30, 2004. 32




---



##### Table of Contents



On October 27, 2004, we notified the required parties of our intention to
exercise our early buyout right to purchase all of the Equipment under the two
lease and security agreements discussed above, dated August 6, 2004. The date
on which the purchase is to
occur under each lease is November 29, 2004. The early termination or buyout
amount is a total of $332 million for both leases. Termination fees under the
lease agreements are not considered to be material. We expect to record an
impairment charge of $177 million in the fourth quarter in connection with the
termination of the operating leases. The impairment charges will be non-cash
charges. The fourth quarter cash flows will reflect the buyout of both leases,
net of the return of collateral associated with the leases. The table above
includes the buyout payment of $332 million to be made in the fourth quarter of
2004, net of the effect of the return of collateral of $311 million. We also lease real estate, certain other equipment and software under
non-cancelable operating leases. We renegotiated the existing lease agreements
for six buildings located in California and established one new lease in
California and one new lease in India in the nine months ended September 30,
2004. The future minimum payments for these new and renegotiated building
leases will be $1 million, $5 million, $6 million, $6 million, $6 million and
$24 million for the years ending December 31, 2004, 2005, 2006, 2007, 2008 and
thereafter, respectively. Purchase Commitments We maintain certain purchase commitments primarily for raw materials with
suppliers and for some non-production items. Purchase commitments for
inventory materials are generally restricted to a forecasted time-horizon as
mutually agreed upon between the parties. This forecast time-horizon can vary
amongst different suppliers. Critical Accounting Policies The discussion and analysis of our financial condition and results of
operations are based on the consolidated financial statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States. The preparation of these financial statements requires
estimates and assumptions that affect the reported amounts and disclosures.
For a detailed discussion of our critical accounting policies, please see the
Critical Accounting Policies contained in Part II, Item 7 of the Managements
Discussion and Analysis of Financial Condition and Results of Operations in our
Annual Report on Form 10-K for the year ended December 31, 2003. Recent Accounting Pronouncements In
October 2004, the Emerging Issues Task Force (EITF) issued EITF Issue No.
04-08, Accounting Issues Related to Certain Features of Contingently
Convertible Debt and the Effect on Diluted Earnings Per Share. This issue
addresses when contingently convertible instruments should be included in
diluted earnings per share computations. The pronouncement will be
effective for reporting periods ending after December 15, 2004.
The adoption of this standard is not expected to have an impact to our
computation of diluted earnings per share. In
October 2004, the EITF issued EITF Issue No. 04-10, Applying Paragraph 19 of
Statement of Financial Accounting Standards (SFAS) No. 131 in Determining Whether to Aggregate
Operating Segments that do not meet
the Quantitative Thresholds. SFAS No. 131,
Disclosures About Segments of an Enterprise and Related
Information, requires that a public
business enterprise report financial and descriptive information about its
reportable operating segments. This issue addresses how to aggregate
operating segments that do not meet the quantitative thresholds in
SFAS No. 131. The pronouncement is effective for fiscal years ending after
October 13, 2004. The
adoption of this standard did not have an impact to our
existing reportable
operating segments. In July 2004, the EITF issued EITF Issue No. 02-14, Whether an Investor
Should Apply the Equity Method of Accounting to Investments Other Than Common
Stock. This issue addresses the determination of whether an investment is
in-substance common stock and when to perform that evaluation, but does not
address the determination of whether an investor has the ability to exercise
significant influence over the operating and financial policies of the
investee. The pronouncement is effective for fiscal periods beginning after
September 15, 2004. For existing investments, the investor should make an
initial determination as to whether the investment is in-substance common stock
based on the circumstances existing as of the date of first application of this
issue. We do not believe that the adoption of this standard will have a
material impact on our consolidated balance sheet or statement of operations. In March 2004, the Emerging Issues Task Force (EITF) issued EITF Issue
No. 03-06, Participating Securities and the Two-class
Method Under SFAS No. 128, Earnings Per Share. EITF Issue No. 03-06 addresses a number
of questions regarding the computation of earnings per share (EPS) 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. The issue
also provides further guidance in applying the two-class method of calculating
EPS. It clarifies what constitutes a participating security and how to apply
the two-class method of computing EPS once it is determined that a security is
participating, including how to allocate undistributed earnings to such a
security. This pronouncement is effective for fiscal periods beginning after
March 31, 2004. The adoption of this standard did not have an impact on our
computation of EPS. In March 2004, the Emerging Issues Task Force (EITF) reached a consensus
on Issue No. 03-01, The Meaning of Other-Than-Temporary Impairment and Its
Application to Certain Investments. EITF No. 03-01 provides guidance on
recording other-than-temporary impairments of cost method investments and
requires additional disclosures for those investments. In September 2003, a
Financial
Accounting Standards Board (FASB) Staff Position was issued that delays the recognition and measurement
guidance in EITF No. 03-01 until the final issuance of FASB Staff Position
Issue 03-01 a. The adoption of the recognition and measurement provisions is
not expected to have a material impact on our consolidated balance sheet or
statement of operations. The disclosure requirements are effective for fiscal 33




---



##### Table of Contents



years ending after June 15, 2004 and are required only for annual periods. We
do not believe that the adoption of this standard will have a material impact
on our consolidated balance sheet or statement of operations. In December 2003, the FASB
released a revision to FASB Interpretation No. 46 (FIN 46), Consolidation of
Variable Interest Entities, an Interpretation of ARB No. 51. FIN 46 requires
certain variable interest entities to be consolidated by the primary
beneficiary of the entity if the equity investors in the entity do not have the
characteristics of a controlling financial interest or do not have sufficient
equity at risk for the entity to finance its activities without additional
subordinated financial support from other parties. A public entity shall apply
the provisions of the FIN 46 revision no later than the end of the first
reporting period that ends after March 15, 2004. However, a public entity
shall apply FIN 46 to entities considered to be special-purpose entities no
later than as of the end of the first reporting period that ends after December
15, 2003. The adoption of this standard did not have a material impact on our
consolidated balance sheet or statement of operations. FACTORS THAT MAY AFFECT FUTURE OPERATING RESULTS We believe that our future operating results will continue to be subject
to quarterly variations based upon a wide variety of factors detailed in the
Risk Factors in Part I of our Annual Report on Form 10-K for the year ended
December 31, 2003, which information is incorporated by reference. Our actual
results in future periods may be significantly different from any future
performance suggested in this report. Although we believe that the
expectations reflected in the forward-looking statements are reasonable, we
cannot guarantee future results, levels of activity, performance or
achievements. Risks and uncertainties that may affect our results include,
among others:  
    
    A general economic weakness may further reduce our revenues.
    
    Engenio represents a significant portion of our business, and an
initial public offering, sale or spin-off of Engenio, may cause our
operating results to suffer and may cause net revenues and income to
decline.
    
    The separation and possible IPO, sale or spin-off of Engenio from us
is a substantial undertaking that may disrupt our ongoing business and
may increase expenses, which may adversely affect our results of
operations and financial condition.
    
    We operate in highly competitive markets.
    
    Our new products may not achieve market acceptance.
    
    The manufacturing facility we operate maintains high fixed costs.
    
    The manufacturing facility we operate is highly complex.
    
    We outsource the manufacturing of a substantial portion of the wafers we supply.
    
    We have significant capital requirements to maintain and grow our business.
    
    We are exposed to fluctuations in foreign currency exchange rates.
    
    We procure parts and raw materials from limited domestic and foreign sources.
    
    We are dependent on a limited number of customers.
    
    We utilize indirect channels of distribution over which we have limited control.
    
    Our operations are affected by cyclical fluctuations.
    
    We engage in acquisitions and alliances giving rise to economic and technological risks.
    
    The price of our securities may be subject to wide fluctuations.
    
    We may rely on capital and bank markets to provide liquidity.
    
    We design and develop products that are highly complex.
    
    Our global operations expose us to numerous international business risks.
    
    The high technology industry in which we operate is prone to intellectual property litigation. 34




---



##### Table of Contents




    
    Our manufacturing facilities may not achieve desired margins.
    
    Our manufacturing facilities are subject to disruption.
    
    We must attract and retain key employees in a highly competitive environment.
    
    Future changes in financial accounting standards or practices or
existing taxation rules or practices may cause adverse unexpected
fluctuations and affect our reported results of operations.
    
    Uncertainties related to attestation of internal controls. Public companies in the United States are required to review their
internal controls over financial reporting under the Sarbanes-Oxley Act of
2002. It should be noted that any system of controls, however well
designed and operated, can provide only reasonable, and not absolute,
assurance that the objectives of the system are met. In addition, the
design of any control system is based in part upon certain assumptions
about the likelihood of future events. Because of these and other inherent
limitations of control systems, there can be no assurance that any design
will achieve its stated goal under all potential future conditions,
regardless of how remote. We are currently undergoing a comprehensive
effort in preparation for compliance with Section 404 of the
Sarbanes-Oxley Act of 2002. This effort includes the documentation,
testing and review of our internal controls over financial reporting under
the direction of senior management. If our internal controls over
financial reporting are not adequate or in conformity with the
requirements of the Sarbanes-Oxley Act of 2002 and the rules and
regulations of the Securities and Exchange Commission, we may be required
to disclose deficiencies and take other actions which could result in the
use of significant financial and managerial resources, as well as be
subject to penalties and other enforcement actions, any of which may have
a material adverse effect on our business, financial condition, results of
operations and/or market price of our common stock. While management believes that the discussion and analysis in this report
is adequate for a fair presentation of the information, we recommend that you
read this discussion and analysis in conjunction with the Annual Report on Form
10-K. 
 Item 3. Quantitative and Qualitative Disclosures about Market Risk Interest rate sensitivity.We are subject to interest rate risk on our
investment portfolio, outstanding debt and equipment operating leases. Our
objective in managing interest rate risk is to protect cash flows and earnings
from the impact of fluctuations in interest rates while minimizing cost of
capital. In May 2003, we entered into an interest rate swap transaction to
effectively convert the LIBOR-based floating rate interest payments on the
equipment operating lease discussed in Note 14 of the Notes, with an original
notional amount of $395 million, to a fixed interest rate (Lease Swap). In
August of 2004, the Company entered into two new equipment operating leases for
the wafer fabrication equipment that was previously on the above-mentioned
leases. As a result of entering into the new leases, the hedged forecasted
interest payments are no longer probable to occur. Hedge accounting treatment
was discontinued prospectively and the balance in accumulated comprehensive
income was immediately recorded as a gain of $3.8 million in restructuring and
other items in the statement of operations. In September 2004, the Company
terminated the Lease Swap. As of September 30, 2004, $12 million was recorded
in other current assets for the amount to be received from the termination and
the collateral that will be returned to the Company. See Note 7 of the Notes. On October 27, 2004, the Company notified the required parties of its
intention to exercise its early buyout right to purchase all of the Equipment
under the two lease and security agreements discussed above, dated August 6,
2004. The date on which the purchase is to occur under each lease is November
29, 2004. See Note 14 of the Notes. An interest rate move of 40 basis-points (10% of our weighted-average
worldwide interest rate on outstanding debt in the nine months ended September
30, 2004) affecting our floating rate financial instruments as of September 30,
2004, including debt obligations, investments and fabrication equipment leases,
would not have had a significant effect on our financial position, results of
operations and cash flows over the next fiscal year, assuming that the
investment balance remains consistent. There have been no significant changes in the foreign currency exchange
risk or equity price risk during the nine months ended September 30, 2004, as
compared to the discussion in Part II of our Annual Report on Form 10-K for the
year ended December 31, 2003. 35




---



##### Table of Contents



Item 4. Controls and Procedures Our management evaluated, with the participation of our chief executive
officer and our chief financial officer, the effectiveness of our disclosure
controls and procedures pursuant to Rule 13a-15 promulgated under the
Securities Exchange Act of 1934 as of September 30, 2004. Based on this
evaluation, our chief executive officer and our chief financial officer have
concluded that our disclosure controls and procedures are effective to ensure
that information we are required to disclose in reports that we file or submit
under the Securities Exchange Act of 1934 is recorded, processed, summarized
and reported within the time periods specified in Securities and Exchange
Commission rules and forms. There was no change in our internal control over financial reporting that
occurred during the period covered by this Quarterly Report on Form 10-Q that
has materially affected, or is reasonably likely to materially affect, our
internal control over financial reporting. We are aware that any system of
control, however well designed and operated, can only provide reasonable, and
not absolute, assurance that the objectives of this system are met, and that
maintenance of disclosure controls and procedures is an ongoing process that
may change over time. 
 PART II  OTHER INFORMATION 
 Item 1. Legal Proceedings This information is included in Note 15 (Legal Matters) of the Notes to
the Unaudited Consolidated Financial Statements, which information is
incorporated herein by reference from Item 1 of Part I hereof. 
 Item 2. Unregistered Sales of Equity Securities and Use of Proceeds On July 28, 2000, the Companys Board of Directors authorized a new stock
repurchase program in which up to 5 million shares of the Companys common
stock may be repurchased in the open market from time to time. There is no
expiration date for the plan. No shares were repurchased under this plan during
the first nine months of 2004. There are 3.5 million shares available for
repurchase under this plan as of September 30, 2004. ISSUER PURCHASES OF SECURITIES (c)
    
    (d)(a)
    
    (b)
    
    Total Number of
    
    Maximum Number (orTotal Number
    
    Average Price
    
    Shares (or Units)
    
    Approximate Dollar Value)ofof Shares (or
    
    Paid per
    
    Purchased as Part of
    
    Shares (or Units) that May YetUnits)
    
    Share (or
    
    Publicly Announced
    
    Be Purchased Under the PlansPeriod
    
    Purchased
    
    Unit)
    
    Plans or Programs
    
    or ProgramsAugust 2004 *
    
    68,500 units
    
    
    0.99438
    
    
    n/a
    
    n/a
 * During the three months ended September 30, 2004, the Company
repurchased approximately $69 million of the 2001 Convertible Subordinated
Notes (the 2001 Convertible Notes) in open-market purchase transactions. The
purchase was an opportunistic buy back of convertible subordinated notes. A
net pre-tax gain of approximately $2 million was recognized, in interest income
and other, net, on the repurchases of the 2001 Convertible Notes. The pre-tax
gain is net of the write-off of debt issuance costs and a portion of the
deferred gain on the related terminated interest rate swap (see Note 9 of the
Notes). 36




---



##### Table of Contents



Item 6. Exhibits  2.1
    
    Real Estate Matters Agreement between LSI Logic Corporation and Engenio Information
Technologies, Inc., effective as of December 31, 2003.2.2
    
    Tax Sharing Agreement between LSI Logic Corporation and Engenio Information
Technologies, Inc., effective as of March 15, 2004.2.3
    
    Transition Services Agreement between LSI Logic Corporation and Engenio Information
Technologies, Inc., effective as of March 15, 2004.2.4
    
    Investor Rights Agreement between LSI Logic Corporation and Engenio Information
Technologies, Inc., effective as of March 15, 2004.10.1
    
    LSI Logic Corporation 1991 Equity Incentive Plan Nonqualified Stock Option Agreement.10.2
    
    Form of Notice of Grant under LSI Logic Corporation Nonqualified Stock Option Agreement.10.3
    
    LSI Logic Corporation 2003 Equity Incentive Plan Restricted Stock Unit Agreement.10.4
    
    Lease and Security Agreement (Lease A) dated as of August 6, 2004, among LSI Logic
Corporation, BTM Capital Corporation and Wells Fargo Bank Northwest, National
Association.10.5
    
    Omnibus Amendment to Lease and Security Agreement (Lease A) dated as of September
16, 2004 among LSI Logic Corporation, BTM Capital Corporation and Wells Fargo Bank
Northwest, National Association.10.6
    
    Lease and Security Agreement (Lease B) dated as of August 6, 2004, among LSI Logic
Corporation, Bank of the West and Wells Fargo Bank Northwest, National Association.10.7
    
    Omnibus Amendment to Lease and Security Agreement (Lease B) dated as of September
16, 2004, among LSI Logic Corporation, Bank of the West, and Wells Fargo Bank
Northwest, National Association.10.8
    
    Engenio Information Technologies, Inc. Amended and Restated 2004 Equity Incentive
Plan. Incorporated by reference from exhibits filed with the Current Report on Form
8-K on November 4, 2004.10.9
    
    Engenio Information Technologies, Inc. 2004 Equity Incentive Plan Nonqualified Stock
Option Agreement. Incorporated by reference from exhibits filed with the Current
Report on Form 8-K on November 4, 2004.10.10
    
    Form of Notice of Grant under Engenio Information Technologies, Inc. 2004 Equity
Incentive Plan Nonqualified Stock Option Agreement. Incorporated by reference from
exhibits filed with the Current Report on Form 8-K on November 4, 2004.31.1
    
    Certification of the Chief Executive Officer pursuant to Securities Exchange Act
Rules 13a-15(e) and 15d-1(e), as adopted pursuant to Section 302 of the
Sarbarnes-Oxley Act of 2002.31.2
    
    Certification of the Chief Financial Officer pursuant to Securities Exchange Act
Rules 13a-15(e) and 15d-1(e), as adopted pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.32.1
    
    Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. *32.2
    
    Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. * * Furnished not filed. 37




---



##### Table of Contents



SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized. LSI LOGIC CORPORATION
(Registrant)Date: November 12, 2004
    By       /s/ Bryon LookBryon LookExecutive Vice President &
Chief Financial Officer 38




---



##### Table of Contents



INDEX TO EXHIBITS  2.1
    
    Real Estate Matters Agreement between LSI Logic Corporation and Engenio Information
Technologies, Inc., effective as of December 31, 2003.2.2
    
    Tax Sharing Agreement between LSI Logic Corporation and Engenio Information
Technologies, Inc., effective as of March 15, 2004.2.3
    
    Transition Services Agreement between LSI Logic Corporation and Engenio Information
Technologies, Inc., effective as of March 15, 2004.2.4
    
    Investor Rights Agreement between LSI Logic Corporation and Engenio Information
Technologies, Inc., effective as of March 15, 2004.10.1
    
    LSI Logic Corporation 1991 Equity Incentive Plan Nonqualified Stock Option Agreement.10.2
    
    Form of Notice of Grant under LSI Logic Corporation Nonqualified Stock Option Agreement.10.3
    
    LSI Logic Corporation 2003 Equity Incentive Plan Restricted Stock Unit Agreement.10.4
    
    Lease and Security Agreement (Lease A) dated as of August 6, 2004, among LSI Logic
Corporation, BTM Capital Corporation and Wells Fargo Bank Northwest, National
Association.10.5
    
    Omnibus Amendment to Lease and Security Agreement (Lease A) dated as of September
16, 2004 among LSI Logic Corporation, BTM Capital Corporation and Wells Fargo Bank
Northwest, National Association.10.6
    
    Lease and Security Agreement (Lease B) dated as of August 6, 2004, among LSI Logic
Corporation, Bank of the West and Wells Fargo Bank Northwest, National Association.10.7
    
    Omnibus Amendment to Lease and Security Agreement (Lease B) dated as of September
16, 2004, among LSI Logic Corporation, Bank of the West, and Wells Fargo Bank
Northwest, National Association.10.8
    
    Engenio Information Technologies, Inc. Amended and Restated 2004 Equity Incentive
Plan. Incorporated by reference from exhibits filed with the Current Report on Form
8-K on November 4, 2004.10.9
    
    Engenio Information Technologies, Inc. 2004 Equity Incentive Plan Nonqualified Stock
Option Agreement. Incorporated by reference from exhibits filed with the Current
Report on Form 8-K on November 4, 2004.10.10
    
    Form of Notice of Grant under Engenio Information Technologies, Inc. 2004 Equity
Incentive Plan Nonqualified Stock Option Agreement. Incorporated by reference from
exhibits filed with the Current Report on Form 8-K on November 4, 2004.31.1
    
    Certification of the Chief Executive Officer pursuant to Securities and Exchange Act
Rules 13a-15(e) and 15d-1(e), as adopted pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.31.2
    
    Certification of the Chief Financial Officer pursuant to Securities and Exchange Act
Rules 13-15(e) and 15d-1(e), as adopted pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.32.1
    
    Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. *32.2
    
    Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. * * Furnished not filed. 39