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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 April 4, 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 May 7, 2004, there were 382,109,210 shares of the registrants Common
Stock, $.01 par value, outstanding.




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LSI LOGIC CORPORATION
Form 10-Q
For the Quarter Ended March 31, 2004
INDEX  
 PageNo.PART I. FINANCIAL INFORMATIONItem 1
    
    Financial StatementsConsolidated Balance
Sheets  March 31, 2004 (unaudited) and December 31, 2003
    
    
    3Consolidated Statements of Operations  Three Months Ended March 31, 2004 and 2003 (unaudited)
    
    
    4Consolidated Statements of Cash Flows  Three Months Ended March 31, 2004 and 2003 (unaudited)
    
    
    5Notes to Unaudited Consolidated Financial Statements
    
    
    6Item 2
    
    Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    16Item 3
    
    Quantitative and Qualitative Disclosures About Market Risk
    
    
    28Item 4
    
    Controls and Procedures
    
    
    29PART II. OTHER INFORMATIONItem 1
    
    Legal Proceedings
    
    
    29Item 2
    
    Changes of Securities, Use of Proceeds and Issuer Purchases of Equity Securities
    
    
    29Item 6
    
    Exhibits and Reports on Form 8-K
    
    
    29Signatures
    
    
    30Index to Exhibits
    
    
    31EXHIBIT 31.1EXHIBIT 31.2EXHIBIT 32.1EXHIBIT 32.2
  2




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PART I  FINANCIAL INFORMATION 
 Item 1. Financial Statements LSI LOGIC CORPORATION 
 CONSOLIDATED BALANCE SHEETS
 (UNAUDITED)
 March 31,
    
    December 31,2004
    
    2003(In thousands, except per-share amounts)AssetsCash and cash equivalents
    
    $
    273,414
    
    
    $
    269,682Short-term investments
    
    
    584,045
    
    
    
    544,007Accounts receivable, less allowances of $5,500 and $7,415
    
    
    247,344
    
    
    
    231,184Inventories
    
    
    205,652
    
    
    
    198,517Deferred tax assets
    
    
    7,646
    
    
    
    8,116Prepaid expenses and other current assets
    
    
    122,206
    
    
    
    138,531Total current assets
    
    
    1,440,307
    
    
    
    1,390,037Property and equipment, net
    
    
    464,520
    
    
    
    481,489Intangibles, net
    
    
    165,219
    
    
    
    161,236Goodwill
    
    
    968,747
    
    
    
    968,483Deferred tax assets
    
    
    7,434
    
    
    
    7,484Non-current assets and deposits
    
    
    297,468
    
    
    
    318,176Investment in equity securities
    
    
    36,064
    
    
    
    35,455Other assets
    
    
    83,836
    
    
    
    85,541Total assets
    
    $
    3,463,595
    
    
    $
    3,447,901Liabilities and Stockholders EquityAccounts payable
    
    $
    88,643
    
    
    $
    102,632Accrued salaries, wages and benefits
    
    
    73,596
    
    
    
    75,968Other accrued liabilities
    
    
    176,677
    
    
    
    153,857Income taxes payable
    
    
    56,870
    
    
    
    58,417Current portion of long-term obligations
    
    
    380
    
    
    
    377Total current liabilities
    
    
    396,166
    
    
    
    391,251Long-term debt and capital lease obligations
    
    
    861,813
    
    
    
    865,606Other non-current liabilities
    
    
    138,378
    
    
    
    141,096Total long-term obligations and other liabilities
    
    
    1,000,191
    
    
    
    1,006,702Commitments and contingencies (Note 13)Minority interest in subsidiary
    
    
    6,755
    
    
    
    7,498Stockholders equity:Preferred shares; $.01 par value; 2,000 shares authorized; none
outstanding
    
    
    
    
    
    
    Common stock; $.01 par value; 1,300,000 shares authorized;
382,033 and 381,491 shares outstanding
    
    
    3,820
    
    
    
    3,815Additional paid-in capital
    
    
    2,955,844
    
    
    
    2,950,051Deferred stock compensation
    
    
    (25,263
    )
    
    
    (24,839
    )Accumulated deficit
    
    
    (911,705
    )
    
    
    (920,790
    )Accumulated other comprehensive income
    
    
    37,787
    
    
    
    34,213Total stockholders equity
    
    
    2,060,483
    
    
    
    2,042,450Total liabilities and stockholders equity
    
    $
    3,463,595
    
    
    $
    3,447,901
 The accompanying notes are an integral part of these Consolidated Financial Statements. 3




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LSI LOGIC CORPORATION 
 CONSOLIDATED STATEMENTS OF OPERATIONS
 (UNAUDITED)
 Three Months EndedMarch 31,2004
    
    2003(In thousands, except per share amounts)Revenues
    
    $
    452,357
    
    
    $
    372,785Cost of revenues
    
    
    250,925
    
    
    
    248,068Gross profit
    
    
    201,432
    
    
    
    124,717Research and development
    
    
    108,941
    
    
    
    115,127Selling, general and administrative
    
    
    61,158
    
    
    
    57,629Restructuring of operations and other items, net
    
    
    (598
    )
    
    
    35,666Amortization of non-cash deferred stock compensation (*)
    
    
    1,826
    
    
    
    10,543Amortization of intangibles
    
    
    18,274
    
    
    
    20,125Income/(loss) from operations
    
    
    11,831
    
    
    
    (114,373
    )Interest expense
    
    
    (5,912
    )
    
    
    (8,831
    )Interest income and other, net
    
    
    9,166
    
    
    
    6,779Income/(loss) before income taxes
    
    
    15,085
    
    
    
    (116,425
    )Provision for income taxes
    
    
    6,000
    
    
    
    6,000Net income/(loss)
    
    $
    9,085
    
    
    $
    (122,425
    )Net income/(loss) per share:Basic
    
    $
    0.02
    
    
    $
    (0.33
    )Diluted
    
    $
    0.02
    
    
    $
    (0.33
    )Shares used in computing per share amounts:Basic
    
    
    381,639
    
    
    
    374,628Diluted
    
    
    389,882
    
    
    
    374,628
  (*) 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 endedMarch 31,2004
    
    2003(In thousands)Cost of revenues
    
    $
    50
    
    
    $
    182Research and development
    
    
    1,181
    
    
    
    8,150Selling, general and administrative
    
    
    595
    
    
    
    2,211Total
    
    $
    1,826
    
    
    $
    10,543
 The accompanying notes are an integral part of these Consolidated Financial Statements. 4




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LSI LOGIC CORPORATION 
 CONSOLIDATED STATEMENTS OF CASH FLOWS
 (UNAUDITED)
 Three Months EndedMarch 31,2004
    
    2003(In thousands)Operating activities:Net income/(loss)
    
    $
    9,085
    
    
    $
    (122,425
    )Adjustments:Depreciation and amortization
    
    
    46,116
    
    
    
    87,058Amortization of non-cash deferred stock compensation
    
    
    1,826
    
    
    
    10,543Non-cash restructuring and other items
    
    
    2,229
    
    
    
    29,754Gain on sale and exchange of equity securities, loss on write-down
    
    
    (3,000
    )
    
    
    7,006Gain on sale of property and equipment
    
    
    (3,101
    )
    
    
    (1,703
    )Changes in deferred tax assets and liabilities
    
    
    520
    
    
    
    (410
    )Changes in assets and liabilities, net of assets
acquired and liabilities assumed in acquisitions:Accounts receivable
    
    
    (15,368
    )
    
    
    24,160Inventories
    
    
    (6,190
    )
    
    
    (11,866
    )Prepaid expenses and other assets
    
    
    12,529
    
    
    
    (336
    )Accounts payable
    
    
    (12,761
    )
    
    
    (1,106
    )Accrued and other liabilities
    
    
    (21,778
    )
    
    
    1,205Net cash provided by operating activities
    
    
    10,107
    
    
    
    21,880Investing activities:Purchase of debt securities available-for-sale
    
    
    (229,440
    )
    
    
    (857,231
    )Maturities and sales of debt securities available-for-sale
    
    
    189,040
    
    
    
    885,609Purchase of equity securities
    
    
    (2,250
    )
    
    
    Purchase of property and equipment
    
    
    (11,557
    )
    
    
    (15,610
    )Proceeds from sale of property and equipment
    
    
    4,014
    
    
    
    4,533Proceeds from the sale-leaseback of equipment
    
    
    
    
    
    
    160,000Increase in non-current assets and deposits
    
    
    (23
    )
    
    
    (389,393
    )Decrease in non-current assets and deposits
    
    
    27,753
    
    
    
    238,983Acquisitions of companies, net of cash acquired
    
    
    (4,777
    )
    
    
    Increase in a payable to acquire a company
    
    
    17,592
    
    
    
    Net cash (used in)/provided by investing activities
    
    
    (9,648
    )
    
    
    26,891Financing activities:Repayment of debt obligations
    
    
    (122
    )
    
    
    (88
    )Purchase of minority interest in subsidiary
    
    
    (1,059
    )
    
    
    Issuance of common stock
    
    
    3,548
    
    
    
    242Net cash provided by financing activities
    
    
    2,367
    
    
    
    154Effect of exchange rate changes on cash and cash equivalents
    
    
    906
    
    
    
    756Increase in cash and cash equivalents
    
    
    3,732
    
    
    
    49,681Cash and cash equivalents at beginning of period
    
    
    269,682
    
    
    
    448,847Cash and cash equivalents at end of period
    
    $
    273,414
    
    
    $
    498,528
 The accompanying notes are an integral part of these Consolidated Financial Statements. 5




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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 April 4,
2004. For presentation purposes, the consolidated financial statements refer
to the calendar quarters for convenience. The results of operations for the
quarter ended April 4, 2004, are not necessarily indicative of the results to
be expected for the full year. The current quarter ended April 4, 2004 was a
14-week quarter while the same quarter of the previous year was a 13-week
quarter. 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. Certain items previously reported in specific financial statement captions
have been reclassified to conform to the current period presentation. Recent Accounting Pronouncements In March 2004, the Emerging Issues Task Force (EITF) issued EITF Issue
No. 03-06, Participating Securities and the Two-class Method Under FASB
Statement 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 Company does not believe that the adoption
of this standard will have a material impact on its 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. The recognition and
measurement guidance in EITF No. 03-01 should be applied to
other-than-temporary impairment evaluations in reporting periods beginning
after June 15, 2004. The disclosure requirements are effective for fiscal
years ending after June 15, 2004 and are required only for annual periods. 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 December 2003, the Financial Accounting Standards Board (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 the
consolidated balance sheet or statement of operations. NOTE 2  SEPARATION OF LSI LOGIC STORAGE SYSTEMS, INC. On November 13, 2003, the Company announced its intention to separate its
wholly-owned subsidiary, Engenio Information Technologies, Inc. (Engenio or
Storage Systems segment), and create an independent storage systems company.
Engenio was formerly referred to as LSI Logic Storage Systems, Inc. The
Company has entered into agreements to implement this separation and to address
various arrangements between Engenio and the Company. On February 19, 2004,
Engenio filed a registration statement on Form S-1 (the Registration
Statement) with the Securities and Exchange Commission (SEC). On March 31,
2004, Engenio filed Amendment No. 1 to the Registration Statement, and on May
10, 2004, Engenio filed Amendment No. 2 to the Registration Statement. 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 6




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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. The Company currently plans to receive the net proceeds of the offering
from Engenio in the form of a dividend and settlement of payables owed to the
Company. The Company may sell shares of Engenios common stock in the public
market or in private transactions, which may or may not include the sale of a
controlling interest in Engenio. The Company currently intends to distribute to its stockholders, by the
summer of 2005, all remaining shares of Engenios common stock held by the
Company at such time. We will determine the timing, structure and all terms of
the distribution, taking into account factors such as market conditions.
Completion of the distribution would also be contingent upon the receipt of a
favorable tax ruling from the Internal Revenue Service and/or a favorable
opinion from the Companys tax advisor as to the tax-free nature of the
distribution for U.S. federal income tax purposes. The Company is not obligated
to undertake the distribution, and the distribution may or may not occur by the
contemplated time or at all. NOTE 3  BUSINESS COMBINATIONS Acquisition of Velio Communications.On April 2, 2004, the Company
acquired Velio Communications, Inc. (Velio). The acquisition will 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. 7




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The Company paid approximately $19.8 million in cash ($2.2 million was
paid in the first quarter, and the remainder was paid early in the second
quarter of 2004). 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
    
    $
    1,783Current technology
    
    
    8,689Customer base
    
    
    8,689Non-compete agreements
    
    
    444Existing purchase orders
    
    
    200Total purchase price excluding deferred stock compensation
    
    
    19,805Deferred stock compensation
    
    
    1,000Total purchase price
    
    $
    20,805
 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 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 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 endedMarch 31,2004
    
    2003(In thousands, except pershare amounts)Net income/(loss), as reported
    
    $
    9,085
    
    
    $
    (122,425
    )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 *
    
    
    1,274
    
    
    
    3,901Deduct: Total stock-based employee
compensation expense determined under fair
value method for all awards, net of related tax
effects
    
    
    (37,841
    )
    
    
    (55,806
    )Pro forma net loss **
    
    $
    (27,482
    )
    
    $
    (174,330
    )Income/(loss) per share:Basic-as reported
    
    $
    0.02
    

    
    $
    (0.33
    )Basic-pro forma
    
    $
    (0.07
    )
    
    $
    (0.47
    )Diluted-as reported
    
    $
    0.02
    
    
    $
    (0.33
    )Diluted-pro forma
    
    $
    (0.07
    )
    
    $
    (0.47
    )
  *
    
    This amount excludes amortization of non-cash deferred stock compensation on
restricted stock awards.**
    
    The amount for the three months ended March 31, 2003 has been adjusted to
reflect higher calculated fair values for the Employee Stock Purchase Plan,
which resulted in a 2% increase in the pro forma net loss in the first quarter
of 2003. 8




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NOTE 5  RESTRUCTURING AND OTHER ITEMS The Company recorded a net gain of $0.6 million in restructuring of
operations and other items during the first quarter of 2004, primarily in the
Semiconductor segment. The Company recorded charges of $35.7 million for
restructuring of operations and other items during the first quarter of 2003.
For a complete discussion of the 2003 restructuring actions, please refer to
the Companys Annual Report on Form 10-K. 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. The fair values of impaired equipment, facilities and intangible assets
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.
Assets held for sale of $28 million and $30 million were included as a
component of prepaid expenses and other current assets as of March 31, 2004 and
December 31, 2003, respectively. Assets classified as held for sale are not
depreciated. The following table sets forth the Companys restructuring reserves as of
March 31, 2004, which are included in other accrued liabilities on the balance
sheet: Balance at
    
    Restructuring
    
    Utilized
    
    Balance atDecember
    
    Expense
    
    during Q1
    
    March 31,31, 2003
    
    Q1 2004
    
    2004
    
    2004(In thousands)Write-down of excess assets (a)
    
    $
    2,661
    
    
    $
    (1,118
    )
    
    $
    718
    
    
    $
    2,261Lease terminations and maintenance
contracts (b)
    
    
    21,021
    
    
    
    252
    
    
    
    (1,886
    )
    
    
    19,387Facility closure and other exit costs (c)
    
    
    2,136
    
    
    
    64
    
    
    
    (782
    )
    
    
    1,418Payments to employees for severance (d)
    
    
    874
    
    
    
    204
    
    
    
    (767
    )
    
    
    311Total
    
    $
    26,692
    
    
    $
    (598
    )
    
    $
    (2,717
    )
    
    $
    23,377
  (a)
    
    The amounts utilized in 2004 reflect $2.2 million of non-cash write-downs
of long-lived assets in the U.S. due to impairment and $0.4 million in
cash payments to decommission and sell assets, offset by $3.3 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 $2.3 million balance as of
March 31, 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 2004.  (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 2004.  (d)
    
    Amounts utilized represent cash severance payments to fourteen employees
during the three months ended March 31, 2004. The balance remaining for
severance is expected to be paid by the end of the second quarter of 2004. 9




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NOTE
6  INVESTMENTS March 31,
    
    December 31,2004
    
    2003(In thousands)Available-for-sale debt securitiesAsset and mortgage-backed securities
    
    $
    352,202
    
    
    $
    345,625U.S. government and agency securities
    
    
    157,289
    
    
    
    104,173Corporate and municipal debt securities
    
    
    71,401
    
    
    
    90,730Auction rate preferred stock
    
    
    3,153
    
    
    
    3,150Foreign debt securities
    
    
    
    
    
    
    329Total short-term investments
    
    $
    584,045
    
    
    $
    544,007Long-term investment in equity securities
    
    $
    36,064
    
    
    $
    35,455
 An unrealized gain on available-for-sale securities of $7 million, net of
the related tax effect of $4 million, and $8 million, net of the related tax
effect of $4 million, was included in accumulated other comprehensive income as
of March 31, 2004 and December 31, 2003, respectively. Net realized gains on
sales of available-for-sale debt securities were $1 million and $7 million for
the three months ended March 31, 2004 and 2003, respectively. For the quarter ended March 31, 2004, the Company realized a net pre-tax
loss of $1 million related to losses from investments in non-marketable equity
securities associated with certain investments in equity securities because
management believed the decline in value was other than temporary. As of March
31, 2004, the carrying value of equity securities impaired during the first
quarter of 2004 was $3 million. There were no impairments related to
investments in marketable available-for-sale equity securities during the
quarter ended March 31, 2004. The Company realized 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 during the quarter
ended March 31, 2004. For the quarter ended March 31, 2003, the Company realized a net pre-tax
loss of $3 million and $4 million associated with the decline in value of
long-term investments in marketable and non-marketable equity securities,
respectively. The decline in value was considered by management to be other
than temporary. As of March 31, 2004, the carrying value of the non-marketable
and marketable equity securities impaired during the first quarter of 2003 was
$1 million and $4 million, respectively. NOTE 7- DERIVATIVE FINANCIAL INSTRUMENTS Foreign currency risk The Company has foreign subsidiaries that operate and sell the Companys
products in various global markets. As a result, the Company is exposed to
changes in foreign currency exchange rates and interest rates. The Company
utilizes various hedge instruments, primarily forward contracts and currency
option contracts, to manage its exposure associated with firm intercompany and
third-party transactions and net asset and liability positions denominated in
non-functional currencies. 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 March 31, 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 nine-month and
twelve-month periods, respectively. For the three months ended March 31, 2004,
the change in time value of these forward contracts was not significant. As of
March 31, 2004, unrealized losses included in accumulated other comprehensive
income, which will be reclassified to the income statement over the next nine
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 months ended March 31, 2004 and the benefit for three months
ended March 31, 2003 reclassified to the income statement was not significant.
The Company did not record any gains or losses due to hedge ineffectiveness for
the three months ended March 31, 2004 and 2003. 10




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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. 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 13 of the Notes,
with an initial notional amount of $395 million, to a fixed interest rate (the
Lease Swap). The Lease Swap qualifies 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. The
unrealized gains or losses included in accumulated other comprehensive income
will be reclassified to cost of revenues on a quarterly basis as lease payments
are made. An unrealized loss of approximately $1 million, net of tax of $1
million was included in accumulated other comprehensive income as of March 31,
2004 and December 31, 2003, respectively, and is expected to be reclassified to
cost of revenues within the next 12 months. The loss due to ineffectiveness
recorded in interest income and other, net during the three months ended March
31, 2004 was not significant. Under the terms of the Lease Swap, the Company
must provide collateral to match any mark-to-market exposure on the swap. As
of March 31, 2004 and December 31, 2003, collateral of approximately $8 million
was included in other long-term assets. NOTE 8- BALANCE SHEET DETAIL March 31,
    
    December 31,2004
    
    2003(In thousands)Cash and cash equivalents:Cash in financial institutions
    
    $
    86,402
    
    
    $
    108,989Cash equivalents
    
    
    187,012
    
    
    
    160,693$
    273,414
    
    
    $
    269,682Inventories:Raw materials
    
    $
    22,139
    
    
    $
    15,352Work-in-process
    
    
    123,714
    
    
    
    116,340Finished goods
    
    
    59,799
    
    
    
    66,825$
    205,652
    
    
    $
    198,517Intangible assets, net of accumulated amortization:Semiconductor segment
    
    $
    144,452
    
    
    $
    137,230Storage Systems segment
    
    
    20,767
    
    
    
    24,006$
    165,219
    
    
    $
    161,236Goodwill:Semiconductor segment
    
    $
    888,114
    
    
    $
    887,992Storage Systems segment
    
    
    80,633
    
    
    
    80,491$
    968,747
    
    
    $
    968,483
 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 11




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##### Table of Contents



accordance with SFAS No. 142, which uses a fair value model for determining the
carrying value of goodwill. See the Companys Annual Report on Form 10-K for
further discussion. NOTE 9  DEBT Interest
    
    Conversion
    
    March 31,
    
    December 31,Maturity
    
    Rate *
    
    Price
    
    2004
    
    2003(In thousands)2003 Convertible Subordinated
Notes
    
    
    2010
    
    
    
    4.00
    %
    
    $
    13.4200
    
    
    $
    350,000
    
    
    $
    350,0002001 Convertible Subordinated
Notes
    
    
    2006
    
    
    
    4.00
    %
    
    $
    26.3390
    
    
    
    490,000
    
    
    
    490,000Deferred gain on terminated swap
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    21,748
    
    
    
    25,416Capital lease obligations
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    445
    
    
    
    567862,193
    
    
    
    865,983Current portion of long-term debt
and capital lease obligations
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (380
    )
    
    
    (377
    )Long-term debt and capital
lease obligations
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    861,813
    
    
    $
    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 March 31, 2004
and 2003, was 4.00% and 2.11%, respectively. NOTE 10  RECONCILIATION OF BASIC AND DILUTED INCOME/(LOSS) PER SHARE A reconciliation of the numerators and denominators of the basic and
diluted loss per share computations is as follows: Three Months Ended March 31,2004
    
    2003Per-Share
    
    
    
    
    
    
    
    
    
    Per-ShareIncome*
    
    Shares+
    
    Amount
    
    Loss*
    
    Shares+
    
    Amount(In thousands except per share amounts)Basic EPS:Net income/(loss) available to common stockholders
    
    $
    9,085
    
    
    
    381,639
    
    
    $
    0.02
    
    
    $
    (122,425
    )
    
    
    374,628
    
    
    $
    (0.33
    )Stock options and restricted stock awards
    
    
    
    
    
    
    8,243
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Diluted EPS:Net income/(loss) available to common stockholders
    
    $
    9,085
    
    
    
    389,882
    
    
    $
    0.02
    
    
    $
    (122,425
    )
    
    
    374,628
    
    
    $
    (0.33
    )
 *      Numerator +      Denominator Options to purchase 42,726,738 shares were outstanding at March 31, 2004
but were not included in the computation of diluted shares for the quarter
ended March 31, 2004 because the exercise prices of these options were greater
than the average market price of common shares for the quarter. The exercise
price of these options ranged from $10.09 to $72.25 at March 31, 2004. Options
to purchase 68,127,695 shares were outstanding at March 31 2003, and were
excluded from the computation of diluted shares because of their antidilutive
effect. The exercise price of these options ranged from $0.06 to $72.25 at
March 31, 2003. Weighted average potentially dilutive shares of 44,684,052 associated with
the 2003 and 2001 Convertible Notes were excluded from the calculation of
diluted shares because of their antidilutive effect on net income per share for
the three months ended March 31, 2004. For the three months ended March 31,
2003, weighted average potentially dilutive shares of 44,808,851 associated
with the 12




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2001, 2000 and 1999 Convertible Notes were excluded from the calculation
of diluted shares because of their antidilutive effect on net loss per share. NOTE 11  COMPREHENSIVE INCOME/(LOSS) Comprehensive income/(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 income/(loss), net of taxes for the current reporting period and
comparable period in the prior year is as follows: Three Months Ended March 31,2004
    
    2003(In thousands)Net income/(loss)
    
    $
    9,085
    
    
    $
    (122,425
    )Change in unrealized gain on derivative instruments
designated as and qualifying as cash-flow hedges
    
    
    (903
    )
    
    
    479Change in unrealized gain on available-for-sale securities
    
    
    (696
    )
    
    
    257Change in foreign currency translation adjustments
    
    
    5,173
    
    
    
    2,192Comprehensive income/(loss)
    
    $
    12,659
    
    
    $
    (119,497
    )
 NOTE 12  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. The 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 months
ended March 31, 2004 and 2003: Three months ended March 31,2004
    
    2003(In thousands)Revenues:Semiconductor
    
    $
    336,898
    
    
    $
    273,064Storage Systems
    
    
    115,459
    
    
    
    99,721Total
    
    $
    452,357
    
    
    $
    372,785Income/(loss) from operations:Semiconductor
    
    $
    1,174
    
    
    $
    (107,894
    )Storage Systems
    
    
    10,657
    
    
    
    (6,479
    )Total
    
    $
    11,831
    
    
    $
    (114,373
    )
 Intersegment revenues for the periods presented above were not
significant. For the three months ended March 31, 2004, restructuring of
operations and other items of a credit of $1 million is primarily included in
the Semiconductor segment. For the three months ended March 31, 2003,
restructuring of operations and other items of $21 million and $15 million were
included in the Semiconductor segment and the Storage Systems segment,
respectively. 13




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##### Table of Contents



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 March 31,2004
    
    2003Semiconductor segment:Number of significant customers
    
    
    
    
    
    
    1Percentage of segment revenues
    
    
    
    
    
    
    12
    %Storage Systems segment:Number of significant customers
    
    
    3
    
    
    
    3Percentage of segment revenues
    
    
    51%, 14%, 14
    %
    
    
    41%, 15%, 13
    %Consolidated:Number of significant customers
    
    
    1
    
    
    
    1Percentage of consolidated revenues
    
    
    15
    %
    
    
    13
    %
 The following is a summary of total assets by segment as of March 31, 2004
and December 31, 2003: March 31,
    
    December 31,2004
    
    2003(In thousands)Total assets:Semiconductor
    
    $
    3,127,564
    
    
    $
    3,115,610Storage Systems
    
    
    336,031
    
    
    
    332,291Total
    
    $
    3,463,595
    
    
    $
    3,447,901
 Revenues from domestic operations were $245 million, representing 54% of
consolidated revenues for the three months ended March 31, 2004 compared to
$207 million, representing 56% of consolidated revenues for the same period of
2003. NOTE 13  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. As of March 31, 2004, the
amount under both leases was fully drawn. 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. The resulting $57 million gain on
the sale of the Equipment will be deferred until the end of the lease term and
has been recorded as a non-current liability as of March 31, 2004. The Company
has $340 million in cash that is posted as collateral for the leases. The
lessor has access to the Companys cash collateral only in the event of a
default. Of this cash collateral, $51 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 $289 million is recorded in other
non-current assets. In addition, the Company is required to maintain
unrestricted cash and short-term investments reserves in an amount no less than
$350 million. The Company was in compliance with this requirement as of March
31, 2004. The Company guarantees residual values related to leased equipment. As of
March 31, 2004, its maximum potential exposure to residual value guarantees was
approximately $163 million and the Company does not expect to have a loss on
such guarantees. The 14




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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 $7 million as of March 31, 2004. In connection with the equipment operating leases described above, the
Company entered into standby letters of credit for $63 million to expire at the
end of the lease term. These instruments are off-balance sheet commitments to
extend financial guarantees. The fair value of the letters of credit
approximates the contract amount. No officer or employee of the Company has any financial interest in these
leasing arrangements. The minimum lease payments, excluding the residual value
guarantees, under the two lease agreements are $48 million, $62 million and $45
million in 2004, 2005 and 2006, respectively. 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. The Company renegotiated the existing lease agreements for five
buildings located in California in the first quarter of 2004. The future
minimum payments for these renegotiated building leases will be $2 million, $3
million, $4 million, $4 million, $4 million and $20 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 14  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 sought an
infringement judgment, an injunction, treble damages, attorneys fees and
further relief as the court may provide. In September 1999, the Company filed
an answer denying infringement, raising affirmative defenses and asserting a
counterclaim for declaratory judgment of non-infringement, invalidity and
unenforceability of Lemelsons patents. As of March 1, 2004, the discovery
phase was continuing. Initial patent claim construction briefs have been
served. As of this time, no claim construction hearing or 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 June 14, 2002, Plasma Physics Corporation (Plasma Physics) filed suit
against the Company in the Eastern District of New York, alleging that the
Company is willfully and deliberately infringing two U.S. patents. LSI was
served with the lawsuit in December of 2002. The case is number CV 02-3462
(LDW) (WDW). The two Plasma Physics patent numbers are 5,470,784 and 6,245,648.
No specific Company products were identified in the complaint. The plaintiff
sought an infringement judgment, an injunction, treble damages, attorneys fees
and further relief as the court may provide. Similar lawsuits were also filed
at the same time against several other corporations. In January of 2003, the
Company answered the complaint denying infringement, asserting affirmative
defenses and asserting counterclaims for judgments declaring patent
non-infringement, declaring patent invalidity, and declaring the patents
unenforceable. The parties currently are to be prepared for trial by July 19,
2004. 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. 15




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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. 
 Item 2. Managements Discussion and Analysis of Financial Condition and
Results of Operations Statements in this discussion and analysis include forward-looking
information within the meaning of Section 27A of the Securities Act of 1933, as
amended, and Section 21E of the Securities Exchange Act of 1934, as amended.
All forward-looking statements included in this discussion and analysis are
based on information available to us on the date of filing of this Quarterly
Report onForm 10-Q, and we assume no obligation to update any such
forward-looking statements. These statements involve known and unknown risks
and uncertainties. Our actual results in future periods may be significantly
different from any future performance suggested in this report. In some cases,
you can identify forward-looking statements by terminology such as may,
will, expects, plans, anticipates, believes, estimates, intends,
projects, predicts, or similar expressions. For such statements, we claim
the protection under the safe harbor for forward-looking statements contained
in the Private Securities Litigation Reform Act of 1995. 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. OVERVIEW Revenues for the quarter ended March 31, 2004, were approximately $452.4
million compared to revenues of $462.8 million and $372.8 million for the
quarters ended December 31, 2003 and March 31, 2003, respectively. We reported
net income of 2 cents per diluted share for each of the quarters ended March
31, 2004 and December 31, 2003. We reported a net loss of 33 cents per diluted
share for the quarter ended March 31, 2003. In 2003, we were still recovering
from the economic downturn that began in 2001. In the second quarter of 2004,
we expect total consolidated revenues to increase to a range of $455 million to
$470 million. We expect our net income per diluted share to be $0.01 to $0.03
in the second quarter of 2004. For the first quarter of 2004, operating cash flows were positive and cash
and short-term investments increased to $857.5 million, up from $813.7 million
at December 31, 2003. Separation of our Storage Systems business.On November 13, 2003, we
announced our intention to separate our storage systems operations  Engenio
Information Technologies, Inc. (Engenio or Storage Systems segment) and
create an independent storage systems company. Engenio was formerly referred
to as LSI Logic Storage Systems, Inc. We have entered into agreements to
implement this separation and to address various arrangements between Engenio
and us. A more comprehensive discussion of the separation agreements is set
forth in Note 2 of the Notes. On February 19, 2004, Engenio filed a
Registration Statement on Form S-1, (the Registration Statement) with the
Securities and Exchange Commission (SEC). On March 31, 2004, Engenio filed
Amendment No. 1 to the Registration Statement, and on May 10, 2004, Engenio
filed Amendment No. 2 to the Registration Statement. If the initial public
offering is completed as currently intended, we plan to receive the net cash
proceeds from the offering from Engenio in the form of a dividend and
settlement of payables owed to us. We may sell shares of Engenios common
stock in the public market or in private transactions, which may or may not
include the sale of a controlling interest in Engenio. We currently intend to distribute to our stockholders, by the summer of
2005, all remaining shares of Engenios common stock held by us at such time.
We will determine the timing, structure and all terms of the distribution,
taking into account factors such as market conditions. Completion of the
distribution would also be contingent upon the receipt of a favorable tax
ruling from the Internal Revenue Service and/or a favorable opinion from our
tax advisor as to the tax-free nature of the distribution for U.S. federal
income tax purposes. We are not obligated to undertake the distribution, and
the distribution may or may not occur by the contemplated time or at all. Significant acquisition.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 that was accounted for as a purchase
of a business 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 acquisition.
The transaction is summarized in the table below. There were no significant
differences between our accounting policies and those of the company acquired.
(See Note 3 of the Notes.) 16




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##### 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)Velio Communications, Inc;
Semiconductor segment;
High-speed interconnect
and switch fabric
application specific
standard products
    
    April 2, 2004
    
    $
    20.8
    
    
    $19.8 cash; and
0.1 million
restricted common
shares
    
    $
    1.8
    
    
    
    
    $
    18.0
    
    
    
    
    $
    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 endedMar. 31, 2004
    
    Dec. 31, 2003
    
    Mar. 31, 2003(in millions)Semiconductor segment
    
    $
    336.9
    
    
    $
    344.0
    
    
    $
    273.1Storage Systems segment
    
    
    115.5
    
    
    
    118.8
    
    
    
    99.7Consolidated
    
    $
    452.4
    
    
    $
    462.8
    
    
    $
    372.8
 There were no significant intersegment revenues during the periods presented. First quarter of 2004 compared to the fourth quarter of 2003 Total consolidated revenues for the first quarter of 2004 decreased $10.4
million or 2% from the fourth quarter of 2003. Revenues for the Semiconductor segment decreased $7.1 million or 2% in the
first quarter of 2004 as compared to the previous quarter. The decrease is
primarily attributable to a seasonal decline in demand for semiconductors used
in certain consumer product applications such as video game consoles. The
decline in revenues was partially offset by increased demand for semiconductors
used in storage component applications, such as disk drive solutions, and
certain other consumer product applications, such as DVD-recordable. Revenues for the Storage Systems segment decreased $3.3 million or 3% from
the fourth quarter of 2003. Three months ended March 31, 2004 compared to the same period of 2003 Total consolidated revenues for the first quarter of 2004 increased $79.6
million or 21% as compared to the first quarter of 2003. Revenues for the Semiconductor segment increased $63.8 million or 23% for
the first quarter of 2004 as compared to the same period of the previous year.
The increase in revenues is primarily attributable to increased demand for
semiconductors used in storage component applications, such as disk drive
solutions, Ultra 320 SCSI standard products and Host Bus Adapters
(HBAs), semiconductors
used in certain consumer product applications, such as DVD-recordable and
digital audio, and increased demand for semiconductors used in communications
product applications, such as Ethernet switching and metro networking products.
The above noted increases in revenues were partially offset by lower demand for
semiconductors used in certain other consumer product applications, such as
video games. 17




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Revenues for the Storage Systems segment increased $15.8 million or 16%
for the first quarter of 2004 from the same period of 2003. The increase was
due to a significant increase in revenues from IBM by 45% from the first quarter
of 2003 to the first quarter of 2004. As a percentage of Storage Systems
segments revenues, revenues from IBM increased from 41% in the first quarter
of 2003 to 51% in the first quarter of 2004. The increase in revenues from IBM
was primarily due to growth in demand for our controller and related enclosure
products. Aggregate revenues from StorageTek and the Teradata division of NCR
also increased by $4.2 million in the first quarter of 2004 as compared to the
first quarter of 2003 primarily as a result of two large shipments for
controller and related enclosure 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: Three months ended March 31,2004
    
    2003Semiconductor segment:Number of significant customers
    
    
    
    
    
    
    1Percentage of segment revenues
    
    
    
    
    
    
    12
    %Storage Systems segment:Number of significant customers
    
    
    3
    
    
    
    3Percentage of segment revenues
    
    
    51%, 14%, 14
    %
    
    
    41%, 15%, 13
    %Consolidated:Number of significant customers
    
    
    1
    
    
    
    1Percentage of consolidated revenues
    
    
    15
    %
    
    
    13
    %
 Revenues by geography.The following table summarizes our revenues by
geography: Three months endedMar. 31, 2004
    
    Dec. 31, 2003
    
    Mar. 31, 2003(in millions)Revenues:North America
    
    $
    244.8
    
    
    $
    230.6
    
    
    $
    206.9Asia, including
Japan
    
    
    164.7
    
    
    
    190.1
    
    
    
    124.9Europe
    
    
    42.9
    
    
    
    42.1
    
    
    
    41.0Total
    
    $
    452.4
    
    
    $
    462.8
    
    
    $
    372.8
 In the first quarter of 2004, revenues increased in North America mainly
as a result of growth in demand for semiconductors used in storage component
product applications as compared to the fourth and first quarters of 2003. The
decline in revenues in Asia, including Japan for the first quarter of 2004
compared to the fourth quarter of 2003 is mainly due to a seasonal decline in
demand for our semiconductors used in consumer product applications, such as
video games. The increase in revenues in Asia, including Japan, in the first
quarter of 2004, as compared to first quarter of 2003, is primarily
attributable to higher demand for semiconductors used in storage component and
other consumer product applications. 18




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Operating costs and expenses.Key elements of the consolidated statements of
operations for the respective segments are as follows: Gross profit margin: Three months endedMar. 31, 2004
    
    Dec. 31, 2003
    
    Mar. 31, 2003(in millions)Semiconductor segment
    
    $
    156.2
    
    
    $
    155.4
    
    
    $
    88.5Percentage of segment revenues
    
    
    46
    %
    
    
    45
    %
    
    
    32
    %Storage Systems segment
    
    $
    45.2
    
    
    $
    43.4
    
    
    $
    36.2Percentage of segment revenues
    

    
    39
    %
    
    
    37
    %
    
    
    36
    %Consolidated
    
    $
    201.4
    
    
    $
    198.8
    
    
    $
    124.7Percentage of total revenues
    
    
    45
    %
    
    
    43
    %
    
    
    33
    %
 First quarter of 2004 compared to the fourth quarter of 2003 The consolidated gross profit margin as a percentage of revenues increased
to 45% in the first quarter of 2004 from 43% in the fourth quarter of 2003. The gross profit margin as a percentage of revenues for the Semiconductor
segment increased to 46% in the first quarter of 2004 from 45% in the fourth
quarter of 2003. The improvement in gross profit margin for the semiconductor
segment was primarily attributable to the following factors:  
    
    Improved efficiencies and higher utilization in the Gresham
manufacturing facility;
    
    A reduction in cost of revenues as a result of the sale of our
Japanese manufacturing facility in the fourth quarter of 2003;
    
    Lower charges for obsolete and unmarketable inventories in the first
quarter of 2004 as compared to the fourth quarter of 2003; and
    
    A favorable shift to selling more relatively higher margin products. The favorable impacts on gross profit margin in the Semiconductor segment
were partially offset by lower sales of previously reserved inventory in the
first quarter of 2004, as compared to the fourth quarter of 2003. The gross profit margin as a percentage of revenues for the Storage
Systems segment increased to 39% in the first quarter of 2004 from 37% in the
fourth quarter of 2003. We expect our consolidated gross profit margin to be in the range of 45%
to 46% in the second quarter of 2004, compared to 45% for the first quarter of
2004. Three months ended March 31, 2004 compared to the same period of 2003 The consolidated gross profit margin as a percentage of revenues increased
to 45% in the first quarter of 2004 from 33% in the first quarter of 2003. The gross profit margin as a percentage of revenues for the Semiconductor
segment increased to 46% in the first quarter of 2004 from 32% in the
first
quarter 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 to selling products with higher
margins in the first quarter of 2004 as compared to the first quarter of
2003;
    
    Lower manufacturing variances in the Gresham manufacturing facility
associated with yield improvements, improved operating efficiencies and
better utilization; and
    
    Lower cost of revenues as a result of the sale of our Japanese
manufacturing facility in the fourth quarter of 2003. The gross profit margin as a percentage of revenues for the Storage
Systems segment increased to 39% in the first quarter of 2004 from 36% in the
first quarter of 2003. The improvement in gross profit margin as a percentage
of Storage Systems segment revenues 19




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is primarily a result of a reduction in the amortization of capitalized
software due to the restructuring actions taken during the first quarter of
2003, lower charges for warranties and lower charges for excess and obsolete
inventory during the first quarter of 2004 as compared to the same period of 2003. Factors that may affect gross profit margins We have advanced wafer-manufacturing operations in Oregon, which is our
primary manufacturing site. 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, require that we manage a
variety of factors. 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. These and other factors could have a significant effect on our gross
profit margin in future periods. Research and development: Three months endedMar. 31, 2004
    
    Dec. 31, 2003
    
    Mar. 31, 2003(in millions)Semiconductor segment
    
    $
    94.8
    
    
    $
    89.6
    
    
    $
    105.1Percentage of segment
revenues
    
    
    28
    %
    
    
    26
    %
    
    
    38
    %Storage Systems segment
    
    $
    14.1
    
    
    $
    12.8
    
    
    $
    10.0Percentage of segment
revenues
    
    
    12
    %
    
    
    11
    %
    
    
    10
    %Consolidated
    
    $
    108.9
    
    
    $
    102.4
    
    
    $
    115.1Percentage of revenues
    
    
    24
    %
    
    
    22
    %
    
    
    31
    %
 First quarter of 2004 compared to the fourth quarter of 2003 Research and development (R&D) expenses increased $6.5 million or 6% in
the first quarter of 2004 as compared to the fourth quarter of 2003 on a
consolidated basis. As a percentage of revenues, consolidated R&D expenses
increased to 24% in the first quarter of 2004 from 22% in the fourth quarter of
2003. R&D expenses in the Semiconductor segment increased $5.2 million or 6% in
the first quarter of 2004 as compared to the fourth quarter of 2003. The
increase in R&D expenses for the Semiconductor segment is primarily due to
increased spending for advanced sub-micron process technologies including the
RapidChip platform infrastructure and increased compensation-related costs. As discussed above, we continued the build-out of the RapidChip platform
infrastructure in the first 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 20




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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 first quarter of 2004. R&D expenses for the Semiconductor segment increased to 28% of revenues in
the first quarter of 2004 from 26% in the fourth quarter of 2003. This is a
result of lower revenues and higher R&D expenses for the first quarter of 2004
as compared to the fourth quarter of 2003. R&D expenses in the Storage Systems segment increased $1.3 million or 10%
in the first quarter of 2004 as compared to the fourth quarter of 2003. Three months ended March 31, 2004 compared to the same period of 2003 R&D expenses, on a consolidated basis, decreased $6.2 million or 5% during
the first quarter of 2004 as compared to the first quarter of 2003. As a
percentage of revenues, consolidated R&D expenses decreased to 24% in the first
quarter of 2004 from 31% in the same quarter of 2003. R&D expenses for the Semiconductor segment decreased $10.3 million or 10%
in the first quarter of 2004 as compared to the same period of 2003. The
decrease in R&D expenses for the Semiconductor segment is primarily a result of
benefits from the cost-cutting measures implemented as part of the
restructuring actions of 2003 (see Note 5 of the Notes). For the Semiconductor segment, R&D expenses as a percentage of revenues
decreased to 28% in the first quarter of 2004 from 38% in the same period of
2003. The decrease in R&D expenses as a percentage of revenues for the
Semiconductor segment is a result of higher revenues and lower R&D expenses in
the first quarter of 2004 as compared to the same period of 2003. R&D expenses for the Storage Systems segment increased by $4.1 million or
41% in the first quarter of 2004 as compared to the same period of 2003
primarily as a result of increased compensation-related costs due to increased
headcount and related expenses and higher expenses for outside service
providers related to development programs. R&D expenses as a percentage of
revenues for the Storage Systems segment increased to 12% in the first quarter
of 2004 from 10% in the same quarter of 2003. Selling, general and administrative: Three months endedMar. 31, 2004
    
    Dec. 31, 2003
    
    Mar. 31, 2003(in millions)Semiconductor segment
    
    $
    43.9
    
    
    $
    45.8
    
    
    $
    42.9Percentage of segment
revenues
    
    
    13
    %
    
    
    13
    %
    
    
    16
    %Storage Systems segment
    
    $
    17.3
    
    
    $
    16.1
    
    
    $
    14.7Percentage of segment
revenues
    
    
    15
    %
    
    
    14
    %
    
    
    15
    %Consolidated
    
    $
    61.2
    
    
    $
    61.9
    
    
    $
    57.6Percentage of revenues
    
    
    14
    %
    
    
    13
    %
    
    
    15
    %
 First quarter of 2004 compared to the fourth quarter of 2003 Selling, general and administrative (SG&A) expenses decreased $0.7
million or 1% during the first quarter of 2004 from the fourth quarter of 2003
on a consolidated basis. As a percentage of revenues, consolidated SG&A
expenses increased to 14% in the first quarter of 2004 from 13% in the fourth
quarter of 2003. SG&A expenses for the Semiconductor segment decreased $1.9 million or 4%
in the first quarter of 2004 as compared to the fourth quarter of 2003. For the
Semiconductor segment, SG&A expenses, as a percentage of revenues, remained
unchanged at 13% in the first quarter of 2004 as compared with the fourth
quarter of 2003. 21




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SG&A expenses for the Storage Systems segment increased $1.2 million or 7%
when comparing the first quarter of 2004 to the fourth quarter of 2003. Three months ended March 31, 2004 compared to the same period of 2003 Consolidated SG&A expenses increased $3.6 million or 6% during the first
quarter of 2004 as compared to the first quarter of 2003. As a percentage of
revenues, SG&A expenses decreased to 14% in the first quarter of 2004 as
compared with 15% during the same period of 2003 on a consolidated basis. SG&A expenses for the Semiconductor segment increased $1.0 million or 2%
during the first quarter of 2004 as compared to the same period of 2003. The
increase in the Semiconductor segment was primarily attributable to higher
compensation related expenses offset in part by lower depreciation expense.
For the Semiconductor segment, SG&A expenses as a percentage of revenues
decreased to 13% from 16% over the same period. The decreases in SG&A expenses
as a percentage of revenues is a result of higher revenues offset in part by
higher SG&A expenses in the first quarter of 2004 as compared to the same
quarter of 2003, as discussed above. SG&A expenses for the Storage Systems segment increased $2.6 million or
18% in the first quarter of 2004 as compared to the same period of 2003. The
increase is primarily due to higher compensation-related costs. These
increases are the result of employees hired for customer training, customer
engineering support and administrative employees hired in anticipation of the
potential initial public offering of Engenios common stock. For the Storage
Systems segment, SG&A expenses as a percentage of revenues remained unchanged
at 15% in the first quarter of 2004 as compared to the same period of 2003. Restructuring of operations and other items:We recorded a net gain of
$0.6 million in restructuring of operations and other items during the first
quarter of 2004, which was primarily associated with the Semiconductor segment.
We recorded charges of $35.7 million for restructuring of operations and other
items during the first quarter of 2003. For a complete discussion of the 2003
restructuring actions, please refer to our Annual Report on Form 10-K. 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. The fair values of impaired equipment, facilities and intangible assets
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. Assets held for sale
of $28 million and $30 million were included as a component of prepaid expenses
and other current assets as of March 31, 2004 and December 31, 2003,
respectively. Assets classified as held for sale are not depreciated. 22




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The following table sets forth our restructuring reserves as of March 31,
2004, which are included in other accrued liabilities on the balance sheet: Balance at
    
    Restructuring
    
    Utilized
    
    Balance atDecember
    
    Expense
    
    during Q1
    
    March 31,31, 2003
    
    Q1 2004
    
    2004
    
    2004(In thousands)Write-down of excess assets (a)
    
    $
    2,661
    
    
    $
    (1,118
    )
    
    $
    718
    
    
    $
    2,261Lease terminations and maintenance
contracts (b)
    
    
    21,021
    
    
    
    252
    
    
    
    (1,886
    )
    
    
    19,387Facility closure and other exit costs (c)
    
    
    2,136
    
    
    
    64
    
    
    
    (782
    )
    
    
    1,418Payments to employees for severance (d)
    
    
    874
    
    
    
    204
    
    
    
    (767
    )
    
    
    311Total
    
    $
    26,692
    
    
    $
    (598
    )
    
    $
    (2,717
    )
    
    $
    23,377
  (a)
    
    The amounts utilized in 2004 reflect $2.2 million of non-cash write-downs
of long-lived assets in the U.S. due to impairment and $0.4 million in
cash payments to decommission and sell assets, offset by $3.3 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 $2.3 million balance as of
March 31, 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 2004.(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 2004.(d)
    
    Amounts utilized represent cash severance payments to fourteen employees
during the three months ended March 31, 2004. The balance remaining for
severance is expected to be paid by the end of the second quarter of 2004. Amortization of non-cash deferred stock compensation:Amortization of
non-cash deferred stock compensation was $1.8 million for the three months
ended March 31, 2004, $3.2 million for the fourth quarter of 2003 and $10.5
million for the three months ended March 31, 2003. The acquisitions for which
deferred stock compensation and related amortization were recorded consisted
primarily of the Velio transaction in the first quarter of 2004 (See Note 3 of
the Notes), an acquisition in the fourth quarter of 2002, 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 shares issued to
an employee of Engenio during the first quarter of 2004. We amortize
deferred stock compensation ratably over the related vesting periods. Deferred
stock compensation is adjusted to reflect the departure of any employee prior
to vesting. Amortization of intangibles:Amortization of intangible assets was $18.3
million and $17.8 million for the first quarter of 2004 and fourth quarter of
2003, respectively. No amortization expense was recorded in the first quarter
of 2004 related to the intangible assets acquired from Velio as they were
acquired on the last day of the first quarter of 2004. Amortization of intangible assets for the first quarter of 2004 decreased
from $20.1 million for the same period in 2003. Amortization decreased as a
result of 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 Microsystems, 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
quarter of 2004. As of March 31, 2004, we had approximately $165.2 million of
intangible assets, net of accumulated amortization that 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 SFAS No. 142, which uses a fair value model for
determining the carrying value of goodwill. We plan to perform our annual
impairment review in the fourth quarter of 2004. Interest expense:Interest expense decreased by $1.7 million to $5.9
million in the first quarter of 2004 from $7.6 million in the fourth quarter of
2003. The decrease is due to the redemption of the $250.0 million of the 2000
Convertible Subordinated Notes (Convertible Notes) at the end of the fourth
quarter of 2003. Interest expense decreased by $2.9 million to $5.9 million
during the three months ended March 31, 2004 from $8.8 million during the same
period in 2003. The decrease is due to the repurchase/redemption of $710.0
million of Convertible Notes during 2003 and changes in the benefit received
from the interest rate swaps before/after termination, 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 $9.2
million in the first quarter of 2004 as compared to $3.7 million in the fourth
quarter of 2003. Interest income increased to $5.4 million in the first
quarter of 2004 from $3.6 million in the 23




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fourth quarter of 2003. The increase in interest income is mainly due to
higher interest rates on our short-term investments. Other income, net of $3.8
million in the first quarter of 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, and other
miscellaneous items. In the fourth quarter of 2003, other income, net of $0.2
million was comprised of various items that were individually insignificant. In the first quarter of 2003, interest income and other, net, was $6.8
million. Interest income decreased to $5.4 million in the first quarter of
2004 from $12.4 million in the first quarter of 2003. The decrease in interest
income is mainly due to lower realized gains on the sale of short-term
investments in the first quarter of 2004 as compared to the first quarter of
2003. Other expense, net, of $5.6 million in the first quarter of 2003
included write-downs of two investments in equity securities by $7.0 million
due to impairment considered by management to be other than temporary (see Note
6 of the Notes), offset in part by net gains on foreign exchange and the sale
of miscellaneous assets. Provision for income taxes:During each of the three months ended March
31, 2004 and December 31, 2003 we recorded an income tax expense of $6.0
million, respectively. The expense relates to foreign income taxes and U.S.
alternative minimum taxes. Income taxes within the U.S. have been partially
offset by the utilization of current foreign tax and research and development
tax credits. For the three months ended March 31, 2003, we recorded an income
tax expense of $6.0 million. The expense relates to foreign income taxes.
Excluding certain foreign jurisdictions, the future benefit of temporary
differences, including operating losses, is not being recognized. FINANCIAL CONDITION, CAPITAL RESOURCES AND LIQUIDITY Cash, cash equivalents and short-term investments increased to $857.5
million at March 31, 2004, from $813.7 million at December 31, 2003. As
described below, the increase is mainly due to net cash inflows from operating
and financing activities, and net cash inflows from investing activities
excluding purchases of short-term investments in debt securities available for
sale, net of sales and maturities. Working capital.Working capital increased by $45.4 million to $1.0
billion at March 31, 2004, from $998.8 million at December 31, 2003. Working
capital was impacted by the following activities during the three months ended
March 31, 2004:  
    
    Cash, cash equivalents and short-term investments increased by $43.8
million at March 31, 2004, as compared to December 31, 2003;
    
    Accounts receivable increased by $16.1 million to $247.3 million at
March 31, 2004 from $231.2 at December 31, 2003. The increase is mainly
attributable to the timing of the shipments and collections in the
quarter;
    
    Accounts payable decreased by $14.0 million due to timing of invoice
receipt and payments;
    
    Inventories increased by $7.2 million to $205.7 million as of March
31, 2004 from $198.5 million as of December 31, 2003. This is mainly due
to the purchase of raw materials toward the end of the first quarter of
2004 in anticipation of inventory to be required in the second quarter
of 2004;
    
    Accrued salaries, wages and benefits decreased by
$2.4 million; and
    
    Income taxes payable decreased by $1.5 million due to the timing of
tax payments made and income tax provision recorded in the three months
ended March 31, 2004. The increase in working capital was offset, in part, by the following:  
    
    Prepaid expenses and other current assets deceased by $16.3 million
primarily due to a $7.0 million decrease in the current portion of
collateral balance on the equipment operating leases (see Note 13 of the
Notes), a $6.1 million decrease in other receivables due to the receipt
of an income tax refund in the first quarter of 2004, a $1.8 million
decrease in assets held for sale due to sales and other retirements (see
Note 5 of the Notes), and the amortization of prepaid software
licenses; and 24




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##### Table of Contents




    
    Other accrued liabilities increased $22.8 million mainly due to an
increase in a payable of $17.6 million for cash to be paid in the second
quarter of 2004 for the acquisition of Velio (see Note 3 of the Notes),
and higher accrued interest on our Convertible Subordinated Notes due to
timing of interest payments. Cash and cash equivalents generated from operating activities.During the
three months ended March 31, 2004, we generated $10.1 million of net cash and
cash equivalents from operating activities compared to $21.9 million generated
in the same period of 2003. Cash and cash equivalents generated by operating
activities for the three months ended March 31, 2004 were the result of the
following:  
    
    Higher 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, and gains on the sale of property and
equipment) over the three months ended March 31, 2004 as compared to the
same period in 2003, offset by lower net changes 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 March
31, 2004 as discussed above. Cash and cash equivalents used in investing activities.Cash and cash
equivalents used in investing activities were $9.6 million for the three months
ended March 31, 2004, compared to $26.9 million provided by investing
activities in the same period in 2003. The primary investing activities during
the three months ended March 31, 2004 were as follows:  
    
    Purchases of debt and equity securities available for sale, net of sales and maturities;
    
    Purchases of property and equipment during the three months ended March 31, 2004;
    
    Proceeds from the sale of property and equipment;
    
    $4.8 million cash paid for acquisitions;
    
    An increase in a payable by $17.6 million for cash to be paid in
the second quarter of 2004 for the acquisition of Velio (see Note 3 of
the Notes); and
    
    Lower non-current assets and deposits in the three months ended March
31, 2004, primarily as a result of the refund of collateral from the
equipment operating lease (see Note 13 of the Notes) and a terminated
letter of credit 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 $100 million in 2004. Cash and cash equivalents provided by financing activities. Cash and cash
equivalents provided by financing activities during the three months ended
March 31, 2004 were $2.4 million as compared to $0.2 million in the same period
in 2003. The increase is primarily attributable to higher cash proceeds from
issuance of common stock under our employee stock option plans. 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 February 19, 2004, Engenio filed a registration statement on Form S-1
(the Registration Statement) with the Securities and Exchange Commission
(SEC). On March 31, 2004, Engenio filed Amendment No. 1 to the Registration
Statement, and on May 10, 25




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2004, Engenio filed Amendment No. 2 to the Registration Statement. If the
initial public offering is completed as currently intended, we plan to receive
the net cash proceeds from the offering from Engenio in the form of a
dividend and settlement of payables owed to us. We may sell shares of
Engenios common stock in the public market or in private transactions, which
may or may not include the sale of a controlling interest in Engenio. We currently intend to distribute to our stockholders, by the summer of
2005, all remaining shares of Engenios common stock held by us at such
time. We will determine the timing, structure and all terms of the
distribution taking into account factors such as market conditions. Completion
of the distribution would also be contingent upon the receipt of a favorable
tax ruling from the Internal Revenue Service and/or a favorable opinion from
our tax advisor as to the tax-free nature of the distribution for U.S. federal
income tax purposes. We are not obligated to undertake the distribution, and
the distribution may or may not occur by the contemplated time or at all. We
do not expect our operating cash flows to be materially affected in periods
subsequent to the distribution. Contractual Obligations The following table summarizes our contractual obligations at March 31,
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
    
    $
    
    
    
    $
    490.0
    
    
    $
    
    
    
    $
    350.0
    
    
    $
    840.0Operating lease obligations
    
    
    139.3
    
    
    
    187.9
    
    
    
    38.8
    
    
    
    43.3
    
    
    
    409.3Capital lease obligations
    
    
    0.4
    
    
    
    0.1
    
    
    
    
    
    
    
    
    
    
    
    0.5Purchase commitment
    
    
    303.1
    
    
    
    1.2
    
    
    
    0.1
    
    
    
    
    
    
    
    304.4Total
    
    $
    442.8
    
    
    $
    679.2
    
    
    $
    38.9
    
    
    $
    393.3
    
    
    $
    1,554.2
 Convertible Subordinated Notes As of March 31, 2004, we have $490 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
convertible at the holders option, at any time after 60 days following
issuance, into shares of our companys common stock. 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,
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 As of March 31, 2004, we had operating leases financing certain wafer
fabrication equipment (see Note 13 of the Notes). The debt related to these
operating leases is not reflected on the balance sheet. Under these leases, we
are required to maintain unrestricted cash 26




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and short-term investment reserves in an amount no less than $350 million. We
were in compliance with this requirement as of March 31, 2004. We guarantee residual values of equipment on these leases. As of March
31, 2004, we do not expect to realize a loss on the guarantee at the end of the
lease term, and accordingly, no additional rent expense has been recognized
(see Note 13 of the Notes). In
connection with the equipment operating leases described above, we entered into standby letters of credit for $63 million to expire at the
end of the lease term. These instruments are off-balance sheet commitments to
extend financial guarantees. The fair value of the letters of credit
approximates the contract amount (see Note 13 of the Notes). We also lease real estate, certain other equipment and software under
non-cancelable operating leases. We renegotiated the existing lease agreements
for five buildings located in California in the first quarter of 2004. The
future minimum payments for these renegotiated building leases will be $2
million, $3 million, $4 million, $4 million, $4 million and $20 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 March 2004, the Emerging Issues Task Force (EITF) issued EITF Issue
No. 03-06, Participating Securities and the Two-class Method Under FASB
Statement 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. We do not believe that the adoption of this
standard will have a material 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. The recognition and
measurement guidance in EITF No. 03-01 should be applied to
other-than-temporary impairment evaluations in reporting periods beginning
after June 15, 2004. The disclosure requirements are effective for fiscal
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 Financial Accounting Standards Board (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 27




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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 Information Technologies, Inc. (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.
    
    We operate highly complex and costly manufacturing facilities.
    
    We outsource a substantial portion of wafers manufactured.
    
    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 highly complex cell-based ASICs.
    
    Our global operations expose us to numerous international business risks.
    
    The high technology industry in which we operate is prone to intellectual property litigation.
    
    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. 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 There have been no significant changes in the market risk disclosures
during the three months ended March 31, 2004, as compared to the discussion in
Part II of our Annual Report on Form 10-K for the year ended December 31, 2003. 28




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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 as of March 31, 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 14 (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. Changes of Securities, Use of Proceeds and Issuer Purchases of Equity
Securities 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 quarter of 2004. There are 3.5 million shares available for
repurchase under this plan as of March 31, 2004. 
 Item 6. Exhibits and Reports on Form 8-K (a) Exhibits 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 200232.1
    
    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. (b) Reports on Form 8-K On January 28, 2004, the Company filed in part and furnished in part a
Form 8-K pursuant to Items 5, 7 and 12 to report information regarding the
financial results for the fiscal quarter ended December 31, 2003 set forth in
the Registrants news release dated January 28, 2004. On February 19, 2004, the Company filed a Form 8-K pursuant to Items 5 and
7 to report the filing of a Form S-1 Registration Statement for LSI Logic
Storage Systems, Inc. as set forth in the Registrants new release dated
February 19, 2004. 29




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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: May 14, 2004
    
    By
    
    /s/ Bryon LookBryon LookExecutive Vice President &
Chief Financial Officer
 30




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INDEX TO EXHIBITS 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. 31